Background:
Before the introduction of Finance Act, 2022, there was a long standing dispute in so far as the allowability of cess and surcharge as a business deductible expenditure is concerned.
Section 40(a)(ii) of the Income Tax Act provides that any sum paid on account of any rate or tax levied on the profits or gains of any business or Profession was not an allowable expenditure.
As there was lack of clarity in the law with regard to allowability of ‘Cess’ or ‘Surcharge’ as an expenditure, certain assesses were claiming deduction on account of ‘cess’ or ‘surcharge’ under section 40 of the Act claiming that ‘cess’ has not been specifically mentioned in the aforesaid provisions of section 40(a)(ii) and, therefore, cess is an allowable expenditure. For this preposition they were relying on the decision of the Hon’ble Bombay High Court in the case of “Sesa Goa Limited Vs. JCIT” (2020) 117 taxmann.com and further on the decision of the Hon’ble Rajasthan High Court in the case of “Chambal Fertilizers & Chemicals Ltd Vs. JCIT” wherein, the Hon’ble High Courts relied upon the CBDT Circular Dt. 18-05- 1967 and in view of the interpretation made by the CBDT have held that ‘education cess’ can be claimed as an allowable deduction while computing the income chargeable under the heads “profits and gains of business or profession”. Based on these decisions ITAT in various judgments have followed the same reasoning and have allowed deduction on account of payment of “Cess”.
However, one of the latest judgments of ITAT Kolkata has discussed the above High Court judgments as well as other judgments vide order dated 26-10-2021 in the case of M/s. Kanoria Chemicals & Industries Ltd ITA No. 2184/Kol/2018 (TS-1129-ITAT 2021 Kol) and has held that the “Cess” is not to be allowed as deduction.
The above issue as to allowability of cess as an expenditure has however, been set at rest by the the Finance Act, 2022 by clarifying that the term “tax” includes and shall be deemed to have always included any surcharge or cess by whatever name called on such tax.
Clarification regarding treatment of cess and surcharge:
In order to make the intention of the legislation clear and to make it free from any misinterpretation, the Finance Act 2022 has introduced an amendment of Section 40 of Income Tax Act, 1961 by inserting an explanation thereto retrospectively-
‘Explanation 3.—For the removal of doubts, it is hereby clarified that for the purposes of this sub-clause, the term “tax” shall include and shall be deemed to have always included any surcharge or cess, by whatever name called, on such tax.’
The above amendment has been made retrospectively with effect from 1st April 2005 and will accordingly apply in relation to assessment for the assessment year 2005-06 and subsequent years. The amendments have been made from 1st April 2005 being the same date from which the provisions of Education & Secondary Education Cess were inserted in the Statute book.
Reasoning given by the government for making clarificatory amendment:
The CBDT Circular Dt. 18-05- 1967 was in reference to “Cess” imposed by State Government which is actually of the nature of “Cess” and not of the nature of “Additional Surcharge” being termed as “Cess” in the relevant Finance Act. When an additional surcharge is imposed by the Central Government and it is named as “Cess”, then its allowability needs to be examined whether an additional surcharge is allowed to be a deduction or not.
Hon’ble Supreme Court in the case of K Srinivasan has held that “surcharge” and “additional surcharge” are tax. Hence, the additional surcharge named as “Cess” and imposed by the Central Government through the Finance Act is nothing but a tax and hence, needs to be disallowed under sub-clause (ii) of clause (a) of section 40 of the Act.
Since the judgments of Rajasthan High Court and Bombay High Court did not consider the judgment of Hon’ble Supreme Court discussed above, the judgments of these two High Courts appear to be per incuriam and are against the intention of legislature and not in line with the judgment of Hon’ble Supreme Court.
Retrospective application of the above clarification & deemed under-reporting of income u/s 270A:
In view of the fact that the above clarifications have been made retrospectively, the Finance Act, 2022 provided that in case of those assessees where the amounts have already been claimed as expenditure and have been allowed will be subjected to the Rectification Proceeding u/s 155(18) of the Income Tax Act, 1961.
Rectification u/s 155(18) in respect of claimed deductions of education cess & surcharge:
Statutory provision of Section 155(18) as inserted by the Finance Act, 2022 provides as under:
“(18) Where any deduction in respect of any surcharge or cess, which is not allowable as deduction under section 40, has been claimed and allowed in the case of an assessee in any previous year, such claim shall be deemed to be under-reported income of the assessee for such previous year for the purposes of sub-section (3) of section 270A, notwithstanding anything contained in sub-section (6) of section 270A, and the Assessing Officer shall recompute the total income of the assessee for such previous year and make necessary amendment; and the provisions of section 154 shall, so far as may be, apply thereto, the period of four years specified in sub-section (7) of section 154 being reckoned from the end of the previous year commencing on the 1st day of April, 2021:
Provided that in a case where the assessee makes an application to the Assessing Officer in the prescribed form and within the prescribed time, requesting for re-computation of the total income of the previous year without allowing the claim for deduction of surcharge or cess and pays the amount due thereon within the specified time, such claim shall not be deemed to be under-reported income for the purposes of sub-section (3) of section 270A”
Thus,
- In case of all those assesses where the claim of education cess & surcharge has been made and allowed for any assessment year, they will be subjected to compulsory rectification proceeding by 31st March 2026.
- It is specifically provided hereinabove that if the assessee voluntary comes forward requesting for recomputation/ rectification of the total income by disallowing the claim of education cess & surcharge and pays the amount due thereon within the specified time, levy of penalty of 50% u/s 270A will be waived.
- In all other cases, where the assesse doesn’t comes forward for rectification of his total income, such claim of education cess & surcharge shall be deemed to be under-reported income of the assessee and the jurisdictional assessing officer will have to recompute the total income by disallowing the claim of education cess & surcharge by 31st March 2026 and in those cases, a penalty u/s 270A of 50% of the amount of tax payable will be levied by the assessing officer.
Retrospective levy of penalty of 50% u/s 270A for all earlier years by treating the claim as deemed under-reporting of income & fresh controversies initiated therefrom:
The Finance Act, 2022 has not only inserted an explanation to section 40(a) retrospectively, but also treated the claim of education cess & surcharge as deemed under-reporting of income when the claim was made in view of the decision of the high court.
As per the established principal of law, where 2 separate views are possible the assessee cannot be faulted for adopting a view favourable to him.
Furthermore without making an amendment in the charging provisions of section 270A dealing with penalty, the levy of penalty on account of the deeming fiction by making amendment in section 155(18) of the Act may not be tenable in the eye of law.
It is settled principal of law that penal provisions cannot be implemented retrospectively. Thus retrospective levy of penalty u/s 270A in respect of claim of cess as an expenditure for all earlier years may be seen as against the settled principal of law.
It is also to be noted here that the provision of Section 270A was inserted by Finance Act, 2016 with effect from 1st April 2017, and was not in statute book before the AY 2017-18, then in such a situation how can the same be applied in respect of claim of cess & surcharge for the assessment year preceding the AY 2017-18.
Consequently, the provisions of Section 155(18) as far as it seeks to levy penalty for deemed under-reporting of income may be subject matter of further litigation in days to come.
Conclusion:
The above mentioned amendments brought by the Finance Act, 2022 is in the nature of clarificatory amendment since the amendments seeks to remove prevailing doubts in the law on which there was divergence of opinion amongst various High Courts/Tribunals.
Considering the above amendments, one may voluntary resolve to get their return rectified by disallowing the Education Cess & Surcharge as expenditure in order to avoid any penal action u/s 270A.
However the retrospective application of above amendments and more particularly the deemed under-reporting of income may face the judicial scrutiny in upcoming days.
(Disclaimer: This write up is based on the understanding and interpretation of author and the same is not intended to be a professional advice.)
[The author is a Chartered Accountant and can also be reached at goyalcanitin@gmail.com]
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