Section 40 of ITA, 1961 : Section 40: Amounts Not Deductible

Explanation using Example

Imagine a company in India, XYZ Pvt Ltd, that has hired a software development firm in the United States, ABC Corp, to provide technical services. XYZ Pvt Ltd is required to pay $100,000 to ABC Corp as fees for these services. According to Indian tax laws, XYZ Pvt Ltd should withhold tax on this payment and remit it to the Indian government before sending the remainder to ABC Corp.

However, XYZ Pvt Ltd fails to deduct this tax at source. As per Section 40(a)(i) of the Income-tax Act, 1961, the $100,000 payment made to ABC Corp cannot be claimed as a business expense by XYZ Pvt Ltd. This means that XYZ Pvt Ltd will have to pay taxes on this $100,000 as if it were income, even though the money was actually spent on services.

Later, if XYZ Pvt Ltd does pay the withheld tax in a subsequent year, they can then claim the $100,000 as a business expense in the year they paid the tax, thus reducing their taxable income for that year by the same amount.