Tax Deduction at Source often referred to as TDS has successfully been able to haunt early-stage companies in their day to day operations. Many early-stage companies (headcount 1-10) does not enjoy the luxury of a full-time finance/tax consultant who can advise on various payments to be made to consultants/vendors/employees etc. As a result, Auditors (which BTW is mandatory to appoint for all Private Limited Companies) bring out observations after the closure of Financial Year about the requirement of Deduction of Tax at Source on the various transaction, which would now be done at a later date and would attract interest and penalty which often goes in thousands.

What is TDS?

To begin with, let’s start with the basics. TDS is a mechanism by which a person (early-stage company/partnership firm), responsible for making payment of income (such as salary, rent, professional fee, etc) is required to deduct the tax at source and deposit the same into Government’s treasury account within the stipulated time.

In simple words, TDS is that element of income tax that the receiver of income (your employee or vendor) has to pay to the government during their income tax filing, but you as a company deduct it in advance and deposit with the government against their PAN number.

OK, So I am making payment to the vendor/employee and also required to do compliance for TDS? This doesn’t sound fair!

Well, it may not, but this is how the law is. The logical reasoning behind this mechanism is to ensure maximum collection of tax by the government. Take the example of a private limited company with a headcount of 2000 employees. In case there is no provision of “Tax Collection at Source”, the government would have to run behind 2000 employees to ensure that they file their tax returns and pay their tax liability. However with TDS, the onus of collection and payment is with the company (at source), so now the government official has to make sure that the company is deducting and paying TDS on time (instead of 2000 individuals). This, in turn, ensures that all 2000 employees have paid the tax and filed their returns.

All Right, we are deducting the TDS, paying it to the government, ensuring a larger tax base for the country, then why should we pay the penalty, interest in case we miss on the timelines?

Well, that’s because everyone is not as good as you are. Every year the tax authorities uncover thousands of cases wherein the companies have deducted the TDS from their employees, vendors, etc but has not paid it in the account of government. There have been many fraud cases wherein the tax money has been deployed back into the business. So to ensure tight control over the collection and deposit process, severe penalties and interest fee is charged from the defaulters. Also since there can not be a system to identify the intention of the deductor, everyone is treated the same by the authorities.

Got some fair idea about TDS, How would I know on which transactions I need to deduct TDS? And on What Rates?

The income tax law provides a detailed set of sections containing various transactions in which a business person is required to deduct and pay TDS. However, as an entrepreneur, you are not expected to know all these sections. However, knowledge of a few transactions will cover 95% of the ground. I have provided these transactions below:

  1. TDS on Payment of Salary (Section 192) – Not going into the technical details of this section. Basically, the person paying salary (Startup Company) is required to compute the total salary and other remuneration that would be paid to the employee over the course of the financial year and should pro-rate the tax liability after allowing the relaxation of minimum income not chargeable to tax (INR 2,50,000). This prorated amount needs to be deducted every month and paid into the account of the government. After the close of the financial year, you are also required to issue Form 16 to your employees. I’m sure this will ring a bell for many entrepreneurs who were employees earlier and were receiving Form 16 from their employers.
  2. Deduction of Tax for Payment to a Contractor or Sub-Contractors (Section 194C) – Might not be applicable to many companies, however, if as a business entity you have got into a contract for the supply of goods and/or services for your business, you should deduct a TDS of 1% in case the contractor is an individual sole proprietorship or a Hindu Undivided Family or for any other business the rate of TDS is 2%. Relaxation has been provided in these transactions viz. if the one-time transaction value does not exceed INR 30,000 and the cumulative value of all payments in a Financial Year does not exceed INR 1,00,000 then no TDS needs to be deducted.
  3. Deduction on Tax at Source for Rent Paid (Section 194-I) – Rent is one of the most common business expense and thus a company is expected to deduct TDS and deposit it into government’s account at the rate 10% (2% in case the rent is paid for plant and machinery equipment). However, no TDS needs to be deducted if the total rent for a Financial Year does not exceed INR 2,40,000.
  4. Tax Deduction at Source for Professional or Technical Services Fee (Section 194J) – These are some of the most common transactions that a startup company often get into. This could be an invoice for legal, accounting, medical, engineering, architectural, advertising services, etc. As a business, you are required to deduct a TDS of 10% if the amount paid in one shot or over a period of a single financial year exceeds INR 30,000. These are the major payments which a startup company makes and often defaults on TDS compliance.

Ensuring compliance for these four types of payments will ensure 95% of TDS compliance, for the remaining 5% you always have your tax consultant to give a call to (hopefully?).

Now, this is not a technical article wherein I will write about penalties if you don’t comply. If you have already defaulted, you must pay the penalty. If not, make sure you deduct TDS on above transactions and you will never have to bother about the penalty and interest on late payment.

Hope this simplifies the understanding of TDS related provisions for your startup business. Have more queries/feedback? Write to us at [email protected]