Income Tax

Old Section 40(a)(ia) Disallowance vs New Business Deduction Rules: Tax Impact & Decision Framework

By CA Nikhil Gupta Updated June 2026 FY 2026-27

Reviewed by CA Nikhil Gupta · Last reviewed 26 September 2026

Corrected 26 September 2026: the Income-tax Act, 2025 equivalents (Section 35 and Section 36) and the worked example dates were re-checked against the Act.

Official sources cited: Income Tax Act 1961 S.40(a)(ia) | Income Tax Act 2025 | ICAI Handbook on Disallowances

Section 40(a)(ia) of the Income Tax Act, 1961 is one of the most consequential TDS compliance provisions for businesses — failing to deduct or deposit TDS on time disallows 30% of the payment as a business expense. Under the Income Tax Act, 2025 (effective from Tax Year 2026-27), this provision continues in equivalent form. This guide covers the exact rules, the 30% disallowance mechanics, the Form 26A relief mechanism, the new Act's equivalent sections, and a practical decision framework for businesses to avoid disallowances in FY 2026-27.

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What Section 40(a)(ia) Does — The Core Rule

Section 40(a)(ia) creates a direct financial penalty for TDS non-compliance in business expenses. When a business pays amounts that are subject to TDS under Chapter XVII-B (salary, contractor fees, rent, professional charges, interest, etc.) and either:

Fails to deduct TDS at all, OR
Deducts TDS but fails to deposit it with the government before the due date of ITR filing under Section 139(1)

Then 30% of the amount paid/credited is disallowed as a business expense deduction. This disallowance applies even though the payment was genuinely made for business purposes. The tax impact is direct: disallowed expense → higher taxable income → higher tax.

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30% Disallowance is NOT Permanent: The disallowed expense becomes deductible in the year when TDS is actually deducted and deposited. So if you missed TDS on a ₹10L professional fee in FY 2025-26, ₹3L is disallowed in FY 2025-26 but allowed in FY 2026-27 when you pay the TDS. It's a timing disallowance — but the tax cost (interest, cash flow, audit risk) can be significant.

Section 40(a)(ia) — Key Parameters

Parameter	Rule
Disallowance percentage	30% of the expense (reduced from 100% by Finance Act 2014, effective AY 2015-16)
When it applies	TDS not deducted; OR TDS deducted but not deposited before ITR due date under Section 139(1)
Who it applies to	All businesses and professions computing income under "Profits and Gains of Business or Profession" — companies, LLPs, firms, individuals, HUFs with business income
Exemption	Does NOT apply to 44AD, 44ADA, 44AE presumptive taxpayers (no expense-wise computation)
When disallowance reverses	In the year TDS is actually deducted and deposited — allowed as deduction in that year
Relief mechanism	Form 26A — payee's CA certifies payee has paid tax on the income; payer not treated as assessee-in-default
Payments to non-residents	Section 40(a)(i) — stricter: 100% disallowance if TDS not deducted on payments to non-residents
New Act 2025 equivalent	Section 35(b)(i) — same 30% mechanics (non-residents: Section 35(b)(ii))

Old Act vs New Act — Section Mapping

Provision	Old Act 1961	New Act 2025	Change?
TDS disallowance on resident payments (30%)	Section 40(a)(ia)	Section 35(b)(i)	Same mechanics; section renumbered
TDS disallowance on non-resident payments (100%)	Section 40(a)(i)	Section 35(b)(ii)	Same mechanics; section renumbered
Cash payment disallowance (₹10K limit)	Section 40A(3)	Section 36	Old Section 40A items sit in Section 36; confirm the clause before citing
Excessive payments to relatives disallowance	Section 40A(2)	Section 36	Old Section 40A items sit in Section 36; confirm the clause before citing
Payment certainties (bonus, PF, statutory dues)	Section 43B	Section 37	Same; the MSME payment rule continues within Section 37
Form 26A relief mechanism	Second proviso to Section 40(a)(ia)	Deeming rule within Section 35(b)(i); certificate is now Form 149 (Section 398(2))	Unchanged in substance

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For Tax Year 2026-27 (New Act): If you are computing business income for Tax Year 2026-27, reference Section 35(b)(i) in your books and in the tax audit report (Form 26 under the new Rules, replacing Form 3CD). For AY 2026-27 ITR (FY 2025-26 income, filed July 2026), continue referencing old Section 40(a)(ia) — old Act governs that period.

How the 30% Disallowance Works — Worked Examples

Example 1: Professional Fees — TDS Not Deducted

TechCo Pvt. Ltd. pays ₹15,00,000 to a digital marketing consultant in FY 2025-26 without deducting TDS under Section 194J (old Act). The consultant's invoice is ₹15L + ₹1.5L GST.

TDS required: 10% × ₹15L = ₹1,50,000 (TDS is on base amount excluding GST)
TDS not deducted
Disallowance under Section 40(a)(ia): 30% × ₹15L = ₹4,50,000 disallowed
Tax impact at 25% corporate tax rate: ₹4,50,000 × 25% = ₹1,12,500 extra tax paid
Interest under Section 201(1A): also payable for non-deduction
Penalty under Section 271C: possible

Example 2: TDS Deducted but Deposited Late

MicroFab LLP, whose accounts must be audited, pays ₹8,00,000 to contractors in March 2026 (FY 2025-26). TDS of ₹16,000 (2%) is deducted but deposited only on 20 November 2026 — after 31 October 2026, the return due date for audit cases for AY 2026-27.

TDS deducted: ✅ Yes
TDS deposited before ITR due date (31 October 2026 for this audit-case LLP): ❌ No (deposited 20 November)
Disallowance: 30% × ₹8,00,000 = ₹2,40,000 disallowed in AY 2026-27
Allowed in: Tax Year 2026-27, the year in which the TDS was actually paid (20 November 2026)
Lesson: Even one day late deposit (after ITR due date) triggers 30% disallowance. Always deposit March TDS by 30 April and clear all TDS before ITR filing.

Case Study: Sunrise Software — Narrowly Avoiding a ₹2.7 Lakh Disallowance

Tech Company, Pune — FY 2025-26 Tax Audit Finding

Sunrise Software Pvt. Ltd. (turnover ₹8 crore) engaged 12 freelancers and 3 agencies totalling ₹30,00,000 in professional fees during FY 2025-26. Their CFO noticed in March 2026 that TDS under Section 194J had not been deducted on 3 agency payments totalling ₹9,00,000 made in October 2025.

Exposure: 30% of ₹9L = ₹2,70,000 potential disallowance
Option 1 — Deduct and deposit before ITR date: Deduct TDS ₹90,000 from March 2026 payment to the same agencies, deposit by 7 April 2026. This brings them into compliance before the ITR filing date (October 31 for tax audit cases).
Option 2 — Form 26A: Contact each agency's CA. If agencies have filed their ITR and paid tax on the ₹9L income, have a CA certify this in Form 26A (request raised on TRACES, certificate filed on the income-tax e-filing portal). With Form 26A, Sunrise avoids being treated as assessee-in-default.
Action taken: Sunrise deducted TDS from March payments and deposited by 7 April. Averted full disallowance. The auditor noted this in Form 3CD but confirmed compliance by filing date.

Missed TDS on Agencies

₹9,00,000 payments

Potential Disallowance

₹2,70,000 (30%)

Extra Tax (25% corp)

₹67,500

Resolution

TDS deducted from Mar. payment

Form 26A Relief — The Second Proviso Escape

Even if you missed TDS on a payment to a resident, Section 40(a)(ia)'s second proviso saves you if all four conditions are met:

The payee is a resident (this relief does not apply to non-resident payments)
The payee has filed their income tax return
The payee has included the income in their return
The payee has paid the tax on such income

A Chartered Accountant certifies these facts in Form 26A (the deductor raises the request on TRACES; the certificate is filed on the income-tax e-filing portal). Once filed, the payer is not treated as assessee-in-default and Section 40(a)(ia) disallowance does not apply. From Tax Year 2026-27 the certificate is Form 149 under Section 398(2).

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Form 26A Has Limitations: Form 26A relief requires active cooperation from the payee and their CA. Small vendors or contractors may not be willing to provide this. The process requires the payee to have already filed their ITR and paid tax. If you discover the TDS miss during tax audit, there may not be enough time to collect Form 26A from all affected vendors before the ITR deadline. Plan for TDS compliance proactively — don't rely on Form 26A as a regular backstop.

Practical TDS Compliance Framework to Prevent Disallowances

Preventing Section 40(a)(ia) / Section 35(b)(i) disallowances requires systematic process controls:

1. Vendor Master with TDS Flag

Tag every vendor in your ERP with the applicable TDS section, rate, and threshold. When a payment is processed, the system automatically computes TDS. No manual calculation means no missed deductions.

2. Monthly TDS Reconciliation

Before the 7th of every month, reconcile all vendor payments in the previous month against TDS deducted and challan deposits. Any outstanding TDS should be deposited without fail. March TDS (special rule) should be deposited by 30 April.

3. Pre-ITR TDS Audit (April–October)

Before filing ITR (especially for tax audit companies — ITR due 31 October), run a complete "TDS vs payments" reconciliation. Identify any payments where TDS was missed or deposited late. Deposit outstanding TDS before ITR filing date to prevent the disallowance from crystallising.

4. Form 3CD / Form 26 Reporting Accuracy

The Tax Audit Report (old Form 3CD, new Form 26 under new Act) requires your auditor to report all instances of TDS disallowance under Section 40(a)(ia). Ensure your accounts payable team provides accurate TDS data to the auditor, and that any genuine missed TDS is either paid before the audit report date or Form 26A is arranged.

Section 40(a)(ia) — Key Compliance Points

30% disallowance if TDS not deducted or not deposited before ITR due date
New Act 2025 equivalent: Section 35(b)(i) — same mechanics, effective Tax Year 2026-27
Not applicable to 44AD, 44ADA, 44AE presumptive taxpayers
Disallowance is not permanent — allowed as deduction in year of actual TDS deposit
Non-resident payments: Section 40(a)(i) / new Section 35(b)(ii) — 100% disallowance (stricter)
Form 26A relief (Form 149 from Tax Year 2026-27): if payee filed return and paid tax, payer avoids disallowance
Cash payment over ₹10,000 per transaction: 100% disallowance under Section 40A(3) / new Section 36
Tax audit (Form 3CD / Form 26): auditor must report all 40(a)(ia) instances
Best practice: Run monthly TDS reconciliation and deposit before the 7th of next month

Related Calculators

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Frequently Asked Questions

Section 40(a)(ia) disallows 30% of a business expense if TDS is not deducted on that payment or if TDS is deducted but not deposited before the ITR filing due date. For example, ₹10 lakh paid to a consultant without TDS → ₹3 lakh (30%) disallowed. The disallowance reverses in the year TDS is actually deposited. Under the Income-tax Act 2025, the equivalent provision is Section 35(b)(i), effective Tax Year 2026-27.

No. Section 40(a)(ia) does not apply to taxpayers under presumptive taxation — Section 44AD (small businesses, turnover up to ₹3 crore), Section 44ADA (professionals, receipts up to ₹75 lakh), or Section 44AE (goods carriage). Under these sections, income is at a fixed percentage of turnover, and expense-wise deduction computation is not done. So TDS disallowance provisions have no application. Once a taxpayer opts out of presumptive taxation and maintains full books, Section 40(a)(ia)/35(b)(i) becomes applicable.

Form 26A is a CA-certified document confirming that the payee has included the income in their return and paid tax on it. Under the second proviso to Section 40(a)(ia), if all conditions are met (resident payee, ITR filed, income included, tax paid), the payer is not treated as assessee-in-default and disallowance does not apply. The request is raised on TRACES and the CA's Form 26A is filed on the income-tax e-filing portal; from Tax Year 2026-27 the certificate is Form 149. This relief is available only for resident payees — non-resident payments have no such relief under Section 40(a)(i).

Sources & Verification: Income Tax Act, 1961, Section 40(a)(ia) and Section 40A | Income-tax Act 2025, Sections 35-37 | DisyTax Section 40A(ia) comprehensive guide (February 2026) | ICAI Handbook on Disallowance of Expenses | CallMyCA.com TDS Disallowance guide | Bajaj Finserv Section 40 article. Data verified June 2026; new-Act references re-checked 26 September 2026.

Disclaimer: This article is for educational purposes. Section numbers and provisions should be verified against the official Income Tax Act, 2025 text. Consult a qualified CA for business-specific TDS compliance advice.

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