Analysis of Section 40(a)(i)- Non-compliance of Provisions of TDS where payment is made to Non Resident
If any interest, royalty, fees for technical services or other sum chargeable under this Act, which is payable,—
(A) Outside India; or
(B) 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 I.T. Act.
Condition 2: The aforesaid sum is paid or is payable:
(i) outside India to a non-resident or a foreign company
(ii) 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
(i) Tax has been deducted in the subsequent year; or
(ii) 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.
Section 40(a)(ia)- Non compliance of Provisions of TDS where payment is made to a Resident
Amounts not deductible.
40. 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”,—
(a) in the case of any assessee—
****
(ia) 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,—
(i) “commission or brokerage” shall have the same meaning as in clause (i) of the Explanation to section 194H;
(ii) “fees for technical services” shall have the same meaning as in Explanation 2 to clause (vii) of sub-section (1) of section 9;
(iii) “professional services” shall have the same meaning as in clause (a) of the Explanation to section 194J;
(iv) “work” shall have the same meaning as in Explanation III to section 194C;
(v) “rent” shall have the same meaning as in clause (i) to the Explanation to section 194-I;
(vi) “royalty” shall have the same meaning as in Explanation 2 to clause (vi) of sub-section (1) of section 9;
Analysis:
- If there is anysum 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 disallowed.
- 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 paid.
- 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 payee.
- Section 201(1) provides that if an assessee:
(a) fails to deduct TDS; or
(b) 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:
(i) Penalty under section 221 which can be upto the amount of TDS not deducted/not paid.
(ii) 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 201.
- 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 directly.
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).
- First proviso to section 201(1)
Any person, including the principal officer of a company, who fails to deduct the whole or any part of the tax in accordance with the provisions of relevant Chapter on the sum paid to a resident or on the sum credited to the account of a resident shall not be deemed to be an assessee in default in respect of such tax if such resident—
(i) has furnished his return of income under section 139;
(ii) has taken into account such sum for computing income in such return of income; and
(iii) has paid the tax due on the income declared by him in such return of income,
and the person furnishes a certificate to this effect from an accountant in such form as may be prescribed.
The above proviso to section 201(1) is applicable in case of amount paid or payable to resident only. It is not applicable to Non Resident.
- The amendment also provides that deductor shall have to pay interestunder Section 201(1A) @ 1% per month or part of the month from the date the tax was so deductible to the date of furnishing of return of income by the payee. The interest shall be levied on the amount of TDS not deducted / short deducted by the deductor.
ILLUSTRATION: M/S XYZ appointed Mr. B for consultancy work. He failed to deduct TDS from payment made to him but Mr. B has paid tax on his total income. Whether payment made to Mr. B will be disallowed in hands of Mr. X?
As per section 40(a)(ia), where any interest, commission or brokerage, rent, royalty, fees for professional services or fees for technical service is payable to a resident on which tax is deductible at source but such tax has not been deducted or after deduction has not been paid to the credit of central government by due date specified under section 139(1), 30% of such amount shall be disallowed.
However, where an assessee fails to deduct tax but the deductee has paid tax on such income by including the same in the return of income furnished by him, then assessee shall not be deemed as an assessee in default for the purpose of section 40(a)(ia).
Thus, when payee files his return, the amount which was disallowed in the hands of payer shall be allowed as a deduction in the financial year in which payee furnish his return of income.
Example, if payee furnishes his return of income on July 15, 2021, it shall be deemed that the assessee has deducted and deposited the tax on July 15, 2021 and he shall be allowed deduction in the Financial Year 2021-22. A tax auditor is required to report the particulars of such disallowance in the tax audit report for FY 2020-21.
How Section 40(a)(ia) operates to allow or disallow an expense?
As per section 40(a)(ia) where an assessee fails to deduct TDS or after deduction fails to deposit the same to the account of the central government on or before the due date specified under section 139(1), 30% of such amount shall be disallowed. However where such tax is deducted in subsequent year or has been deducted during the current year but paid after the due date, then such proportion which has been disallowed shall be allowed as a deduction in the year in which such tax is paid. Let us understand this with the help of table below (assuming assessee is a company):
| Date of Payment/ Credit to the account of assessee | Date of Deduction of tax | Time of Payment of TDS to the credit of government | Year in which deduction will be allowed |
| June 18, 2020 | June 18, 2020 | July 7, 2020 | FY 2020-21 |
| July 12, 2020 | March 28, 2021 | May 31, 2021 | FY 2020-21 |
| March 31,2021 | April 30, 2021 | June 30, 2021 | FY 2020-21 |
| August 14, 2020 | April 30, 2021 | December 31, 2021 | FY 2021-22 |
| July 15, 2020 | June 25, 2021 | July 31, 2022 | FY 2022-23 |
ILLUSTRATION: Whether any exp. would be treated as inadmissible under section 40(a)(ia) even if such exp. isn’t payable as on March 31, 2018?
Clause 21(b) requires reporting of expenses which are not admissible as per the various sub-clauses to section 40(a). Section 40(a)(ia) deals with the disallowance of 30% of any sum payable to a resident on which TDS hasn’t been deducted or after deduction, not paid to Govt. on or before the due date of filing of ITR.
Since the section 40(a)(ia) uses the word ‘Payable’, assessee often argued that the provision is applicable only on such sums which are payable as on March 31 and no disallowance could be made for any sum which has been paid during the year.
The Supreme Court has settled this ‘paid’ vs ‘payable’ controversy in the case of Palam Gas Service v. CIT [2017] 81 taxmann.com 43 (SC). It was held that the disallowance for TDS default shouldn’t be restricted to only those expenses which are outstanding as on the last day of the financial year.
Therefore, expenses would be treated as inadmissible under section 40(a)(ia) even if it is paid during the year.
No TDS default disallowance u/s. 40(a)(ia) for assessee opting presumptive basis taxation u/s 44AD
Surat ITAT in the case of Shri Bipinchandra Hiralal Thakkar
[TS-539-ITAT-2020(SUR)]rules in favour of assessee-individual [who offered income to tax on presumptive basis u/s. 44AD @ 8% on gross turnover), deletes TDS default disallowance u/s 40(a)(ia) for AY 2013-14; Noting that assessee made interest payments on unsecured loans and job work expenses without deducting TDS u/s 194A/194C, AO made disallowance u/s. 40(a)(ia); However, ITAT refers to the non-obstante” clause at the beginning of section 44AD overriding the provisions of sections 28 to 43C; Relies on the judgement of SMS Bench Kolkata in the case of Jaharlal Mukherjee, wherein it was held ..the provisions of section 44AD of the Act overrides all other provisions contained in section 28 to 43C. Admittedly, the provisions of section 40(a)(ia)of the Act falls within this range of sections 28 to 43C of Chapter-XVII B of the I.T. Act.” ; Rejects Revenue’s stand that the dues to the crown has no limitation and has precedence over all other allowance and claims”, opines that provisions of section 44AD have been enacted by the Legislature/Crown to provide benefit to small businessmen in terms of cost savings.
TDS Compliance In Tax Audit Report (Particulars in Form No. 3CD)
Clause 21(b) of Form 3CD – Amounts inadmissible under section 40(a)(i), 40(a)(ia), 40(a)(ic), 40(a)(iia), 40(a)(iib), 40(a)(iii), 40(a)(iv), 40(a)(v). These sections broadly relate to disallowances made in respect of expenditure or a part of an expenditure where tax was required to be deducted at source but the assessee failed to do so.
Amount Inadmissible under section 40(a)
(i) As payment to non-resident referred to in sub clause (i)
(ii) As payment referred to in sub clause (ia)
(iii) As payment referred to in sub clause (ib)
Details are as under:
21(b)(i) As payment to non- resident referred to in sub clause (i)
| Date of payment * |
Amount of payment * |
Nature of payment * |
Name of the payee * | PAN | Address Line-1 * |
Address Line-2 |
City * | Pin * |
(A) Details of payment on which tax is not deducted
(B) Details of payment on which tax has been deducted but has not been paid during the previous year or in the subsequent year before the expiry of time
Date of
|
Amount of
|
Nature of
|
Name of the payee * |
PAN |
Address
|
Address
|
City * |
Pin * |
Amount
|
21(b)(ii) As payment referred to in sub clause (ia)
| Date of payment * |
Amount of payment * |
Nature of payment * |
Name of the payee * | PAN | Address Line-1 * |
Address Line-2 |
City * | Pin * |
(A) Details of payment on which tax is not deducted
(B) Details of payment on which tax has been deducted but has not been paid on or before the due date specified in sub-section (1) of Section 139
Date of
|
Amount of
|
Nature of
|
Name of the payee * |
PAN |
Address
|
Address
|
City * |
Pin * |
Amount
|
Amount
|
Checklist for Clause 34 of Tax Audit Report to be considered by Auditors
Clause 34(a)
i. Obtain a statement of TDS deducted showing the particulars of the head under which tax is deducted.
ii. Identify various heads of expenses where there is a likelihood of TDS liability and scrutinize those accounts to ensure that wherever TDS was liable to be deducted, is deducted and deducted correctly, (Ensure you have the correct heads and rate chart including changes if any during the year)
iii. Check the relevant vouchers, challans of payments.
iv. Scrutinize relevant accounts for expense heads such as salaries, interest, royalties, contractors/sub-contractors, professional technical fees etc.
v. Specify the section under which TDS is required to be deducted, nature of payments, and total payment of such nature.
v. Out of the above payments, check the total amount on which TDS is required to be deducted, amounts on which TDS is actually deducted and deposited.
vii. Scrutinize the ledger to obtain instances where tax is deductible but it is not deducted or there is short deduction.
Clause 34(b)
i. Obtain the receipts / acknowledgements of the various TDS return filed by the assessee during the year.
ii. Check whether the returns are filed within the due dates specified under the act.
iii. Cross verify the TDS and gross amount on which TDS is required to be deducted as specified in the acknowledgement with the books of accounts, to ensure that all transactions on which TDS was required to be deducted are shown in the quarterly returns.
iv. In this regards Scrutinize the accounts as specified in clause 34(a) above.
v. The details in this clause are required to be given only if the assessee has not filed the TDS returns on time.
Clause 34(c)
i. Obtain the payment challans to Verify whether the TDS / TCS deducted / collected has been deposited within the time limit specified in the Act.
ii. Verify in case of delay, the calculations of interest payable for default and whether such interest is paid by the assessee.
Extract of Section 40(a)(i) of Income Tax Act, 1961
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“,—
(a) 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,—
(A) outside India; or
(B) 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,—
(A) “royalty” shall have the same meaning as in Explanation 2 to clause (vi) of sub-section (1) of section 9;
(B) “fees for technical services” shall have the same meaning as in Explanation 2 to clause (vii) of sub-section (1) of section 9;
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