Section 194O of the Income Tax Act

  • Author :
  • TATA AIG Team
  • Published on :
  • 21/11/2023

The retail landscape of India has undergone a remarkable transformation in the past decade, mainly due to the exponential growth of e-commerce businesses. The rise of e-commerce in India has been nothing short of extraordinary, revolutionising the way people shop, sell, and conduct most of their day-to-day activities today.

However, e-commerce businesses in India were exempt from the basic income tax structure for other retail and corporate participants until 2023. It obligates them to deduct a TDS (Tax Deducted at Source) amount from most of the payments they make. But as the volume of e-commerce operators and participants in India continued to expand, it became crucial to bring them within the ambit of the TDS.

With the same objective, the Government of India announced the inclusion of Section 194O in the Income Tax Act of 1961 in the Union Budget of 2020. After the implementation of this section on 1st October 2020, it became mandatory for e-commerce businesses (both participants and operators) in India to pay TDS to the government.

This article discusses everything you need to know about Section 194O of the Income Tax Act and how it can impact your e-commerce business.

The Genesis of E-Commerce in India

Before we delve into the details of Section 194O of the Income Tax Act, let’s discuss the origin and growth of e-commerce in India. Its roots can be traced back to the early 2000s with the launch of some popular online marketplaces such as Flipkart and eBay.

These platforms aimed to connect retail buyers and sellers over the internet, listing a wide range of products from books to electronics at competitive prices.

Soon, these e-commerce platforms gained widespread popularity, resulting in the launch of several more such businesses in the forthcoming years. The main factors that fueled the e-commerce revolution in India include the increased penetration of the internet, the proliferation of smartphones, and the emergence of digital payment platforms.

As per the current estimates, there are more than 19,000 e-commerce companies in India. Furthermore, the Indian e-commerce industry is expected to grow at a Compound Annual Growth Rate (CAGR) of 27% to become a 163-billion-dollar industry by 2027.

Understanding Section 194O of the Income Tax Act

Background

As the number of e-commerce companies in India continued to grow, the government felt a need to bring them under the formal TDS structure. That is why, it proposed the inclusion of section 194O in the Income Tax Act during the presentation of the Union Budget of 2020.

The primary goal of the 194O TDS section was to ensure that all companies offering e-commerce platforms in India withhold a TDS on the sale of goods and services through their apps or websites, thus ensuring tax compliance by the sellers.

Section 1940 was formally passed in the Parliament and came into effect on 1st October 2020. So, it became mandatory for all registered e-commerce companies in India to follow the rules and regulations of this section from the Financial Year 2021 and henceforth.

Applicability

The Section 194O TDS rules apply to all e-commerce operators in India, which can be broadly described as any person or entity who owns, operates, and manages a digital or electronic platform for an ecommerce business. It covers a wide range of marketplaces, ranging from e-commerce websites to smartphone apps.

Section 194O of the Income Tax Act involves two parties – e-commerce participants and e-commerce operators. They can be defined as follows:

E-commerce Participants

An e-commerce participant refers to an individual or entity who is engaged in the sale of their goods or services (or both) through an e-commerce platform. They do not operate an e-commerce platform but only sell their products through it.

They need to register themselves as sellers to offer their products on specific e-commerce websites or apps. One participant can even register with multiple e-commerce platforms.

E-commerce Operators

As mentioned above, e-commerce operators refer to individuals or entities that can own, run, and manage digital or electronic platforms for the sale of goods or services (or both). Their main objective is to create platforms that can act as an interface between buyers and sellers.

They are responsible for collecting payments from consumers and distributing them to online retailers and merchants (known as e-commerce participants).

E-commerce operators invite retailers and merchants to register their products or services (or both) on their platforms so that they can reach a wider audience. In return, they might have to share a portion of their profits or pay a commission to the e-commerce operator.

Provisions

As per section 194O of the Income Tax Act, all registered e-commerce operators in India are required to deduct a TDS of 1% (0.75% for the Financial Year 2021 applicable till 31st March 2021) from the gross amount received from the sale of products or services through their online platforms. The 194O TDS rate remains fixed for all e-commerce participants, irrespective of their nature, type, and size.

Time of TDS Deduction

This deduction has to be made at the time of credit or payment to e-commerce participants. It means that the e-commerce operators are required to deduct the 194O TDS amount before making payments to e-commerce participants against the sale of their goods or services through the e-commerce platforms.

Rate for TDS Deduction

As mentioned, the 194O TDS rate remains the same, i.e., 1% of the gross sales amount, for all e-commerce participants, irrespective of their nature, size, and type.

However, if an e-commerce participant is a resident individual or a Hindu Undivided Family (HUF), the gross sales amount should exceed ₹5 lakhs for TDS deduction under section 194O. No TDS deductions are applicable if an e-commerce participant is a non-resident individual.

Furthermore, if an e-commerce participant fails to provide their KYC documents, including a PAN card and an Aadhar card, the rate for 194O TDS deduction is 5%, irrespective of the gross amount.

Claiming LDC for Lower Tax Deduction

Section 197 of the Income Tax Act allows certain taxpayers to apply for a Lower Deduction Certificate (LDC) with the Income Tax Department. This certificate helps them to lower their TDS rate under special circumstances. Eligible e-commerce participants can also claim LDC for TDS under 194O to reduce their tax deduction rate.

Issuance of the TDS Certificate

After deducting the TDS from the gross sales amount, the deductor (the e-commerce operator in this case) is required to issue a TDS certificate to the deductee (e-commerce participant in this case).

They can issue this certificate through Form 16A. The TDS certificate helps a deductee claim credit of the deducted tax while filing an Income Tax Return (ITR).

Filing of the TDS Return

After deducting the TDS from the gross sales amount, the deductor needs to deposit the TDS amount with the government. The deductor needs to file Form 26Q through the TDS Reconciliation Analysis and Correction Enabling System (TRACES) to report the amount of the TDS.

What is the Purpose of Section 194O?

The primary purpose of section 194O is to bring all e-commerce businesses in India (both e-commerce participants and operators) within the ambit of the TDS rules under the Income Tax Act.

Of late, a large volume of consumers has started preferring online marketplaces over physical markets. Below are a few reasons behind the growth of the online marketplaces in India:

From the buyer’s point of view:

The availability of abundant choices on online platforms

Helps them to compare different products and choose the best one

Helps them save time, energy, and money

From the seller’s point of view:

Facilitates cost-effective business set-up. They do not need to spend a fortune on buying or renting physical premises for the display of their products

Provide them an opportunity to reach a global audience

Allows them to convey product information efficiently to the buyers

However, this made it difficult for the government to identify small merchants and tax evaders active on online marketplaces. That is why it came up with the solution in the form of section 194O.

Since its implementation, it has ensured e-commerce participants are paying timely taxes to the Income Tax Department of India. Moreover, this section has also increased the Government revenues through proper collection of taxes via authorised channels.

Understanding TDS Deduction Under Section 194O Through an Illustration

Section 194O of the Income Tax Act made it mandatory for all e-commerce operators to deduct and submit TDS to the government with effect from 1st October 2020. The TDS amount has to be deducted from the gross sales amount before making the payment to the e-commerce participants. Apart from the TDS, the e-commerce operator can also deduct the commission amount as per the pre-agreed terms.

Let’s understand the calculation of the TDS under section 194O with the help of an illustration:

Suppose “Great Deals” is registered as a seller on an e-commerce platform “eShop”. Both parties have agreed on a commission of 5% on the total sales made. Considering the gross sale amount of ₹6 lakhs (inclusive of the Goods and Services Tax (GST)) during a financial year, the process for the calculation of the TDS under section 194O and the net payment is as follows:

E-commerce operator – eShop

E-commerce participant – Great Deals

Gross sales in a financial year – ₹6,00,000

TDS – 1% of ₹6,00,000, i.e., ₹6,000

eShop’s commission – 5% of ₹6,00,000, i.e., ₹30,000

So, the total amount that the e-commerce operator (eShop) needs to pay to the e-commerce participant (Great Deals) is (6,00,000 – 30,000 – 6,000), i.e., ₹5,64,000.

The e-commerce operator needs to deduct a TDS of ₹6,000 at the time of making the payment and issue Form 16A to the e-commerce participant. Henceforth, it has to deposit ₹6,000 with the government while filing a TDS return through Form 26Q.

In case, the e-commerce participant (Great Deals) fails to furnish the PAN or Aadhar, the TDS amount would be 5% of the gross sales, i.e., 5% of ₹6,00,000, which equals ₹30,000. The total payment in this case would be (6,00,000 – 30,000 – 30,000), i.e., ₹5,40,000.

Penalties Under Section 194O

The Income Tax Department may levy specific penalties on e-commerce operators if they fail to file the TDS return and deposit the TDS amount within the stipulated time. They are as follows:

The TDS has to be filed by the 7th of every month. In case an e-commerce operator fails to do so, an interest of 1.5% per month is applicable on the outstanding amount.

In case an e-commerce participant fails to deduct the TDS amount, an interest of 1% per month is applicable on the TDS amount.

Additionally, a penalty of ₹200 per day is applicable for non-filing of TDS returns every quarter.

The Impact of Section 194O on E-Commerce Operators and Sellers

The implementation of section 194O has helped streamline tax payments by e-commerce vendors. However, it has also impacted both e-commerce participants and operators in some other ways.

It has increased the burden on e-commerce operators

After the implementation of the 194O TDS section, e-commerce operators now have an additional responsibility for TDS deduction, return filing, and issuing Form 16A. This can be burdensome, especially for small e-commerce operators.

It has increased compliance by e-commerce participants

On the other hand, section 194O has increased compliance by e-commerce participants. Earlier, they may refrain from providing their PAN or Aadhar cards for KYC compliance. However, with the new TDS rules under section 1940, they are forced to furnish these documents to the e-commerce operator.

Impact on Cash Flow

The implementation of the 194O TDS rules has negatively impacted the cash flow of e-commerce participants, especially the small players. They do not get their full payment from e-commerce operators, which requires them to manage their working capital more efficiently.

Tips for E-Commerce Participants and Operators

Below are a few tips to help both e-commerce operators and participants navigate section 194O effectively:

For E-Commerce Operators

Invest in robust accounting and compliance systems to ensure accurate TDS deduction and return filing.

Encourage e-commerce participants to provide their PAN or Aadhar and help in TDS compliance.

Maintain records of TDS deductions and other financial transactions for auditing.

For E-Commerce Participants

Ensure you provide your PAN and Aadhar cards to escape a higher TDS.

Keep track of your TDS for accurate income tax filing.

Consult tax professionals or chartered accountants to understand the implications of section 194O on your business.

To Sum It Up

Including Section 194O in the Income Tax Act of India is a significant development aimed at regulating tax compliance in the e-commerce industry. Earlier, there were no rules for tax deductions on payments made to e-commerce participants, which allowed them to evade their tax liabilities.

As the e-commerce landscape in India continues to grow, all stakeholders need to stay updated on the latest laws and adhere to government regulations.

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FAQS

What is TDS?

TDS means tax deducted at source. As per section 194O of the Income Tax Act, TDS on e-commerce transactions can be defined as a percentage of the gross sales amount that an e-commerce operator is required to withhold and deposit to the government.

How can I claim my TDS refund?

As an e-commerce participant, you can claim your TDS refund through Form 16A at the time of filing your Income Tax Return (ITR). This Form will be provided to you by the e-commerce operator that has deducted the TDS.

When can I claim LDC for TDS under section 194O?

If your income tax liability for a year is less than the applicable TDS, you can ask for an LDC certificate from the Income Tax Department. Once you get an LDC certificate, you can claim it to lower your TDS rate under section 194O.

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