Under Canon Law, every missionary in a particular society and belonging to the religious order takes a vow of poverty which means that whatever income that they accrue in any form, is transferred to their society. This vow is an obligation which is followed by all members of a society following the particular order including teachers teaching at educational institutions run by it. Two important circulars amongst others issued by the CBDT (in 1944 and 1977) are relevant here. These have prescribed exemption from tax for such missionaries who collect fees in lieu of the services provided as these fees are ultimately given to the society that they belong to and they don’t have any entitlement to them.
In 2015, there was adoption of Electronic Clearance System (ECS) method by the state government while granting aid to religious educational institutions. This replaced the erstwhile system wherein a lump-sum amount was directly given to the society who was in-charge of using the money for various purposes including that of paying salary to its teachers teaching at such institutions. Due to adoption of ECS method, the state government now directly pays these teachers their salaries into their individual accounts. This led to the applicability of TDS (under Section 192 of Income Tax Act, 1961) on these salaries by the state government. Further it also led to a couple of circulars in 2016 to clarify the position thereof in consonance with a Kerela High Court judgment in the case of Fr. Sabu P.Thomas Vs Union of India which said that such salaries are received by the teachers (whether missionaries or not) in their individual capacities and are hence liable to be taxed under TDS.
This was challenged before a single-judge bench of the Madras High Court in the case of Institute of the Fransican Missionaries of Mary Vs Union of India, wherein it was argued that all the money received by the missionaries in any capacity did not provide them with any entitlement because of their religious obligation. The single-judge bench accepted the argument and via order dated 22nd December, 2016 allowed the writ petitions.
The above judgment was then challenged before a division bench of the Madras High Court by the Income Tax Department claiming that TDS should apply to the salaries of the missionaries who receive these from the state government directly. The judgment was supported by the assessees through the principle of diversion by overriding title along with the fact that when the income tax authorities have exempted tax liability of income of these missionaries for so long, there was no need for a sudden change given that the circumstances have remained the same. The High Court allowed the appeal by the Income Tax department and with due respect to Canon Law, set aside the single-bench judgment and directed for TDS applicability on salaries of missionaries. Case Citation: Union of India Vs The Society of Mary Immaculate (Madras High Court); Writ Appeal Nos. 391; Dated: 20/03/2019
The above judgment has now been appealed against in the Supreme Court and the Court has by order dated 07/05/2019 has posted the matter for final hearing on 7th August, 2019, putting a stay on the latest Madras High Court judgment in the meanwhile.
Previous Circulars – “fees”, and not “salary”
The division bench of the Madras High Court referred to all the circulars issued by tax authorities which are relevant to the issue. The circulars ranging from 1944 to 1977 exempted tax for fees received by missionaries in lieu of services provided by them. The justification given was that of principle of diversion by overriding title as mentioned above.
All the circulars issued by the department have always used the word “fees” and not “salary” except for the one issued in 1977. Although the subject-head of the 1977 circular regarding exemption of taxability used the word “salary”, the body of the letter still used the word “fees”, both in usage of word and meaning. The circular talks about the earnings of the missionaries which they received as fees or otherwise for consideration of their income. All these fees received by them were in form of amounts received from people for the services provided by them. These services cannot be regarded as performance out of employment as they were not performed out of any kind of contract. The earnings hence received were always in form of “fees” and could never have the meaning of “salary” as provided by the state government now. The assessees heavily argued on the fact that principle of diversion by overriding title was accepted by the CBDT previously as given in the circulars and therefore the salaries received now should not be held as taxable.
The court in rejection to the assessee’s contention stated that Section 192 of the Income Tax Act has no nexus with any characteristics of the recipient of salary and it is not relevant here to what their religion is or how the salary is ultimately utilised. It simplifies applicability of TDS on any kind of payment which comes under the head “salary”. The court thereby concluded that the factor of essence in TDS is the word “salary” and it is the innate responsibility of the employer towards deducting the same before paying any “salary”.
Principle of diversion by overriding title v. Application of Income
The division bench of the Madras High Court discussed a huge number of case laws cited by both the appellants and the respondents to clarify the concepts of principle of diversion and application of income. One of the important cases discussed was of Principal Commissioner of Income Tax v. Chamundi Winery and Distillery where the issue was regarding excise taxation of a manufacturer. The assessee had signed a contract with a foreign company and claimed that the manufacturing conducted was on behalf of the said company. Under the contract, most of the amount earned out of sales would go to the company and the assessee would merely receive a small cut and hence contended that he was not liable to pay tax. It was held against the assessee by the Karnataka High Court that the principle of diversion won’t apply to this case as the manufacturing and subsequent sale was done by the assessee under his license with the excise authorities. The company was not privy to this license and as the income would first go in the hands of the assessee, the transaction was that of application of income.
Further, a supreme court judgment namely Commissioner of Income-Tax Vs. Sunil J. Kinariwala was also cited which clearly distinguishes both the principles:
“When a third person becomes entitled to receive the amount under an obligation of an assessee even before he could lay a claim to receive it as his income, there would be a diversion of income by overriding title; but when after receipt of the income by the assessee, the same is passed on to a third person in dis-charge of the obligation of the assessee, it will be a case of application of income by the assessee and not of diversion of income by overriding title.”
Thus, it was held by the Madras High Court that the missionaries working as teachers in educational institutions received their income or salary directly from the State Government in their individual accounts. The salary would be accrued first by the missionaries themselves and only after this receipt, the transfer of the money out of their religious vows would take place. Given the established distinction between principle of diversion and application of income by various courts including the Supreme Court, the Court decided in favour of the department stating this transfer of income to be a case of application and not of diversion by overriding title.
It is true as contended by the assessees that the income tax department had exempted income of the missionaries from TDS. The circulars ensuring so used the word “fees” and in its most widened scope, could include the money that they received from people who attended or used their religious services. The income that the missionaries receive as employment of teaching from the state government cannot be said to have the same meaning and essence to that of the circulars. The incomes of these missionary teachers are in form of “salary” and are transferred by the state government in the same manner as are transferred to teachers who are not missionaries.
Further, it is not relevant in case of TDS to how a particular income is being utilised by the recipient. The principle of diversion applies only when the income is diverted to a third party before reaching the assessee which is not the case here. There doesn’t exist any contractual obligation of these missionaries to transfer their income to their congregation. The obligation is out of a religious order to which no law in force has any control over. Most importantly, the salary in question is not given by the state government as income of the congregation but as that of the missionary herself which does not directly reach the congregation.