Why deduction of tax at source under Section 194R is important to know?

The Finance Act 2022 introduced Section 194R which relates to the deduction of tax on benefits or emoluments connecting businesses or professions. Businesses, companies, or entities often extend various types of perks and benefits to their distributors, distribution partners, agents, or resellers to motivate and incentivize them to support the further growth of the business. A few examples would include but are not limited to, travel packages, gift cards or vouchers, products in incentive programs, or the use of business assets. This article discusses the deduction of tax at source under Section 194R.

Purpose of Section 194R

The purpose of introducing the new section 194R is to block the possibility of tax evasion in businesses or professions. Several companies have applied trade promotion expenses while offering various gifts, perks, benefits, or advantages to their distributors, dealers, or distribution partners (subject to the fulfillment of the terms of the contract or as per the prevailing norms/traditional practice followed over the years by the business entity) under Section 37 of the Act on 1961.

For example, an electronics company provided LCD televisions as incentives to those channel partners who reached a certain revenue target. The company included them as an expense in its profit and loss account and claimed income tax.

Recipients don’t report it on their income tax returns because this particular incentive is in kind, not cash. This leads to reporting incorrect income data. Such a benefit in kind should be disclosed as income under the Income Tax Act 1961 (ITA).

Now, as per Section 194R, if a business provides such benefits or incentives to its distributors or distribution partners which are partly in cash or kind, they are liable to deduct TDS. In case it is a purely benefit in kind, the person providing such benefit or reward is liable to pay TDS on the value of such benefit or reward from his pocket.

The purpose of Section 194R is therefore to widen the tax base and block the potential scope of tax evasion.

Scope of Section 194R

TDS charged under Section 194R is at 10% with effect from 1 July 2022. Applicable only to the resident recipient (beneficiary) of perquisites or benefits. However, section 194R does not apply if the aggregate value of the benefit or provision does not exceed Rs 20,000 during a financial year (FY) for a single beneficiary.

Also, an individual or a Hindu Undivided Family (HUF) is not eligible for TDS deduction if the total turnover does not exceed Rs 1 crore in the case of business or Rs 50 lakh in the case of the profession in the immediately preceding financial year.

Nexus with business or profession

Any individual who provides a resident with any benefit or advantage, whether exchangeable for money or not, arising from the business or exercise of a profession of the such resident shall, before providing such benefit, as the case may be, to the such resident, ensure that the tax is deducted.

Simply put, under Section 194R, TDS applies to any resident who provides any benefit or advantage to another resident. The benefit must be in kind or cash and could come from business promotions.

Validity of circular

A new section 194R was inserted in the Finance Act 2022 for withholding tax at source on benefits or allowances in connection with a business or profession. Subsequently, CBDT issued Circular No. 12/2022 dated 16.06.2022 to remove the difficulties.

Most of the CBDT circulars have been issued under the power conferred by Section 119 of the Act. The contention was accepted that the circulars issued under Section 119 of the Act are binding only on the revenue but not on the taxpayers and the judiciary. Furthermore, circulars as delegated legislation cannot replace statutory provisions and represent a higher burden for taxpayers. However, directions issued u/s 194R are based on the power conferred by sections 194R (2) and 194R (3) itself. These instructions are therefore also binding on taxpayers. However, a few questions arise regarding enforceability and interpretation.

The pertinence of section 194R to reimbursement of out-of-pocket expenses

The words “reimbursements”, “benefit” and “perquisites” are not defined in the Income Tax Act or circular 12/2022. Therefore, we must rely on the common colloquial connotation of the term and judicial definitions.

In common terms, reimbursement is “to restore the equivalent of something paid or spent”. Reimbursement of expenses means that expenses previously incurred by a person on behalf of another are recovered as such. There is usually no profit element in such reimbursement. The definition of reimbursement does not depend on whose name the documents were obtained. Simply put, it is a necessary expenditure incurred by another, which is not his expenditure, but an expenditure incurred on his behalf.

The word “benefit” is an advantage or profit or any contribution to the betterment of a condition.

The word “perquisite” has its normal meaning, namely a personal advantage which would not extend to the mere reimbursement of necessary expenses.

Applicability of section 194R to purely pecuniary emoluments/benefits

Section 194R (1) provides for every person who is liable to give to a resident any advantage or benefit, whether or not convertible into money, arising out of the business or exercise of a profession by such resident, before giving such benefit or advantage, in the case may be to such resident provided that tax has been withheld in respect of such benefit or perquisite at the rate of ten percent of the value or aggregate of the value of such benefit or perquisite:

Provided that where the benefit or remuneration, as the case may be, is wholly in kind or partly in money and partly in kind, but that cash part is insufficient to satisfy the duty to deduct tax in respect of the whole of such benefit or benefit, the person liable for the provision of such benefit or benefit, before releasing the benefit or benefit, it is satisfied that the tax to be deducted has been paid in respect of that benefit or perquisite:

The word “any benefit or perquisite” would cover both cash and kind benefits and allowances, but the words “whether convertible into money or not” limit the scope of the earlier word “any benefit or perquisite” means that the benefit should be non-monetary. If pecuniary benefits or perquisites were intended to be covered, the words “whether or not convertible into money” were not required.

Final words

There are many legal issues in the circular issued and on the contrary, the principle that TDS does not apply to the payment of expenses is settled here. Based on this, my one is taking the opposite view of the circular and not deducting TDS u/s 194R for reimbursement of expenses. However, an aggressive stance may end up in litigation and all issues related to legal arguments may be resolved in the ITAT or higher.

Further, reimbursement of expenses without supporting documents should always be added to the value of goods/services and TDS under relevant sections 194C/194J/194Q should be deducted.