India: Supreme Court Settles ‘Paid' Vs ‘Payable' Debate; Confirms Disallowance Of Expenditure Paid During The Year Without Deduction Of TDS

Last Updated: 18 May 2017
Article by SKP  

Section 40(a)(ia) of the Income Tax Act, 1961 (ITA) provides that failure to deduct Tax Deducted at Source (TDS or withholding tax) on certain specified sums payable to a resident results in denial of tax deduction of the relevant expenditure1. Based on the expression 'payable' used in Section 40(a)(ia) of the ITA, a doubt arose whether the disallowance of expenditure is applicable only in those cases where the expenditure remained 'payable' at the end of the year on which TDS has not been deducted or whether the disallowance would equally apply where the expenditure has already been 'paid' to the vendor during the year without deduction of TDS.

While the majority of the High Courts 2 held that disallowance would arise even for expenditure already 'paid' during the year without deduction of TDS, the Allahabad High Court3 ruled in favour of the taxpayer and held that disallowance would arise only for expenditure remaining 'payable' at the end of the year on which TDS has not been deducted. The Supreme Court dismissed the Special Leave Petition (SLP) filed by the Tax Authorities against the Allahabad High Court judgment.

The controversy around this issue has now been settled by the Supreme Court in a recent case4, which is discussed below.

Facts of the case

During Tax Year 2005-065, the taxpayer paid freight charges to three individual subcontractors without deduction of TDS. The Tax Authorities disallowed these charges under Section 40(a)(ia) of the ITA. The Appellate Authorities, as well as the Himachal Pradesh High Court, confirmed such disallowance.

Supreme Court judgment

Upon an appeal by the taxpayer, the Supreme Court also confirmed the Tax Authorities order and held as under:

  • Although grammatically the words 'paid' and 'payable' denote different meanings, the same is not significant to the interpretation of Section 40(a)(ia) of the ITA.
  • As per the provisions in the ITA dealing with the requirement to deduct TDS, it is a statutory obligation of a person to deduct TDS at the time of credit of the sum to the vendor's account or at the time of payment, whichever is earlier. There are other sets of provisions in the ITA read with the Rules6, which provide for the deposit of such TDS into the government account and filing of a TDS statement within the prescribed time limits. The ITA provides for adverse consequences such as disallowance of expenditure, interest, penalty, etc. in the case of violation of these provisions relating to TDS in the ITA.
  • When the entire scheme in the ITA for obligation to deduct TDS, paying it over to the government and consequences that can arise in case of violation of such statutory obligations are read conjointly and holistically, the taxpayer's interpretation that the word 'payable' occurring in Section 40(a)(ia) of the ITA refers to only those cases where the amount is yet to be paid and does not cover the cases where the amount is actually paid cannot be accepted.
  • If the taxpayer's interpretation is accepted, it would mean that even when a person violates the provisions relating to TDS deduction, he would go scot-free without suffering any adverse consequences of the default provided in the ITA. Furthermore, it would mean that the provisions of disallowance of expenditure would not apply to the taxpayers following cash system of accounting.
  • Section 40(a)(ia) of the ITA does not indicate that it is applicable only to taxpayers following the mercantile system of accounting.
  • The law mandates a person to deduct TDS not only on the amounts payable but also when the amounts are actually paid. Therefore, any person who does not adhere to this statutory obligation has to suffer the consequences which are stipulated by the law
  • The Allahabad High Court judgment (which was favourable to the taxpayer) did not consider these aspects and straightaway concluded the issue without any discussion. It did not decide the question of law correctly. Furthermore, the dismissal of SLP by Supreme Court does not amount to the acceptance of the judgment of the Allahabad High Court.

Footnotes

1 Please note that Section 40(a)(ia) of the ITA currently restricts the tax disallowance to 30% of the expenditure incurred

2 P. M.S. Diesels & others vs CIT [2015] 374 ITR 562 (P&H); CIT vs Crescent Export Syndicate [2013] 216 Taxman 258 (Cal); and Tube Investments of India Ltd vs ACIT (TDS) [2010] 325 ITR 610 (Mad)

3 CIT vs Vector Shipping Services (P) Ltd [2013] 357 ITR 642 (All)

4 M/s Palam Gas Service vs Commissioner of Income Tax [TS-170-SC-2017] in Civil Appeal No. 5512 of 2017 pronounced on 3 May 2017

5 Assessment Year 2006-07

6 The Income Tax Rules, 1962

SKP's comments

The provisions of disallowance of expenditure in cases of failure to deduct TDS were inserted in the law to ensure that taxpayers appropriately comply with the provisions regarding TDS deduction. The Supreme Court has underlined this intention of the legislature and settled the 'paid' vs 'payable' debate. This judgment will provide clarity to taxpayers as well as the Tax Authorities for resolving ongoing litigations.

Where a taxpayer has claimed a deduction for expenditure paid during the year on which TDS was not deducted, a disallowance will now arise. The taxpayer will have to deposit differential tax along with applicable interest. However, since there were conflicting views of the High Courts on this matter, indicating that the issue was debatable, such taxpayers could defend penalty proceedings for any favourable position taken prior to the pronouncement of this Supreme Court judgment.

It may be noted that the taxpayer can clearly protect himself from disallowance of expenditure from Tax Year 2012-131 onwards if he is able to demonstrate the corresponding resident payee (receiver of income from the taxpayer) paid the applicable taxes on such income and he follows certain prescribed procedures.

As regards income in the nature of royalty/fees for technical services of the non-residents (including foreign entities) liable to tax in India on a gross basis as per the applicable Double Taxation Avoidance Agreement, there is one school of thought that non-residents are liable to tax in India only when such income is 'paid' to them and accordingly, the liability to deduct TDS also arises in the hands of the taxpayer at the same time (when the amount is 'paid' to the non-residents). One may refer to the recent judgment2 in support of this proposition. In view of this, a question arises as to whether the taxpayer could take a position that there should not be any disallowance under Section 40(a)(i) of the ITA if the amount is still 'payable' and not actually 'paid' to the non-residents? Although it is a digression from the topic and a situation reverse to what Supreme Court was dealing with, it is a question worth pondering.

With this Supreme Court judgment, the taxpayer also needs to exercise caution while taking any position based on any High Court judgment merely on the ground that such judgment has attained finality upon the dismissal of SLP filed against such judgment by the Supreme Court.

Footnotes

1 Assessment Year 2013-14

2 Saira Asia Interiors (P) Ltd vs ITO [2017] 79 taxmann.com 460

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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