Section 40(a)(ia)- apparently a weakly represented case in DEY'S MEDICAL (U.P.) P. LTD. Vs.UOI 2009 -TMI - 35099 - [2009] 316 ITR 445 (All).

[C.A. DEV KUMAR KOTHARI]

Discussion about provisions:

Section 40(a)(ia)- disallowance for non deposit of TDS:

Sub-clause (ia) in caluse (a) of section 40 was introduced by the Finance (No.2) Act, 2004 w.e.f. 01.04.2005. Broadly speaking this relates to disallowance of certain sums, on which tax is deductible at source and has not been deducted or deducted but after deduction has not been deposited by the deductor. The clause has already seen several amendments in its short span of life. The clause also provide that in case of sums deducted up to the February month of the previous year, the same will be allowed if TDS is deposited by 31st March of the Previous year, and in case of tax deducted during last month of the previous year (that is March), if the tax deducted is deposited by the due date u/s 139(1) for filing of the return of income in the case of assessee / deductor.

If the deposit is not so made, then such sums from which tax was deductible will be allowed in the year in which tax is deposited. Thus for TDS up to February deposits should be made by 31st march and for TDS during march by the due date. Otherwise the deduction of entire sum from which tax is deducted but not paid or was not deducted will be disallowed. It appears that the drafting of the clause is made in a very complex manner, it could have been made in simple words.

February vis a vis March deductions:

There appears no justification for keeping difference in relation to tax deductible till last but one month (that is February) and last month of previous year. It could have been simpler if the sum be made deductible in the previous year if the amount of TDS is deposited by the due date to file return. In relation to March, the sum should be deductible and deducted during March. Therefore, if the AO take a view that the sum was deductible before March but was deduced in March, then the time to deposit TDS to get deduction in the same previous year will be available till March only and not till the due date. For the difference kept, unnecessary complexity will be involved and it will cause lot of litigation.

We may notice that earlier clause (i) was already existing in relation to similar provisions for tax deductible in case of payments made outside India or in India to specified persons in specified circumstances. Therefore, the concept of disallowance due to nonpayment of TDS was enlarged in its scope of application. The new clause is applicable to payments/ credit in favor of residents.

Proposal in Budget 2010:

In the Budget 2010, it is proposed to do away with this difference. And if it is passed, then any sum will be allowed, if the tax deducted is deposited before the due date to file return.

Provision:

Relevant provision as it stands now is reproduced below with high lights:

Amounts not deductible.

40. Notwithstanding anything to the contrary in sections 30 to 38, the following amounts shall not be deducted in computing the income chargeable under the head "Profits and gains of business or profession",-     

in the case of any assessee-

(ia) any interest, commission or brokerage, [rent, royalty,] 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,-

(A) in a case where the tax was deductible and was so deducted during the last month of the previous year, on or before the due date specified in sub-section (1) of section 139; or

(B) in any other case, on or before the last day of the previous year:]

 [Provided that where in respect of any such sum, tax has been deducted in any subsequent year, or has been deducted-

(A) during the last month of the previous year but paid after the said due date; or

(B) during any other month of the previous year but paid after the end of the said previous year,

 such sum shall be allowed as a deduction in computing the income of the previous year in which such tax has been paid.]

 Explanation.- For the purposes of this sub-clause,-

(i) "commission or brokerage" shall have the same meaning as in clause (i) of the Explanation to section 194H;

(ii) "fees for technical services" shall have the same meaning as in Explanation 2 to clause (vii) of sub-section (1) of section 9;

(iii) "professional services" shall have the same meaning as in clause (a) of the Explanation to section 194J;

(iv) "work" shall have the same meaning as in Explanation III to section 194C;

[(v) "rent" shall have the same meaning as in clause (i) to the Explanation to section 194-I;

(vi) "royalty" shall have the same meaning as in Explanation 2 to clause (vi) of sub-section (1) of section 9;]

Analysis:

The section is applicable notwithstanding anything contained in section 30-38 of the Act. Thus a sum may be allowable under these provisions but same shall not be allowed if conditions of S. 40 are not met, if applicable. It can be said that deduction u/s 32 relating to depreciation will not be affected by the provision of S.40(a) (ia) Similarly if any sum is allowable u/s 28 then also the disallowance will not be attracted.

This section will apply to cases where assessee is required to deduct tax at source from specified sums. Whether a person is liable or not itself is many times a disputed issue. From court rulings, we find that in majority of cases, it has been held that tax was not deductible or that the assessee had a bonafide reason for not deducting tax.

The provision will apply only when a computation under the head income from business or profession is made and relevant sum is deductible u/s 30-38. The disallowance will not apply in other cases e.g where deduction is allowed u/s 28.

As discussed earlier in preamble we find following categories of TDS according to deductibility based on deposit of TDS:

Deductibility and deduction	Last date to deposit to avoid disallowance in PY
Deductible and deducted in last month (March)	Due date to file ITR
Deductible earlier but deducted in last month	Last day of PY - say 31st March.
Deductible before the last month ( till February)	Last day of PY 31st- say March.
Deductible in March but deducted earlier.	Last day of PY 31st- say March.
Deductible but not at all deducted	NA. Will be disallowed- can be claimed in subsequent year on deduction and payment. .

Allowance of deduction if TDS paid later:

In case tax is not deducted in a previous year, or deducted but not deposited as per above table, then the sum shall not be allowed against income of the previous year.

However, a safe guard is provided that the assessee shall be entitled to claim deduction in any subsequent year in which the tax is deducted and deposited or deposited as the case may be.

Illustration:

Tax is deducted month to month from factory rent for the month of April 2009 to February 2010. To get deduction in income of PYE 31032010 - this need to be deposited by 31st march 2010. ( As per applicable provisions TDS should be deposited by 7th day of following month every month - default by way of delay in deposit attract interest)

Tax is deducted from factory rent for the month of March 2010 at the time of payment on 7th March. To get deduction in income of PYE 31032010 - this need to be deposited by due date to file return as may be applicable.

Tax is deducted from office rent for the month of April 2009 to March 2010 on 31st march 2010 and deposited by 31st may 2010.

In this case the AO can take view that for the months of April 2009 to February 2010 tax should have been deducted every month or in any case should have been deposited by 31.03.2010 to avoid disallowance. As the same has not be deposited by 31.03.2010, rent for this period will not be allowed in income of PYE 31032010 but only against the income of next year in which tax is deposited. Therefore the AO may restrict allowance of only rent for the month of March 2010 in AY 2010-11 and disallow rent for the earlier period of eleven months.

It may be noted that rent of March may be allowed even if tax deducted is deposited by due date to file return of income.

Whether tax is deductible itself is a doubt full

Whether an assessee is liable to deduct tax, if yes under which category tax is deductible, and in case the payee of income has already paid tax then tax need not be deducted. The payee can also furnish certificate from his AO for no deduction of tax or deduction at lower rate of tax. Thus, we find that there are several issues which may cause confusion or ambiguity or doubt for not deducting tax. For example, in the following table some cases are analyzed to show that matters have gone up to the supreme Court for a final decision as to whether assessee was liable to deduct tax or not. We also notice that cases decided in favor of assessee out number cases in favor of revenue.

Citation of case	SC/ HC held	In favor of
CIT Vs. SIRMOUR TRUCK OPERATORS UNION (No.2) 2009 -TMI 33746 / [2009] 313 ITR 26 (SC)	SC held substantial question of law arose reversing decision of HC	NA remitted matter
CIT Vs. SIRMOUR TRUCK OPERATORS UNION (No.2) 2009 -TMI - 33762 - SUPREME COURT OF INDIA	Matter remitted to High Court to decide the matter treating substantial question of law as per HC no substantial question of law was involved.	NA remitted matter
CIT Vs. Eli Lilly & Company (India) Pvt. Ltd. 2009 -TMI - 32752 - SUPREME COURT	SC held that the assessee was liable to deduct tax u/s 192, and reversed judgments of High courts.	Revenue
Vijay Ship Breaking Corpn. & Ors. Vs CIT 2008 -TMI - 31137 - SUPREME COURT	SC held that tax was not deductible on usance interest paid for purchase of the vessel for ship breaking by accepting contention of the assessee that such interest partook of the character of the purchase price and, therefore, TDS was not deductible u/s 195(1),	Assessee
CIT Vs Rajasthan State Electricity Board 2008 -TMI - 5981/ [2001] 248 ITR 185 (SC) .	The Tribunal was directed to make a statement and refer the following question of law to the High Court for consideration "Whether, on the facts and in the circumstances of the case and in law, the Tribunal was justified in cancelling the direction issued by the Income-tax Officer (TDS) for deposit of amount of TDS at Rs. 37,36,775 with interest thereon at Rs. 1,48,465 thus totalling to Rs. 38,85,240" because as per SC question of law does arise.	NA remitted matter
CIT Vs. INFOSYS TECHNOLOGIES LTD. 2008 -TMI - 2973 - SUPREME COURT OF INDIA	Departments contention was rejected on issue of deduction of tax at source . Department considered that the respondent-assessee as assessee in default for not deducting TDS at the rate of 30% on ESOP- The obligation to deduct TDS arises only when the employee exercise his option and realize money from shares, hence department contention was not valid	Assessee.
Hindustan Coca Cola Beverage Pvt. Ltd Vs. CIT 2007 -TMI - 1676 - SUPREME COURT OF INDIA	Warehousing charges - whether warehousing charges are in the nature of renting and TDS is deductible u/s 194- instead of u/s 194-C. Once tax is paid by the deductee assessee - no demand is sustainable. However, interest liability still required to be discharged by the deductor.	Assessee.
CIT v. Ambuja Darla Kashlog Mangu Transport Co-op. Society [2010] 1 taxmann.com 61 (HP)	The concept of sub-contract is intrinsically linked with section 194C(2); if there is no sub-contract then the person making payment is not liable to deduct tax at source even if payment is being made to a resident. A transport society is not liable to deduct tax at source u/s 194C(2) from freight payment made to its members-owners of trucks because there is no sub-contract between society & its members.	Assessee.

From the above table we notice that whether tax is deductible or not is many times doubtful and one cannot decide with confidence. Therefore, imposing a condition for allowance of deduction of expenditure itself on payment of tax deductible is an unjust provision.

Separate provisions for failure to deduct tax:

We find that there are several provisions to ensure compliance with provisions of TDS. Provisions include levy of interest, penalty and prosecution. Therefore, alleged failure to deduct tax, and failure to pay tax deducted as ground to disallow expenses is not justified.

Tax deducted is to be deposited and the beneficiary (the person from whose income tax is deducted) get credit for the same. Tax deducted is not a final tax payment, the beneficiary of TDS may get a refund against the same. In case there is no TDS or short TDS, the person earning income is liable to pay tax. Therefore,

TDS is simply an easy way of collecting tax in advance and simultaneous with earnings of income. It is believed and experienced that tax deducted is considered as regarded as less painful as final payment of tax as against tax which one need to pay as advance tax or self assessment tax etc.

Case before Allahabad High Court:

In DEY'S MEDICAL (U.P.) P. LTD. Vs.UOI 2009 -TMI - 35099 - ALLAHABAD HIGH COURT decided on 15 February 2008 in Appeal No. - 186 (Tax) of 2008 the case relating to validity of S. 40(a) (ia) came before the Court. On the issue of consequences of failure to deduct TDS u/s 194C when S. section 40(a)(ia) was attracted. The main contention of the assessee was that S. 40(a)(ia) is not valid because if it is applied then there is double taxation. It was not the case of assessee that S. 194C was not applicable or that there were bonafide reasons for not deducting tax u/s 194C.

The court considered that section 4 of the Act provides that for the income of the year concerned, income-tax shall be charged in accordance with the provisions enacted by the legislature. The income is defined under Section 2(24) of the Act. A sum paid for advertisement towards advancement of the business is liable to be deducted from computation of the total income strictly in accordance with the provisions of the Act and not otherwise. It was not disputed that assessee was liable to deduct tax at source by virtue of Section 194C of the Act failing which Section 40 (a)(ia) provides that such payment shall not be allowed to be deducted from computation of total income and shall be treated to be the income of the assessee.

The court considered that once a deduction of a particular amount is not allowable under the Act, it is liable to be taxed and merely because some other person may also be liable to tax after receiving the said amount in one or the other manner, it cannot be said that former assessee is entitled for exemption and cannot be taxed.

The observations of the court and its decision are analyzed below with high lights:

  In this case the assessee / The petitioner has challenged the assessment order dated 31.12.2007 (Annexure-5 to the writ petition) passed by Joint Commissioner of Income Tax, Range-II, Allahabad under Section 143(3) of the Income Tax Act, 1961 (hereinafter referred to as the 'Act') for the assessment year 2005-06 insofar as it has fastened the liability of tax of Rs. 1,29,10,775/- upon the petitioner. He has also challenged the vires of Section 40(a)(ia) of the Act.

The petitioner is engaged in the business of manufacture and sale of cosmetics and medical products having its unit at Allahabad.

With respect to some advertisements made by M/s Dey's Medical Stores Manufacturing Limited, the petitioner claims to have made certain payments being his share of expenditure towards advertisement but the said payments were made without deducting tax at source though mandated under Section 194C of the Act.

For failure of deduction of tax at source, the amount paid by the petitioner claimed to be expenditure on account of advertisement was not allowed to be deducted from computation of his income in view of Section 40(a)(ia) of the Act and the assessing officer treated the said payment to be the income of the petitioner fastening upon him the liability of tax under the Act.

The learned counsel for the petitioner contended that the aforesaid payment is also liable to be taxed in the hands of the persons to whom the payments are made being their income and tax deducted at source on such amount by the petitioner at best would have been in the nature of part payment of tax by such person. Therefore, for such failure of deduction of tax at source, the said payment in its entirety cannot be treated to be the income of the petitioner as it would amount to double taxation of the same amount and, therefore, is illegal and ultravires.

Court held as follows:

However, we do not find any substance in the submission and in our view, the argument is thoroughly misconceived. Section 4 of the Act provides that for the income of the year concerned, income-tax shall be charged in accordance with the provisions enacted by the legislature. The income is defined under Section 2(24) of the Act. However, in several provisions, the income which is not to be included in total income or is liable to be deducted therefrom has been provided in detail. It is only such amount, deduction whereof is permissible under the Act has to be excluded from computation of total income for the year, which is chargeable to tax under the Act. Amount spent towards business expenditure are deductible under Section 37 of the Act in General. However, Section 40 provides for certain amounts, which are not deductible in computing the income chargeable under the Act. A sum paid for advertisement towards advancement of the business is liable to be deducted from computation of the total income strictly in accordance with the provisions of the Act and not otherwise.

 It is not disputed that on the payment made by the petitioner, which are in dispute in the present case, he was liable to deduct tax at source by virtue of Section 194C of the Act failing which Section 40 (a)(ia) provides that such payment shall not be allowed to be deducted from computation of total income and shall be treated to be the income of the assessee.

Once a deduction of a particular amount is not allowable under the Act, it is liable to be taxed and merely because some other person may also be liable to tax after receiving the said amount in one or the other manner, it cannot be said that former assessee is entitled for exemption and cannot be taxed. We are not shown of any authority providing that such taxation is not permissible in law and is bad even otherwise.

Moreover, despite our repeated query, the learned counsel for the petitioner could not show as to how and in what manner he claims Section 40(a)(ia) of the Act to be ultravires. He could not show any legislative incompetence in enacting such provision. Vires of an statute can be challenged on the ground of legislative incompetence. We are not shown that Section 40(a)(ia) of the Act is not within the legislative competence of the Parliament and further learned counsel for the petitioner also could not show that the said provision, in any manner, is violative of any provision of the Constitution including fundamental rights.

7. We, therefore, do not find any merit in this writ petition. It is, accordingly dismissed. No order as to costs.

Weak points in the arguments:

It seems that there may be several weak points in arguments and stand taken by petitioner and his counsels.

About tax deductible:

It appears that the case was not properly represented. In view of author, assessee might not be liable to deduct tax at source as appears from the following observation:

"that With respect to some advertisements made by M/s Dey's Medical Stores Manufacturing Limited, the petitioner claims to have made certain payments being his share of expenditure towards advertisement but the said payments were made without deducting tax at source though mandated under Section 194C of the Act.

From this it is likely that what the assessee had paid to M/s Dey's Medical Stores Manufacturing Limited, is his share in advertisement expenses. It may not be a payment for contracts for advertisement. The fact may be that group company (lead company) M/s Dey's Medical Stores Manufacturing Limited, incurred expenses, made payments to advertising contractors, and the assessee paid his share in such expenses to them. If that be the case then tax was not deductible because the payee company was not an advertising contractor. In that situation the payee M/s Dey's Medical Stores Manufacturing Limited, would have paid to advertising contractors and deducted tax from such payments. The petitioner was not liable to deduct tax on his share of expenses paid / reimbursed to M/s Dey's Medical Stores Manufacturing Limited.

However, there was no argument on this score. It was also not argued that the payee had filed his return and paid tax on his income.

It was also not argued that if at all, the petitioner was under bona fide belief that tax was not deductible u/s 194C from payments made to sister concern M/s Dey's Medical Stores Manufacturing Limited.

When tax deductible itself be not free from doubt, S. 40(a) (ia) cannot be applied.

Regarding Constitutional validity:

Emphasis should have been applied about:

Concept of tax on income:

The Income-tax Act is to impose tax on income, and by treating an amount of expenditure as income, merely because TDS has not been deducted or deposited, an artificial meaning is given to income, and that is beyond the purposes of income-tax Act. A tax cannot be imposed under the Income-tax Act, on an item, which is not 'income' in its true meaning or popular meaning.

Complexity of provisions relating to TDS and therefore, disallowance for alleged failure to deduct tax or deposit tax should not be ground for disallowance. It could be shown that as per reported judgments also in large number of cases it was not crystal clear that assessee was liable to deduct tax. Even Supreme Court has restored the matter to the lower authorities to reexamine such issues in many cases.

Separate provisions to deal with failure to deduct tax or deposit tax deducted, therefore, there should not be provisions for disallowance of relevant sums merely because tax has not been deducted and /or deposited.

Ultimate liability to pay tax is of the recipient of income, in case tax is not deducted, and TDS certificate is not issued, the payee cannot claim TDS. So the payee will be liable to pay advance tax, self assessment tax, and interest for delay in payment of such taxes. By non deduction revenue does not suffer. Rather it can be shown that if tax is not deducted, the revenue will be gainer because the recipient of income will have to pay advance tax much earlier than the average date of payment of TDS. When tax is deducted or is likely to be deducted, there is no payment of advance tax to the extent of likely TDS. Un reasonableness- for failure to deduct tax @ 1% or 2% or at most 10% , 100% of expenses are disallowed. This is not reasonable.

Ignoring concept of 'real income': Provisions of S. 40(a) (ia) results into disregarding concept of taxing real income in more than one years. Provisions resulting into taxing income artificially increased- the addition to income by way of disallowance of actual and genuine expenses incurred results into inflating income unreasonably.

Again by allowing deduction of entire expenditure in another year when expenses are not incurred but only deposit of TDS is made reduces real income of assessee substantially and results into determination of loss or lesser income of subsequent year. This could be illustrated as follows:

Payments to advertising contractors Rs. One crore.

Alleged failure to deduct tax @ 1% amounting to Rs. One lakh.

Treating Rs. One crore as income of the year in which liability is incurred for Rs. One crore. Thus levying tax of say Rs. 35 lakh.

In next year the TDS is deposited, and assessee is allowed Rs. One crore of expenses which were incurred in earlier year. Therefore, there is reduction of income or increase in loss of subsequent year in which really impugned expenditure is not incurred.

Thus, giving artificial meaning to income in two years is not at all reasonable or justified.

There cannot be said any intelligible differentiation in this regard. Because, for failure to deduct tax there are already provisions to compensate the revenue and to penalize assessee. Thus, looking at overall legal positions and all related provisions, enactment of S. 40(a) (ia) is not reasonable and justified.