The Income Tax Act, 1961, is a comprehensive legislation that governs direct taxes in India. It includes various provisions designed to ensure tax compliance and proper revenue collection by the government. One of the key sections in this legislation is Section 43B, which deals with the allowability of certain deductions only on actual payment. A pertinent issue under this section is the treatment of Service Tax/GST liabilities and their disallowance. This article delves into the nuances of Section 43B, its implications for businesses, and the role of tax auditors and income tax officers at assessment stage and litigations arising from them in enforcing this provision.
What is Section 43B?
Section 43B talks abput “Certain Deductions on payment” It was introduced to prevent taxpayers from claiming deductions for expenses they had not actually paid, thereby overstating their deductions and reducing their taxable income. The section applies to certain specified expenses and ensures that they are deductible only when actually paid. This principle helps in maintaining the integrity of the tax system by linking deductions to actual cash outflows rather than mere accruals.
Section 43B(a): Section 43B(a) specifically relates to the deduction of any sum payable by way of tax, duty, cess, or fee under any law for the time being in force. This clause ensures that such sums are allowed as deductions only when they are actually paid, irrespective of the accounting method employed by the taxpayer. The primary aim is to ensure that taxpayers cannot claim deductions for taxes or duties they have not yet remitted to the government, thereby improving the cash flow management and accountability in tax payments.
General Practice of Recording Service Tax/GST as a Liability
Businesses typically record Service Tax or GST as a liability in their books of accounts at the time services are rendered or goods are supplied. This liability represents the amount of tax collected from customers or clients, which must be remitted to the government. Under the accrual basis of accounting, which most businesses follow, revenues and expenses are recognized when they are earned or incurred, not necessarily when the cash transaction occurs.
For instance, consider a business that renders services in March but receives payment in April. Under the accrual basis, the income from these services would be recorded in March, when the services were performed. Similarly, the GST collected on these services would also be recorded as a liability in March, reflecting the business’s obligation to pay this amount to the government.
When businesses issue invoices to clients, they include GST in the invoice amount. This GST component is recognized as a liability in the books of accounts, indicating that the business owes this amount to the government. The liability remains on the books until the GST is actually paid to the tax authorities.
Businesses are required to periodically remit the GST collected from customers to the government. The timing of these payments depends on the GST return filing frequency applicable to the business, which could be monthly, quarterly, or annually. By following this practice, businesses ensure compliance with tax regulations and maintain accurate financial records.
For instance, consider a business, XYZ Ltd., that renders consulting services worth ₹1,00,000 in March and charges 18% GST on this service. The GST amount is ₹18,000 (18% of ₹1,00,000). The client pays for the services in April.
Under the accrual basis, XYZ Ltd. would record the income and the GST liability in March, even though the payment is received in April. The journal entries in March would be:
1. To record the income:
Accounts Receivable (Debtors) Dr ₹1,18,000
To Sales Revenue ₹1,00,000
To GST Payable ₹18,000
This entry reflects that XYZ Ltd. has earned ₹1,00,000 in revenue and has a GST liability of ₹18,000 to the government. (To not incur this GST liability the comcept of Profoma Innvoice is also used to account for revenue on cash basis.)
2. When the payment is received in April, the entry would be:
Bank Dr ₹1,18,000
To Accounts Receivable (Debtor) ₹1,18,000
3. When XYZ Ltd. remits the GST to the government in April, the entry would be:
GST Payable ₹18,000
To Bank ₹18,000
By following this practice, XYZ Ltd. ensures compliance with tax regulations and maintains accurate financial records. The GST liability recorded in March remains on the books until it is paid to the tax authorities in April.
However the most interesting fact to note here is which we can clearly see that at the close of the year even though the amount of GST is shown as a liability due to the government but the assessee has not taken any “Deduction” of the same in the Profit and Loss account Therefore, at the close of the year, despite GST being recorded as a liability due to the government, it is not deducted from the Profit and Loss account. This is because GST collected from clients is classified as a liability, not an expense, reflecting money owed to the government rather than a business expense. Therefore, while the sales revenue of ₹1,00,000 is included in the Profit and Loss account, the ₹18,000 GST liability does not impact this figure, as it is not an operational cost. This approach aligns with accounting standards, which require clear distinction between tax liabilities and business expenses, ensuring transparency and accuracy in financial reporting. Consequently, businesses like XYZ Ltd. maintain accurate financial records without affecting their reported profitability by keeping GST as a liability until it is paid.
Should the Tax Auditor Disallow the Same or Report the Same in Clause 21(i)(B)?
The tax auditor plays a crucial role in ensuring that the taxpayer complies with various provisions of the Income Tax Act, including Section 43B. During the tax audit, the auditor examines the books of accounts and other relevant documents to verify the accuracy and completeness of the financial statements. The auditor must also check for compliance with statutory provisions, including the timely payment of Service Tax/GST liabilities.
The tax auditor prepares the tax audit report in Form 3CD, which includes various clauses requiring specific details about the taxpayer’s financial transactions and compliance with tax laws. One such clause is Clause 21(i)(B), which pertains to the reporting of unpaid statutory liabilities.
Clause 21(i)(B): This clause requires the auditor to furnish details of any sum referred to in Section 43B that has not been paid on or before the due date of furnishing the return of income. If the taxpayer has not paid the Service Tax/GST liability by the due date, the auditor must report the unpaid amount under this clause. However as per various case laws and judicial precedents the tax auditor may take a view that the amount has not travelled through the Profit & Loss account and the assessee has not taken the deduction of the same. Therefore the same is not disallowed under Section 43B and choose not to report the same under this clause.
Further more, the tax auditor does not have the authority to disallow expenses. Instead, the auditor’s role is to report non-compliance in the tax audit report. It is the assessing officer’s responsibility to disallow deductions based on the information provided in the tax audit report and other documents during the assessment proceedings.
Should the Assessing Officer Disallow the Same?
During the assessment proceedings, the assessing officer examines the tax audit report and other relevant documents to determine the taxpayer’s compliance with the Income Tax Act. If the tax auditor has reported unpaid Service Tax/GST liabilities under Clause 21(i)(B), the assessing officer is likely to disallow the deduction for those unpaid liabilities while computing the taxable income.
The assessing officer is responsible for verifying the taxpayer’s compliance with tax laws and ensuring that the taxable income is computed accurately. The officer examines the tax audit report, financial statements, and other relevant documents to identify any discrepancies or non-compliance.
If the assessing officer finds that the taxpayer has not paid the Service Tax/GST liability by the due date of filing the return of income, the officer will disallow the deduction for that unpaid liability. This disallowance is made to ensure that only genuinely paid expenses are allowed as deductions, in line with the principle laid down in Section 43B.
The disallowance of unpaid Service Tax/GST liabilities increases the taxpayer’s taxable income, resulting in a higher tax liability. This ensures that taxpayers cannot reduce their taxable income by claiming deductions for liabilities they have not yet paid.
How is this Disallowance Actually Made?
During the assessment process, which is now largely automated, the Central Processing Centre (CPC) plays a crucial role in disallowing adjustments from the income tax returns filed by the assessee. The CPC operates on the premise that if the tax auditor has reported a disallowance of certain statutory dues, this represents a mistake apparent from the records. Consequently, the CPC adjusts the assessee’s income based on these reported disallowances. This automated approach often means that the CPC is the primary source of issues related to the disallowance of statutory dues, leading to various complications and disputes.
Litigations and Judicial Precedents
There have been numerous litigations concerning the disallowance of Service Tax/GST under Section 43B. Courts have generally upheld the disallowance of unpaid taxes, reinforcing the intent of the legislature to allow deductions based solely on actual payments. However, some cases have also seen relief being granted where the taxpayer demonstrated that the liability was subsequently paid within the permissible time frame.
Judicial Precedents: Courts have consistently held that the provisions of Section 43B are clear and unambiguous. They have ruled that any sum payable by way of tax, duty, cess, or fee shall be allowed as a deduction only if it is actually paid. This principle has been upheld in various judgments, reinforcing the intent of the legislature to link deductions to actual payments. However as stated earlier, whenever the said amount of tax is not routed through the profit & loss account, the deduction is not taken, therefore making the Section 43B non applicable and resultingly such amount even though being present in the liability of the assessee not being disallowed for the computation of income. The courts have granted relief in cases where the amount involved is not deducted from the income of the assessee, otherwise it would lead to undue taxation of the same amount of statutory liability.
In some cases, courts have also granted relief to taxpayers where they demonstrated that the unpaid liability was subsequently paid within the permissible time frame. For instance, if the taxpayer paid the Service Tax/GST liability before the due date of filing the return of income for the subsequent year, the courts have allowed the deduction in the year of payment.
Examples of Judicial Decisions:
- In the case of CIT v. Allied Motors (P) Ltd., the Supreme Court held that if the statutory dues are paid before the due date for filing the return of income, the deduction should be allowed.
- Similarly, in CIT v. Alom Extrusions Ltd., the Supreme Court reiterated that the amendments to Section 43B, intended to mitigate the hardships faced by taxpayers, should be interpreted liberally to allow deductions if the payments are made before the due date for filing the return.
Conclusion & Way Forward:
To avoid disallowance under Section 43B and undue litigation, auditors should not disallow the liability which is not routed through the profit in loss account, as the entire disallowance ahead being automated leaving very less scope of the assessee to gain relief without litigation at appellate stages. Secondly, taxpayers should ensure timely payment of Service Tax/GST liabilities. Additionally, clear communication with tax auditors and regular reviews of the tax positions can preempt potential issues during assessments.
Furthermore, proper documentation and record-keeping are essential for demonstrating compliance with Section 43B. Businesses should maintain records of all tax payments, including payment receipts, bank statements, and reconciliations, to support their claims for deductions. Furthermore to argue at any appellate stage about the disallowance under 43B being unfair, the appellant shall represent proper documents to ensure that all disallowance does not fall wthin the ambit of Section 43B. However, the requsite penalty, interest, late fine, fees, etc. under the GST Laws will have to be paid as per their rules and there would be no escapement from them. It is only under the Section 43B such dues should not be disallowed/ added to income of the assessee.
Section 43B of the Income Tax Act, 1961, is a crucial provision aimed at ensuring that deductions for certain expenses are allowed only on actual payment. The treatment of Service Tax/GST under this section underscores the necessity for timely compliance. While the disallowance of unpaid liabilities may seem stringent, it can be prevented only at the inception level, from where the fire gets its first spark, i.e., the Tax Audit Report, with the help of proper communication with the tax auditor.
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