Section 40(a)(ia) of Income Tax Act 1961

Brief History of Section 40(a)(ia):-

The provision of section 40(a)(ia) of the IT Act, 1961 was brought on the Statute by the Finance Act, 2004, w.e.f. 1-4-2005.

- It provides for disallowance of any interest, commission or brokerage, rent, royalty, 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 P.Y., or in the subsequent year before the expiry of the time specified under section 200(1).

-However, if tax has been deducted in any subsequent year or has been deducted in the previous year but has been paid in any subsequent year after the expiry of the time prescribed under section 200(1), then such sum will be allowed as deduction in the year in which such tax has been paid.

- Thus, the result of non-deduction/non-payment of tax at source in the same P.Y is that the corresponding expenditure would be disallowed, e.g., - if on the contract payment of Rs. 1 lakh, tax deductible at source of Rs. 2,000/- is not deducted or after deductions not paid in the relevant P.Y., the entire expenditure of Rs. 1 lakhs would be disallowed.

- Considering the hardships caused to the taxpayers because of these provisions, the Finance Act, 2008 amended this section with retrospective effect from A.Y. 2005-06 by providing as under :—

- where tax is deducted during the last month of the previous year, i.e., March, then the deduction of expenses will be allowed in the same year in which such expenditure has been incurred, if the payment has been made on or before the due date of filing of return of income   under section 139(1).

-However, if the deduction was made between April to February and the tax was not paid within the previous year, deduction for such expenses will be allowed only in that year in which tax has been paid.

- This amendment only allowed partial relief to the taxpayer.

-  The Finance Act, 2010 has further liberalized the provisions of section 40(a)(ia) w.e.f. 1-4-2010 - The effect of amendment made by the Finance Act, 2010 is that the assessee deducting tax either in the last month of the previous year or first eleven months of the previous year, shall be entitled to deduction of expenditure in the year of incurring it, if the assessee has paid the tax deducted at source on or before the due date of filing of return under section139(1).

- The Finance Act, 2012 has inserted second proviso to section 40(a)(ia) w.e.f 1-4-2013 - The said proviso provides that where an assessee fails to deduct the whole or any part of the tax under Chapter XVII-B but is not deemed to be an assessee-in-default under the 1st proviso to section 201(1), 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 resident payee referred to in the said proviso.

-The proviso to section 201(1) provides that assessee shall not be considered to be an assessee-in-default if the resident payee :

♦ has furnished his ROI under section 139

♦ has taken into account such amount for computing income in such ROI, and

♦ has paid tax due on the income declared by him in such ROI

♦ furnishes a certificate from CA in Form No. 26A

The effect of this amendment is that even if payer has failed to deduct tax at source on any sum paid to the payee but payee has admitted the income in the return filed by him and has paid tax thereon, then it will be deemed that the payer has deducted and paid the tax on such sum on the date of furnishing of ROI by the resident payee. In such an eventuality, section 40(a)(ia) would not be invoked to disallow the expenditure.

Question : Whether the amendment made by the Finance Act, 2010  is retrospective from 1-4-2005 or prospective from 1-4-2010? 

 Note : Amendement made by Finance Act 2010 : The assessee deducting tax either in the last month of the previous year or first eleven months of the previous year, shall be entitled to deduction of expenditure in the year of incurring it, if the assessee has paid the tax deducted at source on or before the due date of filing of return under section 139(1)

Answer :

Hon'ble Delhi High Court in case of CIT v.Naresh Kumar [2013] 39 taxmann.com 182 observed that section 40(a)(ia) is not basically a penal provision. When the TDS is deposited, the amount on which deduction is made is allowed as an expenditure incurred in the previous year in which the payment of TDS is made. Thus, it results in shifting of the year in which the expenditure can be claimed, even if payment has been made to the recipient and is to be allowed as an expenditure in another year. Principle of matching, therefore, gets affected. Marginal and medium taxpayers, who work at low GP rate can suffer severe consequences when expenditure which becomes the subject matter of an order under section 40(a)(ia) is substantial. Transferring or shifting of expenses to a subsequent year, in such cases, will not wipe off the adverse effect and the financial stress. Nevertheless, section 40(a)(ia) has to be given full play keeping in mind the object and purpose behind the section. At the same time the provision can be and should be interpreted liberally and equitably so that an assessee should not suffer unintended and deleterious consequences beyond what the object and purpose of the provision mandates. Therefore, the amendment made to sections 40(a)(ia) by Finance Act, 2010 should be given retrospective effect.

Similar view was also taken by the Court in case of CIT v. Rajinder Kumar [2013] 39 taxmann.com 126 (Delhi) where it was held thatprovisions of section 40(a)(ia) as amended by the Finance Act, 2010 clearly support the view that the expression 'said due date' used in clause (A) of the proviso to unamended sectionrefers to time specified in section 139(1). The amended section 40(a)(ia) expands and further liberalizes the statute when it stipulates that deduction made in the first eleven months of the previous year but paid before the due date of filing the return, will constitute sufficient compliance. Thus, assessee having debited certain amount in the month of Feb. 2007 and deposited TDS in the month of April, 2007, i.e. before the date on which return under section 139(1) was to be filed, section 40(a)(ia) could not be invoked to disallow the payments in the relevant year.

The Calcutta High Court in case of CIT v. Virgin Creations [IT Appeal No. 302 of 2011, dated 23-11-2011] has also expressed similar view. In this case assessee deducted tax at source from the paid charges between 1-4-2005 and 28-4-2006 and the same was deposited in July and August, 2006, i.e., well before the due date of filing of the return of income for the year under consideration. This factual position was undisputed. It was held that in view of the authoritative pronouncement of SC in case of Allied Motors (P.) Ltd. v. CIT [1997] 224 ITR 677/91 Taxman 205 and also in the case of CIT v. Alom Extrusions Ltd. [2009] 319 ITR 306/185 Taxman 416 (SC) section 40(a)(ia) had to be given retrospec-tive application.

Question : Whether the disallowance of TDS  u/s 40a(ia)  is on the amount that is payable or it also cover the amount that has already been paid ?

Section 40(a) of the Income-tax Act, 1961 ("Act") provides for certain expenses which are not deductible in computing the business income of the taxpayers. Clause (ia) of section 40(a)(ia) provides that certain expenses payable to a resident shall not be allowed as deductions if:

♦		tax is deductible at source on such payment, and
♦		such tax has not been deducted/after deduction it has not been paid to the Government before the due date of filing the Return of Income ("ROI").

Further, the proviso to the same section states that if tax has been deducted in any subsequent year, or has been deducted during the year but paid after the due date of filing ROI, then the expense shall be allowed as a deduction in the year in which the tax has been deposited.

The issue on interpretation which arose was that since the section used the word 'payable', the disallowance of expense for non-deduction of tax was to be restricted only to amounts which were 'payable' or whether it was to cover all the expenses, including those which were paid during the year. 

Judgments:
 1)  Only the expenses which are payable at the end of the year can be disallowed under section 40(a)(ia) of the Act

      The meaning of 'payable' is different from 'paid'. The SC in J.K. Synthetics v CIT [1994] 4          SCC 276 discussed the meaning of the word 'payable as under':

		"The word 'payable' is a descriptive word, which ordinarily means "that which must be paid or is due, or may be paid" but its correct meaning can only be determined if the context in which it is used is kept in view. The word has been frequently understood to mean that which may, can or should be paid and is held equivalent to 'due'."
		The word 'paid' has been defined in section 43(2) as follows:
		"'paid' means actually paid or incurred according to the method of accounting upon the basis of which the profits or gains are computed under the head "Profits and gains of business or profession"
		When an expense is incurred and not paid, it is 'payable'. 'Paid' is a wider term compared to 'payable' and, hence, the section 40(a)(ia) cannot be extended to cover amounts already paid and which are not payable. Special Bench of the Income Tax Appellate Tribunal ("SB") in the case of Merilyn Shipping & Transports v. Addl. CIT[2012] 136 ITD 23/20 taxmann.com 244 (Visakhapatnam) which ruled in favour of the taxpayers and held that the disallowance was to be restricted only to the case of amounts which were payable at the end of the year. However, the jurisdictional High Court ("HC") at Andhra Pradesh issued an interim suspension of the above ruling.  Allahabad HC in the case of CIT v. Vector Shipping Services (P.) Ltd. [2013] 38 taxmann.com 77 has ruled in favour of the taxpayers that disallowance would apply only where the expenditure was payable.

        2)      All expenses, whether paid or payable, are subject to disallowance under section 40(a)(ia) of the Act

Calcutta HC in the cases of CIT v. Crescent Export Syndicate [2013] 216 Taxman 258/33 taxmann.com 250 and CIT v. Jakir Hossain Mondal [2013] 33 taxmann.com 123 as well as the Gujarat HC in the case of CIT v. Sikandarkhan N. Tunvar [2013] 33 taxmann.com 133 have taken a view that  disallowance would apply to expenses which have been paid as well as those which are payable.

Question : Whether the Sum paid to NR without deduction of tax would invite sec. 40(a)(i) disallowance if such sum was capitalized ?

Answer : No Where assessee had not claimed payment made to non-resident for providing engineering site services as expenditure but capitalised same and claimed only depreciation thereon, no disallowance could be made under section 40(a)(i).

[2014] 49 taxmann.com 580 (Cochin - Trib.) IN THE ITAT COCHIN BENCH

Muthoot Finance Ltd. v. Additional Commissioner of Income-tax, Cir.1, Range-1, Kochi

Question : whether the Short deduction of tax due to application of wrong provision would  lead to sec. 40(a)(ia) disallowance

Answer : No 

Section 40(a)(ia), read with section 194-I, of the Income-tax Act, 1961 - Business disallowance - Interest, etc., paid to a resident without deduction of tax at source (Short deduction of tax) - Assessment year 2007-08 - Assessee made payment after deduction of tax at rate of 2.06 per cent - However, High Court held that assessee had to deduct tax under section 194-I at rate of 10 per cent - Revenue's case was that in respect of amount related to tax difference of about 8 per cent had to be disallowed under section 40(a)(ia) - Whether short deduction of tax cannot be a reason/basis for disallowance under section 40(a)(ia) - Held, yes [Para 6] [In favour of assessee]

[2014] 49 taxmann.com 578 (Cochin - Trib.) IN THE ITAT COCHIN BENCH

Three Star Granites (P.) Ltd. v. Assistant Commissioner of Income-tax