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.
