Take the following example:
Startup A offers service worth ₹50,000 to a larger business.
April 1, 2016 is the date on which service was availed and payment was due.
B will have to pay ₹50,000 to A. They won’t transfer the full value. Instead they will do the below:
B will transfer ₹45,000 to A
B will deposit the remaining ₹5,000 to the income tax department on behalf of A
This amount is called TDS (Tax Deducted Source) and remains to the credit of A and will be adjusted against A’s total income tax payable at the end of the year.
By March 31, 2017…
A has served 1,000 such customers and each customer has deposited ₹5,000 each to the government (Income tax department) on behalf of A. This results in total tax deposited to IT department is ₹50,00,000. Given A is a startup and possibly due to high expense base, they may not have any income and therefore no tax obligation. Or it could mean that it has tax obligation but it is less than ₹50 lakhs that is deposited. Now A will wait for filing return of income and pursue for a refund from the department.
This means that while A was not obliged to pay tax and got their refund, valuable ₹50 lakhs remained locked in and couldn’t be used.
The tax laws contain a provision where, every company estimating a loss in the subsequent year and will be locking in needless capital with government, can apply to the IT department and request for a certificate that authorises Startup A and similar cos to tell its customers not to deduct tax at 10%. The IT department may issue certification to deduct tax at as low as 1% or even 0%. It will depend on case to case.
Then what’s the catch and why can’t every company use it:
Please note that IT department wants to know following:
0. Your last year income showing such amount of profit that justifies a lower tax deduction certificate or even a Zero tax deduction certificate. There could be a profit in this year and you may still envisage a loss in the next year. That’s fine. Just that your CA should be able to justify the reasons.
0. Next year’s estimate. They will retain a copy in their records and use it to scrutinise when you’re filing your application next year possibly.
0. They need a list of all customers who you expect to transact with during the next year. Now this is where it becomes tricky. If you are a company where there are a humongous number of customers or there are a few but company can’t really predict who these will be, then you can’t be applying for this certificate.
0. So the lower deduction certificate only works best for B2B companies or B2SMB biz provided these are recurring customers.
0. You can also do part lower deduction. That means – if you have some customers who are recurring you can apply for those who are available and IT dept will allow a zero tax rate and for others they can stick to 10%.
0. Each time you raise an invoice you have to share the copy of the certificate and the annexure where the name of the customer is listed.
When giving the projections, while you need to ensure that it gives enough conviction to the IT officer that you deserve a lower deduction due to low profits or losses, do ensure that the projections are realistic.
It takes a few weeks of process to get this done.
If you have further questions feel free to reach out to me or firstname.lastname@example.org.