Recent updates regarding compliance on payment of rent under Section 194-IB of the Income-tax Act, 1961

This Tax Alert aims to provide an update on developments in relation to compliance requirement to deduct tax at source (TDS) on rent paid to residents by individuals and/or Hindu Undivided Family (HUF), under Section 194-IB of the Income Tax Act, 1961 (the Act). 

The Finance Act 2017 introduced Section 194-IB with effect from 1 June 2017, requiring TDS deduction at 5% where rent paid is higher than INR 50,000 per month. The Finance (No. 2) Act 2024 reduced the applicable rate of TDS to 2% effective 1 October 2024, creating ambiguity for tax deductors regarding the applicable rate of TDS for the Financial Year (FY) 2024-25, particularly for tenancies that continued past this date. Two views emerged on the TDS rate application, leading to practical challenges where tax deductors who deducted TDS taking the conservative view, i.e 5% for period 1 April 2024 to 30 September 2024 and 2% for the period 1 October 2024 to 31 March 2025, are facing discrepancies in the tax credit allowed by the Income-tax department. The Income-tax department is restricting the tax credit to an amount equivalent to 2% on rent for the full financial year creating a challenge for both the tax deductor (tenant) and the tax deductee (landlord). Tenant will have to claim a refund of the "excess" tax deducted as also pay to the landlord the shortfall in rent because of this excess deduction of tax at source. Landlord will have to pay additional tax and interest for the shortfall in tax credit. 

Additionally, the Income-tax department has issued notices to taxpayers for non-compliance with TDS provisions while claiming HRA exemptions in previous financial years. Defaulting taxpayers may consider belated compliance.