Amendments, Clarifications, Controversies & Litigation of Section- 40 (a) (ia) of the Income Tax Act, 1961

Amendments, Clarifications, controversies & Litigation of issues revolving around Section- 40 (a) (ia) of the Income Tax Act, 1961

Controversies evolving out of each amendment to section 40 (a) (ia) seem to have  given some sigh of relief to the assessees & their Tax Representatives, "till the time" it receives it’s final verdict from the highest judicial authority i.e. Supreme Court of India

IDEOLOGIES OF TAXATION:

Law of Taxation and changes incorporated by CBDT (Central Board of Direct Taxes) every year has turned out to be more complex and controversial for each passing years. It is a charging statute and levy of tax is separate on each of the individuals and the levy is governed by the Income Tax Act, 1961. The strategy of Taxation can be broadly classified upon considerations like raising revenue/funds, put a check upon consumption and use of articles. The main source of earning of revenue is by way of application of TDS provisions which is laid down by the statute in Chapter-XVII “COLLECTION & RECOVERY OF TAX”.

LEGISLATIVE HISTORY OF THE PROVISIONS OF SECTION - 40 (a) (ia):

Sec- 40 is placed in Chapter- IV D. – Profits and gains of business or profession consists of sec-28 to sec- 44DA, dealing with the “Amounts not deductible” while computing the income under this head. For ready reference, sec- 40 is produced herein, -

“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”, —

 (a)  in the case of any assessee—

 (i)  any interest (not being interest on a loan issued for public subscription before the 1st day of April, 1938), royalty, fees for technical services or other sum chargeable under this Act, which is payable,—         

    (A) outside India; or

    (B) in India to a non-resident, not being a company or to a foreign company, 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 Page 3 of 26subsequent year before the expiry of the time prescribed under sub-section (1) of section 200 :

     

Provided that where in respect of any such sum, tax has been deducted in any subsequent year or, has been deducted in the previous year but paid in any subsequent year after the expiry of the time prescribed under sub-section (1) of section 200, 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, —

     (A)  “royalty” shall have the same meaning as in Explanation 2 to clause (vi) of subsection (1) of section 9;

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

The statute clearly states that Section 40 deals with certain amounts, which will not qualify for deduction in computing the income chargeable to tax. Subsequent insertion of New Sub-Clause (ia) to Section 40 (a) by Finance (No. 2) Act, 2004 w.e.f. 01.04.2005 i.e. from A.Y. 2005-06 was made with a sole objective i.e. to ensure effective compliance with the provisions of TDS (Tax deduction at source).

What the statute reads:

Sec- 40 (a) (ia) reads,-

(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 on or before the due date specified in sub-section (1) of section 139,—

 Provided that where in respect of any such sum, tax has been deducted in any subsequent year, or has been deducted during the previous year but paid after the due date specified in sub-section (1) of section 139, such sum shall be allowed as a deduction in computing the income of the previous year in which such tax has been paid."

Finance (No.2) Act, 2004 states that sec- 40 (a)(ia) would cover, -

a)  any payment made to a resident for any interest covered by Sections 193 and 194A;

b)  commission or brokerage covered by Section 194H;

c)  fees for professional or technical services covered by Section 194J and;

d) payments to contractors or sub contractors covered by Section 194C (specified expenditure)

on which tax has not been deducted, or having been deducted, has not been paid any time during the previous year or in the subsequent year or before expiry of the time limit prescribed u/s 200(1), shall not qualify for deduction in computation of income chargeable to tax under the head “Profits & gains of business or profession”.

It has also provided that, if tax is deducted in any subsequent year, or has been deducted in the previous year but paid in the subsequent year after the expiry of the time limit prescribed u/s. 200(1), then such sum will be allowed as deduction in computing the income of the previous year in which the tax has been paid.

As regards payments to a non resident or a foreign company, the existing Section 40(a)(i) (upto A. Y. 2004-05) provides for disallowances in respect of any interest, royalty, fees for technical services or other sums chargeable under the Act, which are payable outside India or in India to any non resident or to a foreign company, where either tax is not deducted at source or, having deducted the tax, payment is not made before the expiry of time prescribed u/s 200(1).

OBJECTIVE BEHIND INCORPORATION OF SUB- CLAUSE (ia) to SECTION- 40 (a) (ia)

To bring harmony in between the treatments of payments to a non-resident/ foreign company with that of payments to a resident, Section 40(a)(i) is amended retrospectively w.e.f. A. Y. 2005-06. It has been provided that if the tax is deducted and paid within the same previous year, even if the payment is beyond the time prescribed u/s 200(1), the deduction will be allowed in the previous year. Similarly, if tax is deducted in the previous year, and payment is made in the subsequent year before the expiry of time prescribed u/s 200(1), the deduction will be allowed in the previous year. But, if the tax is deducted in the previous year, but paid in the subsequent year beyond the time limit prescribed u/s 200(1), then the sum would be allowable in the subsequent year.

AMENDMENTS TO SEC- 40 (a) (ia):

First Amendment to the provisions of sub-clause (ia) of clause (a) of section 40 of the Income-tax Act was brought in by the Finance Act, 2008.

As per the provisions of sub-clause (ia) of clause (a) of section 40, any interest, commission, brokerage, fees for professional services, fees for technical service payable to a resident, or amounts payable to a contractor or sub-contractor, being resident, for carrying out any work, rent and royalty on which tax is deductible at source 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 shall not be allowed as deduction. However, the sum is allowed as a deduction in the year of actual payment of the TDS.

To mitigate any hardship caused by the above provisions of section 40 while maintaining TDS discipline, the Act has amended provisions of sub-clause (ia) of clause (a) of section 40.

This amendment allows an additional time (till due date of filing of return of income) for deposit of TDS pertaining to deductions made for the month of March so that disallowance under sub-clause (ia) of clause (a) of section 40 is not attracted in such cases.

Fore example, if the last date for filing the return of income in case of a taxpayer (deductor) is 30^th September, he would get an additional time of six months (i.e. from April to September) for depositing the tax deducted at source on an expenditure incurred or payment made in the month of March so as to escape disallowance under sub-clause (ia) of clause (a) of section 40.

The amendment brought in by this Finance Act, 2008 has been made applicable with retrospective effect from 1^st April 2005 and shall accordingly apply to assessment year 2005-06 and subsequent to the said assessment year. 

Thereafter, another amendment to sec- 40 (a) (ia) was brought in by the Finance Act, 2010 which was made applicable with retrospective effect, but from the 1st April 2010 i.e. in relation to the A.Y. 2010-11 and subsequent years.

The provision so amended, reads as under –

“(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 on or before the due date specified in sub-section (1) of section 139 Provided that where in respect of any such sum, tax has been deducted in any subsequent year, or has been deducted during the previous year but paid after the due date specified in sub-section (1) of section 139, such sum shall be allowed as a deduction in computing the income of the previous year in which such tax has been paid.”

To discourage the practice of delaying the deposit of tax after deduction, a significant change was incorporated vide this amendment of Finance Act, 2010 i.e. the rate of interest for non-payment of tax after deduction has been increased from the present one percent (1%) to one-half percent (1 ½ %) for every month or part of month as per provisions of section- 201 (1A) of the Act.   

This amendment has been made applicable w.e.f. 1st July 2010.

DIFFERENCE IN CHANGES BROUGHT IN SEC- 40 (a) (ia) by FINANCE ACT, 2008 & FINANCE ACT, 2010

As per Finance Act, 2008, causing disallowance on the basis of the period of the previous year during which tax was deductible. These two categories of disallowance: -

a)  includes the cases in which tax was deductible and was so deducted during the last month of the previous year but there was failure to pay such tax on or before the due date specified in sub-section (1) of section 139;

b)  includes cases where it requires deposit of tax before the close of the previous year upto 31^st March in case of deduction during the first eleven months i.e. a pre-condition for the grant of deduction in the year of incurring expenditure has been eased by extending such time up to the date u/s. 139 (1) of the Act.

The position with reference to first category of cases was left untouched by the Finance Act, 2010, however, in case of the second portion, the only change that has been made by Finance Act, 2010 is that, the assessee deducting tax either in the last month of the previous year or first eleven months of the previous year shall be entitled to deduction of the expenditure incurred during the year, if the tax so deducted at source is paid on or before the due date u/s 139(1).

UNRESOLVED ISSUE RESOLVED BY FINANCE ACT 2012

Recently, Finance Act, 2012 has made some significant amendment in section- 40 (a) (ia), which may have definitely given some sigh of relief to the Tax Practitioners.

The objective behind the amendment brought in by the Finance Act, 2012, is to rationalize the provisions relating to TDS.

The Issue towards Short-Deduction of Tax seems to have eased out the situation.

The amendment to section- 40 (a) (ia) reads that, disallowance of business expenses payable to resident payee due to non-deduction of TDS will not be made if the payer is not considered as an “assessee in default” under first proviso to section 201(1) of the Income Tax Act.

The first proviso to section 201(1) states that, if a payer who fails to deduct TDS from the amount paid to a resident or on the amount credited to the account of a resident shall not be deemed to be an “assessee in default”, if such resident: (conditions)

(a) has furnished his return of income under section 139;

(b) has taken into account such sum for computing income in such return of income;

(c) has paid tax due on the income declared by him in such return of income and;

(d) if the tax payer furnishes a certificate to this effect from an accountant in such form as may be prescribed.

In such a case, it shall be deemed that the payer has deducted and paid the tax on the date of furnishing of return of income by the resident payee.

To obtain the benefit of amendment to section 40(a)(ia), the payer should not be an “assessee in default” as mentioned in proposed first proviso to section 201(1) and all the above conditions need to be fulfilled in order to avoid disallowance of expenses.

The amendment is effective from assessment year 2013-14.

CONSTITUTIONAL VALIDITY OF THE SECTION- 40 (a)(ia) CHALLENGED BEFORE HIGH COURT

The challenge of the constitutionality of the said provision was raised before the Hon’ble Madras High Court in the case of Tube Investments of India v. Asstt. CIT [2009] 325 ITR 610, although the petition was rejected by the High Court. The petition is based on a very interesting ground wherein it was contended that, the effect of disallowance of the whole of expenditure under Section 40(a)(ia) for deduction of tax but when not paid as provided under the relevant rules, could be draconic and so harsh that it had to be held to be highly arbitrary and unreasonable and in violation of Article 14.

Looking at the practical aspect of the contention, it is pertinent to mention that, disallowance u/s. 40 (a)(ia) even if is made for the default committed in complying with the Tds provisions, the punishment is harsh in respect of the disallowing the entire expenditure that has actually being incurred during the previous year. 

Hon’ble High Court of Madras has clarified by stating that,

“in the event of a reasonable doubt about the applicability of Chapter XVII-B, Section 40(a)(ia) cannot be invoked, would be stretching our jurisdiction beyond the permissible limit which cannot be done. In as much as we have reached a conclusion that the object sought to be achieved while enacting Section 40(a)(ia) was for augmenting the provision of TDS, with which object we do not find any impermissibility or lack of constitutionality and hence there is no scope for applying the doctrine of Reading Down to the said provision.”

Another issue that the petitioner had contended before Hon’ble High Court in this case was regarding the issue & controversy of “DOUBLE TAXATION”.

LANDMARK JUDGMENT BY HON’BLE SUPREME COURT IN HINDUSTAN COCA COLA BEVERAGE P. LTD. VS. COMMISSIONER OF INCOME TAX

The Apex Court held that, -

“the rigor of Section 40(a)(ia) is relaxed and thereby whatever tax liability created due to disallowance can be retrieved and thereby in the ultimate process, the collection of tax will be only that of the payee. It is a misnomer to call the process created under Section 40(a)(ia) as one resulting in Double Taxation.

Circular No.275/201/95- IT (B) dated 29.01.1997 issued by the CBDT, which specifically declares “no demand visualized under Section 201(1) of the Income Tax Act should be enforced after the tax deductor has satisfied the officer-in-charge of TDS, that taxes due have been paid by the deductee-assessee.

However, this will not alter the liability to charge interest under Section 201(1A) of the Act till the date of payment of taxes by the deductee-assessee or the liability for penalty under Section 271C of the Income Tax Act.” It was in the above stated legal position that decision came to be rendered by the Hon’ble Supreme Court.”

Hon’ble High Court strongly quoted in the case of Tube Investments of India v. Asstt. CIT that, the said decision has been rendered in the light of Sections 201(1) and 201(1A) could not have been made applied to a situation where Section 40(a)(ia) gets attracted, as both the provisions stands in different footing under different sets of circumstances.

CONTROVERSY & INTERPRETATION OF THE EXPRESSION ‘PAID’ & ‘PAYABLE’ IMPLIED IN SECTION- 40 (a) (ia)

Section 40(a)(ia) creates a legal anomaly by virtue of which even the genuine and admissible expenses claimed by an assessee and when an assessee does not deduct TDS on such expenses the same are disallowed.

It was enacted for the purposes of augment of tax through the strict compliance of TDS provision in the light of furtherance to the said objective.

The issue that revolves around is in respect to the interpretation of the expression ‘paid’ & ‘payable’ implied in the section- 40 (a) (ia). The question is whether sec- 40 (a) (ia) would get attracted in the case when the amount is already being paid although the tax is not deducted or is not deposited after such deduction or not?

Several judicial Authorities have passed its decisions on this issue and ultimately Income Tax Appellate Tribunal Special Bench, Vishakhapatnam in the case M/s. Merilyn Shipping & Transports vs. ACIT has settled the issue by considering the majority view stating that, sec- 40 (a) (ia) of the Act is applicable only to such expenditures which are payable as on 31^st March of every year and cannot be invoked to disallow the amounts which have already been paid during the previous year, without deducting tax at source.

AMENDMENTS BY FINANCE ACT, 2010

WHETHER PROSPECTIVE OR RETROSPECTIVE ?

The amendment that has been brought by Finance Act, 2010 in the sec- 40 (a) (ia) states that, the due date of depositing the TDS for all the payments has been made as per Section 139(1) of the Act, i.e. before the due date for filing of the returns.

The question as to whether the Amendment by the Finance Act, 2010 shall be applicable with prospective or retrospective effect or not i.e. from 1.4.2005 came up for consideration before the Mumbai Special Bench Income Tax Appellate Tribunal in the case of Bharati Shipyard Ltd.

It was held that, the amendment made by the Finance Act, 2010 with a retrospective effect from assessment year 2010- 2011 cannot be held to be retrospective from assessment year 2005-2006.

The Special Bench held that the amendment brought in by the Finance Act, 2010 to section 40(a)(ia) w.e.f. 01.04.2010 is not remedial or curative in nature.

Finally, the matter came up before Hon’ble High Court Kolkata in the case of Commissioner of Income Tax vs. Virgin Creations, wherein it was held that, when a provision is inserted with an objective to make the provision workable, the same is required to be treated with retrospective operation.

Subsequently, Hon’ble ITAT Kolkata, Mumbai & Vizag Bench have taken similar views in several cases and thereby have provided a big sigh of relief to the assessee’s as well as to their Tax Representatives. 

PERSONAL OBSERVATION & REMARKS:

The judicial decisions are based on the finding of the correct facts and circumstances supported by law. The issue of whether Sec- 40 (a) (ia) would be applicable with retrospective effect i.e. from A.Y. 2005-06 (inception of the provision) or not, has indeed made me confused.

Although for the time being the issue has been resolved by Calcutta High Court in the case of Commissioner of Income Tax vs. Virgin Creations, however, after careful observation of the Judgment passed by Hon’ble High Court, it is necessary to state the finding & observation of Hon’ble HC, -

“It is argued by Mr. Nizamuddin that this court needs to take decision as to whether section 40(A) (ia) is having retrospective operation or not.

The learned Tribunal on fact found that the assessee had deducted tax at source from the paid charges between the period April 1, 2005 and April 28, 2006 and the same were paid by the assessee in July and August 2006, i.e. well before the due date of filing of the return of income for the year under consideration. This factual position was undisputed.

Moreover, the Supreme Court, as has been recorded by the learned Tribunal, in the case of Allied Motors Pvt. Ltd. and also in the case of Alom Extrusions Ltd., has already decided that the aforesaid provision has retrospective application. Again, in the case reported in 82 ITR 570, the Supreme Court held that the provision, which has inserted the remedy to make the provision workable, requires to be treated with retrospective operation so that reasonable deduction can be given to the section as well.

In view of the authoritative pronouncement of the Supreme Court, this court cannot decide otherwise.”

Now, it is pertinent to state briefly the issue, which was adjudicated & decided in the case of Allied Motors Pvt. Ltd. (P) Ltd. vs. Commissioner of Income Tax by Hon’ble Supreme Court of India.

This is as follows: -

“The following question has been referred to us under Section 256(1): -

"Whether on the facts and in the circumstances of the case, the sales-tax collected by the assessee and paid after the end of the relevant previous year but within the time allowed under the relevant sales-tax law is to be Income-Tax Act, 1961 while computing the business income of the said previous year "?

In this case, the deduction that was claimed by the assessee was disallowed by the Income-tax Officer under Section 43B of the Income-tax Act, 1961 which was inserted in the statute with effect from 1.4.1984.

Again in the case of Commissioner of Income Tax vs. Alom Extrusions Limited, the controversy, which was adjudicated and decided by Hon’ble Supreme Court of India was that, -

“whether omission [deletion] of the second proviso to Section 43-B of the Income Tax Act, 1961, by the Finance Act, 2003, operated with effect from 1^st April, 2004, or whether it operated retrospectively with effect from 1^st April, 1988?”

After careful observation of the judgment passed by Hon’ble High Court of Kolkata in the case of Virgin Creations read with the afore-mentioned Supreme Court judgments, it shall not be out of place to mention that, section- 40 (a) (ia) has indeed not been adjudicated by the Hon’ble Apex Court. The judgment that was passed by Hon’ble High Court that states, “has already decided that the aforesaid provision has retrospective application” is erroneous and apparent from record, hence, requires some serious review. 

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