Section 40 — Specific Disallowances

STATUTORY ARCHITECTURE — 18-ROW MAP

HISTORICAL CONTEXT

Section 40 operates as the negative anchor to section 30-38 deductions. Two primary categories: (a) Section 40(a) — TDS-default disallowance; (b) Section 40(b) — Firm-level partner remuneration limits. Section 40(a)(i) — NR payment without TDS → 100% disallowance. Section 40(a)(ia) — resident payment without TDS → 30% disallowance.

Section 40(b) firm-level limits: (a) Salary / remuneration to non-working partner — fully disallowed; (b) Working partner remuneration / interest — must be (i) authorised by deed; (ii) within specified limits. The limits (post FA 2024 revised): On book profit, FIRST Rs 3 L: 90% (or Rs 1.5 L higher); BEYOND Rs 3 L: 60%.

Practitioner significance — comprehensive TDS-vigilance + partnership structuring. Section 40(a)(ia) — 30% disallowance is less punitive than full disallowance under earlier framework. Hindustan Coca-Cola defence — if payee paid tax, principal demand may not survive. Section 40(b) — partnership-deed framework + book-profit computation discipline.

The transition to the Income-tax Act, 2025 preserves the PGBP framework.

FINANCE ACT AMENDMENT TIMELINE

■ FA 1962 — Section 40 came into force.

■ FA 1992 — Section 40(b) partnership framework refined.

■ FA 2004 — Section 40(a)(ia) inserted; non-TDS resident disallowance.

■ FA 2014 — Section 40(a)(ia) reduced from 100% to 30%.

■ FA 2024 — Section 40(b) limits revised + s. 194T introduced.

■ FA 2025 — Cosmetic refinements.

■ Income-tax Act, 2025 — Section 40 successor, operative 1-4-2026.

JUDICIAL EVOLUTION — VERIFIED LANDMARK AUTHORITIES

▸ Commissioner of Income-tax v. Vatika Township Pvt. Ltd. (2014) 367 ITR 466 ; (2015) 1 SCC 1 (Supreme Court — 5-Judge Constitution Bench)

Facts. The Department sought to apply a surcharge provision retrospectively to block-period assessments. The assessee contended that the amendment was substantive and could not have retrospective operation absent express legislative direction.

Issue. Whether amendments to taxing statutes operate prospectively unless the legislature has expressly or by necessary implication conferred retrospective effect.

HELD. The Constitution Bench reaffirmed the general rule against retrospectivity of taxing statutes. A taxing provision must be construed prospectively unless the language compels otherwise; mere insertion or substitution by amendment is not sufficient to deny vested rights.

“Of the various rules guiding how a legislation has to be interpreted, one established rule is that unless a contrary intention appears, a legislation is presumed not to be intended to have a retrospective operation.”

Relevance. Anchor authority for any argument that an amendment to a charging or computational provision must apply only from the AY notified — useful in transitional disputes around FA 2025 and the 1961 → 2025 changeover.

▸ Hindustan Coca-Cola Beverage (P) Ltd. v. Commissioner of Income-tax (2007) 293 ITR 226 ; (2007) 8 SCC 463 (Supreme Court)

Facts. The assessee made payments without deducting tax under section 194-I; the recipient had however paid tax on the receipts. The Department demanded recovery from the assessee-deductor under section 201(1).

Issue. Whether section 201(1) recovery may proceed against a deductor where the recipient has already discharged tax on the same receipts, i.e., whether the Revenue can recover tax twice.

HELD. Once the recipient has paid tax on the income, the Revenue cannot recover the same tax over again from the deductor under section 201(1). Interest under section 201(1A) and penalty under section 271C survive, but the principal tax cannot be recovered twice.

“Once it is shown that the deductee has paid tax, the demand under section 201(1) cannot survive… To accept the Revenue's stand would mean that the deductor would be paying the same tax twice.”

Relevance. Anchor against 'double recovery' in TDS default cases — universally applied across section 201 demands when recipient's tax payment can be demonstrated; supported by section 191 read with section 201(1) proviso.

▸ GE India Technology Centre (P) Ltd. v. Commissioner of Income-tax (2010) 327 ITR 456 ; (2010) 10 SCC 29 (Supreme Court)

Facts. The assessee made payments to non-residents and contended that section 195 obliged deduction only if the payment was chargeable to tax in India; the Department argued that section 195 required deduction on all payments subject only to subsequent refund.

Issue. Whether section 195 mandates withholding on every payment to a non-resident or only on those payments which are chargeable to tax under the Act in the hands of the recipient.

HELD. Section 195 obliges deduction only where the sum is chargeable to tax in India in the hands of the non-resident recipient. The payer is entitled to form a bona-fide view on chargeability; if not chargeable, no withholding is required. The recipient's exemption / treaty relief is to be considered.

“The expression 'chargeable under the provisions of this Act' in section 195(1) shows that the remittance has got to be of a trading receipt, the whole or part of which is liable to tax in India. The payer is bound to deduct tax at source only if the tax is assessable in India.”

Relevance. Foundational on the scope of section 195 — anchors arguments around withholding on cross-border payments, software royalties, FTS, and treaty exempt receipts; followed in Engineering Analysis.

▸ Engineering Analysis Centre of Excellence (P) Ltd. v. Commissioner of Income-tax (2021) 432 ITR 471 ; (2022) 3 SCC 321 (Supreme Court — 3-Judge Bench)

Facts. Indian end-users imported shrink-wrap / off-the-shelf software. The Department characterised the payments as 'royalty' attracting section 195 withholding; the assessees contended that what was sold was a copyrighted article, not the copyright itself, hence no royalty.

Issue. Whether payments for off-the-shelf software amount to royalty under DTAA (Article 12) and trigger section 195 withholding.

HELD. The amounts paid by resident Indian end-users / distributors to non-resident software manufacturers / suppliers for the use of computer software are not payments of royalty for the use of copyright. No section 195 obligation arises; section 9(1)(vi) read with DTAA Article 12 governs.

“Once a DTAA applies, the provisions of the Act can only apply to the extent that they are more beneficial to the assessee… The amounts paid by resident end-users are not the consideration for the use of or the right to use copyright.”

Relevance. Definitive authority on cross-border software royalty — eliminates section 195 obligation on most B2B software import payments; broad implications for licensing, SaaS, cloud-services characterisation.

▸ K.P. Varghese v. Income-tax Officer, Ernakulam (1981) 131 ITR 597 ; (1981) 4 SCC 173 (Supreme Court — 3-Judge Bench)

Facts. Section 52(2) (since deleted) deemed sale consideration to be FMV where FMV exceeded the declared consideration by 15%. The Department applied it on a literal reading even when the assessee had not in fact received more than the declared price.

Issue. Whether a deeming provision in a charging schema can be construed literally where its plain reading produces a result manifestly contrary to legislative object.

HELD. The Court read down section 52(2) to apply only where the assessee had actually received consideration in excess of the declared sum. A literal construction yielding absurd or unjust results must yield to an object-based interpretation; the CBDT's contemporaneous Circular No. 96 was held binding on the Revenue.

“It is well settled that a literal construction of a statutory provision ought not to be adopted if it produces a manifestly unjust result… Where a literal construction creates an anomaly, the courts will adopt that construction which avoids the anomaly.”

Relevance. Anchor authority for purposive construction of deeming fictions across the 1961 Act — applies wherever a deeming clause (e.g., s. 50C, s. 56(2)(x), s. 2(22)(e)) yields a result contrary to legislative purpose.

CBDT CIRCULARS — ECOSYSTEM

▸ CBDT Circular No. 14(XL-35) of 1955 dated 11 April 1955

Subject. Duty of officers to assist assessees in claiming and securing relief

Substance. Foundational circular directing that the AO should not exploit assessee ignorance to deny legitimate reliefs; officer is required to draw attention to refunds or reliefs to which the assessee is entitled. The circular has been judicially noted in several appellate decisions and remains operative for first-appellate practice.

▸ CBDT Circular No. 549 dated 31 October 1989

Subject. Explanatory notes — Finance Act 1989 amendments (incl. PY unification)

Substance. Explained the FA 1987 / FA 1989 amendments unifying the previous year with the financial year preceding the AY, including transitional provisions for assessees with different accounting years. Useful in any controversy on the timing of accrual / chargeability for early post-1989 AYs.

▸ CBDT Circular No. 5 of 2014 dated 11 February 2014

Subject. Section 14A — dis-allowance even where no exempt income earned (since modulated)

Substance. Initially directed AOs to apply Rule 8D disallowance under section 14A even where no exempt income was earned in the year; subsequently modulated by Cheminvest (Del HC) and Maxopp (SC). FA 2022 amendment to section 14A re-asserted the position but remains under litigation.

▸ CBDT Circular No. 6 of 2019 dated 20 March 2019

Subject. Withdrawal of low-tax-effect appeals — monetary thresholds

Substance. Revised monetary thresholds for departmental appeals — ITAT (Rs 50L), HC (Rs 1 Cr), SC (Rs 2 Cr); subsequently further revised. Operates as a non-statutory limitation on the Revenue's appellate engagement, binding under section 119.

▸ CBDT Circular No. 5 of 2024 dated 15 March 2024

Subject. Procedure for transitional reassessment notices post-Ashish Agarwal / Rajeev Bansal

Substance. Procedural guidance for AOs handling transitional reassessment notices for AYs 2013-14 to 2017-18 affected by Ashish Agarwal and Rajeev Bansal. Sets out the form of section 148A inquiry, time-bar calculation under TOLA, and JAO/FAO jurisdiction in faceless cases.

WORKED EXAMPLES

PRACTITIONER PLANNING NOTES

■ Books of accounts maintenance under s. 44AA + Rule 6F — comprehensive discipline.

■ Tax audit u/s 44AB — Rs 1 cr turnover (most); Rs 10 cr (digital transactions); Rs 50 L professional gross receipts.

■ Mercantile accounting basis — ICDS-modulated.

■ Section 43B — Actual-payment basis for statutory liabilities / employee PF / specific items.

■ Section 40(a)(i)/(ia) — Non-TDS disallowance (30% resident; 100% NR).

■ Section 40A(3) — Cash > Rs 10,000 disallowance.

■ Section 40A(2) — Excessive payment to specified persons.

■ Section 32 depreciation — block of assets; 50% rate for assets used < 180 days.

■ Section 44AD / 44ADA / 44AE — Presumptive frameworks (small businesses / professionals / transport).

■ Section 80-IA / 80-IB / 80-IAC interaction.

■ Form 3CD comprehensive disclosure — 41 items; CA tax audit.

■ ICDS compliance — 10 standards; reconciliation with books.

■ Section 14A — Disallowance for exempt-income expenditure (Maxopp).

■ Documentation 7 years (regular); 17 years (foreign-asset BMA-safe).

■ Annual practitioner update — FA framework changes.

LITIGATION DEFENCE

■ Strict construction — Mathuram Agrawal anchor.

■ Object-based — K.P. Varghese.

■ Vatika Township — prospective amendment.

■ BC Srinivasa Setty — charge/computation failure.

■ Excel Industries accrual — for accrual disputes.

■ Maxopp Investment — section 14A apportionment.

■ Reliance Petroproducts — bona-fide claim not concealment.

■ Hindustan Coca-Cola — no double recovery for TDS defaults.

■ GE India — s. 195 chargeability.

■ Engineering Analysis — software royalty / FTS treaty.

■ Calcutta Discount — Article 226 jurisdiction.

■ Section 273B reasonable-cause defence for procedural lapses.

■ Wholly-and-exclusively defence (s. 37) — preserve commercial purpose.

■ Capital vs revenue — preserve characterisation arguments.

■ Beneficial circulars — UCO Bank anchor (s. 119).

■ Section 270A bona-fide claim defence.

PROCEDURE

Step 1. Verify business/profession status

Per s. 2(13)/(36).

Step 2. Maintain books u/s 44AA + Rule 6F

Comprehensive.

Step 3. Audit u/s 44AB if threshold breached

Form 3CA/3CB/3CD.

Step 4. Apply ICDS compliance

10 standards reconciled.

Step 5. Compute PGBP head income

Section 28-44 framework.

Step 6. Apply section 32 depreciation

Block-of-assets + 180-day rule.

Step 7. Apply section 36 specific deductions

Interest / bad debts / etc.

Step 8. Apply section 37 general residual

Wholly + exclusively + revenue.

Step 9. Apply section 40 disallowances

TDS / payments compliance.

Step 10. Apply section 40A excessive / cash

Specified persons + Rs 10K limit.

Step 11. Apply section 43B actual-payment

PF / GST / interest / etc.

Step 12. Section 44AD / 44ADA / 44AE presumptive (where applicable)

Simplified framework.

Step 13. ITR Schedule BP + Form 3CD

Comprehensive disclosure.

Step 14. Section 14A apportionment (if exempt income)

Maxopp framework.

Step 15. Documentation 7-17 years

Books / audit / vouchers.

CROSS-REFERENCES

▸ Section 2(13) — Business.

▸ Section 2(36) — Profession.

▸ Section 4 — Charge.

▸ Section 14 — Heads (PGBP).

▸ Section 28-44 — PGBP framework.

▸ Section 14A — Disallowance exempt.

▸ Section 80-IA / 80-IAC / 80JJAA — Deductions.

▸ Section 115BAA / 115BAB — Concessional company rates.

▸ Section 115BAC — Individual / HUF new regime.

▸ Section 119 — CBDT binding.

▸ Section 139 — Return.

▸ Section 143 — Assessment.

▸ Section 195 — NR TDS framework.

▸ Section 270A — Penalty.

▸ Section 271B — Audit default penalty.

▸ Section 273B — Reasonable cause.

▸ Section 276C — Prosecution.

▸ Rule 5 / 5A / 6F — Operative rules.

▸ Form 3CA / 3CB / 3CD — Audit reports.

▸ ICDS — 10 standards.

▸ Companies Act, 2013 — Schedule III.

▸ Income-tax Act, 2025 — Successor, operative 1-4-2026.

▸ Income-tax Act, 2025 — Section 536 (saving).

▸ Section 28(v) — Partner PGBP.

▸ Section 194T — Partner TDS.

▸ Section 195 — NR TDS.

▸ Section 201 — TDS default.

▸ Section 271C — TDS penalty.

▸ Hindustan Coca-Cola (SC 2007).