Got a Section 201 TDS default demand? Who should handle it, what to check first, how 201(1A) interest works and the defences that cut or remove the demand.
A Section 201 TDS default demand is ordinarily required to be handled by a chartered accountant having experience of TDS assessments and litigation, inasmuch as the reply, the reconciliation and the first appeal involve accounting and tax law in equal measure, whereas an advocate is required before the Hon'ble High Court and is of use where the dispute turns upon a pure question of law such as which section applied. Simple TRACES mismatches such as short payments or unmatched challans can be set right by the in-house finance team of the deductor itself, and in respect of payments to non-residents a chartered accountant conversant with treaty withholding and the Form 15CA/15CB rules ought to be engaged.
Section 201 of the Income-tax Act, 1961 provides that a person who was required to deduct tax at source but has failed to do so, or who having deducted the tax has failed to deposit the same, shall be treated as an "assessee in default" in respect of such tax, whereafter the Department is entitled to recover the said tax from the deductor alongwith interest under Section 201(1A). As per the said sub-section, interest is levied at 1 per cent per month on tax not deducted, from the date on which it was deductible to the date on which it was actually deducted, and at 1.5 per cent per month on tax deducted but not deposited, from the date of deduction to the date of payment. It is pertinent to note that a part of a month is counted as a full month for this purpose, and hence even a short delay results in an interest cost higher than what it would appear at first instance.
Take the case of a Gurugram based real estate developer which paid Rs. 3.6 crore to contractors in FY 2022-23 and deducted tax at 1 per cent under Section 194C. The TDS officer has thereafter taken the view that the said payments were in the nature of professional services covered by Section 194J, wherein the rate is 10 per cent. The shortfall works out to 9 per cent of Rs. 3.6 crore i.e. Rs. 32.4 lakh, on which interest under Section 201(1A) has been running for a number of years. Such a demand usually comes first to the notice of the finance team, and the question which arises at that stage is as to who ought to handle the matter thereafter.
It may be noted that this article covers defaults for the years up to 2025-26, which continue to be governed by the Income-tax Act, 1961. The Income-tax Act, 2025 applies from tax year 2026-27 and renumbers many of the sections, and the section numbers are therefore to be checked with reference to the year mentioned in the notice.
An order under Section 201 is not to be confused with an intimation under Section 200A, which is generated on processing of the TDS return and flags short deduction or late fee. An order under Section 201, on the other hand, is passed only after a proceeding wherein a notice is issued, a reply is filed by the deductor and an order is thereafter passed, and the nature of the communication so received therefore decides the course of action to be followed.
It is generally seen that the demand arises on account of the payment having been classified under a wrong section, as a result of which tax was either not deducted at all or was deducted at a lower rate, the classification under Section 194C in place of Section 194J being a regular instance thereof. A demand may also be raised in the event the tax deducted was deposited late or the challan does not match with the TDS return, or where the PAN of the payee was missing or invalid, in which case the higher rate is attracted. Payments to non-residents which were remitted without proper withholding or without Form 15CA/15CB, a genuine dispute as to whether a payment is in the nature of a contract payment, a professional fee or rent, and errors in the TDS return which were never corrected on TRACES, also account for a considerable number of such demands.
Also Read: TDS Provisions on Foreign Remittances Under Section 195
A chartered accountant is entitled to represent the assessee before the TDS officer, the Commissioner (Appeals) and the ITAT, and for most defaults a chartered accountant is the best fit inasmuch as the work is half reconciliation and half tax law, though it is to be ensured that the CA so engaged has actually handled TDS assessments and appeals and not merely return filing. An advocate can appear at every forum including the Hon'ble High Court, and ought to be brought in where a legal question arises as to how a section is to be read, where a point of limitation is involved, or where a writ is to be filed against an order passed without jurisdiction.
The in-house finance team, being familiar with the transactions, is generally in a position to rectify challan mismatches, file correction statements and respond to simple TRACES intimations, however the matter is to be handed over to a professional once the notice alleges non-deduction or turns upon a disputed section. A TDS consultant is of use for reconciliation and correction filings, but in the case of a contested demand involving a large amount, interest and a possible penalty, the services of a person who can take the matter through appeal are required.
The choice of professional in a given case is to be made with reference to whether the dispute is about numbers or about law, the size of the demand once the interest and the penalty risk are added, whether a non-resident payee or treaty relief is involved, and whether an appeal is likely to be required. A dispute about numbers is generally suited to a chartered accountant or a TDS consultant, whereas a dispute on law involving a large amount is best handled by a chartered accountant and an advocate working to one plan.
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Also Read: Writ vs Appeal
On receipt of a notice or order under Section 201, it is advisable that the section invoked, the financial year involved, the amount of tax and the working of interest, alongwith the time allowed for reply or appeal, be noted at the outset, whereafter the default summary and the justification report as available on TRACES, together with the status of the challans, ought to be downloaded and compared with the books of account of the deductor. It is generally seen that a good number of such demands disappear once each payment, deduction, challan and return line has been reconciled, and in so far as the default arises on account of a wrong PAN, wrong challan details or a wrong section code, the same can be rectified by filing a correction statement, whereafter it is to be seen whether the default stands cleared. In respect of that part of the demand which the deductor accepts, payment ought to be made at the earliest inasmuch as such payment stops further interest on that portion, though it should be recorded in writing at the time of payment that the balance is being contested.
It is pertinent to note that under the first proviso to Section 201(1), where a resident payee has included the income in its return and paid the tax thereon, and the deductor obtains a certificate from a chartered accountant in the prescribed form i.e. Form 26A, the deductor is not treated as an assessee in default in respect of such tax. The interest under Section 201(1A) however continues to run up to the date on which the payee filed its return, and the said route therefore removes the tax demand but not the interest for the intervening period.
The limitation prescribed under Section 201(3) is also to be tested before going into the merits, inasmuch as the said provision limits how late an order can be passed, and the Tribunals have quashed orders which were passed after the expiry of that limit. A reply alongwith the reconciliation and the facts is thereafter to be filed with a request for a hearing, and in the event the order is adverse, the first appeal lies before the CIT(A), generally within 30 days of the order, while a stay of demand may be sought during the pendency of the appeal in order to protect cash flow.
Also Read: Filing the First Appeal Before the CIT(A), Income Tax Dispute Resolution for Businesses and Stay of Demand Under Section 220(6)
A large number of demands are raised on expense provisions booked as on 31st March wherein no payee had been identified or paid as at that date, and the Tribunals have sent several such matters back for fresh verification, more so where the provision was reversed or the vendor credit came later. Where the demand rests on such provisions, the subsequent treatment of each provision is therefore required to be examined.
It may also be noted that where the assessee has already disallowed part of the expense in its own return under Section 40(a)(ia), the same does not automatically mean that it is an assessee in default under Section 201, the Tribunals having treated the two as separate questions, each with its own test. A payment made without TDS can lead to part of the expense being disallowed in the return of the deductor, which raises its tax, though the disallowance can be reversed once the tax is deducted and deposited within the time allowed by law.
Apart from the demand, failure to deduct tax can attract a penalty under Section 271C equal to the amount of tax not deducted, and late filing of TDS returns attracts a late fee, the penalty being a separate proceeding with its own reply and appeal. Deduction of tax without deposit thereof is treated far more seriously than non-deduction and can lead to prosecution, and hence deducted tax ought to be deposited without delay and advice taken at an early stage in the event there is a gap.
Disclaimer: The contents of this article are for general information only.
A chartered accountant is entitled to represent the deductor before the TDS officer, the CIT(A) and the ITAT in respect of a TDS default, however where the matter is required to be taken before the Hon'ble High Court, an advocate has to be engaged for that purpose.
Interest under Section 201(1A) is levied at 1 per cent per month where tax was not deducted and at 1.5 per cent per month where tax was deducted but not deposited, and it may be noted that each month or part of a month is counted as a full month.
An order under Section 201 is appealable in the first instance before the CIT(A) and thereafter before the ITAT, and the first appeal is generally required to be filed within 30 days of receipt of the order by the deductor.
In the case of resident payees the tax demand can go where the payee has included the income in its return and paid the tax thereon, as certified by a chartered accountant in Form 26A, though interest continues to apply up to the date on which the payee filed its return.
A stay of demand may be sought while the appeal is pending, though the officer may ask for a part payment, and hence the portion accepted ought to be paid and the balance contested alongwith a request for stay.
The reply is generally to be supported by the TRACES default summary and justification report, the challans, bank statements and TDS returns, the contracts, invoices and ledgers, the PAN verification and declarations of the payee, and for foreign payments the Form 15CA/15CB, the tax residency certificate and the treaty analysis, alongwith a timeline of the notices and deadlines.
DSRV & Co. LLP has handled tax disputes since 1987. We're an ICAI-registered, peer-reviewed CA firm in Gurugram. Send us the order and your TRACES reports and we'll reconcile them, check the payee certificate route and limitation, and tell you what can be cut before the deadline.
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