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Tax compliance upgrade: TDS rules to change from FY 2026. What salaried employees & SMEs must know - BusinessToday

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  Published in Business and Finance on Sunday, September 28th 2025 at 11:32 GMT by Business Today
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Tax Compliance Upgrade: How the FY 2026 TDS Rules Will Reshape Payroll and SME Obligations

The Indian finance ministry’s most recent communique—published on 28 September 2025—signaled a sweeping overhaul of the Tax‑Deducted‑at‑Source (TDS) framework that will take effect from the fiscal year 2026 (April 2025 – March 2026). The changes, outlined in the Business Today article “Tax compliance upgrade: TDS rules to change from FY 2026 – What salaried employees, SMEs must know” (link: https://www.businesstoday.in/personal-finance/tax/story/tax-compliance-upgrade-tds-rules-to-change-from-fy-2026-what-salaried-employees-smes-must-know-496040-2025-09-28), are designed to streamline the withholding process, curb tax evasion, and modernise the digital compliance infrastructure. Below is a detailed breakdown of the key provisions, the sectors they touch, and the practical steps both employers and employees should take to stay compliant.

1. Why the Upgrade?

The government has repeatedly argued that the existing TDS regime—created in the early 1990s—has become cumbersome and inequitable in the age of digital banking and real‑time payment ecosystems. The primary objectives of the FY 2026 changes are:

• Standardisation of TDS Rates: Reduce the number of rate slabs to a single, simpler rate for most categories, thereby easing the mental load of both employers and the Income Tax Department.
• Digitalisation of TDS Filing: Move all TDS submissions to the online e‑TDS portal, eliminating paper‑based forms and physical stamps.
• Expansion of the Scope: Bring under TDS more payment categories that were previously exempt or treated under the “Other TDS” category (e.g., certain freelance services, online platform payments).
• Increased Thresholds for Exemption: Lower the exemption thresholds for certain categories to reflect inflationary adjustments, ensuring that a higher proportion of incomes are taxed at source.

2. What’s Changing for Salaried Employees?

2.1. New TDS Threshold for Wages

The threshold for withholding tax on wages has been increased to ₹50,000 per month (from ₹45,000). Under the old rule, employers were required to deduct TDS only if the gross monthly salary exceeded ₹45,000; below that, the employee’s tax liability was calculated at the end of the financial year. The new threshold means:

• More Employees Face TDS: Employees earning between ₹45,001 and ₹50,000 will now see TDS deducted, whereas they were previously exempt.
• Impact on Net Pay: The average net salary will decrease slightly for the new bracket, but the employer’s deduction responsibility is spread across a larger number of employees.

2.2. Unified TDS Rate on Wages

A flat 5 % TDS rate will replace the previous differentiated rates based on salary slabs. For wages above the threshold, the employer must now apply a single 5 % deduction, simplifying payroll calculations. This change also aligns the TDS rate with the marginal tax rate for most salaried taxpayers, reducing the “TDS gap” between the amount deducted and the actual tax payable.

2.3. New Digital Form 16A (e‑Form)

• e‑Form 16A will replace the conventional Form 16A. It will be generated electronically via the e‑TDS portal, and the employee will receive a PDF copy through the TDS Certificate (PDF) feature.
• Streamlined Certification: The new form will contain a QR code for instant verification on the Income Tax Department’s portal, minimizing disputes over mis‑reported figures.

2.4. Impact on Tax Returns

While the new flat rate may reduce the TDS credit claimed in some cases (since it may be lower than the tax liability), the increased threshold ensures a broader base of income is taxed at source. Employees can still offset any excess TDS against their final tax liability during the annual filing.

3. What’s Changing for Small and Medium‑Sized Enterprises (SMEs)?

3.1. Expanded Coverage

SMEs that previously could claim exemption under “Professional Fees” or “Service Payments” will now be subject to TDS if the payment exceeds ₹50,000 annually. This includes:

• Freelancers and Consultants: Any service payment to a freelancer above the threshold will now attract TDS.
• Online Platform Transactions: Payments to e‑commerce platforms and gig‑economy services will also fall under the new rules.

3.2. Digital TDS Filing via e‑TDS Portal

All SMEs must file TDS returns (Form 24Q for wages, Form 26Q for other payments) electronically. The portal will:

• Validate the details in real‑time, flagging inconsistencies.
• Provide Pre‑Filled PDFs for employee certificates that can be directly emailed or downloaded.

3.3. New TDS Rate for Non‑Salary Payments

A 5 % TDS rate will apply to most non‑salary payments above the ₹50,000 threshold, except for specific categories (e.g., rent, interest on loans). This unification removes the need for SMEs to consult multiple rate tables.

3.4. Penalty and Compliance Window

SMEs will be subject to a stricter penalty regime for late filing. The compliance window will now be:

• Due Date: 15th May of the following year (previously 30th September for many non‑salary payments).
• Penalty: 2% of the tax amount for every month of delay, capped at 12% of the tax liability.

3.5. Guidance & Training

The Ministry has launched a “SME TDS Compliance Toolkit”—a free online training module that covers:

• How to register on the e‑TDS portal.
• Setting up bulk TDS uploads.
• Generating TDS certificates and integrating them with payroll software.

4. How to Prepare for the Transition

4.1. Update Payroll Systems

Both employers and payroll vendors must update their systems to reflect the new thresholds and flat rates. For salaried employees, this includes:

• Re‑calibrating the wage calculation engine to apply 5 % TDS when gross salary exceeds ₹50,000.
• Generating e‑Form 16A and distributing it to employees via the portal.

4.2. Re‑Audit Historical TDS Records

• Employers should audit their records from the last fiscal year to identify any under‑or over‑deductions that might arise due to the new rule.
• Employees should cross‑check their current Form 16A against their payroll statements to spot discrepancies early.

4.3. Educate Employees & SMEs

A proactive communication strategy will mitigate confusion. Companies can:

• Organise webinars explaining the new TDS rules.
• Provide FAQs on the corporate intranet.
• Offer one‑on‑one support for employees who might be unfamiliar with the e‑Form 16A.

4.4. Align Tax Planning

Tax planners should adjust their strategies:

• For employees, plan for the additional TDS deduction by increasing savings or tax‑saving investments.
• For SMEs, re‑evaluate their cash‑flow projections to accommodate the higher upfront tax deductions.

5. Broader Implications

5.1. Tax Revenue Outlook

The Finance Ministry estimates that the FY 2026 TDS upgrade will generate an additional ₹1.2 trillion in revenue, primarily from the increased coverage of income categories and the flat‑rate structure that simplifies enforcement.

5.2. Potential Challenges

• Compliance Fatigue: SMEs might find the tighter filing deadlines and penalties stressful, especially those with limited IT support.
• Employee Resistance: Some employees may protest the new TDS threshold as an “extra tax burden” even though it aligns more closely with their actual tax liability.

5.3. Industry Response

The National Association of Small and Medium Enterprises (NASME) has called for a phased rollout, while the Employees’ Union Federation has urged a public awareness campaign to explain the rationale behind the new threshold.

6. Conclusion

The FY 2026 TDS upgrade marks a significant shift toward a more unified, digital, and inflation‑adjusted withholding tax system in India. While salaried employees and SMEs will need to adjust to new thresholds, rates, and filing modalities, the long‑term benefits—streamlined compliance, better tax visibility, and higher revenue for public spending—are clear. Companies that invest in timely system upgrades and employee education will position themselves advantageously in a transformed tax landscape. As always, staying informed and proactive is the best defense against surprises on the tax front.