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An Overview on Retention Tax

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An Overview on Retention Tax

The Indian Constitution has given the power only to the Central Government to levy as well as collect tax. People whose gross income surpasses the exemption ceiling have to pay taxes according to the rates referred in the Income Tax Act. Such taxes are charged on the gross income of the last year and to be paid in the consecutive financial year. The residential status of the individual is also considered while calculating the taxable amount.

Residential Status

Income tax payable by an individual is calculated depending on his or her residential status, i.e. whether the individual is a resident or non-resident of the country. A person may be referred as a 'resident', if he or she stays in the country for the stipulated period of time during last year (from 1st April to 31st March) for either,

  • 182 consecutive days or more in previous year
  • She/he should reside in India for a time span of minimum 60 days or even more during previous year. Also, he/she is required to stay for a total 365 days or more in 4 years just preceding the previous year

An individual who doesn't meet the criteria may be referred as a 'non-resident'.

Tax liability - For the Non Residents

Non-resident Indians are required to pay tax for the income that he earned from the country. It may include,

  • Any royalty, fee or interests for providing any technical service by a legitimate resident Indian
  • Income earned from the businesses or assets in India
  • Salary disbursed for the services offered in India

Retention tax - An Introduction

Retention tax may be defined as the obligation on a payer to deduct tax while making payment towards particular purposes like commissions, rents, salary, professional service etc. as per the rate determined by the tax administrators.

The provision of tax retentions is a machinery one applicable to the payers to ensure easy tax collection and retrieval. The provision is free from charging provisions applicable to the recipient companies.

Direct Tax Provisions

While making payment to a non-resident, the person paying is liable to deduct tax at the source. According to the Income Tax Act, it is an obligation for the payer to subtract taxable amount at the source while making the payment or transferring the payable amount to the bank account of the recipient.

However, if the income is non-taxable, the payer may apply to the tax accessing personnel to evaluate the proper proportion that will be chargeable to the tax. The tax amount should be cut on the amount liable to tax.

The taxable amount should be deducted as per the rate referred in the Income Tax Act or Double Taxation Avoidance Agreement (DTAA) whichever will be advantageous to assessee. The payer is responsible to deduct tax while making any payment to a non-resident as per the pre-set rate.

Rate of Tax Retention

The rates of tax retention for making payments to a non-resident are as follows,

  • Interests - 20 percent
  • Dividend rendered by domestic organizations - Nil
  • Royalty - 10 percent
  • Technical service - 10 percent
  • Other services -
    • Individual - 30 percent of earnings
    • Company - 40 percent of net earnings

The above-mentioned rates are common and are applied according to the nations with which India doesn't possess any DTAA.


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