Clause 393 Tax to be deducted at source.

Income Tax Bill, 2025

Introduction

The taxation of income earned by Foreign Institutional Investors (FIIs) and specified funds from securities has long been a significant aspect of Indian tax policy, balancing the twin objectives of attracting foreign capital and ensuring tax compliance. Section 196D of the Income Tax Act, 1961, provided a dedicated withholding tax regime for FIIs, and, following the emergence of new fund structures and investment vehicles, the law has evolved to address specified funds and related entities.

With the introduction of the Income Tax Bill, 2025, Clause 393 proposes a comprehensive overhaul of the tax deduction at source (TDS) regime, including detailed tables for payments to both residents and non-residents. Of particular relevance are Clause 393(2) [Table: S.No. 15 & 16] and Clause 393(4) [Table: S.No. 16 & 17], which directly address TDS on income from securities payable to FIIs and specified funds, and the circumstances where such deduction is not required.

This commentary undertakes a detailed analysis of these provisions, their legislative intent, operational mechanics, interpretative issues, and their comparative positioning vis-`a-vis the existing Section 196D of the Income Tax Act, 1961. The discussion is structured to provide clarity on each relevant aspect, highlight practical implications, and identify areas for potential reform or judicial scrutiny.

Objective and Purpose 

The legislative intent behind the TDS regime for FIIs and specified funds is twofold: to ensure the collection of tax at the earliest possible point and to provide clarity and certainty to foreign investors regarding their tax obligations in India. Historically, ambiguities in the characterization of income, the applicable rates, and the interaction with double taxation avoidance agreements (DTAAs) have led to litigation and compliance challenges.

The Income Tax Bill, 2025, through Clause 393 and its detailed tables, seeks to codify and streamline TDS provisions, making them more accessible and operationally efficient. The specific focus on FIIs and specified funds reflects the increasing complexity of cross-border investments and the need to align domestic law with international best practices, while safeguarding the revenue interests of the exchequer.

Detailed Analysis of Clause 393(2) [Table: S.No. 15 & 16] and Clause 393(4) [Table: S.No. 16 & 17] of the Income Tax Bill, 2025

I. Clause 393(2) [Table: S.No. 15 & 16] - TDS on Income from Securities Payable to FIIs and Specified Funds

A. Clause 393(2) Table: S.No. 15

• Nature of Income: Any income in respect of securities referred to in section 210(1) (Table: Sl. No. 1).
• Payee: Any Foreign Institutional Investor.
• Payer: Any person.
• Rate: As per Note 2.

This provision mandates that any person responsible for making payment of income in respect of specified securities to a Foreign Institutional Investor must deduct tax at source at the rate specified in Note 2. The reference to section 210(1) and Table: Sl. No. 1 is critical, as it defines the universe of "securities" for this purpose.

Note 2 (not fully reproduced in the excerpt) typically clarifies the applicable rate, which may be the rate prescribed under the Act or the rate as per the relevant DTAA, whichever is lower, subject to the fulfillment of prescribed conditions (such as submission of a tax residency certificate, etc.).

B. Clause 393(2) Table: S.No. 16

• Nature of Income: Any income in respect of securities referred to in section 210(1) (Table: Sl. No. 1).
• Payee: A specified fund, referred to in Schedule VI [Note 1(g)].
• Payer: Any person.
• Rate: 10%.

This item extends the TDS regime to "specified funds," a term that generally refers to Category III Alternative Investment Funds (AIFs) set up in International Financial Services Centres (IFSCs), as defined in the relevant Schedules and Notes. The prescribed TDS rate is 10%, aligning with the concessional regime introduced in recent years for such funds to promote the IFSC framework.

II. Clause 393(4) [Table: S.No. 16 & 17] - Exemptions from TDS for FIIs and Specified Funds

A. Clause 393(4) Table: S.No. 16

• Provision for TDS: Income of Foreign Institutional Investors from securities referred to in section 393(2)(Table: Sl. No. 15).
• Condition for No Deduction: Income, by way of capital gains arising from the transfer of securities referred to in section 210, if payable to a Foreign Institutional Investor.

This clause provides that no TDS is required on capital gains arising to FIIs from the transfer of securities, reflecting the policy that while such capital gains are taxable in the hands of FIIs, the mechanism of TDS is not triggered. This is in line with the existing regime u/s 196D(2) of the 1961 Act.

B. Clause 393(4) Table: S.No. 17

• Provision for TDS: Income of Specified Fund from securities referred to in section 393(2)(Table: Sl. No. 16).
• Condition for No Deduction: Income exempt at Schedule VI (Table: Sl. No. 1) to (Table: Sl. No. 4).

This provision ensures that where the income of a specified fund is exempt under the relevant Schedules (typically corresponding to the exempt income u/s 10(4D) of the 1961 Act), no TDS is to be effected. This prevents unnecessary withholding and subsequent refund procedures where the underlying income is statutorily exempt.

Practical Implications

A. For Foreign Institutional Investors (FIIs)

The provisions ensure that FIIs are subject to TDS only on income from securities (such as dividends, interest, etc.), and not on capital gains. This distinction is crucial, as FIIs are often subject to different tax rates on capital gains (short-term and long-term) and other income under the Act and relevant DTAAs. The non-applicability of TDS on capital gains facilitates smoother repatriation of sale proceeds and reduces administrative burdens.

The provision for applying the lower of the domestic rate or DTAA rate (subject to documentation) provides FIIs with the benefit of treaty protection, enhancing India's attractiveness as an investment destination.

B. For Specified Funds

Specified funds (typically Category III AIFs in IFSCs) are subject to a 10% TDS rate on income from securities, with an explicit carve-out for exempt income. This supports the policy objective of promoting IFSCs as competitive investment destinations and aligns with the concessional tax regime introduced in recent years.

The exemption from TDS on exempt income prevents the cash flow and compliance issues that would arise if tax were withheld on income not subject to tax in the first place.

C. For Payers and Intermediaries

The clear tabulation of TDS rates and exemptions in the Bill aids compliance for Indian custodians, brokers, and other intermediaries responsible for making payments to FIIs and specified funds. The alignment with treaty provisions and explicit reference to documentation requirements reduces the risk of disputes and penal consequences.

D. For the Revenue

The provisions strike a balance between revenue protection (by ensuring TDS on taxable income) and administrative efficiency (by exempting TDS on capital gains and exempt income). The requirement for documentation to avail treaty rates helps prevent abuse and ensures that only eligible entities benefit from concessional rates.

Comparative Analysis with Section 196D of the Income Tax Act, 1961

A. Scope and Structure

Both Section 196D and Clause 393(2) of the new Bill address TDS on income from securities payable to FIIs and specified funds. However, the Bill adopts a tabular format, making the provisions more accessible and operationally clear. The structure allows for easy identification of the applicable rate, payee, payer, and nature of income.

B. TDS Rates

• FIIs: Section 196D(1) prescribes a 20% TDS rate (or DTAA rate, if lower). Clause 393(2) Table: S.No. 15 refers to the rate as per Note 2, which is expected to mirror this approach.
• Specified Funds: Section 196D(1A) prescribes a 10% TDS rate, and Clause 393(2) Table: S.No. 16 does the same.

C. Exemption for Capital Gains

Section 196D(2) explicitly provides that no TDS is to be made on capital gains payable to FIIs. Clause 393(4) Table: S.No. 16 replicates this, ensuring continuity and clarity.

D. Exemption for Exempt Income of Specified Funds

Section 196D(1A) (proviso) and Clause 393(4) Table: S.No. 17 both provide that no TDS is required on income of specified funds that is exempt under the relevant provisions (Section 10(4D) in the 1961 Act; corresponding Schedule VI in the Bill). This harmonization prevents unnecessary withholding and aligns with the policy of promoting IFSCs.

E. Operational Aspects

Both regimes require TDS to be effected at the earlier of credit or payment, and both allow for the application of DTAA rates subject to prescribed documentation (tax residency certificate, etc.). The Bill's tabular format, however, may facilitate better compliance and reduce interpretational disputes.

F. Ambiguities and Potential Issues

• Definition of "Securities": Both provisions refer to securities as defined in the respective sections. Any ambiguity in the definition of securities (especially with the proliferation of new financial instruments) could lead to disputes.
• Interaction with DTAAs: While both regimes provide for the application of lower treaty rates, practical issues may arise regarding documentation, timing, and the scope of "beneficial ownership."
• Specified Funds: The definition and eligibility criteria for "specified funds" must be clear to prevent misuse or unintended exclusion.

G. Unique Features of the Bill

• The Bill's Clause 393(4) provides a consolidated table of exemptions from TDS, which is more user-friendly than the scattered provisos and explanations in the 1961 Act.
• The Bill's approach allows for easier updates and amendments, as new categories of payees or types of income can be added to the tables without redrafting the entire section.

H. International Comparison

Many jurisdictions provide for a reduced or zero withholding tax rate for foreign portfolio investors on capital gains, in line with India's approach. The clarity regarding TDS on exempt income and capital gains in the Bill

Practical Implications

For Foreign Institutional Investors

The continuation of the exemption from TDS on capital gains and the recognition of treaty rates for other income streams is a welcome development, as it reduces the risk of over-withholding and the need for refund claims. The tabular presentation in the Bill may facilitate easier compliance and reduce the risk of inadvertent non-compliance.

For Specified Funds

The explicit 10% TDS rate (subject to exemption for non-taxable income) provides certainty for specified funds, particularly those located in IFSCs. The exemption from TDS on exempt income aligns with the policy objective of promoting India as a global asset management hub.

For Payers (Indian Companies, Asset Managers, Custodians)

The clarity on timing, rate, and scope of TDS reduces the compliance burden and the risk of penal consequences for under- or over-withholding. The Bill's structure may also facilitate automation and system-based TDS compliance for large custodians and asset managers.

For Tax Administration

A streamlined and unambiguous TDS regime reduces administrative workload, minimizes disputes, and enhances the efficiency of tax collection. The new Bill's format may also improve data analytics and risk assessment by the tax authorities.

Potential Issues and Areas for Clarification

• Definition Alignment: The definitions of "securities", "specified fund", and "income" should be harmonized across the substantive and procedural provisions to avoid confusion or litigation.
• Applicability of DTAA: While the general law provides for DTAA override, explicit mention in the TDS provisions (as in the 1961 Act) would enhance clarity for payers and recipients.
• Procedural Compliance: The onus on payers to identify exempt income (especially for specified funds with mixed portfolios) may require robust documentation and, potentially, certification from the recipient fund.
• Transition Issues: Implementation of the new Bill may require updated systems and processes for payers, especially for cross-referencing the correct tables and schedules.

Conclusion

Clause 393(2) [Table: S.No. 15 & 16] and Clause 393(4) [Table: S.No. 16 & 17] of the Income Tax Bill, 2025, represent a logical evolution of the existing Section 196D regime, retaining its core principles while enhancing clarity, operational efficiency, and alignment with policy objectives. The provisions ensure that FIIs and specified funds are subject to TDS only on income that is taxable, at rates that reflect both domestic law and treaty obligations, and that capital gains and exempt income are not subject to unnecessary withholding.

The tabular format and consolidated exemption provisions in the Bill are significant improvements, likely to aid compliance and reduce litigation. However, careful attention must be paid to the definitions of securities and specified funds, the operationalization of DTAA benefits, and the prevention of abuse. As India's capital markets continue to evolve, ongoing legislative and judicial scrutiny will be essential to ensure that the TDS regime remains robust, fair, and conducive to investment.

Full Text:

Clause 393 Tax to be deducted at source.