Lower / Nil Deduction & Collection Certificates — Section 395
Lower / Nil Deduction & Collection Certificates
How payees and buyers can obtain certificates for lower or nil TDS/TCS deduction — and other key provisions governing TDS/TCS certificates, deemed income, bar against direct demand, and the Central Government's power to relax.
📖 Also Covers: Section 396 (TDS deemed income) · Section 400 (Central Govt relaxation) · Section 401 (bar against direct demand)
🔄 Replaces: Sections 197, 197A, 195(2), 195(3), 203, 206AA of the Income Tax Act 1961
📅 Effective: 1st April 2026 (Tax Year 2026-27 onwards)
Why These Certificates Matter
The standard TDS/TCS mechanism deducts/collects tax at prescribed rates regardless of the payee's actual tax liability. This can create a cash flow hardship — particularly for:
Payee receives net income after TDS. If their actual tax is nil or lower, they must wait until filing their return and claiming a refund — which can take months.
Payee obtains a certificate from the AO. Deductor then deducts at the lower/nil rate specified — payee receives more cash upfront and avoids a large refund claim.
Section 395 provides three distinct certificate mechanisms — one for TDS (resident payees), one specifically for non-resident payments under Section 393(2) Sl. 17, and one for TCS (buyers/lessees).
Section 395(1) — Lower / Nil TDS Certificate
Who Can Apply?
The payee (the person whose income is subject to TDS) — not the deductor. This includes any resident or non-resident whose income is subject to TDS under Sections 392 or 393.
Application Process — Step by Step
The payee files an application before the Assessing Officer (AO) having jurisdiction over the payee, in the prescribed form and manner. The Board specifies (under Section 400(4)) the cases and circumstances in which applications may be made and the conditions for granting certificates.
The AO examines the payee's estimated total income for the tax year. If satisfied that the total income justifies a lower rate or nil deduction (e.g., income is below taxable limit, or deductions/exemptions reduce effective rate), the AO issues the certificate.
The certificate specifies: (a) the lower rate of TDS (or nil), (b) the validity period (usually the full tax year or a specific period), and (c) the name of the deductor(s) to whom it applies. Multiple deductors can be covered.
The payee hands the certificate to the deductor. From the date of certificate onwards, the deductor must deduct TDS at the rate specified (or not deduct at all if nil rate) until the certificate expires.
Once the deductor receives a valid certificate, they are legally bound to honour it — deducting only at the certificate rate. The deductor is protected from any default liability as long as the certificate is valid and they act in accordance with it.
Who Typically Applies?
| Category of Payee | Common Reason for Applying |
|---|---|
| Mutual funds / investment companies | Tax-exempt under Schedule VII — seek nil TDS on interest/dividend income |
| Banks & financial institutions | Exempt from TDS on interest received — apply for nil certificate |
| Charitable trusts / NPOs | Income exempt under applicable provisions — lower or nil TDS on rent/interest |
| Individuals / HUFs with losses | Large carry-forward losses make effective tax rate lower than TDS rate |
| Non-residents with DTAA benefit | Lower DTAA rate applies — seek certificate at treaty rate rather than statutory rate |
| Contractors/professionals with thin margins | Effective tax rate on net income much lower than TDS rate on gross receipts |
- Application must be filed before the relevant payment is made — a certificate cannot be applied retrospectively
- Valid PAN must be furnished in the application — otherwise the certificate will not be granted [Section 397(2)(f)(ii)]
- The certificate is valid only for the specified period and specified deductors — a new application is needed for each tax year
- The AO may cancel the certificate after giving reasonable opportunity to the applicant [Section 395(5)]
Section 395(2) — Non-Resident: Determination of Taxable Proportion
This sub-section provides a mechanism specifically for payments to non-residents under Section 393(2), Sl. No. 17 (the residual "any other sum" provision — equivalent of old Section 195).
When a payer makes a payment to a non-resident (e.g., software licence fee, management fee, royalty), the entire sum may not be chargeable to tax in India — for example, part of it may relate to services rendered outside India, or it may be partly covered by a DTAA exemption. Without Section 395(2), the payer would have to deduct TDS on the entire amount.
How Section 395(2) Works
The payer (not the payee) may apply to the AO in prescribed form where they consider that the whole of such sum would not be chargeable to tax in the hands of the non-resident recipient.
The AO determines the appropriate proportion of the sum that is chargeable to tax in India — in the prescribed manner. This takes into account applicable DTAA provisions, services rendered in India vs outside, etc.
Once the AO's determination is made, TDS under Section 393(2) Sl. 17 is deducted only on the proportion determined to be chargeable to tax — not on the entire payment.
An Indian company pays ₹1 crore to a US company for software implementation services — 40% of the work was done by the US team sitting in India, and 60% was done remotely from the US. The Indian company can apply under Section 395(2). The AO may determine that only 40% (₹40 lakh) is chargeable to tax in India. TDS is then deducted only on ₹40 lakh at the applicable rate (or DTAA rate if lower) — instead of on the full ₹1 crore.
Note: The Board also has power under Section 400(3) to notify classes of cases where payers must compulsorily apply to the AO to determine the taxable proportion before remitting to a non-resident.
Section 395(3) — Lower TCS Certificate
Mirrors Section 395(1) but applies to Tax Collected at Source (TCS) under Section 394. The buyer/licensee/lessee — not the seller/collector — applies for a lower rate certificate.
| Aspect | Lower TDS Certificate [Section 395(1)] | Lower TCS Certificate [Section 395(3)] |
|---|---|---|
| Who applies? | The payee (recipient of income) | The buyer / licensee / lessee |
| Applies to | TDS under Sections 392 and 393 | TCS under Section 394 |
| AO's test | Total income of payee justifies lower/nil deduction | Total income of buyer/lessee justifies lower rate of collection |
| Certificate issued to | Payee — who then gives it to the deductor | Buyer/lessee — who then gives it to the collector/seller |
| Nil collection possible? | Yes — "no deduction" is explicitly covered | Only lower rate — "no collection" is not explicitly mentioned |
- A manufacturing company buying scrap/minerals whose effective tax rate is lower than 1% due to losses — can apply for lower TCS certificate
- A frequent international traveller whose LRS remittances attract 20% TCS but whose actual tax liability is nil (income below taxable limit)
- An individual whose only income is from the purchase covered by TCS and whose total income does not exceed the basic exemption limit
Section 395(4) — Mandatory TDS/TCS Certificates to Deductees/Collectees
This is a distinct provision from the lower-rate certificates above. Section 395(4) mandates that every deductor and collector must issue a certificate to the deductee/collectee after deducting/collecting tax — irrespective of whether any lower-rate certificate was involved.
| Certificate Type | Form | Issued By | Contents |
|---|---|---|---|
| TDS Certificate — Salary | Form 16 | Employer (deductor) to employee | Amount of tax deducted, rate, salary breakup, perquisite details, TAN, PAN of employee |
| TDS Certificate — Non-Salary | Form 16A | Deductor to deductee (for all non-salary TDS) | Nature of payment, amount credited/paid, TDS amount, rate, TAN, PAN, challan details |
| TCS Certificate | Form 27D | Seller/collector to buyer/collectee | Nature of goods/receipt, amount received, TCS amount, rate, TAN, PAN of buyer, challan details |
| Employer paying tax on perquisites | Special certificate | Employer [Section 392(2)(a)] to employee | Amount of tax paid by employer on non-monetary perquisites, rate at which paid — Section 395(4)(b) |
- The amount of tax that has been deducted or collected
- The rate at which tax has been deducted or collected
- Any other particulars as may be prescribed — typically includes: name and address of deductor/deductee, PAN of both, TAN, assessment year, nature of payment, challan identification number
Section 395(5) — Cancellation of Certificate
The Assessing Officer may cancel a lower/nil TDS certificate (issued under Section 395(1)) or a lower TCS certificate (issued under Section 395(3)) after giving the applicant a reasonable opportunity of being heard.
Grounds for cancellation typically include: the income of the payee exceeds what was projected at the time of application, or circumstances have changed materially, or incorrect information was provided in the application.
Practical effect: Once cancelled, the deductor must revert to deducting TDS at the full applicable rate from the date of cancellation. The deductor is not liable for under-deduction during the period the certificate was validly in force.
Section 396 — Tax Deducted is Deemed Income Received
This section ensures that the gross income (before TDS) is treated as the income received — not just the net amount after deduction. Key implications:
| Situation | Treatment under Section 396 |
|---|---|
| Contractor receives ₹90,000 after ₹10,000 TDS on ₹1 lakh professional fees | Income = ₹1,00,000 (gross). The ₹10,000 TDS is credited against tax liability. |
| Tax paid outside India (foreign TDS) for which credit is available in India | Also treated as income received — credit available under Section 159 (DTAA relief). |
| Exception: Tax paid by employer on perquisites [Section 392(2)(a)] | NOT deemed income received — the employer bears this tax, it does not flow back to the employee's income computation. |
| Exception: TDS on cash withdrawals from bank [Section 393(3), Sl. 5] | NOT deemed income received — cash withdrawal is not income; the TDS is effectively a cost of cash withdrawal. |
Section 400 — Power of Central Government to Relax TDS/TCS
Section 400 provides the Central Government and the CBDT (Board) with broad powers to issue relaxations from the TDS/TCS provisions of Chapter XIX:
The Central Government may, by notification, provide that TDS/TCS shall not be made, or is to be made at a lower rate, from such payments or receipts and in respect of such persons or class of persons as specified. This is the basis for many TDS exemption notifications (e.g., payments to certain government bodies, RBI-regulated entities, etc.).
The Board may issue guidelines (with prior Central Government approval) to remove difficulties in giving effect to Chapter XIX provisions. Such guidelines are laid before each House of Parliament.
The Board may notify classes of cases where payers making payments to non-residents under Section 393(2) Sl. 17 must compulsorily apply to the AO to determine the taxable proportion before remitting. TDS is then deducted only on that proportion.
The Board may make rules specifying: (a) the cases and circumstances for applying under Section 395(1) and (3), (b) the conditions for granting certificates, and (c) all other connected matters. This is the rule-making power that governs the entire lower-rate certificate regime.
Section 401 — Bar Against Direct Demand on Assessee
Plain language: Once TDS has been deducted from your income, the tax department cannot demand the same tax from you again. The deductee is protected from double taxation — the deductor's liability to deposit the TDS is separate from the deductee's obligation.
Key implications:
- If TDS has been deducted but the deductor has not deposited it, the tax department must pursue the deductor — not the assessee/deductee
- The assessee can take credit for the TDS in their return of income (as reflected in Form 26AS/AIS) — even if the deductor has defaulted in depositing it
- This protection applies only to the extent TDS has actually been deducted — if TDS was not deducted, the assessee must pay the tax directly under Section 391
Practical Guide — When to Apply for Which Certificate
| Your Situation | Apply Under | What You Get |
|---|---|---|
| You receive rent, professional fees, interest — but your effective tax rate is lower than TDS rate | Section 395(1) | Certificate specifying lower TDS rate — deductor deducts at that lower rate |
| Your total income is below basic exemption limit — don't want any TDS | Section 395(1) | Nil TDS certificate — no deduction at all |
| You are paying a non-resident where only part of the payment is taxable in India | Section 395(2) | AO determines taxable proportion — TDS only on that proportion |
| You are buying goods/assets subject to TCS but your actual tax is nil/lower | Section 395(3) | Lower TCS certificate — seller collects TCS at reduced rate |
| TDS has been deducted from your income but deductor hasn't deposited it | Section 401 | You cannot be asked to pay again — claim credit in return and department pursues deductor |
| You are a trust/mutual fund with income exempt from tax — want nil TDS on interest/dividends | Section 395(1) or 393(6) self-declaration | Either a nil TDS certificate from AO or a self-declaration for nil deduction (for categories listed in 393(6)) |