Introduction

The Indian financial landscape has witnessed a significant surge in mutual fund investments, with investors increasingly opting for these instruments as a means to grow their wealth. In response to this growing trend, the Indian government has put in place several regulatory measures to ensure transparency, fairness, and compliance in financial transactions. One such regulatory measure is Section 194F of the Income Tax Act, 1961. This section deals with the tax deducted at source (TDS) on payments made on account of the repurchase of units by a mutual fund or the Unit Trust of India (UTI). Understanding the intricacies of this section is crucial for both investors and financial institutions to ensure compliance with tax laws and avoid potential penalties.

Overview of Section 194F

Section 194F of the Income Tax Act, 1961, is a provision that mandates the deduction of TDS on any payment made by a mutual fund or UTI to an investor when units are repurchased. The primary objective of this section is to ensure that the government receives its due share of tax on income generated from the repurchase of mutual fund units or units of UTI. This section is applicable to both resident and non-resident individuals, and the rate of TDS may vary depending on the nature of the investor and the amount of the payment.

Applicability of Section 194F

Section 194F is applicable to any person who is responsible for making a payment on account of the repurchase of units of a mutual fund or UTI. The term "any person" in this context includes mutual funds, UTI, and other entities authorized to repurchase units on behalf of investors. The section applies to both open-ended and closed-ended mutual funds, as well as to units issued by UTI.

The section is applicable to the following scenarios:

1. Repurchase by Mutual Funds: When an investor redeems or repurchases units of a mutual fund, the mutual fund is required to deduct TDS on the payment made to the investor.
2. Repurchase by UTI: Similarly, when an investor redeems or repurchases units of UTI, UTI is required to deduct TDS on the payment made to the investor.
3. Resident and Non-Resident Investors: The provisions of Section 194F apply to both resident and non-resident investors. However, the rate of TDS may differ based on the residential status of the investor.

Rate of TDS under Section 194F

The rate of TDS under Section 194F is prescribed by the Income Tax Act and is subject to change through amendments to the Act or notifications issued by the Central Board of Direct Taxes (CBDT). As of the latest available information, the TDS rates under Section 194F are as follows:

1. Resident Investors: For resident investors, the TDS rate is 20% on the income distributed by the mutual fund or UTI at the time of repurchase.
2. Non-Resident Investors: For non-resident investors, the TDS rate is higher at 30% on the income distributed by the mutual fund or UTI at the time of repurchase. Additionally, non-residents may also be subject to surcharge and cess as applicable.
3. No Surcharge or Cess for Residents: Unlike non-residents, resident investors are not subject to surcharge or cess on the TDS amount.

Calculation of TDS under Section 194F

The TDS under Section 194F is calculated on the income component of the payment made to the investor at the time of repurchase. It is important to note that TDS is not deducted on the entire amount paid to the investor but only on the income portion, which represents the capital gains or profits earned by the investor.

The calculation can be explained with the help of an example:

Mr. A, a resident individual, invested ₹1,00,000 in a mutual fund scheme. After a few years, the value of his investment grew to ₹1,50,000. Mr. A decided to redeem his units, and the mutual fund made a payment of ₹1,50,000 to him.

Here, the income component of the payment is ₹50,000 (₹1,50,000 - ₹1,00,000). The mutual fund is required to deduct TDS on this income component at the rate of 20%. Therefore, the TDS amount would be ₹10,000 (20% of ₹50,000).

Exemptions and Exclusions under Section 194F

While Section 194F mandates the deduction of TDS on payments made during the repurchase of units, there are certain exemptions and exclusions that investors and financial institutions should be aware of:

1. Exemption for Certain Funds: Certain mutual funds and UTI schemes that are specifically exempted under the Income Tax Act are not subject to TDS under Section 194F. These exemptions are typically applicable to funds that are set up for social welfare or other specific purposes and have been granted exemption by the government.
2. Exemption for Specific Investors: Certain categories of investors, such as government institutions, may be exempt from TDS under Section 194F. Additionally, investors who have furnished a valid certificate for lower or nil deduction of tax under Section 197 of the Income Tax Act may also be eligible for exemption or a lower rate of TDS.
3. Exemption for Long-Term Capital Gains: In cases where the income from the repurchase of units qualifies as long-term capital gains (LTCG) and is eligible for exemption under Section 10(38) or other relevant sections of the Income Tax Act, TDS under Section 194F may not be applicable.

Compliance Requirements

Compliance with Section 194F is crucial for mutual funds, UTI, and other entities responsible for making payments on account of the repurchase of units. The following compliance requirements must be adhered to:

1. Deduction of TDS: The mutual fund or UTI must deduct TDS at the prescribed rate before making the payment to the investor. Failure to deduct TDS can result in penalties and interest under the Income Tax Act.
2. Deposit of TDS: The TDS amount deducted must be deposited with the government within the specified time frame. The due date for depositing TDS is typically the 7th of the following month in which the deduction is made.
3. Filing of TDS Returns: The mutual fund or UTI must file quarterly TDS returns with the Income Tax Department, providing details of the TDS deducted and deposited. The returns must be filed using Form 26Q for resident investors and Form 27Q for non-resident investors.
4. Issuance of TDS Certificates: The mutual fund or UTI must issue TDS certificates to the investors, providing details of the TDS deducted and deposited. The TDS certificate is typically issued in Form 16A for resident investors and Form 16C for non-resident investors.
5. Maintenance of Records: The mutual fund or UTI must maintain proper records of the TDS deducted, deposited, and returns filed. These records should be preserved for a period of six years from the end of the relevant financial year.

Penalties for Non-Compliance

Non-compliance with the provisions of Section 194F can result in severe penalties for the mutual fund, UTI, or other entities responsible for making payments. The following penalties may be imposed for non-compliance:

1. Penalty for Failure to Deduct TDS: If the mutual fund or UTI fails to deduct TDS as required under Section 194F, they may be held liable to pay the entire amount of TDS that should have been deducted, along with interest. The interest is calculated at the rate of 1% per month or part of a month from the date the TDS was deductible until the date it is actually deducted.
2. Penalty for Failure to Deposit TDS: If the mutual fund or UTI fails to deposit the TDS amount with the government within the specified time frame, they may be liable to pay interest at the rate of 1.5% per month or part of a month from the date the TDS was deducted until the date it is deposited.
3. Penalty for Failure to File TDS Returns: If the mutual fund or UTI fails to file TDS returns within the due date, they may be liable to pay a penalty of ₹200 per day for each day of delay, subject to a maximum amount equal to the TDS amount.
4. Penalty for Incorrect Filing: If the TDS returns filed by the mutual fund or UTI contain incorrect information, they may be liable to pay a penalty of ₹10,000 to ₹1,00,000, depending on the nature and severity of the default.