Tax Deducted at Source (TDS) - A simple guide with example

Hello and welcome. In this post, we will talk about “Tax Deducted at Source” which is also known as TDS. We will go through various details starting from what TDS is, when it is applicable and how it works.

Let’s start.

What is TDS?

TDS is an abbreviation for ‘Tax Deducted at Source’. TDS is a means of collection of taxes on income from any entity. Under TDS, the tax is collected at the source i.e, from where the income is generated.

The purpose of TDS is so that people will pay tax as soon as they earn or get an income. Income Tax was generally paid once, at the end of a financial year. With TDS, the whole process is changed. The same amount will now be paid in smaller amounts regularly.

This is advantageous in many ways.

  • The tax payer will not have to pay a huge, bulk amount at once. They can pay in smaller denominations.
  • It also minimizes tax evasion by levying tax on the income (partially or wholly) at the time it is generated. And since it is the responsibility of the person who is making payments to deduct tax, they will do so judiciously.
  • This also helps the government to have a regular economical improvements due to continuous flow of income to the treasury.

Entities involved in Tax Deducted at Source

  • Deductor – The company or person that makes the payment after deducting TDS is called a Deductor.
  • Deductee – The company or person receiving the payment is called the Deductee.

It is the responsibility of the deductor to deduct the TDS before making the payment and deposit the amount to the government.

TDS is deducted irrespective of the mode of payment – cash/cheque or credit to the payee’s account whichever happens earlier. The TDS deducted is linked to the TAN of the Deductor and the PAN of the Deductee.

The Deductee receives the net amount after deduction of tax at source. The Deductee will add the gross amount to their income during their annual returns. The amount which is deducted at source is adjusted against their final tax liability. Basically, it is taking credit of the amount already deducted and paid on their behalf.

What is TDS deducted on?

TDS is deducted from various payments like:

  • Salaries
  • Interest payment by banks
  • Payment of commission
  • Payment of rent
  • Payments made to consultants
  • Payments to lawyers or freelancers

Individuals are not expected to deduct TDS while paying rent or while paying fees to doctors or lawyers. TDS is not applicable to all incomes and all persons for all transactions.

Different rates of TDS have been prescribed by the Income Tax Act for different payments and different categories of recipients. For example, employer deducts TDS at the income tax slab rates applicable. Banks deduct TDS on payments made as interest on fixed deposits @10% or they may deduct @ 20% if they do not have PAN information.

For most payments, rates of TDS are set in the Income Tax Act and TDS is deducted by payer based on these specified rates.

How TDS works?

While making a payment (which is subject to TDS), the deductor deducts a certain percentage of the amount paid as tax and pays the balance to the recipient. The deductor is duty bound to deposit the TDS with the government.

Once deposited this amount reflects in the Form 26AS of individual deductee’s on the TRACES website linked to the Income Tax Department’s e-filing website.

The deductee also gets a certificate from the deductor stating the amount of TDS.  The deductee can claim this TDS amount as tax paid by him (i.e. the deductee) for the financial year in which it is deducted.

Important Note: TDS only applicable above a threshold level.  

You must remember that TDS on any transactions is deducted only when the value of payment is above the specified threshold level. TDS will not be deducted if the value does not cross the specified level.

Different threshold levels are specified by the Income Tax department for different payments such as salaries, interest received etc.

For example, there will be no TDS on the total interest received on FD/FDs from a single bank if it is less than Rs 10,000 per year from that bank.

How to avoid TDS?

If a person expects that his total income in a financial year will be below the exemption limit, he can ask the payer not to deduct TDS. This can be done by submitting Form 15G/15H.

On the other hand, while receiving payment which is subject to TDS, the deductee has to provide his PAN details to avoid tax deduction at the higher rates.

If you are a salaried individual looking for tax saving options, take a look at this post – Investment options for Salaried individuals to save on tax.

That’s it for this post on TDS. If you have any questions or comments, leave them in the comments section below.

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