Clause 393 Tax to be deducted at source.

Income Tax Bill, 2025

Introduction

The Income Tax Bill, 2025, introduces a comprehensive and restructured framework for tax deduction at source (TDS), consolidating and rationalizing several provisions previously scattered across the Income-tax Act, 1961. Among its key innovations are the detailed tables and sub-clauses under Clause 393, which specify the nature, rate, threshold, and operational aspects of TDS for various categories of income, payers, and payees. Of particular relevance for the asset management, alternative investment, and capital market sectors are:

• Clause 393(1) [Table: S.No. 4(iii)]: TDS on income distributed to unitholders by investment funds.
• Clause 393(2) [Table: S.No. 8]: TDS on similar income paid to non-resident unitholders.
• Clause 393(4) [Table: S.No. 14]: Exemption from TDS for certain income in respect of investment fund units paid to non-residents, if not chargeable to tax.

These provisions are closely aligned with, and in some respects replace or update, the existing Section 194LBB of the Income-tax Act, 1961, which governs TDS on income in respect of units of investment funds. This commentary offers a detailed, itemized analysis of each relevant clause, followed by a comparative discussion with Section 194LBB, and concludes with practical implications and critical observations.

Objective and Purpose

The legislative intent behind the TDS regime for investment funds is to ensure efficient tax collection on pass-through income structures, prevent revenue leakage, and provide clarity for both resident and non-resident investors. The approach reflects the evolution of the Indian asset management industry, the growing significance of Alternative Investment Funds (AIFs), and the need to align domestic law with international best practices regarding cross-border investors.

The rationale for distinguishing between resident and non-resident unitholders, as well as for exempting income not chargeable to tax, is rooted in the principle of tax neutrality and avoidance of double taxation, especially in cases where treaty benefits or domestic exemptions apply.

Detailed Analysis

Clause 393(1) [Table: S.No. 4(iii)] - TDS on Income from Investment Funds to Resident Unitholders

Text: "Any income, other than that proportion of income which is exempt under Schedule V (Table: Sl. No. 2), in respect of units of an investment fund specified in section 224, payable to its unitholder."
Payer: Any Investment Fund specified in section 224.
Rate: 10%
Threshold limit: Nil (i.e., TDS applies on any amount paid)

Scope and Coverage

This provision mandates that investment funds (typically AIFs, as defined in section 224) must deduct TDS at 10% on income distributed to their resident unitholders, except for that proportion of income which is exempt under Schedule V (Table: Sl. No. 2). The exemption typically refers to income of the nature that is already exempt in the hands of the fund or unitholder, such as business income taxed at the fund level under the special regime.

Timing and Mode

TDS must be deducted at the earlier of credit or payment, whether in cash, cheque, draft, or any other mode, consistent with the general TDS framework.

Interpretation and Issues

• All-Inclusive: The absence of a threshold means that even small distributions are subject to TDS, ensuring comprehensive tax coverage.
• Exempt Income: The carve-out for exempt income aligns with the principle that TDS should not apply where the underlying income is not taxable, reducing the need for refunds and compliance friction.
• Pass-Through Principle: This structure continues the "pass-through" taxation model for certain categories of AIFs (Category I and II), where income (other than business income) is taxed in the hands of the investor, not the fund.

Potential Ambiguities

• Determination of Exempt Proportion: The calculation of the exempt portion may require complex allocation, especially for funds with mixed income streams.
• Overlap with Other Provisions: Coordination with other TDS provisions (e.g., on dividends, interest) must be managed to avoid double deduction.

Clause 393(2) [Table: S.No. 8] - TDS on Income from Investment Funds to Non-Resident Unitholders

Text: "Any income, other than that proportion of income which is exempt under Schedule V (Table: Sl. No. 2), in respect of units of an investment fund specified in section 224."
Payee: Any unit holder, being a non-resident (not being a company) or a foreign company.
Payer: Any investment fund specified in section 224.
Rate: Rates in force (i.e., as per the applicable rates for non-residents, potentially subject to treaty relief)

Scope and Coverage

This provision mirrors the structure for residents but applies to non-resident unitholders. The TDS obligation falls on the investment fund, with the rate determined by the "rates in force," which includes the relevant Finance Act rates and any applicable Double Taxation Avoidance Agreement (DTAA) rates, subject to the fulfilment of conditions such as furnishing of a tax residency certificate.

Interpretation and Issues

• Alignment with International Tax Principles: By allowing for the application of treaty rates, the provision avoids over-taxation and potential treaty violations.
• Exempt Proportion: As with residents, TDS is not to be deducted on exempt income, reducing administrative burden and aligning with the principle of taxing only chargeable income.
• Compliance Complexity: Funds must determine the correct rate for each non-resident investor, factoring in treaty benefits, surcharge, and cess, which can be administratively intensive.

Potential Ambiguities

• Verification of Exemption: Determining whether income is "not chargeable to tax" under the Act or a treaty may require extensive documentation and due diligence.
• Application of Rate: The "rates in force" language may lead to disputes over the applicable rate, especially where the treaty rate is lower than the domestic rate.

Clause 393(4) [Table: S.No. 14] - Exemption from TDS on Certain Income to Non-Residents

Text: "Income in respect of units of investment fund referred to in section 393(2) [Table: S.No. 8]."
Condition for No Deduction: "Income that is not chargeable to tax under the provisions of this Act."

Scope and Coverage

This is a crucial carve-out that provides that if the income paid to a non-resident unitholder is not chargeable to tax under the Income Tax Act, 2025 (including by virtue of a DTAA), then no TDS is required. This is in harmony with the proviso to Section 194LBB and is vital for compliance with international tax obligations and avoidance of unnecessary withholding on exempt income.

Interpretation and Issues

• Alignment with Section 194LBB Proviso: The language closely tracks the existing law, ensuring continuity and legal certainty.
• Administrative Relief: This reduces the need for non-residents to claim refunds for tax withheld on exempt income.
• Proof and Documentation: The onus is on the payer to establish that the income is not chargeable to tax, necessitating robust documentation (e.g., tax residency certificate, DTAA claim, no PE status).

Potential Ambiguities

• Nature of Exemption: Whether the exemption applies automatically or only upon submission of specific documents may require clarification by way of rules or circulars.
• Interaction with Other TDS Provisions: Coordination is needed to ensure that the exemption is not inadvertently denied due to procedural lapses.

Comparative Analysis with Section 194LBB of the Income-tax Act, 1961

Text of Section 194LBB

Section 194LBB, introduced in the Finance Act, 2015 and amended in 2016, provides as follows:

Where any income, other than that proportion of income which is of the same nature as income referred to in clause (23FBB) of section 10, is payable to a unit holder in respect of units of an investment fund specified in clause (a) of the Explanation 1 to section 115UB, the person responsible for making the payment shall, at the time of credit or payment (whichever is earlier), deduct income-tax thereon,

• (i) at the rate of ten per cent., where the payee is a resident;
• (ii) at the rates in force, where the payee is a non-resident (not being a company) or a foreign company:

Provided that where the payee is a non-resident (not being a company) or a foreign company, no deduction shall be made in respect of any income that is not chargeable to tax under the provisions of the Act.

The Explanation defines "unit" and clarifies that credits to suspense accounts are deemed as credits to the payee.

Key Points of Comparison

Critical Observations

• Substantive Parity: The provisions in the Bill are substantively identical to Section 194LBB, ensuring continuity and predictability for stakeholders.
• Structural Clarity: The Bill achieves greater clarity by organizing TDS obligations in tabular form, making it easier for payers and payees to identify their obligations.
• Exemption Mechanism: The explicit table of exemptions in Clause 393(4) improves transparency and reduces litigation risk compared to the more general language of Section 194LBB's proviso.
• Administrative Streamlining: The Bill's approach, with detailed cross-references, should facilitate easier compliance, especially for funds with both resident and non-resident investors.

Practical Implications

For Investment Funds

• Obligation to apply TDS at 10% for residents and "rates in force" for non-residents on all income distributions, except for exempt income.
• Need for robust internal systems to segregate exempt and non-exempt income, especially when funds have mixed income streams.
• Requirement to obtain and verify documentation from non-resident investors (e.g., tax residency certificates, DTAA claims) to apply the correct TDS rate or avail exemption.
• Potential for increased compliance workload due to the need to monitor changes in treaty rates and domestic law.

For Unitholders (Investors)

• Residents will receive income net of 10% TDS, with credit available against their final tax liability.
• Non-residents may benefit from lower TDS rates under treaties or from exemption where income is not chargeable to tax; however, they must ensure timely submission of required documents to the fund.
• Reduced incidence of over-withholding and subsequent refund claims, especially for non-residents, due to the clear exemption mechanism.

For Regulators and Tax Authorities

• Greater transparency and ease of enforcement due to the tabular structure and explicit cross-referencing of exemptions.
• Potential reduction in disputes and litigation over the applicability of TDS and the correct rate, provided the rules for documentation and verification are clear and uniformly applied.

Comparative Features and Potential Issues

1. Alignment with International Best Practices

The Bill's approach, especially for non-residents, is consistent with international norms, which require that withholding taxes not be imposed where income is not taxable under domestic law or a treaty. This enhances India's attractiveness as a fund jurisdiction for global investors.

2. Potential for Litigation and Disputes

Despite the improvements, disputes may still arise over:

• Whether the income is "not chargeable to tax" (e.g. due to treaty provisions or characterization issues).
• The correct rate to be applied under "rates in force," especially where surcharges or multiple rates apply.
• Procedural lapses in documentation, which could lead to denial of exemption or application of higher TDS rates.

3. Transitional and Legacy Issues

Funds with legacy structures or income streams may need to carefully map the transition from the 1961 Act to the new Bill, particularly where definitions or cross-references have changed.

4. Coordination with Other TDS Provisions

The Bill's comprehensive tables may help avoid the double deduction of TDS (e.g. under both the general TDS and the specific investment fund TDS provisions), but only if cross-references are diligently observed.

Conclusion

The provisions of Clause 393(1) [Table: S.No. 4(iii)], Clause 393(2) [Table: S.No. 8], and Clause 393(4) [Table: S.No. 14] of the Income Tax Bill, 2025, represent a logical evolution of the TDS regime for investment fund distributions, building on the foundation laid by Section 194LBB of the Income-tax Act, 1961. The 2025 Bill enhances clarity, consolidates exceptions, and maintains alignment with core principles of TDS-that tax is deducted only on taxable income, at appropriate rates, and with due consideration for residency and treaty benefits. While operational challenges remain-particularly in characterizing income and applying correct rates-the proposed regime is a step forward in rationalizing India's TDS framework for modern investment structures.

Full Text:

Clause 393 Tax to be deducted at source.