Claimed an Expense? The Taxman Might Disallow It — Section 40(a)(i)

Taxation in India works on a self-assessment model — but the government can’t always rely on voluntary declarations, especially when payments flow outside India. That’s why the Income Tax Act built strict guardrails through Section 40(a)(i).

In simple terms, if a business makes a payment to a non-resident (for example, royalties, interest, or fees for technical services) and fails to deduct or deposit TDS, the expense gets disallowed. You can’t claim it as a deduction while computing taxable income.

It’s the government’s way of saying: “Pay the tax first, and then claim the benefit.”

Scope and Applicability

Section 40(a)(i) applies mainly to businesses & professionals making payments to:

• Non-resident individuals, or
• Foreign companies,

for income that’s taxable in India — such as interest, royalties, technical fees, or any other sum chargeable under the Income Tax Act."

If TDS isn’t deducted at the time of payment or credited to the account, or if it’s deducted but not remitted to the Central Government within the due date, the expenditure is disallowed in that financial year.

Nature of Expenses Covered

The section specifically disallows expenditure towards interest, royalty, or fee for technical services, & also any sum chargeable to tax under the Income Tax Act.

For instance:

• A company paying interest to a foreign lender,
• A manufacturing firm paying royalty for use of an overseas patent,
• Or a software company paying a non-resident for technical consultation —

— all must ensure TDS compliance before claiming these as deductible business expenses.

Also Read: The TDS Default That Can Slash Your Tax Deductions

The Disallowance Mechanism — How It Works

When a business files its return, the Assessing Officer reviews the nature of foreign payments. If TDS provisions haven’t been followed properly, the officer has discretion to disallow those expenses.

The principle is clear:

Certain business expenses are not permissible as deductions from income if tax has not been deducted or paid to the government.

Let’s look at a practical example.

Illustration: How Disallowance Arises

Suppose an Indian pharma company pays ₹50 lakh as royalty to a US firm for using a drug formula. Under Section 195, TDS is mandatory.

If the company forgets to deduct tax, or deducts but delays depositing it beyond the due date under Section 200(1), Section 40(a)(i) kicks in.

The entire ₹50 lakh is disallowed in that year.
Only when the company later deposits the TDS can the expense be claimed in the subsequent year — after proof of payment is furnished.

Link Between Section 195 and Section 40(a)(i)

Section 195 requires TDS on payments made to non-residents. Section 40(a)(i) enforces that rule by penalising non-compliance through disallowance. In short:

• Section 195 creates the duty,
• Section 40(a)(i) ensures discipline.

When Can the Deduction Be Claimed Later?

If the taxpayer deducts & deposits the TDS in a later year, the disallowed expense can be claimed in that year.

For example, if you missed deduction in FY 2023-24 but deposit it before filing the next return in FY 2024-25, you can claim the deduction then.
This rule helps genuine businesses that may have made an error but later complied.

Key Judicial Interpretations

Courts have clarified the intent behind this provision — it’s not punitive but regulatory. Some important judgments include:

• CIT v. Eli Lilly & Co. (India) Pvt. Ltd. (2009) — The Supreme Court held that disallowance is justified if TDS is not deducted on payments to non-residents that are taxable in India.
• CIT v. Samsung Electronics Co. Ltd. (2011) — Confirmed that payments for software use can attract TDS & disallowance under Section 40(a)(i).
• CIT v. Model Exims (2013) — Clarified that deduction can be restored once the assessee deposits the tax in a later year.

These cases underline that compliance timing matters just as much as compliance itself.

Also Read: How Non-Resident Investors Avoid Capital Gains Tax Through IFSC

Payments to Related Parties

Section 40(a)(i) also gives the Assessing Officer discretion to disallow payments made to related parties where TDS rules aren’t followed or the transactions appear colourable.
This provision prevents manipulation — for example, routing royalty or interest to group companies abroad to evade tax.

Interaction with Other Clauses of Section 40(a)

To understand it fully, one should see Section 40(a)(i) alongside 40(a)(ia) & 40(a)(iii):

• 40(a)(i) — focuses on payments to non-residents.
• 40(a)(ia) — applies to payments to residents."
• 40(a)(iii) — deals with salary payments outside India without TDS.

Together, they create a complete compliance framework ensuring that no cross-border or domestic payment escapes tax deduction responsibility.

Recent Developments and Compliance Challenges

With globalisation & the rise of digital transactions, identifying when a sum is “chargeable to tax in India” has become complex.
For instance, cloud service payments, overseas advertising charges, or cross-border consultancy fees — are they royalties, technical fees, or business profits?

If classified wrongly, they can trigger Section 40(a)(i) disallowances even years later.
That’s why businesses are now increasingly seeking professional certification (Form 15CA/CB) before making any foreign remittance.

Practical Tips for Businesses

1. Verify Taxability:
   Before paying a non-resident, confirm if the income is chargeable to tax in India under Section 9.
2. Check DTAA Benefits:
   The Double Taxation Avoidance Agreement may reduce or exempt TDS. But documentation (Tax Residency Certificate, Form 10F) is essential.
3. Timely Deposit of TDS:
   Always deposit TDS by the due date & match it with your TDS return (Form 27Q).
4. Maintain Agreements and Proofs:
   The burden of proof is on the payer. Keep contracts and invoices ready during scrutiny.
5. Claim Deduction in the Right Year:
   If you missed compliance earlier, rectify it & claim the expense in the next year after paying TDS.

Example: Digital Service Payments

• A marketing firm in Mumbai pays $10,000 to a UK company for SEO & ad analytics. Since the services are used in India and are in the nature of fees for technical services, TDS is required.
• If the firm skips deduction or delays remittance, the entire amount becomes inadmissible as business expenditure under Section 40(a)(i).
• The firm can claim it later once the tax is paid — but till then, its profits (and tax outgo) increase artificially.

Also Read: Earning Abroad from Royalties or Technical Services? Here’s the Tax Rule You Can’t Ignore

Why Section 40(a)(i) Matters Today

In the age of foreign collaborations, startups, and SaaS-based models, Indian entities often pay for technology, consultancy, or digital services abroad. Non-compliance doesn’t just affect tax deduction — it hits profit margins and triggers audits.

Section 40(a)(i) acts as a compliance checkpoint — pushing taxpayers to ensure taxes are deducted & deposited before claiming deductions."

It’s a preventive mechanism, not a punishment — a reminder that tax withheld at the right time keeps litigation away.

Summary Table: At a Glance

Conclusion

Section 40(a)(i) stands as one of the most practical enforcement tools in the Income Tax Act. It ensures that tax is collected at source whenever Indian entities make cross-border payments. The message is clear — you can’t claim a deduction on an expense that hasn’t met its tax obligations. For businesses dealing with foreign vendors or consultants, timely TDS compliance isn’t optional — it’s protection against future disallowances & litigation.

If your firm regularly makes payments to non-residents or foreign affiliates, our CA team at CallMyCA.com can help you verify each transaction, ensure TDS accuracy, & protect your deductions.