[Opinion] Section 194R – Is it a Brain Teaser for Taxpayers?

Authored by Hema Lohiya – Partner | Deloitte India, Manshi Golchha –  Manager & Aishwarya Alshi – Assistant Manager | Deloitte Haskins & Sells LLP

Table of Contents

1. Background

2. Challenges in implementation of section 194R

3. Conclusion

1. Background

The Finance Act of 2022 had introduced section 194R of the Income-tax Act, 1961, with the objective to widen the tax base by bringing benefits paid by taxpayers, whether convertible into money or not, to their distributors, agents, dealers etc., arising from the business or profession.

In simple terms, government aimed at plugging the tax leakage arising on account of transactions entered by taxpayers for marketing expenditure in the form of gifts, prizes, trips, etc., for dealers and distributors of their products. The taxpayers claimed the said expenditure as deduction in their tax returns. However, since the said benefits or perquisites were in kind, the same were not necessarily reported as income by the recipients in their tax returns, leading to tax evasion.

Section 194R requires the taxpayer to deduct tax at 10% on provision of ‘benefit or perquisite’, whether convertible into money or not, arising from business or profession to a resident. The section provides a de-minimus threshold of INR 20,000 for applicability of the section, such that no tax is to be deducted if the aggregate value of benefits or perquisites provided to a single person during a financial year does not exceed INR 20,000.

Under the insertion of this section, certain clarifications were provided by the Central Board of Direct Taxes (‘CBDT’) vide Circular No. 12 dated 16 June 2022, and Circular No. 18 dated 13 September 2022, for the removal of difficulties in the implementation of provisions of section 194R of the Act.

However, these clarifications triggered more questions than answers.

Therefore, various clarifications were expected in Budget 2023.

2. Challenges in implementation of section 194R

The CBDT has provided certain clarifications and also addressed some issues in the Finance Bill, 2023. However, there are multiple such issues, that are still unaddressed. Some prevailing issues and proposals in Finance Bill, 2023 are discussed in ensuing paragraphs:

1. One of the most prominent issues has been what qualify as benefits, on which the provision of section 194R is applicable. The intent of introducing section 194R was to capture those benefits which were admittedly taxable under section 28(iv) (i.e. non-monetary benefits or benefits received in kind) but were escaping assessment in the absence of reporting framework.

However, as per the first proviso to section 194R(1) and clarification as per Circular No.12, cash benefits are also covered within the purview of section 194R, thus, expanding the scope to cover benefits in the form of cash as well. This created a dichotomy, as based on the decision of the Supreme court in the case of Commissioner v. Mahindra and Mahindra Ltd. [2018] 93 taxmann.com 32/255 Taxman 305/404 ITR 1, it was held that for the benefit to be taxable under section 28(iv) of the Act, the benefit should be received in some form, other than in cash. Therefore, cash benefits were not taxable u/s 28(iv) of the Act. However, the provision of section 194R is mandated for withholding tax on said cash benefits as well. Therefore, the Circular appears to have gone beyond legislative intent and widened the section’s scope.

The Finance Bill of 2023 now proposes to expand the definition of ‘benefit under section 28(iv) and section 194R to cover benefits/perquisites provided in cash or partly in cash and partly in kind.

Rather than solving the issue of whether cash benefits can be covered within the purview of section 194R or not, the Finance Bill, 2023 proposes to expand the definition by bringing in cash benefits within the purview of taxable income.

The said provision may now unsettle the settled questions, for instance as that held by the Supreme Court in the case of Mahindra and Mahindra (referred supra), where write-off of loan for capital assets was held as not taxable under section 28(iv), as it was not a benefit in kind. Will such write-off of the loans now be taxable under section 28(iv) and subject to withholding tax under section 194R?

2. Further, the CBDT, vide Circular No. 12, has widened the scope of section 194R by clarifying that section 194R applies to a benefit or perquisite, irrespective of whether such benefit is chargeable to tax and irrespective of the provision under which it is chargeable to tax.

This has resulted in significant hardship to taxpayers as in the absence of income being taxable, the taxpayer has to claim a refund for such withholding tax, which is time-consuming. Also sometimes, there can be tax credit mismatch resulting in non-receipt of refund.

It may be helpful if the clarifications are provided specifying clearly where the list of benefits are not taxable and therefore no requirement to deduct taxes under section 194R. This should also ease a taxpayer’s compliance burden.

Based on inference from the clarifications in Circular No. 12, the question was whether an interest-free loan can be considered a benefit? As per the clarification, relaxation was provided to banks and financial institutions in respect of the waiver of loans. However, no such relief is provided to other taxpayers. The first question that arises in this scenario is whether said notional interest benefit per-se is taxable? If not, then why is tax to be withheld on the same? Also, what is the benefit to be considered if the transactions are between unrelated parties?

3. The CBDT, vide Circular No. 12, also provides that reimbursement of out-of-pocket expenses should be treated as a benefit/perquisite and section 194R should be applicable. However, reimbursement of expenses would be outside the purview of section 194R, if the expense is incurred wholly and exclusively for the purposes of rendering services to service recipient and the invoice is also in name of such service recipient.

This poses a challenge for service recipients in cases where invoice is issued in their name, but is received by the service provider, as the service recipient is under an obligation to comply with the withholding tax applicable on said invoice. This creates hardship for the service recipients as keeping track of the invoices would be a cumbersome process, especially when the invoice is received by the service provider.

4. Section 194R does not prescribe any valuation method for the valuation of benefit or perquisite. However, CBDT, vide Circular No. 12, clarified that the valuation of benefit should be based on fair market value (‘FMV’), except where the purchase price and price charged if the benefit provider manufactures such item, is available.

More clarification/guidance is required on the basis of the calculation of FMV under various scenarios. For instance, in the case of services, where taxpayers would face challenges to derive the FMV of services provided – in the absence of any clarification, the same can lead to different approaches being adopted by the taxpayer leading to litigation.

3. Conclusion

The proposed amendments in section 194R and section 28(iv) of the Act, while expanding the scope of taxable benefits or perquisites, provided clarity of intention that the provisions are now applicable in respect of benefits in cash or partly in cash and partly in kind.

It will also be helpful if further clarifications are provided to reduce ambiguity and litigation for the implementation of the proposed provisions.

Dive Deeper:
Highlights of the Finance Bill 2023
Income Tax Slab Rates for A.Y. 2024-25 | F.Y. 2023-24
Highlights of Changes Proposed in the New Tax Regime [Section 115BAC]