Section 194A TDS on Interest to NBFCS: Compliance and Challenges

by Varun Mirkhelkar

Senior Associate, Direct Tax

TDS compliance on interest payments to NBFCs is a complex issue that businesses must navigate. The legal requirement to deduct 10% tax on such payments can have financial implications and may lead to penalties if not adhered to. While practical challenges exist, businesses can follow the outlined process to ensure compliance and seek refunds for TDS paid out of pocket. Staying informed and proactive in addressing TDS obligations is essential for businesses to avoid financial penalties and maintain good standing with tax authorities.

Background and Legislative Intent

Non-Banking Financial Companies (NBFCs) play a crucial role in providing financial support to businesses.
However, what many payers may not realize is that there are Tax Deducted at Source (TDS) obligations associated with interest payments made to NBFCs. This article explores Section 194A of the Income Tax Act, shedding light on the TDS requirements and the challenges businesses face in complying with them.

Summary and Procedural Aspects

A. Provisions of Section 194-IA

Section 194A of the Income Tax Act mandates that the payer must deduct a 10% tax on interest payments made to residents who are not classified as Banks, Insurance companies, or other specified exceptions. Interestingly, NBFCs do not fall into the exception category, which means that businesses are obligated to deduct a 10% tax on interest payments to NBFCs.

B. Consequences of Non-Compliance

Failing to deduct the required tax can lead to significant consequences. In such cases, the interest amount can face a 30% disallowance in the hands of the payer. This, in turn, could result in up to 30% tax on the disallowed amount, translating into a 9% tax cost for businesses. Furthermore, non-compliance may trigger penalties and prosecution by the tax department.

C. Challenges in TDS Compliance

Complying with TDS on interest payments to NBFCs is not without its challenges. One significant hurdle is the practical difficulty in deducting tax during the payment of Equated Monthly Installments (EMIs) to NBFCs. Payment portals may not accept payments less than the full EMI amount, making it impossible for businesses to deduct tax on the interest component of EMIs.

D. Probable Solution

Identify Interest Component:
The payer needs to examine the loan repayment schedule provided by NBFCs to identify the interest component within each EMI.

Calculate and Pay TDS:
Once the interest component is identified, the payer can calculate TDS at the rate of 10% on this amount. They must then pay the TDS out of their own pocket.

Report TDS:
The payer should report the TDS paid in their E-TDS returns.
Generate TDS Certificates
After processing the TDS Returns, the payer can generate TDS certificates (in Form 16A).
Apply for Refund:
To recover the TDS paid out of pocket, businesses can submit a refund request letter to the NBFC.
Until NBFCs are brought on par with banks for TDS purposes by the government, businesses will continue to face these challenges.

Conclusion

TDS compliance on interest payments to NBFCs is a complex issue that businesses must navigate. The legal requirement to deduct 10% tax on such payments can have financial implications and may lead to penalties if not adhered to. While practical challenges exist, businesses can follow the outlined process to ensure compliance and seek refunds for TDS paid out of pocket. Staying informed and proactive in addressing TDS obligations is essential for businesses to avoid financial penalties and maintain good standing with tax authorities.