• When the proposal for introducing section 40(a)(ia) was introduced in the Parliament, the words used in the proposal were ‘amount credited or paid to a contractor’.  However, when the proposal was passed by the Parliament, the words used in the section were changed to ‘amount payable to a contractor’.  The Parliament specifically replaced the words ‘credited or paid’ with the words ‘payable’.  Hence, the intention of law was to disallow only those expenses which were ‘payable’ and not the expenses that were paid or credited.
• The Legislature knew that if any amount was already paid, TDS could not be made there from.  If disallowance is made in respect of expenses paid without making TDS, it would result in a permanent disallowance since the tax payer could not recover the TDS from the payee.  This was the reason that the Parliament changed the words ‘credited or paid’ to ‘payable’
• Rule 30 of the Income-tax Rules, 1962 (‘Rules’) as it existed in AY 2005-06 provided the time limit for depositing the TDS after its deduction.  Where any sum was credited to the account of the payee on the date on the last day of the accounting period, the TDS could be deposited within 2 months from the date of credit.  In all other cases, the TDS was required to be deposited within 7 days of the following month.  This difference in time allowed for depositing the TDS also indicates that the terms ‘paid’ and ‘payable’ have different meanings and cannot be used interchangeably.
• If the language of the law is ambiguous or capable of more than one meaning, the Court should adopt the interpretation which favours the tax payer, particularly where the provision relates to imposition of a penalty.  Section 40(a)(ia) is a penal provision since it provides for disallowance of expenditure if TDS is not made.
• Hence, the disallowance should be only for Rs. 178,025/- being the amount payable at the end of the year and not for the entire expenditure of Rs. 41,18,253/-.

Contentions of the Revenue:

• The disallowance of expenditure for failure to make TDS should also cover the expenditure actually paid off during the year.  Liability to make TDS is a continuous liability and cannot be segregated between ‘paid’ and ‘payable’ amounts.
• The intention of law is that if the tax payer fails to make TDS on any expenditure incurred at any time during the year, the expenditure should be disallowed.
• If disallowance is made only for expenses outstanding at the end of the year, it would mean that there would not be any disallowance for failure to make TDS if the tax payer follows cash system of accounting.
• Rule 30 which provide the time limit for depositing the TDS is only a procedural matter and cannot override the provisions of the Act.

Tribunal’s Ruling:

There was a divergence of views between both the members of the Tribunal.  One of the members agreed with the arguments of the tax payer and the other member agreed with the arguments of the Revenue.  Hence, the matter was referred to a Special Bench which held as under:

• The legislature was aware of the fact that there may be a case where the amount is paid and there may be a case where the amount is payable.  The Parliament consciously replaced the words ‘credited or paid’ with the word ‘payable’ while enacting section 40(a)(ia). 
• Where the language of a section is clear, the intention of the legislature has to be gathered from the language used.
• In cash system of accounting, the tax payer would never be able to claim any deduction for any expenses that are payable.  Hence, there would be question of disallowing the same.
• As per Circular No.5 of 2005 issued by the CBDT, the intention behind inserting section 40(a)(ia) was to curb bogus payments by creating bogus liability
• Section 40(a)(ia) is a legal fiction and has to be limited to the area for which it is created.
• For all these reasons, disallowance under section 40(a)(ia) would be attracted only for those payments that are outstanding and payable at the end of the year.  If any expenditure is incurred and paid during the year without making TDS, the same cannot be disallowed, even though the tax payer would face consequences of failure to make TDS.

SKP’s comments:

For expenses where TDS is not made, the widely accepted practice adopted by the Tax Department and also by a large number of tax payers is to disallow the entire expenditure, whether or not the expenditure remains payable at the end of the year.

This judgment would be useful in cases where TDS is not made on certain expenses and the Tax Department is seeking to disallow the same during scrutiny assessment.  However, it is likely that the Tribunal’s ruling would be challenged by the Tax Department before the High Court.   Hence, reliance on this judgment could be aggressive and litigative.  This judgment should be relied upon only in cases where the tax payer has not made TDS, either inadvertently or through a difference in interpretation of law.  It is advisable that the tax payer should refrain from adopting a policy of not making TDS on expenses incurred and paid during the year.