1. Background

1.1 Section 40(a)(ia)

1.1.1 Sub-clause (ia) of section 40(a) was introduced in the statute vide the Finance (No. 2) Act, 2004 w.e.f. 01/04/2005. It provides for disallowance of 30% of certain business expenditure (which are otherwise allowable and claimed as revenue expenditure) when paid/payable to a resident, in case where the payer (tax deductor) fails to comply with the provisions of deduction of tax at source and such TDS is not deposited till the due date of filing of the return of income under section 139(1).

1.1.2 Further, as per the first proviso, in case where tax is deducted in any subsequent year, or has been deducted during the previous year but paid after the due date specified in section 139(1), such sum shall be allowed as a deduction in computing the income of the relevant year in which such tax is paid.

1.1.3 Situation arose, where the recipient/payee duly offered the amount received from the payer as income and had also paid tax thereon, however, still on account of non compliance of the TDS provisions by the deductor/payer, disallowance of the corresponding expenditure were made in accordance with the above mentioned provisions. Thus, provisions of this sub-clause proved harsh and punitive for the deductor/payer.

1.1.4 In order to provide relaxation from disallowance in above scenario, the second proviso to this sub-clause was inserted by the Finance Act, 2012, w.e.f. 01/04/2013. It provides that in case the conditions provided in the first proviso to section 201(1) [for not being considered as ‘assessee-in-default’, viz. when payee has duly furnished his return of income wherein the amount paid/credited by the payer is included in total income, tax is paid on such income and the payer has obtained certificate in Form-26A from Chartered Accountant in this respect] are fulfilled, then it would be deemed as if the deductor/payer has deducted and paid the applicable TDS on the date on which the deduce/payee has furnished his return of income.

The implication of this proviso is that, even if the deductor actually does not either deduct tax or after deducting, does not pay the same; he shall still be deemed to have deducted and paid the tax on the date on which the ‘payee’ has furnished his return of income, if the conditions for not being considered as ‘assessee-in-default’ as per the first proviso to section 201(1), are fulfilled.

Consequently, following two scenarios may arise:

1) There will be no disallowance in case where the dedcutee/payee has furnished the return of income before the due date of filing the return of income for the dedcutor, because it would be deemed as if the TDS is paid before the due date of filing of the return as provided u/s. 139(1) [as explained in ‘para 1.1.1’]; or

2) In case where the deductee/payee files return of income after the due date of filing the return of income for the deductor, then as per the first proviso, expenses already disallowed u/s. 40(a)(ia), if any, will be allowed for the assessment year relating to the previous year in which the deductee/payee files the return of income (i.e. deemed date/year of payment in pursuant to the second proviso).

1.1.5 Though, inserted w.e.f. 01/04/2013, various High Courts and Appellate Tribunals held this proviso to have retrospective operation from the day on which the principal provision [section 40(a)(ia)] came into force, i.e. from 01/04/2005.]

1.2 Section 40(a)(i)

1.2.1 Sub-clause (i) of Section 40(a) forms part of the Income Tax Act, 1961 right from its inception i.e. 01/04/1962. It is similar to sub-clause (ia) [as explained above] and provides for disallowance in case where there is non-compliance of TDS provisions, when such specified payment/credit (i.e. interest, royalty, fees for technical services or other sum chargeable under the Act) are made outside India or in India to a Non-resident or to a foreign company.

1.2.2 The first proviso to this sub-clause is also identical to first proviso to clause (ia), as discussed above in ‘para 1.1.2’

1.2.3 Though, scenario as discussed in ‘para. 1.1.3’, above, persisted even in relation to sub-clause (i) of section 40(a), however, second proviso under this sub-clause was inserted only recently by the Finance (No.2) Act, 2019, w.e.f. 1-4-2020, it reads as:

“Provided further that where an assessee fails to deduct the whole or any part of the tax in accordance with the provisions of Chapter XVII-B on any such sum but is not deemed to be an assessee in default under the first proviso to sub-section (1) of section 201, then, for the purposes of this sub-clause, it shall be deemed that the assessee has deducted and paid the tax on such sum on the date of furnishing of return of income by the payee referred to in the said proviso.”

The above proviso is identical to second proviso to section 40(a)(ia) as explained in ‘Para 1.1.4’ above.

2. Analysis of effect of insertion of the second proviso to sub-clause (i) of section 40(a):

2.1 Position prior to insertion of the second proviso in section 40(a)(i):

2.1.1 The provision of section 40(a)(i)/(ia) were introduced to put check on the payer/deductor to comply with the provisions of tax deduction at source so that there is a track on the income/transactions undertaken by the payee/deductee and probability of revenue leakage is minimized. The purpose of these sub-clauses was never to act as a recovery provisions. Generally speaking, there is no point in disallowing expenditure once the department receives applicable taxes on such sum, irrespective of the source of the receipt of tax. It is not the case where there is any loss caused to the revenue when the deductee/payee has already paid the applicable taxes, though department has the right to recover the interest in case of delay in depositing the sum beyond its actual due date of receipt. Such practice will lead to taxation of the same amount twice; in the hands of payer as well as payee.

2.1.2 Sometimes, there are genuine cases where even after availing legal advice and maintaining the tax compliance to best possible; dispute regarding the applicability of TDS arises. Further, situation gets complex when provisions relating to non-residents persist and the assessing officers mechanically make disallowances u/s. 40(a)(i).

Ideally once a deductor/payer is able to justify and prove that the deductee/payee had duly deposited the impugned tax than there is no loss caused to the revenue w.r.t. the tax amount [though interest can be recovered u/s. 201(1A)] and thus there is no point in burdening the deductor/payer with such disallowance u/s. 40(a)(i)/(ia).

2.1.3 CBDT had issued Circular No. 275/201/95-IT(B) on 29/01/1997 which provides that no demand u/s. 201(1) should be enforced after the tax deductor has satisfied the department that taxes have been paid by the deductee (payee). However, this will not alter the liability of the deductor for interest u/s. 201(1A) or penalty u/s. 271C.

Even though not in context of section 40(a)(i)/(ia), the intention of this circular is to direct the assessing officer not to proceeds with any tax collection from the deductor/payer, once the tax is received from the deductee/payee. Hence, one may rely upon the said circular to derive the intention of the legislature in specifically inserting the second proviso to sub-clause (i)/(ia) which is to relax the disallowance in case where taxes are paid by the dedcutee/ payee

2.1.4 Even prior to insertion of the second provisos in either of the sub-clauses, Hon’ble Supreme Court in the decision of Hindustan Coca Cola Beverage (P.) Ltd. v. CIT [2007] 293 ITR 226 (SC), had relied upon the above circular and held that where deductee/payee has already paid taxes on amount received from deductor/payer, department once again cannot recover tax from deductor on same income by treating deductor to be assessee-in-default u/s. 201(1) for shortfall in its amount of tax deducted at source.

Thus, Hon’ble Supreme Court made it clear that the deductor/payer should not be punished if the department has received the tax from the deductee/payee.

2.1.5 Thus, based on the decision of Hindustan Coca Cola Beverage (P.) Ltd. vs. CIT (supra) and even without going into question of effective date of applicability of the second proviso to sub-clause (i) /(ia) of section 40(a), one may contend that disallowance u/s. 40(a)(i)/(ia) is not justified once the deductee/payee has paid the tax. This contention is also referred in the decision of Hon’ble Bombay High Court in case of PCIT v. Perfect Circle India Pvt. Ltd. [ITA 707/2016 order dated 07/01/2019](Bombay HC), wherein, in para 2 of the said order it was held as follows:

“…We may also note that the Supreme Court in the case of Hindustan Coca Cola Beverages P Ltd v. CIT even in absence of second proviso to Section 40(a)(ia) had noticed that the payee had already paid the tax. Under such circumstances, the Court held that the payer / deductor can at best be asked to pay the interest on delay in depositing tax.”

2.1.6 Further, in the case of Grindlays Bank v. CIT, (1992) 193 ITR 457 (Cal. HC), Hon’ble Calcutta High while examining the applicability of TDS provisions when certain salary payments were made by the assessee to its non-residents employees held as follows:

“A point has been made by the assessee that as a result of this deduction, the Department is realising the tax twice on the same income. It does not appear that this point was agitated before the Tribunal. We, however, make it clear that if the amount of tax has already been realised from the employees concerned directly, there cannot be any question of further realisation of tax as the same income cannot be taxed twice. If the tax has been realised once, it cannot be realised once again, but that does not mean that the assessee will not be liable for payment of interest or any legal consequence for their failure to deduct or to pay in accordance with law to the Revenue.”

2.1.7 Thus, considering the above explanations and legal precedents one may draw a conclusion that even in the absence of second proviso to section 40(a)(i)/(ia), it is not just on the part of the revenue to recover tax from the deductor/payer if it has received it from the deductee/payee.

2.2 Position post insertion of the second proviso in section 40(a)(i):

2.2.1 As discussed in ‘Para. 1’, above, the provisions of sub-clasue (i) as well as sub-clause (ia) are identical and disallowance under clause (ia) is warranted when the deductee/payee is a resident whereas disallowance under clause (i) is warranted when the dedcutee/payee is a non-resident, outside India or a foreign company.

2.2.2 As per the Finance (No. 2) Act, 2019, the second proviso to section 40(a)(i) is inserted w.e.f. 01/04/2020 and hence the dispute regarding the disallowance of the expenditure u/s. 40(a)(i) even in case where the conditions of first proviso to section 201 are complied, is now settled. However, the moot question here is whether insertion of this proviso can have retrospective effect?

2.2.3 Let us first understand the rationale for inserting this proviso in sub-clause (i) of section 40(a). Prior to this amendment, the relaxation of not being considered as ‘assessee-in-default’ in accordance with the first proviso to section 201(1) was provided only in case where the deductee/payee was a ‘resident’. Consequently, even the relaxation from the disallowance of expenditure was extended only for clause (ia) of section 40(a). Inspite of sub-clause (i) and (ia) of section 40(a) being identical provisions, such relaxations where not extended to cases where the deductee/payee was outside India, Non-resident or a foreign company.

2.2.4 In the Explanatory Memorandum explaining the rationale behind the proposed provisions of the Finance (No.2) Bill, 2019; it is stated that relief from not being considered as ‘assessee-in-default’ under first proviso to section 201(1) as well as relaxation from disallowance of corresponding expenditure even on non compliance of TDS provisions, were extended to the deductor/payer only in respect of payments made to a ‘resident’. In case of similar failure to comply with the TDS provisions on payments made to a ‘non-resident’, such relief was not available to the deductor and hence in order to remove this anomaly, these amendments in section 201(1) and section 40(a)(i) were made so as to extend such relaxation even in case where the deductee/payee is a ‘non-resident.’

2.2.5 It is very evident from the above that there were disparities among the identical provisions of the Act. It was in order to remove these disparities; the said amendments were made. Even the Explanatory Memorandum to the Finance (No.2) Bill, 2019, clearly spells that the amendments were been made so as to remove an anomaly i.e. to cure a defect/disparity. From the above discussion it is evident that the amendment was brought to cure the defect as there existed anomaly between two identical provisions. Thus now, second proviso to sub-clause (i) as well as sub-clause (ia) stand identical and parallel, the former provides relaxation form rigors in case where the payee (recipient) is ‘non-resident’ whereas the later provides relaxation in case where payee (recipient) is ‘resident’.

2.2.6 It is settled and undisputed position of taw that an amendment which is curative or declarative in nature has to be given retrospective operation from the point of time when the principal legal provision was introduced. In this respect, one may refer the following:

1. Krishnamurthi & Co. v. State of Madras & Anr. (1973) (2) SCR 54)

2. CIT v. Alom Enterprises (2009) 319 ITR 306 (SC).

3. CIT v. Calcutta Export Company [2018] 404 ITR 654 (SC)

4. Allied Motors (P.) Ltd. v. CIT [1997] 224 ITR 677 (SC)

5. CIT v. Ansal Land Mark Township (P.) Ltd. [2015] 377 ITR 635 (Delhi)

6. CIT v. Chandulal Venichand [1994] 209 ITR 7 (Guj. HC)

2.2.7 Further, Hon’ble Supreme Court in the case of CIT v. Vatika Township P. Ltd., (2014) 367 ITR 466 (SC) has held as under:

“…If a legislation confers a benefit on some persons but without inflicting a corresponding detriment on some other person or on the public generally, and where to confer such benefit appears to have been the legislators object, then the presumption would be that such a legislation, giving it a purposive construction, would warrant it to be given a retrospective effect….”

2.2.8 As discussed earlier, second proviso to sub-clause (i) is identical to second proviso to sub-clause (ia) of section 40(a). Hence, we may refer to various judicial pronouncements wherein it has been held that the second proviso to section 40(a)(ia) will have retrospective operation; and apply the said legal propositions for determining the effect of second proviso to section 40(a)(i).

2.2.9 In case of CIT v. Ansal Land Mark Township (P.) Ltd. [2015] 377 ITR 635 (Delhi), Hon’ble Delhi High Court upheld the decision in case of of Agra Tribunal in case of Rajiv Kumar Agarwal v. ACIT [ITA 337Agra/2013] wherein it was held that second proviso to section 40(a)(ia) substantially mitigates the rigors of a harsh disallowance provision and a curative amendment to avoid unintended consequences is to be treated as retrospective in nature even though it may not be stated so specifically, the insertion of second proviso must be given retrospective effect from the point of time when the related legal provision was introduced.

Accordingly it was affirmed that insertion of second proviso to Section 40(a)(ia) is declaratory and curative in nature and it has retrospective effect from 1st April, 2005, being the date from which sub clause (ia) of section 40(a) was inserted by the Finance (No. 2) Act, 2004.

2.2.10 Similar decisions in context of section 40(a)(ia) have been expressed in the favour of assessee by various High Courts and Tribunals on the ground that second proviso is declaratory and curative in nature hence should be given retrospective effect. Some of such decisions are listed below:

1. CIT v. Bhanot Construction & Housing Ltd. [2019] 261 Taxman 262 (Delhi)

2. CIT v. Naresh Kumar [2014] 362 ITR 256 (Delhi)

3. Thomas George Muthoot v. CIT [(2015) 63 taxmann.com 99 (Kerala HC)]

4. PCIT v. Perfect Circle India Pvt. Ltd. [ITA 707/2016 order dated 07/01/2019](Bombay HC)

At this juncture it is pertinent to note that the Hon’ble Supreme court has admitted the SLP of the revenue against the order passed in the matter of Thomas George Muthoot v. CIT (supra). However, as the matter is not yet disposed of by the Hon’ble Supreme Court and hence the decisions of the Hon’ble High Courts will still remain in force.

2.2.11 Thus from the above, one may adopt an analogy that the second proviso to section 40(a)(i), even though inserted with effect from 01/04/2020, should be given retrospective operation from the point of time when the related principal legal provision was first introduced in the statute, as the said amendment is brought so as to cure an anomaly and hence is curative and directory in nature.

As explained earlier in ‘Para 1.2.1’, Sub-clause (i) of section 40(a) exists since the inception of the Act i.e. from the year 1962. However, the crux of this sub-clause has been amended thrice since inception in order to expand its ambit, firstly vide the Finance Act, 1988 w.e.f. 01/04/1989, Finance Act 2003 w.e.f. 01/04/2004 and then vide the Finance Act, 2004 w.e.f. 01/04/2005.

It is important to note that even though there have been amendments in the crux of clause (i) of section 40(a), the same were to expand its applicability. The purpose of clause (i) since its inception has always been to disallow that part of expenditure relating to which there is non-compliance of the TDS provisions and thus in author’s opinion the retrospective operation of this proviso will be effective from 01/04/1962 i.e. the year in which the Income Tax Act came into force.

3. Summarizing the implication of retrospective operation of second proviso to section 40(a)(i):

Following would be the series of implications of giving retrospective effect:

1. Even though inserted w.e.f. AY 2020-21 as per the Finance (No.2) Act, 2019; the provisions of this proviso can be applied for any of the prior assessment years from the year 1962.

2. Thus, even for the ongoing assessment or appeals before various appellate authorities, if question of disallowance u/s. 40(a)(i) comes up on account of non compliance with the applicable TDS provision, then the deductor/payer needs to first check whether the following conditions of the first proviso to section 201(1) are fulfilled:

   • The payee has furnished his return of income.

   • The payee has taken into account the amount paid/credited by the payer.

   • The payee has paid the tax due on the income declared by him in such return of income.

   • Payer has to furnish certificate of Chartered Accountant in Form-26A.

3. If the above conditions are met, then, such deductor/payee will not be considered as ‘assessee-in-default’ as per the first proviso to section 201(1).

4. Consequently, as per the second proviso to section 40(a)(i), it would be deemed that the deductor/payer has deducted and deposited the applicable TDS on the date on which the deductee/payee has furnished his return of income.

5. If the payee files his return of income before the due date for filing return of income as applicable for the payer:

   As per the second proviso, it would be deemed as if the taxes are paid before the due date for filing return of income as specified in Section 139(1) and hence no disallowance shall be attracted.

   If the payee files his return of income after the due date for filing return of income as applicable for the payer:

   Disallowance u/s. 40(a)(i) may be made for the year in which there is non-compliance of the TDS provisions.

   However, as per the first proviso, the expenditure which was disallowed in any preceding years will be allowed as deduction against the income of the year in which such tax amount is paid to the department.

   Accordingly, if payee files his return of income after the due date (belated return), then as per the second proviso it would be deemed as if the deductor/payer has paid that tax on such belated return and according to first proviso, the expenditure earlier disallowed will now be allowed in the year in which such date falls.

   However, there are certain judicial pronouncements in context of section 40(a)(ia), wherein the tribunals after upholding the position that the second proviso to sub-clause (ia) of section 40(a) operates retrospectively have either directed the assessing officer to delete the addition or have remanded the matter back to Assessing Officer for the limited purpose of verifying whether the payee has included the income in his return of income and has paid the applicable tax thereon; and if the same is done then to delete the disallowance. Thus, tribunals have taken liberal approach and allowed deduction of such expenses in the relevant year itself.

   1. Ballabh Das Agarwal v. ITO [ITA. No. 1278/KOL/ 2011]

   2. Shri Rakesh Tak v. ITO [ITA No. 888/JP/2014]

   3. R K P Company v. ITO [ITA No.: 106/RPR/2016]

   4. Santosh Kumar Kedia v. ITO [ITA. No.1905/Kol/2014]

   5. Shri G.Shankar v. ACIT [ITA No.1832/Bang/2013]

   6. Visu Iternational Ltd. v. DCIT (ITA No. 488/Hyd./2013)

   7. G. Shankar v. ACIT (ITA No. 1832/Bang/2013)

Considering the above discussion, the authors are of the opinion that even though the second proviso to sub-clause (i) of clause(a) of section 40 was inserted by the Finance (No.2) Act, 2019, w.e.f. 01.04.2020; however, the same would still have retrospective operation from the date on which sub-clause (i) of clause(a) of section 40 was introduced in statute books i.e. from 01.04.1962.