TDS on Exempt Incomes (Especially Agricultural income)

It is obvious that the TDS provisions are going to be expanded day by day even in the direct Tax Code era. In the process to recover more and more tax through this mode of recovery, in many cases tax is also deducted from incomes which are expressly exempt. Many cases are wandering the corridors of various courts of law on this ground. This is also reflected in the decided cases. It seems that the issue gets complicated with the increase of TDS coverage. It will be interesting to go through the law and the judge-made law on the issue.

Questions to be answered :

To understand the intricacies of the issue we need to address the following questions :

(1) To what incomes/payments TDS provisions especially S. 194I is applicable ? The question assumes importance because the words in the Explanation to S. 194I are :

(i) ‘rent’ means any payment, by whatever name called, under any lease, sub-lease, tenancy or any other agreement or arrangement for the use of (either separately or together) any :

(a) land; or . . . .

This has created doubts about whether the land here includes agricultural land rent.

(2) What is the nature of the Rent income received from Agricultural land ?

(3) Whether the exempt income is covered under the TDS provisions ?

(4) Whether tax treatment in the hands of the payer is relevant ?

Analysis of the questions :

1. What is agricultural land ?

1.1 Agricultural land is not defined under the Income-tax Act. Hence we will have to rely on allied laws and interpretations by courts.

1.2 Under The Bombay Tenancy and Agricultural Lands Act 1960, (BTAL) in clause (a) of S. 2(8) ‘land’ means :

“(a) land which is used for agricultural purposes or which is so used but is left fallow, and includes the sites of farm buildings appurtenant to such land; . . . . .”

1.3 Under the Income-tax Act, 1961, various Courts have interpreted agricultural land.

The Delhi High Court said :

“In order to come within the category of agricultural land, it must not only be capable of being used for agricultural purposes but should have been actually used as such at some point of time. A temporary non-user for agricultural purposes will not affect the character of the land but a permanent abandonment of user for agricultural purposes will affect the character of the land as agricultural land.”

[Shri Shankar Lal v. CIT, (1974) 94 ITR 433, Delhi High Court.]

The Kerala High Court states :

” ‘Agricultural land’, as we understand it, is land on which a prudent owner will undertake any of the processes of farming in its widest sense. The fact that a particular area is being used for agriculture may indicate that the land is agricultural in character. But a current user is by no means conclusive.”

[Venugopala Varma Rajah v. CED, (1967) 64 ITR 358 (Ker.)]

2.0 What is the nature of the rent income received from agricultural land ?

2.1 The following discussion confirms that Rent received for renting out the agricultural land, and any such income derived from the said land is an agricultural income.

2.2 Agricultural income is defined under the Income-ax Act, 1961 in clauses (a), (b) and (c) of S. 2(1A).

Clause (a) of S. 2(1A) reads as :

“any rent or revenue derived from land which is situated in India and is used for agricultural purposes;”

2.3 It is obvious that the rent derived from agricultural land is an agricultural income as per S. 2(1A) of the Income-tax Act, 1961.

The Patna High Court has stated :

“Rent is obviously an agricultural income which the landlord makes by reason of his having a proprietary interest in the land which he lets out to the tenant and the tenant pays it as a part of the consideration for the use and occupation of the land which he enjoys. The source of the income is the landlord’s superior interest in the agricultural land and, consequently, it is an agricultural income.”

[Srimati Lakshmi Daiji v. CIT, (1944) 12 ITR 309 (PAT)]

2.4 This is also confirmed by various Courts including the Supreme Court :

(i) CIT v. Haroocharai Tea Co., (1978) 111 ITR 495 (Gau.)

(ii) CIT v. Janab Haji Muhammad Sadak Khoyee Sahib, (1935) 3 ITR 1 (Mad.)

(iii) CIT v. Raja Benoy Kumar Sahas Roy, (1957) 32 ITR 466 (SC)

3.0 To what payments TDS provisions, especially S. 194I, are applicable ?

3.1 TDS provisions are contained in Chapter XVII of the Income-tax Act, 1961 and cast a responsibility on the person responsible for payments. The incomes from which TDS is to be deducted and person responsible for paying are defined in S. 204 of the Act, which reads as follows :

“204. For the purposes of the foregoing provisions of this Chapter and S. 285, the expression ‘person responsible for paying’ means :

(i) in the case of payments of income chargeable under the head ‘Salaries’, other than payments by the Central Government or the Government of a State, the employer himself or, if the employer is a company, the company itself, including the principal officer thereof;

(ii) in the case of payments of income chargeable under the head ‘Interest on securities’, other than payments made by or on behalf of the Central Government or the Government of a State, the local authority, corporation or company, including the principal officer thereof;

(iia) in the case of any sum payable to a non-resident Indian, being any sum representing consideration for the transfer by him of any foreign exchange asset, which is not a short-term capital asset, the authorised dealer responsible for remitting such sum to the non-resident Indian or for crediting such sum to his Non-resident (External) Account maintained in accordance with the Foreign Exchange Regulation Act, 1973 (46 of 1973), and any rules made thereunder;

(iii) in the case of credit, or as the case may be, payment of any other sum chargeable under the provisions of this Act, the payer himself, or if the payer is a company, the company it-self including the principal officer thereof. . . “

3.2 It is obvious from the section itself that TDS is to be deducted from income chargeable under the Act. The portion in bold letters and underlined clearly shows this without any ambiguity.

3.3 The next question naturally comes is what is chargeable income under the Act.

3.4 Charge of income is stated in S. 4 of the Act and it states that tax shall be charged on the total income of the previous year of every person. Total income is defined in S. 2(45) and S. 5 of the Act. Hence income chargeable has to be decided as per S. 2(45) and S. 5 of the Act.

3.5 S. 2(45) defines ‘Total income’ and reads as under :

“total income means the total amount of income referred to in S.5, computed in the manner laid down in this Act;”

S. 5 with the heading reads :

“Scope of total income.

5. (1) Subject to the provisions of this Act, the total income of any previous year of a person who is a resident includes all income from whatever source derived which . . . . .”

Bombay High Court has interpreted the highlighted words ‘Subject to’ in S. 5 as follows :

“The expression ‘subject to’ used in the opening portion of both Ss.(1) and Ss.(2) of S. 5 has to be read keeping in mind that S. 5 is intended to explain the scope of total income. Therefore, what the use of the said expression shows is that in considering what is total income u/s.5, one has to exclude such income as is excluded from the scope of total income by reason of any other pro-vision of the IT Act and not that the other provi-sions of the IT Act override the provisions of S. 5.

[ CIT v. F. Y. Khambaty, (1986) 159 ITR 203 (Bom.)]

3.6 Hence, it is obvious that the TDS provisions are not independent of other provisions of the Act and whether the income is chargeable to tax under the Act or not has to be considered while deducting TDS.

4.0 Whether the exempt incomes, especially the Agricultural Rent income, is covered under the TDS provisions ?

4.1 Rent of Agricultural land is an agricultural income as explained in Point Nos. 2.0 to 2.04 supra. Agricultural Income is exempt from income tax and is not to be included even in the total income.

4.2 Chapter III of the Act deals with incomes which do not form part of total income. Relevant S. 10(1) reads with its heading as :

“Incomes not included in total income.

10. In computing the total income of a previous year of any person, any income falling within any of the following clauses shall not be included

(1) agricultural income;”

4.3 It is obvious that in computing the total income under the Act, incomes which are exempt u/s.10 have to be excluded. Consequently they have to be excluded while applying the TDS provisions also. Hence, TDS is not to be deducted on payment of incomes exempted and excluded from the scope of total income under the Act.

4.4 Agricultural Rent is an agricultural income and clearly excluded from the scope of total income u/s.10(1) of the Act.

4.5 Even the parliament has given powers to tax agricultural income to the States only and not to the Union (Central Government).

“Reading entry 82 of the Union List and entry 46 of State List of the Seventh Schedule of the Constitution, it is clear that the Parliament is not competent to tax agricultural income. The expression ‘agricultural income’ occurring in the said entries has to be understood in the manner and in the sense defined in clause (1A) of S. 2.”

[J. Raghottama Reddy v. ITO, (1987) 35 Taxman 298 (AP).]

4.6 It is obvious that Rent of Agricultural land is completely out of the purview of not only TDS provisions but even income-tax.

4.7 In another case before the Andhra Pradesh High Court in Andhra Pradesh Forest Development Corporation Ltd. v. ACIT & Anr., (2005) 272 ITR 245 the question was whether items of sale viz. bamboo, eucalyptus and pepper are forest produce or non-forest produce and that the petitioner is under an obligation to collect tax at the time of effecting sales.

The Court held that in order to attract the provisions of S. 206C it has to be examined whether items sold are forest produce or not — Legislature intends to apply this provision in respect of timber and other produce obtained from forest and not any produce and that if the produce i.e. bamboo, eucalyptus and pepper are forest produce, then only the provisions of S. 206C would be applicable and not otherwise.

4.8 Considering other incomes, various courts have taken a clear view that incomes which are not includible in total income (exempt) are clearly out of the TDS net.

4.9 High Court of Rajasthan had an occasion to test applicability of TDS provisions to interest paid to a non-resident in CIT v. Manager, State Bank of India, 13 DTR (Raj.) 294.

In this case during a survey conducted on the assessee bank, it was found that TDS was not deducted on interest paid to NRIs on deposits in Indian rupees.

The AO did not accept the contention of the bank and levied penalty and CIT confirmed the same. But the Tribunal set aside the CIT’s order. In appeal to the High Court, the revenue contended that interest paid on TDR/STDR doesn’t fall u/s.10(15)(iv) (fa) of the IT Act, hence deduction was not admissible, and learned Tribunal has committed error in accepting appeals on this ground whereas the assessee contended that as per provisions of S. 10(15)(iv)(fa), interest income was exempt from taxable income. The provisions of S. 10(15)(iv)(fa), as it then stood were :

“(fa) by a scheduled bank to a non-resident or to a person who is not ordinarily resident within the meaning of Ss.(6) of S. 6 on deposits in foreign currency where the acceptance of such deposits by the bank is approved by the RBI.”

Relying on the observations of the Apex Court in the case of Transmission Corporation of A.P. Ltd. & Anr. v. CIT, (1999) 239 ITR 587 (SC) which has held that tax is to be deducted at source only on the sum on which income tax is leviable, and which income could be assessed to tax under the Act, the High Court held that STDR — Interest on TDR/STDR paid to non-resident Indians being exempt u/s. 10(15)(iv)(fa), there was no question of deduction of tax at source.

4.10 Before the Gauhati High Court in Sing Killing v. ITO & Ors., 255 ITR 444, the question was — when the transactions entered into by the petitioner in respect of the forest lease situated in Sixth Schedule area and income arising therefrom is exempt from payment of income-tax u/s.10(26) whether collection of income-tax at source under the provisions of S. 206C was applicable.

Petitioner, a member of Scheduled Tribe, was granted a lease of a forest area specified in Sixth Schedule area. The ITO also granted a certificate to the petitioner certifying that he is not liable to pay income-tax u/s.10(26).

The Court held that, Entitlement of the petitioner to the benefit of S. 10(26) in respect of transactions arising out of the lease is not in doubt, S. 206C was not therefore applicable. If the income itself is exempted, any deduction/collection, on account of income-tax, at source, would be beyond the powers conferred by the provisions of the Act.

4.11 In a case to decide disallowance u/s.40(a)(ia) in case of legal fees paid in UK in connection with legal proceedings in UK it was held that where the provisions of Article 15 of the DTAA, between India and UK were applicable, payment of fees for legal consultancy services to UK-based firm of solicitors was taxable in UK and was not exigible to tax in India. Therefore, the assessee (tax deductor) was under no obligation to deduct tax at source from the payment so made. IMP Power Ltd. v. ITO Mumbai E Bench, (2007) 107 TTJ 522.

4.12 In a case before Karnataka High Court in Hyderabad Industries Ltd. v. ITO & Anr., 188 ITR 749 the issue was whether S. 10(6A) has nothing to do with deduction of tax at source and it is attracted only for purposes of computing the total income of a foreign company. In other words, the contention was that, in case the foreign company has to face an assessment proceeding, then only S. 10(6A) will be attracted.

The Court held that, “the construction sought to be placed by the Revenue (to deduct tax) is based on a distinction, which has no substance in it. It is not understandable as to why, a benefit which will not be included in the total income of a person, should be considered as ‘income’ for the purpose of deduction of tax at source at all. Purpose of deduction of tax at source is not to collect a sum which is not a tax levied under the Act; it is to facilitate the collec-tion of the tax lawfully leviable under the Act. The interpretation put on those provisions by the Revenue would result in collection of certain amounts by the State, which is not a tax qualitatively. Such an interpretation of the taxing statute is impermissible. Tax paid on behalf of foreign company, therefore, will not form part of its income.”

“S. 10(6A) nowhere confines its operation to an assessment proceedings; there is no exclusion of its operation from other proceedings under the Act. Language of S. 10 is quite simple and clear. It governs the computation of the total income of the person covered by it; a benefit, which is not includible in the total income of a person, necessarily implies that the said benefit is not the ‘income’ of the person.”

4.13 Transmission Corporation of A.P. Ltd. & Anr. v. CIT, (1999) 239 ITR 587 (SC).

In this case the Apex Court had to decide whether the TDS provisions are applicable to Gross Receipt vis-à-vis Income Receipt in case of payments made to non-residents.

The Court observed in Para 8 that, “the scheme of Ss.(1), Ss.(2) and Ss.(3) of S. 195 and S. 197 leaves no doubt that the expression ‘any other sum chargeable under the provisions of this Act’ would mean ‘sum’ on which income-tax is leviable. In other words, the said sum is chargeable to tax and could be assessed to tax under the Act.

Consideration would be — whether payment of a sum to non-resident is chargeable to tax under the provisions of the Act or not ? That sum may be income or income hidden or otherwise embedded therein. If so, tax is required to be deducted on the said sum — what would be the income is to be computed on the basis of various provisions of the Act including provisions for computation of the business income, if the payment is trade receipt.

However, what is to be deducted is income-tax payable thereon at the rates in force. Under the Act, total income for the previous year would become chargeable to tax u/s.4. Ss.(2) of S. 4 inter alia, provides that in respect of income chargeable u/s.(1), income-tax shall be deducted at source where it is so deductible under any provision of the Act . . . .”

4.14 While deciding the applicability of the TDS provisions it is necessary to look into the fact whether the income is exempt from being included in the total income. There is a difference between income not chargeable to tax and not includible in the total income (agricultural income) and income which forms part of total income but which is made taxfree. The Apex Court observed in — CIT v. Williamson Financial Services & Ors., (2008) 297 ITR 17 (SC) that — Agricultural income not being chargeable to tax does not fall under various computation provisions . . . . . There is a vital difference between income not chargeable to tax and not includible in the total income (agricultural income) and income which forms part of total income but which is made tax-free . . . .

4.15 Further CBDT has issued Circular No. 736 dated 30-1-1996 to deal with incomes received by certain defense funds and clearly states that “. . . . no tax may be deducted at source u/s.194-I, since the income of these organisations is exempt from tax u/s.10(23AA) . . . .”

Although it is for the purpose of defense funds the principle of exempt incomes is clearly borne out.

5.0 Whether tax treatment in the hands of the payer is relevant ?

The last question is whether the tax treatment of the amount paid as agricultural rent or exempt income in the hands of the payer will have any effect on the TDS applicability.

TDS provisions nowhere mention anything about the tax treatment for payments made in the hands of the payer.

As explained hereinabove TDS provisions are not applicable to agricultural land rent or exempt incomes. Hence, this will not have any adverse effect in the hands of the payer i.e. lessee/company, as far as the TDS provisions are concerned. The questions u/s.40(a)(ia) have already been resolved by various Court decisions as discussed in the foregoing paras.

Considering all the relevant facts and the law as discussed hereinabove, and relying and based on the same as mentioned above, it is obvious that, TDS provisions are not applicable to Rent for Agricultural land and TDS cannot be deducted there-from or from incomes which are expressly exempt.

Author/s : Anilkumar Shah, Chartered Accountant

Republished with Amendments