It happens with businessman or companies that after the month of March, they realize that certain payments required tax deduction at source, but now that payment has been done and the financial year has passed, they are in searching or a solution to prevent from the tax authorities various proceedings for interest, penalty and prosecution.  This post is devoted to providing a clear road ahead for all such cases of innocent lapses. What are the consequences of non-deduction of tax at source? Let us first know all the consequences associated with non-deduction of tax at source. These are : Disallowance of expenditure u/s 40(a)(ia) Interest u/s 201(1A) of the Income Tax Act The penalty under section 271C Prosecution for failure to deduct the tax I am going to discuss each of the aforesaid consequences and what to do to save yourself from such consequences. Disallowance of expenditure u/s 40(a)(ia) It is well known that if you do not deduct tax and deposit to govt, 30% of the expenditure on which tax was required to be deducted shall be disallowed while computing your business (or professional ) income. However, there are two provisoes that give relief to a business taxpayer.  These are : 1. Pay next year, claim disallowed amount next year If you fail to deduct by 31st March but deduct and pay the TDS in after 31st March, the disallowed amount (30% ) can be claimed in the year of deduction. The excerpt of the proviso is given below Provided that where in respect of any such sum, tax has been deducted in any subsequent year, or has been deducted during the previous year but paid after the due date specified in sub-section (1) of section 139, thirty per cent of such sum shall be allowed as a deduction in computing the income of the previous year in which such tax has been paid : 2.  Claim deduction when deductee files return If you are not considered as deemed defaulter u/s 201 , then the proviso provides that the tds will be deemed to be deducted and paid to govt. on the date in which the deductee files tax return. That means that your 30% of the expenditure will be disallowed in the year of non-deduction, but shall be allowed in the year of the filing of the tax return by the deductee. Excerpt of the said proviso is as under : Provided further that where an assessee fails to deduct the whole or any part of the tax in accordance with the provisions of Chapter XVII-B on any such sum but is not deemed to be an assessee in default under the first proviso to sub-section (1) of section 201, then, for the purpose of this sub-clause, it shall be deemed that the assessee has deducted and paid the tax on such sum on the date of furnishing of return of income by the resident payee referred to in the said proviso 3. How to not to be deemed as defaulter? First of all, please note that the tag of the defaulter is deemed to be applied on you if you do not deduct tax or after deducting tax does not pay the tax to govt. However, the proviso to section 201 gives relief to you by not deeming you as defaulter if the following three conditions are satisfied The deductee has furnished his return of income under section 139; The deductee has taken into account such sum for computing income in such return of income; and The deductee has paid the tax due on the income declared by him in such return of income What if A.O issues notice u/s 201? You need to do following things that may compel him not to pronounce you a defaulter. Submit a cogent reply to his notice stating clearly a reason why you could not deduct the tax . This should be convincing. Submit a certificate (online ) in Form 26A signed by a chartered accountant In that case , A.O may not pass the order declaring you as a defaulter u/s 201. Interest u/s 201 of the Income Tax Act Whether or not you are declared as a defaulter u/s 201(1) , you will have to pay interest on the amount of tax not deducted as per section 201(1A) . But , as per the proviso, in case you are not considered defaulter, then the interest is to be charged from the date the TDS was required to the date of filing of return by the deductee. For example, suppose you did not deduct the tax at source while paying interest to company X  on 01/01/2018 (FY 2017-18) , . X company filed its return on 15/09/2018 and you were not declared defaulter by the A.O u/s 201, then, the interest u/s 201(1A) will be at the rate 1 % for the period of 9 months ( between 01/01/2018 to 15/09/2018) It is suggested you should deposit this interest amount on your own at the time of filing tax return. The penalty under section 271C The language of the provision for penalty u/s 271C  gives an impression that it is automatic when you fail to deduct the tax . But , it is guided by section 273B which says that penalty cannot be imposed if there was a reasonable cause for the failure to deduct the tax or pay the tax after deducting. In the case of Commissioner of Income Tax , New Delhi vs Eli Lilly & Co. (India) (P.) Ltd [2009] 312 ITR 225 (SC)/[2009] 223 CTR 20 (SC) Supreme Court explained the scope of section 271C read with section 273B  to say that only those persons will be liable to penalty who do not have good and sufficient reason for not deducting the tax at source as under : Section 271C, inter alia, states that if any person fails to deduct the whole or any part of the tax as required by the provisions of Chapter XVII-B, then such person shall be liable to pay, by way of penalty, a sum equal to the amount of tax which such person failed to deduct. In these cases, one is concerned with section 271C(1)(a). Thus, section 271C(1)(a) makes it clear that the penalty leviable shall be equal to the amount of tax, which such person failed to deduct. None can hold this provision to be mandatory or compensatory or automatic because under section 273B, the Parliament has enacted that penalty shall not be imposed in cases falling thereunder. Section 271C falls in the category of such cases. Section 273B states that notwithstanding anything contained in section 271C, no penalty shall be imposed on the person or the assessee for failure to deduct tax at source if such person or the assessee proves that there was a reasonable cause for the said failure. Therefore, the liability to levy penalty can be fastened only on the persons who do not have good and sufficient reason for not deducting tax at source. Only those persons will be liable to penalty who do not have good and sufficient reason for not deducting the tax at source. The burden, of course, is on the person to prove such good and sufficient reason.[Para 35] A similar decision was of Delhi High Court in Woodward Governor India P. Ltd v. CIT (2002) 253 ITR 745 (Del) wherein hon'ble high court held that  the " levy of penalty under section 271C is not automatic. Before levying penalty, the concerned officer is required to find out that even if there was any failure referred to in the concerned provision the same was without a reasonable cause. " There are numerous decision on this issue and now law is settled that deductor has a right and duty to show the "reasonable cause " for failure to deduct or pay the tax . If tax authority finds the reasonable cause sufficient and probable, pealty may not be imposed in such cases. Therefore , if you have failed to deduct the tax during the year , you must prepare a reasonable cause for such a failure. When you receive the notice u/s 271C , you need to argue your case that such a failure was not a deliberate attempt but on account of cerain facts and circumstances. Prosecution for failure to deduct the tax Good news is that failure to deduct the tax is not an offence under Income Tax Act. But if you deduct and did not pay or deduct less than what was required can also be tried under section 276BB of the Income Tax Act. So , if you forgot to deduct the tax during the year , then thereis no big danger of prosecution  u/s 276BB of the Income Tax Act.