Interesting Income Tax Issues: Deduction of Health and Education Cess from Taxable Income : AY 2020-21

Background

Sec. 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 or assessed at a proportion of, or otherwise on the basis of, any such profits or gains’ shall not be deducted in computing business income.

It needs to be noted that while the section specifically covers “any rate or tax”,  word “cess” is  not mentioned there. Accordingly, a  question had been raised before judicial forums  as to whether the expression “any rate or tax levied” as it appears in Section 40(a)(ii) of the IT Act includes “cess” and thereby whether education cess paid by an assessee is covered by the disallowance contemplated u/s. 40(a0(ii)?

Judiciary’s view

Answering the above question, judicial authorities have pronounced that education cess paid by the assesse  DOES NOT  get hit by the restriction created by Sec. 40(a)(ii) and accordingly is a deductible expenditure.

Following are some of the citations in this regard :

  • Rajasthan High Court in Chambal Fertilisers And Chemicals Ltd. Vs. JCIT, Income Tax Appeal No.52/2018 ,31.07.18
  • DCIT Vs Bajaj Allianz General Insurance (ITA No.1111 and 1112/PUN/2017 decided on 25th July, 2019) by the ITAT, Pune.
  • DCIT Vs Graphite India Ltd. (ITA No.472 and 474. Co. No.64 and 66/Kol/2018 decided on 22nd November, 2019 )by the ITAT, Calcutta;
  • DCIT Vs Peerless General Finance and Investment and Co. Ltd. (ITA No.1469 and 1470/Kol/2019 decided on 5th December, 2019) by the ITAT, Calcutta
  • Bombay High Court (Panaji bench) in Sesa Goa Limited vs. JCIT , Tax Appeal No.18/2013 , dt. 02.2020
  • Voltas Ltd. vs. ACIT (ITA No. 6612/Mum/2018 dated June 30, 2020) – Mum. Trib.
  • M/s. Agrawal Coal Corporation Vs. ACIT (ITA No. 776/Ind/2019 dt.22.08.2020) by the ITAT Indore.

Following are the important observations made in the above decisions :

  • Both Rajasthan and Bombay Courts have taken note of board circular NO. 91/58/66-ITJ(19) dt. 18/05/1967 which reads as follows :

Interpretation of provision of s. 40(a)(ii) of IT Act, 1961— Clarification regarding BUSINESS EXPENDITURE SECTIONS 40(a)(ii)- Recently a case has come to the notice of the Board where the ITO has disallowed the ‘cess’ paid by the assessee on the ground that there has been no material change in the provisions of s. 10(4) of the old Act and s. 40(a)(ii) of the new Act.

2. The view of the ITO is not correct. Clause 40(a)(ii) of the IT Bill, 1961 as introduced in the Parliament stood as under: “(ii) any sum paid on account of any cess, 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”. When the matter came up before the Select Committee, it was decided to omit the word ‘cess’ from the clause. The effect of the omission of the word ‘cess’ is that only taxes paid are to be disallowed in the assessments for the years 1962-63 and onwards.

3. The Board desire that the changed position may please be brought to the notice of all the ITOs so that further litigation on this account may be avoided.

Hon. Rajasthan High Court  based its decision on the above circular of CBDT and answered the question of deductibility of cess in favor of the assessee.

  • Bombay High Court also observed as follows :

“Applying the aforesaid principles, we find that the legislature, in Section 40(a)(ii) has provided that “any rate or tax levied” on “profits and gains of business or profession” shall not be deducted in computing the income chargeable under the head “profits and gains of business or profession”. There is no reference to any “cess”. Obviously therefore, there is no scope to accept the contention that “cess” being in the nature of a “Tax” is equally not deductable in computing the income chargeable under the head “profits and gains of business or profession”. Acceptance of such a contention will amount to reading something in the text of the provision which is not to be found in the text of the provision in Section 40(a)(ii) of the IT Act. (para 22)”

  • Bombay High court also noted the fact that no appeal has been filed by the revenue against the decision of Rajasthan High Court in the Chambal Fertiliser’s case.

Now , based on above rulings, assessee may consider claiming deduction of health and education cess (HEC) against its business income. Some practical issues  related with such claim are being discussed further in this article.

Claim in ITR : How to claim

Since for accounting purposes,  HEC is to be reported as part of current taxes, accordingly, in ITR also,  HEC would be reported in Part A-P& L at Sr. no. 54 Provision for current tax.

As per schema of ITR, computation of  Business income in Schedule-BP starts with Profit before tax (item 53 of Part A-P& L). Due to this, deduction of HEC is to be claimed separately in Schedule-BP. This can be done by filling up the relevant amount  against item no. 33 of Schedule-BP –“Any other amount allowable as deduction”.

Whether Sec. 43B applies?

Clause (a) of Sec. 43B coversany sum payable by the assessee by way of tax, duty, cess or fee, by whatever name called, under any law for the time being in force”. (It is interesting to note that though the word “cess” is missing in sec. 40(a)(ii),  Sec. 43B specifically refers to cess in addition to tax, duty and fees.)

Since before due date of filing of ITR, the amount of cess  already stands paid by way of advance tax/TDS/Self assessment tax,  Sec. 43B also gets complied with.

Form 3CD

Since cess is covered by Sec. 43B, claim of  deduction for  cess should find a mention in form 3CD, clause 26 (B)(a) – In respect of any sum referred to in clause (a), (b), (c), (d), (e) [, (f) or (g)] of section 43B, the liability for which, was incurred in the previous year and was paid on or before the due date for furnishing the return of income of the previous year under section 139(1).

MAT and Form 29B

Along with deductibility of cess for normal income calculation, it would be worthwhile to consider treatment of Health and Education cess for the purposes of MAT also.

Clause (a) of Expl. 1 to Sec. 115JB(2) provides that for determination of MAT liability, Book Profits needs to be increased bythe amount of income-tax paid or payable, and the provision therefor”.

Explanation 2 further provides that :

.—For the purposes of clause (a) of Explanation 1, the amount of income-tax shall include—

 (i)  any tax on distributed profits under section 115-O or on distributed income under section 115R;

(ii)  any interest charged under this Act;

(iii) surcharge, if any, as levied by the Central Acts from time to time;

(iv) Education Cess on income-tax, if any, as levied by the Central Acts from time to time; and

(v)  Secondary and Higher Education Cess on income-tax, if any, as levied by the Central Acts from time to time.

It needs to be noted that  Education Cess and  Secondary and Higher Education Cess  were levied till AY 2018-19.  From A.Y. 2019-20 onwards  (starting from Finance Act -2019(No. 2)), respective Finance  Acts  have started levying  “Health and Education Cess”.

Since Expl. 2 , as mentioned above,  is specifically referring to  “Education Cess”  and  “Secondary and Higher Education Cess” as included in amount of income tax, a view is possible that  the amount of cess debited to P and L. A/c for  FY 18-19 onwards, being in the nature of Health and Education Cess, is NOT  required to be added back for the purpose of MAT book profit calculation.

Quantum of Claim

A very interesting issue is to determine the quantum of cess to be claimed as deduction as the  claim of cess would lead to a  circle of dependency. This may be explained by following example :

Income liable for tax (before deduction of cess) 1,00,00,000.00
Tax @30%  30,00,000.00
Cess @ 4% 1,20,000.00

Now if this Rs. 1,20,000 cess is claimed as deduction , the actual cess liability would go down to Rs. 118560 as follows :

Taxable Income ( 1,00,00,000 Less 1,20,000) 98,80,000
Tax @30% 29,64,000
Cess @ 4% 1,18,560

Thus claiming deduction of that much amount of cess as is calculated with reference to original taxable income  (Rs. 1,00,00,000 in above example) is technically incorrect.  However, a bit mathematical calculation may yield the amount, where the amount of cess claimed would be equal to or slightly less than the cess actually payable .  So in the above example, if instead of Rs. 1,20,000, deduction of Rs. 118570 is claimed as cess, the circle of dependency would get  broken as follows :

Taxable Income ( 1,00,00,000 Less 1,18,570) 98,81,430
Tax @30% 29,64,429
Cess @ 4% 1,18,577

Here, the actual cess payable, after claiming deduction of cess, is Rs. 1,18,577 and the deduction on account of cess claimed is Rs. 1,18,570.

Authors believe that there is enough judicial support available to claim Health and education Cess as deductible expenditure against the business income of the assessee. One may consider claiming this deduction, keeping in mind the practical issues discussed above. (With inputs from  CA. Rajesh Sodani, Indore)

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