India's TDS System Needs Major Overhaul: Experts Call for Simplification

India's TDS Framework Demands Urgent Reform

India's tax deduction at source system, known as TDS, was created to ensure steady revenue collection and improve tax compliance. Over time, however, this framework has transformed into a source of significant complexity for businesses. Companies now face cash-flow stress and frequent litigation due to the system's intricate nature.

Growing Complexity and Compliance Challenges

The scope of TDS keeps expanding almost every year. Tax professionals argue that comprehensive rationalization of withholding tax provisions is now essential. The current system features a confusing multiplicity of rates and thresholds.

TDS and TCS rates currently range from as low as 0.1 percent to as high as 30 percent. This variation depends entirely on the nature of each transaction. Such a fragmented structure dramatically increases the risk of compliance errors. These mistakes often lead to disputes, interest charges, and penalties.

Rohinton Sidhwa and Amit Bablani, partners at Deloitte India, explained the situation clearly in their pre-budget booklet. They stated that the current withholding tax framework involves multiple TDS and TCS rates. This creates significant complexity and elevates the risk of compliance errors. Excessive withholding results in liquidity constraints for taxpayers. It also forces additional administrative effort to seek refunds.

The Scale of the Problem

Data from the Central Board of Direct Taxes reveals the magnitude of this issue. Income-tax refunds have increased sharply from Rs. 1.92 lakh crore in FY21 to Rs. 4.76 lakh crore in FY25. A substantial portion of these refunds comes from excess TDS and TCS deductions.

This situation creates blocked working capital for businesses. It also leads to higher interest outgo for the government. Both parties suffer from the current inefficient system.

Recent Changes and Ongoing Issues

The Finance Act of 2024 took some steps toward simplification. It reduced several 5 percent TDS rates to 2 percent. The legislation also aligned the TDS rate on e-commerce transactions with that on purchase and sale of goods, setting it at 0.1 percent.

Despite these changes, tax professionals point out that the underlying structure remains cumbersome. The system still lacks uniformity, creating ongoing challenges for businesses.

Proposed Reforms and Solutions

One key reform proposal involves leveraging India's nationwide GST framework to reduce duplication. Since GST already provides a robust, invoice-level reporting mechanism, experts suggest eliminating TDS and TCS for transactions where GST applies.

Deloitte India has made specific recommendations for improvement:

India now has a Pan-India GST framework with a unified tax reporting system. Experts recommend using this existing system effectively to reduce TDS/TCS compliance burdens. They propose eliminating TDS/TCS on all transactions where GST applies according to the invoice.

The Income-tax Department could obtain necessary information by mandating an appropriate information return from suppliers. Since suppliers already file GST returns, this would not create additional compliance work.

Withholding tax provisions should consolidate into three broad categories:

1. For transactions involving purchase of tangible goods and transactions through electronic platforms (if not subject to GST), a withholding tax rate of 0.1 percent without any threshold limit.
2. For transactions involving supply of services (if not subject to GST), a withholding tax rate of 2 percent without any threshold limit.
3. For residuary transactions like withholding tax on interest and dividends (if not subject to GST), a withholding tax rate of 10 percent.

Procedural Burdens and Enforcement Issues

Experts also highlight the need to ease procedural burdens. The requirement to issue TDS and TCS certificates appears increasingly redundant. In today's digital era, tax credits already reflect electronically through Form 26AS and AIS.

Removing this obligation could significantly reduce compliance costs. Small and mid-sized businesses would benefit particularly from this change.

Perhaps most contentious is the continued use of stringent prosecution provisions. These range from three months up to seven years for delays in depositing TDS and TCS. This applies even when taxpayers pay taxes voluntarily along with interest.

While the law provides relief in cases of reasonable cause, industry feedback suggests prosecution often initiates mechanically. This causes undue hardship for businesses acting in good faith.

Toward a Trust-Based System

As India's tax administration becomes increasingly data-driven, experts argue for a shift in emphasis. The focus should move from excessive withholding and penal action to trust-based compliance.

A simpler, more predictable TDS regime could ease cash-flow pressures significantly. It would reduce litigation and ultimately make tax compliance less adversarial. Both taxpayers and the exchequer would benefit from such reforms.