What is Withholding Tax?

When it comes to flourishing a nation's economy, taxation becomes a major determining factor. The two primary ways taxpayers pay their income tax to the Indian government are quite popular. The first one involves the tax, where you calculate the liability before the due date and then file the returns. So, whatever income tax you calculate, the liability and responsibility of paying it falls on you.

The second type includes the one where you don't pay the tax directly to the government. This type of tax will be deducted from your salary, which the government shall receive. There are two types of taxes under this system - withholding Tax and Tax deducted at source.

We will primarily highlight the various aspects of what is withholding Tax in India in this post.

What is Withholding Tax?

You might wonder what is withholding tax, and here's an overview of the same. 

Withholding tax refers to an obligation wherein a payer must withhold tax when payments are made for commission, rent, professional services, salary, etc. This tax will be applicable when payments are made to non-residents. According to the Income Tax Act's section 195, the payee shall be responsible for deducting tax when depositing payment in the non-resident individual's account. 

The payee will be liable for depositing the deducted withholding tax to the government. The withholding tax amount primarily depends on factors like income amount, type and the country's tax laws. The rate of tax is decided as per the Double Taxation Avoidance Agreement or the 1961 Income Tax Act. The central government of India collects this tax.

How does Withholding Tax Work?

The United States government uses tax withholding to preserve its pay-as-you-go income tax system, often known as pay-as-you-earn. In other words, taxing people at the point of income rather than attempting to collect income tax after salaries are received is what this entails. 

This is how it operates. An employee's employer deducts income tax from their paycheck at the time of payment in accordance with a set percentage. The employer then pays the Internal Revenue Service (IRS) for this. The amount withheld is shown on the employee's paystub, and Form W-2: Wage and Tax Statement contains the total amount withheld each year. W-2s are sent by employers to their staff members annually so they may file their income tax returns.

Several variables determine the deducted amount. These factors include the employee's income, filing status, any withholding allowances they may have claimed, and if they have requested that more money be withheld from their paycheck. Any excess, if justified, is returned to the employee as a tax refund by the IRS.

Calculating Your Withholding Tax

Your Form W-4, which you most likely filled out when you started your employment, substantially determines how much federal and state tax your employer withholds from your cheque. Observe the following information:

• To assist you in determining how much to withhold, Form W-4 inquires about your marital status, number of dependents, and other details. Your paycheck will have less tax deducted if you withhold less.
• The information you provide on your W-4 is then sent via a system known as withholding tables, which your employer's payroll department uses to determine precisely how much income tax—both federal and state—to withhold.
• Your W-4 is subject to change at any moment. Simply get a blank form from the IRS website, complete it, and send it to your payroll or human resources department.

Why is Withholding Tax Charged?

Any nation or government that levies taxes does so purely for financial purposes. The growth of the economy, healthcare system, and infrastructure are some of the purposes for which this money from income taxes and other taxes is used.

Additionally, withholding tax is levied to start generating income early. The yearly income tax is collected in the latter part of the fiscal year. Since taxpayers pay withholding taxes immediately, they enable the government to collect revenue all year.

The benefits of withholding tax are that every transaction is now recorded down and analysed. The person making the payment has the responsibility for it. Therefore, all of these payments are monitored by the government. This makes it possible for the tax authorities to monitor every transaction that takes place.

Reducing tax evasion is also among the significant benefits of withholding tax. There is no way to avoid this tax because the payer must pay it right away.

Rates of Withholding Tax

Withholding tax is applied at the following rates for various payments: 
• Withholding tax is payable at 20% for dividends paid by domestic corporations.
• There is no withholding tax on royalties paid.
• Payments for technical services are subject to a 10% tax.
• A 10% withholding tax is levied on other services.
• Individuals are taxed at a rate of 30% of their income.
• Businesses are taxed 40% of their earnings.

Types of Withholding Taxes

There are two different types of withholding taxes:

US Resident Withholding Tax  

The first and most widely mentioned withholding tax is the one on the personal income of US residents, which every employer in the US must collect. Employers collect withholding tax and transmit it immediately to the government under the existing system, with employees paying the remaining when they file their tax returns in April each year.

Non-resident Withholding Tax  

The other type of withholding tax is imposed on non-resident foreigners to guarantee adequate taxes on income earned within the United States. A non-resident alien is a foreign-born person who has not passed the green card or significant presence criteria.

How is the Assessment of Non-Resident Assessee Done?  

The evaluation of a non-resident taxpayer is conducted via a representative. A non-resident taxpayer can be evaluated either directly or through a designated "agent." Individuals deemed as "Agents" for a non-resident taxpayer include:

• Individuals employed by or serving as trustees for non-resident Indians.
• Any individual with business ties to a non-resident.
• Any person receiving income from a non-resident or acquiring capital assets in India from a non-resident.

The consequences of non-payment of withholding tax are broadly classified as under:

Failure to deduct taxes and non-payment of the deducted tax to the government may lead to penalties. The minimum penalty, determined by the assessing officer, applies, while the maximum penalty is equivalent to the un-deducted or unpaid tax amount. Interest is applicable until the date of withholding tax payment.

Difference Between Withholding Tax And TDS

Given that both withholding Tax and Tax deducted at source (TDS) are paid during payments, they may seem comparable. However, there is a distinction between the two.

What is the Withholding Tax Payment Due Date?

The withholding tax must be remitted by the 7th day of the month in which it was deducted and is applicable for all months except March. For March, the withholding tax is required to be paid by April 30.

What are the Withholding Tax Returns Filling Due Date?

Quarterly withholding tax returns must be submitted, providing details for each payee and the corresponding tax amount deducted in that particular quarter. 

Withholding Tax Certificate

• The payer is required to furnish the payee with this certificate every quarter.
• This certificate for withholding tax deduction can be acquired online by downloading it from the TRACES website.

PAN Card and Filling of returns

• In accordance with the amendment dated April 1, 2010, it is mandatory for a foreign company to register with Indian Tax Authorities and acquire a Permanent Account Number (PAN).
• A foreign company is obligated to provide PAN details to the payer in India.
• Failure to furnish PAN details or the absence of a PAN may result in a higher withholding tax rate, either exceeding the existing rate or a flat 20%. This leads to additional withholding taxes, which are ineligible for credit in a foreign country.
• The absence of a PAN renders any application for reduced withholding tax unacceptable. Therefore, it is strongly recommended for foreign companies to receive commissions, fees, royalties, or interest from Indian companies to obtain a PAN.

Conclusion

Withholding tax meaning is an amount deducted directly from an employee's earnings by the employer, contributing to an individual's tax liability and paid to the government. The responsibility for collecting this tax lies with the central Government of India. It is crucial to comprehend withholding tax, as it can affect any salaried individual whose income surpasses the government-set threshold.