Clause 393 Tax to be deducted at source.

Income Tax Bill, 2025

Introduction

Clause 393(5) of the Income Tax Bill, 2025 and Section 196 of the Income-tax Act, 1961, both address the exemption from tax deduction at source (TDS) for payments made to certain entities, namely the Government, the Reserve Bank of India (RBI), specified corporations, and mutual funds. These provisions are central to the administration of TDS, ensuring that entities inherently exempt from income tax, or those for whom TDS would be redundant or administratively burdensome, do not suffer unnecessary withholding on receipts such as interest, dividends, or other sums. The legislative context of these provisions lies in the broader objective of the TDS regime: to facilitate the collection of tax at the source of income, thereby securing timely revenue for the exchequer and improving compliance. However, for certain entities-such as the Government and RBI-such collection is either unnecessary or contrary to the policy of tax neutrality. Over the years, these exemptions have been refined to reflect changes in the financial sector, the emergence of new investment vehicles (such as mutual funds), and evolving public policy. Clause 393(5) of the Income Tax Bill, 2025, as a successor to Section 196, is intended to modernize and consolidate the law, harmonizing it with contemporary financial realities and the need for legislative clarity. This commentary undertakes a detailed analysis of Clause 393(5), followed by a comparative evaluation with Section 196, highlighting similarities, differences, and the implications for stakeholders.

Objective and Purpose

The primary objective of both Clause 393(5) and Section 196 is to carve out specific exemptions from the general TDS obligations imposed under the Income Tax Act. The rationale is threefold:

1. Administrative Efficiency: Collecting TDS from government entities, the RBI, or specified corporations would be a futile exercise, as these entities are either statutorily exempt from income tax or their receipts would ultimately revert to the government exchequer.
2. Policy Consistency: Certain corporations and mutual funds are statutorily exempt from income tax on their income, and the law recognizes this by exempting them from TDS as well, thereby preventing unnecessary compliance burdens.
3. Clarity and Certainty: By explicitly enumerating exempt entities and the nature of exempt payments, the provisions provide clarity to payers and recipients alike, reducing the risk of interpretational disputes and litigation.

The legislative history of Section 196, and now Clause 393(5), reflects a consistent approach towards these objectives, with periodic amendments to accommodate new categories of exempt entities (such as mutual funds) and to clarify the scope of exempt payments.

Detailed Analysis of Clause 393(5) of the Income Tax Bill, 2025

Irrespective of anything contained in this Chapter, the tax shall not be deducted by any person from any amount payable to- (a) the Government; or (b) the Reserve Bank of India; or (c) a corporation established by or under a Central Act which is, under any law in force, exempt from income-tax on its income; or (d) a Mutual fund as specified at Schedule VII (Table: Sl. No. 20 or 21), where such amount is payable to it by way of- (A) interest; or (B) dividend in respect of any securities or shares owned by it or in which it has full beneficial interest; or (C) any other income accruing or arising to it.

This sub-section can be analyzed under the following heads:

a) Non-Obstante Clause

Clause 393(5) begins with a non-obstante clause ("Irrespective of anything contained in this Chapter"), which overrides all other provisions in the Chapter relating to TDS. This ensures that the exemption is absolute and cannot be diluted by any other TDS provision, whether general or specific.

b) Enumerated Exempt Entities

The provision lists four categories of exempt recipients:

• The Government: This includes the Central and State Governments. The exemption recognizes the principle that the government, being the sovereign, is not subject to its own tax machinery in respect of its income.
• The Reserve Bank of India: As the central bank and monetary authority, the RBI's income is statutorily exempt from tax. The exemption from TDS aligns with this status.
• Corporations Established by or under a Central Act which are Exempt from Tax: This covers statutory corporations (such as Life Insurance Corporation of India, Export-Import Bank, etc.) that have been granted tax-exempt status by virtue of their governing statutes or notifications under the Income Tax Act.
• Specified Mutual Funds: The reference to Schedule VII (Table: Sl. No. 20 or 21) ensures that only those mutual funds explicitly notified as tax-exempt are covered.

c) Nature of Exempt Payments

The exemption applies to amounts payable by way of:

• Interest: This includes interest on securities, deposits, bonds, etc., owned by the exempt entity.
• Dividend: Specifically, dividends in respect of securities or shares owned by or in which the entity has full beneficial interest.
• Any Other Income: This is a catch-all category, ensuring that any income accruing or arising to these entities (not limited to interest or dividends) is exempt from TDS.

d) Scope and Breadth

The language "any other income accruing or arising" broadens the exemption to cover all forms of income, not merely interest or dividend. This is significant, as it precludes the possibility of TDS on miscellaneous receipts such as lease rentals, capital gains, or other forms of investment income, provided these accrue to the specified exempt entities.

e) Ownership or Beneficial Interest

The provision clarifies that the exemption applies not only to securities or shares "owned" by the exempt entity, but also those in which it has "full beneficial interest". This is important in cases where legal ownership may be held by a nominee or custodian, but the economic benefits accrue to the exempt entity.

f) Reference to Schedule VII

The specific reference to Schedule VII (Table: Sl. No. 20 or 21) for mutual funds ensures that only those mutual funds notified under the new law are entitled to the exemption, thereby aligning the provision with the broader legislative framework of the Income Tax Bill, 2025.

g) Interaction with Other Provisions

The non-obstante clause ensures that the exemption under Clause 393(5) prevails over any other TDS obligation that may arise under the rest of Clause 393 or the broader Chapter. This is critical to avoid conflicts and ensure administrative simplicity.

Practical Implications

The practical impact of Clause 393(5) is substantial:

• For Payers: Banks, companies, and other payers are relieved of the obligation to deduct tax at source when making payments to the specified exempt entities. This reduces compliance burdens and the risk of penal consequences for non-deduction.
• For Exempt Entities: The exempt entities receive their income in full, without the need to claim refunds or engage in correspondence with the tax authorities to recover TDS erroneously deducted.
• For Tax Administration: The provision reduces unnecessary administrative work for the tax department, as TDS collected from exempt entities would inevitably result in refund claims and additional workload.
• For Financial Markets: The provision facilitates smoother transactions in government securities, bonds, and mutual fund units, as the flow of funds is not interrupted by TDS procedures.

Potential compliance issues may arise if payers are unaware of the exempt status of the recipient, especially in cases where the status of a corporation or mutual fund is not clearly notified or updated. However, the explicit reference to Schedule VII and the requirement for exemption under "any law in force" mitigate this risk.

Comparative Analysis with Section 196 of the Income-tax Act, 1961

Section 196 of the Income-tax Act, 1961 reads:

Notwithstanding anything contained in the foregoing provisions of this Chapter, no deduction of tax shall be made by any person from any sums payable to- (i) the Government, or (ii) the Reserve Bank of India, or (iii) a corporation established by or under a Central Act which is, under any law for the time being in force, exempt from income-tax on its income, or (iv) a Mutual Fund specified under clause (23D) of section 10, where such sum is payable to it by way of interest or dividend in respect of any securities or shares owned by it or in which it has full beneficial interest, or any other income accruing or arising to it.

A comparative analysis reveals the following:

a) Structure and Content

The structure and language of Clause 393(5) are substantially similar to Section 196. Both provisions:

• Begin with a non-obstante clause overriding other TDS provisions.
• List the same four categories of exempt entities (Government, RBI, exempt corporations, specified mutual funds).
• Apply the exemption to interest, dividends (with reference to ownership or beneficial interest), and any other income accruing or arising to the entity.

b) Mutual Fund Reference

While Section 196 refers to "a Mutual Fund specified under clause (23D) of section 10," Clause 393(5) refers to "a Mutual fund as specified at Schedule VII (Table: Sl. No. 20 or 21)." This reflects a shift in the legislative drafting style under the new Bill, where Schedules are used to enumerate exempt entities, rather than referencing specific clauses of the Act. The substantive effect remains the same, provided the Schedule is kept up to date.

c) Corporations Exempt under Central Act

Both provisions cover corporations established by or under a Central Act and exempt from income tax under any law in force. There is no material difference in the scope of this exemption.

d) Nature of Exempt Payments

Both provisions cover sums payable by way of interest, dividends (on securities or shares owned or in which the entity has beneficial interest), and any other income accruing or arising to the entity. The use of the phrase "any other income accruing or arising" in both provisions ensures that the exemption is comprehensive.

e) Scope of Non-Obstante Clause

Section 196 uses "Notwithstanding anything contained in the foregoing provisions of this Chapter," while Clause 393(5) uses "Irrespective of anything contained in this Chapter." The effect is the same: the exemption prevails over all other TDS provisions in the Chapter.

f) Legislative Modernization

The principal difference lies in the drafting approach. The Income Tax Bill, 2025, by referencing Schedules, aims for greater modularity and ease of amendment (as entities can be added or removed from the Schedule without amending the main provision). This is a modernization of the legislative technique, not a substantive change.

g) No Expansion or Restriction of Scope

There is no evidence that Clause 393(5) either expands or restricts the scope of the exemption as compared to Section 196. The categories of exempt entities and the nature of exempt payments are consistent across both provisions.

Ambiguities and Issues in Interpretation

While the provisions are generally clear, certain practical issues may arise:

• Identification of Exempt Corporations: The payer must ascertain whether the recipient corporation is indeed established by or under a Central Act and is exempt from income tax under any law in force. Ambiguities may arise if the exemption status of a corporation is unclear or disputed.
• Beneficial Interest: The requirement that the securities or shares be "owned by it or in which it has full beneficial interest" may necessitate inquiries into the legal and beneficial ownership structures, especially in the case of nominees or custodians.
• Updating Schedules: The effectiveness of the provision for mutual funds depends on the timely updating of Schedule VII. If the Schedule is not updated to reflect new notifications or changes in status, there is a risk of erroneous TDS or denial of exemption.

Comparative Perspective: Other Jurisdictions

In many common law jurisdictions, similar exemptions exist for government entities and certain public institutions. For example:

• United Kingdom: The UK tax regime exempts government and central bank entities from withholding tax on interest and dividends.
• United States: The Internal Revenue Code exempts federal and state government entities from withholding on many forms of income, and certain tax-exempt organizations are similarly protected.

The Indian provisions align with international best practices, reflecting the universal principle that the sovereign and its instrumentalities should not be subject to tax withholding by their own tax authorities.

Conclusion

Clause 393(5) of the Income Tax Bill, 2025 is a faithful restatement and modernization of Section 196 of the Income-tax Act, 1961. Both provisions serve the critical function of exempting the Government, RBI, specified corporations, and mutual funds from TDS on their receipts of interest, dividends, and other income. The legislative intent is clear: to avoid the administrative absurdity and policy inconsistency of imposing TDS obligations on entities that are inherently exempt from income tax. The principal innovation in Clause 393(5) is the use of Schedules to specify exempt mutual funds, which enhances legislative flexibility and clarity. However, the substantive scope of the provision remains unchanged. For payers, recipients, and tax administrators, the provision ensures clarity, reduces compliance burdens, and aligns Indian tax law with international standards. Potential issues may arise in the identification of exempt entities and the updating of Schedules, but these are administrative matters rather than defects in the legal drafting. The provision is robust, comprehensive, and fit for purpose in the contemporary tax landscape.

Full Text:

Clause 393 Tax to be deducted at source.