Clause 393 Tax to be deducted at source.

Income Tax Bill, 2025

Introduction

Clause 393(2) of the Income Tax Bill, 2025, specifically Table S.No. 11 and 12, introduces provisions regarding tax deduction at source (TDS) on income payable to offshore funds in respect of units and long-term capital gains arising from the transfer of such units. These provisions are the legislative successors to Section 196B of the Income-tax Act, 1961, which has governed similar transactions for over three decades. The new Bill, in seeking to overhaul and modernize the income tax framework, has restructured, clarified, and in some respects, altered the TDS regime for offshore funds investing in India through specified units.

This commentary provides a comprehensive legal analysis of Clause 393(2) [Table: S.No. 11 & 12] of the Income Tax Bill, 2025, examining its objectives, detailed mechanics, and practical implications. It then undertakes a comparative analysis with the existing Section 196B of the Income-tax Act, 1961, highlighting similarities, differences, interpretative issues, and the broader policy context.

Objective and Purpose

The primary objective of Clause 393(2) [Table: S.No. 11 & 12] is to ensure efficient collection of tax at source on income earned by offshore funds from Indian units, as well as on long-term capital gains arising from the transfer of such units. The rationale is twofold:

• To secure tax revenue from cross-border investment flows, particularly where the payee is a non-resident and the risk of non-compliance or non-reporting is higher.
• To provide certainty and clarity to both payers and offshore funds regarding the applicable TDS rates, timing, and procedures, thereby reducing disputes and facilitating ease of doing business.

Historically, Section 196B, read with Section 115AB of the 1961 Act, was introduced to attract foreign investment into Indian capital markets by offshore funds, while ensuring that the tax on such income is collected at the source. The 2025 Bill continues this policy, but with certain updates to reflect evolving market practices, international tax standards, and the need for greater legislative precision.

Detailed Analysis of Clause 393(2) [Table: S.No. 11 & 12] of the Income Tax Bill, 2025

Text of the Provisions

The relevant extract from Clause 393(2) Table is as follows:

The operative provisions require the person responsible for paying such income to deduct income-tax at the specified rates at the time of credit or payment, whichever is earlier, and in accordance with the procedural requirements of the Bill.

Interpretation and Scope

1. Nature of Income and Applicability

The provisions apply to two distinct types of income:

• S.No. 11: Income in respect of units - this generally refers to interest, dividend, or other periodic income (excluding capital gains) accruing to the offshore fund from units specified in section 208.
• S.No. 12: Long-term capital gains from transfer of such units - this covers gains arising on the sale or redemption of the specified units by the offshore fund, provided the gains qualify as long-term under the Act.

Section 208, though not reproduced here, is presumed to define the eligible units and offshore funds, largely in line with the erstwhile section 115AB of the 1961 Act.

2. Payee and Payer

The payee must be an "offshore fund" - a non-resident fund investing in specified Indian units. The payer is "any person" responsible for making such payment, which could include mutual funds, specified companies, or intermediaries.

3. TDS Rates

• For income in respect of units (S.No. 11): 10%
• For long-term capital gains from transfer of such units (S.No. 12): 12.5%

These rates are exclusive of surcharge and cess, unless otherwise provided. The distinction in rates reflects a policy shift, discussed in detail below.

4. Timing and Manner of Deduction

Tax is to be deducted at the time of credit of income to the payee's account or at the time of actual payment, whichever is earlier. This aligns with the general TDS mechanism under the Bill, ensuring that tax is collected at the earliest possible juncture.

5. No Threshold Limit

The table does not specify any monetary threshold for TDS applicability. Thus, tax is to be deducted irrespective of the quantum of payment, which is consistent with the policy of minimizing revenue leakage in cross-border transactions.

6. Interaction with Other Provisions

The deduction is "subject to the provisions of sub-sections (4), (8) and (9)," which deal with exceptions, declarations for non-deduction, and specific exclusions (such as payments to government, RBI, etc.). The Bill also provides for crediting to suspense accounts being deemed as payment to the payee, closing loopholes for deferral.

Ambiguities and Potential Issues

• Definition of "units" and "offshore fund": The interpretation will hinge on the cross-reference to section 208, which must be carefully drafted to avoid disputes about eligibility.
• Interaction with Tax Treaties: The Bill is silent on whether the offshore fund can claim lower rates under a Double Taxation Avoidance Agreement (DTAA). However, as per general principles and Section 90 of the 1961 Act (likely to be retained in the new Bill), the beneficial provisions of tax treaties should prevail.
• Grossing up: If the agreement provides for payment "net of tax," the payer may need to gross up the payment so that the offshore fund receives the agreed amount after TDS.
• Procedural Compliance: The payer must ensure timely deposit of TDS, filing of returns, and issuance of TDS certificates to the offshore fund, failing which penal consequences may arise.

Practical Implications

For Offshore Funds

• Clear certainty on TDS rates applicable to income and long-term capital gains from units.
• Potential for increased tax cost on long-term capital gains (12.5%) compared to the previous uniform rate of 10%.
• Need to evaluate availability of lower rates under applicable tax treaties and the process for obtaining refunds or credit for excess TDS.

For Payers (Indian Mutual Funds, Companies, etc.)

• Obligation to identify payees as offshore funds and apply correct TDS rates without threshold exemption.
• Increased compliance burden in terms of documentation, timely deduction, deposit, and reporting.
• Responsibility to gross up payments where contractually required.

For Tax Authorities

• Enhanced ability to track and collect tax on cross-border investment income at the source.
• Potential reduction in disputes due to clarified rates and scope.
• Need for robust systems to process refund claims by offshore funds, especially where DTAA rates are lower or income is ultimately exempt.

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

1. Text of Section 196B

Section 196B (as amended by the Finance (No. 2) Act, 2024) reads:

Where any income in respect of units referred to in section 115AB or by way of long-term capital gains arising from the transfer of such units is payable to an Offshore Fund, the person responsible for making the payment shall, at the time of credit of such income to the account of the payee or at the time of payment thereof in cash or by the issue of a cheque or draft or by any other mode, whichever is earlier, deduct income-tax thereon at the rate of--
(a) ten per cent. in respect of income from units referred to in clause (i) of sub-section (1) of section 115AB;
(b) ten per cent. in respect of long-term capital gains arising from transfer of units referred to in section 115AB, which takes place before the 23rd day of July, 2024;
(c) twelve and one-half per cent. in respect of long-term capital gains arising from transfer of units referred to in section 115AB, which takes place on or after the 23rd day of July, 2024.

2. Similarities

• Scope of Income: Both the old and new provisions cover income from units and long-term capital gains from the transfer of such units by offshore funds.
• Payee and Payer: In both, the payee is an offshore fund, and the payer is any person responsible for making the payment.
• Timing of Deduction: TDS must be deducted at the time of credit or payment, whichever is earlier.
• Rates: The rates are harmonized, with 10% for income from units and 12.5% for long-term capital gains arising from transfers post-23 July 2024.

3. Differences and Nuances

• Reference to Underlying Provisions: Section 196B refers explicitly to units u/s 115AB, whereas Clause 393(2) refers to units u/s 208 of the new Bill. The substance is likely the same, but the cross-reference reflects the renumbering and restructuring in the new Bill.
• Explicit Segregation in Table: The Bill splits the income into two distinct entries (S.No. 11 and 12), making the distinction between "income from units" and "long-term capital gains" more explicit.
• Clarity in Rate Change: Section 196B details the rate change date (23 July 2024), while the Bill simply prescribes the rates. The transitional provision may be addressed elsewhere in the Bill or through subordinate legislation.
• Wider Framework: Clause 393(2) is part of a comprehensive TDS table covering a wide range of payments to non-residents, providing a more integrated approach than the piecemeal structure of the 1961 Act.
• Potential for Broader Application: Depending on the definition of "units referred to in section 208," the Bill may cover a broader or slightly different set of instruments than section 115AB, though the intent appears to be continuity.

4. Ambiguities and Issues

• Definition of "Offshore Fund": The Bill must clearly define "offshore fund" to avoid interpretational disputes, ensuring it aligns with international usage and the previous regime.
• Transitional Provisions: The Bill should clarify the treatment of capital gains arising from transfers that straddle the effective date of the rate change (i.e., pre- and post-23 July 2024).
• Double Taxation Avoidance Agreements (DTAAs): The TDS rates are subject to relief under applicable DTAAs, and the Bill should reiterate the primacy of treaty provisions where applicable.
• Procedural Compliance: The Bill should clarify procedures for obtaining TDS certificates, filing returns, and claiming refunds, particularly for offshore funds with no presence in India.

Practical Implications of the Changes

1. For Offshore Funds

- The increase in TDS rate on long-term capital gains from 10% to 12.5% may marginally impact post-tax returns for offshore funds on transfers occurring on or after 23 July 2024.

- Offshore funds will need to monitor the date of transfer carefully for transactions near the cut-off date to ensure correct TDS rates are applied.

2. For Payers

- The clarity and explicit rates in the Bill should reduce ambiguity and the risk of under- or over-deduction.

- The need to identify the nature of income (dividend/distributed income vs. long-term capital gains) and apply the correct rate is reinforced.

3. For the Tax Administration

- The integrated TDS table under the new Bill should facilitate easier monitoring and administration.

- The explicit codification of the rate change aligns with the government's objective of transparency and predictability in tax policy.

4. For the Indian Investment Ecosystem

- While the TDS rate hike on long-term capital gains may be seen as a negative by some foreign investors, the overall clarity and continuity of the regime should preserve India's competitive position.

- Advisors and market participants must update systems and processes to ensure compliance with the new rates and definitions

5. Comparative Table

7. Policy and Interpretative Issues

• Increase in TDS Rate on Capital Gains: The Bill cements the recent increase from 10% to 12.5% on long-term capital gains, signaling a policy shift to a higher tax take from offshore funds on exit gains.
• Transitional Issues: Section 196B provides for a cut-off date (23 July 2024) for the rate change, whereas Clause 393(2) applies the new rate prospectively, potentially creating issues for transactions straddling the transition.
• Definition of Units: If Section 208 under the new Bill is not perfectly aligned with Section 115AB, there could be unintended inclusions or exclusions, affecting the scope of the TDS obligation.
• Procedural Modernization: The 2025 Bill is more comprehensive in laying down procedures, exceptions, and administrative machinery for TDS, potentially improving compliance and reducing litigation.
• Interaction with Other Provisions: The Bill's integration of TDS rules across various income streams and payee categories allows for more streamlined administration, but increases the need for careful cross-referencing and compliance by payers.

Conclusion

Clause 393(2) [Table: S.No. 11 & 12] of the Income Tax Bill, 2025, represents both continuity and change in the taxation of offshore funds investing in Indian units. While it preserves the core principles of Section 196B, it updates the TDS regime to reflect recent policy decisions, notably an increased rate on long-term capital gains, and incorporates these rules into a more modern legislative framework. The absence of a threshold, the clear bifurcation between income from units and capital gains, and the cross-references to updated definitions aim to reduce ambiguity and enhance compliance.

Payers and offshore funds must carefully navigate the new provisions, especially in light of the rate changes and any definitional differences in the new Bill. The interaction with tax treaties remains a critical area for both compliance and planning, and procedural diligence is essential to avoid penalties. The legislative evolution from Section 196B to Clause 393(2) demonstrates the balancing act between revenue protection and investment facilitation that underpins India's approach to cross-border taxation.

Full Text:

Clause 393 Tax to be deducted at source.