The disallowance under section 40(a) (ia) of the Income Tax Act proposed to be limited to 30% of the total amount of expenses

It has been recently proposed that in case of non-deduction or non-payment of TDS on payments made to residents of the country according to section 40(a) (ia) of the income Tax Act, the disallowance should be limited to 30% of the total amount of expenses claimed. Such proposal has been given for reducing the hardship upon the common tax payers.

Present provisions of section 40(a) (i) of the Incomes Tax Act:

The present provisions of section 40(a) (i) of the Income Tax Act state that some payments like interest, royalty, fee for technical services or any other sum that is payable in India or outside India to a non-resident or a foreign company shall not be allowed as deduction in the hands of the payer at the time of calculating business income if TDS on such payments are not deducted or is not paid after deduction within the due time as per section 200(1) of the Act. Such provisions have been made in the Income Tax Act to enforce compliance of provisions of TDS for the deductors.
In case of non-deduction of TDS or non-payment of TDS to the account of the Central Government from payments that are made to residents, the total amount of expenses on which tax was deductible is disallowed as per section 40(a)(ia) of the Act for computing income under the head “Profits and gains of business or profession”.
Disallowance according to section 40(a) (ia) of the Income Tax Act extends to all expenses on which tax is deductible as per Chapter XVII-B of the Act.
The Income Tax Act also contains similar provisions for disallowance of business expenses relating to other payments made to the residents of the country.
According to the provisions of section 40(a) (ia) of the Act, in case of payments made to residents, the deductor can claim deduction for payments as their expenses in the earlier year of payment, if tax is deducted in the earlier year and it is paid on or before the due time as provided for filing of return as per section 139(1) of the Act.
However for disallowance relating to non-payment of tax from payments made to non-residents of the country, the extension of time limit of payment till the date of filing of return of income under section 139(1) is not available.

Effects of disallowance of the total amount:

As per existing provisions of section 40(a) (i) of the Act, the disallowance of the total amount of expenses results in undue hardship upon the tax payers.
The proposed amendment will take effect on and from 1.4.2015 and will apply in connection with the assessment year 2015-16 and the following years.

Proposals given:

To give the facility of similar extended time limit for payment of TDS of non-residents, it has been proposed that the deductor shall be permitted to claim deduction for payments made to non-residents in the earlier year of payment, if tax is deducted in such year and it is paid within the due date stated for filing of return as per section 139(1) of the Income Tax Act.
The provisions of Section 40(a) (ia) of the Act were introduced by the Finance Act 2004, with effect from 01.04.2005 and are applicable for the assessment year 2005-06 and the following assessment years.

Amendment retrospective in nature:

The Income Tax Appellate Tribunal by an order dated 29.05.2014 has recently held that such amendment to Section 40(a) (ia) by the Finance Act, 2012 is retrospective in nature.
The issue arose before the Income Tax Appellate Tribunal (ITAT), Agra Bench in the case of Rajeev Kumar Agarwal vs. ACIT being I.T.A. No.337/Agra/2013. The main question was whether the said proviso which has been made effective from 1.4.2013 is retrospective in nature and would it apply to the earlier assessment years.
The ITAT passed the judgment in favour of the taxpayers following that of the Hon’ble Delhi High Court in the case of CIT vs. Rajinder Kumar, 362, ITR 241.

Facts and circumstances of the case:

The instant case was related to the Assessment Year 2006-07. The assessee Rajeev Kumar Agarwal had made payments towards interest without deducting tax under section 194A of the Act. For the said reason the Assessing Officer disallowed the expenses under section 40(a) (ia) of the Act.

The observations of the CIT (A):

The assessee contended that the organization to whom the interest was paid had already included them in their tax returns filed under section 139 of the Act and as per the second proviso to section 40(a) (ia), disallowance should not be attracted.

It was further contended that even though this proviso should be effective from 1.4.2013, but as the amendment is declaratory in nature, it should be made retrospective from 1.4.2005, being the date from when sub clause (ia) was inserted to the section 40(a) of the Act by the Finance Act, 2004.

The Commissioner of Income Tax (Appeals) relied upon the judgment of the Special Bench in Bharti Shipyard Ltd vs. Deputy Commissioner of Income Tax, 141, TTJ, 129 and upheld the order passed by the Assessing Officer.
The Special Bench dealt with a similar issue relating to the first proviso to section 40(a) (ia) which was introduced by the Finance Act, 2010 extending the period of TDS payment up to the due date of filing the return not only in respect of the TDS for the month of March but even also for the previous 11 months for not disallowing the expenses under section 40(a) (ia).
The Special Bench highlighted the settled position of law to the effect that any amendment of a provision which has been made to remove the unwanted consequences to make the provisions flexible should be treated as retrospective though the amendment has been made prospective.
It was also held that if the consequences are aimed to be remedied by the subsequent amendments should be treated as intended consequences; the amendment could not be considered as retrospective.
The Special Bench held that the objective aimed to be achieved by the introduction of section 40(a)(ia) is the compliance of TDS provisions. It was also observed that it is the cost which the legislation has imposed to the assessees who fail to comply with the provisions of TDS compliance.

Issues appearing before the ITAT:

The main issue that arose before the ITAT was whether the new amendment of inserting a second proviso to section 40(a) (ia) was retrospective and whether its benefit would apply to the assessment year 2006-07.

The observations of the ITAT:

The ITAT relied on the judgment of the Hon’ble Delhi High Court in the case of CIT vs. Rajinder Kumar, wherein it was held that section 40(a) (ia) liberalizes the statute when it stipulates that deductions made in the first eleven months but paid before the due date of filing of the return will amount to sufficient compliance.
The ITAT considered the aforesaid judgment while deciding on the case. It was observed that Section 40(a)(ia) cannot be intended to be a penal provision to punish the deductors having latches on their part but is a kind of limitation of compensatory deduction for income tax withholding.
The provisions dealing with penalty for tax withholding is given in section 271C of the Act, and section 40(a) (ia) does not add to the same.
In view of the above, the ITAT observed that the provisions of section 40(a)(ia) went beyond the intentions of the lawmakers and created hardship to the tax payers and accordingly held that insertion of the second proviso is to avoid unintended consequences and should be treated as retrospective.