Mani Square Limited Vs ACIT (ITAT Kolkata)
Bona fide belief that rent paid to Government company was covered by Section 196 and construction scrap was outside TCS constitutes reasonable cause: Kolkata ITAT deletes penalties
The Kolkata Bench of the Income Tax Appellate Tribunal has deleted penalties imposed under Sections 271C and 271CA for failure to deduct TDS on rent and collect TCS on the sale of construction scrap. The Tribunal held that the assessee’s bona fide interpretation of the relevant provisions constituted a “reasonable cause” under Section 273B, even though the tax authorities had treated the underlying transactions as liable to TDS and TCS.
Non-deduction of TDS on rent paid to Government company
The assessee, engaged in the construction and real-estate development business, had entered into a sub-lease agreement with Bengal Chemical and Pharmaceuticals Ltd. for a portion of land situated at Canal Circular Road, Kolkata.
The assessee did not deduct tax under Section 194-I on the lease rent paid to the company. Its understanding was that Bengal Chemical and Pharmaceuticals Ltd. was substantially owned and controlled by the Government of India and was consequently covered by Section 196, which grants exemption from TDS in respect of specified payments made to the Government and certain statutory entities.
The AO, however, observed that Bengal Chemical and Pharmaceuticals Ltd., though substantially owned by the Government, was a separate company incorporated under the Companies Act, 1956. According to the AO, the company could not be equated with the Government merely because the Government held a majority stake in it.
The non-deduction of tax was consequently treated as a default under Section 194-I, and a penalty of ₹27,600 under Section 271C was imposed.
Failure to collect TCS on construction scrap
The assessee had also sold scrap aggregating to approximately ₹2.51 lakh without collecting tax at source under Section 206C(1).
Its contention was that the waste material arose from construction activities involving cutting and moulding of steel and wooden materials. Since the assessee was not engaged in any manufacturing or mechanical working of materials, it believed that the waste generated during construction did not fall within the statutory definition of “scrap” under Explanation (b) to Section 206C.
The AO nevertheless treated the sale as liable to TCS and imposed a further penalty of ₹2,508 under Section 271CA.
Thus, the aggregate penalty imposed under Sections 271C and 271CA amounted to ₹30,108. The CIT(A) confirmed both penalties.
Government ownership supported the assessee’s bona fide belief
Before the Tribunal, the assessee contended that it had acted under an honest belief that no tax was required to be deducted from the payment made to Bengal Chemical and Pharmaceuticals Ltd.
The Tribunal noted that out of the company’s total equity capital of 7,69,603 shares, 7,69,601 shares were held by the President of India, with only two shares standing in the name of another shareholder. The overwhelming Government ownership and control provided a reasonable foundation for the assessee’s understanding that the recipient was an instrumentality of the Government.
The Tribunal referred to Article 12 of the Constitution, under which certain corporations and Government-controlled entities may qualify as “State” or “other authorities.” It also referred to the principles laid down by the Supreme Court in:
- Ajay Hasia v. Khalid Mujib;
- Ramana Dayaram Shetty v. International Airport Authority of India;
- Mysore Paper Mills Ltd. v. Mysore Paper Mills Officers’ Association; and
- Som Prakash Rekhi v. Union of India.
These decisions recognise that factors such as Government shareholding, financial assistance, functional control and performance of public functions may establish that a corporation is an instrumentality or agency of the Government.
Based on the almost complete Government ownership of Bengal Chemical and Pharmaceuticals Ltd., the Tribunal accepted that the assessee’s belief regarding the non-applicability of TDS was bona fide, though the recipient was incorporated as a separate Government company.
Construction activity not equivalent to manufacturing
With regard to the TCS default, the Tribunal examined the definition of “scrap” under Explanation (b) to Section 206C.
Under the provision, scrap means waste and scrap arising from the manufacture or mechanical working of materials, which is not usable as such because of breakage, cutting, wear or other reasons.
The assessee was engaged in construction and real-estate development and not in manufacturing. The waste arose through the deployment of labour and construction materials, including the cutting and moulding of steel and wooden items.
The Tribunal accepted that the assessee could bona fide believe that construction activity was not equivalent to a manufacturing process and that the resultant waste did not fall within the specific definition of scrap for TCS purposes.
Therefore, even if the tax authorities considered the sale liable to TCS, the assessee’s interpretation was not regarded as unreasonable or lacking in good faith.
Protection under Section 273B
Section 273B provides that no penalty shall be imposed for specified failures if the assessee proves that there was a reasonable cause for the failure.
The Tribunal found that the assessee had demonstrated reasonable cause in respect of both defaults:
- It believed that the rent was paid to a Government-controlled entity covered by Section 196; and
- It believed that scrap generated from construction activity was outside the definition applicable under Section 206C.
The Tribunal consequently set aside the CIT(A)’s order and directed the AO to delete the penalties imposed under Sections 271C and 271CA.
Author’s comments
The decision must be understood principally as a penalty ruling. It does not conclusively hold that every Government company is “Government” for the purposes of Section 196 or that every variety of construction scrap necessarily falls outside Section 206C.
A Government company may qualify as “State” under Article 12 of the Constitution because of pervasive Government ownership and control, but that does not automatically mean that it becomes the “Government” for every provision of the Income-tax Act. The tests under Article 12 and the wording of Section 196 operate in different legal contexts.
What persuaded the Tribunal was that the assessee’s interpretation was plausible and bona fide, particularly considering that practically the entire share capital of the recipient company was held by the President of India.
The ruling reiterates the important distinction between existence of a tax default and automatic imposition of penalty. A person may ultimately be held liable to deduct or collect tax, but penalty can still be avoided where the failure arose from a genuine, reasonably arguable interpretation of law rather than deliberate disregard of a statutory obligation.
Cases Discussed
- Ajay Hasia v. Khalid Mujib
- Ramana Dayaram Shetty v. The International Authority of India
- Mysore Paper Mills Ltd. v. Mysore Paper Mills Officers’ Association
- Som Prakash Rekhi v. Union of India
FULL TEXT OF THE ORDER OF ITAT KOLKATA
This appeal is preferred by the assessee against the order of learned Commissioner of Income Tax (Appeals)-21, Kolkata (hereinafter referred to as the “ld. CIT(A)”), dated 05.03.2026 for the Assessment Year (AY) 2010-10.
2. The only issue raised by the assessee is against the confirmation of penalties by the ld. CIT(A) of Rs.27,600/- and Rs.2,508/-, aggregating to Rs.30,108/- as levied by Assessing Officer (In short, ‘the AO’) u/s 271C and 271CA of the Income-tax Act, 1961 (In short, ‘the Act’) for alleged default u/s 194I and 206C(1) of the Act respectively without appreciating the fact there was a reasonable cause for the non-deduction/non-collection of tax, because the assessee acted under a bona fide belief that section 196 of the Act exempted the payment to Govt. Corporations from TDS and therefore, the same is reasonable cause within the meaning of section 273B of the Act.
3. The facts of the case in brief are that an order u/s 201(1)/206C(7) of the Act was passed by ACIT(TDS), Range – 2, Kolkata on 22.02.2017 for A.Y. 2010.11. In the assessment framed, the AO disallowed Rs.2,76,080/- and Rs.2,50,797/- and added to the income of the assessee for violation of provisions contained u/s 40(a)(ia) of the Act arising out of non-deduction of TDS u/s 194I and TCS u/s 206C(1) of the Act. The AO has already forwarded the case for imposing the penalty u/s 271C and 271CA of the Act to the Add. CIT, Range – 2 (TDS), Kolkata. Accordingly, a show cause notice was issued as to why the penalties should not be imposed as above. The assessee submitted that the company has entered into sub-lease agreement with M/s Bengal Chemical and Pharmaceuticals Limited dated 1.02.2004 for payment of Rs.1,38,000/- as annual rent in respect of a portion of land at 37, Canal Circular Road, Kolkata and by relying on provisions of section 196 of the Act that there was no requirement to deduct income tax at source on any sum payable to the Government. The AO observed that Government of India holds majority stakes in the company M/s Bengal Chemical and Pharmaceuticals Limited, but the fact remains that this is a company which is registered under companies Act, 1956 as a government company and therefore the provisions as regards TDS/TCS were applicable. The AO, accordingly, computed the penalties u/s 271C of the Act for non-deduction of tax of Rs.27,600/- and 271CA of the Act Rs.2,508/-, aggregating to Rs.30,108/- vide common order passed u/s 271C and 271CA of the Act.
4. In the appellate proceedings, the ld. CIT(A) confirmed the order of AO by holding that penalty imposing for non-deduction of tax u/s 194I of the Act and collecting of TCS u/s 206C(1) of the Act were rightly levied.
5. We have heard rival submissions and perused the materials available on record. We find that the assessee is engaged in the business of construction and development of real estate. We note that the assessee has not deducted tax u/s 194I of the Act on the payment made to M/s Bengal Chemical and Pharmaceutical Ltd. qua rent in respect of a portion of land at Kolkata of Rs.1,38,000/-. The assessee also defaulted in collecting tax at source u/s 206C(1) of the Act. The total additions made by the AO u/s 40(a)(ia) of the Act in the assessment framed were Rs.2,76,008/- u/s 194I and Rs.2,50,797/- u/s 206C(1) of the Act. Accordingly, a show cause notice issued by the AO on 30.08.2017 u/s 271C and 271CA of the Act and assessee replied the same. However, the AO levied a penalty of Rs.30,108/- (Rs.27,600/- + Rs.2,508/-) u/s 194I and 206C(1) of the Act respectively being 100% of the TDS and TCS sought to be evaded. The ld. CIT(A) also dismissed the appeal of the assessee and now the appeal before us.
6. We find that the assessee had paid rent amounting to Rs.2,76,008/- without deducting TDS u/s 194I of the Act, which was liable for TDS during the year. According to the AO, the said default was in respect of lease payment to lessor a government company M/s Bengal Chemical and Pharmaceutical Ltd. for sub-leasing a land at Kolkata. We note that assessee was under a bonafide belief that the assessee was a government-company and thus an instrumentality of the government, therefore, no tax was required to be deducted. We note that out of the assessee total equity capital 769603, equity shares to the tune of 769601 vested with President of India and other 2 shares in Mr. R.K. Maggo. We also note that under Article 12 of Fundamental Rights of Constitution of India, wherein the definition of “the State” includes the Government and Parliament of India and the Government and the Legislature of each of the States and all local or other authorities within the territory of India or under the control of the Government of India. For the sake of ready reference, Article 12 defines ‘Other authorities’ as follows:
“What is, and what is not a “State” has been the subject matter of rich case law under article 12 From the numerous decisions on the subject, a judgment of the Hon’ble Andhra Pradesh High Court has culled out certain propositions, B. Hassan Ali Khan v. Director of Higher Education, Andhra Pradesh, (1987) 4 Reports 198 (AP). The judgment says that the essential tests to determine whether a particular institution is “other authority” within the meaning of article 12 are substantial financial aid, control by the Government, performance of public functions and entrustment of governmental activities. All of these are not essential, and, in a particular case, one or a combination of more than one of them may suffice.”
7. A perusal of the above Article, makes it abundantly clear that what is the definition of state. In the above Article a reference is made to the judgement of Hon’ble Apex Court in case of Ajay Hasia vs. Khalid Mujib, AIR 1981 SC 487, the Regional Engineering College was held to be a “State” and observation in this case is as under:
“………….The constitutional philosophy of a democratic socialist republic requires the Government to undertake a multitude of socio-economic operations and the Government, having regard to the practical advantages of functioning through the legal device of a corporation embarks on myriad commercial and economic activities by resorting to the instrumentality or agency of a corporation, but this contrivance of carrying on such activities through a corporation cannot exonerate the Government from its basic obligation to respect the Fundamental Rights and not to override them. The mandate of a corporation may be adopted in order to free the Government from the inevitable constrains of red tapism and slow motion but by doing so, the Government cannot be allowed to play truant with the basic human rights. Otherwise, it would be the easiest thing for the Government to assign to a plurality of corporations almost every State business such as Post and
Telegraph, TV and Radio, Rail, Road and Telephones-in short every economic activity and thereby cheat the people of India out of the Fundamental Rights guaranteed to them.
3) The test for determining as to when a corporation can be said to be an instrumentality or agency of Government may be culled out from the judgment in the International Airport Authority’s case. They are not conclusive or clinching, but they are merely indicative indicia which have to be used with care and caution, because while stressing the necessity of a wide meaning to be placed on the expression “other authorities”, it must be realized that it should not be stretched so far as to bring in every autonomous body which has some nexus with the Government with the sweep of the expression. A wide enlargement of the meaning must be tempered by a wise limitation. The relevant tests gathered from the decision in the International Airport Authority’s case may be summarized as:
“(i) One thing is clear that if the entire share capital of the corporation is held by Government it would go a long way towards indicating that the Corporation is an instrumentality or agency of Government.
(ii) Where the financial assistance of the State is so much as to meet almost entire expenditure of the corporation, it would afford some indication of the corporation being impregnated with governmental character.
(iii) It may also be a relevant factor whether the corporation enjoys monopoly status which is the State conferred or State protected
(iv) ………………………….”
8. In the case of Ramana Dayaram Shetty vs. The International Authority of India and Ors 1979 SCR (3) 1014, the Hon’ble Apex Court elaborated on a test, which would suggest whether corporations incorporated under law are agency or an instrumentality of the government. The apex court had given some tests on the basis of which Government Companies under section 617 of the Companies Act were considered as State/Government under Article 12 of the Constitution of India. The tests elaborated are (i) the source of share capital, (ii) Extent of control over the corporation etc. In the case Mysore Paper Mills Ltd. vs. Mysore Paper Mills Officers’ Association [2002] 37 SCL 742 (SC), the main issue was whether a Government Company under section 617 of the Companies Act, 1956 is a State/Government with reference to Article 12.
9. We also perused the provisions of section 273B of the Act, which deals with the case where penalty is not to be imposed if there exist a reasonable cause for the said failure. Since the present case of the assessee is under bonafide belief that the tax was not required to be deducted under the bonafide belief that the assessee being a Govt company is exempt from the provisions of TCS and TCS, which in our opinion is a reasonable case within the meaning of section 273B of the Act.
10. So far as the penalty of TCS is concerned, the assessee sold scrap to the tune of Rs.2,50,797/- without collecting TCS at source on which it was liable to be deduct as such. The said scrap was generated in the normal course of business in real estate. As per the Explanation (b) to section 206C of the Act, ‘Scrap’ is defined as waste and scrap from the manufacture or mechanical working of materials which is definitely not usable as such because of breakage, cutting up, wear and other reasons. Here the assessee is engaged in the business of construction activity cannot be treated at par with manufacturing process. The construction activities were undertaken through deployment of labour and materials. We note that the assessee did not deduct TCS under the bonafide belief that the scrap generated during construction activities was outside the ambit of TCS provisions as the assessee believed the cutting & molding of steel and wooden material was not a manufacturing process. In our opinion, the bonafide belief of the assessee constitute a reasonable cause within the meaning of section 273B of the Act. Accordingly, we set-aside the order of ld. CIT(A) and direct the AO to delete penalties levied u/s 271C and 271CA of the Act.
11. In the result, the appeal of the assessee is allowed.
The order is pronounced in the open Court on 11/09/2026.
