2014 (6) TMI 79 - AT - Income Tax

Disallowance u/s 40(a)(ia) of the Act Tax withholding obligations u/s 194A of the Act not discharged Held that - The net effect of the amendments is that the disallowance u/s 40(a)(ia) shall not be attracted in the situations in which even if the assessee has not deducted tax at source from the related payments for expenditure but the recipient of the monies has taken into account the receipts in computation of income, paid due taxes, if any, on the income so computed and has filed his income tax return u/s 139(1) - it is beyond doubt that the underlying objective of section 40(a)(ia) was to disallow deduction in respect of expenditure in a situation in which the income embedded in related payments remains untaxed due to non-deduction of tax at source by the assessee - section 40(a)(ia) cannot be seen as intended to be a penal provision to punish the lapses of non-deduction of tax at source from payments for expenditure- particularly when the recipients have taken into account income embedded in these payments, paid due taxes thereon and filed income tax returns in accordance with the law. A curative amendment to avoid unintended consequences is to be treated as retrospective in nature even though it may not state so specifically, the insertion of second proviso must be given retrospective effect from the point of time when the related legal provision was introduced - it cannot subscribe to the view that it could have been an intended consequence to punish the assessees for non-deduction of tax at source by declining the deduction in respect of related payments, even when the corresponding income is duly brought to tax - That will be going much beyond the obvious intention of the section - the insertion of second proviso to Section 40(a)(ia) is declaratory and curative in nature and it has retrospective effect from 1st April, 2005, being the date from which sub clause (ia) of section 40(a) was inserted by the Finance (No. 2) Act, 2004 thus, the matter is remitted back to the AO for fresh adjudication Decided in favour of Assessee.

Summary

Issues Involved:
1. Disallowance under Section 40(a)(ia) of the Income Tax Act, 1961.
2. Retrospective application of the second proviso to Section 40(a)(ia).

Issue-wise Detailed Analysis:

1. Disallowance under Section 40(a)(ia) of the Income Tax Act, 1961:
The appeal concerns the correctness of the disallowance of Rs. 5,01,872 under Section 40(a)(ia) of the Income Tax Act, 1961, for the assessment year 2006-07. The Assessing Officer (AO) noted that the assessee made interest payments without fulfilling tax withholding obligations under Section 194A. Consequently, the AO disallowed the deduction under Section 40(a)(ia) due to the non-compliance with tax withholding requirements. The assessee contended that the disallowance should not apply because the recipients of the interest payments had already included these amounts in their tax returns filed under Section 139. The assessee argued that the second proviso to Section 40(a)(ia), introduced by the Finance Act 2012, should apply retrospectively. However, the Commissioner of Income Tax (Appeals) [CIT(A)] upheld the disallowance, relying on the Special Bench decision in Bharati Shipyard Ltd. v. DCIT, which stated that the proviso could not be applied retrospectively.

2. Retrospective application of the second proviso to Section 40(a)(ia):
The Tribunal examined the legislative amendment of Section 40(a)(ia) introduced by the Finance Act 2012, effective from 1st April 2013. The second proviso to Section 40(a)(ia) states that if the assessee is not deemed to be in default under the first proviso to Section 201(1), the disallowance under Section 40(a)(ia) should not apply. The Tribunal noted that this amendment aimed to mitigate the harshness of the disallowance provision by ensuring that if the income embedded in the payments was included in the recipient's tax return and taxes were paid, the disallowance should not be enforced.

The Tribunal referred to the Special Bench decision in Bharati Shipyard, which distinguished between "intended consequences" and "unintended consequences" of legislative provisions. The Special Bench had held that the 2010 amendment to Section 40(a)(ia) was an "intended consequence" aimed at augmenting TDS provisions and thus could not be applied retrospectively. However, this view was disapproved by the Delhi High Court in CIT v. Rajinder Kumar, which emphasized a fair, just, and equitable interpretation of the provision.

The Tribunal concluded that the second proviso to Section 40(a)(ia) was curative and declaratory in nature, aimed at avoiding unintended hardships where the recipient had already paid taxes on the income. Therefore, the amendment should be applied retrospectively from 1st April 2005, the date when Section 40(a)(ia) was initially introduced.

Conclusion:
The Tribunal remitted the matter to the AO for fresh adjudication, directing the AO to verify whether the recipients had included the payments in their income, paid taxes, and filed their tax returns. The AO was instructed to provide a fair hearing to the assessee and decide the matter in accordance with the law. The appeal was allowed for statistical purposes, emphasizing the retrospective application of the second proviso to Section 40(a)(ia).