Disallowance for non-deduction of TDS on non-resident payments

Disallowance for non-deduction of TDS on non-resident payments is restricted to 30% under DTAA non-discrimination clause

Issue

Whether disallowance under Section 40(a)(i) for payments made to non-residents without TDS should be restricted to 30% (at par with resident payments under Section 40(a)(ia)) pursuant to the Non-Discrimination clause in India-USA and India-China DTAAs read with Section 90.
Whether Section 40(a)(ia) disallowance on interest paid to MSMEDs is sustainable where the assessee had already suo motu disallowed the amount.
Whether an amalgamated company is entitled to claim TDS/TCS credits pertaining to the PANs of amalgamating companies following a merger.

Facts

Foreign Payments (Section 40(a)(i)): For AY 2017-18 and 2018-19, the assessee made payments to non-residents (USA and China) without deducting tax at source (TDS). The Assessing Officer disallowed 100% of these payments under Section 40(a)(i). The assessee invoked the non-discrimination clauses under Article 26(3) of the India-USA DTAA and Article 24(5) of the India-China DTAA to argue that the disallowance should not exceed 30%, which is the threshold applicable to resident payments under Section 40(a)(ia).
MSMED Interest Disallowance (Section 40(a)(ia)): The assessee had already voluntarily (suo motu) disallowed interest payable to MSMEDs while computing taxable income. The Assessing Officer again invoked Section 40(a)(ia) to disallow 30% of the same interest, leading to double disallowance.
Amalgamation TDS/TCS Credit (Section 199/206C): Post-amalgamation, the assessee claimed TDS and TCS credits associated with the PANs of the erstwhile amalgamating companies. These credits were denied in the summary processing/intimation issued under Section 143(1).

Decision

Non-Resident Disallowance Restricted to 30%: By virtue of the non-discrimination provisions in Article 26(3) of the India-USA DTAA and Article 24(5) of the India-China DTAA read with Section 90, disallowance under Section 40(a)(i) for non-deduction of TDS on payments to non-residents must be capped at 30%, putting non-residents at parity with domestic payments [Para 11].
MSMED Double Disallowance Remanded: The issue of double disallowance was remitted to the Assessing Officer to verify whether the assessee had already made a suo motu disallowance, and if so, grant appropriate relief [Para 16].
Amalgamation TDS/TCS Credit Remanded: TDS/TCS credits belonging to amalgamating companies are allowable to the amalgamated entity. The matter was remitted to the Assessing Officer for verification of the records and to grant the credit in accordance with law [Para 21].

Key Takeaways

Parity via DTAA Non-Discrimination Clauses: The non-discrimination clauses in tax treaties (e.g., India-USA, India-China) override higher statutory disallowances under Section 40(a)(i); hence, non-resident payments without TDS cannot face a harsher disallowance (100%) than resident payments (30%).
Protection Against Double Disallowance: Assessing Officers cannot make statutory disallowances under Section 40(a)(ia) on amounts that have already been voluntarily added back by the taxpayer in their tax computation.
TDS/TCS Credits Follow Amalgamation: In cases of corporate restructuring, the surviving amalgamated entity is legally entitled to claim the benefit of tax deducted or collected at source under the erstwhile PANs of the amalgamating entities.

IN THE ITAT DELHI BENCH ‘B’

GE India Industrial (P.) Ltd.

ACIT (OSD)

ANUBHAV SHARMA, Judicial Member
and S. Rifaur Rahman, Accountant Member

IT Appeal Nos. 3019 & 3020 (Delhi) of 2022
[Assessment years 2017-18 and 2018-19]

JULY 31, 2026

Tushar Jarwal, Ms. Sherry Goyal and Sarthak Abral, Advs. for the Appellant. Ms. Pooja Swaroop, CIT DR and Rajesh Kumar Dhanesta, Sr. DR for the Respondent.

ORDER

S. Rifaur Rahman, Accountant Member. – These appeals are filed by the assessee against the order passed by the ld. Commissioner of Income-tax (Appeals)/National Faceless Appeal Centre (NFAC), Delhi [for short ‘ld. CIT (A)] dated 04.11.2022 and 28.10.2022 for the Assessment Years 2017-18 and 2018-19 respectively.

2. Since the issues are common and the appeals are connected, hence the same are heard together and being disposed off by this common order. We take up the assessee’s appeal being ITA No.2019/Del/2022 for AY 2017-18 as lead case.

3. At the time of hearing, Grounds No.1 and 2 are not pressed, hence the same are dismissed as not pressed.

4. Ground No.3 is with regard to disallowance u/s 36(1)(va) of the Income-tax Act, 1961 (for short ‘the Act’) in respect of the delay in deposit of employee’s contribution to PF and ESI amounting to Rs.11,32,606/-. In this regard, ld. AR submitted that for the year under consideration, in certain cases, the assessee had deposited employee’s contribution made to PF/ESI after due date under the respective rules. However, since such payment was made before the due date of filing RoI i.e. November 30, 2017, same was claimed as allowable under section 36(1)(va). He submitted that however, in the impugned intimation, without appreciating the fact that payment was made before the due date of filing the RoI, a disallowance of Rs.11,32,606 was made u/s 36(1)(va) of the Act. He submitted that the issue is covered by the decision of ITAT in R.K. & Company Manpower (P.) Ltd. v. DCIT 218 ITD 517 (Delhi – Trib.)/ITA Nos.6600, 6601 and 6602/Del/2025.

5. On the other hand, ld. DR of the Revenue relied on the orders of the lower authorities.

6. Considered the rival submissions and material placed on record. We observed that this issue is squarely covered in favour of the assessee by the decision of coordinate Bench in the case of R.K. & Company Manpower (P.) Ltd. (supra). The relevant findings of the said decision is reproduced below :-

“6. We have heard the rival submissions and perused the material on record as well as the relevant judicial pronouncements. Admittedly, the additions u/s 143(1) have been made in the Assessment Year prior to the decision of the Hon’ble Apex Court. We are, therefore, of the considered view that the impugned addition was outside the scope of adjustments permissible u/s 143(1) of the Act. Accordingly, respectfully following the decisions of the co-ordinate benches cited hereinbefore, we delete the addition of Rs.2,38,15,146/- u/s 36(1)(va) of the Act. The appeal of the assessee is hereby allowed.”

7. Respectfully following the aforesaid decision, we delete the addition and allow Ground No.3 raised by the assessee.

8. Ground No.4 is with regard to disallowance u/s 40(a)(i) of the Act to the extent of Rs.5,40,04,793/- without appreciating that in view of the non-discrimination clause available under the relevant tax treaties with US and China, the disallowance under section 40(a)(i) of the Act should have been limited to 30% of the payments made to the non-residents.

9. Ld. AR submitted that during the year under consideration, the assessee had made certain payments to non-residents without deduction of tax at source and the same has been also reported under clause 21(b)(i)A of the Tax Audit Report (‘TAR’) obtained for the assessment year under consideration. He submitted that with regard to the transaction undertaken with the US entities, the assessee had restricted the disallowance under section 40(a)(i) of the Act to 30% of the amount on which tax was not deducted at source in light of non-discrimination clause i.e. Article 26(3) of the India USA tax treaty read with section 90 of the Act. He further submitted that similarly, disallowance with respect to the China entities was also reduced to 30% in light of Article 24(5) of the India China tax treaty read with section 90 of the Act. Accordingly, the assessee had disallowed a sum of Rs.2,31,96,350 under section 40(a)(i) of the Act as under :-

S. No.	Particulars	Amount reported in TAR	Amount disallowed in the Income tax return
1	Amount payable to USA residents	1,61,03,236	48,30,971
2	Amount payable to China residents	6,10,46,464	1,83,13,939
3	Amount payable to others	51,440	51,440
	Total	7,72,01,140	2,31,96,350

He submitted that however, in the impugned intimation, without appreciating provisions of the applicable tax treaties, disallowance under section 40(a)(i) of the Act has been increased to 100% from 30% resulting in additional disallowance of Rs.5,40,04,793 which is against the law and principle of judicial discipline and ought to be deleted. He submitted that this issue is squarely covered by the decision of ITAT in ITA No.2492/Del/2024 in the case of LinkedIn Technology Information v. PCIT (Delhi – Trib.).

10. On the other hand, ld. DR of the Revenue relied on the orders of the lower authorities.

11. Considered the rival submissions and material placed on record. We find that the issue is covered by the decision of coordinate Bench in the case of LinkedIn Technology Information (supra) and the relevant findings are reproduced below :-

14. In this context, we do not agree with the contention of Revenue that the scope of non-discrimination article is restricted to differential treatment of expenses incurred towards residents and non-residents and it does not refer to the quantum of expense which can be disallowed. We are of the considered view that Section 40(a)(i), in its present form, is violative of nondiscrimination Article 26(3) of India-USA DTAA as far as quantum of disallowance is concerned. In the relevant assessment year of AY 2018-19, in the instant case, Section 40(a)(i) imposed a stringent condition of 100% disallowance for payments to nonresidents as compared to disallowance of 30% for payments to residents for the same default of not deducting TDS. The substantive law laid down in the decision of the Hon’ble Delhi High Court in Herbalife India P Ltd (supra), which pertained to AY 2001-02, holding that Section 40(a)(i) was discriminatory and violated the non-discrimination article 26(3) of DTAA, as there was no disallowance for similar payments to residents, and negating the Revenue action of disallowance u/s 40(a)(i) for payments Page 10 of 16 ITA No. 2492/DEL/2024 [A.Y 2018-19] LinkedIn Technology Information v. PCIT to non-resident without making TDS, still holds relevance. The hon’ble jurisdictional Delhi High Court in the case of Herbalife India P Ltd (supra) held in favour of the Assessee as under:

46. Section 40 is in the nature of a non-obstante provision and therefore, it overrides the other provisions as contained in Sections 30 to 38 of the Act. This means that the expenditure which is allowable under Sections 30 to 38 of the Act in computing business income would be subject to deductibility condition in Section 40 of the Act. The payment of FTS to HIAI would be allowable in terms of Section 37 (1) of the Act but before such payment can be allowed the condition imposed in Section 40 (a) (i) of the Act regarding deduction of TDS has to be complied with. In other words if no TDS is deducted from the payment of FTS made to HIAI by the Assessee, then in terms of Section 40 (a) (i) of the Act, it will not be allowed as a deduction under Section 37 (1) of the Act for computing the Assessee’s income chargeable under the head ‘profits and gains of business’.

47. Article 26(3) of the DTAA calls for an enquiry into whether the above condition imposed as far as the payment made to HIAI, i.e., payment made to a non-resident, is any different as far as allowability of such payment as a deduction when it is made to a resident.

********************

50. **** As far as payment to a non-resident is concerned, Section 40 (a) (i) of the Act as it stood at the relevant time mandated that if no TDS is deducted at the time of making such payment, it will not be allowed as deduction while computing the taxable profits of the payer. No such consequence was envisaged in terms of Section 40 (a) (i) of the Act as it stood as far as payment to a resident was concerned. This, therefore, attracts the nondiscrimination rule under Article 26 (3) of the DTAA.

**************************

52. Section 40 (a) (i), in providing for disallowance of a payment made to a non-resident if TDS is not deducted, is no doubt meant to be a deterrent in order to compel the resident payer to deduct TDS while making the payment. However, that does not answer the requirement of Article 26 (3) of the DTAA that the payment to both residents and nonresidents should be under the ‘same conditions’ not only as regards deduction of TDS but even as regards the allowability of such payment as deduction. It has to be seen that in those ‘same conditions’ whether the consequences are different for the failure to deduct TDS.

*******************

54. In the first place it requires to be noticed that DTAA is as a result of the negotiations between the countries as to the extent to which special concessional tax provisions can be made notwithstanding that there might be a loss of revenue. In Union of India v. Azadi Bachao Andolan (supra) the Supreme Court noted that treaty negotiations are largely —a bargaining process with each side seeking concessions from the other, the final agreement will often represent a number of compromises, and it may be uncertain as to whether a full and sufficient quid pro quo is obtained by both sides.! The Court acknowledged that developing countries allow ‘treaty shopping’ to encourage capital and technology inflows which developed countries are keen to provide to them. It was further noted that the corresponding loss of tax revenues could be insignificant compared to the other non-tax benefits to the economies of developing countries which need foreign investment. The Court felt that this was a matter best left to the discretion of the executive as it is “dependent upon several economic and political considerations”.

55. Consequently, while deploying the ₌nexus’ test to examine the justification of a classification under a treaty like the DTAA, the line of enquiry cannot possibly be whether the classification has nexus to the object of the ₌statute’ for the purposes of Article 14 of the Constitution of India, but whether the classification brought about by Section 40 (a) (i) of the Act defeats the object of the DTAA.

56. The argument of the Revenue also overlooks the fact that the condition under which deductibility is disallowed in respect of payments to non-residents, is plainly different from that when made to a resident. Under Section 40 (a) (i), as it then stood, the allowability of the deduction of the payment to a non-resident mandatorily required deduction of TDS at the time of payment. On the other hand, payments to residents were neither subject to the condition of deduction of TDS nor, naturally, to the further consequence of disallowance of the payment as deduction. The expression ‘under the same conditions’ in Article 26 (3) of the DTAA clarifies the nature of the receipt and conditions of its deductibility. It is relatable not merely to the compliance requirement of deduction of TDS. The lack of parity in the allowing of the payment as deduction is what brings about the discrimination. The tested party is another resident Indian who transacts with a resident making payment and does not deduct TDS and therefore in whose case there would be no disallowance of the payment as deduction because TDS was not deducted. Therefore, the consequence of non-deduction of TDS when the payment is to a nonresident has an adverse consequence to the payer. Since it is mandatory in terms of Section 40 (a) (i) for the payer to deduct TDS from the payment to the non-resident, the latter receives the payment net of TDS. The object of Article 26 (3) DTAA was to ensure non-discrimination in the condition of deductibility of the payment in the hands of the payer where the payee is either a resident or a non-resident. That object would get defeated as a result of the discrimination brought about qua non-resident by requiring the TDS to be deducted while making payment of FTS in terms of Section 40 (a) (i) of the Act.

57. A plain reading of Section 90 (2) of the Act, makes it clear that the provisions of the DTAA would prevail over the Act unless the Act is more beneficial to the Assessee. Therefore, except to the extent a provision of the Act is more beneficial to the Assessee, the DTAA will override the Act. This irrespective of whether the Act contains a provision that corresponds to the treaty provision. In Union of India v. Azadi Bachao Andolan (supra) the Supreme Court took note of the Circular No. 333 dated 2nd April 1982 issued by the CBDT on the question as to what the assessing officers would have to do when they find that the provision of a DTAA treaty is not in conformity with the Act.: —

Thus, where a Double Taxation Avoidance Agreement provided for a particular mode of computation of income, the same should be followed, irrespective of the provision of the Income Tax Act. Where there is no specific provision in the Agreement, it is the basic law, i.e., Income Tax Act, that will govern the taxation of income.”

61. In light of the above discussion, question (b) is answered in the affirmative, i.e., in favour of the Assessee and against the Revenue by holding that Section 40(a)(i) of the Act is discriminatory and therefore, not applicable in terms of Article 26 (3) of the Indo-US DTAA.

15. Though for AY 2018-19, the provision of law provides for disallowance of payments of FTS made to non-resident as well as resident, to that extent section 40(a)(i) is no longer discriminatory. In view of the hon’ble Delhi High Court in the Herbalife (supra) as above however, the application of disallowance @100% u/s 40(a)(i) is held as discriminatory in so far as quantum of disallowance is concerned. The quantum of disallowance for resident is restricted to 30% u/s 40(a)(ia), and therefore to meet the requirement of discriminatory clause of Article 26(3) of DTAA, the disallowance for payment made to non-resident, without deducting TDS, should as well be restricted to 30% u/s 40(a)(i) of the Act. We have seen that the AO has made a disallowance @ 30% of remittance which is similar to the rate of disallowance @30% under the non-discriminatory clause of Article 26(3) of the DTAA, therefore there is no occasion to say that the revenue is prejudiced as far as quantum of disallowance is concerned. We are therefore of the considered view that the second condition of action of the AO, being prejudicial to the interest of the Revenue, is not satisfied. Since both the ingredients of provisions of section 263 of the Act i.e., the order of the AO being erroneous and prejudicial to the interest of the Revenue, is not satisfied, the assumption of jurisdiction by the PCIT u/s 263 cannot be held as valid under the law. We accordingly quash the order of PCIT u/s 263 as being invalid in law. The ground 2.2 and 2.4 of the assessee is accordingly allowed.”

12. Respectfully following the aforesaid decision of the ITAT, we allow ground no.4 raised by the assessee and delete the addition.

13. Ground No.5 is with regard to double disallowance of Rs.84,43,146/-under section 40(a)(ia) of the Act.

14. Ld. AR submitted that in the clause 21(ii)(A) of the TAR for the captioned assessment year, a sum of Rs.5,13,99,933 was reported as expense on which tax was not deducted at source and the same was not allowable in view of provisions of section 40(a)(ia) of the Act. He submitted that out of the said amount, Rs.2,81,43,821 pertains to interest payable to medium small and micro enterprises (‘MSMEDs’). He submitted that as the same was otherwise not allowable under the Act, the assessee disallowed the same under specific clause 19 of schedule BP of the Form ITR 6. He further submitted that however, in the impugned intimation, without appreciating the fact that 100% of the amount is already disallowed by the assessee as interest payable to MSMEDs, 30% of the said amount i.e. Rs.84,43,146/- is again disallowed under section 40(a)(ia) of the Act. He, therefore, submitted that the aforesaid adjustment in the impugned intimation results in double disallowance of the same amount and accordingly ought to be deleted.

15. On the other hand, ld. DR of the Revenue relied on the orders of the lower authorities.

16. Considered the rival submissions and material placed on record. We observed from the submissions of the assessee that they have suo moto disallowed the non-deduction of TDS on the interest payable to the MSMED to the extent of Rs.281,43,821/- and the AO had disallowed 30% of the same while disallowing the overall disallowance of non-deduction of TDS. It was submitted that this amounts to double disallowance. The claim of the assessee seems to be genuine, we are inclined to remit this issue back to the file of AO to verify the claim of the assessee and allow the same after due verification as per law. In the result, the relevant ground raised by the assessee is allowed for statistical purposes.

17. Ground No.6 is with regard to short credit of TDS and TCS amounting to Rs.4,36,05,380/- and Rs.24,261/-.

18. Ld. AR of the assessee submitted that with effect from April 01, 2016, GE India Technology Centre Private Limited (PAN AABCG0559J) and GE India Exports Private Limited (PAN AABCG1257B) were merged with the assessee. He submitted that for the year under consideration, certain parties have deducted or collected tax at source on the erstwhile PANs of the merged companies. He further submitted that accordingly, at the time of filing the RoI for the subject year, since the merged companies ceased to exist and corresponding income was also offered by the Appellant in its RoI, it has also claimed TDS and TCS credit pertaining to PANs of the merged entities. He further submitted that detail of TDS and TCS claimed in the RoI is tabulated below for reference:-

Particulars	Appellant -AAACG4901D	GEIEPL -AABCG1257B	GEITC -AABCG0559J	Total
TDS	42,89,53,255	1,75,66,483	2,60,24,141	47,25,43,878
TCS	72,465	23,811		96,276
Total	42,90,25,720	1,75,90,294	2,60,24,141	47,26,40,154

19. He submitted that, however, in the impugned intimation, without appreciating the fact that TDS and TCS credit available on PANs of merged entities also pertained to the assessee and TDS credit of Rs.4,36,05,380 and TCS credit of Rs.24,261 is denied to the assessee. He further submitted that the aforesaid TDS and TCS credit are erroneously disallowed and accordingly, requested to quash the adjustments in the impugned intimation in this regard.

20. On the other hand, ld. DR of the Revenue relied on the orders of the lower authorities.

21. Considered the rival submissions and material placed on record. We observed that the GE India Technology Centre Private Limited (PAN AABCG0559J) and GE India Exports Private Limited (PAN AABCG1257B) were merged with the assessee. The respective companies had TDS credits in their respective PAN, the same needs to allowed to the assessee to claim. Since the same was not granted to the assessee, we are inclined to remit this issue back to the file of AO to verify the claim of the assessee and allow the same after due verification as per law. In the result, ground raised by the assessee is allowed for statistical purposes.

22. In the result, the appeal filed by the assessee for AY 2017-18 is partly allowed as indicated above.

23. Since the facts in AY 2018-19 are exactly similar to AY 2017-18, our above findings in AY 2017-18 are applicable mutatis mutandis in Assessment Year 2018-19. Accordingly, the appeal filed by the assessee for AY 2018-19 ispartly allowed as indicated above.

24. In AY 2018-19, assessee has also raised the issue with regard to short grant interest u/s 244A of the Act amounting to Rs.44,40,258/-.

25. Ld. AR of the assessee submitted that in the tax return filed by the assessee, it had claimed a refund of Rs.41,70,40,780/-, however, on account of the adjustments made to the returned income and the denial of credit of TDS, the tax refund has reduced to Rs.38,00,38,629/- and accordingly, there has been a short grant of interest u/s 244A of the Act.

26. On the other hand, ld. DR relied on the orders of the lower authorities and submitted that this issue is consequential in nature and has to be sent back to the Assessing Officer for calculation.

27. After hearing both the parties, we are of the considered view that this issue is consequential and has to be sent back to the AO for calculation. Accordingly, we do so and remit this issue to the AO to redo the calculation as per law after giving proper opportunity of being heard to the assessee. This ground is allowed for statistical purposes.

28. To sum up : both the appeals filed by the assessee are partly allowed.