TDS on Provision for Expenses Explained

TDS on provision for expenses

Determining whether Tax Deducted at Source (TDS) applies to provisions for expenses involves understanding a few key factors, including the nature of the provision, the payee's identity, and how the Income Tax Act of 1961 interprets these situations.

According to the Act, TDS must be deducted when an amount is either paid or credited to the payee's account—whichever comes first. However, there are exceptions to this rule when dealing with provisions:

• Uncertain Provisions: If the provision is just an estimate and neither the exact amount nor the payee’s identity is clear, TDS does not need to be deducted. The reasoning is that TDS requires clarity on whose income is being taxed.
• Specific Provisions: If the provision is for a known expense with a clear amount and identified payee, TDS must be deducted. This holds true even if the amount is credited under an account like "Interest Payable" or "Suspense Account" since it's considered credited to the payee.
• Payment in Later Year: If the provision is reversed in the following year and actual payment is made later, TDS must be deducted at the time of payment. This is because TDS must be applied when the expense is either paid or credited, whichever comes earlier.

Simply put, TDS on provisions depends on the certainty of the expense and the payee, with specific guidelines determining when it needs to be deducted.

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Is provision for expenses allowed in income tax?

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.

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What is a provisional entry for expenses?

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.

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Should TDS be deducted on out of pocket expenses?

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.

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What happens if TDS is not deducted from expenses?

If TDS is not deducted from expenses, it may lead to the following consequences:

• The payer may face disallowance of the expenditure under section 40(a)(i) or 40(a)(ia) of the Income Tax Act, 1961. This means that the payer cannot claim the expense as a deduction while computing his taxable income. This will increase his tax liability and reduce his profits.
• The payer may also be liable to pay interest and penalty for non-deduction or non-payment of TDS under sections 201 and 271C of the Income Tax Act, 1961. The interest rate is 1% per month or part of a month for non-deduction and 1.5% per month or part of a month for non-payment of TDS. The penalty amount is equal to the amount of tax that was not deducted or paid.
• The payer may also face prosecution under section 276B of the Income Tax Act, 1961, which can result in imprisonment for a term starting from three months to seven years and a fine. This applies only if the payer fails to deduct or pay TDS.

Therefore, complying with the TDS provisions and avoiding any adverse consequences is important.

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What expenses can be disallowed if TDS is not deducted?

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.

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Is TDS deducted from communication expenses?

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 the 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.

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Should TDS be deducted on reimbursement of expenses?

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.

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