Amounts Not Deductible [Section 40] – Direct and Indirect Taxes with Tax Ready Reckoner

Under the Income Tax Act, 1961, certain expenses are expressly disallowed while computing taxable income under the head “Profits and Gains of Business or Profession” (PGBP). These restrictions are outlined in Sections 40(a), 40(b), and 40(ba) to prevent tax evasion and ensure compliance. Below is a detailed breakdown of these provisions:

Table of Contents

1. Section 40(a): Disallowance Due to Non-Compliance with TDS & Other Provisions

This section disallows deductions for certain payments if Tax Deducted at Source (TDS) is not deducted or deposited on time.

Key Disallowances Under Section 40(a):

SUB-SECTION	NATURE OF PAYMENT	DISALLOWANCE RULE
40(a)(i)	Payments to non-residents (interest, royalty, fees for technical services)	100% disallowed if TDS not deducted/deposited by ITR due date. Deduction allowed in the year TDS is paid.
40(a)(ia)	Payments to residents (contractual, professional fees, rent, etc.)	30% disallowed if TDS not deducted/deposited by ITR due date. Deduction allowed in the year TDS is paid.
40(a)(ib)	Equalisation levy on digital services to non-residents	Disallowed if levy not deducted/deposited by ITR due date.
40(a)(iib)	Royalty/fees paid to State Government Undertakings	Not deductible for the State Government entity.
40(a)(iii)	Salary paid outside India or to non-residents	Disallowed if TDS not deducted/deposited by the due date.
40(a)(v)	Tax on non-monetary perquisites paid by employer	Not deductible (exempt under Section 10(10CC).

Exceptions:

If TDS is paid late but before filing ITR, deduction is allowed in the year of payment.
If the recipient has declared the income and paid taxes, the payer may not be penalized under Section 201(1) proviso.

2. Section 40(b): Restrictions on Partner Remuneration & Interest

This section limits deductions for partner remuneration and interest in partnership firms.

Key Restrictions:

PAYMENT TYPE	CONDITIONS FOR DEDUCTION	DISALLOWANCE RULE
Remuneration (Salary, Bonus, Commission)	– Only for working partners (actively involved).

Must be authorized by the partnership deed.
Must relate to the period after the deed’s execution. | Excess over limits disallowed:
First ₹6 lakh book profit: Higher of ₹3 lakh or 90% of book profit.
Balance book profit: 60% of remaining profit.
Loss cases: Max ₹3 lakh allowed. |
| Interest on Capital/Loan| – Must be authorized by the deed.
Rate must not exceed 12% p.a.(simple interest). | Excess interest over 12% disallowed. |

Example Calculation (FY 2025-26):

Book Profit = ₹10 lakh
- First ₹6 lakh: ₹3 lakh (90% of ₹6 lakh = ₹5.4 lakh → higher is ₹5.4 lakh)
- Balance ₹4 lakh: 60% = ₹2.4 lakh
- Total allowed = ₹5.4 + ₹2.4 = ₹7.8 lakh

TDS on Partner Payments (Section 194T):

10% TDSon salary, interest, commission, etc., if aggregate payments exceed ₹20,000/year.

3. Section 40(ba): Disallowance for AOP/BOI Payments to Members

Unlike firms, Associations of Persons (AOPs) or Bodies of Individuals (BOIs) cannot deduct:

Interest, salary, bonus, commission, or remunerationpaid to members.
Rationale: Prevents profit diversion to members at lower tax rates.

Impact on Consortiums:

If an AOP (e.g., a consortium) pays members for services, the expense is fully disallowed, increasing taxable income.
Suggestion: Firms/LLPs are preferred as they allow deductions under Section 40(b).

Comparison of Disallowances Under Sections 40(a), 40(b), and 40(ba)

SECTION	APPLICABILITY	KEY DISALLOWANCES	EXCEPTIONS
40(a)	All businesses	TDS defaults, payments to non-residents	Deduction allowed if TDS paid later
40(b)	Partnership firms	Excess partner remuneration/interest	Only for working partners
40(ba)	AOPs/BOIs	All payments to members	No exceptions

Key Takeaways

TDS Compliance is Critical: Non-compliance leads to 30%–100% disallowance.
Partnership Firms Have Limits: Remuneration capped at ₹3 lakh + 60% of balance profit.
AOPs/BOIs Face Stricter Rules: No deductions for member payments .
TDS on Partners (Section 194T): Effective from April 2025