Disallowance of Tax Deducted at Source

1. What is Section 40(a)(i)?

Section 40(a)(i)- Non compliance of Provisions of TDS where payment is made to Non Resident

Notwithstanding anything to the contrary in sections 30 to 38, the following amounts shall not be deducted in computing the income chargeable under the head "Profits and gains of business or profession",-

• in the case of any assessee-

(i) any interest (not being interest on a loan issued for public subscription before the 1st day of April, 1938), royalty, fees for technical services or other sum chargeable under this Act, which is payable,-

• outside India; or
• in India to a non-resident, not being a company or to a foreign company,

on which tax is deductible at source under Chapter XVII-B and such tax has not been deducted or, after deduction, has not been paid on or before the due date specified in sub- section (1) of section 139:

Provided that where in respect of any such sum, tax has been deducted in any subsequent year, or has been deducted during the previous year but paid after the due date specified in sub-section (1) of section 139, such sum shall be allowed as a deduction in computing the income of the previous year in which such tax has been paid:

[Provided further that where an assessee fails to deduct the whole or any part of the tax in accordance with the provisions of Chapter XVII-B on any such sum but is not deemed to be an assessee in default under the first proviso to sub-section (1) of section 201, then, for the purposes of this sub-clause, it shall be deemed that the assessee has deducted and paid the tax on such sum on the date of furnishing of return of income by the payee referred to in the said proviso.]

Explanation.- For the purposes of this sub-clause,-

• "royalty" shall have the same meaning as in Explanation 2 to clause (vi) of sub-section

(1) of section 9;

• "fees for technical services" shall have the same meaning as in Explanation 2 to clause
• of sub-section (1) of section 9;

Analysis

• If any interest, royalty, fees for technical services or other sum chargeable under this Act, which is payable,-
  • Outside India; or
  • In India to a non-resident, not being a company or to a foreign company,

On which tax is deductible at source and such tax has not been deducted or, after deduction, has not been paid on or before the due date of filing the income tax Return under section 139(1), then such expenses cannot be allowed as deductions.

Conditions for Disallowance:

Disallowance under section 40(a)(i) shall be attracted if:

Condition 1: The amount paid or payable is interest, royalty, fees for technical services or any other sum chargeable under I.T. Act. The aforesaid sums must be taxable in the hands of the recipient under the IT. Act.

Condition 2: The aforesaid sum is paid or is payable:

• outside India to a non-resident or a foreign company
• in India to a non-resident or a foreign company

Condition 3: Tax is deductible at source on the aforesaid payments

Condition 4: And any of the following defaults takes place

• Default A: Tax at source has not been deducted or
• Default B: Tax at source has been deducted but has not been paid on or before the due date specified in section 139(1).

The proviso to section 40(a)(4) provides that where

• Tax has been deducted in the subsequent year; or
• Tax has been deducted in the previous year but paid after the due date specified in section 139(1).

then such sum shall be allowed as deduction in the previous year in which such tax has been paid.

Relaxing the provisions of Sections 201 and 40 of the Act in case of Payments to Non- Resident

Section 201 of the Act provides that where any person, including the principal officer of company or an employer (hereinafter called the deductor), who is required to deduct tax at source on any sum in accordance with the provisions of the Act, does not deduct or does not pay such tax or fails to pay such tax after making the deduction, then such person shall be deemed to be an assessee in default in respect of such tax.

The first proviso to sub-section (1) of section 201 specifies that the deductor shall not be deemed to be an assessee in default if he fails to deduct tax on a payment made to a resident, if such resident has furnished his return of income under section 139 disclosed such payment for computing his income in his return of income, paid the tax due on the income declared by him in his return of income and furmished an accountant's certificate to this effect.

This relief in section 201 is available to the deductor, only in respect of payments made to a resident. In case of similar failure on payments made to a non- resident, such relief is not available to the deductor. To remove this anomaly, it is proposed to amend the proviso to sub-section (1) of section 201 to extend the benefit of this proviso to a deductor, even in respect of failure to deduct tax on payment to non-resident.

Consequent to this amendment, it is also proposed to amend the proviso to sub- section (1A) of section 201 to provide for levy of interest till the date of filing of return by the non-resident payee (as is the case at present with resident payee).

For the same reason, it is also proposed to amend clause (a) of section 40 to provide that where an assessee fails to deduct tax in accordance with the provisions of Chapter XVII B on any sum paid to a non-resident, but is not deemed to be an assessee in default under the first proviso to sub-section (1) of section 201, then it shall be deemed that the assessee has deducted and paid the tax on such sum on the date of furnishing of return of income by the payee referred to in that proviso. Thus, there will be disallowance under section 40 in respect of such payments:

This amendment will take effect from 1 April 2020 and will, accordingly, apply in relation to the assessment year 2020-21 and subsequent assessment years.

(i) What is Section 40(a)(ia)?

Section 40(a)(ia)- Non compliance of Provisions of TDS where payment is made to a Resident

thirty per cent of any sum payable to a resident, on which tax is deductible at source under Chapter XVII-B and such tax has not been deducted or, after deduction, has not been paid on or before the due date specified in sub-section (1) of section 139 :

Provided that where in respect of any such sum, tax has been deducted in any subsequent year, or has been deducted during the previous year but paid after the due date specified in sub-section (1) of section 139, thirty per cent of such sum shall be allowed as a deduction in computing the income of the previous year in which such tax has been paid :

Provided further that where an assessee fails to deduct the whole or any part of the tax in accordance with the provisions of Chapter XVII-B on any such sum but is not deemed to be an assessee in default under the first proviso to sub-section (1) of section 201, then, for the purpose of this sub-clause, it shall be deemed that the assessee has deducted and paid the tax on such sum on the date of furnishing of return of income by the 71[***] payee referred to in the said proviso.

Explanation.- For the purposes of this sub-clause,-

• "commission or brokerage" shall have the same meaning as in clause (i) of the Explanation to section 194H;
• "fees for technical services" shall have the same meaning as in Explanation 2 to clause

(vii) of sub-section (1) of section 9;

• "professional services" shall have the same meaning as in clause (a) of the Explanation to section 194J;
• "work" shall have the same meaning as in Explanation III to section 194C;
• "rent" shall have the same meaning as in clause (i) to the Explanation to section 194-I;
• "royalty" shall have the same meaning as in Explanation 2 to clause (vi) of sub-section
  • of section 9;

Analysis

• If there is any sum payable to a resident, on which tax is deductible at source and such tax has not been deducted or, after deduction, has not been paid on or before the due date of filing the return under section 139(1) then 30% of such sum should be

Proviso to the section 40

• Where in respect of any such sum, tax has been deducted in any subsequent year, or has been deducted during the previous year but paid after the due date specified in sub-section (1) of section 139, 30% of such sum shall be allowed as a deduction in computing the income of the previous year in which such tax has been
• Where an assessee fails to deduct the whole or any part of the tax in accordance with the provisions of Chapter XVII-B on any such sum but is not deemed to be an assessee in default under the first proviso to section 201(1), then, for the purpose of this sub-clause, it shall be deemed that the assessee has deducted and paid the tax on such sum on the date of furnishing of return of income by the resident

• Section 201(1) provides that if an assessee:
  • fails to deduct TDS; or
  • after deduction, fails to pay the TDS, then he shall be deemed to be assessee in default under section 220 & 221. Consequently he is liable to pay:
• Penalty under section 221 which can be upto the amount of TDS not deducted/not
• Interest under section 220 @ 1% p.m. from the date the tax was deductible payable till the date of passing of an order under section

• It is well established law laid down by various courts that the deductor shall be treated as an assessee in default only if:
  • Deductor has failed to deduct TDS, and
  • Deductee has also failed to pay the tax

Therefore, deductor cannot be treated as an assessee in default where deductor has failed to deduct TDS but deductee has paid the tax directly.

The Finance Act, 2012 seeks to incorporate the above provisions in section 201(1) by inserting Proviso in section 2011). The Finance Act. 2019 has further amended the said proviso to section 201(1).