Need to Rationalize Provisions of Section 40(a)(ia) of Income Tax, 1961

CA Sharad Jain
Introduction: The section 40(a)(ia) of the Income Tax Act (“Act”) was brought on the statute by the Finance (No. 2) Act, 2004, with effect from 1-4-2005 i.e., from Assessment Year 2005-06 with the aim to ensure better compliances of TDS provisions. Since inception, these provisions are being felt by the tax assesses as very harsh. Over a period of time, several measures have been taken by the government to rationalise them, consequent to which, the tax assesses have got some relief from their harshness. Due to various judicial pronouncements also, some more reliefs have became available to the tax assesses. But still, a thorough revision of these provisions are required to make them more logical, more rational and to provide further relief to the tax assesses from the harsh consequences of these provisions.

Analysis of Provisions of Section 40(a)(ia) : Initially, section 40(a)(ia) provided that if the assessee has incurred expenses (e.g., interest, commission, brokerage etc.) or has made some payments (e.g., payment to resident contractors etc.) and tax (TDS) is deductible thereon as per the provisions of Chapter XVII-B, : (a) but the tax has not been deducted up to the end of the concerned previous year or ; (b) if it has been deducted accordingly but has not been deposited to the Central Government within the period mentioned in the section itself, then no deduction shall be allowable in respect of such expenses / payments etc. in computing income chargeable under the head “Profits and Gains of Business or Profession”.

Rationalization and Reliefs Till Date : Some major steps taken in earlier years for rationalization are as under :

Deduction For Disallowed Amount In Subsequent Years : A relief was provided in the initial provisions themselves that, if later on, such tax (TDS) is deducted and paid in any subsequent year (case ‘a’ above) or already deducted tax is paid in any subsequent year (in case ‘b’ above) then the deduction for such expenses / payments etc. will be allowed in computing the income for that subsequent year in which the TDS has been deposited to the Central Government.

Extension of Time Limit For Deposit of TDS : Later on, an another relief was given by way of extending the time limit for deposit of TDS. Initially, the disallowance was not to be made if the TDS was not deposited within the previous year itself (or where the due date of deposit as mentioned in section 200 was falling in the subsequent year then up to that due date). Later on, this period was extended and now the disallowance is not to be made if the TDS is deposited even later i.e., up to the due date U/s. 139(1) for filing of the income tax return of the tax deductor.

Disallowance of Only 30% of Expenses / Payments Amount Instead of Whole Expenses / Payment Amount: Initially, the whole amount of expense / payment etc. was to be disallowed due to non deduction / non deposit of TDS. Later on, the amount of disallowance has been restricted only to the 30% of the expense / payment etc.

No Disallowance If Payee Has Paid Tax, Filed Income Tax Return Etc. : An another relief (as per the second proviso to section 201) has been provided that the disallowance under this section is not to be made if the payee of the amounts on which tax has remained to be deducted / deposited has : (a) furnished his / its income tax return U/s. 139 and ; (b) has included such sum in computing income declared in the income tax return and ; (c) has paid due taxes on the returned income and ; (d) furnishes a certificate of a Chartered Accountant in the prescribed format.

PROBLEMS / DRAWBACKS STILL PERSISTING : Despite various steps taken for rationalization and for providing reliefs, the present provisions are still very harsh and irrational and the available reliefs are also insufficient due to various reasons discussed below:

Real Income Is Not Taxed : It is a settled legal principal that only the real income that too pertaining to the concerned assessment year should be taxed. The real income of a particular assessment year should be computed by considering all the incomes and allowable expenses pertaining to that assessment year only (The disallowance of prior period expenses is an example of this concept ). But in cases where the amount disallowed in one assessment year and allowed in subsequent assessment year / (s) (as per section 40(a)(ia)) is substantial then in many cases, the income of all the assessment years involved may reach at an unrealistic high (in the year of addition) and unrealistic low (in the year of deduction) level.

Severe Adverse Impact On Financial Position Of Business : There may be many cases where the major portion of expenses are liable for TDS and TDS could not have been deducted and /or deposited and benefit of second proviso of Section 201 is also not available due to non cooperation etc. of the payees. For example, one of the most prevailing such a case of major problem may be of labour contractors where entire work / substantial portion of work is sub contracted and the tax could not have been deducted and / or deposited. In such cases, though the deduction is allowable in the subsequent years but due to disallowance in the year of expenditure, there may be substantial tax liability which the assessee may not bear. The problem may be more severe if the disallowance is not made suo moto in the income tax return and later on, the disallowance is made by the assessing officer in the assessment. In such cases, there may be additional liability for interest and penalty. This severe financial liability may break the backbone of any business and may lead to the closure of the business itself. The deduction in the subsequent assessment years may not be helpful in such a critical situation.

Loss To Revenue : In many cases, the above provisions may be used by the tax assesses for tax planning. They may deduct and deposit TDS in various assessment years to keep their total income under low tax slab rates. This may cause loss to the revenue.

SUGGESTIONS : To resolve the above problems, it is suggested that when the tax is deducted and deposited after the prescribed period, then in such cases also the deduction for the expenditure should be allowed in the concerned assessment year only i.e., in the year of expenditure only and not in any subsequent year of deposit of TDS. The year of allowability of expenditure should not be shifted.

This may be possible under the present scheme of the Act itself. The present provisions of Section 155 having heading “Other Amendments” under Chapter XIV “Procedure For Assessment” deals with the situations where the assessing officer can made necessary amendments to the income / contents etc. thereof on subsequent changes in the situations, by passing rectification order U/s. 154 of the Act. An example of such situation is that if in any assessment year, the loss or depreciation is recomputed then for its consequent effect in subsequent assessment years, the assessing officer may proceed under this section. Similarly, if in any assessment there is any change in the income of the firm then the assessing officer may proceed to give effect thereof to the share income of the partners in their returns. There are many other situations dealt with in the section 155.

The present case is also a similar type of case where there is subsequent changes in the situation due to deduction and deposit of tax in subsequent period. This can also be very well included by making suitable provisions in Section 155 of the Act. In such a situation, the assessing officer may be able to make the allowance of the expenditure (disallowed u/s. 40(a)(ia)) in the concerned year itself. This may also be helpful in the cases which are in the stage of appeal. On provision to give deduction in the concerned assessment year itself, the appellate authorities may be able to give directions to the assessing officer to allow deduction in the concerned year itself.

Conclusion: Thus, by extending the present provisions of section 155 itself, the taxation of real and correct income in the concerned assessment year itself may be possible. Further, in the cases of subsequent compliances, the tax assesses will not have to bear much financial burden. At the same time, the revenue may not have any financial losses.