Although the issue discussed in this article is almost a year old, its effects are still significant for trade and industry, and thus is being highlighted again. The Indian Income Tax Act, 1961, was amended by the Finance Ministry, by inserting sub section 2 to Section 194 R, with effect from 1st July 2022. The objective of this amendment was to plug revenue leakage on various kinds of payments, perks, gifts, incentives, and discounts that are prevalent in the normal course of business. However, subsequent Guidelines and Additional Guidelines issued by the Finance Ministry have not clarified one aspect of the amendment, which is highlighted in this article.
The focus of the article is Question No. 4 and its answer provided in the Guidelines. The Guidelines state that sales discounts, cash discounts, or rebates allowed to customers from the listed retail price represent lesser realization of the sale price itself, and all such discounts will be treated as benefits. However, it is unclear who is the "customer" referred to in the Guidelines.
Most consumer durable and white good companies work through a multi-tier supply chain structure, and there are typically 3-4 or even more Tiers before the goods actually reach the consumer. The brand owner of the manufacturer will have privity of contract only with his Tier 1 customer, and the problem arises when the brand owner or the manufacturer launches various schemes of discounts, incentives, and rebates for downstream channel partners other than Tier 1 to encourage each of the Tiers to increase the brand owner's/manufacturer's sales.
These amounts are meant for channel partners who are not the brand owner/manufacturer's direct "customers." Rather, they are the "customers" of each upstream channel partner of the supply chain, respectively. In order to ensure compliance with Section 194 R, sub section 2, the brand owner/manufacturer has no option but to deduct TDS of Tier 1 on the entire amount routed through him, although this amount is not meant for Tier 1. The unintended consequence of this compliance is that TDS is done on income of the Tier for whom it is not income, resulting in capital blockage for Tier 1 to Tier 3.
One important thing to note is that the channel may sell products from multiple brands. In this situation, all the brand owners and manufacturers will deduct TDS, which can cause a significant amount of capital to be blocked, making it difficult to do business.
Complying with the provisions of Section 194 R, sub section 2 can be expensive, especially for Tier 2 and Tier 3 channel partners who may not have the resources to handle the additional manpower and software requirements.
The intent behind the insertion of Section 194 R, sub section 2 was to prevent revenue leakage. However, the Finance Ministry should have clarified the definition of "customer" in the Guidelines or Additional Guidelines to avoid confusion and difficulty for small businesses.
To be on the safe side, brand owners and manufacturers have been deducting TDS on payments made for discounts, incentives, and rebates, treating the various tiers in the channel as "customers." Any non-compliance can result in penalties and disallowance of expenses.
The term "customer" in commercial terms usually refers to an immediate customer or someone with whom there are regular transactions of sale and purchase. It typically does not include downstream channel partners (Tier 2 to Tier 4) as there are no direct transactions of sale and purchase between brand owners/manufacturers and these partners.
Clarifying the term "customer" to include downstream channel partners would help meet the objectives of the legislation and reduce the compliance burden on the entire channel. This would allow brand owners/manufacturers to deduct TDS directly on payments made to channel partners without blocking capital intended for other purposes.
Industry bodies have made representations to the Finance Ministry on this issue, but it has not yet been addressed in the Guidelines or Additional Guidelines. A quick clarification would contribute to the ease of doing business and benefit one of the largest contributors to direct tax and GST revenue collection.
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