Section 194N of Income Tax Act 1961 and Its Validity

Section 194N was introduced by Finance Act 2019 and substituted by Finance Act 2020. The main ingredient of Section 194N is that TDS @ 2% shall be deducted in case any person withdraws in cash an amount exceeding Rs. 1.00 Crore  In cash   from his bank account in an year. A person who has not filed his tax returns for three assessment years relevant to  the three previous years, for which the time to file return of income as prescribed under section 139(1) has expired, immediately preceding the previous year in which the payment of the sum is made to him, then 2% tax shall be deducted in case cash withdrawal from account exceeds Rs. 20.00 Lakhs and 5% in case withdrawals exceed Rs. 1.00 Crores. This section is not applicable to payment drawn by the Government or any Bank mainly. The basic purpose of introducing TDS provisions was to collect tax at earliest point of time as soon any transaction involving some element of income has been done.  Here the word income is important because when there is no income in a transaction there is no income tax and hence no TDS.  Different rates are prescribed in TDS Chapter considering the element of income so as to say @ 10% on Building Rent, 10% on payment to professional, 10% on interest and 1-2% on Contract payment and so on. Contrary to basis scheme of TDS chapter to collect tax whenever there is any income arising, Section 194N provides an obligation to banks and post office to deduct tax on cash withdrawal. The activity of cash withdrawal is not an income generating activity, hence the introduction of Section 194N is not as per scheme of TDS chapter. A provision is added in Section 198  that the sum deducted in accordance with the provisions of Section 194N for the purpose of computing the income of an assessee, shall not be deemed to be income received.  Now I shall discuss the validity of this section in view of various judicial pronouncements and Constitution of India 24 ITR 506 Sir Kikabhai Premchand vs Commissioner Of Income Tax … on 9 October, 1953 (SC)

The appellant deals in silver and shares and a substantial part of his holding is kept in silver bullion and shares. His business is run and owned by himself. His accounts are maintained according to the mercantile system. It is admitted that under this system stocks can be valued in one of two ways and provided there is no variation in the method from year to year without the sanction of the Income- tax authorities an assessee can choose whichever method he wishes. In this case, the method employed was the cost price method, that is to say, the cost price of the stock was entered at the beginning of the year and not its market value and similarly the cost price was again entered at the close of the year of any stock which was not disposed of during the year. The entries on the one side of the accounts at the beginning of the year thus balance those on the other in respect of these items with the result that so far as they are concerned the books show neither a profit nor a loss on them. This was the method regularly employed and it is admitted on all hands that this was permissible under this system of accounting.

The accounting year with which we are concerned is the calendar year 1942. The silver bars and shares lying with the appellant at the beginning of the year were valued at cost price.

In the course of the year the appellant withdrew some bars and shares from the business and settled them on certain trusts, three in number. The appellant was one of the beneficiaries in all three trusts retaining to himself a reversionary life interest after the death of his wife who was given the first life interest. After certain other life interests the ultimate beneficiaries were charities. The appellant was the managing trustee expressly so created in two of the trusts and virtually so in the third. In his books the appellant credited the business with the cost price of the bars and shares so withdrawn and there lies the crux of the issue which we have to determine. There is no suggestion in this case that the bars and shares were withdrawn from the business otherwise than in good faith. According to the appellant, the act of withdrawal resulted in neither income nor profit nor gain either to himself or to his business, nor was it a business trans- action, accordingly it was not taxable.

The principle which emerges from above citation is that a person can’t earn by making a transaction with himself. When there is no element if income in a particular transaction then there is no income tax also and hence no TDS also.

[CIT v. Eli Lilly & Co. (India)(Pvt) Ltd. [2009] 312 ITR 225 (SC)] & [Bharti Airtel Ltd. v. DCIT [2015] 372 ITR 33 (Karnataka)(HC)].

Sections mandating the deduction of tax at source are subservient and subordinate to the charging provision of Section 4 of the Act. 

Chapter II of Income Tax Act forms the very bedrock of the imposition of Income-tax as contemplated by the Act. Section 4(1) of the Act provides that where any Central Act enacts that Income tax shall be charged for any assessment year at any rate or rates, Income-tax at that rate or those rates shall be charged for that year in accordance with, and subject to the provisions (including provisions for the levy of additional income-tax) of, the Act in respect of the total income of the previous year of every person. Section 4(2) provides that “In respect of income chargeable under sub-section (1), income-tax shall be deducted at the source or paid in advance, where it is so deductible or payable under any provision of this Act.” Section 4(2) of the Act provides that in respect of the income chargeable under Section 4(1), Income tax shall be deducted at the source or paid in advance where it is so deductible or payable under any provision of the Act. The language of Section 4(2) therefore makes it clear that what shall be deducted is ‘Income Tax’ in relation to the ‘Total Income’ of a person. It can therefore be construed that there can be no liability to deduct tax at source in respect of a transaction that is not covered within the ambit of Section 4(1) of the Act and does not form a part of the ‘Total Income’ of an Assessee. If a particular Income falls outside of Section 4(1) of the Act, then the tax deduction provisions cannot be applied  It is a settled principle of Tax Jurisprudence that though the legislature enjoys a wide leeway in the imposition of a tax, taxing statutes need to be construed strictly. Sections mandating the deduction of tax at source are subservient and subordinate to the charging provision of Section 4 of the Act.

The Hon’ble Supreme Court in the case of Steel Authority of India Ltd. v. State of Orissia (2000) 3 SCC 200 and in the case of NathpaJhakri Jt. Venture v. State of Himachal Pradesh (2000) 3 SCC 319

Section 2 (45) of the Act, defines the term ‘Total Income’ as the total amount of income referred to in Section 5, computed in the manner laid down in this Act. Section 5(1) being the ‘Scope of total income’ states that subject to the provisions of the Act, the total income of any previous year of a person who is a resident includes all income from whatever source derived which is received or is deemed to be received in India in such a year by a person, or accrues or arises or is deemed to accrue or arise to him in India during such year or accrues or arises to him outside India during such year. It is therefore clear that ‘Total Income’ shall necessarily comprise of ‘Income’ which is received or deemed to be received. As an essential corollary, if a sum of money that is received is neither Income received not Income deemed to be received, it shall not form a part of the Total Income and therefore cannot be covered by Section 4(1) of the Act. The Hon’ble Supreme Court in the case of Steel Authority of India Ltd. v. State of Orissia (2000) 3 SCC 200 and in the case of NathpaJhakri Jt. Venture v. State of Himachal Pradesh (2000) 3 SCC 319 has held that tax cannot be deducted at source in respect of transactions which are not liable to tax and merely because there was an entitlement of refund would not cure the infirmity. Even though the said Judgments are with regards to deduction of tax in the case of the various Sales Tax Acts, the ratio laid down by the apex court shall be equally applicable to Income tax legislation.

Section 190 of the act is the general section that provides for deduction at source and advance payment of tax. Section 190 (1) provides that “Notwithstanding that the regular assessment in respect of any income is to be made in a later assessment year, the tax on such income shall be payable by deduction or collection at source or by advance payment or by payment under sub-section (1A) of Section 192, as the case may be, in accordance with the provisions of this chapter”. It is therefore clear by a plain reading of the words of the section that the payment by deduction or collection at source of tax can only be with respect to ‘any income’ in respect of which a regular assessment of tax is to be made. The use of the word ‘any income’ as opposed to ‘total income’ makes it apparent that there must be a ‘live nexus’ between the deduction of tax at source and the income upon which the obligation to make such deduction is sought to be imposed. It also follows that the deduction of tax at source are only methods of payment of tax and cannot by themselves impose any liability which does not already exist. Every other provision of deduction of tax at source as encapsulated by Chapter XVII conforms to the live nexus theory as they well should.  “If there can be no tax on a particular income by virtue of some special provisions contained in an enactment other than the Income-tax Act, 1961, any provision contained in Chapter XVII of the Income Tax Act cannot be invoked. The emphasis under section 190(1) is on the ‘tax on such income’. What follows from Sections 192 onwards are actually deduction or collection at source or advance payment of ‘tax on income”.[C Nanda Kumar v. UOI [2017] 396 ITR 21 (Andhra Pradesh)(HC)].Section 190(1) is the Section that provides that deduction of tax can be made prior to the regular assessment. Without the backing of Section 190, Section 194N is devoid of any authority  to mandate a deduction of tax prior to regular assessment rendering it a dead letter in law.

The provisions of Chapter XVII cannot be read ‘de hors’ the provisions of Section 190. Section 194N derives its authority to mandate a deduction of tax or collection of tax at source before the actual assessment through Section 190. It therefore also follows that section 194N in as much as it seeks to impose an obligation to deduct tax at source on transactions that do not give rise to any income, shall be ‘de hors’ the authority of law and shall run afoul article 265 of the Constitution of India. Deduction of tax at source is a machinery for the recovery of tax and the said deduction of tax at source should aid the charge of tax under Section 4 as held by the Delhi High Court in UCO Bank V. Union of India [2014] 369 ITR 335 (Delhi)(HC). The provisions of deduction of tax at source are a part of a scheme. The deduction of tax is to be notwithstanding the regular assessment to be made in respect of any income. It has to be made in accordance with the provisions of Chapter XVII. The Consequences of non-deduction of the amount are governed by Section 201 of the Act. As per this Section, the consequence of non-deduction shall be that the person who is required to deduct any sum in accordance with the provisions of the Act, does not deduct the tax or does not pay or after so deducting, fails to pay the whole or any part of the tax, as required under this Act, then such person shall be deemed to be an Assessee in default in respect of such tax. The first Provisio to Section 201 of the Act provides that a person who fails to deduct the whole or part of the tax in accordance with the provision of this Chapter on the sum paid to a resident, shall not be deemed to be an Assessee in default is the said resident has (i) has furnished his return of income under Section 139, (ii) has taken into account such sum for computing income in such return of income, (iii) had paid the tax due on the income declared by him in such return of Income and a certificate to that effect is furnished. A look at the provision of Section 201 make it further clear that the scheme of Chapter XVII is to tax ‘Income’. Section 194N is incongruous to the scheme of deduction of tax at source in as much as it is imposed upon a transaction that can under no circumstances have an element of Income embedded within it. If a person is not liable for payment of tax at all, at any time, the collection of a tax from him, with a possible contingency of refund at a later stage, will not make the original levy valid; because, if particular sales or purchase are exempt from taxation altogether, they can never be taken into account, at any stage, for the purpose of calculating or arriving at the taxable turnover and for levying tax [Bhavani Cotton Mills v. State of Punjab (1967) 3 SCR 577].

Section 194N of the act imposes the obligation to deduct tax at source upon a person being a banking company, a co-operative society carrying on the business of banking or a post office (hereinafter referred to as ‘the bank’) with the recipient of the cash in excess of Rupees one crore from one or more accounts maintained by the recipient. It therefore purports to impose an obligation to deduct tax on a transaction that neither gives rise to any income (taxable or otherwise) in the hands of the recipient, nor results in any transfer of any sort of property or title in the cash withdrawn. Though the bank (for the purposes of the transaction) is a payer of money, the title of the money the payment is made on behalf of the recipient and is therefore a Capital Receipt in hands of the Recipient. Just as the repayment of the principal part of a loan cannot be subject to tax due to the lack of character of ‘Income’, neither can the withdrawal of cash from the bank account. What is accepted by a bank from its account holders is a ‘deposit’ and what is paid back is a ‘withdrawal’. The deposits can be used by the bank in the conduct of its banking business and can be withdrawn by its customers in terms of the agreed parameters of the banking relationship. Interest that accrues on the deposits with a bank are liable to be assessed to tax as Income from other sources and is duly taxed either with or without deduction at source depending upon the type of bank account.  A second school of thought deems that the bank has a fiduciary relationship with the recipient and holds the money of the account holder in trust. According to this school of thought, the money with the bank in an account held by a depositor always remains the money of the depositor and therefore there can be no element of Income in withdrawing the same.  The said section 194N does not purport to ban cash transactions or to levy any tax on them. There can be no levy of tax or the collection thereof on the basis of a transaction that does not give rise to any income either by itself or through deeming fiction.

The mechanism that is suggested through the said amendment does not penalize an Assessee or invite a fresh levy of tax which could add to the total income of an Assessee. There is no whisper that prevention of tax evasion is a reason for the introduction of the said section. The Legislature had introduced a Banking Cash Transaction Tax vide Finance Act, 2005. This was introduced as a specific levy and remained on the statute books until 2009. The said levy was introduced as the Government was concerned with large cash transactions and the lack of trail left by them and was specifically introduced as an anti-tax-evasion measure. It was subsequently removed as the information that was being gathered by the said levy was also being gathered through other means. Section 194N of the Act does not purport to be an anti-tax-avoidance measure. It is therefore abundantly clear that it seeks to arm twist depositors into adopting digital payments and to dissuade them from withdrawing money from banks.

The objective of the introduction of Section 194N into the Act is not to collect tax by deduction at source or even to check evasion. The said section has been imposed upon assessees with the objective of promoting digital payment and a cashless economy. The objective, though laudable, admittedly has nothing to do with either the levy or the collection of income tax. The promotion of the digital economy cannot be done at the cost of the constitutional rights. Section 194N provides for a deduction of money on withdrawal of a person from his own funds with a bank and for the adjustment of the same against his tax liability. The scheme as envisaged by Section 194N is revenue neutral for the Government as it does not affect the tax collection in any manner.

Article 265 of the Constitution of India provides that “no tax shall be levied or collected except by the authority of the law”. The wordings of the Article are restrictive as well as enabling. The said Article 265 seeks to rein in the otherwise unbridled powers of authorities with respect to taxation. The ambit of the said Article is solely to do with the levy or the collection of tax. It becomes immediately clear that Section 194N of the Income-tax Act, 1961, runs beyond the boundaries of Article 265 of the Constitution of India blurring the lines of what can be considered as a valid part of a taxing statute. A cursory glance at Section 194N of the Act immediately brings to light that it is neither a levy of tax nor is a method of collection of the same. Without prejudice, even if it were to be assumed that Section 194N of the Act is a mechanism for the collection, that what is actually cannot by any stretch of imagination be called a tax and therefore shall fall outside the ambit of Article 265 of the Constitution of India. It is established that the ‘authority of law’ as contemplated by Article 265 of the Constitution of India cannot be arbitrary in form or function. The authority of law, though pervasive, cannot be exercised in a manner that is perverse or beyond the scope of the parent legislation. The introduction of a provision of law in a taxing statute which correlates neither to the levy of tax nor the collection of a tax is an aberration and cannot be considered to be a valid part of a taxing statute. A that allows for money to be collected  by the government on a transaction not liable to tax cannot be considered to be a method of collection of tax merely because it permits the money collected to be adjusted against the tax liability of an Assessee.

Article 300A of the Constitution of India states that no person shall be deprived of his property save by the authority of law. The term property is not defined by the said Article, however, ‘cash’ as well as ‘bank balance’ are ‘property’ within the ambit of Article 300A. Even though Right to property is no longer a fundamental right, it is still a constitutional right and must be zealously protected. The action of the Legislature to force a depositor to deposit through the device of a ‘tax deduction at source’ tantamount to the legislator depriving the recipient as defined by Section 194N of the Act of his property, albeit only till either assessment of tax or until the receipt of the refund post assessment. The Government therefore receives the funds, interest free from the date of the deposit of the deducted amount  until the Assessment is made. Section 194N of the Act is therefore an appropriation by the Government to itself of property being money in the guise of a deduction of tax at source without any entitlement to the same through the levy of any tax and without providing any compensation.

Unlike the established narrative surrounding the statutes levying tax, general jurisprudence in as far as deprivation of public property is concerned recognizes the basic principles of equity and inherent fairness of the law. Deprivation of property within the meaning of Article 300-A, generally speaking, must take place for public purpose or public interest. The concept of eminent domain which applies when a person is deprived of his property postulates that the purpose must be primarily public and not primarily of private interest and merely incidentally beneficial to the public. Any law, which deprives a person of his private property for private interest, will be unlawful and unfair and undermines the rule of law and can be subjected to judicial review. But the question as to whether the purpose is primarily public or private, has to be decided by the legislature, which of course should be made known.  A law seeking to acquire private property cannot say that no compensation shall be paid. The legislation providing for deprivation of property under Article 300-A must be ‘Just, fair and reasonable’. [K.T. Plantation Private Ltd. & Onr. V. State of Karnataka (2011) 9 SCC 1]

The Right to Privacy has been recognized as a fundamental right under Article 21 of the Constitution of India [K.S. Puttaswami &Ors. v. UOI (2017) 10 SCC 1].Is the need to withdraw a sum of more than Rupees twenty lakh to be considered a sufficient condition to necessarily cause the deprivation of a person’s privacy guaranteed by the Constitution of India? The Supreme Court has held that the individual lies at the core of constitutional focus and it is in the realization of individual rights that the collective well-being of the community is determined. But the privacy judgement in isolation does not tell the entire story and to bring the current quandary into focus needs to be considered after counter weighing it against the Aadhar judgement [K.S. Puttaswamy (ret) &Onr. V. UOI &Onr. (2019) 1 SCC 1]. The latter contains a considerable deliberation upon the former judgment and also includes amongst the other concepts propounded, the test of proportionality being (i) the existence of a just, fair and reasonable law, (ii) the abridgement serving a legitimate state aim, (iii) the abridgement being proportionate to need such interference.

Considering the three conditions prescribed by the Supreme Court one by one, the fact that the section is not a valid taxing statute and seeks to dissuade a person from handling his own property as he deems fit by forcing the payer to deduct tax at source in a non-taxable transaction against the very grain of the rest of the Chapter as well as the Act within which it is contained can be said to not be just, fair and reasonable. As the aim of the statute is not to prevent evasion but to give an impetus to digital payments which are largely in the hands of private or state-owned enterprises, which is hardly a legitimate state aim, the abridgement of the right to privacy hardly seems to be proportional. Thirdly, it is also required to be tested whether the abridgement of the right to privacy is proportional to the need for such interference. The aim of promoting digital payments when weighed against the right to privacy which has been held to be a part of Article 21 of the consideration of India comes up woefully short and therefore miserably fails the tests laid out for proportionality as prescribed by the Supreme Court.

Though there are other tests also prescribed in the Aadhar judgment, it is important to note that the judgment was with respect to enforcing a right i.e. the right to privacy against an action of the government. This however, is taken one step forward in the case of Section 194N, where data will in effect be mandatorily be furnished to a private party or a public financial institution, both of which are not entitled to the information, but would need to collect it in order to comply with the obligations thrust on them by the section. This therefore places Section 194N on a weaker ground than Aadhar.

A person has a right to dispose of his property in the manner of his own choosing as long as it is within the framework of the law. The very fact that Article 300A of the Constitution of India prescribes that no person shall be deprived of his property save by the authority of law, can be said to establish the right to hold and deal with property as a constitutional right as long as it is done within the four corners of the law. The management of a person’s private property, in accordance with the law of the land in a part of a person leading a dignified existence and is protected by Article 21 of the Constitution of India. If a person deems it risky to keep their wealth at the bank, the Legislature cannot, for the sake of promoting digital payments and a cashless economy, trammel upon his rights guaranteed by the constitution of India.  Transactions done through banks have associated costs with them for the services rendered. The banking industry has been rocked by multiple scandals on a regular basis over the last few years. This has led to a loss of depositor confidence in the industry. There have been instances of banks failing or coming close to failure. There have been multiple occasions where it has been observed that depositors have been unable to withdraw their money from the banks that are extremely close to default. Banks have also been plagued by a large number of non-productive assets (NPAs) due to mismanagement and crony capitalism. The public faith in banks and financial institutions is at an all-time low. Given the uncertainty surrounding the banking industry at large, the action of the government in trying to actively promote digital payments through banks is a deliberate attempt to place roadblocks in the path of those citizens who would wish to withdraw their funds from the banks legally and at their own risk through the guise of an amendment in fiscal statute. The courts have held from time to time that people are free to carry on their business as long as it is within the four corners of the law. The reduction in the limits for cash withdrawal without having to incur the deduction of tax at source is telling. The nation started the process of economic liberalization more than twenty eight years ago (1991). The entire concept of liberalization started from deregulation of controls and simplification of processes. Having taken two steps forwards down this path, perhaps we should stop ourselves from taking one step back?

However, what is critical is the digital web that the digital economy and the government’s actions mean to a person’s privacy and freedom. If a person wishes to withdraw a good amount of cash from the bank and keep it in his bed and sleep upon the same instead of trusting the banking system that seems to be appearing increasingly frail, as long as every single paisa is accounted for and declared, he should be permitted to, without having to pay a toll to the omnipresent big brother that today’s governments all over the globe are turning into.

Hon’ble Madras High Court in the case of Tirunelveli District Central Cooperative Bank Limited vs. JCIT(TDS) in W.P.(MD).No. 6102 of 2020 decided on 27-07-2020

No TDS under section 194N if Cash Withdrawal is not Income: Hon’ble Madras High Court in the case of Tirunelveli District Central Cooperative Bank Limited vs. JCIT(TDS) in W.P.(MD).No. 6102 of 2020 decided on 27-07-2020 held that if the sum received by the assessee will not be an income at his hands, then, the question of deduction under Section 194N on cash withdrawals will not arise. It is further held that if the amounts received (cash withdrawals) by the recipients do not represent income at their hands and had also filed their returns and the case falls under the proviso to Section 201(1) of the Act, the writ petitioners who have failed to deduct (tax on cash withdrawals under section 194N) cannot be fastened with any liability. It should be noted that the validity of the provisions of section 194N has not been questioned in this case.

On the basis of above it is clear that the Section is ultra vires the Constitution of India and also not as per the scheme of TDS provisions and also section 4  due to various judicial pronouncements.