In absence of a written sub-contract: whether contractors liable to deduct TDS?
In general practice the person who generates income is under an obligation to file its return and/or to pay tax under Income Tax Act, 1961 (for brevity hereinafter referred to as “IT Act”). But in certain enumerated situations, the payer of such consideration i.e. income is under an obligation to deduct the tax before paying to the payee and pay it to the Government. It is known as tax deducted at source (TDS). The effective rates of TDS are provided under relevant provisions of the IT Act and relevant Finance Act. Payers/deductors are also required to compute the overall liability incorporating surcharge and cess over and above the prescribed rates of TDS. If the payer fails to either deduct TDS or after such deductions fail to pay to the Government such attracts various provisions of the IT Act.
One such obligation is enumerated under Section 194C of the IT Act that casts an obligation in contracts wherein the payers ought to deduct TDS from the total consideration at specified rates i.e. 1% (where the contractor is individual/HUF) or 2% (where the contractor is other than individual/HUF). The Section 194C (5), provides for the threshold for application of this Section which is as follows:
(i) If the sum of the transaction exceeds Rs. 30,000/-; or,
(ii) The total value of multiple transactions between the same parties exceeds Rs. 1,00,000/- in a particular previous year.[1]
If any/both of the conditions are satisfied then the payer would be under a legal obligation to deduct TDS as per Section 194-C.
Implications on taxpayers upon non-compliance with Section 194-C:
Let us firstly understand as to what would be the implications, if the payer fails either to deduct TDS or after deduction fails to pay to the Government. First and foremost, the payer would be disallowed to claim deduction under Section 40 (a)(ia) of the IT Act. Section 40, provides for a negative list consisting of disallowed deductions, wherein Section 40 (a)(ia) specifically provides that the expenditures would be disallowed for deductions, where the payer either didn’t deduct TDS or if it is deducted but not paid to the Government before the due date.
The consequence of such non-deduction or non-payment would attract Section 201 of the IT Act, which is a deeming provision and the payer would be deemed to be in default of such taxes, provided that the payee does not reflect such amount for taxation in its Income tax return under Section 139 of the IT Act[2]. Moreover, the payer as an assessee would also be liable:
a) to pay simple interest @ 1% per month from the payment made to the contractor till the date of collection; and,
b) to pay simple interest @ 1½ % per month from the date of collection till it is paid to the Government.[3]
Moreover, Section 221 read with section 271C authorizes the joint commissioner to impose a penalty upon any person who failed to deduct TDS.[4] Section 276B provides that if the amount so deducted is not paid to the Government then such payer shall be punishable with rigorous imprisonment which shall be not less than 3 months but which may extend to 7 years and with a fine.[5]
What if there exists no written contract between a contractor and sub-contractor and the contractor fails to deduct TDS?
A similar issue came to the limelight when the taxpayer and the revenue authorities came to uncertainty as to what would be the implication of Section 194-C where there exists no sub-contract between the contractor and the so-called sub-contractor and where the contractor fails to deduct TDS under Sec. 194C. This issue was dealt with by the Hon’ble Supreme Court in the case of Shree Choudhary Transport Company v. ITO, [2020] 118 taxmann.com 47 (SC).
Brief facts:
The Assessee (i.e. ‘contractor’) being a partnership firm was involved in Transportation work for M/s Aditya Cement Limited based in Chittorgarh, Rajasthan. But since the assessee didn’t have any of its transport vehicles it engaged other transporters to fulfil the assessee’s obligation towards M/s Aditya Cement limited. The flow of payments was such that M/s Aditya Cement Co. was liable to pay to the Assessee and thereafter the Assessee was liable to pay to the other transporters.
M/s Aditya Cement Co. paid the amount to the assessee deducting tax at prescribed rates but the Assessee didn’t deduct taxes while paying to the transporter. On this AO disallowed deductions to Assessee amounting to Rs. 57,11,625/- u/s 40 (a)(ia). On appeal, CIT(A), ITAT, Hon’ble High Court upheld the assessment of AO and the appeals were dismissed. The case finally reached before Hon’ble Supreme Court for its observation.
Issue:
The Assessee contended that in the absence of a sub-contract between the assessee and the transporters there doesn’t exist a relationship of contractor-contractee. Therefore, the assessee is not liable to deduct tax at source u/s 194-C. The assessee contended that it was just acting as an intermediary between M/s Aditya Cement Limited and the transporters.
Observations of Hon’ble Supreme Court:
The Hon’ble Supreme Court observed that on the part of the existence of a sub-contract it relied upon the decision of ITO v. Gopal S. Rajput, wherein it was observed that the contracts under Section 194-C can either be in writing, oral, implied contracts or quasi-contracts. And the existence of a written contract is not a sine-qua-non for invoking Section 194-C.
On the contention of the Assessee that it is acting as an intermediary between the M/s Aditya Cement Co. and the transporter, the Hon’ble Supreme Court held that while looking at the facts of the case where the payment was to be made to the assessee(contractor) by the M/s Aditya Cement Limited and not directly to the third party transporters and also that the Assessee had the discretion on deputing the works to the transporters of its choice which, therefore, infers the existence of a sub-contract between the assessee and the transporters. Thus, the tax was required to be deducted at source by the Assessee before paying to the transporter.
Future tax implications upon the taxpayers:
Thus, it is now settled position of law that a written contract is not a sine-qua-non for the mandate of section 194-C and therefore, the AO can disallow payments u/s 40 (a)(ia) of the Income Tax Act, 1961. Such an observation would act as a guiding light for the taxpayers and revenue authorities to understand the tax implications on the transactions between contractors and sub-contractors more specifically in cases where the contractors have the discretion to select the sub-contractors of their choice. Thus, in such circumstances the taxpayers are required to deduct TDS against such transactions.
[1] Section 194C (5), The Income Tax Act, 1961.
[2] Section 201 (1), The Income Tax Act, 1961.
[3] Section 201 (1A), The Income Tax Act, 1961.
[4] Section 271C, The Income Tax Act, 1961.
[5] Section 276B, The Income Tax Act, 1961.
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