Section 40A of the Income Tax Act: Tax Deductions For Companies & Firms
Profits and gains earned by companies, partnership firms, and LLPs (Limited Liability Partnerships) in India are subject to income tax. The Income Tax Act, 1961 allows businesses to claim certain deductions from their income. However, these deductions are applicable only for specific expenses.
Section 40A of the Income Tax Act states the cases where you cannot claim deductions on certain business expenses. Read along to know what is restricted by this Section.
Provisions of Section 40A of the Income Tax Act
Section 40A lists out the various amounts that cannot be deducted from your taxable income under the head ‘profits and gains from business or profession’. The terms of this Section would apply to all taxpayers, regardless of the provisions of Section 30 to Section 38. The incomes not allowed as deductions are as follows:
- Interest, royalty or fees for technical services earned outside India
- Salaries paid to employees outside India
- Any amount paid to a state government by a state undertaking
- Amount paid for fringe benefit tax
- Any taxes levied on profits from business/profession
- Sum paid towards wealth tax
The following sections will discuss the provisions of all the subsections of Section 40 of the Income Tax Act.
Section 40A(i) of the IT Act
It states that you cannot claim deductions on any fees, interest or royalty for technical services paid outside India or to a non-resident. This rule is applicable on technical service fees where TDS (Tax Deducted at Source) has not been deducted or not paid before the due date.
In case the TDS sum was already deducted in the subsequent year or paid after the due date, it will be allowed as a deduction for the previous year. In case the assessee has failed to deduct the TDS but has not defaulted under Section 201(1), the authority will assume that he/she has deducted and paid TDS.
Section 40A(i)(a), Section 40A(i)(b) and Section 40A(i)(c)
Section 40A(i)(a) does not allow you to claim deductions on 30% of any sum that you have paid to an Indian resident where TDS has not been deducted. In case you have deducted the TDS in any subsequent year or paid after the due date u/s 139, you can claim 30% of such an amount as tax deductions.
The next subsection, Section 40A(i)(b), stipulates the cases in which you cannot claim deductions on considerations paid to a non-resident when Equalisation Levy is applicable. The Equalisation Levy is a direct tax on payments made to non-resident service providers. It is applicable if you make annual payments of over Rs. 1,00,000 to a service provider in a financial year.
Section 40A is applicable if you have not deducted Equalisation Levy for specified services or paid it before the due date u/s 139. However, if you deduct the equalisation levy in a subsequent year or pay it after the due date, you can claim a deduction in the previous year when you paid it.
Section 40A(i)(c) disallows deductions for any sum that you paid as fringe benefits tax (FBT). FBT was a tax on benefits that some employers offered to their employees in addition to other compensation.
Section 40A(ii) of the Income Tax Act
Under this subsection, you cannot claim a deduction for the amount paid as taxes on profits earned from a business or a profession or assessed on a certain percentage of such profits. Non-deductible taxes u/s 40A(ii) include the following:
- Income tax in India
- Interest of income tax
- Income tax on agriculture
- Income tax in foreign countries
Section 40A(ii) of the Income Tax Act also disallows deductions on any amount paid outside the country, where tax exemption u/s 90 or deduction u/s 91 are applicable. Furthermore, you cannot claim deductions on taxes where tax benefits u/s 90A are applicable.
Section 40A(ii)(a) and Section 40A(ii)(b)
Under Section 40A(ii)(a), any sum paid towards wealth tax (as defined by the Wealth-tax Act 1957) cannot be claimed as deductions. It is also applicable on taxes of a similar nature in foreign countries and on any tax levied on capital/assets of a business/profession of the taxpayer.
Individuals, HUF (Hindu Undivided Family) and companies with a total net wealth of Rs. 30 lakh had to pay taxes at a 1% rate on excess wealth. The wealth tax was abolished in Union Budget 2015, as it incurred more cost for recovering taxes than the amount recovered. As an alternative, surcharges were hiked for the super-rich segment.
Section 40A(ii)(b) disallows deductions on any amount that a State Government charges from a State Government undertaking. It includes service fees, service charges, license fees, royalty, and other fees/charges.
Undertakings of a State Government referred to in Section 40A are independent statutory bodies separate from the state’s direct control. As a state cannot get income directly from their entities, it instead imposes charges called special levies on them.
Section 40A(iii), Section 40A(iv), and Section 40A(v)
Under Section 40A(iii) of the Income Tax Act, employers cannot claim deductions on expenses for paying salaries to non-residents and foreigners. This is provided that tax has not been deducted under Chapter XVII-B on such salaries.
The next sub-clause states that payments to provident funds or similar funds will not be eligible for deductions unless the employer makes sure to deduct TDS. Section 40A(iv) is applicable on funds under the ‘salaries’ head and on funds created for employees’ benefit.
Under Section 40A(v), employers cannot claim deductions on taxes paid on non-monetary perquisites u/s 10(10CC) for their employees.
Final Word
Section 40A of the Income Tax Act imposes restrictions on income tax deductions for companies and firms. You should check the terms and conditions of such restrictions so that you do not make a mistake when filing your income tax returns.
FAQs on Section 40A of the Income Tax Act
Ans: Section 9(i)(vii) defines the meaning of technical services referred u/s 40A. This includes fees paid for consultancy, managerial or technical services. Payments for construction, mining, assembly or salaries are excluded under this definition.
Ans: The term ‘royalty’ as per Explanation 2 of Section 9(1)(vi) refers to the payments for the following:
Usage of any invention, process, patent, trademark or secret formula
The transfer of any or all rights
Imparting commercial, scientific, industrial or technical knowledge
The right to use any equipment
Transfer of copyright, literary, scientific and artistic work.
Ans: No, sub-clause (ii)(b) of Section 40A disallows deductions for the computation of income taxes from profits and gains of state undertakings.
Before March 1 2014, the state government undertakings could claim deductions on special levies given to the respective governments. This led to disputes with the Income Tax Department for minimising income tax liabilities. As a result, the Finance Act of 2013 introduced the above sub-clause to safeguard the tax base.
Ans: Over the last decade, the IT (Information Technology) sector has exponentially expanded, bringing with it new business models that do not rely on their physical presence. This brought about new difficulties with regard to their taxation and disputes.
Thus, the government introduced a new Equalisation Levy in 2016 to tax the income of foreign e-commerce companies in India. It would impose a tax (6% of gross consideration) for online advertisement and related facilities/services.
Ans: Firms, whether LLPs or other firms, cannot deduct the following expenses from their profits:
Remuneration not authorised by the partnership deed
Payments over Rs. 1,50,000 or 90% of book profit, whichever is higher
Remuneration, bonus, commission or salaries to a non-working partner
Payments not authorised by the partnership deed
Interest payments above 12% p.a. to any party
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This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information, and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.
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