Sharp Lines in the Sand: How the Hazy Law on ‘Tax Deductions at Source’ Found Neat Bounds

The law[1] governing tax deduction at source (‘TDS’) under the Income Tax Act, 1961 (‘the Act’) appears deceptively simple. TDS involves a taxpayer who is earning certain income. The law requires that the payer of an income deduct a portion before handing out the income to the taxpayer. Hence, the payer acts on behalf of the Revenue and collects tax from the taxpayer. However, the law does not always clarify what counts as income. Nor does it state when that income can be said to be a result of the relationship between the payer and the taxpayer. A person may gain financially, but not because the payer intended to enrich them. One party may build a shop, but it cannot be said that the shopkeeper earned profits in sales due to the builder. In other instances, the taxpayer may acquire financial gains that the law may not recognise as taxable income. For instance, suppose an employee at a grocery store enjoys some loyalty points for personal purchases. It is difficult to contend that the money she saves is taxable income.

A recent order by the Supreme Court (‘the Court’) brought such uncertainties back into focus. Priests and nuns working in aided institutions sought to be exempt from TDS obligations, claiming they surrendered their entire salaries to the Church instead of retaining them for personal use. They argued that merely because the payment is made in lieu of their working does not make it income, and it depends on what the taxpayer uses it for. After a crisp exchange between the bar and the bench, the Court dismissed this claim. It ruled that TDS hinges on the payer’s intent to provide income and its receipt by the recipient. Its ultimate use or effect on the earner’s finances was deemed irrelevant.

This paper argues that this clarity has its origins in Bharti Cellular v. CIT (‘Bharti’). It may not have made headlines when delivered, but the ruling has simplified the law on TDS.  Although not expressly relied upon by the Court in the nuns’ case, it reflects what was installed in Bharti: clear-cut means to identify when TDS may be activated.

Part I explains background in which Bharti was delivered, and the reasoning available in written words. Part II explains its silent premises through two sub-parts. Both the premises work as sharp logical tests, and the paper thus endorses them as thresholds to be followed. Part II.A shows the first threshold: a party is an ‘income-payer’ only if the earner’s failure would also cause it to lose. Part II.B shows the other threshold: financial gains are not ‘income’ for the purposes of TDS.

For convenience, this paper uses two means to refer to the parties in Bharti. The Revenue’s case relied on characterising the income-earners as ‘agents’ of a ‘principal.’ However, the Court’s analysis rejected this characterisation. Therefore, while this paper will use those terms when paraphrasing the Revenue’s claim, the neutral terms ‘payer’ and ‘distributor’ or ‘earner’ are used to describe the actual relationship as ultimately defined by the Court.

I. Bharti’s Clarion Call

Bharti Cellular sold SIM cards and talk-time/data coupons to distributors at a steep discount. The distributors would then sell these products to customers at the full-value, printed price. As a result, the distributors realised a profit by selling at a higher price than they bought.

The Revenue suspected a sly manoeuvre, positing Bharti Cellular’s pricing was a deliberate ploy to funnel commissions. It asserted that for the purpose of Section 194H of the Act, which covers payments made as commission, Bharti’s distributors were agents. Hence, Bharti Cellular should have deducted TDS from the amount it received on selling its products to the distributors, before pocketing the rest.

The Court rejected the Revenue’s arguments with a sharp rebuke. It held that Section 194H did not apply because the payer’s arrangement with its distributors was a conclusive sale transaction, and not a tangled arrangement of agency. The Court noted that the title to the goods passed to the distributors at the point of purchase. The immediate transfer of title firmly established the arrangement as a conclusive sale and the distributors’ complete grip over resale prices and margins. The difference between the purchase price and resale price was not a commission paid by Bharti Cellular. Instead, it was simply the distributor’s earnings from their own enterprise. Further, as Bharti Cellular received, rather than made, payments, the Court absolved it of any TDS-obligation, for it was not a payer of income.

II. The Unspoken Premises, And Their Implications

While the Court’s decision in Bharti appears to be a fact-specific ruling, its implications for TDS law are far more significant. Its reasoning has silent premises which quietly restructure how courts and taxpayers can understand the limits of TDS obligations. The judgment boldly carved out clear boundaries, defining income, identifying payers, and pinpointing when TDS obligations arise.

To understand the significance of the arguments to come, it is necessary to understand how TDS provisions breed confusion. TDS provisions are inherently situational and dependent on inter-party relationships, necessitating judicial scrutiny of the income’s nature and the payer’s intent. This paper argues that Bharti introduces two such unspoken, yet pro-taxpayer, implications that facilitate quicker identification of both factors. Firstly, the case has focused on identifying the commercial independence of the earner. If the earner’s interaction with the market has no implications on the payer, the TDS law will not apply. Secondly, it has confined the focus of TDS to earnings that act as income, and not to any flow of value that may have other purposes, such as wealth creation. Hence, the Court establishes a stricter threshold for activating certain TDS provisions.

Before exploring Bharti’s transformative impact, it is necessary to map the precise terrain it reshapes. That is, those provisions must be outlined which bear a strong similarity to Section 194H. If they exist, the logic of Bharti must extend to provisions beyond Section 194H. There exist variations which need to be accounted for. Section 194H requires a principal-agent context, for instance, while other TDS provisions may or may not. To do this, it is best to assess if there exist provisions which share some or specific similarity to the provision, or both.

The present judicial position distinguishes between Section 195 and all the other provisions on TDS. It has been laid down that Section 195 requires a pre-assessment of taxability by the payer. This is because of a unique phrase in its text: “[…] sum chargeable under the provisions of this Act […].”  This phrase is notably absent in all the other provisions in the chapter devoted to TDS. The Court has interpreted this textual absence as a directive: deduct tax first, assess taxability later. In this framework, payers are not tasked with evaluating whether a payment is taxable; that question is deferred to the Revenue and the taxpayer.

This element of ‘deduct first, assess later’ in non-Section 195 provisions is also reinforced by another shared characteristic: their texts fit some pre-defined, specific class. Firstly, these include certain defined payments, for example, those which arise out of dividends, interest, rent or commissions. Secondly, they refer to payments which may not fit a pre-defined category but arise in fact-specific scenarios, such as rent-payment by HUFs, or payment of compensation for the acquisition of immovable property. It is contended that grouping these provisions under a single rubric is justified, as they operate on a common principle: tax is withheld on payments expressly labelled as income, eliminating the need for a payer to probe their taxability.

Section 194H is part of this large cohort. However, Bharti’s impact targets a specific subset of these provisions: those that share its core conceptual ambiguity, not just its procedural nature. This is found in a small yet significant part of these provisions. Arguably, the decision’s impact extends to these provisions since they mirror Section 194H’s one of the two pivotal aspects: they hinge on the relationship between payer and recipient, or personal gain risks being mistaken for income attributable to the payer. The table below illustrates this:

The elements for which Bharti introduced clarity exist equally in the above-named provisions. These provisions share a dual similarity with Section 194H: procedural and conceptual. As a result, it is proposed that these make up the site of Bharti’s impact. Further, due to the preceding discussion, any generic reference to TDS law must be taken as a reference to these analogous provisions.

A.    The Risk-Bearer’s Litmus

Bharti implicitly establishes a sharp, risk-based litmus test for TDS obligations: did the earner earn due to the payer, or through their own endeavour and risk?

Bharti noted that the title to the products was passed down to the distributor, indicating a ‘contract of sale’ [¶23]. The Court observed that the distributors’ earnings result purely from their actions after they acquire complete control over the products. To verify this binding conclusiveness, it scrutinised the contractual terms which fastened liability of losses exclusively on the distributor [¶21]. It then denies the notion of any ‘contract of agency,’ impliedly basing this conclusion on the lack of shared liability [¶¶23, 24, 28-30]. Further, it noted that the losses covered were only those which arose with respect to the sale between Bharti Cellular and the distributors [¶¶11, 12, 29]. The unarticulated premise to deny TDS may be put as thus: Bharti Cellular’s lack of exposure to losses after this sale confirms the relationship that concludes with the transfer of goods.

This is a reasonable view. In law and commerce, agency implies not just the power to act on behalf of another, but a shared structure of accountability. The agent acts for the principal, and in return, the principal stands with the agent in success or failure. Else, the discussion in Bharti suggests, the so-called agent is simply a market participant, operating at their own risk, and any earnings they generate are earned in their own right.

However, this is not to state that the Court was merely identifying a contract of agency to determine the existence of TDS liability. For Section TDS provisions, there needs to exist a specific agency that generates income for the earner as intended by the payer. When the Court in Bharti found that Section 194H did not apply, what it essentially stated is that there is no flow of income from the payer to the earner. There is only a purchase of goods by the distributors, followed by their own effort and outcomes. The earnings in such cases are not income from the payer, but income from the market, and the TDS law has no role to play. The payer’s interest in this case ended with the conclusion of the sale of products to the distributors [¶37].

Distilled further, this approach clarifies that Section 194H targets arrangements where income is functionally attributed to the payer, as in a commission-based agency. In contrast, if the supposed earner is independently responsible for certain revenue, and the payer was a passive enabler, there is no flow of income from the payer to the earner. Commercial independence generally severs the ‘principal-agency’ link in contract law. It now stands imported into law on TDS, with a specific litmus test to discern its existence: assessment of how the supposed payer tackles any losses that may accrue to the earner.

The decision’s assessment of risk-sharing also anchors the applicability of TDS in its nature as a ‘source-based’ taxation. That is, the income must be traceable to the payer (in this case, Bharti Cellular), not merely arise due to the payer. That is, earnings simply enabled by a payer’s actions do not automatically qualify as ‘income paid by the payer’. The Act only requires tax to be withheld when a specific, defined category of income flows from one party to another, like commission, salary, or royalty. This reading, while not made expressly by the Court, is the necessary implication of its reasoning. This tethers TDS law with its proper foundation: income from the payer, not income alongside the payer. Just because the taxpayer earns in circumstances enabled by the payer does not mean the payer is the taxpayer’s source of income. Bharti has thus established a simple ‘loss-sharing test’ to assess the same. This logic applies to any TDS provision where the core question is whether a sum is a payment from the payer or the recipient’s own gain.

B.    TDS Deals With Income, Not Profit

The previous test depended on the thread connecting the payer, the earner and the earner’s income. However, Bharti seems to have provided a separate and clearer ground: TDS law does not operate on profits [¶¶28, 30, 37, 39]. That is, it appears to have tightened the scope of what counts as ‘income’ in the first place. Bharti clearly states that the margin earned by the distributors works purely as an outcome of the distributor’s business acumen. They were given complete control over the goods as well as their pricing, allowing distributors to assess the market [¶31]. This gain was a result of how the distributors chose to utilise the goods supplied by the payer, in a manner which was simply beneficial to them. This perspective examines whether the income was a reward for efforts towards the payer, or a gain out of the taxpayer’s financial prudence.

The neat exclusion of gains from ‘income’ has two logically enduring reasons. Part II.B.1 shows that TDS is inclined to capture income which is guaranteed to exist, unlike profits/gains, which are situational. Part II.B.2 shows that TDS exists for specified transactions to capture both the income’s source and its destination in the State’s logs. Checking the earner’s profits is a test after income has reached its destination, and is irrelevant for this purpose.

1. TDS focuses on income, which is certain to exist

In understanding the law on direct taxation, it is crucial to separate the concept of ‘income’ as it is chargeable under the Act from the economic notion of profit. Certain provisions of the Act, such as Section 28 read with Section 2(24)(i), treat ‘profits and gains’ from business or profession as ‘taxable income.’ This has the tone of an exception which confirms the norm underlying the Act’s text: not all profits, or anything that appears like a profit, may automatically be treated as ‘income’ under the law. Unless the provisions dedicated to contingent gains like profits and losses are involved, ‘income’ in the Act implies a notion of fixity. Bharti seems to have this distinction in mind when it notes that distributors had complete discretion to determine the sale price, pruning the uncertain margins out as ‘taxable income.’

The distinction is deliberate. In its raw economic sense, profit/gain simply means the excess of what is earned over what is spent/invested. But in legal terms, the Act only taxes profits that arise from recognised sources: business, salary, capital gains, etc. This is partly because profit is not always synonymous with income in a social or practical sense. For a large enterprise, it may function as long-term wealth accumulation. However, for small traders, a modest profit may merely sustain daily living.  Law on direct tax, therefore, avoids sweeping all forms of profit as ‘income’ unless they fit the recognised heads of income.

Arguably, TDS provisions belong to the larger design of the Act and reflect this very restraint. Their text does not appear to be designed for detecting or taxing profit. Instead, they are structured to withhold tax from limited and clearly defined payments, such as salary, fees, royalty, commission or interest. These are all treated as ‘income by default,’ regardless of whether the taxpayer ultimately makes a profit overall. That is, the law is not concerned with the taxpayer’s ultimate profitability. Instead, tax is deducted right when these payments occur, because these payments are already recognised as income under the law. It is a system premised on the legal character of a payment, not on the economic result it may produce later on.

2. TDS is a product of the ‘source rule’

The argument that TDS is not concerned with profits is also supported by another design principle of the Act. Generally, the Act appears to have two ways to detect and tax taxpayers: the ‘source rule’ or ‘accretion of wealth rule.’

‘Source rule’ depends on how the income came to be, analysing its path to the taxpayer. If the income is covered by one of the categories in the Act and its path to the recipient’s bank account proves it was intended as such by the payer, taxation shall occur. In the nuns’ case, they received payment for their acts towards their payers, the aided institutions. It was received in their personal bank accounts and was treated as salary in the payers’ books of account. The singular focus of TDS on income, then, is squarely applied.

However, an obfuscated or convoluted trail of money will require the Revenue to wait for taxation until it completes its scrutiny. This will make the State cash-starved for its functions in the interim.  Parallelly, such an enhancement in finance has the same effect as income: the taxpayer is acquiring finances, and there exists no proof that it is not income. Hence, the other method of direct taxation is the ‘accretion to wealth’ approach. This view involves taxation of income when it is simply realised. This only concerns an enhancement of a taxpayer’s finances, and not tracing its source. This approach helps Revenue tax profits like capital gains. Fixed payments like salary or commission immediately generate income at the point of their receipt by the taxpayer. However, for capital gains, their taxable character becomes clear only at the point of realisation. A taxpayer may buy a share, but its dividend income may accrue later in time. Further, and unlike salary or commissions, capital gains don’t flow from a payer to a payee, but emerge from market implications, making source-tracing impractical. Those who earn a living out of securities-trading would then enjoy an undue exemption. Hence, unexplained cash-credits or capital gains are covered by the ‘accretion in wealth’ rule. However, TDS by its very nature is source-based, as demonstrated in Part II.A of this paper. The tax deducted at ‘source’ requires that income flows from one point to another, and the party initiating this flow (the source of income) collects tax on behalf of the Revenue. This again denotes that the generation of profits, be it due to the payer or the taxpayer’s own operations, is out of TDS’ purview.

Hence, even if it is clear that the income flows from the payer, there remains a deeper filter: whether the gain in question qualifies as legal income at all. However, if the person earns from their independent market dealings, and if what they earn is not a payment recognised as ‘income’ under the Act, no TDS obligation can arise.

III. Conclusion

Through Bharti, the Court quietly redrew the map of TDS obligations. The position it gave rise to states that not everyone who gains from a pay-arrangement does so as a potential taxpayer. If the income is contingent on the recipient’s actions, the payer must have a stake in it. If not, the payer has concluded her relationship much before the recipient performs such actions. Further, unless any gain was intended as income, tax need not be withheld. Both the payer and the income-recipient gaining money from a shared-ecosystem do not classify as such.

Bharti thus stands as a reminder that law on direct tax is premised on legal substance instead of optics. It demands a unique blend of analytical restraints: identifying control by looking at the liability-sharing and a refusal to conflate financial gain with legal income. The larger impact of the ruling is that it brings about principled taxation and whittles down mechanical overreach.

[1] Chapter XVII, The Income Tax Act, 1961.

About the Author

Yash Sinha (NLSIU ’19) is presently working as a Judicial law Clerk, Supreme Court. He was previously practising as an advocate based out of New Delhi. His areas of interest include commercial law, money laundering law and select areas in constitutional law.