Interest on Late Payment of TDS- Allowability

PRELUDE:

Sec. 201(1A) of the Income-tax Act mandates Assessee to pay simple interest @ 1%/1.5% per month or part of the month in case if there is failure to deduct tax or delay in remittance of TDS amount deducted, to the Central Government. The prominent question that arises at this point is whether the interest paid on non-deduction of TDS/late payment of TDS after deduction can be claimed as expenditure for determining the taxable income.

For claiming an expenditure while determining the taxable income, it should satisfy the twin conditions, they are:

a) Allowance of expenditure pursuant to the provisions of Sec.30 to 37 of the Act.

b) Said expenditure is not subject to disallowance under section. 40,43B etc.

Twin Conditions need to be complied even for claiming the interest paid on late payment/remittance of TDS.

INCOME-TAX PROVISIONS APPLICABLE TO THE ISSUE UNDER CONSIDERATION AND THEIR EXPLANATION:

Provisions relevant for allowing Interest paid u/s 201(1A) as expenditure:

a) Sec. 36(1)(iii):

Section 36(1)(iii) of the Act allows a deduction for interest paid on capital borrowed while computing the business income of the taxpayer. It provides deduction of the interest paid in respect of capital borrowed for the purpose of the business or profession. The essential ingredients of this clause are-

a) Interest

b) Borrowed capital, and

c) For the purpose of business and profession.

The term “interest” is defined in section 2(28A) of the Act, in the following manner:

Unless the context otherwise required, “interest” means interest payable in any manner in respect of any moneys borrowed or debt incurred (including a deposit, claim or other similar right or obligation) and includes any service fee or other charge in respect of the moneys borrowed or debt incurred or in respect of any credit facility which has not been utilised.

The expression “borrowed money” means real borrowing or real lending. It must be construed in its natural and ordinary meaning and implies a real borrowing and real lending. It requires the existence of a borrower and a lender and accordingly there must be a real borrowing. [K.M.S. Lakshmanier And Sons vs. CIT 1953 AIR 145:1953 SCR 1057 (SC)].

Explanation:

Unlike section 2(28A), clause (iii) of section 36(1) does not use the term ‘debt incurred’. Hence, section 2(28A) defines ‘interest’ in a wider sense whereas Section 36(1)(iii) has used it in a restrictive manner.

Therefore, it may be concluded that there must be a loan on which interest is paid for claiming allowance u/s 36(1)(iii) of the Act. Existence of lender and borrower are must in case of a loan transaction. Hence, it can be safely concluded that non-payment of taxes does not amount to the borrowing of capital from the Government and hence interest paid for delayed deposit of taxes is not covered under section 36(1)(iii) of the Act.

b) Section.37:

Section 37 is a residuary section which allows business expenditure in computing the taxable business income of an Assessee.

Expenses allowed as deductions against Profits and Gains of Business or Profession are covered from Section 30 to 36 of the Act. Section 37(1) provides that any expenditure incurred (except expenditure described in sections 30 to 36, capital expenditure or personal expenses of the assessee), wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head, “Profits and Gains of Business or Profession”.

Explanation 1 to section 37 (1) clarifies that any expenditure incurred by an Assessee for any purpose which is an offence or which is prohibited by any law shall not be deemed to have been incurred for the purpose of the business or profession and no allowance or deduction shall be made in respect of such expenditure.

Explanation:

Interest on late payment of TDS is not covered under Section 30-36 of the Act and thus qualifies for consideration u/s 37. It is neither capital expenditure nor personal expenditure of the Assessee. Further, Courts have time and again held that interest expenses on late payment of taxes which are compensatory in nature should be treated as expended wholly and exclusively for the purposes of the business or profession since responsibility of payment of taxes including deduction and remittance of TDS is part and parcel of the business operations and thus consequences, if any, arising therefrom will have direct connection with the business operations of the Assessee. Even the last limb provided vide explanation 1 to Section 37 of the Act gets satisfied since Interest expenses with regard to late payment of taxes which are compensatory in nature cannot be equated with expenditure incurred for a purpose which is either offence or prohibited by Law.

Therefore, interest expenses with regard to late payment of taxes, which are compensatory in nature, are eligible for deduction u/s 37 of the Act. Apex Court observations in this regard in the case of Lachmandas Mathura Vs. CIT reported in 254 ITR 799 are as follows:

“The High Court has proceeded on the basis that the interest on arrears of sales tax is penal in nature and has rejected the contention of the assessee that it is compensatory in nature. In taking the said view the High Court has placed reliance on its Full Bench’s decision in Saraya Sugar Mills (P.) Ltd. v. CIT [1979] 116 ITR 387 (All.) The learned counsel appearing for the appellant-assessee states that the said judgment of the Full Bench has been reversed by the larger Bench of the High Court in Triveni Engg. Works Ltd. v. CIT [1983] 144 ITR 732 (All.) (FB), wherein it has been held that interest on arrears of tax is compensatory in nature and not penal. This question has also been considered by this Court in Civil Appeal No. 830 of 1979 titled Saraya Sugar Mills (P.) Ltd. v. CIT decided on 29-2-1996. In that view of the matter, the appeal is allowed and question Nos. 1 and 2 are answered in favour of the assessee and against the revenue.”

It is well settled principle that interest on late payment of TDS is not penal in nature; since it is compensatory in nature, it is eligible for deduction u/s 37 of Act as it is expended wholly and exclusively for business purpose and payment of interest on late remittance of TDS is neither an offence nor prohibited by Law.

Reliance can be placed on the Karnataka High Court judgment in the case of COMMISSIONER OF INCOME TAX & ANR. vs. ORIENTAL INSURANCE CO. LTD. [315 ITR 102], wherein Honourabe High court held that interest for late payment of TDS is not in penal nature by observing as follows:

“7. In the Mittal Steel case (supra), the proviso to s. 201 was under consideration. The said proviso empowers levy of penalty if the TDS deduction is not effected for any valid reason. However, s.201(1A) is a distinct provision to levy interest for delayed remittance. It is in the practice of Revenue that for belated payment of tax for any reasonable cause, the assessee is liable to pay interest @ 12 per cent per annum. Similarly, for refunds, Revenue pays interest to the assessee. Therefore, the levy of interest under s. 201(1A) cannot at any rate be construed as a penalty………….”

The Judgment of the Apex Court in the case of Lachmandas Mathura (Supra) and Karnataka High Court decision in the case of ORIENTAL INSURANCE CO. LTD. (supra) amply covers the current issue i.e, claim of interest expense on late payment of TDS as business expenditure, which is compensatory in nature, and thus it can be beyond doubt concluded that interest on late payment of TDS is eligible for deduction u/s 37 of the Act.

Disallowance provisions pertaining to business expenditure relevant in the current scenario/context:

Section 40(a)(ii) disallows any sum paid on account of any rate or tax levied on the profits or gains of any business or profession or assessed at a proportion of, or otherwise on the basis of, any such profits or gains.

Explanation:

It has been categorically held that if tax is disallowed then the interest thereon should also be disallowed. Section 40(a)(ii) disallows the tax on the income of the Assessee. Therefore, it is crucial to understand whether TDS is a tax on the income of the Assessee.

Section 190 of the Act states that the tax on income may be paid by way of advance tax or by way of TDS/TCS. Further, sub-section (2) of section 190 states that the deduction of tax or collection of charge is independent of the charge of tax on income. Further, section 198 states that tax deducted is a part of the income received by the deductee except for TDS under section 194N which deals with TDS on cash withdrawals.

Section 199 of the Act in clear terms provides that any deduction of tax and payment thereof to the Central Government shall be treated as a payment of tax on behalf of the person from whose income the deduction was made. In other words, TDS shall be treated as the tax paid on behalf of the person in respect of whose income such payment of tax has been made.

Therefore, it is crystal clear that ‘TDS’ is not a tax on the income of the deductor. Instead, it is a tax on the income of the deductee. Thus disallowance u/s 40(a)(ii) against the interest expenditure claimed for late payment of TDS is unwarranted.

Conclusion with regard to claiming interest expenditure on late payment of TDS:

From the above explanations it is clear that interest on late payment of TDS is complying all the provisions of Sec.37 of the Act as it is compensatory in nature rather than penal in nature. Further, no disallowance provisions specified under the Act are applicable to the interest paid u/s 201(1A) of the Act on the late remittance of TDS to government.

NOTE: It is pertinent to mention that the Madras High Court Judgment in the case of Chennai Properties and Investments Ltd [239 ITR 435] pertaining to disallowance of interest expenditure paid u/s 201(1A) of the Act was prima facie based on the pretext that interest on late payment of TDS is penal in nature rather than compensatory in nature, which could even be observed from the extract of the judgment, whereas in the subsequent judgment in the case of COMMISSIONER OF INCOME TAX & ANR. vs. ORIENTAL INSURANCE CO. LTD. [315 ITR 102], Honourabe Karnataka High court held that interest paid u/s 201(1A) for late payment of TDS is not penal in nature. Further, this decision is not distinguished till date either by Supreme Court or any other High Court and thus by following the ‘principle of stare decisis’ the observations made by the Karnataka High Court in the above said case needs to be followed by all Tribunals and High Courts for allowing interest on late payment of TDS unless a contrary finding was made. Extract of Madras High Court Judgment in the case of Chennai Properties and Investments Ltd is as follows:

“8. The liability for deduction of tax arises by reason of the provisions of the Act. Under Section 201, the consequence of failure to comply with the same renders that person liable to be deemed as an assessee in default with all the consequences attached thereto. The liability to pay interest on the amount not deducted or deducted but not paid is directly related to the failure to deduct or remit the amount. The amount required to be deducted is the amount payable as income-tax. The interest paid for the period of delay takes colour from the nature of the principal amount required to be paid, but not paid within time. The principal amount here would be the income-tax and the interest payable for delayed payment is the consequence of failure to pay the tax and in the circumstances, in the nature of a penalty though not described as such in Sub-section (1A) of Section 201 of the Act. The fact that the income-tax required to be remitted was not income-tax payable by the assessee, but is ultimately for the benefit of and to the credit of the recipient of the income on whose behalf that tax is payable does not in any manner alter the character of the payment, namely, its character as income tax.

14. As already noticed the payment of interest takes colour from the nature of the levy with reference to which such interest is paid and the tax required to be but not paid in time, which rendered the assessee liable for payment of interest was in the nature of a direct tax and similar to the income-tax payable under the Income-tax Act. The interest paid under Section 201(1A) of the Act, therefore, would not assume the character of business expenditure and cannot be regarded as a compensatory payment as contended by learned counsel for the assessee.” (EMPHASIS SUPPLIED)

OTHER PARAMETER RELEVANT TO THE MATTER DISCUSSED ABOVE:

Interpretation of term month used in phrase ‘month or part of the month’ specified under Sec.201(1A):

It is not out of place to mention that while applying the provisions of Sec.201(1A) of the Act, department is treating the term ‘month’ used in the phrase ‘month or part of the month’ specified under section 201(1A) as calendar month, rather than term of 30 days period, solely to invoke interest for extra months with an intent to recover additional interest capriciously, whereas Honourable Hyderabad Appellate Tribunal in the case of Navayuga Quazigund Expressway (P.) Ltd. Vs. DCIT [39 ITR(T) 612] held that for the purpose of calculating interest under section 201(1A) of the Act term ‘month’ must be given ordinary meaning of term of 30 days period and not British calendar month. This view was even followed by Ahmedabad Appellate Tribunal in the case of Bank of Baroda Vs. DCIT [168 ITD 180].

Note for reconsideration of interest rates and method of calculation in case of refunds to Assesee by the Government:

Pursuant to provisions of Sec.201(1A) of the Act, Government charges interest at the rate of 1% per month or part of the month in case of non-deduction and 1.5% per month or part of the month in case where there is a delay in remittance of TDS amount deducted from the date on which TDS is liable to be deducted/TDS is deducted despite the fact the deductee has tax liability for the year under consideration.

In case if a person against whom TDS was deducted has no tax liability for the year under consideration, a share of his income will already be parted with department by way of TDS and the said person will be entitled to get the refund of the TDS amount only after filing the return and getting it processed u/s 143(1) of the Act.

The fact that requires humble consideration herein is as per provisions of Sec.244A of the Act Assessee/deductee will be not entitled to get interest on refund amount from the date of TDS deduction, Assessee/deductee will be entitled to get interest from the 1st day of the assessment year if Assessee file return of income within the due date specified u/s 139(1) of the Act and in case if don’t file return of income within the due date specified u/s 139(1) of the Act Assessee will be entitled to get interest from the date of furnishing Return of Income that too at the rate of 0.5% per month or part of the month.

It is not out of place to mention that the method of interest calculation of the Department including the interest rates used therein is against the Fundamental Rights (Article 14 of the Constitution of India – Principle of Equality) since in cases of refund of TDS department will give interest @ 0.5% per month or part of the month that too either from the 1st day of the assessment year or from the date of filing return of income, whereas if there is any delay in remittance of TDS to the Government it collects interest @1%/1.5% per month or part of the month that too from the date on which TDS is liable to be deducted/TDS is deducted.

Thus the above method of interest calculation of the department including the interest rates used therein requires a reconsideration for the benefit of Assessees. It would be better if interest rates pertaining to savings bank deposit account are applied for all the above mentioned transactions and in case of refund to the Assessee interest needs to be calculated from the date on which TDS is deducted.

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DISCLAIMER: The contents of this Article are for information purposes only, to enable professionals to have a quick and an easy access to information with regard to the topic ‘interest on late payment of TDS’, and do not purport to be legal opinion.