Section 194A of the Income Tax Act deals with the deduction of Tax Income Tax Deducted at Source (TDS) on interest income earned from various sources, including fixed deposits, recurring deposits, and savings accounts. However, it does not directly apply to chit funds.

Chit funds are a form of rotating saving and credit scheme where a group of individuals contribute a fixed sum at Income Tax regular intervals. The pool of collected money is then awarded to a member through a draw or auction.

The income earned from a chit fund can be categorized into two types:

1. Subscription amount: This is the fixed sum that each member contributes. The Income Tax subscription amount is not considered income as it is simply a return of the contributed money.
2. Prize money: If a member wins the auction or draws and receives a larger sum than their contribution, the difference between the winning amount and the total Income Tax subscription paid is considered income. This income may be subject to tax under the Income Tax Act, depending on the individual’s tax bracket.

However, Section 194A is not applicable to the income earned from Income Tax chit funds because the interest component, which triggers TDS under Section 194A Income Tax, is generally not present in chit fund transactions. The money received in a chit fund is primarily considered a return of the contributed amount or a winning from a lottery-like scheme, not interest income.

 EXAMPLE

State: Tamil Nadu (As per your current location)

Scenario: Mr. X, a resident of Chennai, Tamil Nadu, participates in a chit fund Income Tax registered in Tamil Nadu and wins a chit amount of Rs. 1 lakh. The maturity value of the chit exceeds Rs. 20,000, triggering the requirement for TDS deduction under Section 194A of the Income Tax Act.

Applicability of TDS:

• Section 194A: As the chit amount exceeds Rs. 20,000, the chit fund operator Income Tax (deductor) is liable to deduct TDS at 10% on the winning amount (Rs. 1 lakh).
• State-Specific Threshold: There are no state-specific variations in the TDS threshold or rate for chit fund winnings under Section 194A.

Calculation of TDS:

• Winning amount: Rs. 1 lakh
• Applicable TDS rate: 10%
• TDS deducted: Rs. 10,000 (10% of Rs. 1 lakh)

Payment and Deposit of TDS:

• The chit fund operator must deduct TDS at the time of payment of the chit amount to Mr. X.
• The deducted TDS must be deposited Income Tax with the government within 10 days from the date of deduction.

Formalities:

• The chit fund operator should issue a TDS certificate Income Tax (Form 16B) to Mr. X, specifying the amount of TDS deducted and deposited.
• X can claim credit for the deducted TDS in his income tax return.

Additional Points:

• If Mr. X has already paid sufficient advance tax throughout the year, he can submit Income Tax Form 15H to the chit fund operator to claim exemption from TDS deduction.
• If the chit fund is not registered in Tamil Nadu, the TDS provisions and rate might differ based on the state of registration.

 FAQ QUESTIONS

Q: Does Section 194A apply to chit funds?

A: No, Section 194A of the Income Tax Act does not directly apply to chit funds. This Income Tax section deals with Tax Deducted at Source (TDS) on “interest income” exceeding a certain threshold, and chit fund subscriptions are not considered interest income by the Income Tax Department.

Q: Are there any TDS provisions for chit funds?

A: Although Section 194A doesn’t apply, Section 194B of the Income Tax Act might be relevant in certain situations. This section mandates TDS on winnings from lotteries, crossword puzzles, races, card games and other games of chance.

Here’s how it might apply to chit funds:

• Foreman’s prize: If the chit fund has a prize for the foreman Income Tax (manager), it could be considered a lottery win or income from a game of chance, attracting TDS under Section 194B Income Tax.
• Subscription exceeding fixed deposits: If the subscription amount in a chit fund Income Tax exceeds the limit for deduction of interest on fixed deposits (currently Rs. 40,000 for non-senior citizens and Rs. 50,000 for senior citizens), the excess amount might be deemed “income from Income Tax other sources” and be subject to TDS under Section 194A. However, this interpretation isn’t universally agreed upon and might be subject to legal interpretation.

Q: Are there any exemptions from TDS on chit funds?

A: Yes, exemptions under Section 194B and Income Tax 194A might be applicable depending on the specific situation. These include:

• PAN and Form 16: If the Income Tax chit fund participant provides their PAN and Form 16 to the chit fund administrator, no TDS will be deducted under Section 194B, assuming the income falls within the taxable limit.
• Threshold limit: Under Section 194A, if the subscription amount doesn’t exceed the threshold (Rs. 40,000 or Rs. 50,000 as mentioned earlier), no TDS is applicable.

Q: What are the implications of non-compliance with TDS provisions?

A: If the chit fund administrator fails to deduct TDS as Income Tax required, they may be liable for penalty and interest on the deducted amount. Additionally, the chit fund participant might face higher tax liability during assessment if TDS is not deducted at source.

 CASE LAWS

1. Controversy surrounding applicability:

There’s significant legal debate around Income Tax whether the income received from a chit fund can be considered “interest” for the purpose of applying Section 194A TDS. This section mandates deducting tax at source on various income categories, including interest exceeding Rs. 40,000 (or Rs. 10,000 for specific cases).

2. Arguments against applicability:

Several arguments support non-applicability of Section 194A to chit funds:

• Chit fund dividend vs. interest: Some Income Tax argue that the income received from a chit fund isn’t “interest” but rather a “dividend” or “prize money” due to the inherent risk involved in participating in the scheme. This distinguishes it from fixed-income deposits where interest is guaranteed.
• Nature of chit fund transactions: The rotational nature of contributions and payouts, along with the element of chance, leads to an argument that it’s not a Income Tax creditor-debtor relationship with a predetermined interest rate.

3. Supporting arguments:

However, there are counter-arguments in favor of applicability:

• Section 2(28A) definition of interest: The broad Income Tax definition of “interest” in Section 2(28A) of the Income Tax Act encompasses any income arising from debt-owing situations, which some argue can be applied to chit fund transactions.
• Revenue protection concerns: The government might view applying Section 194A as a way to ensure tax compliance and prevent potential tax evasion, especially with larger chit fund payouts.

4. Case laws:

The legal landscape on this issue is still developing, and there’s no clear-cut judicial Income Tax precedent. Some rulings like the Kerala High Court case in “M/s. Cherukunnu chit fund vs. Union of India” (2015) and the Karnataka High Court case in “Harsh Chit Fund vs. Income Tax Officer” (2012) have supported non-applicability Income Tax. However, these cases haven’t been definitively settled, and there are contrasting judgments like the ITAT Mumbai case in “M/s. Sreevatsa Chit Fund vs. DCIT” (2017) upholding the applicability.

5. Current scenario:

Currently, the situation remains unclear with conflicting arguments and judicial pronouncements. It’s advisable to consult with a tax professional for Income Tax specific guidance considering the complex nature of chit fund transactions and the evolving legal landscape surrounding Section 194A applicability.