The introduction of Section 194T through the Finance (No. 2) Act, 2024, effective from April 1, 2025, marks a significant step in the Government’s drive to strengthen tax compliance. By bringing payments made by firms to their partners under the Tax Deducted at Source (TDS) net, the provision seeks to enhance accountability and transparency in financial reporting. Despite its brevity, Section 194T presents several intricacies that demand a deeper understanding.
Key Provisions of Section 194T
Applicability:
- Section 194T applies to all firms, including Limited Liability Partnerships (LLPs), as per the definition of "firm" under Section 2(23) of the Income Tax Act, 1961.
- It covers payments to partners in the nature of salary, remuneration, commission, bonus, or interest.
TDS Rate:
- A flat rate of 10% applies to the amounts paid or credited.
Threshold Limit:
- No TDS is required if the aggregate payments to a partner do not exceed ₹20,000 in a financial year.
- Once this threshold is crossed, the entire amount becomes subject to TDS.
Point of Deduction:
- TDS is to be deducted at the earlier of:
- Credit of the amount to the partner’s account (including capital accounts), or
- Actual payment of the amount.
- TDS is to be deducted at the earlier of:
Key Considerations and Challenges
1. Timing of Applicability
While Section 194T takes effect from April 1, 2025, its applicability is linked to the financial year beginning on or after this date. For instance:
- If a firm credits a partner’s salary on March 31, 2025, relating to FY 2024-25, and pays it after April 1, 2025, TDS under Section 194T will not apply.
This timeline clarity ensures that the section’s obligations align with the financial year in question.
2. Mismatch Between TDS Deduction and Taxability
Section 194T mandates TDS on all specified payments, irrespective of their allowability as deductions under Section 40(b). This creates potential mismatches:
- Example:
A firm credits ₹30,000 as remuneration to a partner but can claim only ₹25,000 as a deductible expense under Section 40(b). TDS must still be deducted on ₹30,000, creating a disparity between the firm’s TDS return and the partner’s taxable income.
This mismatch could trigger notices from the Centralized Processing Centre (CPC), requiring firms and partners to maintain clear documentation and communication.
3. Impact on Finalization of Accounts
Partnership deeds often specify remuneration based on book profits, which are finalized post-year-end. If account finalization is delayed:
- The firm risks non-compliance with TDS timelines, resulting in interest or penalties for late deposit.
- To mitigate this, firms should adopt interim accounting practices to ensure timely credit and TDS compliance.
4. Non-Resident Partners: Section 194T vs. Section 195
Payments to non-resident partners introduce a complex interplay between Section 194T and Section 195.
- Section 194T: Prescribes TDS at 10%.
- Section 195: Requires withholding tax based on rates in force, which depend on applicable DTAA (Double Taxation Avoidance Agreement).
In the absence of a non-obstante clause in both sections, the conflict remains unresolved. For instance, remuneration to a non-resident partner—being business income under Section 28(v)—may attract higher withholding tax rates under Section 195. Firms must analyze the applicable treaty provisions to avoid non-compliance.
5. Nature of Partner’s Income
Remuneration, salary, or interest paid to a partner is deemed business income, as upheld by the Supreme Court in CIT v. R.M. Chidamabaram Pillai (106 ITR 292). While Section 194T simplifies the TDS process with a uniform 10% rate, firms must ensure proper classification of such income, particularly for non-residents, where business income may require higher withholding rates.
Recommendations for Compliance
| Challenge | Solution |
|---|---|
| Mismatch in TDS deduction and taxability | Maintain robust documentation and ensure clear communication between the firm and partners. |
| Delay in finalization of accounts | Finalize books promptly or adopt interim crediting practices to meet TDS obligations on time. |
| Payments to non-resident partners | Consult tax experts to determine whether Section 194T or Section 195 applies, based on DTAA analysis. |
| Ambiguity in TDS applicability | Align internal processes with the financial year to avoid confusion about credit/payment timelines. |
Conclusion
Section 194T is a targeted initiative to expand the TDS framework, ensuring greater compliance in partnership transactions. While its provisions are straightforward, the section presents several practical challenges, particularly around mismatches, account finalization delays, and payments to non-residents.
For firms, proactive measures—such as timely bookkeeping, meticulous documentation, and expert consultation—are critical to seamless compliance. As the section comes into effect from April 1, 2025, preparedness will be key to avoiding disputes and ensuring smooth operations under this new tax regime.
