Businesses engaged in foreign transactions often overlook that not deducting tax at source can lead to significant costs. That’s where Section 40(a)(i) of the Income Tax Act comes into action.
This section acts as a strict gatekeeper, ensuring that any remittance to a non-resident complies with proper TDS rules. If not, the expense may be disallowed, which could increase your taxable income. Whether you're a startup paying for software licenses or a large company outsourcing overseas services, this section directly impacts your tax liability.
Let’s break it down in a simple & digestible way.
What is Section 40(a)(i) of the Income Tax Act?
Section 40(a)(i) specifies that certain payments made to non-residents will not be allowed as a business deduction if TDS (Tax Deducted at Source) is not deducted or deposited within the prescribed time.
In simpler terms, if you're making any foreign payment such as royalties, technical fees, interest, or any other sum chargeable to tax in India, & you fail to deduct or deposit the TDS correctly, that expense won’t be allowed as a deduction in your profit & loss account.
This leads to increased taxable income, which in turn leads to higher tax liability.
Applicability of Section 40(a)(i)
This section is applicable when:
- A taxpayer makes a payment to a non-resident (including foreign companies).
- The payment is chargeable to tax under the Income Tax Act.
- The payment falls under categories like interest, royalty, technical service fees, or any other sum covered under the Act."
- TDS is either not deducted or not deposited within the due date.
So, if you're sending payment for foreign consultancy, software, or interest on foreign loans, this section applies to you.
Disallowance of Foreign Payments
A major consequence under this section is the disallowance of expenses.
Here’s how it works:
- If TDS is not deducted, 100% of the payment will be disallowed in the year of expense.
- If TDS is deducted but not deposited on time, the expense will be disallowed for that year & can be claimed in the year when TDS is paid.
This is a serious issue, especially for companies with large foreign remittances. It can heavily distort your profit & tax computation.
TDS Compliance Under Section 40(a)(i)
To stay on the safe side, make sure you:
- Determine the nature of payment — is it taxable in India?
- Check DTAA (Double Taxation Avoidance Agreement) — the tax rate could be lower.
- Deduct TDS at the correct rate as per the Act or DTAA.
- Deposit TDS before the due date (typically the 7th of the next month).
- File Form 15CA & 15CB (if applicable) before remittance.
This proper TDS compliance under section 40(a)(i) helps you avoid disallowance & penalties.
Key Concepts Explained Simply
Let’s look at some frequently encountered terms:
- Disallowance under section 40(a)(i): The Expense is not deducted from income, increasing your tax.
- Withholding tax: Tax deducted before making payment to a non-resident.
- Remittance to non-resident: Payment in foreign currency to someone residing outside India.
- Default under section 40(a)(i): Failure to deduct or deposit TDS on such payments.
Consequences of Default Under Section 40(a)(i)
Failing to comply with this section can lead to:
- 100% disallowance of expense
- Interest on late TDS payment
- Penalty under Section 271C for not deducting TDS
- Prosecution under Section 276B in extreme cases
It’s not just about tax savings — non-compliance could mean significant financial & legal consequences."
Real-Life Scenario
Let’s say your company paid ₹10 lakhs to a US-based consultant but forgot to deduct TDS. That entire ₹10 lakh will be added back to your taxable profit. If you fall under the 3a 0% tax bracket, you’ll end up paying ₹3 lakhs extra, just because of a compliance error!
Planning Ahead with Section 40(a)(i)
If you deal with international payments, you must plan:
- Engage with a Chartered Accountant or tax expert to determine taxability.
- Always obtain Form 15CB from a CA before large remittances.
- Stay updated on TDS rates for non-residents under the Act & relevant DTAAs.
Being proactive here will not only help you stay compliant but also protect your profits.
Final Thoughts
Section 40(a)(i) of the Income Tax Act is more than just a tax provision. It’s a reminder that international tax compliance matters as much as domestic. Every rupee you spend on foreign services must be backed by proper TDS deduction & deposit. Otherwise, your business could lose out on valuable deductions & face unwanted penalties.
Don’t let your hard-earned money go to waste due to avoidable tax errors.
Need help with TDS compliance or facing disallowance under section 40(a)(i)? Let our expert team at Callmyca.com help you fix it right the first time — before the taxman knocks. Book your session now & stay compliant, effortlessly.
