What Is Withholding Tax in India? All You Need to Know

What is withholding tax in India? All you need to know
Rohit22 December 2023

GlobalTech Solutions, an I.T. service export provider headquartered in India, secured a contract with a client in Germany. As GlobalTech Solutions progressed with the project and submitted their invoices for the services rendered, they were surprised to receive reduced payments from their client in Germany. The unexpected reduction in revenue not only strained their financial resources but also affected their profit margin. 

Upon further investigation, they discovered that the client deducted withholding tax. Typically, the payer deducts this tax amount before remitting the funds to the non-resident service provider. GlobalTech Solutions was unaware of this fact initially.

While they lost a certain amount due to a tax compliance oversight, you can avoid such financial setbacks by learning everything you need to know about withholding tax in this guide. 

What is Withholding Tax? 

Withholding tax is the amount deducted at the payment source by the payer before remitting the amount to the recipient. This tax amount is paid directly to the government. 

In India, withholding tax takes the form of Tax Deducted at Source (TDS) for domestic transactions. However, withholding tax in international or cross-border transactions includes collecting taxes from non-residents on income generated within their jurisdiction.

Withholding tax requires the payer to hold back a certain percentage of the payment and remit it to the tax authorities on behalf of the recipient. This tax withholding serves as a prepayment of the recipient's tax liability. 

Tax expert and CA, Juhi Shah, states, "Withholding tax ensures that non-resident individuals or entities contribute their fair share of taxes on income earned within a country's borders. Therefore, proper withholding tax compliance is not just a legal obligation but an essential component of responsible tax management."

Let’s consider an example of a software development company based in India providing I.T. services to a client based in the USA. The agreed-upon fee for the services is $10,000. However, the USA imposes a 30% withholding tax on payments made to non-resident service providers. 

When the software development company invoices the client for $10,000, the client must withhold 30% of that amount ($3,000) as withholding tax. Thus, the client remits $7,000 to the software development company. 

Other countries, like The United Kingdom, impose 20% on certain interest payments, rents or royalties. In Australia, withholding tax applies to payments made to non-residents for certain types of income, such as dividends, interest, royalties, and fees for the performance of entertainment or sports activities. The withholding tax rate is generally 10%.

However, the landscape of international tax laws is complex and dynamic. Each country has its regulations and tax rates. Therefore, in the previous example, while the client deducted withholding tax in the US, the remaining income of $7000 may be subject to another form of tax in India. This phenomenon is known as double taxation.

Double Taxation: Why Is It Charged?

This form of taxation applies to the same income in two or more jurisdictions. It can happen when income is subject to tax in the country where it is earned and then again in the country where the taxpayer resides.

Offering tax credits or exemptions can avoid or minimise double taxation. Therefore, countries enter into double tax treaties that aim to provide relief to taxpayers by specifying rules for allocating taxing rights. 

According to a report by the Organization for Economic Co-operation and Development (OECD), more than 3,000 double tax treaties are in effect worldwide, reflecting the intricate nature of international taxation. 

Then, how can you avoid losing your business’s hard-earned money in international taxes? 

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