Disallowance 40(a)(ia) 110905


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Disallowance 40(a)(ia) 110905

  1. 1. DISALLOWANCE OF EXPENSES - INTEREST, COMMISSION OR BROKERAGE & OTHER EXPENSES. By Paresh P. Shah, Chartered Accountant 1. Introduction: The Finance (No. 2) Act, 2004, has amended the section 40(a) of the Income Tax Act, 1961 (the Act), and for sub-clause (i), among other clauses sub-clause (ia) have been substituted with effect from 01.04.2004 i.e., A.Y. 2004-05. Section 40(a)(ia) provides for disallowance of expenses in the nature of (A) Interest (B) Commission or Brokerage (C) fees for professional services or fees for technical services (D) amounts payable to contractor or sub contractor for carrying out any work (including supply of labour for carrying out any work), paid to Residents, 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 subsequent year before the expiry of the prescribed time under section 200(1) of the Act. However in certain cases if tax is deducted in subsequent year or deducted in the previous year and paid in subsequent year after the prescribed date as provided in section 200(1) of the Act, then such sum shall be allowed as deduction in computing the income of the previous year in which such tax has been deposited with the Government. Prior to the substitution of the section, it provided for the disallowance of expenses only in cases when payments are made outside India or in India to a non resident, without deduction of applicable tax or if tax is deducted, it is not deposited with the Government within the prescribed time. Provisions were made applicable to non-residents in order to collect and ensure the payment of taxes from non-residents during the previous year or on or before payment is made to such non-residents so that problems of compliance by such non residents could be minimized and the interest of the revenue is well protected. However sub-clause (ia) to the section 40(a) of the act brings in its scope the disallowance of the payments made to even residents to widen the scope of the provisions, which acts as deterent to the compliance of the provisions of chapter XVIII B of the Income tax act, 1961 and provisions is applicable to payments made to Residents and disallowance refers to only in computing Business Income of the person responsible for deducting tax at source. The sub-clause (ia) of section 40(a) encompasses in its scope the nature of expenses, like (a) commission or brokerage as defined in explanation to section 194H (b) Fees for technical services as defined in explanation 2 to section 9 (i)(vii), (c) Professional
  2. 2. services as defined in clause (a) of the explanation to section 194J and (d) “Work” as defined in explanation II to section 194C. Although sub-clause is also applicable to “any interest”, it is not defined in the explanation to sub-clause and therefore meaning of interest as provided under section 2(28A) and 2(28B) of the Act, may be adopted for the application of the provisions. 1.1 Application of the Chapter XVII & Disallowance under section 40 (a) (ia) : The provisions of disallowance of payments during the previous year are applicable to such payments only if : (a) the tax deductible at source during the previous year under chapter XVII not deducted. (b) If tax is deducted during the previous year same is not deposited either during the previous year or in the subsequent year on or before the due date which falls in the subsequent year, as prescribed in section 200 (1) of the act. (c) Tax is deducted in the previous year and not deposited before the due date during any subsequent year. It further provides that in respect of any such sum on which tax is deducted in the subsequent year then such sum shall be allowed as a deduction in computing the income of the previous year in which such tax has been deposited. Question arises as to what could be the quantum of disallowance in following situations – In a case (a) where amount of tax deducted is lower than as required to be deducted at source under chapter XVII B? (b) where such a amount has been deducted under the said chapter, it is partially deposited or deposited partially in previous year and partially in subsequent year. (c) what could be regarded as “due date” when payment made or credited by the payer pertains to one of the last few months of the previous year and due date falls in the subsequent year? (d) that the amount is deducted during the previous year and deposited during the previous year after the due date falling within such a previous year. I.e. delayed payment of tax deducted at source. (e) Whether the deposit of Tax, without its deduction from the payment as referred to in chapter XVIIB, can have any adverse implication as to its allowance? It is held in the case of Commissioner of Income Tax Vs. Nestle India Ltd. at (2005) 275 ITR 1 (Del) that most significant aspect of this provision is its payment within the time specified in law, Although it is in the context of section 40(a) (i), the guiding principle laid down by the court would equally apply to the provisions of section 40 (a) (ia) of the Act, as language adopted by the section is identical. Court interpreted that both the ingredients of the expression
  3. 3. “the tax is deductible at source under chapter XVII B and has not been deducted” or “after deduction has not been paid during the period specified” must co-exist simultaneously during the period permissible in law. It may therefore be deduced from the courts decision that “Once the payment as referred in the first ingredients is paid by the person there can not be any disallowance under the scheme of section 40.” In order to determine whether short deduction would lead to partial disallowance under section 40(a) (ia), one may examine its cause as to whether such a short deduction have arisen as result of a bonafide or an error of interpretation of the provisions of the Chapter XVII B or it is a mere arithmetical error. The issue arising out of such a cause may be examined on a case to case basis. Support to resolve the problem of disallowance may be found in the following decisions of the court, although they may not strictly apply to section 40 as they are delivered in the context of TDS provisions. (i) (2003) 264 ITR 320 (UL) in the case of Commissioner of Income Tax and another Vs. Sedco Forex International Drilling Co. Ltd. (ii) (2000) 74 ITD 369 (Mum) in the case of ACC Ltd. Vs. Income Tax Officer TDS in ITA No.2309 of 1997 for the AY 1993-94 delivered on 6th June 2003. The demonstration as to honest error may only be judged from the circumstances of each case and the documentations to establish such a cause and hence it may be difficult proposition In a case where payer responsible for deduction of tax has not deducted the taxes, but choose to deposit it, without deducting it, then disallowance of sum is not warranted as was held in the case of Additional Commissioner of Income Tax Vs. Farasol Ltd. (1984) 163 ITR 364 (Raj.) 1.2 Disallowance & Scheme of Chapter VII B: The problem could be aggravated further if one reads, the provisions of disallowance and analyse in contradistinction with Sections 191 and 201(1) of the Act. Section 191 provides that in a case where tax deductible has not been deducted under the chapter, then in such a case the tax shall be directly payable by the assessee, and if assessee has paid the tax, then the person who is responsible for deduction of tax, shall not be treated as “assessee in default” as referred to in Section 201(1) of the Act.
  4. 4. Thus in a case where tax is deductible and it has not been deducted on payment of certain sum, and the payee (assessee) has paid the taxes on such a receipts, there may not be any adverse consequences under Chapter XVII B. However question arises as to disallowance under Section 40(a) (ia), since the tax deductible under Chapter XVII B on payment has not been deducted by the person responsible for making such payment as referred to in the Chapter. The amended Section 201 provides that even short deduction of TDS will be treated as the tax not being deducted as provided under the Chapter and person responsible for making the payment shall be treated as “assessee in default.” In view of the above a question arises, as to whether in such a case of short deduction, entire amount of payment from which tax is deductible shall be disallowed as provided under section 40(a)(ia) or the proportionate amount of such from which tax is deducted will only be disallowed. On the combined reading of the Chapter XVII B and the Scheme of disallowance under Section 40 it may safely be assumed that only proportionate amount on which tax is not deducted (such sum on which tax is not deducted as the language adopted) may only be disallowed. 1.2 Consequences of non compliance of provisions of Chapter XVII : The consequences as provided interalia, in section 40(a)(ia) as to disallowance of amount paid as expenses, is the payment of interest u/s.201(1A) payable when payer is treated as “assessee in default” alongwith penalty u/s.221 of the act and 271 C of the act. Provisions as to prosecution are also provided u/s. 276 B of the act. 2. Provisions of Chapter XVII B and Section 40(a)(ia) It may interestingly be noted that the liability to deduct tax in all the cases of nature of expenses, as referred in sub-clause (ia) is provided on the basis of payment or credit in the books of account, whichever is earlier. The provisions of the act in respect of the TDS in all cases of above nature of expenses may be reproduced as under : Section & When to Rate Person Payee Nature of deduct Obliged to (including payment or Tax at deduct tax Residential Income source status)
  5. 5. 193: Interest At the At the rates Person Any on Securities time of prescribed in responsible Resident credit or Part II of the for payment payment, First Schedule whichever to the Finance is earlier, Act. i.e. when the @10% as I.T. aggregate + S.C. & sums Addl. S.C. (In payable case of a during the domestic co., financial @20% as I.T. year + Addl. S.C.) exceeds Rs.2500/- 194A: Interest At the At the rates Any payer Any other than time of prescribed in other than an Resident “Interest on credit or Part II of the individual or securities” payment First Schedule HUF not whichever to the Finance liable to get is earlier, Act i.e., @ accounts when the 10% as I.T.[In audited aggregate case of a u/s.44AB sums domestic Co., payable @ 20% as I.T] during the + S.C. & financial Addl.S.C. year exceeds Rs.5000/-
  6. 6. 194C: At the In case of Contractee Any Payments to time of payment made specified in Resident contractors / credit or to section sub- payment 1.Contractor@ 194C(1). contractors whichever 2% as I.T. + Contractor is earlier, S.C. & other than when the Addl.S.C. Individual / aggregate 2. Sub – HUF not sums Contractor @ liable to get payable 1% as I.T. + accounts during the S.C. & Addl. audited financial S.C. u/s.44AB year exceeds Rs.20000/- per contract and / or Rs.50000/- in aggregate during the financial year 194H: At the At the rates of Any persons Any person Commission time of 5% as I.T. + other than or Brokerage credit or S.C. & Individual / payment Addl.S.C. HUF not whichever liable to get is earlier, accounts when the audited aggregate u/s.44AB sums payable during the financial year exceeds Rs.2500/-
  7. 7. 194J: Fees for At the At the rates of Any persons Any resident – time of 5% as I.T. + other than (1)Professional credit or S.C. & Individual / Services; or payment Addl.S.C. HUF not (2) technical whichever liable to get services is earlier, accounts [payable by when the audited persons other aggregate u/s.44AB than individual sums / HUF] payable during the financial year exceeds Rs.20000/- Note: In Case payment referred to above section is credited by a person to the account of payee as on the date upto which accounts of such person are made, tax deducted has to be deposited in Government account within 2 months of the expiration of the month in which that date falls. 3. Meaning of the Nature of Expenses as referred in section 40(a)(ia) Number of court decisions have pronounced the meaning of the nature of expenses, the landmark decisions and circulars in respect of each nature of expenses may be summarized as under :- 3.1 Interest – Particulars Treatment / Definition (i) Interest on Securities Defined under section 2(28B) (ii) Interest Defined under section 2(28A) (iii) Deep Discount Bonds Tax is deductible only at the time of redemption - Circular No.4/2004 dt.13th May, 2004 (iv) Deduction of TDS is from Gross Interest [1999] 240 ITR 740, CIT Vs S. K. Sundararamier & Sons (v) Deposit in joint names TDS may be deducted from the one of the payee - Circular No.256 dt.29.05.1979. (vi) Payment of interest by consignors F. NO. 12/12/68-IT (AII) dt.23rd to their agent Sept, 1968 that provisions of TDS
  8. 8. are applicable (vii) Hire Purchase Agreement Provisions of section 194A are not applicable. Instruction No.1425 dt. 16th Nov, 1981 (viii) Commercial paper & Certificate of Section 194A is not applicable. Deposits Circular No.647 dt.22nd March, 1993 3.2 Payment to Contractors or Sub Contractors : Section 194C of the Income tax Act, 1961, contemplates two types of payments, one from principal contractee to the contractor in respect of contract [section 194(c)(1)] and second by a contractor to sub contractor [194(c)(2)] in respect of sub contract. 3.3 Meaning of “any work” in section 194(c)(1) is not confined to a works contract. In order to digest the concept & scope of its application, the important reference may be drawn from (a)(i) Circular No.681 dt.8th March, 1984 regarding what is “work” (ii) Circular No.713 dt. 2nd August, 1995 regarding payments to Airlines (iii) Circular No.714 dt.3rd August, 1995 regarding payment of advertising & broadcasting expenses (iv) Circular No715 dt. 8th August, 1995 regarding media owner, Advertising Agency & Clients. (v) Circular No.723 dt. 19th Sept, 1995 regarding shipping business of non residents. (b) Discussion in the case of (i) State of Himachal Pradesh Vs. Associated Hotels of India Ltd. (1972) 29 STC 474 (ii) Vanguard Rolling shutters and steel works Vs. CST, 39 STC 372 (SC) (iii) Associated Cement Company Vs. CIT (1993) 201 ITR 435 (SC) 3.4 “Widened definition of work”: Definition of work has been extended by explanation III to section 194C that “work” shall include (a) Advertising (b) Broadcasting and telecasting including production of programmes for such broadcasting or telecasting (c) Carriage of goods and passengers by any mode of transport other than railways. (d) Catering.
  9. 9. 3.5 Concept of Accrual : In order to establish that sum is accrued to contractor or the sub-contractor on the basis of credit as referred in section 194C of the Act, a reference may be drawn from following court decisions (i) E. D. Sasoon & Co. Ltd. Vs. CIT (1945) 26 ITR 27 (SC) (ii)ACIT Vs Motor Industries Co.[2001] 249 ITR 141 (Kar) 4. Fees for professional or Technical services. (a) Professional services has been defined to mean services rendered by a person in the course of carrying on a legal, medical, engineering or architectural profession or the profession of the accountancy or technical consultancy or interior decoration or such other profession as is notified by the board for the purposes of section 44AA. (b) Fees for technical services to include any consideration (including any lumpsum consideration) for rendering of any managerial, technical or consultancy services [including the provisions of services of technical or other personnel] but does not include considerations for any constructions, assembly mining or like projects undertaken by the recipient, which would be income of the recipient chargeable under the head salaries. [Section 9(1)(vii) of the Act] 4.1 Courts decisions and Circulars : The important support may be derived from following decisions of the courts to analyse the scope and application of section 194J of the Act. (a) Meaning of professional services. (i) Dr. J. M. Mokashi Vs. CIT 207 ITR 252 (Bom) (ii) Addl. CIT Vs. Ramkripal Tripathi (1980) 128 ITR 408 (All) (b) Meaning of technical services (i) Dalmia Vs. CIT AIR 1977 SC 988 P. 991 (ii) J. K. Bombay Ltd. Vs CBDT 108 ITR 312 (iii) Skycell Communications Ltd. Vs. DCIT 251 ITR 53 (c) Circular No.7 of 2003 dt. 5th Sept, 2003 in respect of applicability to assessee required to get their accounts audited U/s.44AB. 5. Commission or Brokerage : The term commission or brokerage is defined in explanation (i) to the section 194H, to include any payment received or receivable, directly or indirectly, by a person acting on behalf of another person for services rendered (not being professional services) or for any services in the course of buying or selling of goods or in relation to any transaction relating to any asset, valuable article or thing, not being securities
  10. 10. The section has been introduced by finance act, 2001, w.e.f., 1 st June, 2001. It may pertinently be noted that the definition as referred in the section is an inclusive one giving rise to wider scope than the text of the definition however the principal enshrined and contemplated by the explanation, in the transaction giving rise to brokerage or commission, is the presence of the element of agency. Therefore transaction of the services which are on principal to principal basis would not be covered by the definition involving the income of commission or Brokerage. Important support may be drawn from following decisions to analyse the scope and application of the provisions of section 194H (a) Where contracts were held on a principal to principal basis (i) Ahmedabad Stamp Vendors Association Vs. GOI, 257 ITR 202 (ii) Shree Baidyanath Ayurved Bhavan Ltd. Vs. Jt. CIT (2004), 83 TTJ (Cal) 409 (iii) Asstt. CIT Vs. The Samaj (2001) 71 TTJ (ctk) 783 (b) Where contract was considered to be of agency (i) Around the World Trade & Tours Pvt. Ltd. & ORS Vs. Union of India & Others [2004] 268 ITR 447 (Mad) (c) Circular No. 14 of 2001. (d) Circular No.8 of 2002, dt. 27th Aug, 2002 (e) Circular No.6 of 2003 dt. 3rd Sept, 2003 in respect of Turnover commission payable by the Reserve Bank of India. 5. Issues arising from Chapter XVII, its non compliance & disallowance (i) Non payment of TDS : The payer is under a statutory obligation to deduct and pay TDS and to issue a certificate of deduction. Credit for the amount deducted is given to the payee on the deposit of TDS on production of a certificate furnished under section 203 of the Act. The payee only gets a certificate to the effect that taxes have been deducted and deposited, and has no control over the matter. In case of default in making over the amount to the Central Government, the payer is to be held responsible. He is deemed to be an assessee – in – default not only in cases where after deduction he does not make over the amount to the Central Government but also in cases where there is failure on his part to deduct the amount at source. In such cases the amount of tax can be recovered from the payer treating him as an assessee – in – default in respect of the tax. Therefore, tax cannot be recovered from the payee for failure on the part of the payer to deduct and deposit taxes [Assistant Commissioner of Income Tax Vs. Om
  11. 11. Prakash Gattani 242 ITR 638 (Gau)]. However, it has been held that duty of the employer is to deduct tax on the basis of honest estimate of salaries and therefore where the ITO makes controversial addition to salaries and TDS becomes less as a consequence, the employer cannot be held to be assessee in default and further tax cannot be demanded from employer [Gwalior Rayon Silk Co. Ltd. Vs. CIT 140 ITR 832 (MP)] A similar principle was followed in the following decisions: (i) (1998) 233 ITR 678 (AP) in the case of P.V. Raj Gopal and Others Vs. Union of India & others. (ii) 92 TTJ (Mumbai) 1067, in the case of Capt. J. G. Joseph Vs. J. CIT in ITA No. 5824 (Mum) of 1999 for the AY 1996-97 decided on 28.07.04 (ii) Short payment or deduction of TDS : The consequences discussed above for non-payment of TDS also result where TDS is not paid in full, i.e., where only a part of TDS is paid. Earlier the position was not clear. Prior to amendment in 2001, under section 201(1), the payer was considered to be in default if he did not deduct or, after deducting, failed to pay TDS. Therefore, a view was canvassed that so long as some tax was deducted (though not the whole tax), section 201 may not be applied. However, section 201 was amended with retrospective effect from 1-4-1962 to provide that provisions of sections 201(1) and 201(1A) are attracted where there is failure to deduct the whole or a part of the tax, therefore now even part payment of tax would also invoke sections 201(1) and 201(1A). (iii) Disclosure in form 3CD under tax Audit : No deduction of or short deduction of tax has assumed greater importance in respect of the responsibility of the tax auditor U/s.44AB of the Income tax Act, 1961 as auditor is required to report whether provisions of chapter XVII B have been complied with by the assessee. The duty of the tax Auditor arises out of Sr. No.17(f) and another at Sr. No. 27 of the form 3CD are annexure to the Tax Audit Report. (iv) Timing of deductions and its Deposit : Deduction of TDS, its time and circumstances are different depending upon the nature of payments as provided in Chapter XVIIB of the act and the issues arising out of non deduction and its deposit have been highlighted at paragraph (1.1) & (1.2). (v) Meaning of tax deducted , Taxes paid or deducted – Meaning It has been held in the context of section 40(a)(i) that “taxes paid by the assessee will even include, the payment made as a result of the “recovery proceedings” under the act, Addl CIT Vs Farasol Ltd. (1987) 163 ITR 364, 371, 372 (Raj)
  12. 12. (vi) Disallowance & Operation of Section 40 and 40A : By virtue of S. 40, the amounts detailed in various sub-clauses of clauses (a) to (d) shall not be deducted in computing the income chargeable under the head ‘profits or gains of business or profession’ notwithstanding anything to the contrary contained in sections 30 to 39 of the act. Section 40A, inserted with effect from 1.4.1968, contains a non obstante clause saying that this section shall have effect not withstanding anything to the contrary contained in any other provision of the act relating to the computation of income under the head ‘profits and gains or business or profession’ and, therefore, S.40A will have overriding effect even on S.40. Thus, if a matter is covered by both sections 40A and 40, then S.40A, will override the provisions of S. 40. But, where the matter is covered only by S.40 and not S.40A, then S.40A will not stand in the way of the application of S.40 Hence, where the payment of salary to a partner of a firm, who might be working wholetime for the firm, could not come within the ambit of S.40A(2)(a), the allowability of payment of salary to a partner of the firm has to be decided u/s.40(b) alone. Ganesh Factory Vs. CIT (1989) 46 Taxman 325 : (1989) 79 CTR 48 : (1989) 180 ITR 416 (P & H) Held, that it could not be contended that by reason of S. 40A, which contains a non obstante clause, salary paid to a partner by a firm, even when it was reasonable and in lieu of actual and adequate services rendered by the partner concerned, should be allowed. The overriding effect given to S.40A is only in respect of the matters not covered by S 40(b). Section 40(b) has not been made nugatory by the insertion of S.40A. N. M. Anniah & Co. V. CIT (1975) 101 ITR 348, 353-354 (Karn). CONCLUSION : The provisions for TDS and TCS are only the alternatives amongst the four methods of collection and recovery of tax. Section 191 of the act, provides that if the tax has not been deducted in accordance with the provisions, the assessee would be liable to pay it directly. Primarily therefore the liability to pay tax is on the assessee and the obligation to collect is on the Government. Liability on the third party is created by virtue of provisions of Chapter XVII B of the act, and the liability to deduct tax is made mandatory and non compliance has been dealt with seriously and not one but in various forms harsh treatment has been accorded to the payer of the Income or sum to the assessee. Before it is long, facilitative provisions may be made for better compliance & creating cordial atmosphere between the tax payer & the tax collector.