The Government of India had introduced the withholding tax provisions with an intent to recover tax upfront in a timely manner, from specific payments to residents and non-residents.
One of the measures to ensure better compliance in relation to withholding tax obligations towards payments outside India was the insertion of Section 40(a)(i) of the Income-tax Act, 1961 (‘the Act’), which provides for disallowance of expenditures for non fulfilment of withholding tax obligations while making payments to non-residents. Further, the payer is deemed to be an “assesse in default” for failure to withhold such tax with certain associated consequences as provided under section 201 of the Act.
Section 40(a)(i) deals with the disallowance of expenditure in the following cases:
a. Amounts payable to non-residents for which tax is deductible at source but not deducted or
b. Amounts payable to non-residents on which tax is deducted but notdeposited to the Central Government exchequer in accordance with the provisions of Chapter XVII-B of the Act.
Thus, the intent of disallowance under section 40(a)(i) was to ensure prevention of revenue leakage on foreign payments, as subject recovery of tax from non-resident payees were difficult.
Similar disallowance provisions in relation to any interest, commission or brokerage, fees for professional or technical services payable to residents and amounts payable to resident contractors/sub-contractors are provided for under section 40(a)(ia), Provisions under section 40(a)(ia) were inserted in the Act by Finance Act 2004 with effect from 1st April 2005.
Although the aforesaid provisions are almost similar, withholding tax provisions in relation to residents and non-residents are based on different principles. As per the withholding tax provisions applicable to non-residents under section 195, tax at source is to be deducted on the sum chargeable to tax under the provision of this Act, however, as per the withholding tax provisions as applicable to residents (section 192 to 194LD), tax at source is to be deducted on making of any specific type of payment as mentioned therein. This basically has led to various controversies in respect to disallowances of expenses on account of non-adherence to withholding tax compliances.
The law under sections 40a(i) and 40(ia) have evolved through amendments and judicial precedents, the later included constitutional validity of the disallowance provision, issues around discrimination between residents and non-residents on the count of disallowance, connotation of the term “payable”, etc. This article focusses solely of the issue of interpretation of the term “payable” and settlement thereof by the Indian Apex Court.
Controversy in relation to the word ‘payable’ under section 40(a)(ia)
There have been substantial debate around the point whether the term ‘payable’ used in section 40(a)(ia) would include amounts outstanding at the end of the year or both amounts outstanding as well as paid during the year.Online GST Certification Course by TaxGuru & MSME- Click here to Join
Going the by trend of tax rulings, one school of thought was that the word ‘payable’ would mean that only those amounts which are outstanding at the year end and on which tax has not been withheld at source would be disallowed under section 40(a)(ia). The Vishakhapatnam Special bench of Tribunal in the case of Merilyn Shipping & Transports vs. ACIT (136 ITD SB 23), had held that the legislative intent was clear that only the outstanding amounts or provision for expense was sought to be disallowed in event of default of TDS. In other words, this decision affirmed that the disallowance of expenditure on account of non-deduction of tax is restricted only to the expenditure incurred as reflected as ‘payable’ as at the end of the year. However, it is worth noting the basis of interpretation by the Special Bench in this case.
The Special Bench had compared the proposed and enacted provision wherein the legislature had replaced the word “amounts credited or paid” in the draft with the word “payable” in the final enactment. As per the Finance Bill 2004, the proposed provision was –
‘(ia) any interest, commission or brokerage, fees for professional services or fees for technical services payable to a resident, or amounts credited or paid to a contractor or sub-contractor, being resident, for carrying out any work (including supply of labour for carrying out any work), on which tax has not been deducted or, after deduction, has not been paid before the expiry of the time prescribed under sub-section (1) of section 200 and in accordance with the other provisions of Chapter XVII-B’
However, the enacted provision as per the Finance Act 2004 was as follows-
‘(ia) any interest, commission or brokerage, fees for professional services or fees for technical services payable to a resident, or amounts payable to a contractor or sub-contractor, being resident, for carrying out any work (including supply of labour for carrying out any work), 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 during the previous year, or in the subsequent year before the expiry of the time prescribed under sub-section (1) of section 200’.
Based on the aforesaid difference between draft of Finance Bill 2004 and Finance Act 2004, it was enunciated by the special bench that the intent of legislature was very clear that only the outstanding amount or the provision for expenses are liable for TDS are to be disallowed in the event there is default in not following the TDS provisions under chapter XVII-B of the Act, as the it had consciously replacing the words from ‘credited’ or ‘paid’ to ‘payable’.
Further, in the case of Vector Shipping Services (P) Ltd (ITA No. 122 of 2013), it was held that for disallowing expenditure from business and profession on the ground that tax has not been deducted, the amount should be “payable” and not which has been paid by the end of the year.
Another school of thought was that section 40(a)(ia) is applicable not only in respect of payments outstanding at the year-end but also in respect of payments which have been effected during the year without withholding tax at source.
The Calcutta High Court in the case of Crescent Export Syndicate (33 taxmann.com 250) held that the key words used in section 40(a)(ia) are ‘on which tax is deductible at source under Chapter XVII-B‘. Accordingly, once it is determined that tax is deductible at source from a particular payment it does not matter whether the amount is payable or paid as unless the amount is payable, it can neither be paid nor credited. A similar view was taken by the Gujarat High Court in the case of Sikandarkhan N Tunvar (357 ITR 312) wherein it was held that section 40(a)(ia) would cover not only amounts which are payable as on 31st March of a particular year but also which are payable at any time during relevant year
On account of the aforesaid divergent views, the Central Board of Direct Taxes (‘CBDT’) had issued a circular No. 10/2013 dated 16th December 2013 to clarify its view that provisions of section 40(a)(ia) would be applicable to the amounts which are payable at any time during the year and not only those payable at the year end. However, the CBDT clarified that where any High Court decides an issue contrary to the ‘Departmental View’, the `Departmental View’ thereon shall not be operative in the areas falling in the jurisdiction of the relevant High Court. This led to the inference that the term ‘payable’ may carry more than one interpretation.
As discussed above, withholding tax provisions of resident and non-resident payee are based on different principles. Hence, there is one school of thought which states that the decision rendered in respect of the provision of section 40(a)(i) cannot be said to apply in case of section 40(a)(ia) as well. Based on this differential treatment meted to non-residents vis-à-vis the residents, the ruling of the Agra Bench of the ITAT in the case of Gupta Overseas (I.T.A. No.: 257/Agr/2013) had to decide on whether the non-discrimination clause of the relevant DTAA could come at the rescue of non-residents in view of the provisions of section 40(a)(i) vis-à-vis the provisions of section 40(a)(ia) applicable in case of payments made to a resident.
In the said case the assesse had made certain payments to non-residents based in Spain, Italy, Ireland, UK, Denmark, Austria and Belgium and had not withheld tax at source on the basis that the said amount were paid off during the year and there was no amount outstanding/payable at the end of the year. So, in the light of the decisions in case of Merilyn Shipping and Transport and Vector Shipping Services Pvt. Ltd. read with Article on non-discrimination under the relevant DTAAs with the aforesaid countries, the ITAT held that the assessee was not liable to withhold tax on the payments made to the person located in the jurisdictions (where such article for non-discrimination was present in the DTAAs) as the said amounts were not outstanding (payable) at the year end.
In the case of Daimler Chrysler India Pvt. Ltd. (120 TTJ 803) it was held that what is important is that person should be discriminated because of different nationality and it is not even necessary that a person seeking treaty protection under this clause should be resident of any of the Contracting States, and, therefore, residential status is irrelevant for this kind of discrimination. However, the situation in the case of Gupta Overseas is in relation to the differentiation between the treatment given to the payments made to the residents and the non-residents and is not in relation to the payments to different nationals. Article 24(1) of the DTAA deals with non-discrimination on account of nationality. Accordingly, the ITAT held that a differentiation in treatment due to residential status cannot be covered by the scope of Article 24(1) as such a differentiation is not due to nationality.
Also, the Bangalore Tribunal in the case of Cross Tab Marketing Services Pvt. Ltd. (ITA No. 1507/Bang/2012) provided relief from section 40(a)(i) disallowance to the tax payer on the reasoning that no amount remained ‘payable’ at the year end. The Tribunal relied on the co-ordinate bench ruling in the case of Anand Markala which had followed the Allahabad High Court ruling of Vector Shipping.
However, the Punjab & Haryana High Court in the case of P M S Diesels (59 taxmann.com 100) has dismissed the assessee’s contention that disallowance contemplated under section 40(a)(ia) cannot be applied where payment has already been made by the assessee to the payee. The High Court has also referred the provisions of Chapter XVII-B & Rule 30(2) of Income Tax Rules for purpose of construing Sec. 40(a)(ia) and has observed that the liability to deduct tax at source under Chapter XVII is ‘mandatory’ and nothing in any of the sections therein warrant reading of the word “shall” as “may”. Further, Chapter XVII does not categorize defaults on the basis of when the payments are made to the payees of such amounts which attract the liability to deduct tax at source. Thus, disallowance under section 40(a)(ia) is to be applied for both ‘payable’ as well as ‘paid’ during the year.
The Apex Court has recently settled the above controversy in the recent decision of Palm Gas Service (81 taxmann.com 43) wherein it has held that the word ‘payable’ occurring in section 40(a)(ia) not only covers cases where amount is yet to be paid but also those cases where amount has actually been paid. The Apex Court ruled that it is the statutory duty of the tax payer to withhold tax and deposit it to the account of the government within the time specified under the law. Although grammatically, the word ‘payable’ and ‘paid’ denote different meaning but when the entire scheme of obligation to withhold tax and paying it over to the Central Government is interpreted holistically, it cannot be held that the word ‘payable’ occurring in section 40(a)(ia) refers only to those cases where the amount is yet to be paid and does not cover the cases where the amount is actually paid. The intention of the statue is to recover tax from the taxpayer for the income accruing or deemed to accrue in India. While the Apex Court overruled the ratio of the judgments of the Allahabad High Court laid in Vector Shipping Service (P.) Ltd and that of Vishakhapatnam Tribunal Special Bench in case of Merlyn Shipping and Transport it relied on the decision of Punjab & Haryana High Court, in P.M.S. Diesels (supra). The Apex Court decision blesses the ratio of the rulings by the Calcutta High Court in case of Crescent Export Syndicates and Gujarat High Court in case of Sikadarkhan N Tunvar, referred to above.
It may be noted that while CBDT Circular (although binding on the revenue authorities) made an attempt to douse controversy around the term payable by explicitly qualifying that amounts may be payable “at any time” during the year, it could not prevent the continued stint of debate, since language is an imperfect tool of expressing legislative intent. The Apex Court through the above ruling in case of Palm Gas now ended this controversy.
(The authors Zainab Bookwala (Manager) & Risha Gandhi (Deputy Manager) are from Deloitte Haskins & Sells LLP. Views expressed above are personal and not that of the firm.)