Releasing Income-Tax Refunds – A COVID Relief Measure Or A Statutory Obligation?

Advocate Sukhsagar Syal has explained the law relating to the grant of income-tax refunds in the context of the statutory provisions and the circulars issued by the CBDT. He has referred to all the important judgements on the subject including the latest judgement of the Supreme Court in Vodafone Idea Ltd vs. ACIT. He has opined that the legislature should stipulate a time limit for grant of refund to avoid unnecessary hardship to taxpayers

Under the directive of the Ministry of Finance, the Central Board of Direct Taxes (‘the Board’) announced (1) that in order to provide relief to small businesses and individuals, it had issued refunds worth Rs. 5,204 crores in the current fiscal year and that it intends to issue further refunds of Rs. 7,760 crores shortly. While the influx of any capital into the system in the current times is welcome, yet, it begs the question, whether this move really is an act of benevolence or is the Income-tax Department (‘the Department’) duty bound to pay back to the taxpayer, what rightfully belongs to him?

The object of this write-up is to analyse the important aspects of the law on income-tax refunds.

Article 265 of the Constitution states that ‘no tax shall be levied or collected except by authority of law.’ One can safely infer that the constitutional mandate to collect by the authority of law would also encompass the mandate to retain, only by the authority of law. The doctrine of ‘unjust enrichment’, which is embodied into every civilised legal system, also points towards the same principle. Lord Wright, in his oft-quoted judgment (2) , states that a system of law ‘is bound to provide remedies for cases of what has been called unjust enrichment or unjust benefit, that is, to prevent a man from retaining the money of, or some benefit derived from another which is against conscience that he should keep.’

In the Indian tax structure, the question of issuing refunds can arise at two possible stages- 1) Refunds arising from a return of income and 2) Refunds arising from a favourable appellate order.

I. Refunds arising from a return of income-

Background

The law on grant of refunds resulting from a return of income (‘return’) has undergone a significant change by the amendments brought in by the Finance Act, 2017. A return, once validly filed, is processed as per the steps provided under section 143(1) of the Income-tax Act, 1961 (‘the Act’). The last of such steps, under section 143(1)(e), provides for granting of the refund, if claimed in the return. In order to protect the interests of the revenue, sub-section (1D) was introduced by the Finance Act, 2012, which provided that the processing of a return ‘shall not be necessary’ in a case, where a notice under section 143(2) has been issued to carry out a scrutiny assessment. The Board understood (3) this amendment to mean that once a scrutiny notice was issued, the processing of the return was to stop and the consequential refund was not to be issued until the assessment was complete. The Instruction issued by the Board was challenged before the Delhi High Court and ultimately quashed (4) . The High Court clarified that the words ‘shall not be necessary’ used in sub-section (1D) only mean that a discretion has been given to the Assessing Officer (‘AO’) to process the return and issue refunds, notwithstanding the issue of a notice under section 143(2). There is no embargo on the AO’s power to issue a refund, even if the case has been selected for scrutiny. Subsequently, in a case (5) before the Bombay High Court, the Department argued that since the limitation to process a return under section 143(1) is one year from the end of the financial year in which the return is filed, it can, in no circumstance, be called upon to grant refunds before the expiry of such a period, since a refund can only be granted after the return is processed. Rejecting the Department’s argument, the Court explained that the limitation of one year to process a return is an outer limit, and there is no good reason why the refund should not be issued before such date, if found due. The Court reminded the Department of an Instruction (6) issued by the Board, wherein all the Officers were instructed to process the returns where refunds were payable, expeditiously. Terming the Department’s approach as ‘most disturbing’ and ‘in complete variance with the higher echelons of the tax administration being an assessee friendly regime’, the Court directed the AO to consider and process the assessee’s application within a period of 8 weeks from the date of the order.

In a case (7) recently decided by the Supreme Court, the assessee submitted, that in its case, the period for processing the return under the second proviso to sub-section (1) had expired and the AO had neither processed the return, nor passed any order stating that he had decided to withhold the refund under sub-section (1D). It was the assessee’s contention that the expiry of the time limit to process the return, coupled with the AO’s inaction, would amount to a deemed acceptance of the return and the AO was now obliged to grant the refund. Rejecting the assessee’s argument, the Supreme Court held that sub-section (1D) begins with a non-obstante clause, which overrides the provisions of sub-section (1). Such being the case, the time limit prescribed under the second proviso to sub-section (1) cannot be read into sub-section (1D). The Supreme Court further clarified, that in any event, sub-section (1D) does not require the AO to pass any order intimating the assessee, that its refunds are being withheld. The very fact that a notice under sub-section (2) has been issued and the refunds have not been granted meets the test of sub-section (1D), and no further compliance is solicited from the AO. The Supreme Court elucidated that the scheme of processing a return under section 143(1) and making of an assessment under section 143(3) are entirely different. Once a return has been picked up for scrutiny, it cannot form the basis for granting a refund. In such a circumstance, the processing of a return and the grant of a refund must await the outcome of the exercise under section 143(3). The Supreme Court’s verdict, therefore, overrules the judgments of both, Delhi and Bombay High Court (supra), and revives, although not explicitly, the Instruction (supra) issued by the Board. However, these finding are only with respect to the assessment years ending on or before 31st March, 2017, i.e. prior to the amendments brought in by the Finance Act, 2017.

Amendments by the Finance Act, 2017-

As stated herein earlier, this legislative structure, which gave complete autonomy to the AO on the decision to withhold or release refunds, underwent a change by way of the amendments brought in by the Finance Act, 2017. Sub-section (1D) of section 143, the provision enabling the AO’s discretion, was removed prospectively and section 241A was introduced. Section 241A reads as under-

“241A. For every assessment year commencing on or after the 1st day of April, 2017, where refund of any amount becomes due to the assessee under the provisions of sub-section (1) of section 143 and the Assessing Officer is of the opinion, having regard to the fact that a notice has been issued under sub-section (2) of section 143 in respect of such return, that the grant of the refund is likely to adversely affect the revenue, he may, for reasons to be recorded in writing and with the previous approval of the Principal Commissioner or Commissioner, as the case may be, withhold the refund up to the date on which the assessment is made.”

The introduction of this provision has meant that the AO can no longer hold back refunds by simply issuing a scrutiny notice. Under section 241A, he is now additionally required to pass an order in writing, setting out reasons therein, as to why the grant of refund, would in his opinion, ‘adversely affect the revenue’. Further, before passing such an order, he is required to take the Principal Commissioner or Commissioner’s approval.

While the order passed under section 241A is not appealable before any forum, there have been several instances, where such orders have been assailed before the High Courts by way of writs. In one of such cases (8) , the Delhi High Court has laid down a three-step process, which has to be followed by the AOs and examined by the Commissioners, in ascertaining whether the release of refunds will ‘adversely affect the revenue’ or not. Firstly, the AO must make a reasoned prima facie assessment of the probable additions that could be made. This should be followed by determining the possible quantum of such additions and the consequent tax effect thereof. Lastly, the AO must examine the financial standing of the assessee with respect to its ability to meet any demand for tax that may arise as a result of the scrutiny proceedings. The Court further clarified that this process should not be followed mechanically and the AO is expected to apply his mind to the relevant aspects. Echoing the same view is a judgment (9) of the Bombay High Court. The Court, in this case, held that an auto-generated response issued by the CPC, stating that refunds are being withheld in terms of section 241A will not be considered sufficient compliance of the section. This was for the reason that an auto-generated response shows that there is no application of mind and in any event, it is the competent AO, and not the CPC, which is required to pass an order under section 241A. In a case (10) before the Punjab and Haryana High Court, the Department pointed out that certain additions were made in the preceding assessment years and the same additions were likely to be made in the relevant assessment year as well. It was urged that if similar additions were made in the relevant assessment year, it would result in a sizeable tax demand, and therefore, the refunds should be held back. Rejecting this argument, the High Court held that the mere fact that additions may be made on the completion of the assessment, which would result in a tax demand, is not reason enough to withhold refunds. The Court expressed anguish at the conduct of the Department in holding back refunds without sufficient cause and remarked-

“Before parting, it is pertinent to note that in the present case and also from number of cases, it is evident that procedure for refund and withholding of refund is often being used as delaying tactics for various reasons including window dressing of collection of revenue. The method adopted is a short sighted vision. Apart from harassment to the assessee, it results in paying interest on the delayed amount of refund putting further burden on the exchequer. It cannot be lost sight of that trade and commerce is a life blood of the system, if the excess amount deposited as tax is not refunded to the entrepreneur/assessee, it has effect on the liquidity and business. There cannot be second opinion that the revenue collection and securing the interest of the revenue is of great importance, at the same time the revenue is to be collected like an apiarist extracts honey from beehive without destroying it.”

The Supreme Court, in the aforementioned judgment (11) , has clarified that the order passed under section 241A has to comply with two time limits. Firstly, it has to be passed after a notice under section 143(2) has been issued and secondly, it has to passed before the end of the time limit prescribed under section 143(1), i.e. one year from the end of the financial year in which the return is made.

Broadly, the new refund regime has had two main impacts. Firstly, the withholding of refund till the completion of assessment, which was earlier the norm, has now become an exception, since each withholding now requires the passing of a detailed and a well-reasoned order. Secondly, the new regime has taken away the absolute discretion, which earlier vested with the AO. In the current regime, the AO not only has to give reasons, those reasons have to be approved by the Commissioner and are susceptible to a challenge before the High Court under Article 226 of the Constitution.

While the new regime has brought in some much needed changes, it still does not address a critical gap in the process. Section 143(1) provides that a return is to be processed and an intimation determining the tax payable/refundable has to be sent before the expiry of one year from the end of the financial year in which the return is filed. The section also provides that once this intimation is sent, the refund, if due, is to be granted to the assessee. However, the provision is silent on the time limit, within which the actual refund is to be granted, after the intimation under section 143(1) has been issued. The limited guidance on this comes from the ‘Citizen’s Charter’ issued by the Board in 2014. The Charter is a declaration of the Department’s Vision and Mission. One of the declarations in the Charter is that all the refunds will be issued within a period of six months from the end of the month in which the return is filed. Unfortunately, this statement of vision has remained just that, a vision. Lacking any statutory mandate, this declaration has failed to traverse the boundaries of the paper that it is inked on. Although in the Finance Act, 2020, section 119A has been introduced, which empowers the Board to adopt and declare a ‘Taxpayer’s Charter’, the details thereof are yet to be notified. If the aspirations contained in the ‘Citizen’s Charter’ are to trickle down to the ‘Taxpayer’s Charter’, it would go a long way in furthering the Government’s case for a taxpayer friendly administration.

II. Refunds arising from a favourable order-

Section 240 of the Act provides that where, as a result of an order passed in appeal or any other proceeding under the Act, an assessee becomes entitled to a refund, the same must be granted, without the assessee having to make any claim in that regard. The provision entitles an assessee to a refund, not only from an order passed in appeal, but also from an order passed in any other proceeding under the Act, such as, section 154 or section 264 (12) .

A natural question which arises is that whether the Department is obligated to grant refund immediately upon the passing of an order favourable to the assessee, or can it withhold the same if it intends to challenge such an order in further appeal. The erstwhile section 241 is of some guidance on this. Section 241 contemplated three situations, where refunds could be withheld by an AO- (1) where a notice under section 143(2) was issued or was likely to be issued, (2) where the order resulting in the refund was subject matter of a further appeal or (3) where there was any other proceeding pending under the Act; and in any of the above three situations, the AO was of the opinion that the grant of refund was likely to adversely affect the revenue. This provision was omitted by the Finance Act, 2001. As mentioned earlier, section 241A, introduced by the Finance Act, 2017, only permits the AO to hold back refunds where a notice under section 143(2) has been issued and the AO believes that the granting of refund is likely to adversely affect the revenue. Therefore, the new section has only incorporated one of the three situations of the erstwhile section. There is a strong presumption that the legislature, in enacting a statute, is aware of the statutes previously enacted on the same subject matter (13) . This could only mean that the Legislature does not intend to empower the AO to withhold a refund arising from an order passed under the Act [situation (2) of the erstwhile section 241], even if the Department intends to challenge such an order in further appeal.

The lacuna in the first category of refunds, i.e., those arising from a return, is present in this category as well. The entire scheme of sections is conspicuously silent on the time limit within which the refunds are to be granted, once a favourable appellate or other order is passed. Once again, the ‘Citizen’s Charter’ states that the time limit of one month is intended to be followed, but owing to the lack of any statutory mandate, this time limit has been of no significance.

In a case (14) before the Gujarat High Court, the Petitioner was yet to receive its refunds arising from a favourable order of the Commissioner (Appeals) passed over 9 years ago. The Department argued that the order had been the subject matter of further appeals before the Tribunal and then the High Court, therefore, the refunds were held back. Rebuking the Department’s conduct and imposing a cost of Rs. 1 lac on the concerned AO, the High Court held that even though there was no time limit in the Statute, the refunds were to be issued within a reasonable time. The following remarks are noteworthy-

“10. It is well settled legal proposition that an order passed by the judicial or quasi judicial authority should be implemented within a reasonable period; if no specific time frame is provided in such order. The aggrieved person may reasonably pursue the appeal options but not wait indefinitely to implement the adverse order. Mere pendency of the appeal would not prevent implementation of the order under challenge. Unless the order is stayed, the same must be given effect to within a reasonable period.”

Conclusion

Justice M.S. Sanklecha (as he then was), expressed displeasure at the sorry state of affairs in the Department’s machinery, when it comes to handling refund claims. He had the following to remark (15) –

“Similarly, as late as in 2014 in the Citizen’s Charter issued by the Income Tax Department in its vision statement states that the Department aspires to issue refunds along with interest under Section 143(1) of the Act within 6 months from date of electronically filing the returns… there is no reason why the Assessing Officer has not processed the refund and taken a decision to grant or not grant a refund under Section 143(1D) of the Act. This attitude on the part of the Assessing Officer leaves us with a feeling (not based on any evidence) that the Officers of the Revenue seem to believe that it is not enough for the assessee to please the deity (Income Tax Act) but the assessee must also please the priest (Income Tax Officer) before getting what is due to him under the Act. The officers of the State must ensure that their conduct does not give rise to the above feeling even remotely.”

The judicial experience would show that the High Courts have been more than compassionate in stepping in and directing the grant of refunds where the taxpayers have been hard done by the Department. The sheer amount of litigation on enforcing tax refunds and an overwhelming percentage of judgments in favour of the taxpayers is indicative of the fact that there is something amiss in the tax administration, whilst dealing with refunds.

As early as in 1955, the Board issued a Circular (16) directing its Officers to be prompt and enterprising in dealing with refund claims. It was stated therein “2. Complaints are still being received that while Income-tax Officers are prompt in making assessments likely to result into demands and in effecting their recovery, they are lethargic and indifferent in granting refunds and giving reliefs due to assessees under the Act. Dilatoriness or indifference in dealing with refund claims (either under section 48 or due to appellate, revisional, etc., orders) must be completely avoided so that the public may feel that the Government are equally prompt and careful in the matter of collecting taxes and granting refunds and giving reliefs. This attitude would, in the long run, benefit the Department, for it would inspire confidence in him that he may be sure of getting a square deal from the Department. Although, therefore, the responsibility for claiming refunds and reliefs rests with assessees on whom it is imposed by law, Officers should— ( a ) draw their attention to any refunds or reliefs to which they appear to be clearly entitled but which they have omitted to claim for some reason or other; ( b ) freely advise them when approached by them as to their rights and liabilities and as to the procedure to be adopted for claiming refund, and reliefs.” 

The ‘Taxpayer’s Charter’, which is to be adopted and declared by the Board soon under section 119A, would show whether or not the directions contained in the Circular were sincere. Hope floats!