The recent amendment to the Finance Bill has generated a significant amount of buzz within the Fixed Income securities Ecosystem. This is due to the introduction of a new provision requiring companies to deduct (TDS) Tax Deducted at Source on the interest earned from securities.
However, this decision has not received a very warm welcome from everyone. Some question the practicality of the decision to target tax evaders, while others are concerned about its impact on senior citizens or investors whose income falls below the taxable limit.
The new provision that came into existence will have far-reaching consequences in the Fixed income Securities Ecosystem. It is expected to significantly impact companies that issue bonds or other fixed-income instruments as they will now be required to deduct TDS on the interest paid to investors. This will undoubtedly increase their compliance burden and may even deter them from issuing such securities in the future.
The decision to apply TDS on interest earned from securities has also raised concerns about its impact on senior citizens or investors who fall below the taxable limit. These individuals will now be required to claim a refund for the TDS deducted from their interest income, which could prove to be a significant burden for them.
What exactly is Section 193?
Section 193 is a provision under the Indian Income Tax Act, 1961 that pertains to the deduction of tax at source (TDS) on interest income earned from securities. This section mandates that any company or institution that makes payment of interest on securities to a resident of India should deduct TDS on the interest paid.
As per the new Budget, From 1st April 2023, 10% TDS will be deducted from the interest income generated from Listed Bonds, and 20% TDS (as it was already subject to TDS under the IT Act) will be deducted from the interest income generated from Unlisted Bonds.
If you belong to the tax-exempt category or are subject to a lower income tax rate (below 10%), the interest earned from bonds will still be taxed at your relevant income tax slab rate. However, you can avoid a TDS deduction on your interest income by submitting Form 15G or Form 15H to the bond-issuing company. But in order to do that, a PAN card is compulsory. If the recipient of payment does not provide their Permanent Account Number (PAN), the deductor will be responsible for deducting TDS at the highest marginal rate.
What is the purpose of Amending Section 193?
The recent decision by officials to deduct tax at source is expected to address the issue of under-reporting of interest income by taxpayers. This move is being viewed as a step towards ensuring greater transparency in the tax collection and filing system. The practice of underreporting income has been a persistent challenge for tax authorities across the world. In many cases, taxpayers deliberately conceal the true amount of their income to avoid paying taxes. This not only results in a loss of revenue for the government but also undermines the integrity of the tax system.
To tackle this problem, officials have now decided to introduce a new mechanism that will require tax to be deducted at source from interest income. This means that the payer of the interest will deduct the tax before it is paid to the recipient. By doing so, officials hope to fill the gap in reporting interest income and ensure taxpayers are held accountable for their full income.
The introduction of this mechanism is likely to bring about several benefits. For one, it will provide a more accurate picture of taxpayers’ income and help prevent tax evasion. It will also simplify the process of tax filing for taxpayers, as they will not have to report their interest income separately. Furthermore, it will enhance the overall efficiency of the tax system, making it easier for officials to collect taxes and monitor compliance. While this move has been welcomed by many, it has also raised concerns among some taxpayers who fear it may lead to double taxation or a higher tax burden. Officials have assured that adequate safeguards will be put in place to prevent such outcomes and that the mechanism will be implemented in a phased manner to allow for a smooth transition.
How have the investors perceived this change?
Investors have expressed their discontent over the recent imposition of TDS (Tax Deducted at Source) on their interest incomes. This has caused a lot of concern among investors, particularly those who fall under the lower tax bracket. For many investors, the interest earned on their investments is a source of security and an important means to cover their livelihood expenses. Therefore, the cut in interest income due to the TDS deduction certainly has an impact on their cash flows.
While the government’s intention behind this move is to trace tax evaders, it has ended up leaving a bitter taste in the mouth of humbler investors who depend on their interest income. This new regulation has burdened investors, especially those in the lower tax bracket, who already struggle with various financial obligations.
Which is the loophole for the tax evader?
An individual who evades taxes can potentially avoid consequences by transferring their security to another investor. It’s important to note that we’re not specifically referring to “bond washing transactions” but rather any transaction in which the investor sells the security near the interest payment date.
A “bond washing transaction” refers to a situation where an investor sells their bond shortly before the interest payment date and then buys it back after the interest has been paid. Since the bond is ex-interest when repurchased, he can make a capital gain and avoid tax. If the Assessing Officer determines that a transaction was carried out with the purpose of evading taxes, any interest earned from the transaction will be considered income for the Suppose the Assessing Officer determines that a transaction was carried out with the purpose of evading taxes. In that case, the person transferring the funds (i.e., the transferor) rather than the person receiving the funds (i.e., the transferee). [Section 94(1)]))
Bonds and debentures are frequently traded in the secondary market. The company that issued these securities only pays interest to the security holder who is officially registered as such on the record date. During the period between the Record Date and the Coupon or Interest Payment Date, the Issuer’s books do not reflect any transfer of securities. This is commonly known as the Shut Period. This was implemented to avoid the confusion of coupon payments on a bond in the exact account holder.
There is a period of time when securities cannot be bought or sold in order to facilitate the settlement of accounts. However, due to the negative impact of prolonged shut periods on the security’s liquidity, the Reserve Bank of India has revised its regulations to allow the respective dealers to trade bonds during the shut period, with the aim of improving market liquidity during that time.
Therefore, investors who want to avoid tax deductions at source can sell their security before the closing period begins. By doing so, they can sell their security at a higher price because it will still be entitled to receive interest payments (i.e., it will be “cum-interest”). This is a significant warning sign because: –
- The investor escapes TDS as he is not the final recipient of the interest payment. And through this way, it will be easier for the investor to get exempted from the TDS deduction.
- The income tax authorities would find irregularities in the repurchaser’s tax return, leading to further questioning and assessment. The time and effort made by the authorities will ultimately be wasted until they can track the original investor.
- The repurchaser of the Bond/debenture will be subjected to 10% interest on the income received, whereas his liability would be only for the proportionate period of holding. His only choice to avoid extra taxation is to make adjustments in his return filing for the same.
Let us understand the whole above scenario with the help of an example.
For example – Mr E buys a 10-year debenture with a 12% interest rate for Rs. 100,000 on 1/4/2023 with an annual payout. The interest will be paid on 31st March every year, and the record date is 15th March. Thus making 15-31st March the shut period.
Mr E sold the debenture to Mr R on 1st March 2024 for Rs.1,11,000 (including the accrued interest)
| Party | Holding Period | Accrued Interest (Rs.) | TDS deducted |
| Mr. E | 11 months | 11,000 | Nil |
| Mr. R | 1 month | 1,000 | Rs. 1200 (10% of coupon interest received of Rs.12,000) |
For the assessment year 2023, Mr. R’s interest income will only be Rs. 1000. Even if we assume that he falls under the highest tax bracket of 30%, his tax liability would not exceed Rs. 300. Therefore, Mr. R will need to modify his tax returns to account for the excessive tax deducted at source (TDS). However, this may lead to an inquiry and assessment process.
This is unfair to investors like Mr R, who would have bought the debentures in good faith. Also, it defeats the purpose of charging TDS on interest payments since investors like Mr E could easily evade the tax by transferring the debenture to another party and extra hassle for the transferee party. The TDS discrepancy can cause disruptions in the cash flows of organizations around the interest payment dates. Additionally, it can increase the workload on the income tax office, as they must trace the original buyer and make claims. These issues can arise even with monthly, quarterly, and semi-annual payouts.
Conclusion
Tax evasion is a serious issue that can have a negative impact on a country’s economy. In an effort to combat this problem, new tax amendments are frequently introduced to ensure that everyone pays their fair share of taxes. However, some tax evaders have found a deceptive tactic that can potentially undermine the benefits of these new tax amendments. This tactic can also harm compliant investors who follow the rules and pay their taxes on time. It is essential for policymakers to carefully consider this issue and take appropriate action to prevent fraudulent behaviour. By doing so, they can ensure that the benefits of the new tax amendments are supported by those who seek to avoid paying their fair share of taxes. It is highly advisable that everyone pays their fair share of taxes to support the growth and prosperity of the nation.