DISALLOWANCE OF EXPENSES - INTEREST, COMMISSION OR
BROKERAGE & OTHER EXPENSES.
By Paresh P. Shah, Chartered Accountant
1. Introduction: The Finance (No. 2) Act, 2004, has amended the section 40(a) of the
Income Tax Act, 1961 (the Act), and for sub-clause (i), among other clauses sub-clause
(ia) have been substituted with effect from 01.04.2004 i.e., A.Y. 2004-05.
Section 40(a)(ia) provides for disallowance of expenses in the nature of
(A) Interest (B) Commission or Brokerage (C) fees for professional services or fees for
technical services (D) amounts payable to contractor or sub contractor for carrying out
any work (including supply of labour for carrying out any work),
paid to Residents, on which tax is deductible at source under chapter XVII B and such tax
has not been deducted or after deduction has not been paid during the previous year or in
subsequent year before the expiry of the prescribed time under section 200(1) of the Act.
However in certain cases if tax is deducted in subsequent year or deducted in the previous
year and paid in subsequent year after the prescribed date as provided in section 200(1) of
the Act, then such sum shall be allowed as deduction in computing the income of the
previous year in which such tax has been deposited with the Government.
Prior to the substitution of the section, it provided for the disallowance of expenses only
in cases when payments are made outside India or in India to a non resident, without
deduction of applicable tax or if tax is deducted, it is not deposited with the Government
within the prescribed time.
Provisions were made applicable to non-residents in order to collect and ensure the
payment of taxes from non-residents during the previous year or on or before payment is
made to such non-residents so that problems of compliance by such non residents could
be minimized and the interest of the revenue is well protected.
However sub-clause (ia) to the section 40(a) of the act brings in its scope the
disallowance of the payments made to even residents to widen the scope of the
provisions, which acts as deterent to the compliance of the provisions of chapter XVIII B
of the Income tax act, 1961 and provisions is applicable to payments made to Residents
and disallowance refers to only in computing Business Income of the person responsible
for deducting tax at source.
The sub-clause (ia) of section 40(a) encompasses in its scope the nature of expenses, like
(a) commission or brokerage as defined in explanation to section 194H (b) Fees for
technical services as defined in explanation 2 to section 9 (i)(vii), (c) Professional
services as defined in clause (a) of the explanation to section 194J and (d) “Work” as
defined in explanation II to section 194C.
Although sub-clause is also applicable to “any interest”, it is not defined in the
explanation to sub-clause and therefore meaning of interest as provided under section
2(28A) and 2(28B) of the Act, may be adopted for the application of the provisions.
1.1 Application of the Chapter XVII & Disallowance under section 40 (a) (ia) :
The provisions of disallowance of payments during the previous year are applicable to
such payments only if :
(a) the tax deductible at source during the previous year under chapter XVII not
(b) If tax is deducted during the previous year same is not deposited either during the
previous year or in the subsequent year on or before the due date which falls in
the subsequent year, as prescribed in section 200 (1) of the act.
(c) Tax is deducted in the previous year and not deposited before the due date during
any subsequent year.
It further provides that in respect of any such sum on which tax is deducted in the
subsequent year then such sum shall be allowed as a deduction in computing the income
of the previous year in which such tax has been deposited.
Question arises as to what could be the quantum of disallowance in following situations –
In a case
(a) where amount of tax deducted is lower than as required to be deducted at source
under chapter XVII B?
(b) where such a amount has been deducted under the said chapter, it is partially
deposited or deposited partially in previous year and partially in subsequent year.
(c) what could be regarded as “due date” when payment made or credited by the
payer pertains to one of the last few months of the previous year and due date falls
in the subsequent year?
(d) that the amount is deducted during the previous year and deposited during the
previous year after the due date falling within such a previous year. I.e. delayed
payment of tax deducted at source.
(e) Whether the deposit of Tax, without its deduction from the payment as referred to
in chapter XVIIB, can have any adverse implication as to its allowance?
It is held in the case of Commissioner of Income Tax Vs. Nestle India Ltd. at
(2005) 275 ITR 1 (Del) that most significant aspect of this provision is its
payment within the time specified in law, Although it is in the context of section
40(a) (i), the guiding principle laid down by the court would equally apply to the
provisions of section 40 (a) (ia) of the Act, as language adopted by the section is
identical. Court interpreted that both the ingredients of the expression
“the tax is deductible at source under chapter XVII B and has not been deducted”
“after deduction has not been paid during the period specified”
must co-exist simultaneously during the period permissible in law.
It may therefore be deduced from the courts decision that “Once the payment as
referred in the first ingredients is paid by the person there can not be any
disallowance under the scheme of section 40.”
In order to determine whether short deduction would lead to partial disallowance
under section 40(a) (ia), one may examine its cause as to whether such a short
deduction have arisen as result of a bonafide or an error of interpretation of the
provisions of the Chapter XVII B or it is a mere arithmetical error.
The issue arising out of such a cause may be examined on a case to case basis.
Support to resolve the problem of disallowance may be found in the following
decisions of the court, although they may not strictly apply to section 40 as they
are delivered in the context of TDS provisions.
(i) (2003) 264 ITR 320 (UL) in the case of Commissioner of Income Tax
and another Vs. Sedco Forex International Drilling Co. Ltd.
(ii) (2000) 74 ITD 369 (Mum) in the case of ACC Ltd. Vs. Income Tax
Officer TDS in ITA No.2309 of 1997 for the AY 1993-94 delivered on 6th
The demonstration as to honest error may only be judged from the circumstances
of each case and the documentations to establish such a cause and hence it may be
In a case where payer responsible for deduction of tax has not deducted the taxes,
but choose to deposit it, without deducting it, then disallowance of sum is not
warranted as was held in the case of
Additional Commissioner of Income Tax Vs. Farasol Ltd. (1984) 163 ITR 364
1.2 Disallowance & Scheme of Chapter VII B:
The problem could be aggravated further if one reads, the provisions of disallowance and
analyse in contradistinction with Sections 191 and 201(1) of the Act.
Section 191 provides that in a case where tax deductible has not been deducted under the
chapter, then in such a case the tax shall be directly payable by the assessee, and if
assessee has paid the tax, then the person who is responsible for deduction of tax, shall
not be treated as “assessee in default” as referred to in Section 201(1) of the Act.
Thus in a case where tax is deductible and it has not been deducted on payment of certain
sum, and the payee (assessee) has paid the taxes on such a receipts, there may not be any
adverse consequences under Chapter XVII B.
However question arises as to disallowance under Section 40(a) (ia), since the tax
deductible under Chapter XVII B on payment has not been deducted by the person
responsible for making such payment as referred to in the Chapter.
The amended Section 201 provides that even short deduction of TDS will be treated as
the tax not being deducted as provided under the Chapter and person responsible for
making the payment shall be treated as “assessee in default.”
In view of the above a question arises, as to whether in such a case of short deduction,
entire amount of payment from which tax is deductible shall be disallowed as provided
under section 40(a)(ia) or the proportionate amount of such from which tax is deducted
will only be disallowed.
On the combined reading of the Chapter XVII B and the Scheme of disallowance under
Section 40 it may safely be assumed that only proportionate amount on which tax is not
deducted (such sum on which tax is not deducted as the language adopted) may only be
1.2 Consequences of non compliance of provisions of Chapter XVII : The
consequences as provided interalia, in section 40(a)(ia) as to disallowance of amount paid
as expenses, is the payment of interest u/s.201(1A) payable when payer is treated as
“assessee in default” alongwith penalty u/s.221 of the act and 271 C of the act. Provisions
as to prosecution are also provided u/s. 276 B of the act.
2. Provisions of Chapter XVII B and Section 40(a)(ia)
It may interestingly be noted that the liability to deduct tax in all the cases of nature of
expenses, as referred in sub-clause (ia) is provided on the basis of payment or credit in
the books of account, whichever is earlier. The provisions of the act in respect of the TDS
in all cases of above nature of expenses may be reproduced as under :
Section & When to Rate Person Payee
Nature of deduct Obliged to (including
payment or Tax at deduct tax Residential
Income source status)
193: Interest At the At the rates Person Any
on Securities time of prescribed in responsible Resident
credit or Part II of the for payment
payment, First Schedule
whichever to the Finance
is earlier, Act. i.e.
when the @10% as I.T.
aggregate + S.C. &
sums Addl. S.C. (In
payable case of a
during the domestic co.,
financial @20% as I.T.
year + Addl. S.C.)
194A: Interest At the At the rates Any payer Any
other than time of prescribed in other than an Resident
“Interest on credit or Part II of the individual or
securities” payment First Schedule HUF not
whichever to the Finance liable to get
is earlier, Act i.e., @ accounts
when the 10% as I.T.[In audited
aggregate case of a u/s.44AB
sums domestic Co.,
payable @ 20% as I.T]
during the + S.C. &
194C: At the In case of Contractee Any
Payments to time of payment made specified in Resident
contractors / credit or to section
sub- payment 1.Contractor@ 194C(1).
contractors whichever 2% as I.T. + Contractor
is earlier, S.C. & other than
when the Addl.S.C. Individual /
aggregate 2. Sub – HUF not
sums Contractor @ liable to get
payable 1% as I.T. + accounts
during the S.C. & Addl. audited
financial S.C. u/s.44AB
and / or
194H: At the At the rates of Any persons Any person
Commission time of 5% as I.T. + other than
or Brokerage credit or S.C. & Individual /
payment Addl.S.C. HUF not
whichever liable to get
is earlier, accounts
when the audited
194J: Fees for At the At the rates of Any persons Any resident
– time of 5% as I.T. + other than
(1)Professional credit or S.C. & Individual /
Services; or payment Addl.S.C. HUF not
(2) technical whichever liable to get
services is earlier, accounts
[payable by when the audited
persons other aggregate u/s.44AB
than individual sums
/ HUF] payable
Note: In Case payment referred to above section is credited by a person to the account of
payee as on the date upto which accounts of such person are made, tax deducted has to be
deposited in Government account within 2 months of the expiration of the month in
which that date falls.
3. Meaning of the Nature of Expenses as referred in section 40(a)(ia)
Number of court decisions have pronounced the meaning of the nature of expenses, the
landmark decisions and circulars in respect of each nature of expenses may be
summarized as under :-
3.1 Interest – Particulars Treatment / Definition
(i) Interest on Securities Defined under section 2(28B)
(ii) Interest Defined under section 2(28A)
(iii) Deep Discount Bonds Tax is deductible only at the
time of redemption - Circular
No.4/2004 dt.13th May, 2004
(iv) Deduction of TDS is from Gross Interest  240 ITR 740,
CIT Vs S. K. Sundararamier & Sons
(v) Deposit in joint names TDS may be deducted from the one
of the payee - Circular No.256
(vi) Payment of interest by consignors F. NO. 12/12/68-IT (AII) dt.23rd
to their agent Sept, 1968 that provisions of TDS
(vii) Hire Purchase Agreement Provisions of section 194A are
not applicable. Instruction No.1425
dt. 16th Nov, 1981
(viii) Commercial paper & Certificate of Section 194A is not applicable.
Deposits Circular No.647 dt.22nd March, 1993
3.2 Payment to Contractors or Sub Contractors : Section 194C of the Income tax Act,
1961, contemplates two types of payments, one from principal contractee to the
contractor in respect of contract [section 194(c)(1)] and second by a contractor to sub
contractor [194(c)(2)] in respect of sub contract.
3.3 Meaning of “any work” in section 194(c)(1) is not confined to a works contract. In
order to digest the concept & scope of its application, the important reference may be
(a)(i) Circular No.681 dt.8th March, 1984 regarding what is “work”
(ii) Circular No.713 dt. 2nd August, 1995 regarding payments to Airlines
(iii) Circular No.714 dt.3rd August, 1995 regarding payment of advertising &
(iv) Circular No715 dt. 8th August, 1995 regarding media owner, Advertising Agency
(v) Circular No.723 dt. 19th Sept, 1995 regarding shipping business of non residents.
(b) Discussion in the case of
(i) State of Himachal Pradesh Vs. Associated Hotels of India Ltd. (1972) 29 STC 474
(ii) Vanguard Rolling shutters and steel works Vs. CST, 39 STC 372 (SC)
(iii) Associated Cement Company Vs. CIT (1993) 201 ITR 435 (SC)
3.4 “Widened definition of work”: Definition of work has been extended by
explanation III to section 194C that “work” shall include
(b) Broadcasting and telecasting including production of programmes for such
broadcasting or telecasting
(c) Carriage of goods and passengers by any mode of transport other than railways.
3.5 Concept of Accrual : In order to establish that sum is accrued to contractor or the
sub-contractor on the basis of credit as referred in section 194C of the Act, a reference
may be drawn from following court decisions
(i) E. D. Sasoon & Co. Ltd. Vs. CIT (1945) 26 ITR 27 (SC)
(ii)ACIT Vs Motor Industries Co. 249 ITR 141 (Kar)
4. Fees for professional or Technical services.
(a) Professional services has been defined to mean services rendered by a person in
the course of carrying on a legal, medical, engineering or architectural profession
or the profession of the accountancy or technical consultancy or interior
decoration or such other profession as is notified by the board for the purposes of
(b) Fees for technical services to include any consideration (including any lumpsum
consideration) for rendering of any managerial, technical or consultancy services
[including the provisions of services of technical or other personnel] but does not
include considerations for any constructions, assembly mining or like projects
undertaken by the recipient, which would be income of the recipient chargeable
under the head salaries. [Section 9(1)(vii) of the Act]
4.1 Courts decisions and Circulars : The important support may be derived from
following decisions of the courts to analyse the scope and application of section 194J of
(a) Meaning of professional services.
(i) Dr. J. M. Mokashi Vs. CIT 207 ITR 252 (Bom)
(ii) Addl. CIT Vs. Ramkripal Tripathi (1980) 128 ITR 408 (All)
(b) Meaning of technical services
(i) Dalmia Vs. CIT AIR 1977 SC 988 P. 991
(ii) J. K. Bombay Ltd. Vs CBDT 108 ITR 312
(iii) Skycell Communications Ltd. Vs. DCIT 251 ITR 53
(c) Circular No.7 of 2003 dt. 5th Sept, 2003 in respect of applicability to assessee
required to get their accounts audited U/s.44AB.
5. Commission or Brokerage : The term commission or brokerage is defined in
explanation (i) to the section 194H, to include any payment received or receivable,
directly or indirectly, by a person acting on behalf of another person for services rendered
(not being professional services) or for any services in the course of buying or selling of
goods or in relation to any transaction relating to any asset, valuable article or thing, not
The section has been introduced by finance act, 2001, w.e.f., 1 st June, 2001. It may
pertinently be noted that the definition as referred in the section is an inclusive one giving
rise to wider scope than the text of the definition however the principal enshrined and
contemplated by the explanation, in the transaction giving rise to brokerage or
commission, is the presence of the element of agency. Therefore transaction of the
services which are on principal to principal basis would not be covered by the definition
involving the income of commission or Brokerage.
Important support may be drawn from following decisions to analyse the scope and
application of the provisions of section 194H
(a) Where contracts were held on a principal to principal basis
(i) Ahmedabad Stamp Vendors Association Vs. GOI, 257 ITR 202
(ii) Shree Baidyanath Ayurved Bhavan Ltd. Vs. Jt. CIT (2004), 83 TTJ
(iii) Asstt. CIT Vs. The Samaj (2001) 71 TTJ (ctk) 783
(b) Where contract was considered to be of agency
(i) Around the World Trade & Tours Pvt. Ltd. & ORS Vs. Union of India &
Others  268 ITR 447 (Mad)
(c) Circular No. 14 of 2001.
(d) Circular No.8 of 2002, dt. 27th Aug, 2002
(e) Circular No.6 of 2003 dt. 3rd Sept, 2003 in respect of Turnover
commission payable by the Reserve Bank of India.
5. Issues arising from Chapter XVII, its non compliance & disallowance
(i) Non payment of TDS :
The payer is under a statutory obligation to deduct and pay TDS and to issue a
certificate of deduction. Credit for the amount deducted is given to the payee on the
deposit of TDS on production of a certificate furnished under section 203 of the Act.
The payee only gets a certificate to the effect that taxes have been deducted and
deposited, and has no control over the matter. In case of default in making over the
amount to the Central Government, the payer is to be held responsible. He is deemed
to be an assessee – in – default not only in cases where after deduction he does not
make over the amount to the Central Government but also in cases where there is
failure on his part to deduct the amount at source. In such cases the amount of tax can
be recovered from the payer treating him as an assessee – in – default in respect of the
tax. Therefore, tax cannot be recovered from the payee for failure on the part of the
payer to deduct and deposit taxes [Assistant Commissioner of Income Tax Vs. Om
Prakash Gattani 242 ITR 638 (Gau)]. However, it has been held that duty of the
employer is to deduct tax on the basis of honest estimate of salaries and therefore
where the ITO makes controversial addition to salaries and TDS becomes less as a
consequence, the employer cannot be held to be assessee in default and further tax
cannot be demanded from employer [Gwalior Rayon Silk Co. Ltd. Vs. CIT 140 ITR
A similar principle was followed in the following decisions:
(i) (1998) 233 ITR 678 (AP) in the case of P.V. Raj Gopal and Others Vs.
Union of India & others.
(ii) 92 TTJ (Mumbai) 1067, in the case of Capt. J. G. Joseph Vs. J. CIT in ITA
No. 5824 (Mum) of 1999 for the AY 1996-97 decided on 28.07.04
(ii) Short payment or deduction of TDS :
The consequences discussed above for non-payment of TDS also result where TDS is
not paid in full, i.e., where only a part of TDS is paid. Earlier the position was not
clear. Prior to amendment in 2001, under section 201(1), the payer was considered to
be in default if he did not deduct or, after deducting, failed to pay TDS. Therefore, a
view was canvassed that so long as some tax was deducted (though not the whole
tax), section 201 may not be applied. However, section 201 was amended with
retrospective effect from 1-4-1962 to provide that provisions of sections 201(1) and
201(1A) are attracted where there is failure to deduct the whole or a part of the tax,
therefore now even part payment of tax would also invoke sections 201(1) and
(iii) Disclosure in form 3CD under tax Audit :
No deduction of or short deduction of tax has assumed greater importance in respect
of the responsibility of the tax auditor U/s.44AB of the Income tax Act, 1961 as
auditor is required to report whether provisions of chapter XVII B have been
complied with by the assessee. The duty of the tax
Auditor arises out of Sr. No.17(f) and another at Sr. No. 27 of the form 3CD are
annexure to the Tax Audit Report.
(iv) Timing of deductions and its Deposit : Deduction of TDS, its time and
circumstances are different depending upon the nature of payments as
provided in Chapter XVIIB of the act and the issues arising out of non
deduction and its deposit have been highlighted at paragraph (1.1) & (1.2).
(v) Meaning of tax deducted , Taxes paid or deducted – Meaning
It has been held in the context of section 40(a)(i) that “taxes paid by the assessee will
even include, the payment made as a result of the “recovery proceedings” under the
act, Addl CIT Vs Farasol Ltd. (1987) 163 ITR 364, 371, 372 (Raj)
(vi) Disallowance & Operation of Section 40 and 40A :
By virtue of S. 40, the amounts detailed in various sub-clauses of clauses (a) to (d)
shall not be deducted in computing the income chargeable under the head ‘profits or
gains of business or profession’ notwithstanding anything to the contrary contained in
sections 30 to 39 of the act. Section 40A, inserted with effect from 1.4.1968, contains
a non obstante clause saying that this section shall have effect not withstanding
anything to the contrary contained in any other provision of the act relating to the
computation of income under the head ‘profits and gains or business or profession’
and, therefore, S.40A will have overriding effect even on S.40. Thus, if a matter is
covered by both sections 40A and 40, then S.40A, will override the provisions of S.
40. But, where the matter is covered only by S.40 and not S.40A, then S.40A will not
stand in the way of the application of S.40
Hence, where the payment of salary to a partner of a firm, who might be working
wholetime for the firm, could not come within the ambit of S.40A(2)(a), the
allowability of payment of salary to a partner of the firm has to be decided u/s.40(b)
alone. Ganesh Factory Vs. CIT (1989) 46 Taxman 325 : (1989) 79 CTR 48 : (1989)
180 ITR 416 (P & H)
Held, that it could not be contended that by reason of S. 40A, which contains a non
obstante clause, salary paid to a partner by a firm, even when it was reasonable and in
lieu of actual and adequate services rendered by the partner concerned, should be
allowed. The overriding effect given to S.40A is only in respect of the matters not
covered by S 40(b). Section 40(b) has not been made nugatory by the insertion of
S.40A. N. M. Anniah & Co. V. CIT (1975) 101 ITR 348, 353-354 (Karn).
The provisions for TDS and TCS are only the alternatives amongst the four methods of
collection and recovery of tax. Section 191 of the act, provides that if the tax has not been
deducted in accordance with the provisions, the assessee would be liable to pay it
directly. Primarily therefore the liability to pay tax is on the assessee and the obligation to
collect is on the Government. Liability on the third party is created by virtue of
provisions of Chapter XVII B of the act, and the liability to deduct tax is made mandatory
and non compliance has been dealt with seriously and not one but in various forms harsh
treatment has been accorded to the payer of the Income or sum to the assessee. Before it
is long, facilitative provisions may be made for better compliance & creating cordial
atmosphere between the tax payer & the tax collector.