11 June 2014 | Volume 7 Issue 2
Agra Bench rules that amendment to section 40(a)(ia) by way of second proviso is to avoid unintended hardship and hence, retrospective in nature

Section 40(a)(ia) of the Income Tax Act, 1961 (ITA) provides for disallowance of expenses on failure to deduct tax at source (TDS) or delay in depositing the tax so deducted beyond the due date for filing the return of income. The Finance Act, 2012 inserted a second proviso to section 40(a)(ia) with effect from 1 April 2013, providing that despite failure to deduct tax by the payer, disallowance of the expenditure shall not be made if the resident payee has:
  • furnished his return of income under section 139;
  • taken into account such sum while computing his income in such return;
  • paid the tax due on the income declared by him in such return of income and
  • furnishes a certificate to this effect from an accountant in the prescribed form.
The issue for consideration before the Agra Bench of the Income Tax Appellate Tribunal (hereafter referred to as ITAT) in the case of Rajeev Kumar Agarwal vs ACIT (I.T.A. No.337/Agra/2013) was whether the abovementioned proviso, which has been made effective from 1 April 2013, is retrospective in nature and accordingly, whether it would apply even with respect to earlier assessment years. The ITAT ruled in favour of the taxpayers following the judgement of the Delhi High Court (HC) in the case of CIT vs Rajinder Kumar (362 ITR 241).  A summary of this ruling is discussed in this alert.

Facts of the case
In the present case related to assessment year (AY) 2006-07, the taxpayer, Rajeev Kumar Agarwal, had made certain interest payments without deducting tax as applicable under section 194A of the ITA.  Therefore, the Assessing Officer (AO) disallowed the interest expense under section 40(a)(ia) of the ITA.

CIT(A)'s observation 
The taxpayer contended that the recipients of the interest had already included the income embedded in the interest payments in their tax returns filed under section 139 and that in view of the insertion of the second proviso to section 40(a)(ia), disallowance should not be invoked.

It was also contended that even though this proviso is stated to be effective from 1 April 2013, since the amendment is "declaratory and curative" in nature, it should be given retrospective effect from 1 April 2005, being the date from when sub clause (ia) of section 40(a) was inserted by the Finance (No. 2) Act, 2004.

The Commissioner of Income Tax (Appeals) (CIT(A)) relied on the Special Bench (SB) decision in the case of Bharati Shipyard Ltd vs Deputy Commissioner of Income Tax (DCIT) (141 TTJ 129) and upheld the order passed by the AO.  Some of the important principles and deciding factors in the ruling of the SB decision are reproduced below:
  • The SB dealt with a similar issue with respect to the first proviso to section 40(a)(ia) which was introduced by the Finance Act, 2010 and which extended the period of TDS payment upto the due date of filing the return of income not only in respect of tax deducted for the month of March but even in respect of the earlier 11 months for not disallowing the expenses under section 40(a)(ia).
  • The SB summed up the settled legal position to the effect that "any amendment of the substantive provision which is aimed at removing unintended consequences to make the provisions workable has to be treated as retrospective notwithstanding the fact that the amendment has been given effect prospectively".
  • It however held that if the consequences sought to be remedied by the subsequent amendments were to be treated as "intended consequences", the amendment could not be treated as retrospective in effect.
  • The SB was of the considered view that "the objective sought to be achieved by bringing out section 40(a)(ia) is the augmentation of TDS provisions". It was further observed that "this is the cost which parliament has awarded to those assessees who fail to comply with the relevant provisions by considering overall objective of boosting TDS compliance"
  • Thus, the amendment made in the first proviso was held to be prospective because, in the wisdom of the SB, section 40(a)(ia) as it stood prior to amendment in the first proviso was an "intended consequence" of the provision of section 40(a)(ia).
Issues before the ITAT
The main issue before the ITAT was whether the 2012 amendment of inserting a second proviso to section 40(a)(ia) was retrospective in nature and whether the benefit of the same would apply to AY 2006-07.

ITATís observation and ruling
The ITAT relied on the decision of the Delhi High Court in the case of CIT vs Rajinder Kumar, wherein it was held that 'the amended section 40(a)(ia) expands and further liberalises the statute when it stipulates that deductions made in the first eleven months of the previous year but paid before the due date of filing of the return, will constitute sufficient compliance". The ITAT considered the following while deciding on the matter:
  • Observations of the HC on the object of section 40a(ia): "The provision should be interpreted in a fair, just and equitable manner"
    • The HC recognised the bigger picture of realisation of legitimate tax dues as the object of section 40(a)(ia).
    • The ITAT considered this approach as qualitatively different from perceiving the object of section 40(a)(ia) as awarding of costs on the "assessees who fail to comply with the relevant provisions by considering the overall objective of boosting TDS compliance", thus disapproving the conclusion arrived at by the SB (supra).
  • Overall scheme of section 40a(ia)
    • The underlying objective of section 40(a)(ia) was to disallow deduction in respect of expenditure in a situation in which the income embedded in related payments remains untaxed due to non-deduction of tax at source by the taxpayers.
    • A deduction for expenditure is not allowed to the taxpayers, in cases where taxpayers had tax withholding obligations from the related payments, without corresponding income inclusion by the recipient.
    • On a conceptual note, primary justification for such a disallowance is that such a denial of deduction is to compensate for the loss of revenue by corresponding income not being taken into account in computation of taxable income in the hands of the recipients of the payments.
    • Section 40(a)(ia) cannot be seen as intended to be a penal provision to punish the lapses of non-deduction of tax at source from payments for expenditure. It is a sort of compensatory deduction restriction for income going untaxed due to tax withholding lapse.
    • The penalty for tax withholding lapse per se is separately provided for in section 271C of the ITA, and, section 40(a)(ia) does not add to the same.
In view of the above, the ITAT observed that "the provisions of section 40(a)(ia), as they existed prior to insertion of second proviso thereto, went much beyond the obvious intentions of the lawmakers and created undue hardship even in cases in which the taxpayers'  tax withholding lapses did not result in any loss to the exchequer."

Thus, the ITAT held that insertion of the second proviso is a curative amendment to avoid unintended consequences and is to be treated as retrospective in nature.
SKP's Comments
This is certainly a welcome ruling for all assessees. Not only has it provided much-needed clarity on the retrospective/prospective applicability of the second proviso of section 40(a)(ia) but has also re-emphasised the fact that the legislative purpose and the object behind its introduction must be given due regard. This view has been endorsed by the Supreme Court in several of its judgements. The Delhi HC had relied on one such judgement namely, R B Jodha Mal Kuthiala vs CIT (80 ITR 570) of the Supreme Court where the court ruled that "a proviso which supplies an obvious omission in the section and is required to be read into the section to give the section a reasonable interpretation, requires to be treated as retrospective in operation so that a reasonable interpretation can be given to the section as a whole."

This judgement will surely bring relief to taxpayers whose proceedings are pending before the appellate authorities for earlier years.   

19 Adi Marzban Path | Ballard Estate | Fort | Mumbai 400 001 | India   
+91 22 6730 9000 | skp.tax@skpgroup.com | www.skpgroup.com

Mumbai | Pune | Hyderabad | New Delhi | Chennai  | Bangalore

This SKP Tax Alert contains general information existing at the time of its preparation only. It is intended as a news update and is not intended to be comprehensive nor to provide specific accounting, business, financial, investment, legal, tax or other professional advice or opinion or services. This tax alert is not a substitute for such professional advice or services, and it should not be acted on or relied upon or used as a basis for any decision or action that may affect you or your business. Before making any decision or taking any action that may affect you or your business, you should consult a qualified professional adviser and also refer to the source pronouncement/documents on which this tax alert is based. It is also expressly clarified that this tax alert is not a solicitation or an invitation of any sort whatsoever or a source of advertising from SKP Group or any of its entities to create any adviser-client relationship.

Whilst every effort has been made to ensure the accuracy of the information contained in this tax alert, this cannot be guaranteed, and neither SKP Group nor any related entity shall have any liability to any person or entity that relies on the information contained in this publication. Any such reliance is solely at the user's risk.