The introduction of Section 194T in the Finance (No. 2) Bill, 2024, brings a significant shift in tax compliance for partnership firms and Limited Liability Partnerships (LLPs). This amendment, effective from 1st April 2025, expands the scope of Tax Deducted at Source (TDS) to include payments made by firms to their partners, aligning them with corporate practices.
Overview of Section 194T
Under Section 194T:
- TDS Rate: 10%
- Threshold Limit: Rs. 20,000 per type of payment (salary, remuneration, commission, bonus, and interest) per financial year
Payments Covered:
- Salary
- Remuneration
- Commission
- Bonus
- Interest on any account
Exclusions:
- Drawings: TDS does not apply to drawings or capital repayments to partners.
- Interest on Capital: TDS applies to interest on capital or loans from partners.
Reasoning Behind the Amendment
Objective:
- Enhanced Transparency: The amendment aims to improve transparency in financial transactions between firms and their partners.
- Revenue Assurance: By mandating TDS at the source, the government seeks to ensure timely tax collection and minimize revenue leakage.
Challenges and Burden on Firms
Increased Administrative Burden:
- TDS Implementation: Firms must now manage TDS deductions on partner payments, adding to their administrative workload and costs.
- Advance Tax Payments: Partners are required to pay taxes in advance, impacting their cash flow and financial planning.
Comparison with Corporate Entities:
- Corporate Entities: In contrast, companies benefit from lower corporate tax rates compared to the personal income tax rates applicable to partners in a firm. Companies also follow a similar TDS regime for their directors' remuneration, but they benefit from lower overall tax rates and deductions available under corporate tax laws.
- Partnership Firms: Partnership firms face higher effective tax rates compared to corporates, which increases the financial strain on partners who are now treated similarly to corporate directors for tax purposes.
Operational Impact
TDS Timing:
- Credit or Payment: TDS must be deducted at the earliest of either the credit to the partner’s account or the actual payment made.
Impact on Cash Flow:
- Cash Flow Management: Firms need to adjust their cash flows to accommodate TDS deductions, which could impact their liquidity.
Accounting Adjustments:
- Enhanced Accuracy: Accurate TDS deductions and reporting will require firms to update their accounting practices and systems.
Applicability to LLPs
Section 194T applies to both partnership firms and LLPs, aligning with the definitions provided in the Income Tax Act. This uniformity ensures consistent TDS obligations across different business structures but also adds to the compliance burden for LLPs.
Strategic Recommendations
1. Monthly Withdrawals and TDS Payment:
- Strategy: Partners can withdraw their remuneration monthly from profits earned in the previous year. Firms can deduct TDS on these monthly payments, easing cash flow management.
- Benefits: This approach allows for regular TDS deductions and avoids large, year-end tax payments.
2. Year-End Credit and Payment:
- Strategy: Firms can credit the remuneration to partners’ accounts at the end of the financial year and deduct TDS at that time.
- Benefits: Simplifies accounting but requires careful planning to ensure compliance.
3. Policy Adjustment:
- Revise Policies: Firms should update their payment and accounting policies to align with the new TDS requirements.
4. Compliance Monitoring:
- Implement Systems: Invest in systems to monitor TDS compliance and ensure timely deductions and payments.
5. Professional Consultation:
- Engage Advisors: Consult with tax professionals to navigate the complexities of Section 194T and mitigate its impact on business operations.
Conclusion
The introduction of Section 194T represents a significant change in tax regulations, aimed at enhancing transparency and improving tax compliance. However, this amendment imposes additional burdens on partnership firms, particularly regarding advance tax payments and increased administrative requirements. Compared to corporate entities, firms face higher effective tax rates, adding to the financial strain on partners.
To manage the impact effectively, firms should consider strategic adjustments in their payment processes and consult with tax advisors to ensure compliance and optimize their financial management.
