Disallowance for non-deduction of TDS - Supreme Court interprets ’amount payable’

The Honorable Supreme Court of India in a recent Judgment in the case of Palam Gas Agencies ltd.  set at rest a controversy which had been raging in the Income Tax circles from 2012. The moot question before the Hon’ble Supreme Court was whether the expression “payable” used in Section 40(a)(ia) means payable at the end of the year or payable at any time during the year though paid during the year itself.

Background

Section 40(a)(ia) was introduced in the Income Tax Act, by the Finance Act, 2004 with effect from 1-4-2005 with a view to augment the revenue through the mechanism of deduction of Tax at source. This provision was brought on the statute to disallow the claim of even genuine and admissible expenses of the assessee under the head 'Income from Business and Profession' in case the assessee does not deduct Tax at Source [TDS] on such expenses. The default in deduction of TDS would result in disallowance of expenditure on which such TDS was deductible.

While enacting the above provision the legislature stated that it  proposed to extend the provisions of section 40(a)(i) to payments of interest, commission or brokerage, fees for professional services or fees for technical services to residents, and payments to a resident contractor or sub-contractor for carrying out any work (including supply of labour for carrying out any work), on which tax has not been deducted or after deduction, has not been paid before the expiry of the time prescribed under sub-section(1) of section 200 and in accordance with the other provisions of Chapter XVII-B. …in order to ensure compliance with the TDS provisions.

In 2012, the majority view of a Special Bench of the Income Tax Appellate Tribunal [see end note 1] had given a conclusion that provisions of section 40(a)(ia) are applicable only to the amounts of expenditure which are payable as on the date 31st March of every year and it cannot be invoked to disallow expenditure which has been actually paid during the previous year, without deduction of TDS.

This view was overruled by the High Court of Calcutta in the case of Crescent Export Syndicate [see end note 2]. A view similar to that of the Calcutta High Court was taken by the Punjab & Haryana High Court as well as the Madras High Court [see end note 3].

The Allahabad High Court in the case of Vector Shipping Services Pvt. Ltd. [see end note 4] however approved the decision of the Special Bench in the case of Merilyn Shipping & Transports.

The case of Palam Gas Agencies before the Supreme Court

The assessee in the case on hand had made a sub-contract with three persons towards freight within the meaning of Section 194C of the Act and, therefore, he was liable to deduct tax at source from the payment of Rs. 20,97,689/-. On account of his failure to do so the said freight expenses were disallowed by the Assessing Officer as per the provisions of Section 40(a)(ia) of the Act. The assessee argued that that since the amounts had already been paid, it can straightaway be concluded, that such amounts would not be covered within the mischief of Section 40(a)(ia), that Section 40(a)(ia) would apply only when the amount remains 'payable' at the end of the year.

 Against the order of the Assessing Officer, the assessee preferred an appeal before the Commissioner of Income Tax (Appeals), Shimla who vide order dated August 17, 2012 upheld the order dated November 30, 2011. The matter thereafter came up in appeal before the Income Tax Appellate Tribunal (for short 'ITAT') which too met with the same fate. In further appeal to the High Court under Section 260A of the Income Tax Act, the outcome remained unchanged as the High Court of Himachal Pradesh also dismissed the appeal affirming the order of the ITAT.

Observations of Supreme Court

The Supreme Court was of the view that when the entire scheme of obligation to deduct the Tax at Source and paying it over to the Central Government is read holistically, it cannot be held that the word 'payable' occurring in Section 40(a)(ia) refers to only those cases where the amount is yet to be paid and does not cover the cases where the amount is actually paid. If the provision is interpreted in the manner suggested by the appellant , then even when it is found that a person, like the appellant, has violated the provisions of Chapter XVIIB (or specifically Sections 194C and 200 in the instant case), he would still go scot free, without suffering the consequences of such monetary default in spite of specific provisions laying down these consequences. Insofar as judgment of the Allahabad High Court is concerned, a reading thereof would reflect that the High Court, after noticing the fact that since the amounts had already been paid, it straightaway concluded, without any discussion, that Section 40(a)(ia) would apply only when the amount is 'payable' and dismissed the appeal of the Department stating that the question of law framed did not arise for consideration. Thus, though, the Special Leave Petition there against was dismissed in limine, itwould not amount to confirming the view of the Allahabad High Court.

In view of the aforesaid discussion, the Honorable Supreme Court held that the view taken by the High Courts of Punjab & Haryana, Madras and Calcutta is the correct view and the judgment of the Allahabad High Court in CIT v. Vector Shipping Services (P) Ltd., [2013] 357 ITR 642 did not decide the question of law correctly.

To conclude,

The elaborate judgment of the Supreme Court has in this decision analyzed the provisions of section 40 (a)(ia) and set at rest a controversy caused by the judgement of the Special Bench of the Income Tax Appellate Tribunal at Vishakhapatnam in the case of Merlyn Shipping & Transports Pvt. Ltd. which had opened a Pandora’s Box as it were and which should not have existed in the first place.
 
[The author is a Principal Associate, Direct Tax Practice, Lakshmikumaran & Sridharan, Bengaluru]