Legal Quagmire: Section 194R adds even more complexities to the taxation law regime

Section 194R adds even more complexities to the taxation law regime

Nidhi Kansal, Partner, Corporate and International Tax, BSR & Co. LLP
Sanchit Bansal, Associate Director, Corporate and International Tax, BSR & Co. LLP

India, by far, has been one of the na­tions with an extensive withholding tax regi­me. As per the press release dated Sep­tem­ber 18, 2022, issued by the Minis­try of Finance, the gross collection of di­rect taxes (before adjusting for refunds) for financial year 2022-23 stands at Rs 8,362,250 million, out of which tax collection through the tax deduction at source (TDS) route ac­counts for Rs 4,347,400 mi­llion or approximately 52 per cent of the overall direct tax collection.

The scope of withholding tax provisions has been widening with every Union Bud­get. We saw an extension of the TDS and tax collected at source (TCS) provisions on the purchase and sale of goods vide the Finance Act, 2021 and Finance Act, 2020 respectively. The Finance Act, 2022 further broadened the scope of TDS provisions by introducing Section 194R to provide for deduction of tax at the rate of 10 per cent on benefits or perquisites arising fr­om a business or profession in ex­cess of Rs 20,000 during a financial year. The ra­tio­nale behind the introduction of this section, as explained by the memorandum to the Finance Act, 2022, was to prevent tax evasion in cases where the recipients do not report the receipt of benefits or per­quisites as taxable income while filing their return of income.

At first glance, one gets the impression that this section will have significant relevance for the consumer goods sector or the pharmaceutical sector, owing to the specific na­ture of these industries. However, from the Cen­tral Board of Direct Taxes (CBDT)-issu­ed guidelines, vide circular no. 12 of 2022 dated June 16, 2022 and circular no. 18 of 2022 dated September 13, 2022, for remo­ving difficulties in the implementation of the provisions of Section 194R, it is evident that the section will find significant ap­plication in the renewable sector as well.

Some of the critical areas that have been clarified in these circulars are:

  • Section 194R is applicable even on monetary payments and not restricted to in-kind transactions
  • Taxability in the hands of the recipient is irrelevant to determining withholding un­der Section 194R
  • Sales discounts, cash discounts and re­bates are exempted from tax withholding under Section 194R
  • Section 194R may be applicable on payments for reimbursement of expenses, unless expense reimbursement qualifies for pure agent criteria as per GST law
  • Section 194R may be applicable in the ca­se of dealer conferences in certain si­tuations

The nature of the renewable sector is such that it requires an investor or operator to have multiple special purpose vehicles (SPVs) to house every project. Monitoring withholding tax compliance for every SPV is an operational challenge. The complexity of ensuring compliance with the newly introduced Section 194R compounds this challenge multifold.

The aforesaid circular expanded the sco­pe of section 194R to cover monetary be­nefits, which seems to be contrary to the intent behind the introduction of Section 194R and erstwhile judicial precedents in the context of Section 28(iv), which inten­ded to cover only non-monetary benefits or perquisites.

For a business that has multiple SPVs within a group, there may be cases where the manpower is housed in one group en­tity or the holding entity, which may ne­ed to cross-charge for accounting, finance and other forms of support to other group entities. The price at which such cross-charges take place may also be relevant to examine from the perspective of trigge­ring Section 194R.

Similarly, the extension of inter-company loa­ns is quite prevalent amongst SPVs in the renewable sector. Where such inter-company loans offer favourable conditi­ons such as a low or zero rate of interest, which is otherwise permissible under the Com­panies Act, they may require examination as to whether they qualify as benefits to the borrower requiring withholding under Section 194R.

Tracking the applicability of Section 194R on such transactions as well as identifying the timing of withholding and the quantum of benefit will pose substantial challenges to businesses. A question that is relevant to these scenarios is, does 194R withholding automatically lead to taxability for re­cipients of such benefits? To this end, the circular clarifies that Section 194R do­es not impact taxability in the hands of a re­cipient of benefit and therefore, an independent analysis needs to be done to as­sess whether such a benefit is in fact taxable in the hands of the recipient, keeping in perspective the scheme of the act and judicial precedents.

Being a capital-intensive industry with thin margins, there may be a potential risk of a loan turning bad. Question number 3 of circular no. 12 of 2022, dated June 16, 2022, provides that the amount representing the principal loan waived by a bank under a one-time settlement scheme wou­ld constitute income falling under Section 28(iv) relating to the value of any benefit or perquisite, arising from business or exercise of profession and accordingly, the provisions of Section 194R would apply on the same. Relaxation has been provided vide circular no. 18 of 2022 dated Septem­ber 13, 2022, to one-time settlement of lo­ans by specified financial institutions. How­ever, such limited exclusion may re­sult in the imposition of a financial burden for inter-company loans within a gro­up, whereby the lender may be required to bear the cost of such withholding in the event of a loan turning bad.

A transaction that one could not have envisioned as falling within the ambit of Section 194R is reimbursement of expenses. CBDT has clarified that any reimbursement of ex­penses, irrespective of the terms of the contract, is a benefit to the service provider and requires TDS under Section 194R.  The only exceptions are tho­se cases where the expenses are in­curred by the service pro­vider in the capacity of a pure agent, satisfying the relevant criteria under GST law. In the past, companies have been taking varied TDS positions in relation to reimbursement of expenses including a position of no withholding on such expenses on ac­count of the cost-to-cost nature of such reimbursements. However, now one will have to reassess these past positions and streamline internal processes to undertake withholding of taxes wherever a situation is covered under the circular. Further, for ca­ses where TDS on out-of-po­cket expenses has already been deducted under Section 194J of the act, question no 3 of circular no 18 of 2022 clarifies that as the out-of-pocket expense has already been included as part of the professional fee, there is no further benefit/­perquisite that requires tax deduction under Section 194R. Other clarificati­ons, such as exemption from Section 194R for cases involving issuance of bonus and rights shares by companies in which the public are substantially interested, have also raised doubts.

Given the wide coverage of Section 194R, assessments need to take into ac­count the new provisions of Section 194R and ev­aluate the nature of transactions that may require withholding. The clarifications provided in the aforesaid circulars are overarching to a certain extent and travel beyond the contours of the se­ction itself. Taxpayers do have the option to challenge the contours of the circular through a writ. However, until the circulars are st­ruck down by the courts, taxpayers will have to follow the guidance provided in the circulars to avoid any interest and penal consequences.