Opinion – Failure to deduct TDS –Whether amounts not deductible?

The above named Querist has forwarded to me a case for opinion through its representatives. I had the benefit of discussing the case with these representatives and being instructed by them.

Based on the facts as cited to me, the discussions with Querist’s representatives and the case laws referred by me above, I have accordingly framed this opinion.

Facts

The facts, as cited to me, are reproduced below:—

1. The Querist is a private limited company engaged in the manufacturing. The Querist makes payments to various agencies for carrying out their various assignments and work like payment to clearing and forwarding agents, professional fees, bus hiring charges etc. and they deduct income tax as required under various provisions of Income-tax Act, 1961 and deposit the same regularly with the Government Treasury.

2. The Querist makes payments to clearing and forwarding agents for the services rendered by clearing agents. These charges include reimbursements of various expenses and service charges incurred by them. Each bill of forwarding charges was less than Rs. 20,000/- and hence the Querist hasn’t deducted TDS up to 31-3-2004. Subsequently the overall limit of payments per party per year for tax deduction purposes has been increased to Rs. 50,000/-.

However due to ignorance of law the Querist was under bona fide impression that as per earlier law it is required to deduct TDS only if each bill exceeds Rs. 20,000/-. Since no bill was beyond Rs. 20,000/-, the Querist has not deducted any TDS.

3. There was TDS survey and the survey party noticed that no TDS has been deducted from the freight and clearing charges paid. The Querist was supposed to deduct the TDS if payment per person exceeds Rs. 50,000/- per year even though each bill is less than Rs. 20,000/-.

4. The Querist represented that it has not deducted the TDS amount under a bona fide belief and ignorance of law. Even though ignorance of law is not an excuse, but the party to whom clearing and forwarding charges have been paid they have properly paid their Income Tax and filed the return and as per the ratio of recent Supreme Court decision in the case of Coca Cola Beverages Pvt. Ltd vs. CIT (2007) 293 ITR 226 (SC), no penalty is leviable if the payee party has paid its Income tax dues properly and payer failed to deduct the TDS.

Issues involved

Based on the above facts, the Querist has posed to me the following queries for rely:—

First query

In the circumstances explained above, can the Assessing Officer disallow the expenses on which TDS is not deducted under section 40a(ia),even though the payee party has fully paid its taxes and the necessary evidences to that respect is produced to the Assessing Officer.

More particularly, whether the ratio of the Supreme Court decision in the case of Coca Cola Beverages Pvt. Ltd vs. CIT (2007) 293 ITR 226 (SC) rendered for penalty and interest, also equally applicable for disallowance of expenses u/s 40A(ia).

Is there any other case law which supports the contention of the Assessee?

Opinion

Let me now proceed to deal with the query raised by the Querist.

1. Provisions of section 40[ia] Since the issue concerns the provisions of Section 40(ia) of the Income-tax Act, it would be worthwhile to reproduce the relevant portions of same for benefit of the Querist.

Section 40

Notwithstanding anything to the contrary in sections 30 to 38, the following amounts should not be deducted in computing the income chargeable under the head “Profits and gains of business or profession”—

ia] any interest, commission or brokerage, rent, royalty, fees for professional services or fees for technical services payable to a resident, or amounts payable to a contractor or subcontractor, being resident, for carrying out any work (including supply of labour for carrying out any work), on which tax is deductible at source under Chapter XVII-B and such tax has not been deducted or, after deduction, has not been paid during the previous year, or in the subsequent year before the expiry of the time prescribed under sub-section (1) of section 200:

Provided that where in respect of any such sum, tax has been deducted in any subsequent year or, has been deducted in the previous year but paid in any subsequent year after the expiry of the time prescribed under sub-section (1) of section 200, such sum shall be allowed as a deduction in computing the income of the previous year in which such tax has been paid.

2. The Board Circular

The provisions of section 40[ia] were brought on the statute book by the Finance {No. 2] Act, 2004 w.e.f. 1-4-2005; i.e., Assessment Year 2005-06.

The CBDT Circular explaining this amendment states as under :—

“Subject: Finance (No. 2) Act, 2004 — Explanatory Notes on provisions relating to Direct Taxes Circular No. 5 of 2005, dt. 15th July, 2005 (2005) 276 ITR (St) 151 (165)

Certain amounts not to be allowed as deduction while computing income under the head “Profits and gains of business or profession” if tax not deducted at source

Under the existing provisions of sub-clause (i) of clause (a) of section 40 of the Income-tax Act, no deduction is allowed in the computation of income on account of interest, royalty, fees for technical services or any other sum which is payable outside India, or in India to a non-resident or to a foreign company, if tax is not deducted at source from payments of these sums or after deduction of tax at source, payment is not made to the account of the Central Government before the expiry of time prescribed under sub-section (1) of section 200 and in accordance with other provisions of Chapter XVII-B. Deduction of the sum is, however, allowed where tax has been deduced, or after deduction has been paid in any subsequent year in computing the income of that previous year.

With a view to rationalize the provisions of sub-clause (i), the Act has substituted the said sub clause to provide that in any case in which tax has been deducted in any subsequent year or, has been deducted in the previous year but paid in any subsequent year after the expiry of time prescribed under sub-section (1) of section 200, the sum from which tax has been so deducted or paid shall be allowed as deduction in computing the income of the previous year in which the tax has been paid to the account of the Central Government.

Further, with a view to augment compliance of TDS provisions in the case of residents and curb bogus payments to them it has been provided that no deduction will be allowed in the computation of income where tax is not deducted from payments of interest, commission or brokerage, fees for professional services or fees for technical services and payments to a contractor or sub-contractor for carrying out any work (including supply of labour for carrying out any work), on which tax is deductible at source under Chapter XVII-B and such tax has not been deducted or, after deduction, has not been paid during the previous year, or in the subsequent year before the expiry of the time prescribed under sub-section (1) of section 200.

It has, however, been provided that in any case where tax has been deducted from the payments of any of the aforementioned sums to residents in any subsequent year or has been deducted in the previous year but paid in any subsequent year after the expiry of the time prescribed under sub-section (1) of section 200, the sum of payment shall be allowed as deduction in computing the income of the previous year in which the tax has been paid to the account of the Central Government.

These amendments take effect from 1st April, 2005 and apply in relation to the assessment year 2005-06 and subsequent assessment years.”

3. Literal meaning

A reading of the language in section 40[ia] give the following apparent meaning:—

[a] The language in main provision suggests that any expenditure on which tax is deductible will not be allowed as a deduction unless the tax has been deducted at source or the tax having been deducted, the same has not been paid either during the previous year or in the subsequent year before the time period under section 200[1].

[b] However, there is a saving provision in the proviso to the main provision to the effect that of the tax is deducted in any subsequent year or has been deducted in the previous year, but paid in the subsequent year after the expiry of the time prescribed under sub section [1] of section 200, then the expenditure will be allowed in the year in which the tax so deducted has been paid.

4. Modes of interpretation —Strict literal mode and other modes

From the above, the provisions of section 40[ia] throws out an apparent meaning that if tax is not deducted, the expenditure will not be allowable even if the tax deduction amount is paid in to the treasury either by the payer from his own pocket or by the payee in form of his own tax.

This will surely strike any one as unjust and perverse to one’s conscience that the deduction should be denied even when the tax deducted amount has been deposited in the Government coffers.

These provisions are therefore being challenged in writ petitions in several Courts as on date and the matters are pending.

5. Literal mode of interpretation: Whether correct

It can be seen above that if the provisions are literally interpreted as per the plain meaning conveyed by the language in the provisions, the effect would be that the expenditure would be denied if the tax has been not deducted, even if paid in to the Government treasury.

But this, in my opinion, is not the correct manner of interpretation and I shall explain to the Querist, why this is so.

6. Normal mode is strict mode

It is true that the normal rule is that a taxing statute must be strictly interpreted from the language used in the provisions.

Fiscal laws are expected to be strictly construed. The words must say what they mean and nothing more must be implied or read in to. The interpretation of the provisions must proceed from the express language in the statute and nothing more.

To the above effect, one will find several authorities and suffice it will be to rely on the Supreme Court decisions in the case of Goodyear India Ltd. vs. State of Haryana [1991] 188 ITR 402 (SC) and also CIT vs. National Taj Traders [1980] 121 ITR 535 (SC).

7. When strict mode can be departed

Yet, the above rule of strict interpretation is not so absolute and give way in exceptional circumstances.

There are sufficient authorities in the decisions of the Supreme Courts on this aspect.

8. Supreme Court decision No. 1

The first Supreme Court decision, I shall cite, is its decision in the case of K.P. Verghese vs. ITO 131 ITR 597 (SC).

Here, the Supreme Court was concerned with the capital gains provisions of section 52[2] of the Income-tax Act. As per the language in the said provisions, if the market value of a capital asset transferred exceeded the value of sale consideration declared by the assessee by 15% or more, the Assessing Officer is entitled to take the market value as the sale consideration.

The issue canvassed by the assessee was whether these provisions can be invoked even if it was not proved that the assessee has understated his sale consideration.

The Supreme Court held as under:—

“The task of interpretation of statutory enactment is not a mechanical task. It is more than a mere reading of mathematical formulae because few words possess the precision of mathematical symbols. It is an attempt to discover the intent of the Legislature from the language used by it and it must always be remembered that language is at best an imperfect instrument for the expression of human thought and, as pointed out by Lord Denning, it would be idle to expect every statutory provision to be “drafted with divine prescience and perfect clarity”. We can do no better than repeat the famous words of Judge Learned Hand when he said:

“ …… it is true that the words used, even in their literal sense, are the primary and ordinarily the most reliable source of interpreting the meaning of any writing: be it a statute, a contract or anything else. But it is one of the surest indexes of a mature and developed jurisprudence not to make a fortress out of the dictionary; but to remember that statutes always have some purpose or object to accomplish, whose sympathetic and imaginative discovery is the surest guide to their meaning.”

“It is now a well-settled rule of construction that where the plain literal interpretation of a statutory provision produces a manifestly absurd and unjust result which could never have been intended by the Legislature, the court may modify the language used by the Legislature or even “do some violence” to it, so as to achieve the obvious intention of the Legislature and produce a rational construction: Vide Luke vs. IRC [1963] AC 557; [1964] 54 ITR 692. The court may also in such a case read into the statutory provision a condition which, though not expressed, is implicit as constituting the basic assumption underlying the statutory provision.”.

The Supreme Court held that the objective behind the provisions of section 52 was to prevent tax evasions and this being the case, it held that if the provisions were literally interpreted and applied, it would lead to manifestly unjust results. Keeping in view the purpose behind the provisions to prevent capital gains tax by under statement of sale considerations, the Court held that the provisions must be interpreted so as to apply only where there was a case of understatement of sale consideration and not when merely the fair market value exceeded the sale consideration declared.

9. Supreme Court decision No. 2

The next Supreme Court decision, I shall cite, is the decision in the case of CIT vs. J. H. Gotla 156 ITR 323, 339 (SC). Here, the issue was whether the loss incurred by an assessee can be set off against the share of profits of his wife and children which profits were clubbed in his hands for taxation. In those days, loss from one business can be adjusted against profits of another business only if the other business is carried on by the assessee himself. The Tribunal had denied the setoff of the business loss of the assessee on the ground that the share of profits of wife and children could not be said to be derived from business carried on by the assessee, but were profits derived from wife’s business.

The Querist may note that if the statute was literally interpreted, the assessee would not have got the set of at all.

The Supreme Court however held otherwise by resorting to a dynamic mode of interpretation as under:—

“Where the plain literal interpretation of a statutory provision produces a manifestly unjust result which could never have been intended by the Legislature, the court might modify the language used by the Legislature so as to achieve the intention of the Legislature and produce a rational construction. The task of interpretation of a statutory provision is an attempt to discover the intention of the Legislature from the language used. It is necessary to remember that language is at best an imperfect instrument for the expression of human intention. It is well to remember the warning administered by judge Learned Hand that one should not make a fortress out of the dictionary but remember that statutes always have some purpose or object to accomplish and sympathetic and imaginative discovery is the surest guide to their meaning.

If the purpose of a particular provision is easily discernible from the whole scheme of the Act, which in this case is to counteract the effect of the transfer of assets so far as computation of income of the assessee is concerned, then bearing that purpose in mind, we should find out the intention from the language used by the Legislature and if strict literal construction leads to an absurd result; i.e., a result not intended to be subserved by the object of the legislation found in the manner indicated before, then if another construction is possible apart from strict literal construction, then that construction should be preferred to the strict literal construction. Though equity and taxation are often strangers, attempts should be made that these do not remain always so and if a construction results in equity rather than in injustice, then such construction should be preferred to the literal construction”

The Supreme Court here discarded the literal rule of interpretation as producing manifestly unjust and unintended result and chose to apply the rule of interpretation by modification of the language to align it with the intention of the law makers. It ruled that the business carried on by the assessee’s wife and children should be treated as business carried on by the husband in whose hands the income was clubbed and set off of loss allowed.

10. Supreme Court decision No. 3

The next decision, I would refer is the decision of the Supreme Court in the case of C.W.S. (India) Ltd. vs. CIT 208 ITR 649(SC).

In this decision, the Apex Court noted that while literal construction may be the general rule in construing taxing enactments, it does riot mean that it should be adopted even if it leads to a discriminatory or incongruous result.

Interpretation of statutes cannot be a mechanical exercise. The object of all the rules of interpretation is to give effect to the object of the enactment having regard to the language used.

The Court then referred to the well-recognised rule of interpretation of statutes that where a literal interpretation leads to an absurd or unintended result, the language of the statute can be modified to accord with the intention of Parliament and to avoid absurdity.

The following passage from Maxwell’s Interpretation of Statutes (12th edition), was quoted by the Supreme Court:

“1. Modification of the language to meet the intention. — Where the language of a statute, in its ordinary meaning and grammatical construction, leads to a manifest contradiction of the apparent purpose of the enactment, or to some inconvenience or absurdity which can hardly have been intended, a construction may be put upon it which modifies the meaning of the words and even the structure of the sentence. This may be done by departing from the rules of grammar, by giving an unusual meaning to particular words, or by rejecting them altogether, on the ground that the Legislature could not possibly have intended what its words signify, and that the modifications made are mere corrections of careless language and really give the true meaning. Where the main object and intention of a statute are clear, it must not be reduced to a nullity by the draftsman’s unskilfulness or ignorance of the law, except in a case of necessity, or the absolute intractability of the language used. Lord Reid has said that he prefers to see a mistake on the part of the draftsman in doing his revision rather than a deliberate attempt to introduce an irrational rule: ‘the canons of construction are not so rigid as to prevent a realistic solution’”.

11. Principles in above Supreme Court decisions: A summary

From the above discussions, we can summarise that while the normal rule of interpretation of a taxing statute is the rule of strict literal interpretation, when it found that the results of such interpretation results in unjust punishment of the assessee, which was not intended by the law makers, the Courts can step in and supply an interpretation which aligns with the purpose behind the statutory provision.

Let us now proceed to test the instant case of the Querist in light of the above interpretation.

12. Section 40 [ia] – Law makers intention

In the first place, it may be agreed that the language in the section 40[ia] does not imply that the legislature intended to deny the deduction in toto, if tax is not deducted and paid. In fact, from the language in the proviso to the main provision in section 40[ia] suggest that the deduction would be allowed in the subsequent year in which the tax deducted is found to be paid.

A strong view emerges that the intention of the legislature was to only deny the deduction for the expenditure as long as the tax deducted is not paid. Even the explanatory notes supplied by the CBDT explaining the Finance Bill [see para 2 above] stated that the provision was only to make the assessee tax complaint and prevent bogus transactions.

13. TDS – Only one of many modes of recovery

The Querist may note that the purpose of tax deduction provisions is only to ensure early recovery of tax. The attention of the Querist is also invited to the provisions of section 202 of the Income-tax Act, which clarify that deduction of tax at source is only one mode of recovery of tax and this mode is without prejudice to any other mode of recovery.

In short, deduction of tax is only one of the modes of recovery of tax. Once tax is recovered by any other mode, in my opinion, it is not permissible to recover the same tax again by tax deduction. After all, there cannot be recoveries of the same tax twice.

Tax deduction is an interim payment of tax to be adjusted by the deductee against his tax liability in the return he is filing. If tax is not deducted by the payer of the sum of expenditure and the payee has paid the tax by including the sum in his income, the income tax department cannot compel the payer to deduct the tax now or to pay it from his pocket.

Once the payee has paid the tax on the sum, the payer is only liable to pay interest u/s 201(IA) of the Income Tax on the tax that should have been deducted up to the date on which the payee has paid the tax on the sum. The payer cannot be treated as being in default u/s 201 in respect of the principal amount of the tax deductible since the tax has been now paid by the payee in his return.

This above principle is supported by the decision laid by the Supreme Court in the case of Hindustan Coca Cola Beverage (P) Ltd. vs. CIT [2007] 293 ITR 226 (SC). Here, the Apex Court held that where the deductee, recipient of income has already paid taxes on amount received from the deductor, the department once again cannot recover tax from deductor on the same income by treating the deductor to be assessee in default. The deductor would only be liable to pay interest u/s. 201 [1A] till the date of payment by the deductee.

13. Reply to query Based on the above, I am of the opinion that once the Querist shows to the Income Tax Department that the payee has paid the tax, he must be impliedly treated as being discharged from the liability of deducting tax and paying the tax deducted to the Government.

We have seen above that recovery of tax by deduction at source is only mode of recovery of tax and there are other alternative modes of recovery like direct recovery from the payee.

Once the tax is found to be recovered by any other mode, there is a bar on recovery of the TDS by the Department from the Querist. It is also my view that the tax cannot also be deducted by the Querist now, because the same has already been paid. There cannot be two recoveries of the same tax on the same income and each method of recovery is only an alternative to the other.

We have seen that as per the proviso to section 40 [ia], the deduction is to be allowed to the Querist in the year in which the Querist complies with the tax deduction obligation of deduction and payment to the Government.

Now, when the Querist payer is prevented by the law from recovery the tax by deduction because the payee has already paid the tax in his return, the same law should no longer expect it to do the impossible at this stage to avail of deduction for expenditure in terms of section 40[ia].

That the law does not compel the impossible is accepted principle “{Lex Non Cogit ad impossibilia}”.

In Asset CIT vs. Jindal Irrigation Systems Ltd. (1996) 56 ITD 164 (Hyd.) the Tribunal has held that when it was impossible to the assessee to perform, interest under section 234C, cannot be levied. The above principle may be applied while interpreting the section 40(ia) of the Income-tax Act.

To interpret the provisions of section 40[ia] in strict literal manner to the effect that the deduction for the sum of expenditure paid by the Querist would be allowed only when tax is deducted and paid by it would result to unjust consequences more particularly when the person subject to the law [the Querist] is prevented by the same law from recovering the tax from the payee, once the payee has paid the tax on the sum as his income in his return.

It is pertinent that such unjust consequences were not intended by the law makers because the purpose behind section 40[ia] is not to deny the deduction, but only to postpone the deduction to the year in which the tax deduction procedure is complied with. This should give enough encouragement to us to discard the strict literal method of interpretation and opt for an interpretation, which will not only skirt unjust consequences, but also aligns with the purpose and objective behind the provisions of section 40[ia].

Since tax deduction is only one of the modes of recovery and recovery can be attained by any other mode, the Querist must be treated as discharged from his obligation to recover tax by deduction, once the payee has paid the tax on his own.

We have seen from the Explanatory notes to the Finance Bill issued by the CBDT that the provisions of section 40[ia] had been introduced to remedy the malady of non compliance of tax deduction procedures and therefore, the remedy should not turn out to became another malady of unfairly denying deduction for expenditure.

In my opinion, the Querist has a strong arguable case to contend that the pre-condition in section 40[ia] to deduct and pay the tax deducted in order to be eligible for deduction of the expenditure has been impliedly complied by the Querist.

*Reprodued with permission from the AIFTP Journal – April 2008 issue.