Disallowance on account of Non-deduction of TDS – Section 40(a)(ia)

(i) Analysis of Section 40(a)(ia) provisions- Legislative History

• The provisions of Section 40(a)(ia) of the Act were brought on Statute by Finance Act 2004, w.e.f. 01.04.2005, i.e the same is applicable for assessment year 2005-06 and subsequent assessment years.
• Under the existing provisions of sub-clause (i) of clause (a) of Section 40, failure to make deduction at source from payment of interest, royalty, fees for technical services or any other sum which is payable outside India, or in India to a non-resident or to a foreign company or failure to make payment to the account of the Central Government, attracts disallowance of such payments in the hands of the payer. Deduction of such sum is, however, allowed in the computation of income if tax is deducted, or after deduction, paid in any subsequent year in computing the income of that year.
• As step toward enforcing compliance of provisions of TDS it was proposed to extend the provisions of Section 40(a)(i) to payments of interest, commission or brokerage, fees for professional services or fees for technical services to residents, and payments to a resident contractor or sub-contractor for carrying out any work (including supply of labour for carrying out any work), on which tax has not been deducted or after deduction, has not been paid before the expiry of the time prescribed under sub-section (1) of Section 200 and in accordance with the other provisions of Chapter XVII-B. It was also proposed to provide that where in respect of payment of any sum, tax has been deducted under Chapter XVII-B or paid in any subsequent year, the sum of payment shall be allowed in computing the income of the previous year in which such tax has been paid.
• Section 40(a)(ia) as introduced through Finance Act 2004

Section 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 – (i)

(ia) any interest, commission or brokerage, fees for professional services or fees for technical services payable to a resident, or amounts payable to a contractor or sub-contractor, being resident, for carrying out any work (including supply of labour for carrying out any work), 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 during the previous year, or in the subsequent year before the expiry of the time prescribed under sub-section (1) of Section 200

Provided that where in respect of any such sum, tax has been deducted in any subsequent year or, has been deducted in the previous year but paid in any subsequent year after the expiry of the time prescribed under sub section (1) of Section 200, such sum shall be allowed as a deduction in computing the income of the previous year in which such tax has been paid.

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;

By the Taxation Laws (Amendment) Act 2006 w.r.e.f 01.04.2006, “rent and royalty” was also brought within the purview of provisions of Section 40(a)(ia) of the Act.

Liberalization of provisions of Section 40(a)(ia) made through Retrospective amendment brought by the Finance Act 2008

• With a view to liberalize provisions of Section 40(a)(ia) of the Act, the Finance Act 2008 brought amendment r.e.f 01.04.2005 as under.
• In Section 40 of the Income-tax Act, in clause (a), –

(a) in sub-clause (ia), with effect from the 1st day of April, 2005, –

(i) for the words, brackets and figures “has not been paid during the previous year, or in the subsequent year before the expiry of the time prescribed under sub-section (1) of Section 200”, the following words, brackets and figures shall be substituted and shall be deemed to have been substituted, namely: –“has not been paid, –

(A) in a case where the tax was deductible and was so deducted during the last month of the previous year, on or before the due date specified in sub-section (1) of Section 139; or

(B) in any other case, on or before the last day of the previous year”;

(ii) for the proviso, the following proviso shall be substituted and shall be deemed to have been substituted, namely: –

“Provided that where in respect of any such sum, tax has been deducted in any subsequent year, or has been deducted –

(A) during the last month of the previous year but paid after the said due date; or

(B) during any other month of the previous year but paid after the end of the said previous year, such sum shall be allowed as a deduction in computing the income of the previous year in which such tax has been paid.”;

Further liberalization of provisions of Section 40(a)(ia) made through Prospective amendment brought by the Finance Act 2010

• The legislature has brought further liberalization by way of amendment in provisions of Section 40(a)(ia) of the Act e.f. 01.04.2010 as under.
• In Section 40 of the Income-tax Act, in clause (a), in sub-clause (ia),

(a) for the portion beginning with the words “has not been paid, – ” and ending with the words “the last day of the previous year”, the words, brackets and figures “has not been paid on or before the due date specified in sub¬section (1) of Section 139” shall be substituted;

(b) for the proviso, the following proviso shall be substituted, namely: –

“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.”.

Further liberalization of provisions of Section 40(a)(ia) made through Prospective amendment brought by the Finance Act 2012

• With a view to liberalize provisions of Section 40(a)(ia) of the Act Finance Act 2012 brought amendment e.f 01.04.2013 as under.
• The following second proviso shall be inserted in sub-clause (ia) of clause (a) of Section 40 by the Finance Act, 2012, w.e.f. 1-4-2013 :

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 resident payee referred to in the said proviso.

Since provisions of Section 40(a)(ia) as amended by Finance Act 2012 is linked to Section 201 of the Act, so it is essential to know and understand the provisions of Section 201 of the Act.

Relevant provisions of Section 201.

(1) Where any person, including the principal officer of a company –

(a) who is required to deduct any sum in accordance with the provisions of this Act; or

(b) referred to in sub-section (1A) of Section 192, being an employer, does not deduct, or does not pay, or after so deducting fails to pay, the whole or any part of the tax, as required by or under this Act, then, such person, shall, without prejudice to any other consequences which he may incur, be deemed to be an assessee in default in respect of such tax:

[Provided that 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 this 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:]

Further liberalization of provisions of Section 40(a)(ia) made through Prospective amendment brought by the Finance Act 2014

1. Section 40(a)(ia) is amended via Finance (No. 2) Act, 2014 to restrict the amount of disallowance for non-deduction of tax to 30% of expenditure.
2. The proviso is also amended to the effect that 30% of such sum shall be allowed as a deduction in computing the income of the previous year in which tax has been paid.

Extract Of Section 40(a)(ia) after amendment:

(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 resident 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 Explanation2 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;

Salient features of Provisions of Section 40(a)(ia)

• Applicable to all assessees, e irrespective of its status.
• Applies only for computation of income chargeable under the head “Profits and gains of business or profession”.
• Applies to payments made to resident
• Applies to expenses/payments as specified therein, if otherwise these payments are allowable as deduction under Sections 30 to 38 of the Act, i.e. the genuineness of expenses/payments and other criteria to be satisfied under Sections 30 to 38 of the Act must be satisfied, otherwise theses expenses/payments will not be allowable under Sections30 to 38 of the Act itself. Hence, when all the conditions/criteria of any particular section are satisfied and the payments are otherwise allowable under Sections 30 to 38 of the Act and if the provisions of Section 40(a)(ia) of the Act are not complied with in any particular financial year, then such payments will not be allowable as expense in that particular financial year.
• Point of TDS made and it’s remittance to the Govt. account need to be analysed from assessment year 2005- 06 and subsequent years in accordance with the Substantive provisions as brought by Finance Act 2004 and various retrospective/prospective amendments brought therein through various Finance Act in various years.

(ii) Important Issues and Judicial decisions on Section 40(a)(ia).

A. Constitutional validity

• For violation of TDS provisions the Income Tax Act already provided for levy of penalty and prosecution, so the assessees had challenged the validity of provisions of Section 40(a)(ia), which provides for disallowance of payments/expenses for TDS default, on the ground/ principle of double jeopardy.
• The Hon’ble Punjab & Haryana HC in the case of Rakesh Kumar & Co. vs. UOI reported in 178 Taxman 481, the Hon’ble Madras HC in the case of Tube Investment of India Ltd & Anr. Vs. ACIT reported in 325 ITR 610 and the Hon’ble Allahabad HC in the case of Deys’s Medical (UP) P Ltd, vs. UOI reported in 316 ITR 445 has upheld the constitutional validity of Section 40(a)(ia) of the Act.

B. Amendments – Retrospective vs. Prospective

• The amendment, in respect of point of TDS deducted and remittance thereof in Govt. account, brought through Finance Act 2008 has been made applicable retrospectively from Y. 2005-06 and hence there is controversy for same.
• The amendment, in respect of point of TDS deducted and remittance thereof in Govt. account, brought through Finance Act 2010 has been made applicable prospectively from 04.2010. However some courts/tribunals have held the same to be retrospective on the ground that the same has been brought to rationalize and mitigate the provisions of Section 40(a)(ia) of the Act.
• In the case of Bharati Shipyard Ltd. vs. DCIT reported in 13 com 101, the Hon’ble Mumbai Special Bench decided the matter in favour of Revenue and held that amendment brought out by Finance Act, 2010 to Section 40(a)(ia) with effect from 1-4-2010 being not remedial and curative in nature cannot be declared as having retrospective effect from date of insertion of provision, i.e., 1-4-2005.
• However the Hon’ble Calcutta High Court in the case of CIT vs. Virgin Creations in ITA No. 302 of 2011 in GA No. 3200/2011, vide its order dated 23.11.2011 has decided the issue against the Revenue, and after relying on the decision of the Hon’ble SC in the case of Allied Motors P Ltd, and Alom Extrusions Ltd has held that the provisions which has inserted the remedy to make the provision workable, requires to be treated with retrospective operation so that reasonable deduction can be given to the section as well, and accordingly has held the said amendment is retrospective.

C. Paid vs Payable.

The uses of word “Payable”, in Section 40(a)(ia) of the Act has created controversy as to whether payable includes amounts paid during the year. The Courts/ tribunals have given conflicting decisions.

• In the case of DCIT vs. Ashika Stock Broking Ltd. reported in 44 SOT 556 the Hon’ble Kolkatta ITAT has decided the matter in favour of revenue and after following its decision dated 15.01.2010 in the case of Poddar Son’s ExL P Ltd vs. ITO in ITA No. 1418(Kol.)/09 has held that provisions of Section 40(a)(ia) of the Act are applicable to even sums paid during the year.
• In the case of Teja Construction vs. ACIT reported in 39 SOT 13 the Hon’ble Hyderabad ITAT has decided the issue against the Revenue and has held that provisions of Section 40(a)(ia) of the Act are not applicable in respect of sums/amount paid during the year and which are not payable at end of the year on date of balance sheet, as it is applicable only in respect of “Payable amount” shown in balance sheet as outstanding expenses on which TDS has not been made. Similar laws were laid in various other cases.
• To resolve the above issue Special Bench was constituted and the Hon’ble Visakhapatnam Special Bench of ITAT in the case of Merilyn Shipping & Transport vs. Addl CIT reported in 20 com244 has decided the issue against the Revenue and after comparing the proposed and enacted provision which is intended from the replacement of the words in the proposed and enacted provision from the words ‘amount credited or paid’ to ‘payable’ has held that it has to be concluded that provisions of Section 40(a)(ia) are applicable only to the amounts of expenditure which are payable as on the date 31st March of every year and it cannot be invoked to disallow expenditure which has been actually paid during the previous year, without deduction of TDS.
• However the Hon’ble Andhra Pradesh HC in the case CIT vs. Merilyn Shipping & Transports, vide its order dated 08.10.20 12 in T.T.A.M.P.No.908 of 2012 in I.T.T.A. No.384 of 2012 has granted interim stay/suspension on the order of the Hon’ble Special Bench.

D. Applicability to head “Profits and gains of business or profession” or other heads of income also

• A controversy arose as to whether the provisions of Section 40(a)(ia) is applicable for computing the income chargeable under the head “Profits and gains of business or profession” or computation of income under any other heads of income also.

The Section 40 clearly stipulates that “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”. Hence it is evident that the provisions of Section 40(a)(ia) is applicable while computing the income chargeable under the head “Profits and gains of business or profession” and it is not applicable to any other heads of income.

• In the case of Mrs. Sushila Mallick vs. ITO reported in 19 com233, the Hon’ble Lucknow ITAT has held that the brokerage had been paid on account of sale of the properties, the income of which had been shown under the head ‘short-term capital gain’. The selling of properties was not the business of the assessee and, as such, the amount involved in the transaction relating to the selling of properties was not the part of turnover of the assessee. In view of same the Hon’ble ITAT held that in facts of the case the provisions of Section 40(a)(ia) of the Act is not applicable.
• In the case of Mahatma Gandhi Seva Mandir vs. DDIT(Exemp) reported in 21 com321 the Hon’ble ITAT has held that the exception in Section 40 is carved out, only for the purpose of Section 28 and not for computing the exemption of income of a charitable trust under Section 11. The disallowance made under Section 40(a) will only go to enhance the business profit of an assessee whose income is assessable under Section 28 and not otherwise. Hence, provisions of Section 40(a) are not applicable in case of charitable trust or institution where income and expenditure is computed in terms of Section 11.

E. Applicability to Section 30 to 38 or other Sections also

• A question arose whether the provisions of Section 40(a) (ia) is applicable to sums allowable as expenses under Sections other than 30 to 38 of the Act, for computation of income chargeable under the head “Profits and gains of business or Profession”.

Section 40 clearly stipulates that “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”. Hence from the above it is evident that the provisions of Section 40(a)(ia) of the Act is applicable only for sums which are otherwise allowable under Sections 30 to 38 of the Act and not under any other section of the Act.

• In strict sense if any expense is otherwise allowable under Section 28 of the Act then the same will not be covered by the provisions of Section 40(a)(ia) of the Act. Similar law has been laid down by the Hon’ble Hyderabad ITAT in the case of Teja Construction vs. ACIT reported in 39 SOT 13.

F. Whether the provisions of Section 40(a)(ia) is applicable to Capital expenses.

• As discussed above provisions of Section 40(a)(ia) of the Act is applicable to sums allowable under Sections 30 to 38 of the Act. Hence if any capital expense is allowable as deduction under Sections 30 to 38 of the Act while computing income under the head “Profits and gains from business or profession”, the same will be covered under Section 40(a)(ia) of the Act.
• Under Section 35 of the Act expenses incurred on capital assets for research and development is allowable as deduction and hence the same will be covered by the provisions of Section 40(a)(ia) of the Act.
• A question arises where the claim of depreciation under Section 32 of the Act is covered under Section 40(a) (ia) of the Act. The provisions of Section 40(a)(ia) of the Act is applicable to payments specified therein which are allowable under Section 30 to 38 of the Act. Since the claim of depreciation is not payment or expenditure in strict sense but the same is statutory allowance, so strictly the claim of depreciation will not be covered under Section 40(a))(ia) of the Act. Further the actual cost and WDV is defined in Section 43 of the Act and provisions of Section 40(a)(ia) of the Act does not override the provisions of Section 43 of the Act.
• In the case of Shri Vishnu Anant Mahajan vs. ACIT in ITA No. 3002/Ahd/2009 for A.Y. 2006-07 the Hon’ble Special Bench ITAT, Ahmedabad vide its order dated 25.05.2012, after relying on the decision of the Hon’ble SC in the case of Nectar Beverages P Ltd vs. DCIT reported in 314 ITR 314 and of Hon’ble Mumbai ITAT in the case of Hoshang D Nanavati vs. ACIT in ITA No. 3567/Mum/2007 has held that “Depreciation” is not an expenditure but the same is statutory deduction.

G. Whether the provisions of Section 40(a)(ia) of the Act is applicable to computation of presumptive income under Sections 44AD, 44AE, etc.

• From the provisions of Section 40(a)(ia) of the Act it is evident that the provisions of Section 40(a)(ia) of the Act will not be applicable while computing presumptive income under Section 44AD, 44AE etc.
• In the case of Teja Construction vs. ACIT reported in 39 SOT 13 the Hon’ble ITAT has held that as such, it may be observed that it is only the deductions referred to in Sections 30 to 38 which would definitely fall for consideration of disallowance under Section 40 and they cannot be claimed as deduction under Section 28. This reasoning applies with equal force to the analogous provision of Sections 43, 44AD, 44AE, 44B, 44ABA, 44BBB, 44C and 44D and so on, which all relate to computation of business income and clearly start with a non obstante clause, which is similar to the one in Section 40, but reading ‘Notwithstanding anything to the contrary in Sections 28 to 43C’.
• In the case of ITO vs. Mark Construction reported in 23 comthe Hon’ble Kolkatta ITAT has held that in the case of CIT v. Surindra Pal Anand [2010] 192 Taxman 264 (Punj. & Har.) the Hon’ble Punjab and Haryana High Court has held that once under the special provision of Section 44AD of the IT Act exemption from maintenance of books of account have been provided and the presumptive tax at 8% of the gross receipts itself is the basis for determining the taxable income, the assessee was not under obligation to explain individual entry of cash deposits in the bank unless such entries had no nexus with the gross receipts. In the present case though from the details filed by assessee the ld. AO observed that no TDS has been recovered, in our opinion, since assessee has disclosed the profits more than 8% of the gross receipts and there is no dispute in receipt of the gross receipts the addition made by ld. CIT(A) under Section 40(a)(ia) of the IT Act is not sustainable.

H. Whether under Section 40(a)(ia) of the Act the TDS is required to be deducted under proper section or it is sufficient if any TDS is deducted.

Situations may also arise where the deduction of tax and its payment is lower than what was required under the law. The issue would be;

(i) if the full amount will be allowed as deduction: or

(ii) it will only be proportionate to the tax deducted at source: or

(iii) no deduction at all will be allowed.

There are judgments, in the area of short deduction of tax, which show that the issue has to be judged on the basis of the facts and circumstances of each case.

• In the case of ITO vs. Premier Medical Supplies & Stores reported in 25 com171 the Hon’ble Kolkatta ITAT has held that the conditions laid down under Section 40(a) (ia ) for making addition are that tax is deductible at source and such tax has not been deducted. If both the conditions are satisfied then such payment can be disallowed under Section 40(a)(ia ), but the provisions of Section 40(a)(ia) have two limbs, one is where, inter alia, assessee has to deduct tax and the second where after deducting tax, inter alia, the assessee has to pay into Government Account. There is nothing in the said section to treat, inter alia, the assessee as defaulter where there is a shortfall in deduction. The Section 40(a) (ia) refers only to the duty to deduct tax and pay to government account. If there is any shortfall due to any difference of opinion as to the taxability of any item or the nature of payments falling under various TDS provisions, the assessee can be declared to be an assessee-in-default under Section 201 and no disallowance can be made by invoking the provisions of Section 40(a )(ia).
• Similar law has been laid down by the Hon’ble Kolkatta ITAT in the case Dy. CIT v. S. K. Tekriwal [2011] reported in 48 SOT 515, and by the Hon’ble Mumbai ITAT in the case of DCIT vs. Chandabhoy & Jassobhoy reported in 17 com158.
• The above referred law laid down by the Hon’ble Kolkatta ITAT in the case of S.K. Tekriwal has been confirmed by the Hon’ble Calcutta HC in same case in ITAT No. 183 of 2012 GA No. 2069 of 2012, wherein the Hon’ble Calcutta HC vide its order dated 03. 12.2012.
• In the case of Diplomat Enterprises the assessee had deducted on certain payments @ 2.20% as against 2.24%. The assessee had suo motu disallowed the said sum under Section 40(a)(ia) of the Act (mainly due to reason that the assessee was claiming deduction under Section 80IB of the Act). The AO was of the opinion that disallowance needed to be made only proportionately, e. in other words, proportionate to the tax actually deducted at source. Therefore he scaled down the disallowance made by the assessee under Section 40(a)(ia) of the Act. The CIT(A) reinstated the working done by the assessee. The Hon’ble Chennai ITAT in the case of ACIT vs. Pixie Enterprises reported in 15 taxmann. com314, wherein the case of Diplomat Enterprises in I. T. A. No. 1557/Mds/2009 was also decided, held that the line of reasoning adopted by the learned Commissioner of Income-tax (Appeals) is incorrect. He was bound to look into the aspect whether the disallowance suo motu done by the assessee was justified after analysing Section 40(a)(ia) and the effect of allowing such claim, in future years when the assessee made good the short fall in deduction of tax. The disallowance contemplated under Section 40(a)(ia) is where tax has not been deducted or where, after deduction, it is not paid. Whether such disallowance can be done even when deduction has been effected but at a rate lower than the prescribed one has not been looked into by the learned Commissioner of Income-tax (Appeals). The view of the learned Commissioner of Income-tax (Appeals) that the exercise is futile is not correct since it will have ramifications in future years, when allowances are claimed by the assessee after remitting the short fall. Hence the Hon’ble ITAT set aside the order of the learned Commissioner of Income-tax (Appeals) in this regard and remitted it back to him, for disposal in accordance with law.
• The provisions of Section 40(a)(ia) of the Act uses the words “….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 ”.The use of words “Such tax” clearly denotes that the tax has to be deducted at per rate prescribed under the appropriate section in Chapter XVII-B of the Act which is applicable to the sums under consideration. The expression “on which tax is deductible at source under Chapter XVII-B and on which such tax has not been deducted” clearly indicates that the disallowance provisions get attracted when such tax is not deducted- i.e. tax deductible under Chapter XVII-B. So, even if part of tax deductible is not deducted, the disallowance under Section 40(a)(ia) kicks in.

The said proposition of law gets further fortified from the proviso inserted by the Finance Act 2012, which provides 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 sums”. The use of words “whole or any part of the tax” makes it evident that the TDS not only need to be deduct but the same need to be deducted at appropriate rate under applicable section in Chapter XVII-B of the Act.

I. Meaning of tax deductible under chapter XVII for Section 40(a)(ia)

• The courts have held that under Section 40(a)(ia) of the Act there should be legal liability to deduct the tax under Chapter XVII. If there is no such liability to deduct TDS then the provisions of Section 40(a)(ia) of the Act cannot be invoked.
• In the case of Pareek Electricals vs. Assistant Commissioner of Income-tax, Circle 2(1), Cuttack reported in 27 com219 the Hon’ble Cuttack ITAT has held that Where assessee paid rent to land lady, which was below taxable limit, without deduction of tax at source under Section 194-I and filed Form No. 15G being given by land lady, disallowance of rent paid under Section 40(a)(ia) on plea that there were infirmity in Form No. 15G was unjustified.
• In the case of ACIT vs. Meerut Rubber Factory reported in 25 com338, the Hon’ble Delhi ITAT has held that the assessee had not deducted tax at source on the ground that the depositors intended to file form No. 15G/15H in time but Form No. 15G/15H were not filed by the date on which it credited/paid the interest to the depositors. In Section 40 the word ‘shall not be deducted in computing the income chargeable under the heads ‘Profits and gains of business or profession’ have been employed. It is a settled law that where the word ‘shall’ is used, it is mandatory. Therefore, for allowance of deduction under Section 40(a)(ia), the assessee should have either obtained Form No. 15G/15H on or before the end of the accounting year or it should have deducted tax at source. Since provisions of Section 40(a)(ia) are mandatory in nature, in cases where the assessee had not deducted tax at source, the deduction would not be allowable.
• In the case of Shyam Sunder Kailash Chand vs. ITO reported in 19 com342 the Hon’ble Jaipur ITAT has held that where the amount was paid/payable to contractor/sub¬contractor and where Form No. 15G was received by the assessee from depositors was submitted to AO late by few days but before framing assessment, interest paid by assessee to depositors without deduction of tax at source could not be disallowed since said forms were available to AO while framing assessment order.
• In the case of CIT vs. Valibhai Khanbhai Mankad in Tax Appeal No. vide its order dated 01.10.2012, the Hon’ble Gujarat HC has held as under.

For application of Section 40(a)(ia) of the Act, the foremost requirement would be of tax deduction at source.

Section 194C, as already noticed, makes provision where for certain payments, liability of the payee to deduct tax at source arises. Therefore, if there is any breach of such requirement, question of applicability of Section 40(a)(ia) would arise. Despite such circumstances existing, sub-section (3) makes exclusion in cases where such liability would not arise. We are concerned with the further proviso to sub-section (3), which provides that no deduction under sub-section (2) shall be made from the amount of any sum credited or paid or likely to be credited or paid to the sub-contractor during the course of business of plying, hiring or leasing goods carriages, on production of a declaration to the person concerned paying or crediting such sum in the prescribed form and verified it in the prescribed manner within the time as may be prescribed, if such sub-contractor is an individual who has not owned more than two goods carriages at any time during the previous year.

The exclusion provided in sub-section (3) of Section 194C from the liability to deduct tax at source under sub-section (2) would thus be complete the moment the requirements contained therein are satisfied. Such requirements, principally, are that the sub-contractor, recipient of the payment produces a necessary declaration in the prescribed format and further that such sub-contractor does not own more than two goods carriages during the entire previous year. The moment, such requirements are fulfilled, the liability of the assessee to deduct tax on the payments made or to be made to such sub-contractors would cease. In fact he would have no authority to make any such deduction.

The later portion of sub-section (3) which follow the further proviso is a requirement which would arise at a much later point of time. Such requirement is that the person responsible for paying such sum to the sub-contractor has to furnish such particulars as prescribed. We may notice that under Rule 29D of the Rules, such declaration has to be made by the end of June of the next accounting year in question.

In our view, therefore, once the conditions of further proviso of Section 194C(3) are satisfied, the liability of the payee to deduct tax at source would cease. The requirement of such payee to furnish details to the income tax authority in the prescribed form within prescribed time would arise later and any infraction in such a requirement would not make the requirement of deduction at source applicable under sub-section (2) of Section 194C of the Act. In our view, therefore, the Tribunal was perfectly justified in taking the view in the impugned judgment. It may be that failure to comply such requirement by the payee may result into some other adverse consequences if so provided under the Act. However, fulfillment of such requirement cannot be linked to the declaration of tax at source. Any such failure therefore cannot be visualized by adverse consequences provided under Section 40(a)(ia) of the Act.

When on the basis of the record it is not disputed that the requirements of further proviso were fulfilled, the assessee was not required to make any deduction at source on the payments made to the sub-contractors. If that be our conclusion, application of Section 40(a)(ia) would not arise since, as already noticed, Section 40(a)(ia) would apply when there is a requirement of deduction of tax at source and such requirement is either not fulfilled or having deducted tax at source is not deposited within prescribed time.

J. Effect of Explanation to Section 40(a)(ia) of the Act.

• The effect of Explanation to Section 40(a)(ia) of the Act is that the nature of any sums has to be determined within the meaning of definition of such sums given in the said Explanation.
• In the case of Sonata Information Technology Ltd vs. DCIT reported in 25 com125 it has been held that for the purpose of Section 40(a)(ia), royalty shall have the same meaning as in Explanation 2 of clause (vi) of sub-section (1) of Section 9. Explanation 4 which was introduced with effect from 1-6-197 6 by the Finance Act, 2012 has no effect as that Explanation was not referred to in Section 40(a)(ia). Since the definition of royalty is specifically mentioned in Section 40(a)(ia), the examination of the issue can only be made with reference to Explanation 2 alone.

K. Whether provisions of Section 40(a)(ia) of the Act can be invoked when TDS was deducted but not paid on the ground that in earlier years excess TDS has been paid and refund is arising therein.

• In the case of HCC Pati Joint Venture vs. ACIT reported in 12 taxmann.com179 the Hon’ble Mumbai ITAT has held that the provisions of Section 40(a)(ia) are in the nature of additional measure to ensure the deduction and deposit of the tax (TDS) within time. When the assessee makes more payment than requirement, the CBDT has given a right to the deductor to claim refund or adjust the excess payment, the refund and claim of excess payment has to be decided by the revenue authorities. But in the garb of the claim of excess deposit, the TDS deducted by the assessee on the payment during subsequent year cannot be withheld. The assessee has to deposit the TDS in compliance with the provisions of the Act. Since, the TDS deducted by the assessee is not the assessee’s own tax liability but the assessee is under obligation and duty to deposit the same with the Government, non-deposit of the TDS deducted by the assessee is clear contradiction of the provisions of the Act. Moreover, when the TDS is deducted on the payment, the said payment is allowed as expenditure only when the assessee fulfils the conditions as prescribed under Section 40(a)( ia). Therefore, irrespective of the fact that the assessee is entitled to claim the refund or get it adjusted against the tax liability under the provisions of the Act, the assessee cannot withhold the TDS deducted and if the assessee does so then the relevant provisions of the Act are attracted. Therefore, when the assessee undisputedly deducted the tax but to the extent the same was not deposited with the Government, the provisions of Section 40(a)(ia) were attracted and the claim of the deduction of such expenditure was to be disallowed.

L. Single transactions- Whether maxim of “Lex Non Cogit Ad Impossibilia” is applicable.

• Under Section 40(a)(ia) of the Act if tax is deducted and paid in a subsequent year, the business expenditure can be reduced from total income in that year. But tax can be deducted if there is another transaction between the assessee and the same payee or some amount should remain outstanding to enable deduction. However if there was only one transaction and the payment was made in full without deduction of tax, then TDS cannot be deducted in subsequent year and hence such sums will not be allowable in any of the year. In such a situation the assessee may rely on the well-known maxim of Lex Non Cogit Ad Impossibilia, which means that the law does not compel a person to do that what he cannot possibly perform. However this is yet to be decided by the Judiciary with respect to Section 40(a)(ia) of the Act.

M. Tax paid voluntarily or collected involuntarily without deduction from the payee

• Another situation would be where the tax was not deducted at source but was paid voluntarily or collected by the Income-tax authorities from the assessee through coercive methods prescribed in Section 201. The way sub-clause (ia) to Section 40(a) is worded, a view can be taken that the assessee will not be entitled to the deduction of the expenditure where tax was not deducted by him but was voluntarily paid by him or involuntarily collected from him. The main sub-clause (ia) as well as the proviso thereto makes deduction from the payee an essential condition for allowing expenditure as business deduction in the hands of the assessee.
• However, in a similar provision contained in sub-clause (i) of Section 40(a) in respect of payments to non-residents and foreign companies, the Rajasthan High Court, in Addl. CIT v. Farasal Ltd. (1987) 163 ITR 364 (Raj), interpreted the word “paid” in that sub-clause to include involuntary payment of tax collected by the Revenue. In doing so, it took into account the fact that the object of Section 40(a)(i) is to protect the interest of Revenue by ensuring that in respect of the amount chargeable under the Act and payable outside India, the tax is paid by the non-resident or deducted in cases where the non-resident does not have any agent in India from whom the tax can be recovered. From this point of view, it is immaterial whether the Revenue has received payment of the tax due either voluntarily or by initiation of recovery proceedings against him. In all likelihood the courts may take similar views as Rajasthan HC has taken in above referred case.

N. Disharmony between provision to Section 40(a) (ia) and Section 199.

• Section 199 prescribes that the credit for the tax deducted at source will be allowable to the payee in the year in which the income liable to deduction is assessed to tax. Normally, income is assessed on accrual basis. The payee may not get the benefit of the deduction of tax at source if it is deducted by the assessee in a year subsequent to the year in which it is assessable in the payee’s hands. This will also cause problem as the system will show the credit in 26AS in next year and system will not allow credit in any other year.

O. Possible Misuse/Tax planning

• It is possible to misuse of or tax planning through Section 40(a)(ia).
• If any assessee is eligible for deduction under Chapter VIA or exemption under chapter III of the Act at 100% or some other percentage of its income in any particular assessment year, then the assessee may deliberately not deduct or less deduct TDS on the payments on which TDS are required to be made in any particular section under Chapter XVII-B of the Act and disallow such sums in computation of its income and claim exemptions under Chapter III or deduction under Chapter VIA of the Act on such enhanced income in that particular assessment year and in any subsequent assessment year where the assessee is not eligible for exemption/deduction at the rate of 100% or not eligible for any such exemption/ deduction, the assessee pays the TDS and claim such expenses in such year reducing its tax liabilities. There is no express provision under the Act to tackle such a situation. Similar tax planning was made by the assessee in the case of Diplomat Enterprises, the facts of which are discussed above.
• Similarly, in case the assessee has huge business loss in any particular assessment year then the assessee may willingly default either fully or partly the TDS provisions and suo motu make disallowance under Section 40(a)(ia) of the Act in that assessment year and rectify such TDS default in later year and claim such expenses in that later year and get the benefit of extended period of carry forward of business losses.

(iii) Collection of facts and investigation thereof

• The Assessing officers have to go through the various payments debited in the P & L account.
• Identify the payments on which prima-facie the TDS was required to be made in any of the Sections under Chapter XVII-B of the Act.
• Call for details of such payments and nature thereof, including necessary evidences, during the course of assessment proceedings.
• Analyse the nature of payments and ascertain whether the payments were of such in nature on which TDS was required to be made in any particular section in Chapter XVII-B.
• Verify with evidences, i.e. quarterly TDS returns filed by the assessee, as to whether correct TDS have been deducted on such payments and deposited in the Govt. account within the stipulated time under Section 40(a)(ia).
• It is important to note that TDS on payments of one particular nature need to be made under only applicable section and no other section, i.e. various Sections under Chapter XVII-B are mutually exclusive. The CBDT vide Circular No. 720 dated 30.08.1995 has clarified that each section regarding TDS under Chapter XVII, deals with a particular kind of payment to the exclusion of all other sections in this Chapter. Thus, payment of any sum shall be liable for deduction of tax only under one section. Therefore, a payment is liable for tax deduction only under one section.
• The AO should go through the Circular No.5/2002, Circular No. 715 of 2002 and other Circulars wherein the Board has clarified in the form of question and answers and otherwise the liabilities of TDS on various payments made and the liability to deduct TDS should be ascertained in harmony to said Circulars.
• In view of the decision of Hon’ble Gujarat HC in the case of CIT(TDS) vs. Krishak Bharati Coopeartive Ltd. in Tax Appeal No. 618 of 2010, order dated 12.07.2011, the CBDT vide Circular No. 9/120 in F.No. 275/11/2012-IT(B) dated 17.10.2012 has clarified that in case the owner/seller of the gas sells as well as transport the gas to the purchaser till the point of delivery, where the ownership of gas to the purchase is simultaneously transferred, the manner of raising the sale bill (whether the transportation charges are embedded in the cost of gas or shown separately) does not alter the basic nature of such contract which remain essentially a ‘contract for sale’ and not a ‘works contract’ as envisaged in Section 194C of the Act. Here in such circumstances, provisions of Chapter XVII-B of the Act are not applicable on the component of Gas Transportation Charges paid by the purchaser to the Owner/Seller of gas. The use of different modes of transportation of gas by Owner/Seller will not alter the position. It is needless to mention that transportation charges to a third party transporter of gas, either by the Owner/Seller of the gas or purchaser of the gas or any other person, shall continue to be governed by the appropriate provisions of the Act and TDS shall be deductible on such payment to the third party at the applicable rates.
• In the case of Mitra Logistic P Ltd vs. ITO reported in 27 com, the Hon’ble Kolkatta ITAT has held that where an expenditure, being fully reimbursable by assessee’s principal, is not claimed as expenditure by assessee it would not be subject to rigour of Section 40(a) (ia) of the Act.
• In the case of Pareek Electricals vs. ACIT, reported in 27 com219, the Hon’ble Cuttack ITAT has held that where the assessee was a franchisee of BSNL and received commission on gross value of purchase and on said commission BSNL had deducted tax at source under Section 194H of the Act. It had also appointed sub-franchise for selling products of BSNL and out of its commission allowed trade discount to sub-franchisees. The AO treated the trade discount as commission and disallowed same by applying Section 40(a)(ia) on plea that the assessee had not deducted tax at source under Section 194H on traded discount. It was held that trade discount made available to sub-franchise was a compensation by foregoing part of commission already subjected to tax at source by BSNL and it could not have suffered taxation under Section 194H and hence disallowance under Section 40(a)(ia) was unjustified.

In the case of Sri Venkatesh Paper Agencies(Hyd) P Ltd reported in 24 taxmann.com 52, the Hon’ble Hyderabad ITAT has held that it is not disputed that the interest paid is not for any loan or debt incurred by the assessee but for the delay in payment of bills for purchases effected from company. Therefore, it has to be seen as to whether such payment is in the nature of interest as envisaged under Section 2(28A). As seen from the order of the ITAT Ahmedabad Bench in the case of ITO v. Parag Mahasukhlal Shah 46 SOT 302 the Tribunal has held that a payment which has direct link and immediate nexus with the trading liability being connected with the delayed purchase payments will not fall within the category of interest as defined in Section 2(28A). The payment made by the assessee in the present appeal being of similar nature also cannot be termed as interest as defined under Section 2(28A).

(iv) Drafting of assessment vis-à-vis Section 40(a)(ia)

• The drafting of assessment order is an art and dealing the issue of disallowance under Section 40(a)(ia) of the Act is not different from dealing of any other issue.
• The AO must bring all the facts of the case. It is of utmost importance that the AO has to bring all the facts of the case, because if the AO fails to bring all the facts, relevant to the issue, on the record then the same is lost forever until and unless the same is brought on record from some third source of information.
• The law can be taken care of at any stage, i.e. at the assessment or appellate stage as held by the Hon’ble SC in the case of National Thermal Power Co. Ltd vs. CIT, reported in 229 ITR 383. After ascertaining full facts of the case and analyzing the same the AO should ascertain whether the TDS was required to be made and also the relevant/appropriate section under Chapter XVII-B.
• Once it is established that on any sums/payments the tax was deductible under Chapter XVII-B of the Act, then it should be verified whether the assessee has deducted the tax at applicable rate on not and whether after deducting the tax at source the assessee has remitted/deposited the same within the time stipulated under the provisions of Section 40(a)(ia) of the Act.
• Every default under Section 40(a)(ia) for any payment, should be determined and listed out in detail.
• The assessee should be given show cause pointing out each default committed under Section 40(a)(ia) of the Act.
• Both factual and legal grounds raised by the assessee in response to show cause notice should be dealt elaborately and clear finding on all the grounds raised by the assessee should be given in assessment order while making disallowance under Section 40(a)(ia) of the Act.

Note:

After amendment made by Finance Act, 2014, the disallowance under Section 40(a)(ia) is resticted to 30% of the expenditure and allowance in the subsequent year of payment shall also be 30% of such expenditure will be allowed as deduction.

(Republished With Amendments)

Authored By- Rajesh Kumar- JCIT, Range 3, Ahmedabad