What is Withholding Tax?

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The Supreme Court (SC) recently held that without an express notification, the companies cannot, automatically, claim lower withholding tax of 5% even if provided for in the Direct Tax Avoidance Agreement (DTAA).

About Withholding Tax

  • Withholding tax is withheld or deducted from certain types of income, such as wages, dividends, interest, and royalties, when they are paid to the recipient (non-resident individual).
  • It is also known as Retention tax. 
  • The purpose of withholding tax in India is to ensure that the government receives a portion of the income tax owed by the recipient. 
  • Withholding tax is applicable in the case of payments made to non-resident individuals.
  • If the income is paid in India, the person responsible for payments to NRI must deduct the withholding tax at the time of payment or when the amount is credited to the NRI’s account, according to Section 195 of the Income Tax Act.
  • The amount of withholding tax in India depends on the type of income, the amount of income earned, and the tax laws of the country where the income is earned. 
  • The tax rate is decided as prescribed in the Income Tax Act, 1961, or Double Taxation Avoidance Agreement (DTAA), whichever is lower.
  • The central government of India collects this tax.
  • India has signed DTAAs with many countries to avoid taxing individuals twice for the same income (in India and the partner country). Currently, India has DTAA treaties with more than 80 countries around the world.
  • How to determine tax liability for withholding tax?
    • To calculate tax liability, it is important to know the residential status of any person:“Resident Indian” and “Non-Resident Indian”. 
    • An individual is considered to be a resident in India for tax purposes if he or she satisfies any of the following conditions:
  • Stays in India for 182 days or more during the financial year, or
  • Stays in India for 60 days or more during the financial year and for 365 days or more during the 4 years immediately preceding the financial year.
    • If an individual does not meet either of these conditions, he or she will be considered a non-resident for tax purposes.
    • Income earned or received in India:
  • If an individual is a resident of India for tax purposes, he or she will be taxed on his or her global income, including income earned or received in India and outside India.
  • If an individual is a non-resident of India for tax purposes, he or she will be taxed only on the income earned or received in India.
    • Citizenship or place of birth: 
  • Citizenship or place of birth is not a determining factor for residential status for tax purposes in India.
  • An individual may be a citizen of India or born in India but may still be considered a non-resident for tax purposes if he or she does not meet the criteria outlined above.

Difference between Withholding Tax and TDS?

  • Withholding Tax: It is the amount that is deducted in advance, and the same is deposited to the government before the amount is paid to the payer. It is generally applicable on payments to non – residents, that are foreign transactions.
  • TDS (Tax Deducted at Source): A person (deductor) who is required to make a payment of a specific nature to another person (deductee) must deduct tax at source and send it to the Central Government's account. It is applicable on specified transactions under the income tax act, 1961 to both resident and non-resident.
  • Both withholding tax and TDS serve the same purpose: to ensure that taxes are collected at the source of income. They are used to ensure tax compliance and prevent tax evasion.

Q1) What is a Double Taxation Avoidance Agreement (DTAA)?

A Double Taxation Avoidance Agreement (DTAA) is a pact signed by two nations that encourages capital investment, trade in goods and services, and other economic activities between the two nations by preventing International Double Taxation. This suggests that there are agreed-upon tax rates and jurisdictions for certain types of income that originate in one country and are received by tax residents of another country.

Source: SC clarifies companies can’t claim lower withholding tax under tax treaties without notification