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INCOME TAX REVIEW

Interest & Dividends

This article deals with the provisions of Tax Deduction at Source in respect of Interest on Securities (Section 193), Dividends (Section 194) and Interest Other than Interest on Securities (Section 194A).

The specific issues of each of the sections are dealt with first and the common issues are discussed in the latter part of the article.

  1. Interest on Securities (Section 193):
    Any person responsible for paying any interest on securities to a resident is required to deduct income-tax at source at the rates in force. Tax shall be deducted under section 193 either at the time of credit to the account of the payee or atthe time of payment thereof, whichever is earlier. For this purpose credit to any suspense account or any other account by whatever name called shall be deemed to be a credit of such income to the account of the payee.

    1. Definition of Securities:
      "Securities" are not defined in the IT Act, However, "interest on securities" has been defined under cl. (28B) of Section 2 which has been introduced by the Finance Act, 1988 w.e.f. 1st April, 1989. "Securities" includes shares, scrips, stocks, bonds, debentures, debenture-stocks or other marketable securities of a like nature in or of any incorporated company or other body corporate and also Government Securities. This is the definition in Forward Contracts (Regulation) Act, 1952.

      Section 2(28B) reads as under :-

      "interest on securities" means, -

      1. interest on any security of the Central Government or a State Government;

      2. interest on debentures or other securities for money issued by or on behalf of a local authority or a company or a corporation established by a Central, State or Provincial Act;

      "Interest on securities" was assessable earlier under ss. 18 to 21 of the IT Act. Under section 8 of the IT Act, 1922, tax was payable by an assessee under the head "Interest on Securities" in respect of interest received by him on any security of the Central Government or of the State Government or on debenture or other securities issued by or on behalf of a local authority or a company. Section 18 of IT Act, 1961 excluded annuity deposit as defined under to Section 280B from the purview of securities and confined securities, as before, to bonds or debentures issued by or on behalf of local authority, company, corporation established by Central, State or Provincial Act or any security issued by Central or State Government.

    2. Securities On Which No Tax Is Required To Be Deducted:

      1. 4 ¼ percent National Defence Bonds, 1972, where the bonds are held by any resident individual;

      2. 4 ¼ percent National Defence Loans, 1968, or 4 ¼ percent National Defence Loan, 1972, held by an individual.

      3. National Development Bonds;

      4. 7 year National Savings Certificates (IV Issue);

      5. debentures issued by any institution or authority or any public sector company or co-operative society (including a co-operative land mortgage bank or a co-operative land development bank) notified by the Central Government;

      6. 6½ percent Gold Bonds, 1977 or 7 percent Gold Bonds, 1980, held by a Resident individual provided conditions specified in section 193 are fulfilled;

      7. any securities of the Central / State Government; and

      8. securities beneficially owned by the Life Insurance Corporation of India or the General Insurance Corporation of India or to any of the four companies formed by virtue of the schemes framed under section 16(1) of the General Insurance Business (Nationalisation) Act, 1972 or any other insurer (applicable from June 1, 2002).

    3. Tax Rates:

      1. Where recipient is a resident noncorporate assessee:

        1. in respect of listed securities: 10 percent plus surcharge plus education cess;

        2. inrespect of unlisted securities: 20 percent plus surcharge plus education cess;

      2. Where the recipient is a domestic company: 20 percent plus surcharge plus education cess.

    4. Non-Deduction:
      It will not be necessary to deduct tax at source on debentures paid to a resident individual, if all the following conditions are satisfied:

      1. The debentures are issued by a company in which the public are substantially interested;

      2. The debentures are listed on a recognised stock exchange in India;

      3. The interest is paid by the company by an account payee cheque;

      4. The aggregate amount of interest paid or likely to be paid by the company to the holder of the debentures during the financial year does not exceed Rs.2500.

    5. Charitable Institutions, Scientific Research Association, Etc. [Rule 28AB]
      With effect from 1st April 2004, if the recipient of income is one of the two entities given below, then a few additional conditions should be satisfied to make the application in Form 13:

      1. it is in receipt of income (or deemed income) derived from property held under trust wholly for charitable or religious purposes and it claims exemption under section 11 or 12; or

      2. it is required to file a return in respect of a scientific research association, news agency, association or institution or any hospital or other medical institution or trade union referred to in section 139(4C).

      In any of the above cases, application in form 13 can be made if the following conditions are satisfied:

      1. the person concerned has furnished the returns of income for all assessment years for which such returns became due on or before the date on which the above application in form no. 13 is made;

      2. the trust, scientific research association, news agency, association or institution, fund or trust or university or other educational institution or trade union referred to above is for the time being approved for the purpose of exemption from income tax; and

      3. the applicant gives a list of deductors from whom amounts are to be received without deductions of tax at source every six months alongwith the name, addresses and the amounts received.

    6. Amount Payable To Fund Established For The Benefit Of Armed Forces –
      Since the income of these organisations is exempt under section 10(23AA), no tax should be deducted at source under section 193 from the income of such funds – Circular No. 735, dated January 30, 1996.

    7. Interest To Provident Funds
      The Board has decided that in the case of a provident fund whose income is exempt under section 10(25)(ii), the income by way of interest on securities of Central and State Governments may be paid to such provident fund without deduction of income-tax at source – Circular No. 741, dated April 18, 1996.

    8. Interest To Certain Institution Whose Income Is Exempt Under Section 10(23C) –
      In the following cases tax is not deductible in respect of interest on securities payable to the following –

      Recipient Circular No. Period
      Ramkrishna Math & Ramkrishna Mission  11/2002,
      dated November 11, 2002       		Any
      Shri Ram Chandra Mission, Chennai 2/2003,
      dated March 11, 2003
             		 Financial years 2002-03
      and 2003-04.
      World Renewal Spirit Trust, Mumbai 3 /2003,
      dated March 11, 2003      		 Financial years 2002-03
      and 2003-04.

    9. Deep Discount Bonds
      Tax is deductible at the time of redemption [ see Circular No. 4/2004, dated May 13, 2004 ]. If the recipient has paid tax on interest on accrual basis, he can take relief under section 197 or 197A .

    10. TDS from payments made to residents only
      Under the provisions as they existed in section 193 up to 30th May, 2003, the person responsible for paying any income by way of interest on securities was required to deduct tax at source at the time of credit of such income to the account of the payee or at the time of payment thereof in cash or by issue of a cheque or a draft or any other mode at the rates in force. Further, under the then existing provisions contained in section 194-I, any person who was responsible for paying to any person any income by way of rent was required to deduct tax at source at the specified rates. Hence, the provisions of these sections applied in relation to payments made both to non residents as well as residents.

      Under the then existing provisions contained in section 195, any person responsible for paying to a non-resident, not being a company, or to a foreign company, any interest (not being interest on securities) or any other sum chargeable under the provisions of the Income-tax Act (not being income chargeable under the head Salaries) was required to deduct tax at source at the rates in force.

      The Finance Act, 2003 amended the provisions w.e.f. 1st June, 2003 to enjoin that the person responsible for deducting tax under section 193 and 194-I from interest on securities and rent shall be required to do so in the case of payments made to residents only. The Finance Act, 2003 expanded the scope of section 195 so as to include payments made by way of interest on securities.
       

  2. Deduction of Tax at Source from Dividends [Sec. 194 ]
    The law places liability for tax deduction at source on dividend in respect of those dividends which are distributed by "an Income company or a company which has made prescribed arrangement for the declaration and payment of dividend", including dividends on preference shares. "Indian company" has been defined under cl. (26) of Section 2 to include all companies registered under any law in India established by a Central, State or Provincial Act and / or recognised by the Board as a Company.

    No tax is deductible from June 1, 1997 to March 31, 2002 and from April 1, 2003 in the case of dividend referred to in section 115-O, which applies only to domestic companies.

    1. Deemed Dividend:
      The principal officer of an Indian company or a company which has made the prescribed arrangements for the declaration and payment of deemed dividend under section 2(22)(e) within India to a shareholder who is resident in India, is required, before making any payment, to deduct tax at source from the amount of dividend at the prescribed rate. For the financial years 2003-04 and 2004-05, rate for tax deduction is 20 per cent (plus surcharge plus education cess).

    2. Cases when tax is not deducted or deducted at lower rates
      In the following cases tax is not deducted or deducted at lower rates :

      1. Dividend Up To Rs. 2,500 –
        No tax shall be deductible after March 31, 2002, in the case of a shareholder, being an individual if the following conditions are satisfied –

        1. the dividend is paid by the company by an account payee cheque; and

        2. the amount of such dividend or, as the case may be, the aggregate of the amounts of such dividend distributed (or paid or likely to be distributed or paid) during the financial year by the company to the shareholder, does not exceed Rs.2,500 (Rs. 1,000 from June 1, 2002 to July 31, 2002).

      2. Dividend to LIC / GIC: No deduction of tax at source shall be made under this section in respect of any dividend payable to the Life Insurance Corporation of India or the General Insurance Corporation of India or to any of the four companies formed by virtue of the schemes framed under sub-section (1) of section 16 of the General Insurance Business (Nationalisation) Act, 1972 or any other insurer in respect of any shares owned by them or in which they have full beneficial interest.

      3. Dividend To Shri Ram Chandra Mission- During 2002-03, dividend can be paid to Shri Ram Chandra Mission, Chennai, without tax deduction- Circular No.2/2003, dated March 11,2003.

      4. Even a company registered under section 25 of the Companies Act without any profit motive will have to be assessed only as a company if there is any liability to tax, but since such companies cannot declare dividend, section 194 can have no application.
         

  3. Deduction of Tax at Source from interest other than interest on securities [Sec.194A]
    Any person, not being an individual or a Hindu undivided family, who is responsible for paying to a resident any income by way of interest other than income chargeable as interest on securities, is required to deduct income-tax thereon at the rates in force [see Appendix 1] at the time of credit of such income to the account of payee or "interest payable account" or "suspense account" or at the time of payment thereof in cash or by issue of a cheque or draft or by any other mode, whichever is earlier.

    With effect from 1st June, 2002, Individuals and HUFs who are subject to the audit u/s. 44AB during the financial year immediately proceeding the financial year in which the interest is credited or paid, shall be liable to deduct tax at source.

    1. When Section 194A is not applicable –
      By virtue of section 194A(3), tax is not deductible in the following cases :

      1. where the aggregate amount of interest credited or paid (or likely to be credited or paid ) during the financial year does not exceed Rs.5,000;

      2. where interest is credited or paid to any banking company, co-operative society engaged in backing business, public financial institutions, the Life Insurance Corporation, the Unit Trust of India, a company or a co-operative society carrying on the business of insurance, or notified institutions [see Taxmann’s Direct TaxesCirculars, Vol.2, 2002 edition];

      3. where interest is credited or paid by the firm to its partner(s);

      4. where interest is credited or paid by a co-operative society to its members [i.e. interest on time deposits / other deposits to members holding one share – Circular No. 9/2002 ] dated September 11, 2002 ] or to any other co-operative society;

      5. where interest is credited or paid in respect of deposits under the schemes of Post Office (Time Deposits), Post Office (Recurring Deposits), Post Office Monthly Income Account, Kisan Vikas Patra, National Saving Certificates VIII Issue, and Indira Vikas Patra;

      6. where interest is credited or paid in respect of deposits (other than time deposits made on or after July 1, 1995) with a banking company or (interest to non-members on deposits) with a co-operative society engaged in carrying on the business of banking;

      7. where interest is credited or paid in respect of deposits (by non-members) with a primary agricultural credit society or primary credit society or co-operative land mortgage bank or co-operative land development bank;

      8. where interest is credited or paid by the Central Government under different provisions of the direct taxes; and

      9. where the interest is paid or credited on compensation awarded by the Motor Accidents Claims Tribunal if the amount of payment or the aggregate amount of such payment does not exceed Rs.50,000 (applicable from June 1, 2003).

    2. Tax rates
      Generally, tax is deducted at the rate of 10 per cent (plus surcharge+and education cess) if the recipient is a resident non-corporate assessee and 20 per cent (plus surcharge + and education cess) if the recipient is a domestic company

    3. Adjustment in the case of short deduction
      The person responsible for making the payment at the time of making any deduction increase or reduce the amount to be deducted under section 194A for the purpose of adjusting any excess or deficiency arising out of any previous deduction or failure to deduct during the financial year.

    4. Tax Deduction from Interest On The Deposits With Bank And Housing Finance Companies
      Section 194A provides for deduction of income-tax at source from payments of interest exceeding Rs.5,000 in a financial year on time deposits made with a banking company or with a co-operative society engaged in carrying on the business of banking or with housing finance companies which are eligible for deduction under section 36(1)(viii). The aforesaid limit of Rs.5,000 shall be computed with reference to the income credited or paid by a branch of the banking company or the co-operative society, as the case may be. The interest on time deposits made with a primary agricultural credit society or a primary credit society or a co-operative land mortgage bank or a co-operative land development bank, shall not be subject to the requirement of deduction of income-tax at source. The expression "time deposits" has been defined to mean deposits, excluding recurring deposits, repayable on the expiry of fixed period.

    5. Interest to Certain Institutions Whose Income is Exempt Under Section 10(23c)
      In the following cases interest other than interest on securities can be paid without tax deduction -

      Recipient Circular No. Period

      Ramkrishna Math & 3/2002, Any
      Ramkrishna Mission dated June 28, 2002

      Shri Ram Chandra Mission, 2/2003, Financial years 2002-03
      Chennai dated March 11, 2003 and 2003-04.

      Sri Sathya Sai Central Trust , 12/2002,
      Bangalore; Sri Sathya Sai Institute dated November 22, 2002. Financial years 2002-03
      of Higher Learning, Bangalore; and 2003-04.
      Sri Sathya Sai Medical Trust,
      Bangalore

      World Renewal Spirit Trust, 3 /2003, Financial years 2002-03
      Mumbai dated March 11, 2003 and 2003-04.

    6. Deduction of tax is to be made from gross interest and not net interest payable after mutual off between parties - CIT vs. S.K. Sundararamier & Sons [1999] 240 ITR 740 (Mad.).

    7. Deposit in joint names
      In case of a deposit in joint names, in the absence of any proof to the contrary, both the persons can be treated as payees for the purpose of deduction of tax under this section. As such, unless the person paying the interest on such deposit(s) has definite information about the beneficial ownership of deposit(s), the interest payable under a joint account can be aggregated with the amount of interest payable by that person to any one of the payees in their separate or independent accounts. The persons responsible for deducting tax under this section, in the absence of any information to the contrary, may therefore, aggregate the interest of a joint account with the interest on deposits in the individual account who has higher interest income – Circular No. 256, dated May 29, 1979.

    8. Interest payment under Land Acquisition Act
      The Supreme Court has stated in Bikram Singh v. Land Acquisition Collector [1996] 89 Taxman 119 that section 194A is not applicable in the case of delayed compensation for compulsory acquisition.

    9. Interest payable on hundi by buyer to supplier in the case of outstation sale of goods – Whether tax to be deducted by the buyer
      In the case of out-station sale of goods, the supplier draws a hundi on the buyer and routes it through his banker along with transport documents with instructions to deliver the documents on retirement of the hundi and no charge interest on the amount of hundi from the date of acceptance thereof to the date of actual payment. A problem arises whether, in such circumstances tax is to be deducted at source by the party retiring the hundi on the amount of interest at the time of making payment to the bank, or whether the exemption provision of section 194A(3) would be attracted. In the aforesaid case, interest paid by the buyer to the supplier is not to the bank as such but only routed through the bank.

      In accordance with section 194A(3)(iii)(a) no tax is to be deducted at source in respect of interest paid to a bank but whether the interest from the buyer is not for the bank as such, but only routed through bank to the supplier who is the recipient, the buyer has to deduct tax at source under section 194A from the interest paid and routing of the interest through bank will not make any difference – Circular No. 48, dated November 7, 1970.

    10. Interest payable by consignors to their commission agent
      Tax is to be deducted at source in accordance with section 194A from the interest paid by the consignors to their commissioner agent even where such interest is paid under an arrangement whereby the commission agent retains for himself the interest due to him at the time of paying to the consignor the moneys due to him at the time of paying to the consignor the moneys due to him on account of the consignment – Circular letter F.No. 12/12/68-IT(A-II), dated September 23,1968.

    11. Interest payable by retail finance service company
      Payment made by the assessee, which is a company engaged in retail finance services, corporate advisory services, securities trading and assets securitisation, to the persons who has invested in a scheme floated by the assessee under which the investor is guaranteed a minimum return of 1.5 per cent a month, is ‘interest’ as defined in section 2(28A) and as such assessee is liable to deduct tax at source under section 194A from payment of interest made to investors under the above scheme – Viswapriya Financial Services & Securities Ltd. vs. CIT [2002] 258 ITR 496 (Mad.).

    12. Payment under a hire purchase agreement
      When a part of purchase instalment is paid by a hirer to the owner under a hire purchase contract, the provisions of section 194A are not attracted – Instruction No. 1425, dated November 16, 1981.

    13. Who is an individual
      Section 194A is not applicable in some cases if the payer of income is an individual or a Hindu Undivided Family. Even an artificial judicial person can be treated as an individual under section 194A. Status fixed for the purpose of assessment cannot get altered for the purpose of section 194A. Once a trust has been assessed as an individual under section 161, section 194A will not be applicable to it - ITO vs. Arihant Trust [ 1995 ] 214 ITR 306 (Mad.).

    14. Difference between the issue price and the face value of CPs and CDs not interest.
      The Circular No. 647, dt. 22nd March, 1993 has clarified that difference between the issue price and the face value of the Commercial Papers (CPs) and the Certificate of Deposits (CDs) has to be treated as ‘discount allowed’ and not as ‘interest paid’. Therefore, the provisions of section 194A are not applicable in the case of transactions in these two instruments.
       

  4. Cases where Tax is Deducted at Lower Rate or when no tax is deducted
    In the following cases tax is not deducted or deducted at lower rates :

    1. Application to the Assessing Officer in Form No. 13
      It is open to the recipient to make an application in Form No. 13 to the concerned Assessing Officer and obtain a certificate authorising the payer to deduct tax at lower rates or deduct no tax at all.

    2. Declaration to the payer in Form No. 15G
      Form No. 15G can be submitted if the following conditions are satisfied –

      1. The recipient is a person other than a company or firm.

      2. Tax on the estimated income of the recipient of the financial year will be nil.

      3. The amount of interest on securities, dividends, interest other than interest on securities, payments in respect of deposits under National Savings Scheme and income in respect of units credited or paid during the previous year does not exceed the maximum amount which is not chargeable to income-tax (i.e. Rs.50,000).

    If the aforesaid condition are satisfied, the recipient of income can submit Form No. 15G in duplicate to the payer and no tax will be deducted at source.

    Condition (c) is not applicable up to May 31, 2002. Condition (c) is not applicable even from June 1, 2002 if the income of recipient is exempt under section 10(20), (23AA), (23AAB) (23BB), (23BBA), (23BBC), (23BBD), (23BBE), (23C), (23EB), (25), (25A), (26BB) and (29A) – Circular No. 4/2002, dated July 16, 2002. In other words, if income of the recipient is exempt under these clauses of section 10, then the recipient (other than a company or firm) can give a declaration in Form No. 15G to the payer of the income to the effect that tax on his income will be nil. In such a case no tax will be deducted at source.

    Condition (c) is not applicable from June 1, 2003 if the recipient is a senior citizen (i.e., a resident individual who is at least 65 years at any time during the previous year) [in the case of a senior citizen, declaration should be submitted in Form 15H].

    One should also keep in view the following points –

    1. The payer of the income will deliver to the Commissioner of Income-tax one copy of aforesaid declaration on or before the 7th day of month next following the month in which the declaration is furnished to him [ sec. 197A].

    2. It is the duty of the Assessing Officer to give an opportunity to rectify the defects in the declarations in Form No. 15G and imposition of tax liability without giving an opportunity to the petitioner to rectify the defects in the declarations, in spite of the petitioner asking for an opportunity to rectify the defects, is not justified in the eyes of law – Vijay Hemant Finance & Estates Ltd. vs. ITO [1999] 105 Taxman 519 / 238 ITR 282 (Mad.)
 

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