Introduction

In the realm of taxation, the Indian government has devised numerous strategies to ensure that tax is collected efficiently and in a timely manner. One of the primary methods employed for this purpose is Tax Deducted at Source (TDS), a mechanism where tax is deducted at the point of income generation itself. Over the years, the scope of TDS has been broadened to cover various types of payments and transactions, ensuring that tax evasion is minimized and compliance is maximized.

Section 194M of the Income Tax Act, 1961, is one such provision introduced to plug gaps in the TDS framework. This section, brought into effect by the Finance Act of 2019 and operational from September 1, 2019, mandates TDS on certain payments made by individuals and Hindu Undivided Families (HUFs) who are not required to deduct tax under Sections 194C, 194H, or 194J due to their exemption from tax audit. This article addresses a critical loophole, ensuring that substantial payments made by these entities are brought under the TDS net.

Background and Need for Section 194M

Before diving into the specifics of Section 194M, it is essential to understand the background that necessitated its introduction. The Indian tax system has long imposed TDS obligations on businesses, corporations, and individuals or HUFs who are subject to tax audit under Section 44AB. Key sections such as 194C (payments to contractors), 194H (commission or brokerage), and 194J (professional fees) ensured that these entities deducted tax at the source before making payments.

However, individuals or HUFs not engaged in business or professional activities subject to tax audit were not required to deduct TDS, even if they made significant payments. For instance, a salaried individual constructing a house and paying a contractor a substantial amount could bypass TDS obligations, as could a HUF making large payments for professional services. This created a significant gap in the tax collection process, leading to potential revenue losses and opportunities for tax evasion.

Recognizing this loophole, the government introduced Section 194M to expand the scope of TDS to include individuals and HUFs who, despite not being subject to tax audit, make substantial payments in specific categories. This move ensures that all significant transactions are taxed appropriately, regardless of the payer's audit status.

Applicability of Section 194M

Section 194M is specifically applicable to individuals and Hindu Undivided Families (HUFs) who are not required to deduct TDS under Sections 194C, 194H, or 194J. This is primarily because these entities do not fall under the ambit of tax audit as per Section 44AB(a) or 44AB(b). In simpler terms, even if you are not running a business or profession that necessitates a tax audit, you could still be liable to deduct TDS under Section 194M if you make certain types of payments exceeding a specified threshold.

Who Needs to Deduct TDS Under Section 194M?

1. Individuals: This includes salaried individuals or those with income from other sources who are not subject to a tax audit.

2. Hindu Undivided Families (HUFs): HUFs not engaged in business or professional activities subject to tax audit.

These entities are required to deduct TDS when they make payments exceeding the threshold of ₹50 lakh in a financial year for specified services.

Threshold Limit: When Does Section 194M Apply?

Section 194M comes into effect only when the total payment made by an individual or HUF to a resident for specific services exceeds ₹50 lakh in a financial year. This threshold is designed to ensure that the TDS obligations do not burden smaller payments, focusing instead on substantial transactions.

For example:

• If an individual pays a contractor ₹60 lakh for home renovation in a financial year, Section 194M will apply since the payment exceeds ₹50 lakh.

• If a HUF pays ₹40 lakh to a lawyer for legal services and ₹15 lakh to another professional, the combined payments exceeding ₹50 lakh would trigger the applicability of Section 194M.

It’s important to note that the threshold applies to aggregate payments made in a financial year. Therefore, even if multiple smaller payments are made across different services or to different payees, Section 194M would apply if the total exceeds ₹50 lakh.

Types of Payments Covered Under Section 194M

Section 194M encompasses payments made by individuals or HUFs in the following categories:

1. Contractual Payments (Section 194C): Payments made for any work contract, including the supply of labor. This typically covers payments to contractors for construction, renovation, repair, or other similar services.

2. Commission or Brokerage (Section 194H): Payments made as commission or brokerage, excluding insurance commissions referred to in Section 194D. This includes payments to intermediaries such as commission agents, brokers, or sales agents.

3. Professional Fees (Section 194J): Payments made for professional services. This includes fees paid to lawyers, doctors, architects, engineers, accountants, and other professionals.

These categories are broad enough to ensure that most significant payments related to contracts, services, or commissions fall within the purview of Section 194M, thereby extending the TDS net to previously uncovered transactions.

TDS Rate and Deduction Under Section 194M

The rate of TDS under Section 194M is set at 5% of the payment amount. This standard rate ensures that the tax burden is reasonable while still ensuring that a significant portion of the transaction is captured as tax revenue.

Key Points to Note:

• The 5% TDS rate is applicable across all types of payments covered under Section 194M.

• The tax should be deducted at the time of credit of the sum to the account of the payee or at the time of payment, whichever is earlier.

• The rate was temporarily reduced to 3.75% for payments made between May 14, 2020, and March 31, 2021, as part of the COVID-19 relief measures, but the standard rate of 5% has since been reinstated.

This deduction process ensures that the tax is collected at the source itself, reducing the chances of tax evasion and ensuring timely payment to the government.

Compliance Requirements Under Section 194M

Compliance with Section 194M is designed to be straightforward, particularly for individuals and HUFs who may not be familiar with the complexities of TDS obligations. Here’s how the compliance process works:

1. No TAN Requirement: Unlike other TDS sections where a Tax Deduction Account Number (TAN) is mandatory, Section 194M allows the deductor to use their Permanent Account Number (PAN) for making TDS payments. This simplifies the process for individuals and HUFs who do not regularly engage in TDS activities.

2. Filing TDS: The deductor must file a challan-cum-statement in Form 26QD within 30 days from the end of the month in which the TDS was deducted. This form serves both as a statement of the TDS deduction and as a challan for payment.

3. Issuing TDS Certificate: After filing Form 26QD, the deductor must issue a TDS certificate in Form 16D to the payee within 15 days from the due date of filing Form 26QD. This certificate is essential for the payee, as it allows them to claim the TDS while filing their income tax returns.

4. Due Dates: The TDS deducted must be deposited with the government by the 7th of the following month in which the TDS was deducted.

5. Penalty for Non-Compliance: Failure to deduct TDS or deposit it within the stipulated time can lead to penalties and interest charges under the Income Tax Act. The deductor may also be subject to prosecution in severe cases of non-compliance.

By simplifying the compliance requirements, Section 194M ensures that individuals and HUFs can easily fulfill their TDS obligations without the need for extensive administrative work.

Practical Examples Illustrating Section 194M

To better understand how Section 194M operates, let’s consider a few practical examples:

Example 1: Payment to a Contractor

• Scenario: Mr. Sharma, a salaried individual, hires a contractor for building his house. He pays the contractor ₹75 lakh in a financial year.

• Application: Since the payment exceeds ₹50 lakh, Mr. Sharma is required to deduct TDS under Section 194M. The TDS amount would be 5% of ₹75 lakh, which is ₹3.75 lakh.

• Compliance: Mr. Sharma must file Form 26QD and deposit the TDS with the government. He also needs to issue Form 16D to the contractor.

Example 2: Payment for Professional Services

• Scenario: A HUF makes payments to an architect and a lawyer for designing and legal services, totaling ₹55 lakh in a financial year.

• Application: Since the aggregate payments exceed ₹50 lakh, the HUF is liable to deduct TDS under Section 194M. The TDS amount would be 5% of ₹55 lakh, which is ₹2.75 lakh.

• Compliance: The HUF must file Form 26QD and deposit the TDS, followed by issuing Form 16D to both the architect and lawyer.

Example 3: Multiple Payments Below the Threshold

• Scenario: Mrs. Verma, a retired individual, makes payments to a contractor, broker, and lawyer, each totaling ₹20 lakh in a financial year.

• Application: Since none of the individual payments exceeds ₹50 lakh, Section 194M does not apply. Mrs. Verma is not required to deduct TDS.

Conclusion

Section 194M of the Income Tax Act, 1961, plays a vital role in expanding the scope of TDS to cover significant payments made by individuals and HUFs not subject to tax audit. By imposing a 5% TDS on payments exceeding ₹50 lakh for specific services, this section ensures that substantial transactions are taxed appropriately, thereby reducing opportunities for tax evasion and increasing compliance.

The introduction of Section 194M reflects the government’s commitment to creating a robust and comprehensive tax collection system that leaves little room for loopholes. While the compliance requirements under this section are straightforward, they are crucial for ensuring that tax is collected efficiently and effectively at the source.

For individuals and HUFs, understanding and adhering to Section 194M is essential not only for compliance but also for contributing to the nation’s fiscal health. By being aware of the obligations under this section and fulfilling them diligently, taxpayers can avoid penalties and legal complications, ensuring smooth financial operations.