Section 2(24) (x) deeming contributions of employees as income appears to be ultravirse the Constitution of India (COI) and purposes of the Income-Tax Act (ITA).

[CA DEV KUMAR KOTHARI]

References and links:

Statutory provisions:

The Constitution of India Article 246 read with Union List entries 82 and 85, Article 366 clauses –1, 6, 8, 28 and 29.

Section 2 (24) (x), 36(1) (va), 57 (ia).

Power to levy tax on income:

The Central Government of India or UOI is authorized to levy tax on income and corporation tax the relevant entries are as follows:

List I - Union List

82. Taxes on income other than agricultural income

85. Corporation tax.

Definitions in COI:

The meaning of some related words are found in the article 366 of the COI. Related definitions are reproduced below:

Article 366 in The Constitution Of India 1949

366. Definition In this Constitution, unless the context otherwise requires, the following expressions have, the meanings hereby respectively assigned to them, that is to say

(6) “corporation tax” means any tax on income, so far as that tax is payable by companies and is a

tax in the case of which the following conditions are fulfilled:—

(a)     that it is not chargeable in respect of agricultural income;

(b) that no deduction in respect of the tax paid by companies is, by any enactments which may apply to the tax, authorised to be made from dividends payable by the companies to individuals;

(c) that no provision exists for taking the tax so paid into account in computing for the purposes of Indian income-tax the total income of individuals receiving such dividends, or in computing the Indian income-tax payable by, or

refundable to, such individuals;

(8) “debt” includes any liability in respect of any obligation to repay capital sums by way of annuities

and any liability under any guarantee, and “debt charges” shall be construed accordingly;

(28) taxation includes the imposition of any tax or impost, whether general or local or special, and tax shall be construed accordingly;

(29) tax on income includes a tax in the nature of an excess profits tax;

The Central Government or the UOI is empowered to levy tax on income other than agricultural income. Even in case of Corporation tax, the Central Government is not authorized to levy tax on agricultural profits of a corporation.

The term ‘corporation tax’ has been specifically defined in the COI. The terms ‘income ‘ and   ‘excess profit’ are not defined in the COI.

The term ‘tax’ has not been specifically defined in COI but it derives meaning from the specific meaning given for the word ‘taxation’.

Therefore, ‘tax’ in nature of tax on income can be either a tax or an impost on the following type of incomes:

1. tax or impost on ‘income’ , which can be levied by the central Government,
2. tax or impost on excess profits , which can be levied by the central Government,
3. tax or impost on income of companies as ‘corporations tax’ as defined in Article 366 (6).

Therefore, UOI is empowered to levy tax on income and corporation tax. A tax on an item which is not an income but is a capital receipt or a liability or debt cannot be considered as income for the purpose of levy of tax on income.

Relevant and operative portion of Section 2 (24) (x), which was inserted w.e.f. 01.04.1988 reads as follows:

  2. In this Act, unless the context otherwise requires,—

(x) any sum received by the assessee from his employees as contributions to any provident fund or superannuation fund or any fund set up under the provisions of the Employees' State Insurance Act, 1948 (34 of 1948), or any other fund for the welfare of such employees ;]

Position prior to 01.04.1988:

It is worth to mention that Income-tax Act , 1922 and Income-tax Act, 1961 did not provide for such deeming provision till the previous year ended on 31.03.1987. For the first time the deeming provision was inserted to apply on and from previous year 1987-88 relevant to the assessment year 1988-89 onwards. Thus one is at loss to understand the sudden reason for such a deeming provision which goes against all known commercial and accounting provisions and practices that any contribution received by employer from his employees are received in trust and for onward payment to the respective funds. Even if the amount is kept by assessee in his own control it bears character of liability or debt of employer. It may be noted that for not depositing such contributions as per applicable law the employer can be severely punished as a crime including crime in nature of cheating, dishonesty and breach of trust.

Allowance of actual payment is one of permissible aspect of taxation of income:

When a contribution of employer to such funds is his allowable expenditure, disallowing such contributions of employer for non-payment and allowing the same on actual payment is one of permissible aspects of taxation. Actual payment has been extended to many of expenses under section 36 and 43B. However, an amount cannot be considered as income. Unpaid PF contribution of employer cannot be called his income, the amount is not allowable till it is actually paid. An addition by way of disallowance is not income, it is adjustment for allowable expenses.  

Liability cannot be income:

A liability cannot be income in any sense. Except when the liability is a trading liability, which was allowed as an expenditure and only when it ceases to be payable and assumes character of revenue income.

Liability towards employees welfare funds particularly PF, SAF, GF, ESI and other welfare funds are associated with the business or business unit in which employees are employed. Even in case of transfer of the business undertaking , the liability is statutorily transferred with the business unit when undertaking is sold as a going concern.

Accounting entries and accounting standards:

When a sum is received or deducted from salary of employee as his contribution to a fund or for any specific purposes directed by employee or as specifically required to be paid under any law, contract or trade practices, the sum so received is credited in separate account which is a liability account e.g. employees contribution to PF/ SAF/ ESI/ Labour Welfare Fund/ TDS from salary/ P.Tax of employees or say Employees contribution to PM Relief Fund.

In all such cases the sum received or deducted is with an obligation to pay or deposit the same to respective account. Therefore, the sum so received or deducted cannot be considered as income by any standard and under any norms.

In context of meaning of income, excess profit or tax on income as per various relevant meanings, such receipts or deductions from salary cannot be considered as ‘income’ within the widest possible meaning of ‘income’ under the Constitution of India.

Separate provisions for recovery:

There are separate provisions for recovery of such sums from employers who have collected such sums. There are statutory and contractual obligations to deposit the same in respective funds. In case ultimately such sums are not deposited or paid to such funds, the employees can claim refund of the same. Therefore, for this reason also such sums cannot be called income.

Provisions to allow payments cannot make a capital receipt income:

Though in the ITA correspondingly provisions have been made to allow payments into funds by employer, ( in section 36(1) (va)/ 43B and 57 (ia) but mere provisions to allow actual payment or payment within due date etc. cannot make a receipt of capital / liability / non-income nature as income.

It is well settled that even an item of receipt which is of nature of income but which is received subject to conditions and contingencies cannot be treated as income until all such conditions are met and there remains no contingency about the sum being income. Therefore, how a sum received or deducted with perfect statutory and contractual obligations to deposit in respective funds can be treated as income.

Mere inclusion of any sum in definition of income will not render an items income, which in fact is a liability and the liability is definitely payable.

All liabilities towards such funds are required to be shown separately or with adequate disclosures about delayed deposits in case of accounts of companies and other institutions. Non-payment and even delayed payments are considered seriously by balance sheet readers.

Delays in deposit is due to financial constraints:

When business runs into difficulty, the employers first target it to get production going on by making arrangements for essential inputs including labour. In priority he find first to pay to the workers and for essential items of input material and services. Employer try to exploit sources of capital including by availing facility of current liability to accumulate. It is fact that contribution to PF can be delayed but payment of wages need to be made so as to sustain employer and employee relationship by enabling employees to run their home.

We find even many cases of public sector undertaking in which there was accumulation of liability of PF etc.

For example:

In case of Gujarat State Road Transport Corporation Versus Assistant Commissioner of Income-tax, Circle-4 2012 (4) TMI 323 - ITAT AHMEDABAD the AO levied penalty u/s. 271(1) (c) on the ground that the assessee has made a false claim u/s. 43B as well as the assessee declared income of Rs. 2 crore on account of employee's contribution, in response to notice u/s. 148 of the Act. The AO levied minimum penalty of Rs. 12,75,41,087/-. The basis of holding that the assessee has claimed false claim. The AO in his discussion held that the assessee was well aware about the law that employees' contribution to PF is not deductible u/s. 43B of the Act and according to the provisions of section 2(24)(x) r.w.s. 36(i) (va) are attracted so far as the contribution from the employees' is concerned. Similarly the assessee has disclosed Rs. 2 crore additional loss and claiming deduction u/s. 43B. The assessee could not substantiate the proof of bona fide claim u/s. 43B as no payment was credited to Government account as required by the law. The CIT (A) deleted the penalty in respect of loss of Rs. 33,55,15,227/- on the ground of bonafideness of the assessee, however, the CIT (A) confirmed the penalty u/s. 271(1)(c) of Rs. 2 crore as the assessee disclosed this amount of loss only in response to notice u/s. 148 and the assessee has failed to discharge the onus cast upon it within the meaning of Explanation-1 to section 271(1) (c) of the Act.

However the penalty was deleted by Tribunal by observing and holding that when the assessee is able to offer reasonable explanation based on some evidence, the AO cannot invoke Part B of the explanation unless he has given finding based on some contradictory evidence to disapprove that explanation offered by the assessee - There is no finding of the AO based on some contradictory evidence to disapprove that explanation offered by the assessee was false or the assessee was not able to substantiate the explanation furnished or fails to prove that such explanation is not bona fide and that all the facts relating to the same and material to the computation of his total income has not been disclosed by him - Decided in favor of the assessee

This case shows that in some circumstances even public sector undertaking are forced to cause delay in deposit of sums received or deducted from employees. Merely because employer could not make a deposit in time, sums so received or deducted cannot be considered as income.

Conclusion:

Therefore, clause (x) of Subsection (24) of section 2 appears to be ultravirse the COI and ITA, however, so far, surprisingly, this provision has not be challenged. Particularly because the employers get deduction on deposit. However, on principal this clause need to be struck down as being ultravirse the COI and purposes of ITA.