Withholding tax also referred as retention tax is generally found in all tax systems and is an income tax obligation that is charged to income at source and herein the payer of the income is liable to pay this tax to the government. Hence, the tax is withheld or deducted from the income which is due to the recipient or the payee.
These taxes are generally applicable in case of employment income and in case of many jurisdictions withholding tax is required for payments such as interest, dividends, royalties etc. Also for most jurisdictions, in case the recipient of income resides in a different jurisdiction then there arises additional withholding tax obligations and the same can apply in respect of payment of rent, royalties and even in case of real estate sale.
In the Indian context, withholding tax applies to sources of income such as work contract, salary, commission, professional service, rent, income from business, technical services etc.
So, after reading until here, you might be assuming withholding tax to be same as TDS or tax deducted at source. But the two are different in few of the respects which we will be discussing later in the article:
Illustration to understand the concept of Withholding tax
Say Mr A is an IT professional who has rendered from services to Mr. B and for the same Mr. A has raised a bill of Rs. 50,000 then in this case Mr. B who has the liability to make the payment to Mr. A for his services can credit an amount of Rs. 45,000 to Mr. A's account after deducting the withholding tax at source. It is of paramount importance to note that the liability to make the income tax payment to the government in case of withholding tax lies with the payer of the income and not the recipient of the income.
Importantly such a withholding tax is required to be deducted when the payment is being made to the non-resident Indian.
As per the Income Tax Act under the provisions of section 195, it is obligatory for the payer, who is responsible for making the payment, to deduct tax while crediting the amount or making payment to the NRI or non-resident individual.
Difference between TDS and WHT or Withholding tax
There are basically two main differences between the two forms of taxes
1. TDS applies to Indian nationals while withholding tax applies in case of payment tendered to foreign nationals or NRIs: Say for instance, for services from local vendors, businesses will be required to deduct TDS at source but in the case when services are rendered by foreign vendors, withholding tax will apply.
2. TDS is deducted while making the payment whereas WHT is deducted in advance: For the different income sources, payer of the income deducts TDS at the time of making the payment but the withholding tax is deducted beforehand i.e. even before the payment is made to the payee in order to clear off the liability towards the government.