Volume 6, Issue 11

1 July 2013

Tax Alert

Expense ‘paid’ during the year without deduction of tax – Should disallowance be effected under Section 40(a)(ia) of the Income Tax Act, 1961?

The Special Bench of the Vishakhapatnam Income Tax Appellate Tribunal in the case of M/s. Merilyn Shipping & Transports vs. ACIT, Range – 1, Vishakhapatnam (ITA No. 477/Viz/2008) had held that the provisions of Section 40(a)(ia) of the Income Tax Act, 1961 (ITA) are applicable only with respect to the amount ‘payable’ at the end of the year and would not apply to the amount actually ‘paid’ during the year. Section 40(a)(ia) of the ITA provides for the disallowance of expenditure on which tax is deductible at source (TDS) and has not been deducted or after deduction has not been deposited with the government treasury. Also, in this decision of the Tribunal, there were dissenting views between the Accountant Member and the Judicial Member, wherein the Accountant Member was of the view that the provisions of Section 40(a)(ia) would apply not only to the amount remaining outstanding at the end of the year but even to the amount paid during the year, whereas the Judicial Member was of the view that they would apply only to the amount remaining outstanding at the end of the year. Due to the difference in opinion between the two members of the Tribunal, the matter was referred to the Vice President of the Tribunal who concurred with the view of the Judicial Member to hold that the provisions of Section 40(a)(ia) would apply only to the amount remaining outstanding at the end of the year. This decision was also discussed in our Tax Alert “Disallowance of expense due to non deduction of tax at source” dated 24 April 2012. Thereafter, the Andhra Pradesh High Court had issued an interim suspension order on this order of the Tribunal. This tax alert discusses the decision on a similar issue that came up recently before the Kolkata High Court in the case of CIT vs. Crescent Export Syndicate (ITAT 20 of 2013).

Issue before the High Court

Whether the provisions of Section 40(a)(ia) are applicable to the amount ‘paid’ during the year and not only to the amount ‘payable’ at the end of the year.

Contentions of the Revenue

The Revenue mainly relied on the following observations made by the Accountant Member in the case of Merilyn Shipping & Transports:

  • The terms ‘credited’ or ‘paid’ come within the ambit of the term ‘payable’ and therefore, the two terms ‘credited or paid’ were superfluous and were accordingly dropped while inserting the final provisions of Section 40(a)(ia).
  • Section 40(a)(ia) is to be interpreted harmoniously with Chapter XVII-B as its operation solely depends on the provisions contained in that Chapter. Various sections of the chapter make it clear that it is mandatory to deduct tax on any amount paid or credited. Thus, based on harmonious construction, the term ‘payable’ in Section 40(a)(ia) cannot be read independently from the provisions relating to TDS contained in Chapter XVII-B.
  • Section 40(a)(ia) is applicable irrespective of the method of accounting followed by the taxpayers. Thus, if TDS is not deducted on the amount paid, the provision will stand meaningless for taxpayers following the cash system.            
  • The intention of the Legislature was to include payables during the whole year. If the Legislature’s intention was to include payables at year-end only, “outstanding as on 31 March” would have been mentioned.
  • The Revenue further contended that the term ‘paid’ as defined under Section 43(2) does not only include the amount paid but also the liability incurred according to the method of accounting followed. Thus, if ‘paid’ and ‘payable’ are assigned different meanings for Section 40(a)(ia), this section would become redundant.
  • The Revenue referred to the decision of the Madras High Court in the case of Tube Investments of India Ltd [325 ITR 610] wherein the constitutional validity of Section 40(a)(ia) had been examined. It was contended that though the specific issue regarding the term ‘payable’ was not discussed in this decision, the reading of the decision as a whole meant that if taxpayers’ contention is accepted and Section 40(a)(ia) is  not applied to cases where payment has been made before the year-end without deducting TDS, the purpose of the incorporation of Section 40(a)(ia) would be defeated.

Contention of the Taxpayer

  • The taxpayer relied on the judgement of the Vishakhapatnam Special Bench (supra) where the Tribunal held that only the amount remaining ‘payable’ at the end of the year on which tax is not deducted should be disallowed under Section 40(a)(ia). The main thrust, inter alia, of this decision was based on the premise that when the proposal for Section 40(a)(ia) was introduced in the Parliament by the Finance (No.2) Bill 2004, the words used in the proposal were ‘amount credited or paid.’ However, when the proposal was passed by the Parliament, the words used in the section were changed to ‘amount payable’. The Legislature specifically replaced the words ‘credited or paid’ with the words ‘payable’. Hence, the intention of law was to disallow only those expenses that were ‘payable’ at the end of the year and not the expenses that were paid during the year.
  • Such disallowance of expenditure may lead to double jeopardy i.e. on one hand the expenditure shall not be allowed to the taxpayer while on the other hand it shall be treated as the income of the recipient and tax shall be paid on the same. This could not have been the intention of the Legislature.
  • The taxpayer further contended that the Legislature was not in favour of creating undue hardship. This is clearly evident from the second proviso to Section 40(a)(ia) inserted by the Finance Act 2012. According to the proviso, even if an assessee has not deducted tax, he would not be considered as an assessee in default if the deductee has duly paid taxes on such income and produced proof of payment of such taxes to the deductor. In such circumstances, no disallowance is to be made under Section 40(a)(ia) in the hands of the deductor. Relying on this amendment, the taxpayer contended that the existing provisions of Section 40(a)(ia) should also be construed to apply only to those cases where payment is outstanding at the end of the year.

The High Court’s Ruling

Commenting on the judgement laid down in case of Merilyn Shipping, the High Court stated as under:

  • The Tribunal (supra) erred in comparing the draft law and the enacted law. It failed to appreciate the fact that only a comparison between pre-amendment and post-amendment law is permissible for the purpose of ascertaining the mischief sought to be remedied or the object sought to be achieved by an amendment. A draft or a bill cannot be used for the purpose of regulating the meaning and purpose of the law. The enacted law shall be the concluding will of the Legislature.
  • The Tribunal sought to remove the rigours of law and consequently, the Tribunal, by majority view, sought to supply additional meaning to Section 40(a)(ia), which is not permissible in law and could only be done by the Supreme Court in the appropriate case.
  • The High Court opined that the key words used in Section 40(a)(ia) are ‘on which tax is deductible at source under Chapter XVII-B’. This would mean all the amounts on which tax has not been deducted according to the provisions of Chapter XVII-B are to be disallowed and the words ‘payable’ or ‘paid or credited’ would not affect this provision. 
  • The Court declared that the provision was deliberately made harsh to ensure compliance and there was no ground to read the same in a manner that was not intended by the Legislature.
  • Thus, the High Court held that the provisions of Section 40(a)(ia) are applicable not only to the amount ‘payable’ at the end of the year but also to any expenditure that becomes payable at any time during the relevant year and was actually ‘paid’ during the previous year.

SKP’s Comments

The judgement rendered by the Special Bench in the case of M/s Merilyn Shipping & Transports vs ACIT is now reversed by the Kolkata High Court. The High Court being a superior forum than the Tribunal, the ratio of the High Court would have a binding precedent compared to the decision of the Tribunal. Thus, the decision rendered in Merilyn Shipping (supra) is no longer a good law. After the Kolkata High Court, the Gujarat High Court also upheld a similar view in the case of Sikandarkhan N Tunvar [2013] 22 taxmann.com 133 (Guj) and accordingly, provisions of Section 40(a)(ia) would also apply to the amounts paid during the year. According to us, the Kolkata High Court and Gujarat High Court made the right decision considering the intention and spirit of the provisions of Section 40(a)(ia).