JULY 18, 2014

By Rajesh C Patil, Deloitte Haskins & Sells LLP

DISALLOWANCE of expenditure for non-deduction of tax has been a matter of dispute. The Courts have dealt with the controversies in various judicial pronouncements. The Finance (No. 2) Bill, 2014 (‘the Bill'), proposes to do away with or mitigate some of the hardships of disallowance of expenditure.

The amendments proposed in relation to disallowance due to non-deduction of tax at source are discussed below:

Curtailed disallowance

The Finance Minister in the Budget speech stated that undue hardship to the taxpayer is caused where the taxpayer fails to deduct and pay tax on payments to resident by virtue of which whole amount of expenditure gets disallowed but the TDS rate range from 1% to 10%. For default of deduction or payment of TDS from certain payments ( interest, commission, brokerage, rent, royalty, fees for professional services or fees for technical services or amounts payable to a contractor or sub-contractor) to residents, the whole amount of expenditure on which tax was deductible is disallowable under section 40(a)(ia) of the Income-tax Act, 1961 (“the Act”). With a view to liberalize provisions of section 40(a)(ia), the Bill proposes to restrict the disallowance to 30% of sum payable to a resident on which tax has not been withheld or paid before the due date.

The Bill only provides for relief of reduced disallowance in case of payments to resident. In such scenario, an issue may arise as to whether the benefit of restricted disallowance can be availed by the tax payers for payments made to non-resident by resorting to the Non-discrimination Article under the Tax Treaties in certain cases (treating the non-resident tax payers pari materia to the resident tax payers) where such Tax Treaty benefits are available.

It needs to be seen how the Courts interpret the above amendment to resolve the controversy.

Scope expanded

Albeit a favourable and restricted disallowance of expenditure, the Bill proposes to expand the scope of payments covered under section 40(a)(ia) of the Act on which TDS is deductible. Currently, certain expenditures such as salaries, director's fees, etc. are outside the purview of section 40(a)(ia). The expanded scope proposes to cover all expenditure on which tax is deductible under Chapter XVII-B. The Memorandum explaining the provisions of the Bill clarifies that the intention to widen the scope is to improve the TDS compliance in respect of payments made to residents on which TDS is deductible but are currently not specified in section 40(a)(ia) in line with the existing provisions in respect of payments made to residents.

Payments on or before due date of filing the return of income

Currently, provisions of section 40(a)(i) of the Act provide that certain payments such as interest, royalty and fee for technical services made to a non-resident shall not be allowed as deduction if tax on such payments is not withheld, or after withholding, was not paid within the timelines prescribed u/s 200(1) of the Act. The Bill has proposed to extend the time limit for payment of TDS for payments made to non-residents, in order to bring parity with the existing provisions applicable to the payments made to residents. Accordingly, the deduction is proposed to be allowed to the tax payers for the payments made to non-residents as well, if the tax is withheld and paid on or before the due date of filing the return of income ('the due date').

By virtue of the above amendment, the tax payers would also get the benefit of the deduction of expenditure for payment to non-residents, if the TDS is paid before the due date.

While the tax payer would welcome the above proposed amendments, clarification may still be required on the issue whether disallowance is warranted in case of short deduction of TDS.

Conclusion

Though the above amendments may be a welcome measure for the tax payers, it needs to be seen how the Bill is finally enacted and how the Courts interpret the amendments.