Disallowance of expense u/s 40(a)(ia) untenable when TDS deducted at lower rates

M.V.A. Seetharama Raju Vs DCIT (ITAT Chennai)

ITAT Chennai held that if TDS is deducted by applying wrong provisions or at lower rates, the sum paid cannot be disallowed attracting provisions of section 40(a)(ia) of the Income Tax Act.

Facts-

During the year under consideration, the assessee had entered into agreements for supply of iron ore with various companies, however, the assessee could not supply iron ore to his customers as agreed due to Supreme Court order banning mining licenses. As per contractual terms with his customers, the assessee has agreed to pay penalty for cancellation of contracts for non-supply of iron ore, as per which it has debited a sum of Rs.2,40,50,000/- as compensation for termination of contract. The assessee has made payments after deducting TDS @ 2% as applicable to contractors and sub­contractors u/s.194C of the Income Tax Act, 1961. However, compensation paid by the assessee for breach of contract is in the nature of interest which attract TDS as per provisions of section 194A of the Act @ 10%, but not TDS @ 2%. Therefore, after considering relevant facts, the Assessing Officer has worked out TDS deducted by the assessee @ 2% and assumed that the assessee has only deducted TDS on 20% of amount debited into profit & loss account and thus, balance 80% of Rs.1,92,40,000/- has been disallowed u/s.40(a)(ia) of the Act, for non-deduction of tax at source u/s.194A of the Income Tax Act, 1961.

CIT(A) dismissed the appeal. Being aggrieved, the present appeal is filed.

Conclusion-

Hon’ble Calcutta High Court in the case of CIT Vs. S.K. Tekriwal has held that where the assessee deduct TDS at lower rates or under wrong provisions of TDS, provisions of section 40(a)(ia) of the Act cannot be invoked. In this case, there is no doubt with regard to compliance of TDS provisions by the assessee, because, the assessee has deducted TDS @ 2% as applicable to contractors / sub-contractors u/s.194C of the Act. Therefore, we are of the considered view that once any payment made by the assessee which is covered under the provisions of section 40(a)(ia) of the Act is subjected to TDS, then even if, the assessee has deducted TDS by applying wrong provisions of the Act or at lower rates, then sum paid by the assessee cannot be disallowed u/s.40(a)(ia) of the Act, on the ground that the assessee has deducted TDS at lower rates or under wrong TDS provisions of the Act. The Assessing Officer as well as the learned CIT(A), without appreciating facts has simply disallowed compensation paid by the assessee for breach of contract u/s.40(a)(ia) of the Act. Hence, we direct the Assessing Officer to delete additions made towards disallowance of expenses u/s.40(a)(ia) of the Act.

FULL TEXT OF THE ORDER OF ITAT CHENNAI

This appeal filed by the assessee is directed against the order passed by the learned Commissioner of Income Tax (Appeals)-2, Chennai, dated 25.01.2019 and pertains to assessment year 2013-14.

2. The assessee has raised following grounds of appeal:-

“1) The order of the Assessing officer is contrary to the law, facts and circumstances of this case, irrational and unfair.

2) It is a prima facie case of high-pitched assessment, non­observance of principles of natural justice and non-application of mind.

3) This high-pitched scrutiny assessment not only reflects harassment of taxpayers but also leads to generation of unproductive work for department as well as appellate authorities.

4) The learned Assessing Officer erred in disallowing the Foreign Travel Expenses on his own imaginary explanation which is totally contrary to the explanation given by the Assessee during the scrutiny proceedings.

5) The learned Assessing Officer erred in disallowing the Contract Cancellation Charges paid as penalty for breach of Contract, without considering the TDS provisions of the Income Tax Act, which is contrary to the law, facts and circumstances of this case.

6) The courts have held that under Section 40(a)(ia) of the Act there should be legal liability to deduct the tax under Chapter XVII. If there is no such liability to deduct TDS, then the provisions of Section 40(a)(ia) of the Act cannot be invoked.

7) With a view to liberalize provisions of Section 40(a)(ia) of the Act, Finance Act 2012 brought amendment with effect from 01.042013 as under:

• • The following second proviso shall be inserted in sub-clause (ia) of clause (a) of Section 40 by the Finance Act, 2012, w.e.f. 1-4-2013:
  • 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.

8) Since provisions of Section 40(a)(ia) as amended by Finance Act 2012 is linked to Section 201 of the Act, so it is essential to know and understand the provisions of Section 201 of the Act:

Where any person, including the principal officer of a company

(a) who is required to deduct any sum in accordance with the provisions of this Act; or

b) referred to in sub-section (1A) of Section 192, being an employer, does not deduct, or does not pay, or after so deducting fails to pay, the whole or any part of the tax, as required by or under this Act, then, such person, shall, without prejudice to any other consequences which he may incur, be deemed to be an assessee in default in respect of such tax:

[Provided that any person, including the principal officer of a company, who fails to deduct the whole or any part of the tax in accordance with the provisions of this Chapter on the sum paid to a resident or on the sum credited to the account of a resident shall not be deemed to be an assessee in default in respect of such tax if such resident –

(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 person furnishes a certificate to this effect from an accountant in such form as may be prescribed:]

Further liberalization of provisions of Section 40(a)(ia) made through Prospective amendment brought by the Finance Act 2014

• • Section 40(a)(ia) is amended via Finance (No. 2) Act, 2014 to restrict the amount of disallowance for non-deduction of tax to 30% of expenditure.
  • The proviso is also amended to the effect that 30% of such sum shall be allowed as a deduction in computing the income of the previous year in which tax has been paid.

9) The Assessing Officer did not give a show cause notice pointing out the default committed under Section 40(a)(ia) of the Act.

10) For these grounds and such other grounds that may be adduced before or during the hearing of this appeal with the leave of this respected authority, it is prayed that this respected authority may be pleased to:

a) Quash the assessment order u/s 143 (3) passed on 29/03/2016, and/or

b) Cancel the demand raised u/s 156 and

c) Pass such other orders as this respected authority may deem fit.”

3. Brief facts of the case are that the assessee is an individual and engaged in the business of trading in iron ore filed his return of income for assessment year 2013-14 on 07.09.2013 declaring total income of Rs.4,69,69,680/-. During the year under consideration, the assessee had entered into agreements for supply of iron ore with various companies, however, the assessee could not supply iron ore to his customers as agreed due to Supreme Court order banning mining licenses. As per contractual terms with his customers, the assessee has agreed to pay penalty for cancellation of contracts for non-supply of iron ore, as per which it has debited a sum of Rs.2,40,50,000/- as compensation for termination of contract. The assessee has made payments after deducting TDS @ 2% as applicable to contractors and sub­contractors u/s.194C of the Income Tax Act, 1961. During the course of assessment proceedings, the Assessing Officer, however was not convinced with explanation furnished by the assessee and according to him, compensation paid by the assessee for breach of contract is in the nature of interest which attract TDS as per provisions of section 194A of the Act @ 10%, but not TDS @ 2% as applicable to contractors and sub-contractors and thus, opined that the assessee ought to have been deducted TDS @ 10% on total amount debited into profit & loss account. Therefore, after considering relevant facts, the Assessing Officer has worked out TDS deducted by the assessee @ 2% and assumed that the assessee has only deducted TDS on 20% of amount debited into profit & loss account and thus, balance 80% of Rs.1,92,40,000/- has been disallowed u/s.40(a)(ia) of the Act, for non-deduction of tax at source u/s.194A of the Income Tax Act, 1961. The relevant findings of the Assessing Officer are as under:-

“4.2 On Careful examination of the payments made to to 12 entities in the form of compensation summing up to Rs.2,40,50,000/- the amounts due to them is payable as on 31/03/2013and tax has been deducted @ 2%. The compensation has been given to persons who contributed the capital for venturing into iron export business and due to failure to keep up with the commitment, the assessee had to compensate them which is actually the interest cost on the funds lying idle with the assessee.

4.3 Sec 2(28A) of the I.T. Act defines interest as below:

“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 utilized.”

From the above definition, it is clear that the compensation amount received by the assessee for breach of contract by M/s.TiffinBarytes is also in the nature of interest. It is under such circumstances that M/s. Tiffin Barytes had deducted TDS 10%. The same principle applies to the payments made by the assesseeto the 12 entities.

4.4 The nature arid characteristics of the compensation received by the assessee and paid by the assessee are identical and hence the same yardstick has to be applied with regard to compliance of TDS provisions. When the compensation received by the assessee has suffered TDS @ 10% there Is no rationale on the part of the assessee to have deducted tax at a lesser rate of 2%. The non-compliance to TDS provisions in a partial manner also attracts disallowance u/s 40(a)(ia). The decision rendered in the case of Vector Shipping is not applicable to the facts situation in the present case as the compensation of Rs.2.40crores remains payable as on 31/03/2013.

4.5 In view of the foregoing discussions, considering the fact that on an amount if Rs,2,40,50,000/-, TDS ought to have been deducted @ 10%, it could be seen the assessee by deducting TDS @ 2% has deducted tax only on 20% of the amount payable by him. Hence. the balance 80% of the amount payable of Rs.2,40,50,000/- being Rs. 1,92,40,000/- on which TDS has not been deducted is disallowed u/s.40(a)(ia) and added back to the total income.”

4. Being aggrieved by the assessment order, the assessee preferred an appeal before the learned CIT(A). Before the learned CIT(A), the assessee has submitted that provisions of section 40(a)(ia) of the Act can be invoked, where any person making payment without deduction of TDS, but said provisions cannot be applied where a person makes TDS at lower rates. The assessee, further, claimed that if at all the assessee has deducted TDS at lower rates, then the assessee can be held as assessee in default u/s.201(1) & 201(1A) of the Act, but sum paid by the assessee cannot be disallowed u/s. 40(a)(ia) of the Act. In this regard, he relied upon decision of the Hon’ble Calcutta High Court in the case of CIT Vs. S.K.Tekriwal, 15 taxmann.com 289.

5. The learned CIT(A), after considering relevant submissions of the assessee and also by following decision of the Hon’ble Kerala High Court in the case of CIT Vs. P.V.S. Memorial Hospital Ltd., 380 ITR 284, opined that the assessee has deducted TDS at lower rates on payments made to parties and thus, not satisfied conditions prescribed u/s.40(a)(ia) of the Act, for allowing deduction towards said payment. Therefore, the learned CIT(A) opined that there is no error in the reasons given by the Assessing Officer to disallow sum paid by the assessee u/s. 40(a)(ia) of the Act. The relevant findings of the learned CIT(A) are as under:-

“4. Decision: I have considered the observations of the Assessing Officer and the submissions made by the appellant. Ground No.1 is with regard to the disallowance of Rs. 1,92,40,000/- u/s 40(a)(ia). The Assessing Officer observes that the appellant received an amount of Rs.3,29,50,000/- as income from ‘contract cancellation charges’ and likewise made a payment of Rs.2,40,50,000/- to 12 companies for the same reason. Tax has been deducted @ 10% on the contract cancellation charges paid by Tiffin Barytes Asbestos & Paints Ltd. (TBAPL) whereas the appellant deducted tax @ 2% on the contract cancellation charges claimed to have been paid to the 12 companies. The Assessing Officer further observes that the compensation received by the appellant is in the nature of interest which is further confirmed by the fact that the TDS has been made @ 10% that is applicable to interest.

The Assessing Officer concluded that there is no rational to deduct tax at the lesser rate of 2%, and therefore, made a disallowance of Rs.1,92,40,000/- u/s 40(a)(ia) of the total pay­out of Rs.2,40,50,000/- made to the 12 companies.

On the other hand, the appellant contends that the Income Tax Act does not contain any provisions for deduction of tax on payments made towards breach of contract, nevertheless, tax has been deducted as per the provisions of Section 194C voluntarily. The appellant further contends that short deduction is not subject to disallowance u/s 40(a)(ia) and relies on the following cases in support of their contention.

1. CIT Vs. S.K. Tekriwal (15 taxmann.com 289).

2. CIT Vs. Chandabhoy & Jassobhoy (49 SOT 448).

4.1 To resolve the issue on hand, it is pertinent here to refer to the decision of the Kerala High Court in the case of CIT Vs. P V S Memorial Hospital Ltd (380 ITR 284) wherein it was declared as follows:

Section 40(a)(ia) is attracted in cases where fee for professional services or technical services is ‘payable’ an which tax is ‘deductible at source’ and ‘such tax’ has not been deducted or after deduction not paid. Provision of section 40(a)(ia) is not a charging section but is a machinery section and such a provision should be understood in such a manner that the provision is workable.

The expression ‘tax deductible at source under Chapter XVII-B ’ occurring in the section 40(a)(ia) has to be understood as tax deductible at source under the appropriate provision of Chapter XVII-B. Therefore, as in this case, if tax was deductible under section 194J but was 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 shows that deduction under a wrong provision of law will not save an assessee from section 40(a)(ia).

Therefore, the order passed by the Tribunal, which is challenged by the assessee concerning the assessment order 2005-06, is confirmed and the order of the Tribunal, which is challenged by the revenue concerning the assessment year 2006-07 is set aside.

The Hon’ble High Court of Kerala after considering the case of CIT Vs. S.K. Tekriwal (supra), relied upon by the appellant, concluded that the provisions of Section.40(a)(ia) are applicable in case of short deduction of tax as well. Respectfully following the above decision of the Hon’ble High Court of Kerala, I have no hesitation in holding that short deduction of tax would not satisfy the requirements of Section 40(a)(ia). I also agree with the view of the Assessing Officer that tax should have been deducted@10% and not 2% since the nature of payments on both the occasions is same i.e., contract cancellation charges. Therefore, the Assessing Officer rightly disallowed the expenses of Rs 1,92,40,000/- The disallowance u/s 40(a(ia) made by the Assessing Officer is confirmed. The appellant fails on this ground.”

Being aggrieved by the learned CIT(A) order, the assessee is in appeal before us.

6. The learned A.R for the assessee submitted that the learned CIT(A) erred in sustaining additions made by the Assessing Officer towards disallowance of compensation paid for breach of contract u/s.40(a)(ia) of the Act, even though the assessee has deducted applicable TDS @ 2% in terms of the provisions of section 194A of the Income Tax Act, 1961. The learned A.R further submitted that by no stretch of imagination sum paid by the assessee can be considered as interest, because what was paid by the assessee is compensation for breach of contract, but not sum which is in the nature of interest, which attracts TDS @ 10% u/s.194A of the Act. In this regard, he relied upon decision of the Hon’ble Calcutta High Court in the case of CIT Vs. S.K. Tekriwal (supra).

7. The learned DR, on the other hand, supporting order of the learned CIT(A) submitted that as per decision of the Hon’ble Kerala High Court in the case of CIT Vs. P V S Memorial Hospital Ltd.(supra), if assessee deducted TDS at lower rate, then it is not sufficient compliance of provisions of section 40(a)(ia) of the Act, and thus, sum paid by the assessee cannot be allowed as deduction u/s.40(a)(ia) of the Act. The learned CIT(A), after considering relevant facts has rightly sustained additions made by the Assessing Officer towards disallowance of compensation paid by the assessee u/s. 40(a)(ia) of the Act for non-deduction of TDS.

8. We have heard both the parties, perused material available on record and gone through orders of the authorities below. Admittedly, facts borne out from records clearly indicate that the assessee has paid compensation for breach of contract for non-supply of iron ore and such payment has been made after deducting TDS @ 2% in terms of the provisions of section 194A of the Act, as applicable to contractors / sub­contractors. The Assessing Officer has disallowed part of compensation paid by the assessee u/s.40(a)(ia) of the Act, on the ground that the assessee has deducted TDS at lesser rates and thus, it is as good as non-deduction of TDS on remaining part of the amount. We have gone through the reasons given by the Assessing Officer in light of the provisions of section 40(a)(ia) of the Act and arguments advanced by the learned AR for the assessee in light of decision of the Hon’ble Calcutta High Court in the case of CIT Vs. S.K. Tekriwal (supra) and we ourselves do not subscribe to the reasons given by the Assessing Officer for disallowing part of the amount u/s.40(a)(ia) of the Act for simple reason that once the assessee deduct TDS on any payment made, then said payment cannot be disallowed u/s.40(a)(ia) of the Act, even if, the assessee has deducted TDS at lower rate or under different TDS provisions of the Act. The sole reason for inserting provisions of section 40(a)(ia) of the Act in statute book was to put check on payments made by an assessee for various services and to track such payments in the hands of recipients. When sole object of insertion of provisions in the statute to comply with TDS provisions for tracking payments, then it cannot be said that when the assessee has deducted TDS at different rates and for shortfall in deduction of TDS impugned payment cannot be allowed as deduction u/s.40(a)(ia) of the Act. If at all there is shortfall in TDS deducted by the assessee, then the assessee can be treated as an assessee in default u/s.201(1) / 201(1A) and recover shortfall in TDS amount and consequent interest thereon, but sum paid by the assessee cannot be disallowed u/s.40(a)(ia) of the Act, by holding that the assessee has not deducted TDS on said payment. This legal principle is supported by the decision of the Hon’ble Calcutta High Court in the case of CIT Vs. S.K. Tekriwal (supra), where it has been very clearly held that where the assessee deduct TDS at lower rates or under wrong provisions of TDS, provisions of section 40(a)(ia) of the Act cannot be invoked. A similar view has been taken by the ITAT., Kolkata Bench in the case of A.K. Industries Vs. ACIT in ITA No.665/Kol/2018, where the Tribunal by following the decision of Hon’ble Calcutta High Court in the case of CIT Vs. S.K. Tekriwal (supra), held that provisions of section 40(a)(ia) of the Act does not apply in a case involving short deduction of TDS. As regards decision relied upon by the learned CIT(A) in the case of CIT Vs. P V S Memorial Hospital Ltd.(supra) of the Hon’ble Kerala High Court, we find that though the Hon’ble Kerala High Court has taken a different view and observed that provisions of section 40(a)(ia) of the Act, applies when the assessee has deducted TDS under wrong provisions of the Act, but because there is divergent views from various High Courts, we prefer to follow decision of the Hon’ble Calcutta High Court in the case of CIT Vs. S.K. Tekriwal (supra), because law is very clear from the decision of the Hon’ble Supreme Court in the case of CIT Vs. M/s. Vegetable Products Ltd. 88 ITR 192 (SC), where it was clearly held that when two views are possible in respect of an issue from different High Courts, then view which is in favour of the assessee needs to be followed. In this case, there is no doubt with regard to compliance of TDS provisions by the assessee, because, the assessee has deducted TDS @ 2% as applicable to contractors / sub-contractors u/s.194C of the Act. Therefore, we are of the considered view that once any payment made by the assessee which is covered under the provisions of section 40(a)(ia) of the Act is subjected to TDS, then even if, the assessee has deducted TDS by applying wrong provisions of the Act or at lower rates, then sum paid by the assessee cannot be disallowed u/s.40(a)(ia) of the Act, on the ground that the assessee has deducted TDS at lower rates or under wrong TDS provisions of the Act. The Assessing Officer as well as the learned CIT(A), without appreciating facts has simply disallowed compensation paid by the assessee for breach of contract u/s.40(a)(ia) of the Act. Hence, we direct the Assessing Officer to delete additions made towards disallowance of expenses u/s.40(a)(ia) of the Act.

9. The next issue that came up for our consideration from ground no.4 of assessee appeal is disallowance of foreign travel expenses. The Assessing Officer has disallowed a sum of Rs.5.00 lakhs, out of total foreign travel expenses incurred by the assessee at Rs.10,55,183/- on the ground that the assessee has failed to prove nexus between foreign travel expenses and business connection in the countries to which the assessee has travelled. It was the explanation of the assessee that when the Assessing Officer accepts fact that there was nexus between foreign travel expenditure incurred by the assessee and business connection, then ad-hoc disallowance cannot be made.

10. We have heard both the parties and considered relevant materials along with arguments advanced by the learned counsel for the assessee and learned DR present for the Revenue. We find that although the Assessing Officer has stated that the assessee has not provided any evidence of having attended any trade fair or meeting in countries in which he has travelled, but has made ad-hoc disallowance of Rs.5,00,000/- without pointing out any errors or in the reasons given by the assessee to claim foreign travel expenses of Rs.10,55,183/-. It is an admitted legal position of law that unless the Assessing Officer points out specific defects in expenditure claimed by the assessee, no ad-hoc disallowance can be made for reason that the assessee has not filed any evidence to justify expenses. In this case, admittedly, the Assessing Officer has accepted fact that the assessee has incurred foreign travel expenses for business purpose and out of total expenditure claimed by the assessee he has allowed 50% of expenses. But, made ad-hoc disallowance of Rs.5.00 lakhs without any valid reason. At the same time, the assessee has also failed to adduce proper evidence to justify huge foreign travel expenses claimed for the year under consideration. Therefore, to resolve dispute between the parties and also in the interest of justice, we deem it appropriate to direct the Assessing Officer to restrict disallowance of foreign travel expenses to a sum of Rs.2,50,000/-. Accordingly, we direct the Assessing Officer to restrict disallowance of foreign travel expenses to Rs.2,50,000/- out of total foreign travel expenses claimed by the assessee at Rs.10,55,183/-.

11. In the result, appeal filed by the assessee is partly allowed.

Order pronounced in the open court on 31st January, 2022