Section 398 of the Income-tax Act, 2025 deems a person who fails to deduct, collect or pay tax to be an assessee in default, with interest at 1% a month from the date deductible to deduction and 1.5% from deduction to payment.
What section 398 does
Section 398 is the consequences provision for TDS and TCS defaults — the successor to section 201 of the Income-tax Act, 1961. It answers three questions: who is in default, what interest applies, and when the default is excused.
The interest is asymmetric and deliberately so. It runs at 1% for every month or part of a month from the date tax was deductible or collectible to the date it is actually deducted or collected; and at 1.5% for every month or part of a month from the date it was deducted or collected to the date it is actually paid. Holding on to money already deducted costs half as much again.
The safe harbour in sub-section (2) is the provision most often relied on. A deductor is not deemed to be in default if the payee has filed a return, taken the amount into account in computing income, and paid the tax — and the deductor furnishes an accountant's certificate to that effect in the prescribed form.
The Income-tax Act, 2025 takes effect from 1 April 2026 and applies from tax year 2026-27. The Income-tax Act, 1961 continues to govern every year up to 31 March 2026, including assessments, appeals and penalties for those years, because of the repeal and savings provision in section 536. Figures quoted here are the amounts written into the Act as enacted (with the Gazette corrigenda of 3 September 2025); the annual Finance Act can change rates and thresholds.
Old Act and new Act, side by side
The table below shows what the Income-tax Act, 1961 did and where the same ground is covered in the Income-tax Act, 2025.
| Income-tax Act, 1961 | What it did | Income-tax Act, 2025 |
|---|---|---|
| 201(1) | Assessee in default | 398(1) |
| 201(1), proviso | Safe harbour where the payee has paid the tax | 398(2) |
| 201(1A)(i) | 1% interest to the date of deduction | 398(3)(a)(i) |
| 201(1A)(ii) | 1.5% interest to the date of payment | 398(3)(a)(ii) |
| 201(1A), proviso | Interest where the safe harbour applies | 398(3)(c) |
| 206C(6A) and (7) | Same consequences for TCS | 398 |
| 271C | Penalty for failure to deduct | 448 |
Section 398 sub-section by sub-section
Read this alongside the bare text — each heading below is a sub-section of the section as enacted.
Sub-section (1) — who is deemed to be in default
If a person, including the principal officer of a company, who is (a) required to deduct or collect any amount, or (b) an employer referred to in section 392(2)(a) — one who opted to bear tax on a non-monetary perquisite — does not deduct or pay, does not collect or pay, or after deducting or collecting fails to pay the whole or part of the tax, that person is deemed to be an assessee in default, in addition to any other consequences.
Sub-section (2) — the payee-has-paid safe harbour
Irrespective of sub-section (1), a person who fails to deduct, or a person responsible for collecting under section 394(1) (Table serial numbers 1 to 5 and 9) who fails to collect, is not deemed to be an assessee in default if the payee, buyer, licensee or lessee has (i) furnished his return under section 263; (ii) taken the amount into account in computing income in that return; and (iii) paid the tax due on the income declared — and the person furnishes an accountant's certificate to that effect in the prescribed form.
Note what the safe harbour does not cover
Sub-section (2) applies to a failure to deduct or collect. It does not protect a person who deducted the tax and failed to deposit it — that remains a default under sub-section (1), attracts 1.5% interest, and carries prosecution exposure under section 476.
Sub-section (3)(a) — the two interest rates
Interest is payable at 1% for every month or part of a month on the tax, from the date it was deductible or collectible to the date it was deducted or collected; and at 1.5% for every month or part of a month from the date it was deducted or collected to the date it was actually paid.
Sub-sections (3)(b) and (c) — when interest is paid and the safe harbour case
The interest shall be paid before furnishing the statement under section 397(3)(b). And where the person is not deemed to be in default under sub-section (2), interest still runs — under clause (3)(c) — from the date the tax was deductible to the date the payee furnished the return. The safe harbour removes the default status and the tax demand, not the interest for the period of delay.
Worked example
A company should have deducted ₹5,00,000 of tax on 15 May 2026.
| Scenario | Facts | Consequence under section 398 |
|---|---|---|
| A | Deducted on 15 May, deposited 7 June — on time | No default |
| B | Deducted 15 May, deposited 20 December 2026 | Assessee in default for the delay; 1.5% a month from 15 May to 20 December; prosecution exposure under section 476 unless deposited before the statement due date |
| C | Never deducted; the vendor filed its return, included the income and paid the tax | Not deemed in default under sub-section (2), provided an accountant's certificate is furnished; but 1% interest still runs to the date the vendor filed |
| D | Never deducted; the vendor did not file a return | Assessee in default for ₹5,00,000 plus 1% interest, and penalty under section 448 |
Scenario C is the one worth building into vendor management. The safe harbour requires all three payee conditions and the accountant's certificate — a vendor's verbal assurance is not enough. And even then, interest at 1% runs for the period of the delay under clause (3)(c).
Scenario B shows why the two rates differ. Money that was deducted belongs to the Government, and the 1.5% rate reflects that.
Compliance checklist and due dates
- Deduct on time; if a deduction was missed, obtain the accountant's certificate under sub-section (2) with evidence that the payee returned and paid the tax.
- Remember the safe harbour covers a failure to deduct or collect, never a failure to deposit tax already deducted.
- Compute interest at 1% to the date of deduction and 1.5% to the date of payment, counting part months in full.
- Pay the interest before furnishing the statement under section 397(3)(b), as clause (3)(b) requires.
- Note that the safe harbour still leaves interest running to the date the payee filed the return — clause (3)(c).
- Track the TCS limb: sub-section (2) applies only to serial numbers 1 to 5 and 9 of the section 394(1) table.
- Expect penalty under section 448 for failure to deduct and prosecution under section 476 for failure to deposit.
Common mistakes
- Relying on the payee having paid the tax without obtaining the accountant's certificate.
- Assuming the safe harbour protects a failure to deposit deducted tax; it does not.
- Applying 1% throughout instead of switching to 1.5% from the date of deduction.
- Treating part months as fractions; each part month attracts a full month's interest.
- Overlooking that the TCS safe harbour is limited to specified serial numbers of the section 394(1) table.
This is an explanatory guide, not tax advice, and it does not reproduce the section in full. Read the bare text of the section before you rely on it, and check for later amendments, the Income-tax Rules made under the new Act, and CBDT circulars and notifications.