Section 195 of Income Tax Act - TDS on Payments to Non-Residents

Section 195 of the Income Tax Act, 1961 deals with Tax Deducted at Source (TDS) on payments made to non-residents. Whenever a resident or a non-resident makes certain payments to a non-resident or a foreign company, tax must be deducted at source if the income is taxable in India. This section plays a critical role in ensuring that India collects tax on income that arises in India but is paid to persons residing outside the country. It applies widely to payments such as interest, royalty, fees for technical services, dividends and other income.

What is Section 195 of the Income Tax Act?

Section 195 requires any person responsible for paying a sum to a non-resident (or foreign company) to deduct income tax at source at the time of credit or payment, whichever is earlier, if the income is chargeable to tax in India.

The responsibility to deduct TDS lies on the payer, not on the non-resident recipient. This applies even if the payer is an individual or a business and even if the payment is made outside India, as long as the income is taxable in India.

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Purpose of Section 195

The main objectives of Section 195 are:

• To ensure tax collection on cross-border payments
• To prevent tax leakage on income earned in India by non-residents
• To place the compliance burden on the payer, who is easier to regulate
• To align Indian tax law with international taxation principles

This section ensures that tax is collected at the source itself, instead of relying on non-residents to file returns in India.

Who is covered under Section 195?

Section 195 applies when:

• Payer: Any person (resident or non-resident)
• Payee: A non-resident or a foreign company
• Nature of payment: Any sum that is chargeable to tax in India

It applies regardless of:

• Whether the payer has a business in India
• Whether the payment is made in India or outside India
• Whether the non-resident has a permanent establishment in India (subject to taxability)

Similar read: Section 195: TDS on Non-Residents

Payments covered under Section 195

TDS under Section 195 applies to various types of payments made to non-residents, including:

• Interest (on loans, debentures, deposits, etc.)
• Royalty
• Fees for technical services
• Professional or consultancy fees
• Commission or brokerage
• Dividend income
• Any other income chargeable under Indian tax law

The key condition is that the income must be taxable in India under the Income Tax Act or under a Double Taxation Avoidance Agreement (DTAA).

When Is TDS Required Under Section 195?

TDS must be deducted at the earlier of:

• Credit of income to the non-resident’s account, or
• Actual payment (cash, cheque, transfer, or any other mode)

Even a provision or book entry in the accounts can trigger TDS.

TDS Rates Under Section 195

There is no fixed rate under Section 195. The applicable TDS rate depends on:

• The nature of income
• The provisions of the Income Tax Act
• The DTAA between India and the country of the non-resident (if beneficial)
• Whether the non-resident provides PAN

If PAN is not provided, a higher TDS rate may apply under Section 206AA, subject to certain DTAA relaxations.

Role of DTAA Under Section 195

If India has a DTAA with the non-resident’s country, the payer can apply the lower tax rate mentioned in the DTAA instead of domestic law.

To claim DTAA benefits, the non-resident must generally provide:

• Tax Residency Certificate (TRC)
• Form 10F (if required)
• Declaration of beneficial ownership

If DTAA applies, tax should be deducted at the lower of:

• Rate under Income Tax Act, or
• Rate under DTAA

Grossing up of Tax

In some agreements, the payer agrees to bear the tax liability. In such cases, tax must be grossed up, meaning:

• Tax is calculated on a higher amount so that the net amount received by the non-resident remains unchanged

Grossing up increases the overall tax cost for the payer.

Lower or Nil TDS under Section 195

Application to Assessing Officer (Section 195(2))

If the payer believes that:

• Only a portion of the payment is taxable in India

They can apply to the Assessing Officer to determine the appropriate proportion on which tax should be deducted.

Certificate for Lower / Nil Deduction (Section 197)

A non-resident can apply for a lower or nil TDS certificate if their actual tax liability in India is lower than the standard rate.

Consequences of Non-Compliance

Failure to comply with Section 195 can lead to:

• Disallowance of expense under Section 40(a)(i)
• Interest for late deduction or payment
• Penalty under the Income Tax Act
• Prosecution in serious cases

This makes Section 195 compliance extremely important for businesses making foreign payments.

Practical Example

Example 1:
An Indian company pays ₹10,00,000 as technical fees to a US-based consultant.
The income is taxable in India and the DTAA rate is 10%.

TDS must be deducted at 10% (plus applicable surcharge and cess).

Example 2:
An Indian importer pays for purchase of goods from a foreign supplier.
The payment is not taxable in India.

No TDS is required under Section 195.

Common mistakes to avoid

• Assuming TDS applies on all foreign payments
• Ignoring DTAA benefits
• Not obtaining TRC or Form 10F
• Deducting tax at incorrect rates
• Missing deduction on book entries

Conclusion

Section 195 of the Income Tax Act is a crucial provision governing TDS on payments to non-residents. It ensures that India collects tax on income that is taxable in India but paid abroad. The obligation lies with the payer to determine taxability, apply the correct rate, consider DTAA benefits and comply with deduction and deposit timelines. Proper understanding and compliance with Section 195 help businesses avoid disallowances, penalties and cross-border tax disputes.