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You might have heard the term "TDS" thrown around a lot, especially when talking about expenses. TDS stands for Tax Deducted at Source. Primarily, this is how the government collects taxes in India.
When specific expenditures are incurred, a particular percentage of the amount must be deducted by the paying party before transferring the remaining sum to the recipient. The deducted portion is then remitted directly to the government, ensuring timely tax collection. This practice serves as a preventive measure to discourage tax evasion. By deducting taxes at the source, the government sets aside a portion of the tax before it is even due. This process is typically applied to significant expenses such as salary, commissions, interest, and rent. Essentially, it is a more methodical and effective tax collection mechanism.
The determination of whether Tax Deducted at Source (TDS) is applicable to provisions for expenses in tax accounting is a matter of significance and often necessary for detailed analysis. The Complexities surrounding this issue arise from an intersection of factors, including the specific nature and certainty of the provision, the status and identity of the payee, and the exact interpretation of relevant sections within the framework of the Income Tax Act of 1961.
In accordance with the provisions set forth by the Act, the obligation to deduct and remit TDS arises upon the payment or crediting of an amount to the account of the payee, depending on which event happens earlier.
Nonetheless, the applicability of TDS on provisions for expenses is subject to certain exceptions and explanations that affirm consideration.
For instance, if the provision is estimated and the precise amount or identity of the payee remains undisclosed, the necessity for a TDS deduction does not arise. This exemption finds its basis in the fundamental premise that the implementation of the TDS mechanism demands the verification of the individual whose income is subject to taxation.
If the provision is established for a specific liability accrued during the fiscal year, and both the amount and identity of the payee are ascertainable, TDS must be deducted. This guideline is predicated on the notion that the act of crediting any sum to an account, regardless of its denomination as an "Interest Payable Account," "Suspense Account," or under any other appellation, within the financial records of the liable entity, is deemed to be a credit of income to the account of the payee.
Furthermore, in situations where the provision is reversed in the subsequent year and the actual disbursement occurs subsequently, TDS is obligatory at the time of payment. This provision is rooted in the principle that TDS must be deducted at the source during the actual disbursement or crediting, whichever event precedes.
Provision for expenses is a common accounting practice that involves setting aside an estimated amount of money to cover future liabilities or losses. However, not all provisions are allowed as deductions in income tax computation. According to the Income Tax Act, 1961, only those provisions that are based on a reasonable estimate of an existing obligation and are not contingent or uncertain are eligible for deduction.
For example, the provision for income tax is an allowable expenditure, as it is derived by adjusting the reported net income with various permanent and temporary differences and multiplying it by the applicable tax rate. On the other hand, provisions for doubtful debts or warranty expenses are not allowed as deductions, as they depend on the occurrence of uncertain future events. Therefore, provision for expenses is allowed in income tax only if it meets the criteria of certainty, measurability, and enforceability.
A provisional entry for expenses is a method of recording an expense in the accounting system before it is actually incurred or paid. It is based on an estimate or a budget and is used for expenses that are not certain in amount or timing, such as engineering, R&D, logistics, legal & professional charges, or administrative expenses. A provisional entry should be reversed when the actual expense is recorded, and the difference between the provisional and the actual amount should be adjusted accordingly. A provisional entry for expenses is also subject to tax deduction at source (TDS) as per the Income Tax Act. A provisional entry for expenses is a way of ensuring that the expenses are matched with the revenues of the same period and that the financial statements indicate a true and fair view of the business performance.
Out of pocket expenses are expenses that are paid on behalf of someone else and are not in the nature of professional service or contract. For example, travel expenses reimbursed by the client of the consultant would be regarded as out of pocket expenses. The issue of whether tax deducted at source (TDS) should be applied to such expenses has been a matter of debate and confusion among taxpayers and tax authorities. According to the CBDT circular no. 12/2022, TDS is required to be deducted on out of pocket expenses if documents in the name of the payee do not support them. However, this view has been challenged by some experts and judicial decisions, who argue that there is no element of profit or benefit in such reimbursements and, hence, they should not be subject to TDS. Therefore, it is advisable that a separate bill is prepared for out of pocket expenses and that they are clearly distinguished from the fees for services rendered. This would avoid any unnecessary tax liability and litigation on this issue.
If TDS is not deducted from expenses, it may lead to the following consequences:
Therefore, complying with the TDS provisions and avoiding any adverse consequences is important.
If the payer fails to deduct or deposit the TDS on certain payments made to the payee, the Income Tax Act imposes a penalty by disallowing such expenses as deductions while computing the taxable income. The expenses that can be disallowed if TDS is not deducted include payments made to a resident or a non-resident for interest, royalty, technical fee, commission, brokerage, professional services, rent, etc. The rate of disallowance is 30% of the amount of such expenditure. The disallowance can be avoided if the payer deducts and deposits the TDS in the subsequent year or if the payee furnishes a return of income and pays the tax due on such income.
Communication expenses are the costs incurred by a business or an individual for using telecommunication services such as telephone, internet, mobile, etc. Whether tax deducted at source (TDS) applies to these expenses depends on the nature and purpose of the payment.
According to section 194J of the Income Tax Act, 1961, TDS must be deducted from any payment made to a resident for fees for technical services or fees for professional services or royalties. The term “royalty” has been defined in section 9 (1) (vi) of the Act, and it includes any consideration for the use or right to use any industrial, commercial, or scientific equipment. However, this does not include the use of telecommunication equipment such as telephone, internet, mobile, etc. Therefore, no TDS is required to be deducted from the payment of communication expenses if they are made for the use of telecommunication services.
This view is supported by various judicial pronouncements and circulars issued by the CBDT (Central Board of Direct Taxes). For example, in the case of ACIT vs SDV International Logistics Ltd, the Kolkata Bench of Income Tax Appellate Tribunal (ITAT) held that the assessee was not liable to deduct TDS from the payment of internet connectivity charges and specialized line rental as they were not in the nature of royalty. Similarly, in Circular No. 5/2002, the CBDT clarified that no TDS is required to be deducted when payment is made for platter in a restaurant or for hotel accommodation or for hire charges for bus/car or for use of gas, electricity, or water.
Thus, it can be concluded that TDS is not deducted on communication expenses if they are made for the use of telecommunication services and not for any other purpose. However, if the payment is made for any other service that falls under the scope of section 194J, such as software development, web designing, consultancy, etc., then TDS will be applicable as per the prescribed rates and provisions.
Reimbursement of expenses is a common practice in business transactions, where one party pays for the expenses incurred by another party on its behalf. However, there is a lack of clarity on whether such reimbursements are subject to tax deduction at source (TDS) under the Income Tax Act, 1961. The issue is whether reimbursement of expenses can be considered as income or benefit or perquisite of the recipient or merely a recovery of the actual expenditure without any profit element. The answer to this question may vary depending on the nature of the expenses, the terms of the agreement between the parties, and the mode of billing and payment.
According to some judicial pronouncements and circulars issued by the Central Board of Direct Taxes (CBDT), reimbursement of expenses is not considered income and is not liable for TDS under section 195 of the Income Tax Act.
Similarly, reimbursement of expenses is not eligible for deduction of TDS under section 194C of the Act. However, if there is a composite bill of service charges and reimbursement, then TDS will be deducted from the whole bill amount.
In some cases, reimbursement of expenses has been held as income of the recipient liable for TDS and taxability in India, even without the profit element. If the reimbursement is added to the value of goods or services, TDS should be deducted under relevant sections.
Therefore, it is advisable that the parties should clearly specify the nature and amount of reimbursement in their agreement and raise separate bills for reimbursement and service charges. This will help to avoid any ambiguity and dispute regarding the applicability of TDS on reimbursement of expenses.
