1) As per S. 40(a)(ii) of the Income-tax Act, the payment of
income-tax is not allowed as deduction from the total income.
It is generally understood that education cess and secondary
and higher education cess are also not allowable deductions.
However, the Bombay High Court in the case of Sesa Goa Ltd.
(423 ITR 426) has held that education cess and secondary and
higher education cess are allowable as deductions from the
total income.

2) Subsequently, vide Finance Bill, 2022, it was proposed to
clarify that surcharge and cess would not be considered to be
deductible expenditure. This came by way of a clarification
and made effective from A.Y. 2005-06 as according to the
legislature, this was always the intention.

3) While moving the Bill in the Lok Sabha on 25.03.2022, the
Finance Minister has proposed certain amendments in the
Finance Bill, 2022. Vide one such amendment, it has been
proposed to introduce sub-section (18) to S. 155 of
the Income-tax Act. The proposed sub-section (18),
which has since become part of the Income-tax Act reads as
under;

“(18) Where any deduction in respect of any surcharge or
cess, which is not allowable as deduction under section 40,
has been claimed and allowed in the case of
an assessee in any previous year, such claim shall be
deemed to be under-reported income of the assessee
for such previous year for the purposes of sub-
section (3) of section 270A, notwithstanding anything
contained in sub-section (6) of section 270A,
and the Assessing Officer shall
recompute the total income of the assessee
for such previous year and make necessary amendment; and the
provisions of section 154 shall, so far as
may be, apply thereto, the period of four years specified in
sub-section (7) of section 154 being reckoned from the end
of the previous year commencing on the 1st day of April,2021

Provided that in a case where the assessee makes an
application to the Assessing Officer in the prescribed form
and within the prescribed time, requesting for recomputation
of the total income of the previous year without allowing
the claim for deduction of surcharge or cess and pays the
amount due thereon within the specified time, such claim
shall not be deemed to be under-reported income for the
purposes of sub-section (3) of section 270A”
(emphasis supplied)

4) Since the above sub-section has been added vide subsequent
amendment and not as a part of the Finance Bill, it has not
received the requisite attention. The implication of sub-
section (18) is twofold;

i) Where surcharge or cess has been claimed and allowed in
any previous year, the Assessing Office shall recompute
the income after disallowing the same by passing an order
u/s. 154 of the Act and the time limit for the said
purpose would be up to 31.03.2026. Thus, there would not
be any need of reopening the assessment u/s. 148 or
revising the assessment u/s. 263 of the Act. Even those
cases where return of income has not been picked up for
scrutiny, the modification order can be passed;

ii) If any such deduction has been claimed and allowed, such
claim shall be deemed to be under reported income and the
penalty u/s. 270A of the Act would be imposed.
Simultaneously, immunity has been provided in a case where
assessee makes necessary application in the prescribed
form and within the prescribed time and pays the amount
due after disallowing the claim of surcharge and cess.

5) Certain issues arising out of the above are discussed hereinbelow.

Cases where deduction has not been allowed, the provisions would not be applicable

6) As sub-section (18) uses the phrase ‘claimed and allowed’, the
provisions would not be applicable in a case where deduction
has been claimed but not allowed and the matter is pending
before the appellate authorities. In such cases, obviously,
the Assessing Officer would not be passing any modification
order and the action of making the claim would not be deemed
to be under-reporting of the income. The fate of the penalty
proceedings would be decided on the merits of the case either
u/s. 271(1)(c) of the Act (up to A.Y. 2016-17) or u/s. 270A of
the Act (from A.Y. 2017-18). It is opined that this being
purely a legal issue and the decisions of the High Court in
favour of the assessee being available, there should not be
any penalty u/s. 271(1)(c) of the Act (as there is no
concealment of income, or furnishing of inaccurate particulars
of income) or u/s. 270A of the Act (the claim being bonafide).

If deduction has been claimed and allowed, penalty would be levied

7) However, where the deduction has been claimed and allowed, the
assessee would be deemed to have under-reported its income for
the purposes of S. 270A(3) of the Act. The provision further
states that provisions of S. 270A(6) of the Act would not
apply. The provisions of S. 270A(6) of the Act provide that
certain cases would not be considered as cases of under-
reporting of income for the purpose of S. 270A of the Act.
Clause (a) of S. 270A(6) provides as under:

“(a)the amount of income in respect of which the assessee
offers an explanation and the Assessing Officer or the
Commissioner (Appeals) or the Commissioner or the Principal
Commissioner, as the case may be, is satisfied that the
explanation is bona fide and the assessee
has disclosed all the material facts to substantiate the
explanation offered
……” (emphasis supplied)

8) It is evident from the above that if the assessee offers an
explanation in respect of under-reported income and the
Assessing Officer is satisfied with the explanation, then the
same would not be considered as under-reported income.
However, by virtue of S. 155(18) of the Act, the Legislature
has taken away this benefit available to the assessee u/s
270A(6) of the Act. However, the levy of penalty is subject to
the immunity provided in the proviso to S. 155(18).

9) It is interesting to note that even in these cases the
legislature deems the same to be cases of ‘under reporting of
the income’ and not ‘concealment’ or ‘furnishing of inaccurate
income’. Therefore, there would not be automatic levy of
penalty in respect of assessment years prior to A.Y. 2016-17.

10) As stated above, disallowance of a claim, which has been
found to be in order by the High Court cannot result in levy
of concealment penalty. This is more particularly so when
disallowance has been made on account of retrospective
amendment in the Act. Disallowance made by virtue of insertion
of Explanation 3 to S. 40(a)(ii) of the Act with retrospective
effect from 01.04.2005 (A.Y. 2005-06) could not result in to
levy of penalty.

Immunity from penalty – Proviso to S. 155(18) of the Act

11) The proviso to S. 155(18) of the Act states that in a case
where the assessee makes an application to the Assessing
Officer in the prescribed form and within the prescribed time
(such prescription are yet to be made), requesting for re-
computation of the total income of the previous year without
allowing the claim for deduction of surcharge or cess and pays
the amount due thereon within the specified time, such claim
shall not be deemed to be under-reported income for the
purposes of S. 270A(3) of the Act.

12) On perusal of the proviso, it is amply clear that the
Legislature wants the assessees to come forward and point out
the years in which they have claimed deduction on account of
surcharge and cess while computing ‘Business Income’ and the
same has been allowed. This is a carrot and stick approach by
the income tax department.

Assessee should avail the benefit of Proviso but will the department wait?

13) Considering that the department is seeking to levy penalty,
the assessees must avail the benefit of the proviso. The
department, at the earliest (hopefully) would prescribe a form
wherein the application can be made by the assessee to the
Assessing Officer and also prescribe a reasonable time limit
within which the application can be made. The assessee must
avail this opportunity at the earliest and not wait for the
department to pass the order u/s 154 of the Act to avoid
penalty u/s 270A of the Act. However, till such form is
prescribed and the time limit to make application to the
Assessing Officer in such form does not expire, the department
should wait and not start rectifying orders u/s 154 of the
Act. If the department does so, it would deprive the assessee
from taking benefit of the Proviso.

Can the amendment be given retrospective effect?

14) While the Legislature intends to give the amendments
retrospective effect, a question remains as to whether such an
intention is in accordance with the well settled principles of
law. It is an unexceptionable principle of law that if an
amendment proposes to make substantive changes to the law, it
ought to be given prospective effect, even if such an
amendment is proposed to be made retrospective by the
Legislature [MM Aqua Technologies Ltd. vs. CIT (2021) (436 ITR
582) (SC), Sedco Forex International Inc. vs. CIT (2017) (399
ITR 1) (SC), Virtual Soft Systems Ltd. vs. CIT (2007) (289 ITR
83) (SC)]. The proposed amendments seeking to undo various
judgements of the Hon’ble High Courts which had held that
education cess is an allowable expenditure are certainly
substantive in nature. Applying the test of the aforesaid
judgements, a view could possibly be taken that the same
cannot be given retrospective effect.

15) Further, the provisions of section 40(a)(ii), as they stood
prior to the amendment, have been interpreted by several
Courts as permitting for deduction of education cess. Hence,
the amendment providing for imposition of penalty for such
deductions claimed in the preceding years may fall foul of
Article 20 of the Constitution thereby raising a question as
to whether the amendment is constitutionally valid or not?

Posted on: April 24th, 2022