Cross-border payments are always a tricky area of taxation. Whenever an Indian resident makes a payment to a non-resident, the law ensures tax is deducted at the source to avoid revenue loss. Section 195 of the Income Tax Act, 1961 deals with the deduction of TDS (Tax Deducted at Source) on payments made to non-resident Indians (NRIs).
However, the law also acknowledges situations where deducting full TDS may not be justified. That’s where Section 195(3) comes into play. This provision gives certain categories of non-residents the right to apply for a certificate that allows them to receive payments without deduction of tax, or with a lower deduction.
What is Section 195 of the Income Tax Act?
To understand Section 195(3), we must first look at the broader section. Section 195 of the Income Tax Act, 1961 deals with the deduction of TDS on payments made to non-residents. This includes payments like interest, royalty, fees for technical services, dividends, or any sum that qualifies as income chargeable under the Act.
The idea is simple: every person making a payment to non-residents must deduct TDS at the time of payment or credit, whichever is earlier. This ensures India collects its fair share of taxes from income generated within the country, even if the recipient is outside India.
Why Section 195(3) is Important
While deducting TDS is mandatory, there are cases where the non-resident may not actually owe tax in India, or the income may already be covered by Double Tax Avoidance Agreements (DTAAs). In such cases, deducting TDS creates unnecessary cash flow problems and refunds later.
Section 195(3) addresses this by allowing non-residents to apply for a certificate from the Assessing Officer. With this certificate, they can receive payments without TDS, or with a reduced TDS rate.
This provision is especially relevant for multinational companies, foreign banks, and other entities engaged in cross-border trade and services.
Also Read: What to Do If You Receive a Reassessment Notice
Who Can Apply under Section 195(3)?
The Income Tax Act restricts eligibility to certain categories. Typically, the following non-residents can apply:
- Foreign companies carrying on business in India through a branch or project office.
- Non-resident banking companies operating through branches."
They can apply to the Assessing Officer for a certificate allowing payments to them without TDS deductions. This balances compliance with business convenience.
Key Conditions under Section 195(3)
The Income Tax Rules specify conditions that must be met before applying:
- The applicant must have been regularly assessed to income tax in India.
- They should have filed all returns due under the Act.
- No default should exist in payment of taxes, interest, or penalties.
- Proper arrangements must exist to deduct tax at source from payments made to others.
If these conditions are satisfied, the Assessing Officer may grant the certificate.
Example to Understand Section 195(3)
Let’s take an example.
A foreign bank branch in India earns interest income from lending activities. Normally, Indian payers would deduct TDS before making payments to this branch. However, since the branch already pays full tax on its Indian income, deducting TDS again causes duplication.
In this scenario, the bank can apply under Section 195(3) for a certificate. Once approved, Indian payers can make payments without deducting TDS.
This saves the bank from cash flow issues and aligns with the principle that tax should only be collected once.
Also Read: Special Provisions for Non-Residents Turning Resident
Difference Between Section 195(2) and 195(3)
Both subsections deal with TDS but have different scopes.
- Section 195(2): Applicable when the payer believes only part of the payment is taxable. The payer can apply for permission to deduct TDS only on the taxable portion.
- Section 195(3): Applicable when the non-resident recipient wants to receive income without TDS, because they believe no tax or lower tax is payable in India."
Thus, Section 195(2) benefits the payer, while Section 195(3) benefits the non-resident recipient.
Impact on NRIs and Businesses
For non-resident Indians, TDS deductions on payments or income of non-resident Indians can create significant delays in accessing funds. While refunds are possible, they take time and create compliance hassles.
By applying under Section 195(3), eligible entities ensure smoother cash flows, reduced compliance, and faster access to funds. For Indian businesses, it provides clarity and avoids disputes with foreign partners.
Compliance Requirements
- Application is made in Form 15C or 15D as prescribed.
- It must be submitted to the Assessing Officer with supporting documents."
- The certificate, once granted, remains valid until withdrawn.
- The payer must confirm the validity of the certificate before making payments without TDS.
This way, compliance is ensured at both ends.
Challenges in Implementation
While Section 195(3) provides relief, it is not without challenges.
- Obtaining the certificate requires detailed paperwork.
- The Assessing Officer has discretion, which may cause delays.
- Not all non-residents are eligible.
Still, it remains an important provision balancing tax compliance with business convenience.
Also Read: Tax on Investment Income and Long-Term Capital Gains for Non-Residents
Conclusion
Section 195 of the Income Tax Act, 1961 deals with the deduction of TDS on payments made to non-resident Indians. While it ensures compliance, Section 195(3) introduces flexibility by allowing certain non-residents to receive payments without deduction of TDS, through a certificate issued by the Assessing Officer.
This provision is a win-win: it protects government revenue while reducing hardship for foreign companies and branches operating in India.
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