Many taxpayers are surprised when a business expense that is fully supported by an invoice, a contract and a bank payment is disallowed in assessment. The expense is not in doubt. The service was received, the vendor was paid and the entry is in the books. The disallowance arises because tax was not deducted at source, or was deducted but not deposited in time.
A separate article on this site covers the 30% disallowance for payments to residents under Section 40(a)(ia). This article looks at the wider picture: why the law links deductibility to TDS compliance, the stricter 100% disallowance for payments to non-residents under Section 40(a)(i) (now Section 35(b)(ii) of the Income-tax Act, 2025), the relief available, and a practical checklist for finance teams.
Key points at a glance
- Section 40(a) disallows certain expenses where TDS is not deducted, or not paid by the return due date, even though the expense is genuine.
- For payments to non-residents, the entire sum is disallowed under Section 40(a)(i), now Section 35(b)(ii) of the Income-tax Act, 2025.
- For payments to residents, 30% is disallowed under Section 40(a)(ia), now Section 35(b)(i).
- The disallowance reverses in the year the TDS is paid, and does not apply where the payee has paid tax and the prescribed certificate is furnished.
- TDS on non-resident payments under Section 195 of the 1961 Act is now in Section 393(2) of the 2025 Act.
Why does TDS compliance decide whether an expense is allowed?
TDS is a collection mechanism. The payer is made responsible for collecting tax on behalf of the Government at the time of payment, particularly where the payee may otherwise be difficult to reach. To enforce this, the law makes the payer's own deduction conditional on compliance. The objective is threefold:
- to secure tax at the point of payment;
- to place the compliance responsibility on the payer, who controls the payment; and
- to discourage regularisation after the event, when the payee may no longer be traceable.
The consequence is that the question in assessment becomes technical rather than factual: not "was the expense incurred?" but "was TDS deducted at the right rate and paid in time?"
Section 40(a)(i): payments to non-residents
Section 40(a)(i) disallows any interest, royalty, fees for technical services or other sum chargeable to tax in India, payable outside India or to a non-resident, on which tax is deductible under Chapter XVII-B and has not been deducted, or after deduction has not been paid by the due date for filing the return. Unlike the resident provision, the entire sum is disallowed.
Under the Income-tax Act, 2025, the provision is in Section 35(b)(ii), and the TDS obligation on sums paid to non-residents (earlier Section 195) is in Section 393(2).
Only sums chargeable to tax in India
In GE India Technology Centre (P.) Ltd. v. CIT (2010), the Supreme Court held that the obligation to deduct tax under Section 195 arises only if the payment is chargeable to tax in India. Where a payment to a non-resident is not taxable in India, for example because of the applicable tax treaty, there is no TDS obligation and hence no disallowance. This is why the treaty position, the tax residency certificate and Form 10F of the payee should be on file before the payment is made.
Non-discrimination under tax treaties
In CIT v. Herbalife International India (P.) Ltd. (2016), the Delhi High Court held that Section 40(a)(i), as it stood when comparable payments to residents were not subject to disallowance, was discriminatory under the non-discrimination article of the India-USA tax treaty. The relevance of such arguments today depends on the treaty and on the current parity between the resident and non-resident provisions.
Resident vs non-resident: how the disallowance compares
| Aspect | Payments to residents | Payments to non-residents |
|---|---|---|
| Provision (1961 Act) | Section 40(a)(ia) | Section 40(a)(i) |
| Provision (2025 Act) | Section 35(b)(i) | Section 35(b)(ii) |
| TDS provision (2025 Act) | Section 393(1) | Section 393(2) |
| Extent of disallowance | 30% of the sum | 100% of the sum |
| Allowed later? | Yes, in the year TDS is paid | Yes, in the year TDS is paid |
| Relief if payee paid tax | Yes, with accountant's certificate | Yes, since the Finance (No. 2) Act, 2019 |
The relief for non-residents was introduced by the Finance (No. 2) Act, 2019, which extended the "payee has paid tax" protection in Section 201(1) to non-resident payees and added a corresponding proviso to Section 40(a)(i). In practice, obtaining the non-resident's return and the certificate can be difficult, so the relief is less useful than it appears.
Worked example: foreign technical services without TDS
Consider an Indian company, taxed at an effective rate of 25.168%, that pays ₹50,00,000 in FY 2025-26 to a foreign firm for technical consultancy. The treaty does not exempt the fees, but no tax was deducted.
- Disallowance for FY 2025-26 under Section 40(a)(i): ₹50,00,000 (the full amount).
- Additional tax for that year: ₹50,00,000 × 25.168% = ₹12,58,400.
- The company pays the TDS in Tax Year 2026-27, with interest for late deduction and payment.
- If the foreign firm's fees were agreed net of tax, the TDS must be computed on the grossed-up amount, increasing the cost.
- The ₹50,00,000 is claimed as a deduction in Tax Year 2026-27, the year of payment of TDS.
Had the same payment been made to a resident, the disallowance would have been ₹15,00,000 (30%). The difference shows why non-resident payments deserve a separate review before payment.
Practical point: Remittances abroad usually require the Form 15CA/15CB process with the bank. Where a remittance was made on the basis that it is not taxable, the reasoning in the chartered accountant's certificate and the treaty documents become the primary evidence against a later disallowance.
Common situations where disallowances arise
- Professional and consultancy fees: wrong classification between professional and technical services, or missed aggregate thresholds.
- Contractor and sub-contractor payments: payments split across invoices, each below the single-payment threshold but above the annual limit.
- Rent, commission and brokerage: year-end provisions booked without deduction.
- Non-resident payments: software subscriptions, cloud services, marketing fees, commissions to foreign agents and reimbursements, where the taxability in India was not examined.
- Salary payable outside India without TDS, which is separately disallowed under Section 40(a)(iii).
Practical checklist before booking or paying an expense
- Was TDS applicable? Identify the nature of payment and, for non-residents, whether the sum is chargeable to tax in India under the Act and the treaty.
- Was it deducted at the correct rate? Check the section or Section 393 payment code, PAN availability and treaty rate documentation.
- Was it deducted at the right time? TDS applies on credit or payment, whichever is earlier, including year-end provisions.
- Was it deposited within time? At the latest, before the return filing due date to avoid disallowance; monthly due dates to avoid interest.
- If missed, can relief apply? Explore the payee-paid-tax route and maintain a register of disallowed sums for claim in the year of payment.
Frequently Asked Questions on TDS Default Disallowance
Can a genuine expense be disallowed for not deducting TDS?
Yes. Under Section 40(a) of the 1961 Act, now Section 35(b) of the Income-tax Act, 2025, an expense can be disallowed for TDS default even if it is genuine, subject to later allowance when the TDS is paid.
How much is disallowed for payments to non-residents without TDS?
The entire sum is disallowed under Section 40(a)(i), now Section 35(b)(ii), compared to 30% for payments to residents.
Is TDS required on every payment to a non-resident?
No. Following the Supreme Court in GE India Technology Centre (2010), TDS is required only if the sum is chargeable to tax in India, after considering the applicable tax treaty.
What is the new section for Section 195 under the Income-tax Act, 2025?
TDS on sums paid to non-residents is covered by Section 393(2) of the Income-tax Act, 2025.
Is the disallowed amount lost permanently?
No. It is allowed in the year in which the TDS is deducted and paid, so the default becomes a timing difference with interest and cash-flow costs.
Is there relief if the non-resident has paid tax in India?
Yes. Since the Finance (No. 2) Act, 2019, where the non-resident payee has filed its return and paid tax on the income, and the prescribed certificate is furnished, the payer is not treated as in default and the expense is allowed.
Conclusion
TDS compliance travels with the expense. A service received and paid for can still produce a disallowance if tax was not deducted or deposited on time, and for non-resident payments the entire amount is at stake. The 2025 Act retains this structure in Section 35(b), with the TDS provisions consolidated in Section 393.
The practical answer is a pre-payment review: nature of payment, taxability, rate, timing and deposit. Before asking whether an expense is allowable, it is worth asking whether its TDS was in order.
This article is intended for general information and knowledge sharing only and does not constitute professional advice or solicitation of any kind. Provisions are summarised as of September 2026. Readers should refer to the relevant provisions, regulations and judicial pronouncements for their specific facts.