Advocates Devendra Jain and Radha Halbe have pointed out that the disruption caused by the Covid-19 pandemic is likely to lead to defaults in payment of salaries, rent, business transactions, execution of contracts etc. The ld. authors have systematically analyzed the tax implications of these defaults and explained whether the income will still be assessable in the hands of the assessee. A plethora of important judgements have been referred to by the ld. authors in support of their analysis
In the wake of the ongoing Covid-19 crises, the country has seen unprecedented times and the downfall in terms of the socio-economic environment has directly affected people at large. Temporary disruptions of trade and commerce might stress many organisations, particularly those with inadequate liquidity. In our fight against the Covid-19 Pandemic,Prime Minister Narendra Modi unveiled a comprehensive package of Rs 20 lakh crore under the ‘Atmanirbhar Bharat Abhiyan’ campaign to build a resilient India. Various measures have need taken by all at their individual levels to restore normalcy, medical and economic, at the earliest.
However, the void that these 2 months of lockdown (so far and continuing) have created, will have far reaching effects that will haunt the economy even after restoration of normalcy. Defaults and variations in execution of various transactions and existing contracts are imperative. It is therefore important to analyse the tax issues that will arise as an after effect of the Pandemic. The Authors propose to analyse some transactions that will have a tax implication on account of the economic disruption in the wake of the Covid-19 crises as follows:
2. Income from Salary
2.1. Insofar as salary is concerned, there is one possibility that many employers might defer the salary for the month of April and May due to cash flow problems either fully or partly and may release such salary in the later part of financial year 2020-21. In that case there will be no problem as to the taxability of salary during assessment year 2021-22. Difficulty will arise in situations where the employer doesn’t pay the salary at all for one or two months citing that due to lockdown, business was completely at standstill and therefore it was not in the position to pay the salary. The question then arises as to what will be the tax treatment of such salary. From a non-technical perspective it may appear to be a simple issue that employee will be liable to pay tax only on the amount of salary he actually receives. However, we need to see the problem from a technical perspective also.
2.2 During the lock down period, various measures have been undertaken by the government for general welfare of the people and one of them was a circular issued by Union Ministry of Home Affairs on 29th March 2020 requiring the employers not to deduct the salary of employees during the lock down period. The circular applied to certain categories of employees. Further the same has been challenged in several writ petitions in various High Courts and also before Supreme Court.
The general principle of ‘no work no pay’ has been accepted in large number of decisions such as Chief Regional Manager, United India Insurance Company Limited V. Siraj Uddin Khan Civil APPEAL NO.5390 OF 2019(SC). However, the underlying reasoning of such decisions is that where the employee remains absent from work without any justification he is not entitled to wages or salary for that period. But in the lockdown situation it cannot be said that employee had remained absent from work without any justification. In fact, Aurangabad bench of Bombay High Court in case of Rashtriya Shramik Aghadi v. The State of Maharashtra And Others (W.P. No. 4013 of 2020) has observed that the principle of ‘no work no pay’ will not apply in the lockdown situation. The High Court noted that “This Court cannot turn a Nelson’s eye to an extraordinary situation on account of Corona virus/ COVID19 pandemic. Able bodied persons, who are willing and desirous to offer their services in deference to their deployment as contract labourers in the security and housekeeping sector of the Trust, are unable to work since the temples and places of worships in the entire nation have been closed for securing the containment of COVID19 pandemic. Even the principal employer is unable to allot the work to such employees in such situation. Prima facie, I feel that the principle of “no work no wages” cannot be made applicable in such extraordinary circumstances. The Court cannot be insensitive to the plight of such workers, which has unfortunately befallen them on account of the Covid19 pandemic.”
2.3. Interestingly, the Supreme Court, in one of the matters, had directed not to take coercive action against the employer not following the said circular. It appears that the said circular has later been withdrawn by the Union Ministry of Home Affairs. There are doubts raised whether the said withdrawal is ab initio or from the date of withdrawal. In any case the matter is sub-judice and if it is ruled that the employers cannot deduct any part of the salary of employees, the question of being liable to pay tax without actually earning the salary doesn’t arise at all. However, since the circular does not have universal applicability to all the employers and also considering the peculiar situation of our country, the author feels that there will be still many cases where an employer may deduct the salary of employees for the lock down period whether partly or wholly. The present article attempts to analyse the taxability of salary for such lockdown period which is not actually paid to the employees.
2.4. Section 15 of the Income Tax Act, 1961 is the charging section for income falling under the head salaries. Section 15 reads as below:
"15. The following income shall be chargeable to income tax under the head "Salaries" –
(a) any salary due from an employer or a former employer to an assessee in the previous year, whether paid or not;
(b) any salary paid or allowed to him in the previous year by or on behalf of an employer or a former employer though not due or before it became due to him;
(c) any arrears of salary paid or allowed to him in the previous year by or on behalf of an employer or a former employer, if not charged to income-tax for any earlier previous year.
Explanation 1.-………….(not relevant)
Explanation 2. – ……….(not relevant)”
As per section 15(1)(a), any salary due from an employer or a former employer is chargeable to tax in that previous year whether it is actually paid or not. Therefore the moot question to be decided is – during the period for which salary was not paid by the employer, whether the salary was due to the employee? If this question is answered in affirmative employee may be liable to pay tax on something which he never earned. So, can we say that such salary was never due to the employee and hence not chargeable to tax or in the alternative can we claim any deduction for the same!
2.5. The word “due” has not been defined in the Income Tax Act. Gujarat High court in CIT vs. Bachubhai Nagindas Shah (1976) 104 ITR 551 held that taxability of salary on “due basis” under section 15 is nothing but taxability on “accrual basis”. The word ‘accrue or arise’ has been subject to judicial interpretation in many cases. One of the most celebrated judgement in this case is of E.D. Sassoon & Co. Ltd. v. CIT 26 ITR 27 (SC) where the Honourable Apex Court observed that…..
“If the assessee acquires a right to receive the income, the income can be said to have accrued to him though it may be received later on its being ascertained. The basic conception is that he must have acquired a right to receive ‘ the income. There must be a debt owed to him by somebody. There must be as is otherwise expressed debitum in praesenti, solvendum in futuro See W. S. Try Ltd. v. Johnson ( Inspector of Taxes)  1 All E.R. 532 at 539 and Webb v. Stenton and Others, Garnishees 11 Q.B.D. 518 at 522, 52. Unless and until there is created in favour of the assessee a debt due by somebody it cannot be said that he has acquired a right to receive the income or that income has accrued to him.”
Therefore, it may be argued that where the employer denies his liability to pay salary to employees during the lockdown period, no debt is created in favour of the employee and hence such salary has not accrued to him. The observations of the Supreme Court while passing the interim order in case of Hand Tools Manufacturers Association v. UOI and Others (W.P. Civil Diary No. 11193 of 2020) of no coercive action against the employers not paying salary for lockdown period, also supports this view.
2.6. There can be yet another argument for the non-taxability of such salary. The charging section 4 of the Income Tax Act provides that total income of every person is liable to tax. The expression “total income” is defined in section 2(45) as the amount of income referred to in section 5 computed in the manner laid down in the Act. Thus, before computing the income classified into various heads under section 14, we need to see the scope of the total income under section 5. As per section 5 (1), in case of a person resident in India income which is received or deemed to be received in India, income which accrues, arises or is deemed to accrue or arise in India and income which arises to him outside India is covered in the scope of total income. Section 5(2) provides the scope of total income of a non-resident to include income which is received or deemed to be received in India and income which accrues, arises or is deemed to accrue or arise in India. Thus section 5 visualizes income which is either received by the person or an income which accrues or arises to him. Therefore, in the situation which we are trying to analyse, salary for the lock down period which is not actually received by the employee, we need to see whether it can be said to have accrued or arose to him. This leads us to the question what is the trigger point for accrual of salary income- is it the contract of employment or is it the rendering of services by the employee. In CIT v. S.G. Pgnatale reported in 124 ITR 391, Gujarat High Court held that although the amount payable was for rendering services in India but having been paid by a person responsible outside India, the said earning of salaries cannot be treated as having accrued or arisen in India. In other words, Gujarat High Court held that the place of rendering of services is irrelevant and salary is accrued from the contract of employment. In order to nullify the effect of the judgment of the Gujarat High Court, an amendment was brought in Section 9(1)(ii) by the Finance Act, 1983, with retrospective effect from 1.4.1979 adding an Explanation which read as below:
“Explanation.– For the removal of doubts, it is hereby declared that income of the nature referred to in this clause payable for service rendered in Indiashall be regarded as income earned in India.”
2.7. Thus, what the legislature always intended was that salary is accrued when the services are rendered. The opening words of the Explanation –“For the removal of doubts” as also the retrospective insertion of the Explanation makes this very clear. The effect of this amendment has been explained by the Supreme Court in CIT vs. Eli Lilly & Company (India) Pvt. Ltd. Civil Appeal No. 5114/2007 in the following words:
“To offset the effect of the judgment of the Gujarat High Court, an Explanation was inserted by which the expression "earned in India" stood equated to "services rendered in India".
Thus, where no services are rendered by the employee during the lockdown period, no salary can be said to have accrued or arose to him as per section 9(1)(ii) and therefore it is outside the scope of his total income as per section 5. Once such salary is outside the scope of section 5, one need not go to section 15(1)(a) to contend that it is liable to pay tax on salary “due”.
2.8. In this context it is also interesting to note the decision of Gujarat High Court in CIT v. Bachubhai Nagindas Shah (1976) 104 ITR 551(Guj). In the facts of the case, salary due to an employee but waived or foregone by him voluntarily after the close of the year, was held to be liable to tax under section 15(1)(a) on due basis. Since the employee had already rendered services, the salary had definitely accrued to him and the subsequent waiver was held to be a disposal of the income already received by him. However, the High Court also observed that if subsequently it becomes clear that that amount is not to be received though accrued earlier and is not going to be received at all, corresponding deduction for the amount waived should be given to the assessee in the year of account in which such amount is written off. The Court also noted that no such deduction is specifically allowable under section 16, but observed that such a deduction goes to the very root of the notion of “income”. Applying this obiter dicta of the Gujarat High Court, one can also argue that though salary has become due, in the same year it is established that amount is not to be received and hence it should be deductible not under section 16 but under the very root of the notion of “income”.
2.9. Lastly, it should also be noted that if such an amount of salary not paid by the employer is not taxed on due basis under section 15(1)(a) and in subsequent year, if such salary is received by the employee, the revenue would not be without a recourse. This is because section 15(1)(c) provides for taxability of any arrears of salary paid or allowed to employee in the previous year by or on behalf of an employer or a former employer, if not charged to income-tax for any earlier previous year. In CIT v. Sardar Arjun Singh Ahluwalia (Dead) Through Lrs. Etc. Appeal (Civil) 1206-07 of 1982, the Honourable Supreme Court held that said clause (c) would not apply only to arrears of salary which could have been charged but were not charged. The Court held that the words used in clause (c) "if not charged to income tax", were wide enough to cover all cases where the charge could or could not have been imposed earlier.
Therefore, in the authors’ humble opinion, salary not paid by the employer during the lockdown period is not chargeable to tax in the hands of the employees.
3. Rental income:
3.1. Section 22 of the Act is the charging section for taxing any income under the head “Income from house property” which states that the annual value of any property comprising of a building or land appurtenant thereto of which assessee is the owner, is chargeable to tax under this head. The process of computation of income under this head, starts with the determination of Annual Letting Value (ALV) of the property. The concept and method of determining the ALV is laid down in section 23 of the Act. Section 23(1)(a)/(b) states that where the property is let out for the whole or part of the year, then the Gross Annual Value (GAV) would be the higher of:
1. Expected Rent – 23(1)(a)
2. Actual rent received or receivable – 23(1)(b)
3.2. However, by virtue of Explanation to section 23(1), the actual rent received or receivable should exclude any amount which is not capable of being realised, subject to the conditions prescribed in Rule 4 which are:
1. The tenancy is bona fide
2. The defaulting tenant has vacated or steps have been taken to compel him to vacate the property
3. Defaulting tenant is not in occupation of any other property of the assessee
4. The assessee has taken all reasonable steps to institute legal proceedings for the recovery of the unpaid rent or satisfied the assessing officer that legal proceedings would be useless.
3.3. In the present situation, there will be a number of tenants who would not be able to pay the rent for these months owing to the economic crises. Moreover, as a gesture of courtesy, many land owners have forgone rent so as to offer a helping hand to the tenants under stress. If the law is to be strictly interpreted, rent is taxable on notional basis where actual rent is not received subject to the conditions laid down in Rule 4.
Thus, where the conditions laid down in Rule 4 are complied with, the amount of rent which could not be recovered will not be taxable by virtue of the clear provisions of section 23. However, where such conditions are not complied with, it is critical to analyse the taxability of rent.
3.4. Literally speaking, rent is a contractual liability and accrues on time basis. In case of a commercial property, even for the two months of lockdown period, the tenant is said to be in passive use of the property as his stock and other assets may still be lying in the premises and the tenant has not literally vacated the property. In case of a residential property, there is actual utilisation of the property for these two months. Thus, rent will definitely accrue as per the contractual agreement. If a literal interpretation is adopted, in both cases rent will technically be taxable in hands of the landlord on a notional basis even when not actually received. Even a subsequent waiver of such rent does not absolve him from liability to pay Income tax. However, this approach may not be applicable in such unprecedented situation for the reasons explained hereunder.
3.5. Noting that migrant workers and other urban poor face difficulties in finding affordable housing, the Finance Minister on May 14, 2020 said that the Centre will help create affordable rental housing for the urban poor and provide relief worth Rs. 1,500 crores to small businesses through an interest subvention scheme, apart from extending credit for street vendors, farmers, and middle-class housing as part of its 20 Lakh Crore relief package. In such a situation, taxing the landlords for their act of chivalry would just mean putting the innocent into double jeopardy. The provisions of the Act should be interpreted with an approach of placing justice in the foreground. It is only natural that the rules of interpretation should not be static but dynamic. Rules of interpretation are not the rules of law and have to evolve constantly to ensure that they lie in sync with the march of the society. It is in this context that the Supreme Court in Kehar Singh vs. State (A.I.R. 1988 Supreme Court 1883) gave a go-by to the golden rule by which statutes were to be interpreted according to the grammatical and ordinary sense of the word. The courts have time and again prioritised justice over the literal interpretation of the statutes.
3.6. Nevertheless, in the contemporary socio-economic environment, the provisions of section 23(1) ought to be interpreted as follows:
a. the sum for which the property might reasonably be expected to let from year to year;
b. where the property or any part of the property is let and the actual rent received or receivable by the owner in respect thereof is in excess of the sum referred to in clause (a), the amount so received or receivable
Thus, the words ‘reasonably expected’ are of prime importance. In the given situation, rent cannot be said to have been reasonably expected to be received at all looking at the economic situation of the persons who have defaulted in such rent owing to a financial crunch and even when the land owners have themselves foregone the rent through self-realisation of this fact. Thus, the rent for the two months of default cannot be said to be reasonably expected to be received in terms of section 23(1)(a).Furthermore, section 23(1)(b) is to be read together with the wordings of section 23(1)(a) as can be seen from the wordings of section 23(1)(b). Therefore, while comparing the ALV as computed under section 23(1)(a) and 23(1)(b), the comparison should accordingly be qua the actual period (say 10 months excluding the period of lockdown) for which the rent can be reasonably expected to be received.
3.7. Secondly, it is a well-established principle that only real income of the assessee can be brought to tax under the provisions of the Income Tax Act. To arrive at the real income, accrual basis cannot always be a justifying factor and the commercial and business realities of the assessee, should be considered. In E.D. Sassoon & Co. Ltd. V. CIT [supra], the Supreme Court interpreted the word accrued to mean establishing a right to receive such income. However, due to the economic crises created by Covid-19 pandemic worldwide, authors are of the opinion that the right to receive income needs to be seen not only from a pure technical perspective but also from a realistic perspective in the current scenario. Accordingly, for the purpose of determining whether there has been accrual of real income or not, recourse is to be made to ascertain the nature and character of the transaction and the realities and peculiarities of the situations. Reliance is placed on the decisions of the Supreme Court which largely held that whether income has accrued must be considered from a realistic & practical angle – Godhra Electricity 225 ITR 746 (SC), Excel Industries Ltd 358 ITR 295 (SC) & UCO Bank 237 ITR 889 (SC).
Therefore, in the authors’ humble opinion, rent not paid by the tenants during the lockdown period is not chargeable to tax in the hands of the landlords on notional basis.
4. Business Income:
Many defaults can also occur in the course of business due to Covid 19 pandemic, which might have impacts on the taxability under the head ‘Profits and Gains from Business and Profession’. The Authors attempt to discuss some of these issues as follows:
4.1. Bad debts on account of failure to pay dues:
If any debt is written off as irrecoverable on account of the on-going crises, the same shall be allowable as a deduction by virtue of section 36(1)(vii), subject to the fulfilment of conditions u/s 36(2). If any such debt is recovered later on, it will be chargeable to tax u/s 41(4).
4.2. Breach of contract:
Owing to the on-going lockdown conditions, many situations may arise which will lead to non-fulfilment of contractual conditions such as non-timely delivery of goods/services or inability to supply imported materials /goods for which advanced agreement was entered into and many such more. Damages on account of such lapses may be payable by the entities responsible for such lapses and issues may arise whether the amounts so payable are deductible u/s 28 or 37.
It is a settled principle that subject to the special requirements of the Act, the profits to be assessed are the real profits and they must be ascertained on ordinary principles of commercial trading and commercial accounting. It is thus clear that profits should be computed after deducting the losses and expenditure incurred for the purposes of business unless the losses and expenditure are expressly, or by necessary implication, disallowed by the Act – Pondicherry Railway Co Ltd v.CIT  5 ITC 363 (PC)/Badridas Daga v. CIT  34 ITR 10 (SC). Hence, there should not be a difficulty in claiming such losses as incidental business losses.
An assessee in business may be liable for compensation either for breach of law or for breach of contract. If it were for breach of law, it is not allowable as a deduction especially after amendment to section 37(1), which specifically bars such deduction. The revenue authorities tend to treat these damages on account of a breach of contract to be covered by Explanation 1 to Section 37 thereby not allowing the said deduction to the assessees. It is however important to note that Explanation 1 to Section 37 specifically provides that deduction shall not be allowed for any payments on account of a breach of law and does not bar claiming of deduction of any damages paid on account of breach of a contract. Present is a situation where non fulfilment of a contractual liability would result into a breach of contract which should be allowed as a deduction by virtue of section 37 of the Act.Where the assessee is obliged to pay compensation in the course of business, because of breach of contract on its part, such payment will not partake the character of penalty even if it were so described, so that it cannot be disallowed. The law on this point is well settled as decided in CIT v Amalgamated Development Ltd (1967) 65 ITR 395(SC).
Another controversy in such cases is by virtue of section 43(5) which defines a speculative transaction as “a transaction in which a contract for the purchase or sale of any commodity, including stocks and shares, is periodically or ultimately settled otherwise than by the actual delivery or transfer of the commodity or scrips.” Further section 73 bars the set off of speculative loss against any other income of the assessee. So, where a contract for delivery of goods is broken and the same is settled by payment of compensation, question arises whether such a loss is speculative in nature. The preponderant view expressed in many cases was that payment of compensation on account of a breach of contract does not amount to a loss in a speculative transaction. This view is based on the premise that what is received by a party after the breach of contract by way of settlement is the quantum of damages suffered by him by reason of the breach of the contract and, therefore, the nature of the transaction cannot be said to be speculative under the Income-tax Act. [See CIT v. Paioneer Trading Co. Pvt. Ltd. (1968) 70 ITR 347(Cal.), Daulatram Rawatmull v. CIT (1970) 78 ITR 503 (Cal.)]
The other view expressed in few cases was that all cases of settlement without actual delivery of the goods or transfer of the scrips contracted must fall within the definition of ‘speculative transaction. The date of settlement, it was opined, may be either before the breach of the contract or subsequently thereafter.[Chinnaswami Chettiar (R) v. CIT (1974) 96 ITR 353 (Mad.), Sri Ranga Vilas Ginning & Oil Mills v. CIT (1982) 133 ITR 85 (Mad.)]
The above controversy has been decided in favour of the former view by the Supreme Court in CIT v Shantilal (P) Ltd. [(1983)144 ITR 57 (SC)]. It has been held that a transaction cannot be said as a speculative transaction where there is a breach of the contract and on a dispute between the parties damages are awarded as compensation by an arbitration award. What is really settled by the award of such damages and their acceptance by the aggrieved party is the dispute between the parties.
These are few instances of peculiar situations arising due to Covid-19 pandemic in determination of total income under the Income Tax Act,1961. Many such situations may arise, not comprehended by the authors. Whenever faced with difficulty in interpreting a Statute, we should keep in mind the guidance given by the Preamble to our Constitution – “…to secure to all citizens JUSTICE, social, economic and political”. For ultimately, law is for the people.
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