Section 40(a)(ia) Income Tax Act: 30% Disallowance for TDS Non-Compliance - Complete Guide FY 2026-27

Section 40(a)(ia) of the Income Tax Act is one of the most critical provisions that disallows 30% of business expenses when Tax Deducted at Source (TDS) is not deducted or not deposited by the specified due date. This provision acts as a compliance enforcement mechanism ensuring timely TDS deduction and payment. For businesses, understanding Section 40(a)(ia) is essential because non-compliance can result in significant disallowance of legitimate expenses, increasing tax liability substantially. This comprehensive guide covers all aspects of Section 40(a)(ia) for FY 2026-27, including legislative history, current provisions, relief mechanisms, practical examples, and important judicial precedents.

What is Section 40(a)(ia)?

Section 40(a)(ia) was introduced by the Finance Act, 2004 with effect from 1st April 2005 (Assessment Year 2005-06). It is a disallowance provision that restricts the deduction of certain business expenses when TDS obligations are not fulfilled properly.

Scope of Application

Legislative Evolution of Section 40(a)(ia)

Section 40(a)(ia) has undergone several amendments since its introduction. Understanding this evolution is crucial for proper compliance.

Current Provisions of Section 40(a)(ia) for FY 2026-27

As applicable for Assessment Year 2027-28 (Financial Year 2026-27), the current text of Section 40(a)(ia) reads:

Key Components Explained

1. "Thirty per cent":
   • Only 30% of the expense is disallowed (from AY 2015-16 onwards)
   • Remaining 70% is allowed as deduction
   • Earlier it was 100% disallowance (till AY 2014-15)
2. "Any sum payable to a resident":
   • Covers ALL types of payments to residents
   • Not limited to specific categories anymore
   • Includes payments under all TDS sections (192, 194C, 194J, 194I, etc.)
3. "Tax is deductible at source under Chapter XVII-B":
   • TDS must be legally required to be deducted
   • If no TDS liability exists, Section 40(a)(ia) doesn't apply
   • Exemptions like Form 15G/15H, threshold limits, etc. are relevant
4. "Has not been deducted":
   • First limb - TDS not deducted at all
   • Also includes short deduction (deducted at wrong rate)
5. "After deduction, has not been paid":
   • Second limb - TDS deducted but not deposited with government
   • Late payment attracts disallowance
6. "Due date specified in sub-section (1) of section 139":
   • For companies: 31st October of assessment year
   • For others requiring audit: 31st October of assessment year
   • For others: 31st July of assessment year
   • Specific dates for FY 2026-27 covered in Return Due Dates guide

When Does Section 40(a)(ia) Apply?

For Section 40(a)(ia) disallowance to be triggered, the following conditions must be satisfied:

Mandatory Conditions for Disallowance

Situations Where Section 40(a)(ia) Does NOT Apply

Proviso 1: Subsequent Year Deduction

The first proviso provides relief for subsequent rectification of TDS default.

How First Proviso Works

Proviso 2: Form 26A Relief (Game Changer)

The second proviso, introduced by Finance Act 2012 (effective AY 2013-14), provides significant relief where the payee has fulfilled tax obligations even though the payer failed to deduct TDS.

Connection with Section 201(1) - First Proviso

The second proviso is linked with Section 201(1) first proviso, which states:

Section 201(1) First Proviso Conditions:

1. Payee has filed return of income u/s 139
2. Payee has included the payment in return and computed income accordingly
3. Payee has paid tax due on income declared
4. Payer furnishes certificate from Chartered Accountant in Form 26A

If all four conditions are met, the payer is not deemed assessee-in-default and consequently, Section 40(a)(ia) disallowance doesn't apply.

Form 26A - Certificate Format

Practical Example - Form 26A Relief

Calculation of Disallowance Under Section 40(a)(ia)

Basic Formula

Scenarios with Calculations

Scenario 1: Complete Non-Deduction

Scenario 2: Late Payment of TDS

Scenario 3: Short Deduction of TDS

Paid vs. Payable Controversy

One of the most litigated issues under Section 40(a)(ia) is whether it applies only to "payable" amounts (outstanding at year-end) or also to "paid" amounts during the year.

Controversy Background

The section uses the term "any sum payable to a resident" - Does this mean:

• Only amounts outstanding (payable) at year-end? OR
• Both paid during year + payable at year-end?

Judicial Decisions

Applicability to Different Types of Expenses

Capital Expenditure and Depreciation

Presumptive Taxation Schemes

Section 40(a)(ia) does NOT apply to income computed under presumptive taxation schemes:

• Section 44AD: Presumptive taxation for small businesses (8%/6% of turnover)
• Section 44ADA: Presumptive taxation for professionals (50% of receipts)
• Section 44AE: Goods carriage business (fixed amount per vehicle)
• Section 44BB, 44BBB, etc.: Special presumptive provisions

Reason: These sections have non-obstante clause overriding Sections 28 to 43C; no expense-wise computation required

Other Heads of Income

TDS Under Wrong Section

A common practical issue is when TDS is deducted but under the wrong section of Chapter XVII-B. Does this attract Section 40(a)(ia) disallowance?

Case Law Position

Practical Advice: While judicial support exists for taxpayer view, always deduct TDS under correct section to avoid litigation

No TDS Liability Situations

Section 40(a)(ia) applies only when there is a legal liability to deduct TDS. If no TDS liability exists, the provision doesn't apply.

Common No-TDS-Liability Scenarios

Important Court Judgments - Summary

Constitutional Validity

Key Precedents Table

Practical Compliance Tips for FY 2026-27

1. Timely TDS Deduction:
   • Deduct TDS at the time of payment or credit, whichever is earlier
   • Maintain TDS register with deduction dates
   • Use correct TDS sections and rates (refer TDS Guide)
2. Payment Before Due Date:
   • Pay TDS on or before 31st July 2027 (non-audit) or 31st October 2027 (audit cases)
   • Don't wait till last day - pay monthly by 7th of next month
   • Track payment dates and obtain challans
3. Form 26A Strategy:
   • If TDS missed, immediately communicate with payee
   • Ensure payee includes income in return and pays taxes
   • Obtain CA certificate in Form 26A before assessment proceedings
   • Keep Form 26A ready during audits
4. TDS Certificates and Returns:
   • Issue Form 16A to payees quarterly
   • File quarterly TDS returns (Form 26Q) on time
   • Reconcile TDS with Form 26AS
5. Lower/Nil Deduction Certificates:
   • If payee has lower/nil tax liability, advise them to apply for certificate u/s 197
   • Maintain valid certificates on record
6. Documentation:
   • Maintain vendor master with PAN details
   • Keep Form 15G/15H declarations (where applicable)
   • Document threshold limit exemptions
7. Tax Audit Reporting:
   • Clause 30(c) of Form 3CD requires reporting of Section 40(a)(ia) disallowances
   • Coordinate with tax auditor for proper reporting
8. Advance Tax Planning:
   • If disallowance expected, factor in advance tax computation
   • Pay advance tax to avoid interest u/s 234B/234C

Frequently Asked Questions (FAQs)

Key Takeaways for FY 2026-27

• Section 40(a)(ia) disallows 30% of business expenses when TDS not deducted or not paid by ITR due date
• Applies to ALL payments to residents under Chapter XVII-B (not limited to specific categories anymore)
• Does NOT apply to non-residents (covered under Section 40(a)(i) with 100% disallowance)
• TDS must be paid by 31st July 2027 or 31st October 2027 (depending on audit requirement) to avoid disallowance
• Form 26A relief is available if payee has filed return and paid taxes - can save entire 30% disallowance
• First proviso allows deduction in subsequent year when TDS is paid
• "Paid vs Payable" issue remains controversial - Special Bench favors taxpayers (only payable amounts)
• Wrong section TDS: Favorable judgments exist that no disallowance if TDS deducted and paid
• Does NOT apply to presumptive taxation schemes (44AD, 44ADA, 44AE)
• Depreciation generally not affected as it's statutory allowance, not expenditure
• Applies only to "Profits and Gains of Business or Profession" head, not other income heads
• No TDS liability = No disallowance (threshold limits, Form 15G/15H cases, etc.)

Conclusion

Section 40(a)(ia) of the Income Tax Act is a crucial compliance provision that every business must understand and follow diligently. The reduction of disallowance from 100% to 30% (from AY 2015-16) and the introduction of Form 26A relief mechanism (from AY 2013-14) have significantly reduced the hardship on taxpayers, but the provision still demands strict adherence to TDS rules.

For FY 2026-27, businesses must ensure timely TDS deduction and payment by the due date u/s 139(1) to avoid 30% disallowance. The key is proactive TDS management - maintaining proper systems, documenting exemptions, issuing certificates, filing returns on time, and keeping Form 26A as a backup option for genuine cases where TDS was missed.

Several judicial precedents provide relief in specific situations - whether it's the "paid vs payable" issue, wrong section TDS, or no TDS liability cases. However, relying on litigation should be the last resort. The safest approach is full TDS compliance from the start.

The Form 26A mechanism under the second proviso is particularly useful for genuine hardship cases where the payer forgot to deduct TDS but the payee has already paid taxes. This provision reflects the legislature's intent to provide relief where revenue has not been lost to the government, though procedural compliance was missed.

As we move forward in FY 2026-27, businesses should integrate TDS compliance into their payment systems, conduct periodic reviews, coordinate with vendors for Form 15G/15H or Section 197 certificates where applicable, and maintain robust documentation. Proper tax audit reporting in Form 3CD and timely response to assessment notices are equally important.

Remember, Section 40(a)(ia) disallowance is just one consequence of TDS non-compliance. Interest u/s 201(1A), penalties u/s 271C, and prosecution provisions create additional burdens. Therefore, investing in proper TDS compliance systems and training is not just good tax practice - it's essential business risk management.

Need Professional Help with TDS Compliance? Explore our comprehensive guides on TDS, Business Income, Tax Audit, and Income Tax Compliances for complete business tax solutions.