Section 206 AB of Income Tax Act

Section 206AB compliance check of the Income Tax Act is a new rule introduced by the Finance Act 2021 and came into effect on 1st July 2021. Its purpose is to ensure that individuals or businesses who have not filed their income tax returns for the past two years, despite having a high amount of tax deducted or collected at source (TDS/TCS), comply with the law.

According to Section 206AB, if someone pays or credits a sum to a specified person (someone who has not filed tax returns for two years), they must deduct tax at a higher rate. This rate will be either twice the normal rate or 5%, whichever is higher.

This section applies to almost all payments subject to TDS, such as salary, interest or contractor payments. However, there are a few exceptions, like payments covered under sections 192 (salary), 192A (employee provident fund), 194B (lottery), 194BB (horse race winnings), 194LBC (securitisation trusts) and 194N (cash withdrawals).

By enforcing this rule, the government aims to encourage non-filers to stay compliant and submit their income tax returns regularly. However, 206AB and 206CCA are two different sections.

Not in 2024, but in the Union Budget 2023, the government proposed an important change in the definition of a "specified person" under the Income Tax Act, aimed at offering relief to certain individuals.

According to the update, individuals who are not required to file income tax returns for the relevant assessment year, as well as non-residents who do not have a permanent establishment in India, will no longer be treated as non-filers. This means they will not be subject to higher tax deductions at source (TDS).

The updated definition of a "specified person" under Sections 206AB and 206CCA now excludes:

• Non-residents without a permanent establishment in India.

• Individuals who are not obligated to file income tax returns for the assessment year related to the previous year, as notified by the Central Government in the Official Gazette.

This amendment reduces the burden on those who genuinely do not need to file tax returns, ensuring that they are not unfairly penalised by higher TDS rates.

Section 206AB is designed to ensure higher TDS (Tax Deducted at Source) for individuals or businesses that have not filed their income tax returns in the last two assessment years.

This section applies to various types of payments, such as contract payments, professional fees, rent and other transactions. The main goal is to promote compliance and penalise those who fail to file their returns on time.

-Applicability of Section 206AB:

Higher TDS will be deducted for the following types of transactions:

• Contract payments for services or goods.

• Professional charges paid to freelancers, consultants or contractors.

• Rent payments for leasing properties.

• Payments for sale of goods or services.

However, certain types of transactions are excluded from this higher TDS rule:

• Salary payments under Section 192.

• Premature withdrawal of EPF under Section 192A.

• Winnings from lotteries, card games or crossword puzzles under Section 194B.

• Horse race winnings under Section 194BB.

• Income from investment in securitisation trust under Section 194LBC.

• Cash withdrawals under Section 194N.

• Payments to non-residents who do not have a permanent establishment in India.

-Non-Applicability of Section 206AB

• Several payments are not subject to higher TDS under Section 206AB, including:

• Sale of immovable property (Section 194-IA).

• Rent payments exceeding ₹50,000 (Section 194-IB).

• Payments for contractual or professional services above ₹50 lakh (Section 194M).

Transfer of virtual digital assets (Section 194S) to small businesses or individuals with turnover or receipts below specified limits.

When a payment is made to a specified person (someone who has not filed their income tax returns for the last two years and has TDS/TCS of ₹50,000 or more), a higher rate of TDS (Tax Deducted at Source) will be applied. The TDS under Section 206AB will be the higher of the following:

• Twice the rate specified in the Income Tax Act or Finance Act.

• 5% of the payment amount.

For example, if the standard TDS rate for a transaction is 10%, under Section 206AB, the applicable TDS will be 20% (twice the standard rate) or 5%, whichever is higher.

If a person provides their PAN (Permanent Account Number) but has not filed their tax return, the higher TDS rate will still apply. However, if the person does not provide their PAN, a much higher rate, 20%, will be deducted under Section 206AA, which specifically deals with the non-provision of PAN.

Let us say Ramesh makes a payment of ₹5 lakhs for professional services to Suresh. The standard TDS rate for professional services under Section 194J is 10%. However, since Suresh has not filed his tax return for the past year, Section 206AB applies. The applicable TDS will be the higher of:

• Twice the standard rate: 20% (10% × 2)

• Fixed-rate: 5%

Since 20% is higher, Ramesh will deduct ₹1 lakh (20% of ₹5 lakhs) as TDS.

In cases where both Section 206AA and Section 206AB apply, the higher rate between the two will be considered, ensuring that non-compliant individuals face higher tax deductions.

A specified person under Section 206AB of the Income Tax Act refers to an individual or entity that meets certain criteria related to non-compliance with tax filing requirements. This section targets people who have not filed their income tax returns in the past two assessment years despite having a significant amount of TDS (Tax Deducted at Source) or TCS (Tax Collected at Source) deducted from their income.

To qualify as a specified person, the following conditions must be met:

The individual or entity has not filed their income tax returns for the previous two assessment years.

The total TDS or TCS in each of these years is ₹50,000 or more.

For such specified persons, a higher rate of TDS is applicable on any payments they receive. This is either twice the regular TDS rate or 5%, whichever is higher.

However, there are exceptions to who can be considered a specified person. Non-residents who do not have a permanent establishment in India are excluded from this definition. Additionally, individuals who are not required to file income tax returns, such as those with income below the taxable limit, or senior citizens exempt from filing are also not classified as specified persons.

The purpose of this classification is to encourage timely tax filing and prevent tax evasion by imposing a financial penalty in the form of higher TDS rates for non-filers.

Section 206AB has introduced higher TDS rates for non-compliant taxpayers, affecting various sectors differently. While salaried individuals may experience minimal impact, the section significantly influences self-employed professionals, business owners and industries like IT, manufacturing, and services, making it crucial for everyone to stay tax-compliant.

Here is a breakdown of its impact across different sectors:

-Impact on Salaried Individuals

For salaried individuals, Section 206AB does not directly impact the TDS on salaries. Salaries are covered under Section 192 of the Income Tax Act, which is excluded from the purview of Section 206AB.

Therefore, employees who receive their income solely through salary payments are not subject to the higher TDS rates under this section, even if they have not filed their income tax returns in the past two years.

However, individuals earning additional income from other sources, such as freelance work or rent, may see higher TDS rates applied to those incomes if they are classified as specified persons.

-Impact on Self-Employed and Business Owners

Section 206AB has a more significant effect on self-employed individuals, freelancers and business owners. Since many transactions in these professions, such as payments for services or goods, are subject to TDS under various sections of the Income Tax Act, non-compliance with filing returns can result in higher TDS rates.

For instance, professional fees paid to freelancers may be subject to TDS under Section 194J, which could be doubled or raised to 5% under Section 206AB if the recipient has not filed tax returns. This puts additional financial pressure on non-compliant individuals by reducing their cash flow.

-Sector-Specific Impacts

In industries like IT, manufacturing and services, Section 206AB can significantly increase the cost of non-compliance. Many transactions in these sectors—like payments for contractual services, professional fees and rent - are subject to TDS. Failure to file returns could lead to higher TDS deductions, impacting business relationships and operations.

For example, an IT company that outsources services to freelancers or contractors would have to deduct TDS at twice the regular rate or 5%, which may discourage businesses from engaging with non-compliant professionals.

Section 206AB can impact policyholders paying health insurance premiums, particularly those who are non-compliant with their income tax filing obligations. While TDS (Tax Deducted at Source) is typically not applied to health cashless insurance premiums, it may come into play if policyholders earn income through commissions or other taxable sources related to their insurance policies.

If a policyholder is classified as a specified person under Section 206AB, the insurer could deduct higher TDS on such earnings at twice the standard rate or 5%, whichever is higher.

-How Insurers Are Adapting

Insurance companies are increasingly ensuring that they comply with Section 206AB for any payments made to non-filers. For non-compliant health insurance plan policyholders who earn commissions (like agents or partners), insurers may apply additional TDS deductions at higher rates.

This ensures that the insurer adheres to tax regulations while requiring policyholders to file their returns.

-Importance of Filing Income Tax Returns

For policyholders, especially those who receive commissions or other income, it is crucial to file their income tax returns to avoid falling under the higher TDS rates imposed by Section 206AB. By filing timely returns, policyholders can ensure they are not classified as "specified persons" and can avoid unnecessary financial deductions.

Staying compliant not only helps in tax savings but also maintains smooth transactions with insurers.

Under Section 206AB, non-compliance with tax return filing can lead to higher TDS deductions from medical insurance claims, particularly for those receiving payouts under corporate or group health policies.

Suppose an individual or business has not filed income tax returns for the last two assessment years and qualifies as a specified person. In that case, TDS will be deducted at a higher rate (twice the standard rate or 5%) on payments like medical claim reimbursements.

Relevance for Employers Offering Group Health Plans

Employers offering group medical insurance to employees need to ensure that both they and their employees are tax-compliant. If the employer or employees fall under the specified person category, higher TDS deductions from medical claims could potentially affect both parties' financial planning. Therefore, employers need to encourage tax compliance within their workforce to avoid these complications.

Consequences for Individuals

Staying tax-compliant ensures individuals can receive their full medical claim benefits without facing higher TDS deductions. Non-compliance can lead to reduced payouts, affecting their ability to cover medical expenses. Filing timely income tax returns safeguards individuals from these deductions, ensuring they get the full benefit of their medical insurance.

Section 206AB(3) outlines specific exemptions from the higher TDS rates imposed by the section. These exemptions primarily apply to:

-Non-residents without a permanent establishment in India: Foreign individuals or entities that do not maintain a fixed place of business or operations in India are exempt from the higher TDS rate. This ensures that non-residents who may not be subject to India's tax filing requirements are not unfairly penalised.

-Persons notified by the Central Government: Certain individuals or entities, as specified by the Central Government in the Official Gazette, who are not obligated to file an income tax return for the relevant assessment year, are also exempt from Section 206AB. This could include individuals with incomes below the taxable threshold or others deemed not required to file returns.

These exemptions are designed to ensure that only relevant taxpayers face higher TDS rates while protecting those who are not legally required to file returns.

Filing your Income Tax Return (ITR) is essential for settling your tax liabilities accurately. Whether you owe additional taxes or are eligible for a refund, you can only ensure that your tax obligations are fully met by filing your ITR and avoiding potential penalties.

The tax rates you are subject to may vary depending on whether you have filed your ITR in the past or provided your PAN to those you work with. Failing to file returns or furnish your PAN can lead to higher TDS rates, which acts as a financial deterrent.

Beyond the immediate tax implications, filing your ITR on time demonstrates that you are a responsible, law-abiding citizen. It is a good financial habit that contributes to your long-term financial health, ensuring you stay compliant and free from any legal or tax-related issues.

Understandably, health insurance plans play a critical role in tax planning, offering individuals both financial security and tax-saving opportunities. Premiums paid towards health insurance policies are eligible for tax deductions under Section 80D of the Income Tax Act.

This allows policyholders to claim deductions up to ₹25,000 for themselves, their spouse, and dependent children. For senior citizens, the limit increases to ₹50,000, making health insurance a valuable tool in reducing taxable income.

Beyond the tax benefits, health and medical insurance provide crucial coverage for unexpected medical expenses, protecting individuals from financial strain. Experts advise that incorporating these policies into one’s financial plan ensures both immediate tax savings and long-term financial protection.

Furthermore, with the introduction of Section 206AB, non-compliance with tax return filing can lead to higher TDS deductions on other taxable earnings. Staying compliant and maintaining up-to-date tax filings, including claiming deductions for health insurance, can prevent additional financial burdens.

Thus, health and medical insurance are essential not only for safeguarding your health but also for strategic tax planning that ensures optimal savings.

Section 206AB introduces higher TDS rates for non-compliant taxpayers, specifically targeting those who fail to file their income tax returns. The section aims to promote tax compliance by applying higher tax deductions, either twice the standard rate or 5%, whichever is higher.

Individuals must stay compliant with their tax filings to avoid unnecessary financial burdens, including higher deductions on payments like health and medical insurance. In terms of health insurance, staying tax-compliant ensures that policyholders are not subjected to higher TDS on premiums or claim payouts. Filing returns on time also helps maximise tax-saving opportunities under Section 80D.

Looking ahead, the evolving nature of Section 206AB may bring further changes in compliance requirements, emphasising the importance of being proactive in managing tax liabilities and financial planning for the future.