ISSUE FOR CONSIDERATION
Section 40(a) provides for a list of expenses that are not
deductible in computing the income chargeable under the head “Profits and gains
of business or profession”, notwithstanding the provisions of sections 30 to 38
of the Act in case of any assesse. Vide clause (ii), any sum paid on account of
any rate or tax levied on the profits or gains of any business or profession
of, or otherwise on the basis of any such profits or gains is disallowable.
Explanations 1 & 2 of the said clause,
provide that any tax eligible for relief u/s. 90, 90A and 91 shall be deemed
to be the rate or tax. Likewise, any sum paid on account of wealth-tax is also
disallowable vide clause (iia) of section 40 (a).
The term ‘tax’ is defined by section 2(43) of the Act to mean income-tax
chargeable under the provisions of the Act. The courts often have been asked to
examine the true meaning of the term “tax” and to determine whether any of the
following are includible in the meaning of the term tax.
- Education cess including secondary and higher
education cess.
- Interest on late payment of tax deducted at
source.
- Foreign taxes i.e. taxes on foreign
income.
The Tribunals and the Courts at
times have delivered conflicting
decisions on each of the above issues. The short issue which however is sought
to be examined here is about the deductibility of the payment of the education
cess, in computing the profits and gains of business or profession.
SESA GOA LTD’S CASE
The issue arose in the case of Sesa Goa Ltd vs. JCIT, 38 taxmann.com
(Panaji), 60 SOT 121, for assessment
year 2009-10. In that case, the assessee company had claimed a deduction of an
amount of Rs.19.72 crore towards payment of education cess, which amount was
disallowed by the AO and the disallowance was confirmed by the CIT (Appeals) by
applying provisions of section 40(a)(ii) of
the Act.
On appeal to the Tribunal, it was contended that the education cess was
paid for providing finance for quality education and therefore should be
considered to have been paid and incurred for the purposes of business. It was
further explained that cess was not listed for disallowance under the
provisions of clause (ii) of section 40 of the Act. In reply, it was contended
by the Revenue that the education cess formed an integral part of the direct
tax collection and the payment thereof was clearly covered for the disallowance
under the aforesaid clause of section 40(a) of the Act.
On hearing the rival submissions and on due consideration of the
parties, the Tribunal held that the education cess was collected as a part of
the income tax and the provisions of the respective clauses of section 40(a)
were applicable and the assessee was not entitled for the deduction of the
amount paid towards education cess.
According to the Tribunal, the payment of the education cess could not
be treated as a “fee” but should be treated as a “tax” for the reason that the
payment of fees was meant for getting certain benefits or services, while tax
was imposed by the Government and was levied without promising in return any
benefit or service to the assessee.
The Tribunal held that such payment could not be said to be an
expenditure incurred wholly and
exclusively for the purpose of the business. An appeal filed by the
assessee against the order of the Tribunal in this case has been admitted by
the High Court and is pending for hearing.
CHAMBAL FERTILIZERS AND CHEMICALS’ CASE
The issue again came up for
consideration of the Jaipur bench of the Tribunal in the case of ACIT vs.
Chambal Fertilizers & Chemicals Ltd., for assessment year 2009-10, in
ITA No.412/JP/2013. In that case, the assessee had challenged the action of
the CIT (Appeals) in confirming the
action of disallowance of education cess of Rs.3.05 crore, by the AO, u/s. 40
(a) (ii). The AO had also held that such cess was not an allowable expenditure
u/s. 37. The Tribunal noted that the same issue, in the assessee’s own case,
was adjudicated by a co-ordinate bench of the Tribunal vide an order dated
28.10.2016 passed in ITA No.s 459 and 558/JP/2012.
In the said appeals, it was contended by the assessee that the
legislature, where desired had provided
that the payment of cess was not deductible, by specifically including the same
in the language of the provisions; it was explained that there was no intention
to disallow the payment of education cess in computing the income. The Tribunal
observed that the basic character of the education cess was that of a tax which
was levied on the profits or gains of the business and given that such a tax
was liable for disallowance u/s. 40(a) (ii), the payment of education cess was
not eligible for deduction. The Tribunal, in the later case under
consideration, following the above mentioned orders, decided the appeal against
the assessee by confirming the disallowance made by the AO.
On further appeal by the assessee to the high court in the case of Chambal Fertilizers & Chemicals Ltd. vs. JCIT in
D.B ITA No. 52 of 2018 decided by an order dt. 31.07.2018, the assessee,
relying on the decision in the case of Jaipuria Samla Amalgamated Collieries Limited vs. CIT , 82 ITR 580 (SC)
contended that the term tax did not
include cess. Attention of the court was invited to circular No. 91 of 1967, bearing number
91/58/64–ITJ(19) dated 18.05.1967 to contend that the CBDT vide that circular
had clarified that the cess was not specifically included in section 40(a)(ii)
for disallowance and that no disallowance of education cess was possible.
The following submissions made before the lower authorities by the
assessee were taken note of by the court;
- On a plain reading of the above provision of
section 40(a) (ii), it was evident that
a sum paid of any rate or tax was expressly disallowed only where : (i) the
rate was levied on the profits or gains of any business or profession, and
(ii) the rate or tax was assessed at a
proportion of or otherwise on the basis of any such profits or gains. It was
evident that nowhere in the said section, it had been mentioned that education
cess was not allowable. Education cess was neither levied on the profits or
gains of any business or profession nor assessed at a proportion of, or
otherwise on the basis of, any such profits or gains.
- In CBDT Circular No. 91/58/66 ITJ (19), dated
May 18, 1967 it has been clarified that the effect of the omission of the word
“cess” from section 40(a)(ii) was that only taxes paid were to be disallowed in
the assessment for the years 1962-63 onwards. Thus, as per the said circular,
Education cess could not be disallowed; there could not be a contradiction, as
the circulars bind the tax authorities.
- That education cess could not be treated at
par with any “rate” or “tax” within the meaning of section 40(a)(ii) especially
when the same was only a “cess” as seen from the speech of the Finance Minister .
The Revenue placed reliance on
the decision in the case of Smithkline & French (India) Ltd. vs. CIT, 219 ITR 581 (SC) wherein it
was held that ‘surtax’ was levied on business profits of the company and was
therefore, disallowable u/s. 40(a)(ii) of the Act. It was also contended
relying on the decision in the case of SRD Nutrients Private Limited vs. CCE AIR 2017 SC 5299 that ‘education
cess’ was in the nature of surcharge, which the assessee was required to pay
along with the basic excise duty.
The following submissions made before the lower authorities by the
Revenue were taken note of by the court;
- The purpose of introducing the cess was
to levy and collect, in accordance with
the provisions of the relevant chapter,
as surcharge for purposes of Union, a cess to be called the Education
Cess, to fulfill the commitment of the Government to provide and finance
universalised quality basic education. It was clear that the said cess was
introduced as a surcharge, which was admittedly not deductible.
- The
provision was wide enough to
cover any sum paid on account of any rate or tax on the profits or assessed at
a proportion of such profits. Education cess being calculated at a proportion
(2% or 1%) to Income Tax, which in turn, was in proportion to profits of
business, would certainly qualify as a sum assessed at a proportion to such
profits.
- If education cess was considered deductible,
then by the same logic Income-Tax or any surcharge would also became
deductible, which would be an absurd proportion.
- If Education cess were to be deductible, then
it would not be possible to compute it, e.g. If profit is Rs. 100, Income Tax
was Rs. 30 and Education Cess was Rs. 0.90 and if education cess were to be
deductible from profit, such profit (after such deduction) would become Rs.
99.1 (100-0.9) which would again necessitate re-computation of Income-Tax. The
vicious circle of such re-computation would continue, which was why the
legislature, in its wisdom, had not allowed deductibility of amounts calculated
at a proportion of profits.
- The mechanism of recovery of unpaid Education
cess and the penal provision for non payment being the same as that for income tax, indicated that unpaid cess was
treated as unpaid tax and was visited with all consequences of non-payment of
demand. There was no separate machinery in the Act for recovery of unpaid cess
and imposition of interest and penalty in case of default in payment of unpaid
cess. This indicated that cess is a part of tax and all recovery mechanisms and
consequences pertaining to recovery of tax apply to recovery of cess also
without explicit mention of the word “cess” in the foregoing
provisions. Hence, drawing a parallel, no explicit mention of “cess”
was required in section 40a(ii) for making disallowance thereof.
On due consideration of the submissions by the parties, the Rajasthan
high court allowed the appeal of the assesse and ordered the deletion of the
disallowance of the education cess by holding in paragraph 5 that ;
“On the third issue in appeal no.52/2018, in view
of the circular of CBDT where word “Cess” is deleted, in our
considered opinion, the tribunal has committed an error in not accepting the
contention of the assessee. Apart from the Supreme Court decision referred that
assessment year is independent and word Cess has been rightly interpreted by
the Supreme Court that the Cess is not tax in that view of the matter, we are
of the considered opinion that the view taken by the tribunal on issue no.3 is
required to be reversed and the said issue is answered in favour of the
assessee.”
The High Court directed the AO to allow the claim of the assesse for
deduction of the cess in computing the profits and gains of business.
OBSERVATIONS
The issue, under the controversy,
is all about deciding whether the education cess levied under the
Finance Act with effect from financial year 2004-05 is disallowable under
clause (ii) of section 40(a) of the Income tax Act.
The Education Cess, secondary and higher, has been levied since financial year 2004-05
by the respective Finance Acts. The Finance Minister, while presenting the
Finance (No.2) Bill, 2004, 268 ITR (st.) 1, had explained the objective and the
purpose behind the levy of cess in the following words. “Education 22.
In my scheme of things, no issue enjoys a higher priority than providing basic
education to all children. I propose to levy a cess of 2 per cent. The new cess
will yield about Rs. 4000- 5000 crores in a full year. The whole of the amount
collected as cess will be earmarked for education, which will naturally include
providing a nutritious cooked midday meal. If primary education and the
nutritious cooked meals scheme can work hand-in-hand, I believe there will be a
new dawn for the poor children of India.”
The cess is levied and collected
at a specified percentage of the Income tax i.e. otherwise payable on the total
income, including the profits or gains of any business or any profession. It is
deposited in a separate account to be known as ‘Prarambhik Shiksha Kosh’ which
deposits are used for this specific purpose of meeting the educational needs of
the citizens of India. The power to levy income tax as also cess is derived by
the parliament under Article 270 of the Constitution of India. The term ‘tax’
is defined by section 2 (43) of the Income tax Act and in the context, means,
the income tax chargeable under the provision of the Act. With effect from
financial year, 2018-19, this cess includes collection for health also and is
now know as the Health & Education Cess.
A provision similar to section 40(a)(ii), is not contained in section 58
for disallowance of tax payable on the income computed under the head Income from
Other Sources. Explanation 1 of section 115JB(2) provides that the
amount of income tax paid or payable and the provision therefore should be
added to the profit, as shown in the Statement of Profit and Loss, in computing
the book profit that is liable for the MAT.
Explanation 2 specifically provide, vide clauses (iv) and (v), that the
income tax shall include education cess levied by the Central Acts. No such
extension of the meaning of the term ‘tax’, used in section 40(a)(ii), has been
provided for or clarified for including the education cess, in its scope for
disallowance u/s. 40(a)(ii) of the Act.
Section 10(4) of the Income tax Act, 1922 provided for a similar
disallowance in computing the income from the specified sources. The said
section in clear words provided that the income tax and “cess” were to be
disallowed in computing the income. Section 40(a)(ii) which is the successor of
section 10(4) of 1922 Act, has chosen to not include the term “cess” in its
fold specifically, there by indicating that the cess would not be subjected to
disallowance, unless the term “tax”, used therein, by itself includes a cess.
Importantly a circular issued by the CBDT, in the year 1967,
specifically clarified for the purpose of section 40(a)(ii), that the term
“tax” did not include in its scope any cess and the exclusion of ‘cess’ in
section 40(a)(ii) of the Act of 1961, in contrast to section10(4) of the Act of
1922, was for a significant reason. In
short, the said circular bearing number 91/58/64–ITJ(19) dated 18.05.1967
clarified that a cess was not disallowable u/s. 40(a)(ii) of the Income tax Act
of 1961. The relevant part of the circular reads as;
CIRCULAR F. NO. 91/58/66-ITJ(19) DT. 18TH
MAY, 1967 Interpretation of provision of s.40(a)(ii) of IT Act,
1961-Clarification regarding 18/05/1967 . BUSINESS EXPENDITURE SECTION
40(a)(ii),
1. Recently a case has come to the notice of the
Board where the ITO has disallowed the ‘cess’ paid by the assessee on the ground
that there has been no material change in the provisions of s.10(4) of the old
Act and s.40(a)(ii) of the new Act.
2. The view of the ITO is not correct. Clause
40(a)(ii) of the IT Bill, 1961 as introduced in the Parliament stood as under:
“(ii) any sum paid on account of any cess, rate or tax levied on the profits or
gains of any business or profession or assessed at a proportion of, or
otherwise on the basis of, any such profits or gains”. When the matter came up
before the Select Committee, it was decided to omit the word ‘cess’ from the
clause. The effect of the omission of the word ‘cess’ is that only taxes paid
are to be disallowed in the assessments for the year 1962-63 and onwards.
3. The Board desire that the changed position may
please be brought to the notice of all the ITOs so that further litigation on
this account may be avoided.
Under the Constitution of India, the collected tax is to be used for the
general purpose of running and administration of the country, while the cess is
collected for a specified purpose. In
that sense, the cess is usually held to be in the nature of a fee and not a
tax. The education cess as noted
earlier, is levied for a specific purpose of promoting education in India; importantly the cess is not calculated as a
tax, at the specified rate on the income of an assessee, it is rather calculated as a percentage
of such tax, so determined on income, by
applying the specified rate to the tax, so computed.
The Supreme court in the case of Dewan Chand Builders &
Contractors vs. UOI [CA Nos. 1830 to 1832 of 2008, dated 18-11-2011], held
that a cess levied under the BOCW Welfare Cess Act was a fee, not a tax,
collected for a specified purpose. It
was not a part of the consolidated fund and was to be used for the specified
purpose of promoting the security of the workers. Similarly, the Apex court in
the cases of Kesoram Industries Ltd. 262 ITR 721(SC)– held that a cess
when levied for the specific purpose was a fee and not a tax.
The Mumbai bench of the Tribunal, in an unreported decision in the case
of Kalimata Investment Co. Ltd., ITA No. 4508/N/2010 dated 19.05.2012, held that the term ”tax” used in section
40(a)(ii) included education cess, levied w.e.f. financial year 2004-05, and that a cess was an additional sur-charge
and was therefore disallowable in computing the income of an assessee. An
appeal filed against the decision is admitted by the High Court and is pending
for hearing.
The related issue, of education
cess being an expenditure incurred wholly or
exclusively for the purpose of business or profession, was also
addressed by the Rajasthan high court in
the case of Chambal Fertilizers & Chemicals Ltd. (supra) by holding
that the payment of education cess was for the purpose of business, by
referring to the objective behind its levy and the purpose for which it is
collected by the Government, and was allowable as a deduction u/s. 37 of the
Act.
In a different context, a cess may also be a tax and not only a
fee. Entry 49, List 2 of the Government
of India Act which uses the expression “cesses” was examined by the Supreme Court in the case of Kunwar Ram
Nath vs. Municipal Board AIR 1983 SC 1930 to hold that such a cess levied
under Entry 53 of List 2 of the Constitution of India was a “tax”. In the case
of Shinde Brothers vs. Deputy Commissioner, Raichur, AIR 1967 SC 1512, it was held that a ‘cess’ meant a ‘tax’ and
was generally imposed for meeting some special administrative expenses, like
health cess, education cess, road cess, etc.
For the
reason noted above and in particular on accounts of the circular No. 91 of
1967 (supra) and the provisions of section 2(43) and section115JB, the
expenditure on education cess is not disallowable u/s. 40(a)(ii) of the Act,
unless the Government is able to establish that the education cess is also a
tax chargeable under the provisions of the Income Tax Act, 1961. Presently the
education cess is levied under sub-sections (12) & (13) of section 2 of the Finance Act, 2018. The
decisions of the tribunal had not taken in to
consideration circular 91 of 1967 in deciding the issue against the
assessee; had the same been brought to the attention of the Tribunal, the
decision could have been different.
