Withholding tax is a tax that is deducted by the payer of the income. This withholding tax is also called retention tax. Under withholding tax, the taxable amount is deducted at source by the payer i.e. the payer of the income is liable to deduct the withholding tax before making payment to the payee.
The withholding tax sounds similar to Tax deducted at source. Many are of the opinion that outside India the terminology for Tax deducted at source (TDS) is Withholding Tax. But there are few differences between TDS and Withholding Tax which we shall study subsequently. In India, the withholding tax is applicable on various sources of income namely: Salary, work contract, Commission, Rent, Interest, Professional services, Technical Services, Income from Business etc.
Let us see how a withholding tax is charged with use of an example which will make it easier to understand the its applicability and simplify the concept of withholding tax.
Example: Let’s assume that Mr. X is a doctor by profession. He is providing dental services to his patients. One such patient is Mr. Y who has taken dental services from Doctor Mr. X for which the doctor (Mr. X) has charged his patient (Mr. Y) a bill of Rs 50,000. So now while paying the bill to the doctor (Mr. X) the patient (Mr. Y) has credited Rs 45000 to the doctor (Mr. X) and deducted Rs 5000 as withholding tax. Mr. Y has deducted the withholding tax. Now it is Mr. Y’s liability to deposit the deducted withholding tax with the Central Government. Under withholding tax it is the liability of the payer to deduct the tax and deposit the same with the government. In the above stated scenario, the income tax credit can be availed by the doctor (Mr. X) while filling his income tax return.
Withholding tax is applicable in case of payments done to non-resident individuals. So when a liability to carry out payment to a Non-Resident Indian arises the payer is liable to deduct the tax at source. As per the Income Tax Act under section 195, it is obligatory for the payee, who is the person responsible to make payment, to deduct the tax at the time of payment or at the time of crediting the payment in the account of the Non-Resident Individual.
It is to be noted that the payment is taxable only on the chargeable income i.e. the chargeable payment to be done to the non-resident individual. If the payment does not fall under the tax net then the person responsible to make any such payment and deduction (payee) shall make an application to the assessing officer. An application to the assessing officer can also be made to know the exact chargeable portion on which the withholding tax has to be deducted. Only the person making payment for the services received by him from a non-resident individual can deduct withholding tax. And it is obligatory on the part of the payee to deposit the deducted withholding tax with the government. The withholding tax is to be deducted as per the prescribed rates stated in the act or at the rates mentioned in the Double Taxation Avoidance Agreement whichever is beneficial for the non-resident individual. Now that we have seen how withholding tax is charged and deposited with the government, let us now see the benefits of the withholding tax.