TDS Disallowance Rules Explained for Businesses and Professionals: Section 40(ia) of Income Tax Act

Every business and professional claims expenses to reduce taxable income — from consultancy charges to commission and interest paid to contractors or service providers. But the Income Tax Act sets one clear rule — if you don’t deduct Tax Deducted at Source (TDS) properly, you cannot claim those expenses as a deduction.

This rule comes from Section 40(ia). It was introduced to make sure that TDS compliance is not ignored by anyone running a business or profession. Even a small non-deduction or delay in depositing TDS can block the expense deduction for that financial year.

The Purpose Behind Section 40(ia)

Before this provision existed, many businesses claimed huge deductions while completely ignoring TDS obligations. To stop this leakage, Section 40(a)(ia) was introduced under Chapter IV-D of the Income Tax Act. It essentially says — if you don’t deduct TDS where it was required, or if you deduct but fail to deposit it within the prescribed time, the corresponding expense will not be allowed as a deduction while calculating business income."

The idea is simple: you can claim deductions only after fulfilling your duty of remitting tax to the government.

When Section 40(ia) Applies

Section 40(ia) applies to the following types of payments made to residents —

• Interest (other than interest on securities)
• Commission or brokerage
• Rent or royalty
• Professional or technical fees
• Contractual payments under Section 194C
• Director remuneration covered by TDS provisions

If TDS was required to be deducted on these payments but was either not deducted or deducted late and not deposited before the due date of filing ITR under Section 139(1), the entire expense will be disallowed under Section 40(ia).

Example — How It Works

Imagine a company pays ₹10 lakh to a consultant in FY 2024-25 but fails to deduct TDS of 10 % as required under Section 194J.
When it files its return, the Assessing Officer will disallow ₹10 lakh as an expense under Section 40(ia).

If the company later deducts and deposits the TDS in FY 2025-26, the same expense can be claimed in that subsequent year. So the disallowance is not permanent — it only defers the benefit until TDS compliance is complete.

Also Read: Interest on Late Payment of TDS

TDS Payment Deadline and Reversal of Disallowance

If TDS is deducted during March, it must be deposited by 30 April of the next financial year. For other months, it must be paid by the 7th of the next month.

If you deposit TDS before the due date of filing the income tax return (Section 139(1)), the deduction for that expense will be allowed in the same year.
Otherwise, it gets carried forward and allowed in the year you actually make the TDS payment.

This provision creates discipline in both deduction and deposit of TDS timely.

Applicability to Individuals and Firms

Section 40(ia) is not limited to companies — it applies to any business or profession where books of accounts are maintained under Section 44AA and income is computed under the head “Profits and Gains from Business or Profession.”

That means even partnership firms, LLPs, and individual professionals like architects, doctors, or consultants are liable if they miss TDS on applicable payments."

However, it does not apply to taxpayers covered under presumptive income schemes like Sections 44AD or 44ADA where no books are maintained.

Judicial Interpretations and Relief

Courts have played a major role in interpreting Section 40(ia) fairly. Some important rulings include —

• CIT v. Vector Shipping Services (P) Ltd. (2013) — If the payee has already paid tax on such income, disallowance under Section 40(ia) should not apply again to the payer.
• CIT v. Ansal Landmark Township (P) Ltd. (2015) — If TDS is deducted & deposited before the due date of return filing, no disallowance can be made.

These judgments ensure that the law serves its purpose without causing unnecessary hardship to taxpayers acting in good faith.

Key Amendments Over the Years

Since its introduction, Section 40(ia) has seen several amendments for clarity & ease of compliance:

• Finance Act 2008: Clarified that the provision applies to resident payments only.
• Finance Act 2010: Allowed deduction in the same year if TDS was deposited before ITR due date.
• Finance Act 2014: Restricted disallowance to 30 % of the expense, instead of 100 %, reducing the burden on taxpayers.

Today, if TDS is not deducted or deposited on time, 30 % of the expense is disallowed, not the entire amount — a more balanced approach.

Also Read: TDS on Professional & Technical Services

Why Section 40(ia) Matters for Businesses

Ignoring TDS rules can hurt your books in more ways than one.
Apart from cash-flow disruption, non-compliance under Section 40(ia) can lead to:

• Higher taxable income because of disallowed expenses.
• Interest under Section 201(1A) for delay in deposit.
• Penalties under Section 271C for failure to deduct TDS.
• Possible audit scrutiny & loss of credibility with clients and vendors.

Thus, TDS is not just a compliance task — it’s a crucial part of your tax planning & financial credibility.

How to Ensure Compliance Under Section 40(ia)

1. Identify TDS applicable expenses — interest, rent, professional fees, contracts, commission, etc.
2. Deduct TDS on time — at the rate prescribed for each section.
3. Deposit TDS before the due date — generally by the 7th of next month.
4. File TDS returns accurately — Form 26Q or 24Q based on nature of payment.
5. Reconcile Form 26AS / AIS with books to ensure proper credit is reflected.

By following these simple steps, you can avoid the pain of disallowance & interest liability.

Interaction with Other Provisions

Section 40(ia) is closely linked with Sections 194C, 194J, and other TDS provisions. While those sections explain when to deduct tax, Section 40(ia) explains what happens if you don’t.

It also ties into Section 37(1), which allows general business expenses — but only when they are “wholly and exclusively” for business & not hit by any disallowance clause like Section 40.

Real-World Scenario

Let’s say a CA firm pays ₹5 lakh as consulting fees to another CA but fails to deduct TDS under Section 194J. Later, during assessment, the Assessing Officer disallows ₹1.5 lakh (30 % of ₹5 lakh) under Section 40(ia).

If the firm later deducts and deposits TDS in the next year, the disallowed amount can be claimed back then. It’s a simple example of how non-compliance affects cash flow & tax outgo.

Connection with Scientific Research Expenses

Just like the Income Tax Act allows deductions for expenses on scientific research and development, Section 40(ia) works in the opposite way — by restricting deductions where tax is not paid on time.

The law creates a balance — rewarding genuine business investment & penalizing neglect of tax obligations.

Common Mistakes to Avoid

• Forgetting to deduct TDS on freelancer payments or commission.
• Assuming TDS is not required for small payments (sometimes aggregate limits apply).
• Late deposit of TDS even after deduction.
• Mismatch between TDS return & Form 26AS.

A small error can lead to a big disallowance under Section 40(ia). Regular compliance reviews help avoid this.

Also Read: TDS on Contractor and Subcontractor Payments

Key Takeaways

Why Taxpayers Should Pay Attention

Section 40(ia) is not just about penalty — it’s about responsibility. By keeping your TDS compliance in order, you save tax, avoid interest, and maintain clean books that can withstand scrutiny.

For growing businesses, this transparency also helps build trust with investors, banks, and partners.

Conclusion

Section 40(ia) of the Income Tax Act is a disciplinary clause ensuring that tax deducted at source is not ignored in the process of claiming expenses. It disallows 30 % of payments like professional fees, commission, & rent if TDS is not deducted or deposited on time. But once TDS is complied with, the benefit returns in the next year. It’s a system of temporary restriction, not permanent punishment — a gentle push toward compliance.

If your business has faced disallowance under Section 40(ia) or you’re unsure about your TDS obligations, talk to our experts at CallMyCA.com. We help you review compliance, fix pending issues, and reclaim eligible deductions in your next return — before the tax department does.