Where a business incurs expenditure that requires tax to be deducted at source under the applicable TDS provisions — payments to contractors, professional fees, commission, rent, interest, and similar categories — and the assessee either fails to deduct the tax or, having deducted it, fails to deposit it with the government within the prescribed time, a specified proportion of that expenditure is disallowed in computing business income for the relevant year. The disallowed amount can, however, generally be claimed as a deduction in the later year in which the default is cured — the tax is deducted and deposited, or simply deposited, as the case may be.

This provision is squarely aimed at compliance rather than punishing genuine business expenditure, and its scope has been the subject of substantial litigation on two specific points: whether it applies only to amounts still 'payable' at the year-end (as opposed to amounts already fully paid during the year), and whether a curative amendment permitting a later-year deduction on rectification of the default applies retrospectively to earlier years as well.

Relevant Case Laws

Palam Gas Service v. CIT (2017) 394 ITR 300 (SC) — held that the disallowance for non-deduction of TDS applies not only to amounts that remain 'payable' at the end of the year, but also to amounts that have already been fully paid during the year, rejecting the narrower interpretation that would have confined the disallowance only to year-end payables and thereby significantly widening the provision's practical reach.

CIT v. Calcutta Export Company (2018) 404 ITR 654 (SC) — held that the amendment allowing a deduction in the year in which TDS is eventually deposited (even where it was originally deducted late) applies retrospectively, recognising the amendment's curative and compliance-encouraging purpose, so as to avoid an unduly harsh, permanent disallowance for a delay that has since been cured.

Frequently Asked Questions

Q. Does the disallowance apply only to amounts still outstanding at year-end?

A. No — following Palam Gas Service, the disallowance applies to the specified categories of expenditure regardless of whether the amount was paid during the year or remained payable at year-end, so long as the applicable TDS was not properly deducted and deposited.

Q. If TDS is deducted late but eventually deposited, is the expense permanently lost as a deduction?

A. No — following Calcutta Export Company, the expenditure becomes deductible in the year in which the TDS is actually deposited, even where the original default (late deduction or deposit) occurred in an earlier year, given the retrospective, curative nature of the relevant amendment.

Q. Does this disallowance apply to payments made to a non-resident?

A. Yes, and often with a wider consequence — non-deduction of tax on payments to non-residents attracts its own specific disallowance regime, generally without the partial-disallowance relief available for domestic payments, making TDS compliance on cross-border payments especially important.

Q. Is there any relief if the payee has already paid tax on the income independently?

A. In certain circumstances, relief from the disallowance (and from being treated as an assessee-in-default) is available where the recipient has furnished a certificate confirming that the corresponding income has already been included in their return and tax paid on it, subject to the prescribed conditions and documentation being satisfied.

Precautions to Be Taken

1.      Map every category of business expenditure against the applicable TDS provision at the start of the year, rather than discovering a default only during finalisation of accounts or in scrutiny.

2.      Reconcile TDS deducted and deposited against the corresponding expense ledger on a monthly or quarterly basis, since delayed reconciliation makes it far harder to identify and cure defaults before year-end.

3.      Where a default is identified after the year-end, deposit the shortfall promptly and track the year in which the deposit is actually made, since this fixes the year in which the corresponding deduction becomes available.

4.      For payments to non-residents, apply extra diligence given the more stringent consequences of non-deduction, and consider obtaining a certificate or advance determination of the correct withholding rate where the position is unclear.

5.      Where relying on the payee's independent tax payment as relief from disallowance, obtain and retain the prescribed certificate and supporting documentation contemporaneously, rather than attempting to source it retrospectively during assessment.