The Income Tax Appellate Tribunal, Mumbai, has clarified a critical principle in income tax computation: disallowance under Section 40(a)(ia) of the Income Tax Act, 1961, applies only to expenditures actually claimed as deductions in the profit and loss account, and not to amounts capitalised in work-in-progress. This ruling resolves long-standing ambiguity for real estate developers and other businesses using project-based accounting.
Background & Facts
The Dispute
The assessee, Orbit Ventures Developers, a partnership firm engaged in real estate redevelopment, filed its return of income for Assessment Year 2018-19 on 31.10.2018, declaring a loss of Rs. 19,13,36,376/-. The case was selected for scrutiny under the E-Assessment Scheme, 2019, with focus on TDS compliance, disallowances under Section 40(a)(ia), and treatment of expenditures in work-in-progress (WIP). The Assessing Officer (AO) proposed disallowances totaling Rs. 1,82,85,535/- and Rs. 3,52,949/- under Section 40(a)(ia) for non-deposit of TDS deducted on various payments.
Key Facts
- The assessee deducted TDS amounting to Rs. 6,08,51,784/- during the year but failed to deposit it before the due date under Section 139(1)
- The tax audit report (Form 3CD) disclosed the default in TDS deposit
- The firm capitalised substantial project-related expenditures to work-in-progress (WIP) in accordance with ICAI Guidance Note on Real Estate Projects
- The accounting policy, submitted to the AO, indicated use of the Percentage Completion Method (PCM) for revenue recognition
- The AO initially disallowed 30% of the unpaid TDS (Rs. 1,82,85,535/-) and an additional Rs. 3,52,949/- for under-disallowed TDS
- Rectification orders under Section 154 were passed on 29.12.2022 and 09.03.2023, modifying the quantum of disallowance and brought forward losses
Procedural History
- 31.10.2018: Return of income filed for A.Y. 2018-19
- 23.09.2019: Notice under Section 143(2) issued
- 16.12.2020, 03.01.2021, 31.03.2021: Notices under Section 142(1) issued
- 08.04.2021: Show cause notice issued proposing disallowance under Section 43B (later corrected to Section 40(a)(ia))
- 19.04.2021: Assessment order passed under Section 143(3) read with Section 144B, assessing loss at Rs. 17,26,97,892/-
- 06.11.2025: Order of Learned CIT(A) passed, setting aside disallowances and directing verification of WIP
- 25.02.2026: AO issued order giving effect to CIT(A)’s directions, accepting 80.75% of expenditure remained in WIP and only 19.25% was claimed in P&L
- 27.04.2026: Hearing before ITAT
- 30.04.2026: Judgment pronounced
The Parties' Positions
For the Revenue (AO and DR): Contended that Section 40(a)(ia) mandates automatic disallowance upon non-deposit of TDS, irrespective of accounting treatment. Argued that Form 3CD disclosures are conclusive and that the CIT(A) erred in restoring the matter for verification. Asserted that the decision in Savala Associates applies only to Completed Contract Method, not PCM.
For the Assessee (AR): Argued that Section 40(a)(ia) applies only to expenditures claimed as deductions in the computation of business income. Submitted that expenditures capitalised in WIP are not claimed in the P&L and therefore cannot be disallowed in the current year. Relied on Savala Associates and the AO’s own verification order dated 25.02.2026.
Relief Sought
The Revenue sought to set aside the CIT(A)’s order and restore the AO’s disallowances of Rs. 1,82,85,535/- and Rs. 3,52,949/- under Section 40(a)(ia). The assessee sought confirmation of the CIT(A)’s order and dismissal of the appeal.
The Legal Issue
The central question was whether Section 40(a)(ia) mandates disallowance of expenditure in the year of default, even when such expenditure is capitalised to work-in-progress and not claimed as a deduction in the profit and loss account, and whether the accounting method (Percentage Completion Method vs. Completed Contract Method) affects the applicability of the disallowance.
Arguments Presented
For the Appellant/Petitioner (Revenue)
The Departmental Representative contended that Section 40(a)(ia) operates as a statutory penalty triggered solely by non-deposit of TDS, irrespective of accounting treatment. Relied on the disclosures in Form 3CD as conclusive evidence of default. Argued that Savala Associates is distinguishable because it applied to the Completed Contract Method, whereas the assessee used the Percentage Completion Method. Asserted that directing adjustment to WIP is computationally incomplete and legally unsound, as it does not ensure disallowance is ultimately reflected in taxable income. Claimed that the CIT(A)’s direction to reduce WIP creates a loophole allowing deferred deduction without statutory cure.
For the Respondent/State (Assessee)
The Authorised Representative argued that Section 40(a)(ia) is not a penalty provision but a disallowance rule tied to the computation of business income. Emphasised that the provision applies only where an expenditure is claimed as a deduction. Cited the AO’s own verification order dated 25.02.2026, which confirmed that 80.75% of the expenditure remained in WIP and was not claimed in the P&L. Relied on Savala Associates to establish that disallowance must be reflected through adjustment of WIP, not direct addition to income, to prevent double deduction in future years. Argued that the distinction between PCM and CCM is irrelevant if the expenditure is not claimed in the current year’s income computation.
The Court's Analysis
The Tribunal undertook a detailed examination of the statutory language of Section 40(a)(ia), which states: "No deduction shall be allowed in respect of any sum payable by the assessee... if tax has not been deducted or, if deducted, has not been paid within the time specified." The Court observed that the provision is framed in the context of "computation of income under the head Profits and gains of business or profession," thereby conditioning its application on the existence of a claimed deduction.
"Section 40(a)(ia) disallows expenditure while computing income under the head 'Profits and gains of business or profession'. Therefore, the pre-condition for its application is that the expenditure must be claimed as deduction in computation of income. If an expenditure has not been claimed in the profit and loss account and is merely carried forward as WIP, the question of disallowance in the current year does not arise, as there is no deduction claimed."
The Tribunal rejected the Revenue’s argument that Form 3CD disclosures are conclusive. It noted the AO’s own observation in the OGE that "figures in clause 34(a) of Form 3CD were aggregate reporting figures and not the exact base for disallowance." The Tribunal held that statutory compliance must be assessed on actual accounting treatment, not aggregated disclosures.
The Tribunal further held that the distinction between Percentage Completion Method and Completed Contract Method is not determinative. It reasoned that under PCM, only the proportion of expenditure attributable to revenue recognised in the year is charged to the P&L. The balance remains in WIP and is not claimed as a deduction. Therefore, the principle from Savala Associates - that disallowance must be reflected through WIP adjustment, not direct addition - applies equally under PCM.
"Even under Percentage Completion Method (PCM) only that portion of expenditure which is charged to Profit & Loss Account is considered for computing income. The balance portion remains embedded in WIP. Thus, even under PCM, the principle remains the same 'Expenditure not claimed cannot be disallowed. It can only be adjusted in WIP and carried forward.'"
The Tribunal upheld the CIT(A)’s direction to verify the segregation of WIP and claimed expenditure, noting that the AO had already complied with this direction on 25.02.2026, accepting that only 19.25% of the expenditure was claimed in the P&L. The Tribunal concluded that the direction to adjust WIP is legally sound to prevent double deduction in future years when WIP is transferred to cost of sales.
The Verdict
The appeal of the Revenue was dismissed. The ITAT upheld the order of the Learned CIT(A) dated 06.11.2025. The disallowances of Rs. 1,82,85,535/- and Rs. 3,52,949/- under Section 40(a)(ia) were set aside. The Tribunal confirmed that disallowance under Section 40(a)(ia) applies only to the portion of expenditure claimed in the profit and loss account, which the AO had verified as Rs. 17,68,78,548/- × 19.25% = Rs. 34,04,842/- (implied from 80.75% in WIP). No further disallowance is permitted for the portion carried in WIP. The direction to adjust WIP is binding and must be applied in subsequent years upon project completion.
What This Means For Similar Cases
Disallowance Under Section 40(a)(ia) Is Not Automatic
- Practitioners must now prove that the disputed expenditure was actually claimed as a deduction in the P&L before invoking Section 40(a)(ia)
- Merely showing TDS default via Form 3CD is insufficient; the actual accounting treatment must be examined
- Revenue authorities cannot assume disallowance applies to all TDS defaults without verifying claim status
Work-in-Progress Adjustment Is Legally Valid
- Adjustments to WIP to reflect disallowance are permissible and preferred over direct additions to income
- This prevents double deduction when WIP is later transferred to cost of sales in future years
- Assessing Officers must verify the proportion of expenditure claimed in P&L versus carried in WIP
Accounting Method Is Not Dispositive
- Whether a taxpayer uses PCM or CCM is irrelevant if the expenditure is not claimed in the current year
- The focus must be on whether the cost has entered the computation of income, not the label of the accounting method
- Taxpayers may rely on this judgment to challenge disallowances where costs remain in WIP under any accounting method
