In the world of Indian taxes, your Permanent Account Number (PAN) is like your financial identity card. If you don't show it when you're supposed to, the tax department assumes the worst and applies a penalty rate of tax. This is exactly what Section 206AA is all about. It’s a rule that forces anyone paying you (such as your bank or employer) to deduct a significantly higher tax slice if you haven't provided your PAN. As we move into the 2025-26 tax year, this rule has become even more important because an inoperative PAN (one not linked to Aadhaar) is now treated the same as having no PAN at all.

What Exactly is Section 206AA?

Section 206AA is a compliance tool. Its job is to make sure the tax department tracks everyone who earns taxable income in India.

The Core Rule: If you are receiving a payment that attracts Tax Deducted at Source (TDS), you must give your PAN to the person paying you.
The Consequence: If you don't provide it, or if the PAN you provide is invalid, the person paying you must deduct tax at a significantly higher rate.

The Higher of Three Rule (Rates for 2025-26)

If Section 206AA kicks in, your TDS won't be the usual 1% or 10%. Instead, the deductor must use the highest of these three rates:

The rate specified in the Income Tax Act (the normal rate for that payment).
The rate in force (the rate mentioned in the Finance Act for the year).
A flat 20% rate.

Example: Imagine you have a Fixed Deposit. Normally, the bank cuts 10% TDS on your interest.

With PAN: Bank cuts ₹1,000 on ₹10,000 interest.
Without PAN: Section 206AA kicks in. The highest of 10% or 20% is 20%. The bank now cuts ₹2,000. You just lost an extra ₹1,000 instantly!

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The 2025 Inoperative PAN Warning

As of late 2025, simply having a PAN card isn't enough. If you haven't linked your PAN with your Aadhaar, your PAN becomes Inoperative.

The Law says: An inoperative PAN is treated as if no PAN was provided.
The Result: Even if your employer or bank has your PAN number on file, if the status is inoperative, they are legally forced to apply the 20% TDS rate under Section 206AA.

Exceptions: When 20% isn't 20%

There are a few special cases in the 2025-26 rules where the 20% rate is lowered:

E-commerce & Goods (194-O & 194Q): If you are a seller on an e-commerce site or selling goods over ₹50 Lakh, and you don't provide a PAN the higher rate is capped at 5% instead of 20%.
Non-Residents (NRIs): If an NRI doesn't have a PAN but provides other documents (like a Tax Residency Certificate, Tax ID from their home country, and contact info) the 20% rule might not apply to payments like interest, royalties, or dividends.

Summary Table: Section 206AA at a Glance

Type of Payment

Normal TDS Rate (with PAN)

Rate Without PAN (Sec 206AA)

Bank Interest / FDs

10%

20%

Professional Fees

10%

20%

Contractor Payments

1% or 2%

20%

E-commerce Sales (194-O)

0.1%

Salary

Slab Rates

Slab Rate or 20% (Whichever is Higher)

How to Avoid the Section 206AA Trap

Double-Check Your Status: Log into the e-filing portal and make sure your PAN is Active and Operative.
Update Your Records: Every time you start a new job, open a new FD, or take a freelance gig, ensure your PAN is correctly mentioned in the contract or bank form.
No Form 15G/15H Without PAN: You cannot submit these forms to stop TDS on interest if you don't have a valid PAN. The bank is required to reject them and cut 20% tax instead.

Conclusion

Section 206AA is basically a tax on negligence. In 2025-26, it is no longer enough to just own a PAN; you must ensure it is linked, active, and shared with anyone who pays you. The jump from a 1% or 10% rate to a flat 20% can seriously hurt your monthly cash flow. If you discover that your PAN was inoperative and extra tax was cut, your only way to get that money back is to file your ITR and claim a refund, a process that can take months. Save yourself the headache: link your Aadhaar, keep your PAN active, and always keep your Motilal Oswal profile updated with your latest tax details.

Frequently Asked Questions (FAQs)

My bank already has my PAN. Why did they cut 20% TDS?

It’s likely because your PAN is Inoperative (not linked to Aadhaar). Check your status on the Income Tax portal immediately.

Can I get the extra 20% tax back?

Yes, but only by filing your Income Tax Return (ITR) at the end of the year. If you owe less tax than what was cut the government will refund the difference.

What is an Invalid PAN?

A PAN is invalid if it doesn't exist in the tax database, if it belongs to someone else or if the name on the card doesn't match the name on your bank account.

Does Section 206AA apply to salary?

Yes. If you don't give your PAN to your employer, they must deduct tax at your slab rate or 20%, whichever is higher.

What if the normal tax rate is already 30%?

Then 30% will be cut. Section 206AA says the highest of the rates must be used. Since 30% is higher than 20%, the 30% rate applies.

I’m an NRI. Do I need an Indian PAN?

Not always. If you provide a Tax Residency Certificate (TRC) and other required documents from your home country, you can often avoid the 20% rate.

Can I provide my Aadhaar instead of PAN?

Yes. Under the Interchangeability rule, you can often provide your Aadhaar. The system will automatically link it or generate a PAN for you.

What is the deadline to link PAN and Aadhaar?

The final deadlines have passed, but you can still link them by paying a ₹1,000 fine. Your PAN will become operative again after about 30 days of linking.

Does 206AA apply to small payments?

Yes. If the payment is high enough to require TDS (like ₹40,000 interest in a bank), Section 206AA will apply if there's no PAN.

Why is the rate 5% for some sellers?

For specific sections like 194-O (e-commerce) and 194Q (purchase of goods), the government capped the penalty at 5% to avoid hurting small business cash flows too severely.

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