What is Withholding Tax?

5paisa Research Team

Last Updated: 22 May, 2025 06:51 PM IST

What is Withholding Tax?

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Taxation plays an important role in a country’s economic framework, ensuring that the government collects revenue efficiently. One such tax concept that taxpayers and businesses need to understand is Withholding Tax. In simple terms, withholding tax is the amount deducted at the source of income before it is paid to the recipient.

For individuals and businesses in India, withholding tax applies to various payments, including salaries, rent, commissions, and foreign transactions. This article will provide a detailed guide on withholding tax, including its applicability, rates, impact, and how it differs from Tax Deducted at Source (TDS).

By the end of this guide, Indian taxpayers will have a clear understanding of withholding tax, its compliance requirements, and how it impacts cross-border transactions.
 

What is Withholding Tax?

Withholding tax refers to the tax deducted at the time of making payments to a recipient. Instead of the recipient paying tax later, a portion of the tax is deducted upfront by the payer and deposited with the tax authorities.

This system ensures that tax evasion is minimized and the government collects taxes in advance. In India, withholding tax is applicable to various domestic and international transactions, ensuring that the government gets a steady flow of tax revenue.

Example of Withholding Tax

Let’s say a company in India hires a foreign consultant for advisory services. If the payment to the consultant is ₹10,00,000, the company may be required to withhold 10% tax (₹1,00,000) before making the payment. The consultant receives ₹9,00,000, and the withheld tax is deposited with the Indian tax authorities.
 

Applicability of Withholding Tax in India

Withholding tax is applicable to various types of payments, both domestic and international. Here are the key areas where it is applicable:

1. Withholding Tax on Salaries
Employers deduct TDS under Section 192 on employee salaries.
The tax is deducted based on the income tax slabs applicable to the employee.

2. Withholding Tax on Interest Payments
Banks and financial institutions deduct 10% TDS on interest earned on fixed deposits (FDs) and recurring deposits if the amount exceeds ₹40,000 (₹50,000 for senior citizens).
This tax is deducted before crediting interest to the account.

3. Withholding Tax on Rent
If the monthly rent exceeds ₹50,000, the tenant must deduct 5% TDS under Section 194IB before paying the landlord.

4. Withholding Tax on Professional Fees and Contract Payments
Companies deduct TDS at 10% on professional fees (Section 194J) and 2% on contract payments (Section 194C) before making payments.

5. Withholding Tax on International Transactions
Any payment made to a non-resident for services, royalty, technical fees, or interest is subject to withholding tax.
The tax rate varies based on Double Taxation Avoidance Agreements (DTAA) between India and the recipient's country.
 

Withholding Tax Rates in India

The withholding tax rates depend on the nature of the payment. Here’s a quick look at some common tax rates:

Nature of Payment Withholding Tax Rate Applicable Section
Salary As per Income Tax Slabs Section 192
Interest on Fixed Deposits 10% Section 194A
Rent (Above ₹50,000 per month) 5% Section 194IB
Professional Fees 10% Section 194J
Contractor Payments 2% Section 194C
Commission & Brokerage 5% Section 194H
Royalty/Technical Fees to Non-Residents 10% - 15% Section 195
Dividend Income 10% Section 194


 

Withholding Tax on Foreign Payments

For payments to non-residents, the tax rates vary based on:

  • Income Tax Act Rates (Section 195)
  • Double Taxation Avoidance Agreement (DTAA) between India and the recipient country

For example, India has DTAA agreements with the USA, UK, and other countries that allow reduced tax rates on royalty, dividends, and interest income.
 

Difference Between Withholding Tax and TDS

Many taxpayers confuse withholding tax with Tax Deducted at Source (TDS). While both involve tax deduction at the time of payment, there are key differences:

Aspect Withholding Tax TDS (Tax Deducted at Source)
Scope Includes both domestic and foreign payments Primarily applicable to domestic transactions
Applicability Covers salary, interest, rent, professional fees, foreign payments Applies to salaries, rent, interest, commissions, dividends, etc.
Governing Section Section 195 (for foreign transactions) Sections 192 to 206
Tax Rate Varies based on DTAA agreements for foreign transactions Fixed by the Income Tax Act


 

How to Deposit and File Withholding Tax?

1. Deducting Withholding Tax: The payer (deductor) must deduct tax at the applicable rate at the time of making payment.
2. Depositing Withholding Tax:The deducted tax must be deposited with the government before the 7th of the next month.
3. Filing TDS Returns: Deductors must file quarterly TDS returns using Form 26Q (for residents) and Form 27Q (for non-residents).
4. Issuing TDS Certificates: The deductor must provide the recipient with a TDS certificate (Form 16/16A), showing the amount deducted.
 

Impact of Withholding Tax on Taxpayers

For Individuals

  • Salaried individuals receive a net salary after TDS deduction.
  • They can adjust the TDS deducted against their final tax liability while filing ITR.
  • If excess TDS is deducted, a refund can be claimed.

For Businesses

  • Businesses must ensure timely deduction and deposit of withholding tax to avoid penalties.
  • Failure to deduct and deposit TDS leads to interest charges and penalties under the Income Tax Act.
     

Consequences of Non-Compliance

Failure to deduct or deposit withholding tax results in:

Non-Compliance Penalty
Not deducting tax Deductor pays the entire tax amount + interest
Late deposit of TDS Interest at 1.5% per month till payment
Non-filing of TDS returns Late fee of ₹200 per day


 

Conclusion

Withholding tax plays a crucial role in India’s tax collection system by ensuring that taxes are deducted at the source before payments are made. Understanding withholding tax rates, compliance requirements, and DTAA agreements can help individuals and businesses avoid penalties and optimize tax payments.

For taxpayers, timely filing of TDS returns and claiming deductions can help in managing tax liability effectively. Ensuring compliance with withholding tax rules will prevent legal issues and maintain smooth financial operations.
 

Disclaimer: Investment in securities market are subject to market risks, read all the related documents carefully before investing. For detailed disclaimer please Click here.

Frequently Asked Questions

Various factors, such as total annual earnings and your filing status, determine the income tax amount deducted from each paycheck.

The withholding of federal taxes relies on the details you furnish on your W-4 form, which is completed and submitted to your employer upon starting a job. If there is a substantial overpayment or underpayment in income tax, it is likely necessary to revisit and update the information on this form.

Workers who had no tax liability in the prior year and anticipated none in the current year can utilise Form W-4 to direct their employer not to withhold any federal income tax from their wages. This exemption remains applicable for the entire calendar year.
 

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