Disallowance of Salary Expenditure- Paid to Non-Resident or outside India- Case when there is no such disallowance

Disallowance of Salary Expenditure- Paid to Non-Resident or outside India- Case when there is no such disallowance

Section 40a(iii) provides that in computing income under the head business or profession, no deduction shall be allowed in respect of salary expenditure, if following conditions are satisfied:-

1.       Amount paid is chargeable under the head Salaries

2.       Amount is paid outside India or to non-resident

3.       No TDS has been deducted on such payments.

In this write up, attempt is made to analyse the situation, when above-said Salary expenditure will NOT be disallowed in the hands of employer, while computing income under the head business or profession, if no TDS has been deducted.

The pre-requisite for attracting disallowance u/s 40a(iii) is that  amount paid is chargeable under the head Salaries. In the other words the amount concerned should be chargeable to tax in India under the head Salaries.

The chargeability of income to Tax in India is dependent upon the residential status of assessee, which is governed by section 5.

Section 5 provides that following income shall be chargeable to tax in India, in hands of following assessee:-

The point for consideration is when shall salary be accrue or deemed to accrue in India to employee, if the employer is resident and making payment from India.

In this connection, it is essential to look at section 9(1)(ii) and 9(1)(iii), which provide guidance on accrual of salary in India

1.       Section 9(1)(ii) provides that salary shall be taxable in India, if it is connection with service rendered in India. Thus rendition of service governs the place of accrual of salary in normal situation.

2.       Section 9(1)(iii) provides that salary paid to citizen of India for service rendered outside India, by the Government shall be taxable in India. Thus this is special provision providing of taxability of salary in India, even if service is rendered outside India.

At this point, it is also important to look at Article 16 of Model DTAA, which governs the right to taxability of Salary among two contracting states.

1.       It provides that primary right to tax the salary income will be with state, where the employee is resident.

2.       The other state, where employee render services, will also have right to tax, if prescribe conditions are met.

Based on above, the salary paid by Indian employer, will be taxable in India in the hands of employee in following cases:-

1.       Employee is resident in India, irrespective of rendition of service

2.       Employee is Non-resident but rendition of service is in India.

Thus the disallowance/non-disallowance u/s 40a(iii) is summarised as under:-