Section 194Q TDS and the Section 40(a)(ia) Disallowance: When Late Deduction Costs You Thirty Per Cent

A trading or manufacturing business that buys goods in volume can discover, years later, that a missed deduction of a few thousand rupees has cost it lakhs. The reason is the link between section 194Q TDS, the buyer’s duty to deduct tax on purchases, and the section 40(a)(ia) disallowance, which removes thirty per cent of the purchase expense from the buyer’s deductible costs if the tax was not deducted or not deposited in time. This article explains how the two provisions fit together, the routes back from a disallowance, and the points the courts have not yet settled. It sits in our income-tax appeals series.

What Section 194Q Requires of a Buyer

Section 194Q was inserted by the Finance Act 2021 with effect from 1 July 2021. Its first sub-section requires a buyer who is responsible for paying any sum to a resident for the purchase of goods, where the value or aggregate value exceeds fifty lakh rupees in a previous year, to deduct 0.1 per cent of the sum exceeding fifty lakh rupees. A “buyer” is a person whose total sales, gross receipts or turnover from business exceeded ten crore rupees in the financial year immediately before the year of purchase, other than persons the Central Government notifies. The deduction is made at the time the sum is credited to the seller’s account or paid, whichever is earlier. Where the seller does not furnish a Permanent Account Number, the rate is five per cent.

The Central Board of Direct Taxes explained the section in Circular 13 of 2021 (30 June 2021). Three of its answers matter most in disputes. First, where GST is shown separately in the invoice or contract when the amount is credited, tax is deducted on the amount excluding GST; if deduction happens only at payment, with no prior credit, the GST component cannot be identified and tax runs on the whole amount. Second, the section applies to advance payments, because payment is itself a trigger. Third, where a transaction falls under both section 194Q and the seller’s tax-collection duty under section 206C(1H), section 194Q prevails and the seller does not collect. Sub-section (5) of section 194Q is drafted in the same sense.

The overlap has since mostly fallen away. We understand that the Finance Act 2025 withdrew the seller’s collection duty under section 206C(1H) from 1 April 2025, leaving section 194Q as the only turnover-based tax on goods transactions from financial year 2025-26. For the years 2021-22 to 2024-25, which are the years now being assessed and appealed, the overlap rule still matters.

How the Thirty Per Cent Disallowance Works

Section 40(a)(ia) of the 1961 Act disallows, in computing business profits, thirty per cent of any sum payable to a resident on which tax is deductible at source under Chapter XVII-B and such tax has not been deducted or, after deduction, has not been paid on or before the due date for filing the return under section 139(1). Section 194Q sits in Chapter XVII-B. On its words, therefore, a purchase on which section 194Q tax was due and not deducted is a sum within section 40(a)(ia).

Two features make the provision punishing. The thirty per cent is computed on the sum payable, which is the purchase value, not on the 0.1 per cent tax that should have been deducted. A hypothetical makes the scale clear. A buyer purchases Rs 2 crore of goods from one seller in a year and deducts nothing. The tax it should have deducted was 0.1 per cent of Rs 1.5 crore, or Rs 15,000. The disallowance is thirty per cent of Rs 2 crore, or Rs 60 lakh, which at a corporate rate in the region of 25 per cent adds roughly Rs 15 lakh of tax, plus interest. The second feature is that the Supreme Court has refused to soften it by reading it narrowly. In Palam Gas Service v. CIT (Supreme Court, 3 May 2017) the Court held that section 40(a)(ia) reaches not only amounts still payable at year-end but also amounts already paid during the year. In Shree Choudhary Transport Co. v. ITO (Civil Appeal No. 7865 of 2009, 29 July 2020; (2020) 426 ITR 289) the Court upheld a full disallowance for assessment year 2005-06 and held that the Finance Act 2014 reduction of the disallowance from a hundred to thirty per cent operates only from assessment year 2015-16. For the years in which section 194Q applies, thirty per cent is therefore the rate.

Relief from Section 194Q TDS Disallowance: The Two Provisos to Section 40(a)(ia)

First Proviso: Deposit-Timing Relief

If tax is deducted in a later year, or is deducted in the year but deposited after the section 139(1) due date, the first proviso allows the thirty per cent as a deduction in the year in which the tax is actually paid. The effect is to shift the cost between years, not to remove it, which still helps a buyer whose profits are higher in the later year. A deposit made on or before the due date for the return avoids the disallowance entirely.

Second Proviso: Where the Seller has Already Paid the Tax

The second proviso, inserted by the Finance Act 2012, provides that where the buyer has failed to deduct tax but the resident payee has furnished a return, taken the sum into account in computing income and paid the tax due, and the buyer obtains the accountant’s certificate in Form 26A (Rule 31ACB), the buyer is deemed to have deducted and paid the tax on the date the seller furnished the return. The related first proviso to section 201(1) protects the buyer from being treated as an assessee in default. The courts have treated the provision as remedial. The Delhi High Court in CIT v. Ansal Land Mark Township (P) Ltd (ITA 160 and 161 of 2015, 26 August 2015) held the second proviso declaratory and curative and retrospective from 1 April 2005, reasoning that where the seller has paid tax on the same receipt there is no loss to the revenue. In CIT v. Calcutta Export Co. (Supreme Court, 24 April 2018) the Court treated the earlier Finance Act 2010 amendment, allowing deposit up to the return due date, as curative. The related principle in Hindustan Coca-Cola Beverage (P) Ltd v. CIT ((2007) 293 ITR 226 (SC)) is that no demand under section 201 can be raised against a payer where the payee has paid the tax. That decision concerns recovery of the tax, not the computation under section 40(a)(ia), which is a separate provision.

The practical lesson is that the second proviso is a documents exercise. The buyer needs the seller’s return particulars and proof of tax paid, an accountant’s certificate in Form 26A, and, ideally, the seller’s confirmation, assembled before the appellate stage. Failure to produce them is the commonest reason relief is refused.

What is Still Unsettled

Three important questions concerning Section 194Q TDS and disallowance under Section 40(a)(ia) remain open. First, whether section 40(a)(ia) applies to section 194Q purchases. The text says yes, and but we found no ruling of a High Court or the Supreme Court deciding the point. The scope of the provision offers a narrower argument: items that are not “goods”, or not a “purchase” from a resident, fall outside both provisions.

Second, the base. The thirty per cent is applied to the “sum payable”, which on the plain words is the whole purchase value. A buyer might argue that tax was “deductible” only on the part above Rs 50 lakh, so that the disallowance should be limited to that part. We found no decision on this. It is a respectable argument, but an untested one.

Third, the effect of deducting under the wrong section. A buyer that deducted tax, but under a head other than section 194Q, may argue that the purpose of the provision is met; we have not verified any decision applying that argument to section 194Q, and it should be treated as untested.

Balance: What Cuts for and Against the Buyer

For the buyer: the second proviso gives a complete answer where the seller is compliant; the first proviso converts a permanent disallowance into a timing difference where the tax is deposited late; the Delhi High Court’s reading of the second proviso as retrospective protects older years; and the scope of section 194Q is limited to goods bought from residents.

For the Revenue: the section’s words are wide; the Supreme Court has refused to read down the disallowance in Palam Gas and Shree Choudhary Transport; the thirty per cent is levied on the whole sum, not on the tax missed; an advance payment above the threshold is itself a default point; and the burden of establishing the seller’s compliance lies on the buyer. Interest on the late or short deduction under section 201(1A) is a separate exposure.

Which Act Applies from Here On?

The Income-tax Act 2025 has been in force since 1 April 2026. Under its savings clause (section 536(2)(c)), proceedings, including appeals, relating to a tax year beginning before 1 April 2026 continue under the 1961 Act. The disallowance and the deduction duty for the years now in dispute therefore remain governed by sections 40(a)(ia) and 194Q of the 1961 Act. The 2025 Act re-enacts both in its own numbering, but we have not confirmed the section numbers against the official text, and readers working on tax years from 2026-27 should check them directly. Our article on the transition for ITAT appeals explains the tax-year test.

Frequently Asked Questions

When must a buyer deduct TDS under section 194Q?

When a buyer whose turnover exceeded Rs 10 crore in the preceding financial year pays or credits a resident seller for goods, and the purchases from that seller in the year exceed Rs 50 lakh. Tax at 0.1 per cent is deducted on the amount above Rs 50 lakh, at the time of credit or payment, whichever is earlier.

How much is disallowed under section 40(a)(ia) if I miss the deduction?

Thirty per cent of the sum payable to the resident on which tax was deductible. The disallowance is computed on the sum payable, not on the tax that should have been deducted. For assessment years from 2015-16 the rate is thirty per cent; the Supreme Court has held the reduction from a hundred per cent is prospective.

Can I avoid the disallowance if the seller has already paid tax on the income?

Yes, in principle. The second proviso to section 40(a)(ia) treats the buyer as having deducted and paid the tax where the seller has filed a return, included the sum in income and paid the tax due, and the buyer obtains the accountant’s certificate in Form 26A. The Delhi High Court has held this proviso curative and retrospective.

What if I deducted the tax but deposited it late?

The first proviso allows the thirty per cent as a deduction in the year in which the tax is actually paid, if tax was deducted late or deposited after the due date for filing the return. The relief is one of timing, not a permanent saving, but a deposit made by the due date under section 139(1) avoids the disallowance altogether.

Is GST included when working out section 194Q tax?

Not if it is shown separately in the invoice or contract when the amount is credited. CBDT Circular 13 of 2021 says tax is then deducted on the amount excluding GST. If deduction happens only at the stage of payment, with no earlier credit, the GST component cannot be separated and tax is deducted on the whole amount.

Sources

• Income-tax Act, 1961, section 194Q (inserted by the Finance Act 2021, w.e.f. 1 July 2021) — Income Tax Department.
• CBDT Circular No. 13 of 2021, 30 June 2021 (F. No. 370142/26/2021-TPL), clarifications on sections 194-O, 194Q and 206C(1H) — incometaxindia.gov.in.
• Income-tax Act, 1961, section 40(a)(ia) and provisos; section 201(1) and first proviso; Rule 31ACB of the Income-tax Rules, 1962 — India Code.
• Palam Gas Service v. CIT, Supreme Court of India, 3 May 2017 — report.
• Shree Choudhary Transport Co. v. ITO, Civil Appeal No. 7865 of 2009, Supreme Court of India, 29 July 2020; (2020) 426 ITR 289 — report.
• CIT v. Ansal Land Mark Township (P) Ltd, ITA 160 and 161 of 2015, Delhi High Court, 26 August 2015 — judgment.
• CIT v. Calcutta Export Co., Supreme Court of India, 24 April 2018 — report.
• Hindustan Coca-Cola Beverage (P) Ltd v. CIT, (2007) 293 ITR 226 (Supreme Court of India).
• Income-tax Act, 2025, section 536(2)(c) (savings) — CBDT transition FAQs.