Taxing gifts — circular adding to confusion

From July 1, a new TDS provision (Section 194R) is being introduced in the Income Tax Act with a view to taxing benefits and perquisites provided by one person to another. In terms of the Budget Speech of the Finance Minister, the provision ostensibly seeks to cover business promotion strategies, whereby there is a tendency of businesses to pass on benefits/gifts to their agents/distributors, etc.

These benefits were always taxable as business income in the hands of the recipient. However, due to the inherent non-cash nature of the transaction as well as a lack of reporting mechanism, it was observed that in many instances, the recipient did not pay tax on these transactions. The intent of the new TDS provision is to cover cases where there is a circumvention of income by taking or receiving income in a non-monetary form (that is, in the form of benefits or perquisites).

The new TDS provision comes with its own set of interpretational and practical challenges. Section 194R requires the person providing a “benefit” or “perquisite” to a resident to deduct tax at 10 per cent on the value of such benefit or perquisite. Such benefit or perquisite must necessarily arise in the course of the business or profession of the recipient. A de minimis exemption of ₹20,000 per recipient per financial year is available.

On a bare reading of the provision, it appears that TDS will be deducted when the benefit is paid wholly in kind or partly in cash and partly in kind. It is also understood that the provision would not apply when the benefit is fully paid in cash.

The term “benefit” or “perquisite” is not defined in the Income Tax Act. In terms of the regular commercial parlance, the transactions that appear to be covered under Section 194R are: providing sales promotion incentives/gifts to distributors; gifts to celebrities and social media influencers endorsing brands; and bikes, helmets, etc., given to delivery boys by online aggregator companies.

Similarly, given the statutory requirement that the benefit must accrue in the course of business or profession of the recipient, reward/loyalty points provided to customers shall be excluded from the TDS requirement.

On June 16, 2022, the Central Board of Direct Taxes (Board) issued a circular to clarify the scope and applicability of the new TDS provision. However, ironically, the circular issued for the purpose of “removing any difficulty” has added to the confusion. While the intent of issuing a circular must be lauded, a deeper reading suggests that the same is contrary to the statutory provision.

The circular clarifies that TDS would have to be deducted even when the benefit is paid in cash. The interpretation adopted by the Board appears to be directly in the teeth of the statutory provision as well as the Supreme Court judgments. The apex court has held that only those benefits that were paid in non-monetary form were covered under the charging provision — Section 28(iv). Given the analogous wordings of the charging and TDS provision, there is no plausible reason why the same principle should not apply in the context of Section 194R. In any case, most of the cash payments are covered by other TDS provisions and there was no need to introduce a new provision to cover such cash payments.

No requirement to verify

Income tax can be only levied on real, not hypothetical, income. The government can collect tax only when it is authorised by law to do so. Therefore, before deducting tax, it is imperative for the benefit provider to examine whether the amount is even taxable in the hands of the recipient.

However, the Board circular states that there is no requirement for the provider to verify whether the income is taxable in the hands of the recipient. This interpretation is contrary to the machinery provision as well as the scheme of deduction of tax at source.

The implementation of the provision would also be a challenge. In a lot of cases, the gifts are offered to small agents to incentivise sales. A lot of these agents form part of the lower income threshold. The new TDS compliance would inherently increase the cost of compliance even in cases where the income may not be taxable per se. The onerous burden placed on the deductor would further discourage grant of such gifts/incentives.

In the context of the pharma industry, free medical samples are rarely used by doctors themselves and cannot qualify as “benefit” or “perquisite”. These samples are usually dispensed to patients free of cost. There are regulatory guidelines governing the provision of free medical samples. The levy of TDS on free samples as a “benefit” is debatable.

It is well settled that a Board circular cannot override the Act. To the extent that the guidelines are contrary to the Act, the same is not binding on the assessee or the courts. Given the industry-wide ramifications, it would be advisable for the government to re-examine the recent Board circular. The circular, in its current form, may set the ball rolling for another round of unwarranted tax litigation.

Visalaksh is a Partner, and Tater is a Principal Associate, at Economic Laws Practice (ELP). Views are personal

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