TDS Non-Deduction and Late Payment: Interest, Penalty and Disallowance under the Income Tax Act 2025

If you must deduct or collect tax at source and you do not, or you deduct it and do not deposit it, the Income Tax Act 2025 treats you as an "assessee in default" under section 398(1). Simple interest runs at 1% per month until the tax is deducted and 1.5% per month until it is deposited (section 398(3)). The Assessing Officer can also levy a penalty equal to the tax (sections 448 and 449), and a business payer can lose part of the expense claim under section 35(b).

This guide covers who is affected, how interest is counted, when penalty applies, the 30% disallowance, and how a deductor can avoid default status when the payee has already paid the tax. Figures are from the Act as amended by the Finance Act, 2026, and the Income-tax Rules, 2026, with section and rule numbers beside them. Last reviewed against that text on 10 November 2026.

What does "assessee in default" mean for TDS and TCS?

Section 398(1) applies to any person, including the principal officer of a company, who is required to deduct or collect tax under the Act (and to an employer referred to in section 392(2)(a)) and who:

• does not deduct or collect the tax; or
• does not pay it to the Government; or
• deducts or collects it but fails to pay the whole or any part.

Such a person is deemed to be an assessee in default for that tax, in addition to any other consequences under the Act. Deemed default is the base on which interest, the charge on assets and the Assessing Officer's order (section 398(5)) all rest.

How much interest is charged on late TDS?

Section 398(3)(a) charges simple interest in two stages. Both count every month or part of a month as a full month.

Stage	Rate	Interest runs from	Interest runs to
Tax not deducted or collected	1% per month	Date the tax was deductible or collectible (section 398(3)(a)(i))	Date it is actually deducted or collected
Tax deducted or collected but not paid	1.5% per month	Date it was deducted or collected (section 398(3)(a)(ii))	Date it is actually paid

The interest must be paid before the TDS or TCS statement is filed (section 398(3)(b), read with section 397(3)(b)). Where the Assessing Officer passes an order for default, the interest is paid as that order directs (section 398(3)(d)).

How is the interest calculated? Two worked examples

Example 1: tax deducted late and deposited late (tax year 2026-27). Assumptions: tax of Rs 20,000 was deductible on 10 August 2026. It was deducted on 10 November 2026 and deposited on 25 December 2026.

Step	Working	Amount
1. Months from 10 Aug to 10 Nov (deductible to deducted)	10 Aug to 10 Nov = 3 months	3 months
2. Interest at 1%	Rs 20,000 x 1% x 3	Rs 600
3. Months from 10 Nov to 25 Dec (deducted to paid)	10 Nov to 10 Dec = 1 month, plus part of a month = 2 months	2 months
4. Interest at 1.5%	Rs 20,000 x 1.5% x 2	Rs 600
Total interest	Rs 600 + Rs 600	Rs 1,200

Example 2: tax deducted on time but deposited 8 days late. Assumptions: Rs 1,00,000 of tax was deducted on 20 September 2026. The payment is not of a kind covered by rule 218(3), so the due date under rule 218(2)(b) is 7 October 2026, and it was deposited 8 days late, on 15 October 2026.

1. The tax was deducted, so only the 1.5% stage applies (section 398(3)(a)(ii)).
2. From 20 September to 15 October is less than a full month, but part of a month counts as one month, so 1 month.
3. Interest = Rs 1,00,000 x 1.5% x 1 = Rs 1,500.

Interest runs from the date of deduction, not from the due date, which is why even a short delay costs a full month of interest.

When can the Assessing Officer levy a penalty equal to the tax?

Two provisions allow a penalty equal to the tax:

• Section 448 (TDS): if a person fails to deduct the whole or any part of tax as required under Chapter XIX-B, the Assessing Officer may impose a penalty equal to the tax not deducted. The same section covers failure to pay or ensure payment of tax in two situations: winnings that are wholly or partly in kind (Note 2 below the table in section 393(3)) and in-kind consideration or benefit for the cases in Note 6 to section 393(1), Sl. No. 8, where the payer must ensure the tax is paid before releasing the consideration.
• Section 449 (TCS): if a person fails to collect the whole or any part of tax under Chapter XIX-B, the Assessing Officer may impose a penalty equal to the tax not collected.

The word is "may", so the penalty is discretionary. Section 398(7) separately provides that no penalty under section 412 is levied on the person in section 398(1) unless the Assessing Officer is satisfied that the person, without good and sufficient reasons, failed to deduct or collect and pay the tax. That sub-section names section 412 only.

Section 412 is the separate penalty for an assessee who is in default or deemed to be in default in paying tax, which is what section 398(1) deems a deductor to be. It allows an amount the Assessing Officer directs, capped at the tax in arrears (section 412(2)), only after a reasonable opportunity of being heard, and not where the default was for good and sufficient reasons (section 412(3)). Paying the tax before the penalty is levied does not by itself remove the liability to penalty (section 412(4)).

What is the 30% disallowance for TDS default?

Section 35(b) is a separate hit on the payer's business or professional income. If tax was deductible on a sum payable to a resident and, during the tax year, the tax was not deducted, or was deducted but not paid by the due date in section 263(1) (the return filing due date), then 30% of that sum is not allowed as a deduction (section 35(b)(i)).

The disallowance reverses in time. If the tax is deducted in a later year, or deducted in the year but paid after the section 263(1) due date, the 30% is allowed in the tax year in which the tax is paid (section 35(b)(i)(A)).

For interest, royalty, fees for technical services or other sums payable outside India, or in India to a non-resident other than a company or to a foreign company, the disallowance is the whole sum, not 30% (section 35(b)(ii)). Salary payable outside India or to a non-resident, with tax deductible but not deducted or not paid, is also not deductible (section 35(c)).

Example 3: 30% disallowance (tax year 2026-27). Assumptions: Meena runs a trading business and booked Rs 4,00,000 of payment to a resident contractor as an expense. Tax was deductible but she did not deduct it during the year. Her profit before this adjustment is Rs 25,00,000, after claiming the Rs 4,00,000.

Step	Working	Amount
1. Disallowed portion	30% of Rs 4,00,000	Rs 1,20,000
2. Business income after adding back	Rs 25,00,000 + Rs 1,20,000	Rs 26,20,000
3. Later year: tax deducted and paid	Rs 1,20,000 allowed in the year of payment	Rs 1,20,000 deduction

Tax on the extra Rs 1,20,000 depends on Meena's slab or rate, which is not shown here.

Is a deductor safe if the payee has already paid the tax?

Under section 398(2), a person who failed to deduct (or, for TCS under section 394(1) Table Sl. Nos. 1 to 5 and 9, failed to collect) is not deemed an assessee in default if the payee or buyer has:

1. furnished a return of income under section 263;
2. taken the amount into account in computing income in that return; and
3. paid the tax due on the income declared in that return,

and the deductor furnishes an accountant's certificate to that effect. Rule 221 prescribes the certificate form: Form No. 149 for non-deduction or short deduction, and Form No. 150 for non-collection or short collection, furnished to the Director General of Income-tax (Systems) or a person he authorises.

This relief is partial. Interest at 1% is still payable, but only from the date the tax was deductible to the date the payee furnished the return (section 398(3)(c)). Section 35(b)(i)(B) also treats the tax as deducted and paid on the date the payee filed the return, which lines up the disallowance with this relief.

Example 4: payee has already paid the tax (tax year 2026-27). Assumptions: Rs 50,000 of tax was deductible on 5 January 2027 and not deducted. The payee furnished the return for tax year 2026-27 on 20 July 2027, included the income and paid the tax. The deductor obtains the accountant's certificate in Form No. 149.

1. The deductor is not deemed an assessee in default (section 398(2)).
2. Months from 5 Jan to 20 Jul: 5 Jan to 5 Jul = 6 months, plus part of a month = 7 months.
3. Interest = Rs 50,000 x 1% x 7 = Rs 3,500.
4. Without the certificate, interest would continue at 1% per month until the tax is actually deducted, and a penalty up to Rs 50,000 could be considered under section 448.

What is the late fee for filing the TDS statement, and can non-payment lead to prosecution?

Two further consequences sit outside section 398. Section 427(1) charges a fee of Rs 200 for every day a TDS or TCS statement is delivered after the time in section 397(3)(b). The fee cannot exceed the tax deductible or collectible, and it must be paid before the statement is delivered (section 427(2)).

Section 476 makes failure to pay tax deducted at source to the Central Government an offence. Where the tax exceeds Rs 50 lakh, punishment is simple imprisonment up to two years, or fine, or both. Where it exceeds Rs 10 lakh but not Rs 50 lakh, it is simple imprisonment up to six months, or fine, or both. In any other case it is a fine (section 476(1)). The section does not apply if the tax was paid on or before the time for filing the statement under section 397(3)(b) (section 476(2)).

Example 6: late statement fee. Assumption: tax deductible for the statement is Rs 4,000, and the statement is delivered 30 days late. The fee is Rs 200 x 30 = Rs 6,000, but it is capped at the tax deductible, so the fee is Rs 4,000.

Does the tax become a charge on the deductor's assets?

Yes. Where tax has been deducted or collected but not paid, the tax together with the simple interest under section 398(3)(a) is a charge upon all the assets of the person in default (section 398(4)).

How long can the department go back?

An order deeming a person an assessee in default for failure to deduct or collect cannot be made after the later of two dates (section 398(5)):

• six years from the end of the tax year in which the tax was deductible or collectible; or
• two years from the end of the tax year in which a correction statement is delivered under section 397(3)(f).

Section 398(6) applies sections 286(1) and 286(3) to this time limit, so the exclusions in section 286(3) can extend it.

Example 5: time limit. Ravi, a partner in a trading firm, missed deducting tax on a payment due in tax year 2026-27 (ending 31 March 2027). Six years from the end of that tax year is 31 March 2033, so an order for non-deduction on that payment cannot be made after that date, subject to the later-date rule and section 286(3) exclusions.

Quick reference: consequences of TDS and TCS default

Consequence	Trigger	Amount	Provision
Deemed assessee in default	Not deducted, not collected, or not paid	The tax itself	Section 398(1)
Interest, first stage	Tax not deducted or collected	1% per month or part	Section 398(3)(a)(i)
Interest, second stage	Tax deducted or collected, not paid	1.5% per month or part	Section 398(3)(a)(ii)
Penalty, TDS	Failure to deduct, or to ensure payment in the in-kind cases	Up to the tax	Section 448
Penalty, TCS	Failure to collect	Up to the tax	Section 449
Penalty, tax in default	Default in payment	Up to the tax in arrears	Section 412(2)
Disallowance, resident payee	Not deducted, or not paid by the section 263(1) due date	30% of the sum	Section 35(b)(i)
Disallowance, non-resident payee	Same	Whole sum	Section 35(b)(ii)
Charge on assets	Tax deducted or collected, not paid	Tax plus interest	Section 398(4)
Fee for late statement	Statement not delivered by the section 397(3)(b) time	Rs 200 a day, capped at the tax deductible or collectible	Section 427
Prosecution	Tax deducted but not paid to the Government	Fine, or jail up to 6 months or 2 years by tax amount	Section 476
Time limit for order	Failure to deduct or collect	6 years from end of the tax year, or 2 years from correction statement, whichever is later	Section 398(5)

Real-life scenarios

Meena pays a contractor and forgets TDS. She books the bill in March and sees the miss only at audit time. Tax was deductible when the sum was credited, so she is deemed in default for that tax, owes 1% a month until she deducts the tax and 1.5% a month from then until she deposits it, and 30% of the bill is disallowed for the year. If she deducts and pays in a later year, the 30% is allowed in the year of payment.

Ravi deducts TDS on a contractor's bill but his accountant is on leave. The tax was deducted on time but deposited two months after the due date. The 1.5% stage applies from the date of deduction. If it takes months and the deduction was real, the tax and interest can also become a charge on his assets until paid.

A small firm and an honest oversight. The firm did not deduct tax on a payment to a resident vendor. The vendor had already included the income in a filed return and paid the tax. With the accountant's certificate in Form No. 149, the firm is not deemed in default, and interest at 1% stops running at the vendor's return date.

Common mistakes

• Treating a few days' delay as free. Part of a month counts as a month, and the 1.5% stage starts from the deduction date, not the due date.
• Assuming deducted-but-unpaid TDS is safe because the payee got credit. It is still a default for the deductor and a charge on assets.
• Forgetting the disallowance. Interest is paid once, but 30% of the expense is lost for the year unless the tax is deducted and paid in time.
• Assuming relief under section 398(2) is automatic. It needs the payee's return, income and tax payment, plus the accountant's certificate in Form No. 149 or 150.
• Paying the tax and skipping the interest. Interest under section 398(3)(a) is to be paid before the statement is filed.

How do CA firms track TDS defaults across clients?

For a CA firm, the hard part is not the arithmetic. It is knowing which client has an unpaid deposit, which payment still has no deduction, and which clients need a Form 149 certificate before a notice arrives. Finexo's practice management software tracks deadlines across your client book and reminds you and your clients ahead of them. It does not compute interest or file statements for you. For deposit dates on a common case, see the guide on TDS on rent under the Income Tax Act 2025.

Where this is in the Act

• Section 398: consequences of failure to deduct or pay, or collect or pay (sub-sections (1) to (7))
• Section 448: penalty for failure to deduct tax at source
• Section 449: penalty for failure to collect tax at source
• Section 412: penalty payable when tax is in default
• Section 35(b) and (c): amounts not deductible for TDS default
• Section 427: fee for default in furnishing statements
• Section 476: prosecution for failure to pay tax deducted at source
• Section 397(3): payment, statements and correction statements
• Rule 218: time and mode of payment of tax deducted or collected
• Rule 221: accountant's certificate, Form No. 149 and Form No. 150

This article explains the Income-tax Act, 2025 (as amended by the Finance Act, 2026) and the Income-tax Rules, 2026. It is general information, not tax advice. Confirm the position for a specific case with a qualified chartered accountant.