Disallowance of expenditure for non deduction of tax at source – Implications and Explanations

Disallowance of expenditure for non deduction of tax at source – Implications and Explanations:

(A) Specified sums payable outside India or payable to non-residents in India:

Section 40(a)(i) provides that notwithstanding anything to the contrary in sections 30 to 38, the following amounts shall not be deducted in computing the income chargeable under the head “Profits and gains of business or profession”,—

(a) in the case of any assessee—

(i) any interest, royalty, fees for technical services or other sum chargeable under this Act, which is payable,—

(A) outside India; or

(B) in India to a non-resident, not being a company or to a foreign company,

on which tax is deductible at source under Chapter XVII-B and such tax has not been deducted or, after deduction, has not been paid on or before the due date specified in sub-section (1) of section 139

Provided that where in respect of any such sum, tax has been deducted in any subsequent year, or has been deducted during the previous year but paid after the due date specified in sub-section (1) of section 139, such sum shall be allowed as a deduction in computing the income of the previous year in which such tax has been paid.

Explanation.—For the purposes of this sub-clause,—

(A) “royalty” shall have the same meaning as in Explanation 2 to clause (vi) of sub-section (1) of section 9;

(B) “fees for technical services” shall have the same meaning as in Explanation 2 to clause (vii) of sub-section (1) of section 9;

1. Disallowance of expenditure for deduction of tax at source but non payment of the same on or before the due date of filing of return of income: Sub-clause (i) of clause (a) of aforesaid section has been amended by the Finance (No. 2) Act, 2014 to provide that disallowance under the said sub-clause will be attracted, if, after deduction of tax during the previous year, the same has not been paid on or before the due date of filing of return of income specified in sub-section (1) of section 139. This amendment will take effect from assessment year 2015-16. [1]The existing provisions of section 40(a)(i) of the Act provide that certain payments such as interest, royalty and fee for technical services made to a non-resident shall not be allowed as deduction for computing business income if tax on such payments was not deducted, or after deduction, was not paid within the time prescribed under section 200(1) of the Act. The Act contains similar provisions for disallowance of business expenditure in respect of certain payments made to the residents. Under section 40(a)(ia) of the Act, in case of payments made to resident, the deductor is allowed to claim deduction for payments as expenditure in the previous year of payment, if tax is deducted during the previous year and the same is paid on or before the due date specified for filing of return of income under section 139(1) of the Act. However, in case of disallowance for non-payment of tax from payments made to non-residents, this extended time limit of payment up to the date of filing of return of income under section 139(1) is not available. In order to provide similar extended time limit for payment of tax deducted from payments made to non-residents, it is proposed that the deductor shall be allowed to claim deduction for payments made to non-residents in the previous year of payment, if tax is deducted during the previous year and the same is paid on or before the due date specified for filing of return under section 139(1) of the Act. The existing proviso to the sub-clause (i) of clause (a) of section 40 provides that where in respect of any such sum, tax has been deducted in any subsequent year or, has been deducted in the previous year but paid in any subsequent year after the expiry of the time prescribed under sub-section (1) of section 200, such sum shall be allowed as a deduction in computing the income of the previous year in which such tax has been paid. Finance (No. 2) Act, 2014 has substituted the said proviso so as to provide that where in respect of any such sum, tax has been deducted in any subsequent year, or has been deducted during the previous year but paid after the due date specified in sub-section (1) of section 139, such sum shall be allowed as a deduction in computing the income of the previous year in which such tax has been paid. These amendments will take effect from 1st April, 2015 and will, accordingly, apply in relation to the assessment year 2015-16 and subsequent years.

2. Tax not deducted on reimbursement of expenses and allowability of expenses thereof: If tax at source is not deducted on reimbursement of expenses, then section 40(a)(i) is not applicable. In HNS India VSAT Inc. v. Dy. DIT, International Taxation [2005] 95 ITD 157 (Delhi), the Tribunal held that the payment made by the assessee to the concerned sub-contractors on account of travelling expenses was not covered by the provisions of section 195 for the simple reason that the amount so paid was on account of reimbursement of actual expenses incurred by the sub-contractors and the same, therefore, could not be treated as income of the concerned sub-contractors much less income chargeable to tax in India so as to attract the provisions of section 195.

3. Disallowance of the foreign exchange fluctuation provided for in the accounts on grounds of no TDS: In Commissioner of Income-tax v. Mac Charles (India) Ltd. [2010] 195 Taxman 296 (Kar.), it was observed that increase or decrease in actual payment of technical know-how fee would ultimately depend upon foreign exchange fluctuation at time of actual payment and, therefore, deduction of tax at source would have to be done when amount would be actually paid on a future date. The increase or decrease in the actual payment of the technical know-how fee would ultimately depend upon the foreign exchange fluctuation and that when a provision has been made on the basis of the exchange rate then existing and TDS has been deducted on the said sum, in the event of there being any higher payment of fee made on account of fluctuation, it would not be necessary to once again deduct TDS on the said amount as the same would have to be done when the amount would be actually paid at a future date. Since the assessee is following the Mercantile System of Accounting, it is only in respect of the provision made in the accounts that the TDS amount would be deducted and the same would have been passed on to the department. It is also to be noted that on account of the fluctuation in the foreign exchange if there would be a reduction of the technical know-how fee, then there is no provision for return of the refund of the TDS which would have already been paid by the assessee on account of the said fluctuation.

(B) Specified sums payable to residents on which TDS is deductible:

Section 40(a)(ia) provides that notwithstanding anything to the contrary in sections 30 to 38, the following amounts shall not be deducted in computing the income chargeable under the head “Profits and gains of business or profession”,—

(ia) thirty per cent of any sum payable to a resident, on which tax is deductible at source under Chapter XVII-B and such tax has not been deducted or, after deduction, has not been paid on or before the due date specified in sub-section (1) of section 139

Provided that where in respect of any such sum, tax has been deducted in any subsequent year, or has been deducted during the previous year but paid after the due date specified in sub-section (1) of section 139, thirty per cent of such sum shall be allowed as a deduction in computing the income of the previous year in which such tax has been paid

Provided further that where an assessee fails to deduct the whole or any part of the tax in accordance with the provisions of Chapter XVII-B on any such sum but is not deemed to be an assessee in default under the first proviso to sub-section (1) of section 201, then, for the purpose of this sub-clause, it shall be deemed that the assessee has deducted and paid the tax on such sum on the date of furnishing of return of income by the resident payee referred to in the said proviso.

Explanation.—For the purposes of this sub-clause,—

(i) “commission or brokerage” shall have the same meaning as in clause (i) of the Explanation to section 194H;

(ii) “fees for technical services” shall have the same meaning as in Explanation2 to clause (vii) of sub-section (1) of section 9;

(iii) “professional services” shall have the same meaning as in clause (a) of the Explanation to section 194J;

(iv) “work” shall have the same meaning as in Explanation III to section 194C;

(v) “rent” shall have the same meaning as in clause (i) to the Explanation to section 194-I;

(vi) “royalty” shall have the same meaning as in Explanation 2 to clause (vi) of sub-section (1) of section 9

1. Whether section 40(a)(ia) would apply only to amounts outstanding as of 31st March of every year: In Merilyn Shipping & Transports v. Addl. CIT [2012] 20 taxmann.com 244 (Vishakha. – Trib.) (Special Bench), it was held that section 40(a)(ia) would apply only to amounts outstanding as of 31st March of every year on which TDS not deducted and not to amounts paid during previous year without deduction of TDS. However, the Gujarat High Court and Calcutta High Court have rejected the interpretation of section 40(a)(ia) by ITAT in Merilyn Shipping case. In CIT v. Sikandarkhan N Tunvar [2013] 33 taxmann.com 133 (Guj.) and CIT v. Md. Jakir Hossain Mondal [2013] 33 taxmann.com 123 (Calcutta), it was held that section 40(a)(ia) would cover not only to the amounts which are payable as on 31st March of a particular year but also which are payable at any time during the year. The term used is interest, commission, brokerage etc. is payable to a resident or amounts payable to a contractor or sub-contractor for carrying out any work. The language used is not that such amount must continue to remain payable till the end of the accounting year. Any such interpretation would require reading words which the legislature has not used and is not acceptable. The Tribunal committed an error in applying the principle of conscious omission in the present case. Firstly, there is serious doubt whether such principle can be applied by comparing the draft presented in Parliament and ultimate legislation which may be passed. Secondly, the statutory provision is amply clear. Section 40(a)(ia) would cover not only to the amounts which are payable as on 31st March of a particular year but also which are payable at any time during the year, of course, as long as the other requirements of the said provision exist.

2. Payer not to be deemed as an assessee in default in certain cases: The Finance Act, 2012 has amended section 201 by inserting a new first proviso with effect from assessment year 2013-2014 to provide that the payer who fails to deduct the whole or any part of the tax on the payment made to a resident payee shall not be deemed to be an assessee in default in respect of such tax if such resident payee—

(i) has furnished his return of income under section 139;

(ii) has taken into account such sum for computing income in such return of income; and

(iii) has paid the tax due on the income declared by him in such return of income,

and the payer furnishes a certificate to this effect from an accountant in such form as may be prescribed.

The date of payment of taxes by the resident payee shall be deemed to be the date on which return has been furnished by the payer. The Finance Act, 2012 has also made related and consequential amendment to section 40(a)(ia) with effect from A.Y. 2013-14 to provide that where an assessee fails to deduct the whole or any part of the tax in accordance with the provisions of Chapter XVII-B on any such sum but is not deemed to be an assessee in default under the first proviso to sub-section (1) of section 201, then, it shall be deemed that the assessee has deducted and paid the tax on such sum on the date of furnishing of return of income by the resident payee referred to in the said proviso.

3. Disallowance only to the extent of 30% of the expenditure: The Finance (No. 2) Act, 2014 has amended sub-clause (ia) of clause (a) of aforesaid section to provide that disallowance under the said sub-clause shall be restricted to 30% and the provisions of this section shall be applicable to all expenditure, which is payable to a resident, on which tax is deductible under the sub-heading “B.—Deduction at source” of Chapter XVII. The existing provisions contained in first proviso of sub-clause (ia) of clause (a) of section 40 provide that where in respect of any such sum, tax has been deducted in any subsequent year, or has been deducted during the previous year but paid after the due date specified in sub-section (1) of section 139, such sum shall be allowed as a deduction in computing the income of the previous year in which such tax has been paid. The first proviso of sub-clause (ia) of clause (a) of aforesaid section has been amended to provide that where in respect of any such sum, tax has been deducted in any subsequent year, or has been deducted during the previous year but paid after the due date specified in sub-section (1) of section 139, 30% of such sum shall be allowed as a deduction in computing the income of the previous year in which such tax has been paid. These amendments will take effect from 1st April, 2015 and will, accordingly, apply in relation to the assessment year 2015-16 and subsequent years.

The relevant extracts from the Explanatory Memorandum are as follow:

In case of non-deduction or non-payment of tax deducted at source (TDS) from certain payments made to residents, the entire amount of expenditure on which tax was deductible is disallowed under section 40(a)(ia) for the purposes of computing income under the head “Profits and gains of business or profession”. The disallowance of whole of the amount of expenditure results into undue hardship.

In order to reduce the hardship, it is proposed that in case of non-deduction or non-payment of TDS on payments made to residents as specified in section 40(a)(ia) of the Act, the disallowance shall be restricted to 30% of the amount of expenditure claimed.

Further, existing provisions of section 40(a)(ia) of the Act provides that certain payments such as interest, commission, brokerage, rent, royalty fee for technical services and contract payment made to a resident shall not be allowed as deduction for computing business income if tax on such payments was not deducted, or after deduction, was not paid within the time specified under the said section. Chapter XVII-B of the Act mandates deduction of tax from certain other payments such as salary, directors fee, which are currently not specified under section 40(a)(ia) of the Act. The payments on which tax is deductible under Chapter XVII-B but not specified under section 40(a)(ia) of the Act may also be claimed as expenditure for the purposes of computation of income under the head “Profits and gains from business or profession”.

Section 40(a)(ia) has proved to be an effective tool for ensuring compliance of TDS provisions by the payers. Therefore, in order to improve the TDS compliance in respect of payments to residents which are currently not specified in section 40(a)(ia), it is proposed that the disallowance under section 40(a)(ia) of the Act shall extend to all expenditure on which tax is deductible under Chapter XVII-B of the Act. These amendments will take effect from 1st April, 2015 and will, accordingly, apply in relation to the assessment year 2015-16 and subsequent years.

4. Deduction of TDS under wrong provision of law will not save assessee from disallowance u/s 40(a)(ia): The SC in Gurusahai Saigal v. CIT, enunciated as follows:

“Now it is well recognised that the rule of construction on which the assessee relies applies only to a taxing provision and has no application to all provisions in a taxing statute. It does not, for example, apply to a provision not creating a charge for the tax but laying down the machinery for its calculation or procedure for its collection. The provisions in a taxing statute dealing with machinery for assessment have to be construed by the ordinary rules of construction, that is to say, in accordance with the clear intention of the legislature which is to make a charge levied effective. Reference may be made to a few cases laying down this distinction.”

If Section 40(a)(ia) is understood in the manner as laid down by the SC, it can be seen that the expression “tax deductible at source under Chapter XVII-B” occurring in the Section has to be understood as tax deductible at source under the appropriate provision of Chapter XVII-B. Therefore, as in this case, if tax is deductible under Section 194J but is deducted under Section 194C, such a deduction would not satisfy the requirements of Section 40(a)(ia). The latter part of this Section that such tax has not been deducted, again refers to the tax deducted under the appropriate provision of Chapter XVII-B. Thus, a cumulative reading of this provision, therefore, shows that deduction under a wrong provision of law will not save an assessee from Section 40(a)(ia) [(2015) 60 taxmann.com 69 (Kerala), Commissioner of Income-tax-1, Kochi v. P V S Memorial Hospital Ltd.]

[1] The Explanatory Memorandum to the Finance (No. 2) Act, 2014

The above article is contributed by CA Kamal Garg having professional and academic interests in IFRS, Accounts, Auditing and Corporate Laws arenas. He can be approached at [email protected]