The Payer Did Not Deduct on a Payment to a Non-Resident: What Section 398 Costs, and What the Certificate Does Not Save
| Authored by R & D Law Chambers LLP | Practice led by Ravish Bhatt, Dual-qualified lawyer (India and England & Wales) | Bar Council of Gujarat, Enrolment G/504/2008 | SRA (non-practising) Registration No. 492 477 | ADIT, Chartered Institute of Taxation, London
Published: 10 October 2026 | Last reviewed: 10 October 2026 |
| Instruments. This article states the position under the Income-tax Act, 2025, which replaced the Income-tax Act, 1961 with effect from 1 April 2026, read with the Income-tax Rules, 2026. The obligation to deduct on payments to non-residents sits in section 393(2), Table Sl. No. 17, which replaced section 195 of the 1961 Act. Payments and credits before 1 April 2026 remain governed by the earlier Act.
Scope. We advise on Indian law only, for businesses anywhere, wherever a matter has an India connection. |
| Short answer. Section 398(2) is a defence to being treated as an assessee in default, and to nothing else. Interest still runs under section 398(3)(c) to the date the payee filed its return. The penalty equal to the whole of the tax under section 448 survives unless reasonable cause is proved under section 470. And the disallowed deduction returns only in the year of that return, not the year of payment. |
Index of Topics
- The obligation, and the word that gates it
- When the payer becomes an assessee in default
- The defence in section 398(2) and the certificate in Form No. 149
- Why that defence is often unavailable on a payment to a non-resident
- Interest, which the defence does not stop
- The charge on assets, and what it does not reach
- A penalty equal to the whole of the tax: sections 448 and 470
- Penalty when the tax itself is in default: sections 412 and 398(7)
- The deduction you lose, and the deeming that returns it late
- Prosecution, limitation, and the appeal
- The obligation, and the word that gates it
| In short: Section 393(2), Table Sl. No. 17 requires deduction from “any other sum chargeable under the provisions of this Act” paid or credited to a non-resident or foreign company, at the rates in force. Chargeability is the gate. A sum that is not chargeable in India carries no obligation, however large the remittance. |
The entry applies to any person as payer and to any non-resident, not being a company, or foreign company as payee, and covers any interest other than that dealt with elsewhere in the Table, or any other sum chargeable under the Act, not being income chargeable under the head Salaries. Note 3 to the Table records that the obligation extends to all persons irrespective of residence in India or of any business presence or connection here.
The gating word is chargeable. Construing the same words in section 195(1) of the repealed Act, the Supreme Court in GE India Technology Centre Private Limited v Commissioner of Income Tax, decided on 9 September 2010 and reported at (2010) 327 ITR 456, held that the obligation to deduct arises only where the sum is chargeable to tax under the Act, so that the charging and treaty provisions are read together with the deduction provision before any obligation arises. The operative words are carried into section 393(2), Table Sl. No. 17 unchanged.
That is why the first question in any default is not what rate should have been applied. It is whether the sum was chargeable at all. Characterisation and taxable presence decide it, and both are dealt with separately in our work on royalty, fees for technical services and business profits and on business connection and permanent establishment.
- When the payer becomes an assessee in default
| In short: Under section 398(1) a person required to deduct who does not deduct or pay, or who deducts and fails to pay, the whole or any part of the tax is deemed an assessee in default in respect of that tax, “in addition to any other consequences”. Section 391(3) adds that the deeming operates where the payee has also failed to pay directly. |
Two provisions have to be read together. Section 391(1) makes income-tax on any income payable directly by the assessee where there is no provision to deduct at source, or where tax has not in fact been deducted. Section 391(3) then provides that where the payer does not deduct, or after deducting fails to pay, and the assessee has also failed to pay the tax directly, the payer is deemed an assessee in default within the meaning of section 398(1).
The closing words of section 398(1) are the ones to notice. The deeming operates “in addition to any other consequences which that person may incur under this Act”. Nothing in the section treats being an assessee in default as the whole of the exposure, and the sections that follow confirm it.
- The defence in section 398(2) and the certificate in Form No. 149
| In short: Section 398(2) removes the deeming where the payee has furnished a return under section 263, taken the amount into account in computing income in that return, and paid the tax due on the income declared, and the payer furnishes an accountant’s certificate to that effect. That certificate is Form No. 149 under Rule 221 of the Income-tax Rules, 2026. The relief does not, by itself, extinguish other consequences of the failure to deduct, including interest under section 398(3), a penalty that may be imposed under section 448, or the consequences under section 35(b)(ii). |
All four conditions are cumulative. Three are about the payee and one is about the payer, and the payer controls only the fourth. Form No. 149 replaced Form No. 26A under Rule 31ACB of the Income-tax Rules, 1962, and the Income Tax Department’s guidance describes it as filed as and when the case arises, where deduction was missed or short and the deductor seeks relief from being treated as in default.
The limit of the provision is textual and easily missed. Section 398(2) opens with a person “who fails to deduct”. It does not reach a person who deducted and then failed to pay. For that payer there is no equivalent relief, however completely the payee has accounted for the income.
- Why that defence is often unavailable on a payment to a non-resident
| In short: Section 398(2) is conditioned on the payee having furnished a return under section 263 and paid the tax on the income declared in it. A non-resident recipient that files no Indian return satisfies neither condition, and the payer has no certificate to furnish. The defence exists but the facts frequently do not support it. |
This is the practical asymmetry between a domestic default and a cross-border one. Where the payee is an Indian company that has returned the receipt, the accountant can certify the three matters from the payee’s own filings and the certificate is a paperwork exercise. Where the payee is a foreign supplier with no Indian filing obligation it has chosen to discharge, there is nothing for the accountant to certify.
The consequence is that the payer’s realistic defences on a cross-border payment are usually the two that sit before section 398(2) rather than within it: that the sum was never chargeable, so no obligation arose, or that the correct amount was determined in advance. The second is the route in section 395(2), where a payer who considers that the whole of a sum would not be chargeable applies in Form No. 129 for determination of the appropriate proportion. That route is dealt with in our work on lower and nil deduction certificates under section 395. It is available before the remittance and not after it, which is the whole point of it.
- Interest, which the defence does not stop
| In short: Section 398(3)(a) charges simple interest at one per cent per month or part from the date the tax was deductible to the date it was deducted, and at one and a half per cent from deduction to payment. Section 398(3)(c) makes clear that a payer saved by section 398(2) still pays the first, to the date the payee furnished its return. |
The structure is deliberate. The lower rate compensates for the period the tax was never deducted, the higher rate penalises the period money was held after deduction, and the two do not overlap. Section 398(3)(b) requires the interest to be paid before furnishing the statement under section 397(3)(b), so it is a self-assessed liability rather than one that waits for an order. Where an order is made for the default, section 398(3)(d) requires interest to be paid as directed by that order.
Section 398(3)(c) is the provision that defeats the common assumption that the certificate cleans the slate. Where the payer is not deemed an assessee in default because section 398(2) applies, interest at one per cent per month still runs from the date the tax was deductible to the date of furnishing of the return of income by the payee. The certificate moves the end point of the interest period. It does not remove the period.
- The charge on assets, and what it does not reach
| In short: Section 398(4) creates a charge upon all the assets of the person for the tax together with interest, but only “where the tax has not been paid after it is deducted or collected”. A payer who never deducted is outside it. |
The distinction matters commercially, because a charge on all assets is a very different fact in a financing or a sale process from an unsecured demand. Section 398(4) attaches to the case of money withheld from a payee and retained, not to the case of money never withheld at all. A default consisting only of non-deduction produces a liability, not an encumbrance.
- A penalty equal to the whole of the tax: sections 448 and 470
| In short: Section 448 empowers the Assessing Officer to impose a penalty equal to the tax which the person failed to deduct, subject to the requirements of that section. The penalty is not automatic merely because a failure to deduct has occurred. Nothing in section 398(2) touches it. The defence is section 470, which provides that no penalty shall be imposed under the listed sections, section 448 among them, if the person proves that there was reasonable cause for the failure. |
This is the largest single number in the exposure and the one most often left out of the arithmetic. The penalty is measured by the tax that was not deducted, not by the shortfall net of what the payee later paid, and it is a separate proceeding from the section 398 order.
Section 470 is a non obstante provision and its protection is section-specific. It names section 448 expressly, so reasonable cause is available here. The burden sits on the person: the section requires that he “proves that there was reasonable cause for the said failure”. A contemporaneous analysis of chargeability, a treaty position taken on documents held at the time, or an application made under section 395(2) before the remittance are the materials that discharge it. A position reconstructed after the notice is a weaker thing.
- Penalty when the tax itself is in default: sections 412 and 398(7)
| In short: Section 412 allows the Assessing Officer to direct a penalty where an assessee is in default in making payment of tax, capped at the amount of the tax in arrears. Section 398(7) adds a gate: no such penalty on a person within section 398(1) unless the Assessing Officer is satisfied that the failure was without good and sufficient reasons. |
Section 412 sits alongside section 448 rather than in place of it, and answers a different question: section 448 penalises the failure to deduct, section 412 penalises default in payment. Its own limits are express. The total penalty cannot exceed the tax in arrears. It cannot be levied without a reasonable opportunity of being heard, or where the assessee proves to the Assessing Officer’s satisfaction that the default was for good and sufficient reasons. Paying the tax before the penalty is levied does not by itself remove the liability, by section 412(4). And where a final order wholly reduces the tax, section 412(5) requires the penalty to be cancelled and any penalty paid to be refunded.
- The deduction you lose, and the deeming that returns it late
| In short: Section 35(b)(ii) disallows the sum paid to the non-resident where tax was deductible and not deducted, or deducted and not paid by the due date. The deduction returns in the tax year in which the tax is paid. Where the payer is saved by section 398(2), it is deemed to have deducted and paid on the date the payee filed its return. |
The disallowance reaches interest, royalty, fees for technical services or other sum chargeable under the Act payable to a non-resident outside India, or in India to a foreign company, on which tax is deductible under Chapter XIX-B and has not been deducted during the tax year, or after deduction has not been paid up to the due date. It is the second liability in the sequence and it is measured by the gross payment, not by the tax.
Relief is by deferral rather than forgiveness. Where tax is deducted in a subsequent year, or deducted in the tax year but paid after the due date specified in section 263(1), the sum is allowed as a deduction in computing the income of the tax year in which the tax has been paid.
The interaction with the certificate is the point worth carrying away. Where the payer fails to deduct but is not deemed an assessee in default under section 398(2), section 35(b)(ii) deems it to have deducted and paid the tax on the date on which the payee filed the return referred to in section 398(2). The deduction is therefore restored, but in the tax year of that return. Where the payee filed in a later year than the payment, the payer has still lost the deduction for the year it wanted it, and carries the cash-flow cost of that shift.
- Prosecution, limitation, and the appeal
| In short: Section 476 punishes failure to pay tax deducted at source to the credit of the Central Government, not failure to deduct. Section 398(5) bars an order after six years from the end of the tax year in which the tax was deductible, or two years from the end of the tax year of a correction statement, whichever is later. The order is appealable. |
Section 476(1)(a) is drawn around a person who fails to pay the tax deducted at source by him to the credit of the Central Government. A payer who never deducted is outside that limb. Where it does apply, punishment is simple imprisonment up to two years or fine or both where the tax exceeds fifty lakh rupees, up to six months where it exceeds ten lakh rupees but not fifty lakh, and fine in any other case. Section 476(2) removes the offence where the payment has been made to the credit of the Central Government on or before the time prescribed for filing the statement under section 397(3)(b).
On limitation, section 398(5) bars an order under section 398(1) deeming a person to be an assessee in default for failure to deduct after six years from the end of the tax year in which the tax was deductible, or after two years from the end of the tax year in which the correction statement is delivered under section 397(3)(f), whichever is later. The second limb can extend the period well beyond the first, so a correction statement filed late reopens the window rather than closing it.
An order under section 398 is appealable. Section 356(1)(d) provides an appeal to the Joint Commissioner (Appeals) and section 357(k) an appeal to the Commissioner (Appeals), the first being unavailable where the order was passed by or with the prior approval of an authority above the rank of Deputy Commissioner. The appeal is in Form No. 99 under Rule 167 of the Income-tax Rules, 2026, which replaced Form 35 under Rule 45 of the 1962 Rules. Section 358(3) fixes thirty days, running from the date of service of the notice of demand where the appeal relates to an assessment or penalty and in any other case from the date on which intimation of the order appealed against is served. Section 358(5) allows a late appeal on sufficient cause. Section 358(6) requires, before admission, that the assessee have paid the tax due on the income returned where a return has been filed, or an amount equal to the advance tax payable where none has.
The four liabilities, side by side
| Liability | Provision | Measured by | Does section 398(2) help? |
| Tax as assessee in default | Section 398(1), with section 391(3) | The tax not deducted or not paid | Yes. The deeming is removed on the certificate in Form No. 149 |
| Interest | Section 398(3)(a) | One per cent per month to deduction, one and a half per cent from deduction to payment | No. Section 398(3)(c) runs interest to the date the payee filed its return |
| Penalty for failure to deduct | Section 448 | The whole of the tax not deducted | No. The defence is reasonable cause under section 470 |
| Disallowance of the payment | Section 35(b)(ii) | The gross sum paid to the non-resident | Partly. The deduction returns in the year of the payee’s return, not the year of payment |
Frequently Asked Questions
Is an Indian payer liable if it did not deduct tax on a payment to a foreign company?
It is deemed an assessee in default under section 398(1) of the Income-tax Act, 2025 where it was required to deduct and did not, subject to section 391(3), which operates where the payee has also failed to pay the tax directly. The obligation itself arises only where the sum is chargeable to tax in India under section 393(2), Table Sl. No. 17.
What is Form No. 149 and when is it used?
Form No. 149 under Rule 221 of the Income-tax Rules, 2026 is the accountant’s certificate required by section 398(2). It certifies that the payee furnished a return under section 263, took the amount into account in computing income in it, and paid the tax due on the income declared. It replaced Form No. 26A under Rule 31ACB of the Income-tax Rules, 1962.
Does that certificate stop interest running?
No. Section 398(3)(c) provides that where a person is not deemed an assessee in default because of section 398(2), interest at one per cent per month or part is payable from the date the tax was deductible to the date of furnishing of the return of income by the payee. The certificate changes the end date of the interest period, not its existence.
How large is the penalty for failing to deduct?
Section 448 empowers the Assessing Officer to impose a penalty equal to the tax which the person failed to deduct. Section 470 provides that no penalty shall be imposed under section 448 if the person proves that there was reasonable cause for the failure, and the burden of proving it is on that person.
Is the payment disallowed in the payer’s own assessment?
Section 35(b)(ii) disallows a sum chargeable under the Act payable to a non-resident where tax was deductible under Chapter XIX-B and was not deducted, or was deducted and not paid by the due date. The sum is allowed in the tax year in which the tax is paid, and where section 398(2) applies the payer is deemed to have deducted and paid on the date the payee filed its return.
How long can an order be passed, and can it be appealed?
Section 398(5) bars an order for failure to deduct after six years from the end of the tax year in which the tax was deductible, or two years from the end of the tax year in which a correction statement is delivered under section 397(3)(f), whichever is later. The order is appealable under section 356(1)(d) or section 357(k), in Form No. 99 under Rule 167, within the thirty-day period fixed by section 358(3).
How R & D Law Chambers Works on These Matters
A withholding default is treated here as four proceedings, not one. The section 398 order, the interest computation, the section 448 penalty and the section 35(b)(ii) disallowance are decided separately and on different materials, and a defence that answers the first will not by itself answer the other three. What is put on the record in the section 398 proceeding about why the sum was thought not chargeable is also the material on which reasonable cause under section 470 is later argued, so the two are prepared together rather than in sequence.
The firm acts on both sides of the deduction, for payers facing short or non-deduction and for non-resident recipients whose treaty position is being tested through the payer. Where a remittance is still pending, the work moves to the section 395(2) determination, because a proportion fixed in advance is worth more than any defence available afterwards. The practice is led by a lawyer holding the Advanced Diploma in International Taxation of the Chartered Institute of Taxation, and the direct tax disputes practice is conducted from Ahmedabad.
Related services
- Withholding tax on payments to non-residents: advisory, certification support and dispute representation.
- Income tax assessments, reassessments and ITAT appeals: representation on section 398 orders, penalties and appeals.
- International taxation and cross-border tax planning and litigation: treaty positions, characterisation and taxable presence.
Related reading
- What is withholding tax: a guide for foreign businesses receiving payments from India: the recipient’s side of the same obligation.
- Lower and nil deduction certificates under section 395: Form No. 128 and Form No. 129, and the determination made before the remittance.
| This article is provided for general information only. It does not constitute legal or tax advice and does not create a lawyer-client relationship. Specific matters should be referred to qualified advisers. Practice led by Ravish Bhatt, dual-qualified lawyer (India and England & Wales), Bar Council of Gujarat (Enrolment G/504/2008), SRA (non-practising) Registration No. 492 477, ADIT (CIOT, London). |