The new section 194Q along with 206AA and 206 AB(I) has caused new headache for the tax heads across corporate India.

The government has placed controls on the flow of money across the economy through these new sections. Service industry being well equipped to deal the TDS issues but the manufacturing and trade sectors will struggle with the new rules being announced.

There has been a sense of caution in finance departments of the companies as

  • How to comply with these new sections?
  • What are the focus areas before compliances?

And, once the compliance is done on the TDS payable side, what will be course of action for the accounting of the TDS and TCS receivable for the business?

This problem can be stated from three perspectives, which needs improvement before companies can comply with the changes brought by the Government:

  • Implementing the TDS deduction on the entire Profit and Loss
  • Determination of TDS vs TCS on a particular transaction
  • Accounting for the TDS and TCS receivable as a blocked working capital

 1.  Implementing the TDS deductions on the entire profit and loss

There are many ifs and buts in the implementation of the new provisions as:

a. If the vendor has not filled its returns in past 2 years, then the rate is different for the TDS.

b.  If the vendor has complied then the rate is the usual rate of TDS.

c. Vendor is not complied in the first month but has come back with its certificate of compliance for returns in the later period.

d. Vendor complied with the tax returns rules in the beginning but failed to file the return in the later period.

e. Vendor has just started its business, then the 2 years rule shall be at a later stage.

f. Vendor has changed the PAN / Merged or got acquired, then the tax records need to be updated again.

g. Vendors need to mapped to each and every expense / purchase line item of the profit and loss account.

The businesses have to implement a vendor master in their system or a new system where they need to maintain the history of each of vendor before making any payments / credits to such vendors. The SAPs and Oracles of the world would need customization (which is an expensive affair) or the good old excels will come in handy for the business but the same shall not be able to accommodate the volume of data of corporate India. This leads to a requirement of technology solution which can plug into the legacy ERPs of the companies and maintain these details in an efficient manner.

“Unless a business implements an efficient solution to these issues, the finance departments of companies will be heavily overburdened with work”

All the above becomes the pre-requisites before any business can implement the new rules.

2.  Determination of TDS vs TCS on a particular transaction:

Other than the earlier sections of the TDS compliance the new sections 194Q and 206C 1H have interesting cross over where at the time of receiving money (advance) it is not clear as whether the payer has deducted TDS under 194Q or not. If yes, then the accounting for such deduction needs to account for, whereas if the payor has not deducted then receiver has to collect TCS per the 2nd proviso of 206C 1H. However, there is significant time lapse between the receipt of such money and the actual status check on the same from the new rules’ perspective.

As a matter of prudence, it is better to assume that the TDS have not been deducted and comply with TCS but that is not very effective as there will be additional working capital investment in such case and increased follow-ups on the same.

On the hand, assuming that the 194Q has been complied by the payor of the money is also risky as the case maybe different than the assumption and the additional interest and penalty for late compliance of TCS shall be cost for the businesses.

Solution to this issue lies in the AR / Sales reconciliation of the business. As soon as there is a money received in the account in a particular month, the first thing should happen is a sales register reconciliation with the AR register.

Following such, shall result into either mapping of the receipts with the invoices or the booking of advance payments. This summary is then to be communicated to the customer / payors along with the estimated break-up of the payment and confirmation be taken from the payor on the same.

Timely reporting to customers shall ensure that the books reconcile with the customers/ payors and the confirmations shall help in classification of the transactions as TDS u/s 194Q complied and the remaining that are required to be complied as TCS u/s 206C 1H.

3.  Accounting for the TDS and TCS receivable as a blocked working capital

It is well established that any TDS receivable is part of the sales which was never received in bank account and in case of TCS receivable, it is the money that has been over paid than the cost of the purchase. Both of these accounts represent a chunk of working capital that is not available to the business unless they are looking to pay their tax instalment (both advance tax and the final tax).

The law of Income Tax Act, 1961 requires one more element before this chunk of working capital can be claimed as a credit, i.e., before claiming any of the TDS or TCS appearing in the 26AS statement:

a.   There has to be revenue booked against the TDS deducted, and

b.   In case of TCS, there has to be expense booked against the TCS collected

The Rule 37BA 3(i) and 3(ii) of the Income Tax Act, 1961 in relation to Credit for TDS for the purposes of section 199, states:

“(3) (i) Credit for tax deducted at source and paid to the Central Government, shall be given for the assessment year for which such income is assessable.

(ii) Where tax has been deducted at source and paid to the Central Government and the income is assessable over a number of years, credit for tax deducted at source shall be allowed across those years in the same proportion in which the income is assessable to tax.”

Hence, this can be concluded that “The mere appearing of the TDS / TCS in 26AS do not entitle a claim of the Tax credit. 26AS needs to be mapped to the books of accounts with income and expenses of the business and that too with the relevant time period”

So far, the TDS has been a matter of service industry. Over the period the service industry developed SOPs and processes around to get by. Whereas the manufacturing and trade industry has to deal with TDS for the first time. And as such there are few major changes to the accounting of the TDS / TCS receivable that are now required.

Before companies comply with changes required, let’s talk about the current accounting process and the challenges it creates for the business.

Current Accounting of TDS / TCS receivable

The current accounting practice of TDS / TCS comes from the 26AS statements and the receipt of TDS and TCS certificates that are shared by the customer and vendors respectively. Which creates multi-fold effort on the part of the team as there is a big difference in the books of accounts principal and the TDS/ TCS.

The books are maintained on the accrual basis and the TDS / TCS are implemented on the hybrid basis, i.e., payment or credit whichever is earlier.

Hence, the two system gives the problem of cross mapping of the 26AS with books of accounts. The difference in time period, different values of transactions, receipt of advances vs the accrual of sales, multiple TANs of the customers make the job even harder for this mapping. As a cherry on the cake, the tax department expects the taxpayer to submit the 26AS reconciliation instantly at the time of the assessments.

This exaggerate the pain of the tax teams. Let’s understand how:

For e.g., Company A paid advance to taxpayer of Rs. 1 crore on 20 Feb 2022 and deducted TDS 10%, assuming all the other issues mentioned above have already been resolved before this point.

The natural accounting shall happen for such advance as

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The sales made to Company A amounts to Rs. 20 Lakhs on 31 Mar 2022 and the rest of the money is booked as advance from customer in the balance sheet

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The auditor comes and as TDS reflects in the 26AS or form 16A is received, the entry is made at the closure of the books as

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Now, at the end of the year and on balance sheet date 31 Mar 2022, there will be following balances appearing in financials:

Company A as Advance from Customer – Rs. 80 Lakhs

TDS deducted as Current Asset – Rs. 10 Lakhs

 Problems in Current Accounting System

The above system is how the things are recorded as on date. There may be some difference because of the implementation of different ERPs and Accounting systems but the overall crux remain same. There are many inherent problems in this system of TDS accounting:

A.  TDS have been recorded when the same appeared in 26AS which makes the effort to record the same into the system double, this entry should have been recorded at the time of receipt of advance only, hence there would be savings in effort. Imagine a large company having 10 lakhs TDS entries in their 26AS and equal number of entries in their AR & Sales. If TDS is entered from the 26AS then there would be 20 Lakhs entries to be entered in the system, making it double effort than required.

B.  At the end of the year, the balance in the TDS account shall comprise of the all the balance of 26AS without the bifurcation of TDS that can be claimed against the tax liability and the remaining balance which belongs to the next period. In case the taxpayer gets a notice of assessment of income tax from the government, the balance of TDS which was claimed in the return but didn’t belong to that period shall be added back to tax liability along with the interest and penalty on the same.

C.  There will be cases where the customer has not paid the amount to business and claims to show that they have deducted TDS however the same do not reflect in the 26AS statement of the taxpayer, in such case there is no mechanism to check as how much money was expected to be deducted by the customer.

D.  The rule 37BA 3(i) and 3(ii) needs to be complied in the books of accounts for which there is no information that is readily available from the financials statements as such.

New Accounting System for TDS / TCS Receivables

As stated above, there are many problems that need to be solved before the TDS / TCS appearing in 26AS can be claimed in the books. Further, to improve the overall compliance of the TDS/ TCS receivables the new accounting system is required.

As such, the above mentioned example can be captured in the accounting system in the following manner:

For the advance received as on 20 Feb 2022 from Company A and the confirmation of the breakup has been taken from the customer.

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The sales made to Company A amounts to Rs. 20 Lakhs on 31 Mar 2022 and the rest of the money is booked as advance from customer in the balance sheet

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The auditor comes and as the TDS reflects in the 26AS or form 16A is received, the entry at this stage won’t be required as the same has been intelligently recorded in above entries.

At the end of the year and on balance sheet date 31 Mar 2022, there will be following balances appearing:

Company A as Advance from Customer – Rs. 80 Lakhs

TDS Deducted A/c as Current Asset – Rs. 8 Lakhs

TDS Accrued A/c as Current Asset – Rs. 2 Lakhs

Solutions from the New Accounting System:

A.  As the above case shows, there is no need to record the TDS entry, as earlier was required to be entered, from 26AS. Thus, it reduces the effort to complete the accounting of the TDS receivable.

B.  The balance at the end of the year correlates completely with the balance of advance from customer, i.e., TDS on the revenue booked appears as the TDS due (2 Lakhs on 20 Lakhs of revenue) and the TDS on the Advance from customer still sits as the deducted balance in the books (8 Lakhs on 80 Lakhs of advance from customer). This way enables the taxpayer to be in compliance with the rule 37BA 3(i) and 3(ii) of the Income Tax Rules for the credit of TDS.

C.  The case where the customer has not deposited the TDS shall be resolved in many ways. One – the confirmation that comes at the time of receipt shall help in the communication with the customer. Two – if the customer fails to deposit money as TDS, then the business shall have clarity in terms of what amount should come from each customer in the 26AS and how much is missing to follow-up.

D.  The report for the assessment officer can be taken from the system itself for the compliance of Rules 37BA 3(i) and 3(ii).

The new system only needs simple configuration in the existing system of accounting and the benefits make the new system a “too good to miss” system.

However, so far these have been the internal reconciliations. The next and important part comes where you have to maintain transaction level reconciliation of the 26AS statement with the invoices, advances, by customer and comparison of TDS appearing in the books vs TDS in 26AS.

The required follow up and communications around the management of TDS shall be the key to manage the entire new empire of compliances and management of the working capital stuck in TDS / TCS.

What and how the 26AS needs to be reconciled with books of accounts? That shall be topic for another time.