Section 194NF of the Income Tax Act

Section 194NF of the Income Tax Act. Section 194NF of the Income Tax Act was introduced through the Finance Act, 2021, and came into effect from April 1, 2021. This provision aims to bring transparency in the taxation of income distributed by business trusts or investment funds to their unit holders. In addition, Section 194NF works in tandem with Section 194N of the Income Tax Act to discourage cash transactions and promote digital payments. In this article, we will explore Section 194NF of the Income Tax Act, its implications, exemptions, and other relevant details.
Section 194NF of the Income Tax Act mandates a tax deduction at source (TDS) at the rate of 10% on any income distributed by a business trust or investment fund to its unit holders. The person responsible for making such a payment must ensure that the tax is deducted before disbursing the income.
This income can be in the form of interest, dividends, capital gains, or any other returns generated by the trust or fund. The responsibility for TDS lies with the trustee, fund manager, or any other designated individual who makes the payment. This section ensures that income from such business entities does not escape tax liability and that the income is appropriately reported in the income tax returns of the beneficiaries.
Section 194N and Cash Transactions
While discussing Section 194NF of the Income Tax Act, it is also important to understand Section 194N, as both relate to tax deductions on cash transactions.
Section 194N applies to any person who withdraws cash exceeding Rs. 1 crore in a financial year from a bank, co-operative bank, or post office. Under this provision, the bank or financial institution must deduct TDS at the rate of 2% on the amount exceeding Rs. 1 crore.
For example, if a person withdraws Rs. 1.5 crore in a financial year, TDS of 2% will be applicable on Rs. 50 lakh, which amounts to Rs. 1 lakh. Though this TDS can be claimed as a credit during income tax filing, the intent is to reduce the use of high-value cash transactions.
Implications of Section 194NF
HUFs and Individuals
Hindu Undivided Families (HUFs) and individual taxpayers receiving income from business trusts or investment funds are subject to TDS under Section 194NF of the Income Tax Act. If the total amount of such income exceeds Rs. 5,000 in a financial year, the 10% TDS applies.
This affects the cash flow of taxpayers, as the amount deducted may reduce immediate liquidity. Though the deducted TDS can be claimed while filing income tax returns, it still puts a financial burden on individuals and HUFs with large investments in such funds.
Businesses
Business entities face dual compliance requirements. First, if they withdraw cash beyond the threshold under Section 194N, they must bear TDS. Second, if they distribute income to unit holders, they must comply with Section 194NF.
Businesses distributing returns in cash must deduct TDS at 10% under Section 194NF. This increases operational responsibilities such as documentation, payment of TDS, filing TDS returns, and record-keeping.
Funds and Trusts
Investment funds and business trusts have the primary responsibility for compliance under Section 194NF. They must ensure TDS deduction on any income they distribute to unit holders.
For such entities, failing to comply with the deduction requirements can result in interest and penalties. Additionally, frequent TDS compliance could pose administrative challenges, especially for large funds with numerous beneficiaries.
Exceptions to Section 194NF of the Income Tax Act
Certain exceptions have been carved out to reduce the compliance burden on small investors and to ensure the regulation does not affect long-term investments unfairly. These are:

Income below Rs. 5,000 to Resident Individuals or HUFs If the total income distributed to a resident individual or HUF in a financial year does not exceed Rs. 5,000, then Section 194NF is not applicable. This is to ensure small-scale investors are not burdened with TDS compliance.

Income below Rs. 1,000 to Other Persons If the income paid to any other person (not an individual or HUF) is below Rs. 1,000 in a financial year, then TDS under Section 194NF does not apply.

Capital Gains from Long-Term Capital Asset Transfer If the income paid to a unit holder is in the nature of capital gains from the transfer of a long-term capital asset, then it is exempt from TDS under this section.

Income from SEZ Developers or Units Any income in the form of interest or receivables from a Special Economic Zone (SEZ) developer or unit is not subject to TDS under Section 194NF.

What is Section 194NF of the Income Tax Act, 1961?
Section 194NF is a provision under the Income Tax Act, 1961 that mandates a 10% TDS on any income distributed by a business trust or investment fund to its unit holders. This measure was introduced to ensure that such distributed income is taxed at the source, thereby improving transparency and compliance in the taxation system. The income could be in any form, including dividends, interest, capital gains, or other distributions.
When did Section 194NF come into effect?
Section 194NF came into effect from April 1, 2021, following its introduction in the Finance Act, 2021. The government included this provision to plug loopholes in the taxation of distributed income from trusts and investment funds and to encourage timely tax compliance by making deduction mandatory at the source itself.
What is the tax deduction rate under Section 194NF?
The tax deduction rate prescribed under Section 194NF is 10%. This means the person or entity distributing income to unit holders must deduct 10% of the income before transferring it to them. This helps ensure that the income is pre-taxed and reflects appropriately in the recipient’s income tax return. The deducted amount can later be claimed as a credit against their total tax liability.
What is the difference between Section 194N and Section 194NF TDS?
Section 194N and Section 194NF are distinct but interconnected in the government’s effort to curb cash usage and increase transparency. Section 194N deals with cash withdrawals above Rs. 1 crore and mandates TDS at 2% on the amount exceeding this limit. Its purpose is to discourage high-volume cash transactions. On the other hand, Section 194NF applies specifically to income distribution by business trusts or investment funds. It mandates a 10% TDS on all such payments regardless of whether they are in cash or other forms.
Who is responsible for deducting tax under Section 194NF?
The responsibility for deducting TDS under Section 194NF lies with the person managing or operating the business trust or investment fund. This includes trustees, fund managers, or any authorized individuals or entities that disburse income to unit holders. They must ensure TDS is properly deducted before making any payments and must deposit the same with the government within the stipulated time.
What types of income are covered under Section 194NF?
Section 194NF covers all types of income that are disbursed by business trusts or investment funds to their unit holders. This includes but is not limited to interest income from investments, dividend payments, capital gains from asset transfers, and any other form of income distributed. The provision makes it mandatory to deduct TDS on each type of income uniformly.
What happens if the person making the payment fails to deduct tax under Section 194NF?
Failure to deduct TDS under Section 194NF or deducting at a lower rate can lead to serious consequences. The payer may be liable to pay interest on the shortfall or the entire undeducted amount. Additionally, penalties may be imposed under the Income Tax Act. This non-compliance also raises red flags during tax audits and could affect the credibility of the payer.
Is Section 194NF applicable to income like capital gains or interest received from a Special Economic Zone (SEZ) developer or SEZ unit?
No, such income is specifically excluded from the purview of Section 194NF. If the income distributed is in the nature of capital gains from long-term asset transfers or interest earned from an SEZ developer or SEZ unit, then TDS under this section is not applicable. These categories are granted exemption to avoid double taxation and to support growth in SEZ regions.
Conclusion
Section 194NF of the Income Tax Act is an important provision that helps plug tax leakage in the distribution of income from business trusts and investment funds. It ensures that income reaching unit holders is subject to TDS, thereby aiding in better reporting and compliance. Understanding this provision is essential for trustees, fund managers, and unit holders alike. Non-compliance may lead to penalties and legal complications, hence adhering to the law is not just prudent but necessary.
FAQs
Q1. Does Section 194NF apply to non-resident investors in business trusts or investment funds?
Ans. No, Section 194NF primarily applies to resident unit holders. The taxation of income distributed to non-resident investors is generally governed by Section 195 of the Income Tax Act. In such cases, TDS is deducted at rates prescribed under the Income Tax Act or as per the applicable Double Taxation Avoidance Agreement (DTAA), whichever is more beneficial to the non-resident.
Q2. Can the deducted TDS under Section 194NF be claimed as a refund?
Ans. Yes, the unit holder can claim the deducted TDS as a credit while filing their income tax return. If the total tax liability is lower than the amount of TDS deducted under Section 194NF, the excess amount will be refunded by the Income Tax Department after processing the return.
Q3. Is it necessary to issue a TDS certificate to the unit holder under Section 194NF?
Ans. Yes, the person or entity deducting tax under Section 194NF must issue a TDS certificate in Form 16A to the unit holder. This certificate serves as proof of TDS deduction and is required while filing the income tax return to claim credit for the tax deducted.
Q4. What is the due date for depositing TDS deducted under Section 194NF?
Ans. TDS deducted under Section 194NF must be deposited with the government by the 7th day of the following month in which the deduction is made. For deductions made in March, the due date is extended to April 30. Timely deposit of TDS is crucial to avoid interest and penalties.
Q5. Is TDS under Section 194NF applicable even if income is reinvested and not paid out?
Ans. No, TDS under Section 194NF is applicable only when income is actually distributed or paid to the unit holder. If the income is retained or reinvested within the business trust or investment fund, no TDS liability arises under this section until the income is disbursed.
Q6. Are REITs and InvITs also covered under Section 194NF?
Ans. Yes, Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs), which are types of business trusts, fall within the ambit of Section 194NF. Any income distributed by these entities to unit holders is subject to 10% TDS under this section, subject to prescribed exceptions.
Q7. Can Form 15G/15H be submitted to avoid TDS under Section 194NF?
Ans. No, Form 15G or 15H cannot be submitted to avoid TDS under Section 194NF. These forms are applicable for specific types of incomes like bank interest, subject to conditions. Section 194NF does not permit self-declaration to avoid tax deduction.

Section 194NF of the Income Tax Act was introduced through the Finance Act, 2021, and came into effect from April 1, 2021. This provision aims to bring transparency in the taxation of income distributed by business trusts or investment funds to their unit holders. In addition, Section 194NF works in tandem with Section 194N of the Income Tax Act to discourage cash transactions and promote digital payments. In this article, we will explore Section 194NF of the Income Tax Act, its implications, exemptions, and other relevant details.

Section 194NF of the Income Tax Act mandates a tax deduction at source (TDS) at the rate of 10% on any income distributed by a business trust or investment fund to its unit holders. The person responsible for making such a payment must ensure that the tax is deducted before disbursing the income.

This income can be in the form of interest, dividends, capital gains, or any other returns generated by the trust or fund. The responsibility for TDS lies with the trustee, fund manager, or any other designated individual who makes the payment. This section ensures that income from such business entities does not escape tax liability and that the income is appropriately reported in the income tax returns of the beneficiaries.

Section 194N and Cash Transactions

While discussing Section 194NF of the Income Tax Act, it is also important to understand Section 194N, as both relate to tax deductions on cash transactions.

Section 194N applies to any person who withdraws cash exceeding Rs. 1 crore in a financial year from a bank, co-operative bank, or post office. Under this provision, the bank or financial institution must deduct TDS at the rate of 2% on the amount exceeding Rs. 1 crore.

For example, if a person withdraws Rs. 1.5 crore in a financial year, TDS of 2% will be applicable on Rs. 50 lakh, which amounts to Rs. 1 lakh. Though this TDS can be claimed as a credit during income tax filing, the intent is to reduce the use of high-value cash transactions.

Implications of Section 194NF

HUFs and Individuals

Hindu Undivided Families (HUFs) and individual taxpayers receiving income from business trusts or investment funds are subject to TDS under Section 194NF of the Income Tax Act. If the total amount of such income exceeds Rs. 5,000 in a financial year, the 10% TDS applies.

This affects the cash flow of taxpayers, as the amount deducted may reduce immediate liquidity. Though the deducted TDS can be claimed while filing income tax returns, it still puts a financial burden on individuals and HUFs with large investments in such funds.

Businesses

Business entities face dual compliance requirements. First, if they withdraw cash beyond the threshold under Section 194N, they must bear TDS. Second, if they distribute income to unit holders, they must comply with Section 194NF.

Businesses distributing returns in cash must deduct TDS at 10% under Section 194NF. This increases operational responsibilities such as documentation, payment of TDS, filing TDS returns, and record-keeping.

Funds and Trusts

Investment funds and business trusts have the primary responsibility for compliance under Section 194NF. They must ensure TDS deduction on any income they distribute to unit holders.

For such entities, failing to comply with the deduction requirements can result in interest and penalties. Additionally, frequent TDS compliance could pose administrative challenges, especially for large funds with numerous beneficiaries.

Exceptions to Section 194NF of the Income Tax Act

Certain exceptions have been carved out to reduce the compliance burden on small investors and to ensure the regulation does not affect long-term investments unfairly. These are:

Income below Rs. 5,000 to Resident Individuals or HUFs If the total income distributed to a resident individual or HUF in a financial year does not exceed Rs. 5,000, then Section 194NF is not applicable. This is to ensure small-scale investors are not burdened with TDS compliance.
Income below Rs. 1,000 to Other Persons If the income paid to any other person (not an individual or HUF) is below Rs. 1,000 in a financial year, then TDS under Section 194NF does not apply.
Capital Gains from Long-Term Capital Asset Transfer If the income paid to a unit holder is in the nature of capital gains from the transfer of a long-term capital asset, then it is exempt from TDS under this section.
Income from SEZ Developers or Units Any income in the form of interest or receivables from a Special Economic Zone (SEZ) developer or unit is not subject to TDS under Section 194NF.

What is Section 194NF of the Income Tax Act, 1961?

Section 194NF is a provision under the Income Tax Act, 1961 that mandates a 10% TDS on any income distributed by a business trust or investment fund to its unit holders. This measure was introduced to ensure that such distributed income is taxed at the source, thereby improving transparency and compliance in the taxation system. The income could be in any form, including dividends, interest, capital gains, or other distributions.

When did Section 194NF come into effect?

Section 194NF came into effect from April 1, 2021, following its introduction in the Finance Act, 2021. The government included this provision to plug loopholes in the taxation of distributed income from trusts and investment funds and to encourage timely tax compliance by making deduction mandatory at the source itself.

What is the tax deduction rate under Section 194NF?

The tax deduction rate prescribed under Section 194NF is 10%. This means the person or entity distributing income to unit holders must deduct 10% of the income before transferring it to them. This helps ensure that the income is pre-taxed and reflects appropriately in the recipient’s income tax return. The deducted amount can later be claimed as a credit against their total tax liability.

What is the difference between Section 194N and Section 194NF TDS?

Section 194N and Section 194NF are distinct but interconnected in the government’s effort to curb cash usage and increase transparency. Section 194N deals with cash withdrawals above Rs. 1 crore and mandates TDS at 2% on the amount exceeding this limit. Its purpose is to discourage high-volume cash transactions. On the other hand, Section 194NF applies specifically to income distribution by business trusts or investment funds. It mandates a 10% TDS on all such payments regardless of whether they are in cash or other forms.

Who is responsible for deducting tax under Section 194NF?

The responsibility for deducting TDS under Section 194NF lies with the person managing or operating the business trust or investment fund. This includes trustees, fund managers, or any authorized individuals or entities that disburse income to unit holders. They must ensure TDS is properly deducted before making any payments and must deposit the same with the government within the stipulated time.

What types of income are covered under Section 194NF?

Section 194NF covers all types of income that are disbursed by business trusts or investment funds to their unit holders. This includes but is not limited to interest income from investments, dividend payments, capital gains from asset transfers, and any other form of income distributed. The provision makes it mandatory to deduct TDS on each type of income uniformly.

What happens if the person making the payment fails to deduct tax under Section 194NF?

Failure to deduct TDS under Section 194NF or deducting at a lower rate can lead to serious consequences. The payer may be liable to pay interest on the shortfall or the entire undeducted amount. Additionally, penalties may be imposed under the Income Tax Act. This non-compliance also raises red flags during tax audits and could affect the credibility of the payer.

Is Section 194NF applicable to income like capital gains or interest received from a Special Economic Zone (SEZ) developer or SEZ unit?

No, such income is specifically excluded from the purview of Section 194NF. If the income distributed is in the nature of capital gains from long-term asset transfers or interest earned from an SEZ developer or SEZ unit, then TDS under this section is not applicable. These categories are granted exemption to avoid double taxation and to support growth in SEZ regions.

Conclusion

Section 194NF of the Income Tax Act is an important provision that helps plug tax leakage in the distribution of income from business trusts and investment funds. It ensures that income reaching unit holders is subject to TDS, thereby aiding in better reporting and compliance. Understanding this provision is essential for trustees, fund managers, and unit holders alike. Non-compliance may lead to penalties and legal complications, hence adhering to the law is not just prudent but necessary.

FAQs

Q1. Does Section 194NF apply to non-resident investors in business trusts or investment funds?

Ans. No, Section 194NF primarily applies to resident unit holders. The taxation of income distributed to non-resident investors is generally governed by Section 195 of the Income Tax Act. In such cases, TDS is deducted at rates prescribed under the Income Tax Act or as per the applicable Double Taxation Avoidance Agreement (DTAA), whichever is more beneficial to the non-resident.

Q2. Can the deducted TDS under Section 194NF be claimed as a refund?

Ans. Yes, the unit holder can claim the deducted TDS as a credit while filing their income tax return. If the total tax liability is lower than the amount of TDS deducted under Section 194NF, the excess amount will be refunded by the Income Tax Department after processing the return.

Q3. Is it necessary to issue a TDS certificate to the unit holder under Section 194NF?

Ans. Yes, the person or entity deducting tax under Section 194NF must issue a TDS certificate in Form 16A to the unit holder. This certificate serves as proof of TDS deduction and is required while filing the income tax return to claim credit for the tax deducted.

Q4. What is the due date for depositing TDS deducted under Section 194NF?

Ans. TDS deducted under Section 194NF must be deposited with the government by the 7th day of the following month in which the deduction is made. For deductions made in March, the due date is extended to April 30. Timely deposit of TDS is crucial to avoid interest and penalties.

Q5. Is TDS under Section 194NF applicable even if income is reinvested and not paid out?

Ans. No, TDS under Section 194NF is applicable only when income is actually distributed or paid to the unit holder. If the income is retained or reinvested within the business trust or investment fund, no TDS liability arises under this section until the income is disbursed.

Q6. Are REITs and InvITs also covered under Section 194NF?

Ans. Yes, Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs), which are types of business trusts, fall within the ambit of Section 194NF. Any income distributed by these entities to unit holders is subject to 10% TDS under this section, subject to prescribed exceptions.

Q7. Can Form 15G/15H be submitted to avoid TDS under Section 194NF?

Ans. No, Form 15G or 15H cannot be submitted to avoid TDS under Section 194NF. These forms are applicable for specific types of incomes like bank interest, subject to conditions. Section 194NF does not permit self-declaration to avoid tax deduction.