What is ‘cess’?

The concept of ‘‘cess’’ though very old was introduced monetarily in the Finance Act, 2004, as “an additional surcharge” to finance the Central Government’s commitment to universalize quality basic education in the form of an ‘education ‘cess’’ at 2 percent rate which was latter on raised to 3 percent. In 2018, this education ‘‘cess’’ was replaced with a ‘health and education ‘cess’’, which was to be levied at the rate of 4 percent. Under the Income Tax Act, 1961, a deduction from the taxable business income of a taxpayer is generally allowed for all business-related expenses, subject to certain exceptions. However, while computing the taxable income under the head  business, profession and vocation, expenses in the nature of ‘rate’ or ‘tax’ are specifically not allowed pursuant to provisions contained in Section 40(a)(ii) of the Income tax Act, 1961. Therefore, a million dollar query arises to the mind as to whether, for the purpose of this section, the word ‘‘cess’’ would be labeled as a ‘tax’ and hence accordingly, will not be allowed as an item of business expenditure.

Precedents. Does ‘Tax’ Include ‘‘cess’’ ?

It would be pertinent to note that the Supreme Court in the case of Virtusa (India) Private Limited Vs Assessee decided on 4 March, 2016 erred in disregarding the judicial precedent in the case of K. Srinivasan vs CIT (1972) 83 ITR 346 (SC) submitted by the Appellant which has held that the term ‘tax’ includes surcharge and education ‘cess’. In the case of The Boc Group Limited, Kolkata vs Department Of Income Tax on 30 November, 2015 it was held that where the assessee was expected to pay 15% tax in terms of DTAA. It was held that education ‘cess’ is essentially of the same nature as surcharge, being an additional surcharge, the scope of article 2 of DTAA also extends to the education ‘cess’.  In the case of Richa Global Exports Pvt. Ltd., … vs Assessee it was held that the explanation (2) to section 115JB according to which tax includes surcharge and education ‘cess’. It was further argued that definition … surcharge & education tax. It talks about only income tax. There are several decisions in the context of the definition of “tax” in tax treaties, and in this connection it has been held that “‘cess’” is nothing but a “surcharge”. The interplay of these decisions with the favourable decisions of the High Courts and the CBDT circular would caution all stake holders in the matter. In addition, it needs to be highlighted that in relation to ‘‘cess’’ and whether it forms part of taxes or not  separate mode of collection or recovery of ‘cess’ has been prescribed under the income tax act 1961, that speaks of separate nature of the levy. Overall observation was tax includes ‘cess’ despite conflicting and overriding decision..

Bombay High Court’s Take:

In Sesa Goa Ltd. in the Bombay High Court the taxpayer contended that the term ‘any rate or tax’ does not include ‘‘cess’’ and therefore, ‘cess’ should be allowed as a deduction against its business income. The Bombay High Court held on 28 February 2020 in Sesa Goa Limited that the education ‘cess’, and higher and secondary education ‘cess’ (‘cess’) is an allowable business expense in the year of payment, since the word “‘cess’” is conspicuously absent from the descriptions of amounts not deductible under section 40 of the Income tax Act, 1961, specifically section 40(a)(ii), dealing with taxes. The High Court ruled in favour of the taxpayer and noted the following:

Assessment made by the Income tax department in this case:

1. The taxpayer had filed both original and revised returns of income in which it had not claimed a deduction for the ‘cess’ as a business expense. The taxpayer had instead claimed the deduction in a separate letter to the Assessing Officer (AO). The AO denied the claim and the taxpayer appealed the assessment order issued by the AO.

2. The Commissioner of Income tax (Appeals) (CIT(A)). The CIT(A) also denied the deduction of the ‘cess’ as a business expense, relying on an earlier decision of the Supreme Court in which it was held that where a taxpayer has claimed a deduction after a return has been filed, the assessing authority has no power to consider the claim unless made by way of a revised return.

3.The Panaji bench of ITAT again denied the deduction and held that the ‘cess’ is an element of income tax and, therefore, the provisions of section 40(a)(ic) and 40(a)(ii) of the ITA apply. Further, it held that the ‘cess’ is not a fee but a tax, since fees are payable in return for a certain benefit or services, while tax is imposed by the government and the taxpayer is not entitled to any benefit or service in return, as with the ‘cess’.

4. The taxpayer challenged the ITAT’s order before the Bombay High Court.

Vital Evidence relied upon by High court

1. The High Court observed that under the previous legislation no deduction was permitted for any sum paid on account of “any ‘cess’, rate or tax levied on the profits or gains of any business or profession.” This is clearly spelled out in section 10(4) of the Income tax-Act, 1922. However, in the corresponding section 40(a)(ii) of the present Income tax act, 1961, the word “‘cess’” is absent.

2. It was also pointed out that The Income Tax Bill, 1961, which is the base of present Income tax act 1961 had introduced Section 40(a)(ii) into the Income tax act 1961, that contained the expression ‘‘cess’, rate or tax’ and therefore specifically included ‘‘cess’’ as an item separate from income tax. However, the Select Committee of the Parliament categorically omitted the term ‘‘cess’’ under the final provisions of the Income tax Act. and there is no change till date.

3. The matter of ‘cess’ has also been dealt with in a circular issued by the Central Board of Direct Taxes dated May 18, 1967, which specifically refers to the omission of the word ‘‘cess’’ from section 40(a)(ii), and that only taxes paid are to be disallowed in assessments for 1962-63 and subsequent years. The CBDT circular is binding upon the authorities under the Income tax act 1961, including the Assessing Officer and Commissioner of Income tax(Appeals). The high court has referred certain judicial precedents those have discussed the various principles for interpreting taxing statutes. The High Court, therefore, observed that the legislature could have included a reference to ‘cess’ in the provision, and the non-inclusion of the same shows the intention was to allow such ‘‘cess’’ as a deduction from business/profession profits/surplus. A deduction in relation to ‘cess’ was therefore allowed to the taxpayer in this case.

4. It is worth noting here that a circular issued by the CBDT is binding on tax authorities, more so when the circular confers some benefit upon the taxpayers. Additionally, the CBDT circular on this issue also provides for the income tax authorities to take note of the issue, and avoid further litigation on this account. It would also be important to mention that the Rajasthan High Court has also ruled in favour of the taxpayer on this issue, in an earlier decision, relying on the CBDT circular.

5. Another important aspect requiring consideration is the timing and manner of claiming this deduction, in relation to tax years for which the income tax return has already been filed. In absence of any claim made in the tax return for earlier years, the permissibility of claiming the same by way of additional grounds in ongoing tax proceedings would need to be assessed.

 6. This issue has been the subject of several previous conflicting decisions of the Mumbai Income tax Appellate Tribunal, and the High Court’s ruling provides some clarity. However, the High Court did not discuss a 1972 Supreme Court judgment that addressed the meaning of surcharge, and concluded that surcharges form a part of income tax and super tax.

Decision of the Bombay High Court

The High Court noted that section 40(a)(ii) of the ITA provides that notwithstanding anything to the contrary in sections 30 to 38 of the ITA, the following amounts are not deductible when calculating the income chargeable under the head “Profits and gains of a business or profession ”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,” despite the tax department’s stand that ‘‘cess’’ is inherently included in the scope of the expression ‘any rate or tax’ and therefore, should not be allowed as a deduction.

There are two explanations to the sub-clause clarify that, for the purposes of the sub-clause, any sum paid on account of any rate or tax levied which (a) Includes, and is deemed always to have included, any sum eligible for relief of tax under section 90 or, as the case may be, deduction from the Indian income tax payable under section 91 of the ITA; and (b) Includes any sum eligible for relief of tax under section 90A.

The Mumbai High Court discussed a number of judicial precedents in which it was held that:

a) One safe and infallible guiding principle is to read the wording of the legislation and see if the rule is clearly stated. If the language employed conveys the rule in words of sufficient clarity and precision, nothing more is required; the language used in the legislation best declares the government’s intention and must be accepted as conclusive;

b) In the context of the interpretation of the legislation, it is well established that no tax can be imposed on a taxpayer without words in the legislation clearly demonstrating the intention to put such a burden on the taxpayer;

c) In a taxing statute, it is ne’cess’ary to look merely at what is clearly stated; there is no room for guessing intent. “There is no equity about a tax; there is no presumption as to a tax.” Nothing may read or implied into the provisions that has not been stipulated by the legislature;

d) One can only look fairly at the language used and no tax can be imposed by inference or analogy. It also is not permissible to construe a taxing statute by making assumptions and presumptions;

e) Provisions for deductions, exemptions, or reliefs should be interpreted liberally, reasonably, and in favor of the taxpayer, and construed in a manner so as to effect the object of the legislature and not to defeat it. The interpretation may not go to the extent of reading something into the provision that is not stated;

f) A rate was not “assessed on the basis of profits” and was allowable as a business expense; and

g) The expression “profits or gains of any business or profession” refers only to profits and gains determined in accordance with section 29 of the ITA, and any rate or tax imposed on profits calculated in a different manner may not be disallowed under section 40(a)(ii).

h) It also needs to look into the intention of the legislature especially the Select committee which has dropped the word ‘‘cess’’ from draft bill of income tax act 1961 which was verbatim copy of old Income tax act. 1922.

The High Court also evaluated an earlier ruling of the Rajasthan High Court and subsequently followed in three cases by the Income tax Appellate Tribunal, that relied on the 1967 Central Board of Direct Taxes Circular in holding that the Income tax Appellate Tribunal had erred in finding the education ‘‘cess’’ is a disallowable expense under section 40(a)(ii) of the Income tax act, 1961. The court rejected the tax authorities’ reliance on the Supreme Court decision in the case of Unicorn Industries v. Union of India and others, on the basis that the case involved a different issue and accordingly was not applicable. Finally, the High Court held that although the taxpayer did not claim any deduction for the ‘cess’ in the original or revised returns, there was nothing to prevent the Commissioner of Income tax (Appeals) or the Income tax Appellate Tribunal from allowing the deduction. In reaching this decision, the court relied on previous decisions that the appellate authorities may confirm, reduce, enhance, or annul an assessment, or remand the case to the AO. The court distinguished the decision of Goetze (India) Ltd. v. Commissioner of Income Tax relied upon by the tax authorities as the Supreme Court in that case was not dealing with the extent of the powers of the appellate authorities, but the powers of the assessing authority. The High Court concluded that there is no reference to ‘cess’ in section 40(a)(ii) of the ITA, and hence there can be no disallowance under that section for the ‘cess’ paid.

Actionable decision and hence What next  ?

1. The decision of the Mumbai High court has opened up a huge box of sweets to the tax payers and now it is up to the tax payers to take a call on it as to whether they wish to avail the benefits conferred by the Mumbai High court or not.

2. The benefits as per the present law are limited to six years initially. However, through writ petition on ‘equality before law’ principle it may be claimed from the beginning of the year i.e. since 2004, it is felt.

3. If a deduction in relation to ‘cess’ is being claimed, several other nuances would also need attention such as whether the deduction would be allowable on an accrual basis or on a payment basis which will have impact on overall taxation.

4. As regards scope, as a deduction is available against the business income of a taxpayer, the deduction, if claimed should be restricted only to ‘cess’ paid on the business income of a taxpayer.

5. Those who are lazy tax payers and as a result of which they have not filed their income tax returns till today, Korona pandemic has given them an opportunity to avail benefit by filing income tax returns by claiming ‘‘cess’’ as business expenditure for the preceding two years i. e for financial years 2018-19 before the extended date i.e.30th September 2020 gets over. Similarly for the last financial year i.e. 2019-20 all can avail this benefit when they will be filing their tax retruns on due date fixed this year as on or before 30th November 2020. However, to remain on the safer side, it is hereby suggested to make the payment of income tax on profits of the year and let refund be allowed or education cess be disallowed by the assessing officer, which may absolve tax payers from interest.

6. If the legal claim regarding allowability of ‘‘cess’’ as a business expenditure is not upheld by the judiciary, on factual grounds, it may lead to initiation of penalty proceedings and hence it is suggested that the tax payer should pay income tax on entire profit that is likely to be reduced due to claim of education ‘cess’ as expenditure in case appeal has been preferred by department in supreme court and claim of refund of taxes in these two years and also for arrears of taxes since 2004 has been rejected by Supreme court.

7.It is suggested that the tax payer also may think of claimimg all the amount of education ‘cess’ since 2004 as expenditure from current year’s income but by paying full amount of tax as if this deduction of education ‘cess’ is not claimed on an expectation that the amount will be disallowed..

8. This will also give the tax payer an opportunity to file an appeal and get the decision reversed if not accepted by the Assessing officer as the matter pertaining to approach of the Income tax department is not known. However, this is also subject to decision of supreme court of India, if appeal is filed and entertained and interim stay has been granted.

9. If ‘‘cess’’ is allowed as an eligible expenditure, it will have substantial impact on the tax collection by the Government. It is expected that a suitable clarity would be provided by the CBDT by notifying their future course of action against this judgment at the earliest or one can expect a retrospective amendment in the law by way of insertion of an explanation in section 40(a)(ii) of the Act explaining the term ‘taxes’ used in such section. However, now due to one of the most important clauses inserted in “Tax charter’ no amendment can have a retrospective effect and hence this possibility needs to be ruled out. 

10. Those tax payers who have filed their income tax returns in the past and their assessments are pending can revise their returns by incorporating education ‘cess’ as an expenditure and can claim refund if they so wish as entire tax must have been paid in the past.

11. Those who have filed their income tax returns and assessments have been done, they can calculate arrears of education ‘cess’ not claimed in earlier years from 2004 and claim it in one stretch in the current year by disclosing that it is for earlier years besides asking auditors to qualify in the tax audit report to invite attention of the tax officials and then contest the case till end as assessing officer may not agree with it and finally tax payer will have to approach the Mumbai High court for ultimate decision.

12. Other alternate is to file an application for rectification of mistake under section 154 of the income tax act, 1961 knowing the fact that it will be rejected and once it gets rejected, taxpayer can proceed to higher appellate authorities by climbing the ladder of appeals and finally to the high court.

13. The Department of income tax due to Korona pandemic has so far not preferred an appeal against the decision of the Mumbai High court. That does not mean that it will never be preferred. The income tax department has to prefer an appeal to keep tax payers at a distance till final decision of Supreme court of India. The final outcome of this issue will lie in the hands of Supreme court of India.


The judicious and thoughtful decision given by Mumbai High court is so sound decision that it will have to be confirmed by Supreme court, it is felt.


The contents of this article are for information purposes only and does not constitute an advice or a legal opinion and are personal views of the author. It is based upon relevant law and/or facts available at that point of time and prepared with due accuracy & reliability. Readers are requested to check and refer relevant provisions of statute, latest judicial pronouncements, circulars, clarifications etc before acting on the basis of the above write up.  The possibility of other views on the subject matter cannot be ruled out. By the use of the said information, you agree that Author is not responsible or liable in any manner for the authenticity, accuracy, completeness, errors or any kind of omissions in this piece of information for any action taken thereof. This is not any kind of advertisement or solicitation of work by a professional.

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Qualification: CA in Practice
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Location: Pune, Maharashtra, India
Member Since: 22 Jan 2021 | Total Posts: 3
Dr. Dilip V. Satbhai is the senior partner of Messrs D. V. Satbhai & Co. Chartered Accountants having registered office located at Karve Road, Pune. The senior partner of the firm was the Chairman,Vice-chairman, Secretary and Treasurer of the Pune Branch of the Western India Regional Council of View Full Profile

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