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28 十月 2015

Month-end Provisions and Reversal – Is TDS called for?

by Rajat Juneja

Problem Statement

Multi-national enterprises (MNEs) do make monthly provision for various expenses in their ERP system at the end of each month. This might be a nearer approximation of the expenditure to be incurred. It is a method of generating a debit entry in the accounting system for an expenditure relating to, say, engineering, R&D, logistics, legal & professional charges or administrative expenses – based on their monthly budgeting process.  
This is done primarily for two reasons:

  1. The parent company ought to know the true and fair view of the profit or loss earned during the respective month/quarter/half year or on an annualised basis.
  2. To amortise a provision for big ticket expense, which is budgeted and is accrued or is incurred over a period of time.

Accrual being one of the fundamental accounting assumptions requires that the provisions for expenses are recorded, as and when they are incurred or accrued.

AS-29[see end note 1] attempts to distinguish ‘provisions’ with ‘contingent liabilities’ and provides that ‘provisions’ are present obligations, i.e., its existence is considered probable (more likely than not), while ‘contingent liabilities’ are possible obligations, i.e., its existence is considered not probable.

Typically, such provisions are made on the last date of the every month, quarter or half yearly or annually, as the case may be, and usually reversed on the first day of the subsequent month /quarter / half year or year respectively. Usually, such provisions are made on estimated basis or on historical data base available in some cases.

The tax deduction provisions require that the payer should deduct taxes at source at the time of payment or credit to the account of payee, whichever is earlier. Further, it also provides that if the relevant amount is credited to a ‘suspense account’ or ‘any other account’ by whatever name called, even then it calls for deduction of tax at source.

Of late, the issue that whether the payer should be treated as ‘assessee in default’ under section 201(1) of the Act [see end note 2] for not deducting tax at source on the year end provisions and whether the interest under section 201(1A) of the Act is leviable in such cases, has gained significance. Perplexed and wary of such situations, the payers are taking varied stands.

 

Legal framework

The crucial words in all the respective provisions relating to tax deduction at source are ‘at the time of credit of such income to the account of payee or at the time of payment thereof…….. whichever is earlier’.

Thus, where such sum is (a) paid to the account of payee or (b) liability in respect thereof is booked with a corresponding credit to the account of payee, whichever is earlier, the obligation to deduct tax will trigger at that point of time.
 
Tax deduction was circumvented by large number of payers by adopting device of crediting the sum to ‘suspense account’ and it was easier for the payers in such cases to take a stand that though the liability was booked, so far as it was not credited to the account of the payee, tax thereon was ought not to be deducted. With a view to plug that loophole the Finance Act, 1987 first introduced the Explanation in section 194A of the Act to provide that, “where any income by way of interest is credited to any account, whether called ‘Interest payable account’ or ‘Suspense account’ or by any other name in the books of account of the person liable to pay such income, such crediting shall be deemed to be the credit of such income to the account of the payee………”

Similar amendment was later brought at relevant places in some of the other tax deduction provisions as well. Since then, the issue has been a subject matter of big dispute and there has been contradictory ruling on this aspect; let us have a look at the key findings of some of these rulings.

Pfizer’ case[see end note 3]- The provision for expenses was made without crediting the same to the accounts of the respective payees. The payer disallowed the entire expenditure in respect of the said provision under section 40(a)(i) and 40(a)(ia) of Act. In the next year the entire provision for expenses was reversed and the actual amounts paid to the respective payees were credited to their respective accounts after deducting tax thereon. On these facts, the Tribunal held that (a) as the payees were not identifiable, the tax deduction provisions were not applicable, the whole scheme of tax deduction is based on the assumption that the payer knows the identity of the payee, and (b) once the amount has been disallowed under section 40(a)(i) of the Act, it cannot be again subjected to deduction of tax.

IBM’s case [see end note 4]- On similar set of facts, as stated in Pfizer’s case (supra), the Tribunal held that, (a) once there is a disallowance under Section 40(a)(i) and 40(a)(ia) of the Act, it is not possible to argue that there was no liability to deduct tax at source, (b) it is clear from the statutory provisions that the liability to deduct tax at source exists when the amount is credited to a ‘suspense account’ or any other account by whatever name called, which will also include a ‘provision’ created in the books of accounts, (c) the argument, that there is no accrual of expenditure as per the mercantile system of accounting since the payee is not identified, is not tenable and (d) the statutory provisions clearly envisage ‘collection at source’ de hors the ‘charge under Section 4(1) of the Act’.

Ericsson’s case[see end note 5]- On similar set of facts, the High Court held that the machinery sections of collection and recovery of tax cannot be read in isolation of the charging provisions. The credit of any sum to the account of payee would be subject to tax deduction only if credit of such amount reflects accrued income in the hands of the payee, which is chargeable to tax under the Act. The High Court further observed that, the rationale for imposing an obligation to deduct tax at source on a credit entry being passed by a payer in favour of payee, is that such entry represents an acknowledgement of debt by a payer in favour of a payee; the debt acknowledged is in respect of an income that has accrued in favour of the payee; and such income is exigible to tax under the Act. The High Court concluded that mere passing of book entries, which are reversed, would not give rise to an obligation to deduct tax at source by the payer, as clearly, there is no debt that can be said to be acknowledged.

Thus, the following important ratios emerge which may be determinative:

  • where the payees were not identifiable, the tax deduction provisions are not applicable,
  • once the amount has been disallowed under section 40(a)(i) of the Act, it cannot be again subjected to deduction of tax,
  • mere passing of book entries, which are reversed, would not give rise to an obligation to deduct tax at source by the payer, since there is no debt that can be said to be acknowledged

However, given the aforesaid ratios, we still have two different tribunals with dramatically opposite conclusions and one High Court ruling amidst which one is left with no clear stand to adopt and follow.

There could be following two situations under which the payer is obliged to deduct taxes:


a. where the liability has become due but is not paid

b. where the liability has not become due but is paid
 

In case (a), the obligation to deduct taxes arises at the time of credit and, in case (b), such obligation arises at the time of payment.
However, there can be a third situation also,

c. where the liability itself has not become due and is not paid also
 

The revenue authorities in such cases seek to lay their hands on a sum, which is only an estimation of an eventual liability. This was never intended to be covered under the ambit of ‘tax deduction’ provisions. Similar view was also highlighted in CBDT Circular [see end note 6] issued in the context of section 194A of the Act.

 

Conclusion

Thus, mere book entries, being notional and interim in nature should ideally be not subjected to deduction of tax at source as per the relevant provisions of Act. With conflicting decisions of two Tribunals and one High Court decision to the rescue of the taxpayer, the legal position is quite perplexing for the taxpayers. However, since the accounts drawn up on a monthly/quarter/yearly basis are not final and subject to the test of law, it is fair to conclude that mere book entries and reversal shall not be subjected to the rigours of the provisions relating to deduction of tax.

[The author is a Principal Associate, Direct Tax Practice, Lakshmikumaran & Sridharan, Delhi]
 

End Notes:

  1. ‘Accounting Standard – 29’ on ‘Provisions, Contingent Liabilities and Contingent Assets’ issued by ICAI
  2. Income Tax Act, 1961
  3. Pfizer Ltd. v. ITO - (2013) 55 SOT 277 (Mum Trib.)
  4. IBM India (P.) Ltd. v. ITO (TDS) - (2015) 59 taxmann.com 107 (Bang. Trib.)
  5. DIT v. Ericsson Communications Ltd. (ITA No. 106/2002)
  6. Circular No. 3 of 2010 dated 2-3-2010

 

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