Disallowance for Non-deduction of TDS u/s 40(a)(ia) – Common Mistakes in Income Tax Audit

Section 40(a)(ia) of the Income-tax Act is one of the most frequently triggered disallowance provisions during tax audits, especially for businesses subject to TDS requirements. Despite being in the law for years, taxpayers and auditors continue to commit errors leading to unnecessary additions, penalties, and litigation.

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. The provision is re-produced below for reference-

“Section 40. Amounts not deductible

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"

ia) thirty percent. 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, 16[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 subsection (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”

Common Mistakes in Income Tax Audit

1. Failure to Deduct TDS on Applicable Payments: The most fundamental mistake is not identifying which payments (e.g., rent, professional fees, commission, interest, contract payments) are subject to TDS provisions and consequently failing to deduct the tax at source.

2. Missing the Payment Deadline: Even if TDS is deducted, a disallowance of 30% of the expenditure is triggered if the deducted amount is not paid to the government before the due date for filing the income tax return for the relevant previous year.

3. Short Deduction of TDS: While there has been legal debate, the disallowance under Section 40(a)(ia) is generally understood to cover a complete failure to deduct tax, not merely a short deduction due to a bona fide difference in opinion or a genuine mistake in applying the correct rate. However, some interpretations suggest that 30% of the short-deducted portion could be disallowed.

4. Incorrect Classification of Payments: Misclassifying the nature of a payment (e.g., treating commission as a cash discount to avoid TDS under Section 194H) can lead to disallowance if the tax authorities determine the correct classification required TDS deduction.

5. Ignoring Year-End Provisions: Failing to deduct TDS on expenses that are "payable" or provided for at the end of the financial year is a common error, as the section applies to both amounts paid and amounts payable.

6. Mechanical Disallowance: Auditors and assessing officers sometimes make disallowances in a mechanical manner without properly examining the nature of the payment or verifying if the assessee had a valid reason for non-deduction (e.g., the payee provided a valid Form 15G/15H or the income was not taxable in India)

7. Misunderstanding Scope of "No TDS" Scenarios: Incorrectly assuming no TDS liability in situations like pure reimbursements of expenses (which are generally not subject to TDS if they don't contain an income component) can lead to issues if not properly documented.

To avoid these mistakes, businesses should:

• Regularly review all expense heads to identify payments that attract TDS provisions.

• Ensure a robust system for timely deduction and deposit of TDS.

• Obtain and verify the Permanent Account Number (PAN) of all payees, as non-availability mandates a higher TDS deduction rate.

• Maintain clear documentation, including TDS challans and quarterly returns (Form 26Q, Form 24Q), for audit purposes.

• Reconcile ledger vs 26AS

• Check all bills for threshold limits

• Deduct TDS even on year-end provisions

• Deposit TDS before due date of ITR

• Review new TDS sections

• Document vendor contracts for correct TDS section mapping

Conclusion- Section 40(a)(ia) is one of the most litigated disallowance sections, and most disallowances occur due to simple procedural errors, not intentional default.

Proper documentation, timely deduction, and ensuring Form 26A availability can save significant disallowance.