Disallowance of an expenditure ‘Payable’ u/s. 40(a)(ia)

The part, relevant for the discussion of the issue under consideration here, reads as under:

“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) —————–

(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 …………………………………………………..
Provided  further ………………………………………
Explanation: …………………………………………….

On an apparent reading of the provision, it appears that an expenditure of the nature specified in the section, payable to a resident, shall not be allowed to be deducted where tax is deductible at source but has not been paid.

Since its introduction by the Finance (No.2) Act, 2004, w.e.f. assessment year 2005-06, this provision has been the subject matter of one or more controversies, some of them grave, including the challenge to the constitutionality of the provisions. The resistance of the taxpayers attracts sympathy on account of the fact that the provisions are very harsh as they call for disallowance of a genuine business expenditure, in its entirety, simply on account of non-deduction or non-payment of a miniscule amount. This torturous treatment attracts fierce opposition from the taxpayers and provides a breeding ground for an endless spate of litigation involving innovative contentions.

One such proposition, that found favour with the tribunal, is that the disallowance u/s. 40(a)(ia) be restricted to the amount that remained unpaid or payable at the end of the year on which tax is not deducted or is deducted but has not been deposited with the Government. The tribunal based its finding on the use of the term ‘payable’ in section 40(a)(ia) to hold that the said term conveyed that the expenditure that is ‘ paid’ during the year is not disallowable even where the tax is not deducted or is not deposited after deduction. In short, the disallowance is to be restricted to the expenditure that is ‘payable’ and is not to be extended to cover an expenditure that has been ‘paid’.

The Special Bench of the tribunal in Merilyn Shipping & Transports vs. Addl. CIT, 136 ITD 23 (Vishakhapatnam) accepted this line of thinking by holding that the provisions of section 40(a)(ia) were not applicable in respect of such expenditure, the payment for which was made during the year without deducting tax at source. It held that the disallowance was possible only in respect of such expenditure, the payment for which was outstanding at the end of the year.

This decision of the special bench has subsequently been expressly overruled by two decisions of the Calcutta High Court and also by a decision of the Gujarat High Court. In contrast, the Allahabad High Court recently noted that the provisions of section 40(a)(ia) applied only to such expenditure, the payment for which had remained outstanding at the year end. In the meanwhile, the operation of this decision of the special bench was put under an interim suspension by the Andhra Pradesh High Court. However, it is believed that the operation of such suspension was limited to Merilyn Shipping & Transports or at the most to the assesses in the state of Andhra Pradesh.

Any issue concerning section 40(a)(ia) assumes importance, as the said provision seeks to disallow a genuine business expenditure, for non-deduction or payment of an insignificant amount of tax.

2. Crescent Export Syndicate’s case

The issue arose before the Calcutta High Court, for the first time, in the case of CIT vs. Crescent Export Syndicate, 33 taxmann.com 250. In this case, the court was concerned with two appeals involving a common issue. In both the cases, the tribunal, relying on the decision of the Special Bench in the case of Merilyn Shipping & Transports, deleted the disallowance by the AO by holding that:

“If all the amounts have been paid, then obviously following the principles laid down by the Hon’ble Special Bench of this Tribunal in the case of Merilyn Shipping & Transports, no addition shall be made. If any amount is found to be payable as on the year end, then the Assessing Officer shall give the assessee adequate opportunity to substantiate his case as to why the disallowance, if any, should not be made by invoking the provisions of section 40(1) (ia) of the Act”.

“As the issue claimed by the assessee is that there is nothing payable as on 31-03-2006 and this expenditure of Rs. 1,08,80,559/- is paid during the year and nothing remains payable, it means that the issue is covered. Principally, we have agreement with the assessee’s counsel and are of the view that the issue is squarely covered in favour of the assessee. Principally, we allow this issue of the assessee but subject to the verification by AO that these expenses are paid within the year i.e., up to 31-03-2006 and nothing remains payable. Hence, this appeal of assessee in principle is allowed in favour of the assessee but subject to verification.”

The revenue filed appeals in both the matters requesting the Calcutta High Court to set aside the orders of the tribunal.

On behalf of the assessee, the following important contentions were placed for the consideration of the court;

• The Legislature has replaced the words “amounts credited or paid” used in the Finance Bill with the word “payable” in the final enactment. The change clearly conveyed the legislative intent of restricting the scope of the disallowance to the amounts ‘payable’ by excluding those amounts that were ‘paid’ during the year.

• Such change was not without any purpose. By changing the words from “credited or paid” to “payable”, the legislative intent has been made clear that only the outstanding amount or the provision for expense liable for TDS was sought to be disallowed in the event there was a default of TDS. Reliance was placed on the decision in the case of CIT vs. Kelvinator of India, 320 ITR 561 wherein the court, in the context of section 147, examined the implications of the deletion of the word ‘opinion’ used in the Finance Bill with the words “reason to believe” on enactment of the Bill, on receipt of representations against the omission of the words “reason to believe”,

• A construction which required, for its support, addition or substitution of words or which resulted in rejection of words, had to be avoided, unless it was covered by the rule of exception, including that of necessity. In the present provision of section 40(a) (ia) of the Act, there was no such exception and the only word used by the legislature was “payable”.

•    The legislative intent had been made clear by consciously replacing the words “credited or paid” with “payable”, that only the outstanding amount or the provision for expenses were liable for TDS were to be disallowed in the event there was default in not following the TDS provisions under Chapter XVII-B of the Act.

•    Sections 194 L and 194 LA provided that tax was to be deducted only at the time of payment. The language in these sections therefore showed that the legislature, where desired, had used different language in different sections.

•    Reference was made, for explaining the scope and effect of section 40(a)(ia), to the circular No.5 of 2005, dated 15th July, 2005, issued by the CBDT to show that the intention to introduce the provision was to curb bogus payments by creating bogus liability.

•    Section 40(a)(ia) created a legal fiction for the amounts outstanding or remained payable i.e. at the end of every year as on 31st March and such fiction could not be extended for taxing the amounts already paid.

•    Section 201 took care of tax to be collected in the hands of the payee and other TDS provisions under

Chapter XVIIB of the Act. No further legal fiction from elsewhere in the statute could be borrowed to extend the field of section 40(a)(ia) for disallowing the genuine and reasonable expenditure on the amounts of expenditure already paid.

•    That there might be two possible constructions. However, the construction that the word ‘payable’ was interchangeable with the word ‘paid’ made the position of the assessee, who had already paid his dues, without deducting tax, worse than the assessee who had not as yet paid his dues. In the case of the assessees, who had paid the dues without deduction of tax, disallowance of the expenditure was permanent and they had no means of deducting the tax later on relatable to the amount already paid in the earlier year and thus the relief contemplated by the proviso could never be availed by them.

•    While the income in the hands of the recipient was taxed, the payer did not get the benefit thereof. A second proviso to clause (ia), effective from 1st April, 2013, was enacted to lessen the rigour of clause (ia).

The Calcutta High Court, on hearing the rival contentions, observed and held as under:

•    The main thrust of the majority view, in the decision of the special bench, was based on the fact that the legislature had replaced the expression “amounts credited or paid” with the expression “payable” in the final enactment.

•    The tribunal fell into an error in not realising that a comparison between the pre-amendment and post-amendment law was permissible for the purpose of ascertaining the mischief sought to be remedied or the object sought to be achieved by an amendment which precisely was what was done by the Apex Court in the case of CIT vs. Kel-vinator of India Ltd. 187 Taxman 312. But the same comparison between the draft and the enacted law was not permissible. Nor could the draft or the bill be used for the purpose of regulating the meaning and purport of the enacted law. It was the finally enacted law which was the will of the legislature.

•    The tribunal once having held “that where the language is clear the intention of the legislature is to be gathered from the language used”, then it was not open to seek to interpret the section on the basis of any comparison between the draft and the section actually enacted nor was it open to speculate as to the effect of the so-called representations made by the professional bodies.

•    The tribunal having held that “Section 40(a)(ia) of the Act created a legal fiction by virtue of which even the genuine and admissible expenses claimed by an assessee under the head ‘income from business and profession,’ if the assessee does not deduct TDS on such expenses, are disallowed”, was it open to the tribunal to seek to justify that by stating that “this fiction cannot be extended any further and, therefore, cannot be invoked by Assessing Officer to disallow the genuine and reasonable expenditure or the amounts of expenditure already paid”? Did that not amount to deliberately reading something in the law which was not there?

•    The tribunal sought to remove the rigour of the law by holding that the disallowance should be restricted to the money which was yet to be paid. What the Tribunal by majority did was to supply the casus omissus which was not permissible and could only have been done by the Supreme Court in an appropriate case as was done in the case of Bhuwalka Steel Industries vs. Bombay Iron & Steel Labour Board , 2 SCC 273.

The Calcutta High Court thereafter endeavoured to show that no other interpretation was possible in the following words:

•    The key words used in section 40(a)(ia), according to the court, were “on which tax is deductible at source under Chapter XVII –B”. If the question was “which expenses are sought to be disallowed?”, the answer was bound to be “those expenses on which tax is deductible at source under Chapter XVII –B”.

Once that was realised, nothing turned on the basis of the fact that the legislature used the word ‘payable’ and not ‘paid or credited’. Unless any amount was payable, it could neither be paid nor credited. If an amount had neither been paid nor credited, there could be no occasion for claiming any deduction.

•    The language used in the draft was unclear and susceptible to giving more than one meaning. By looking at the draft it could be said that the legislature wanted to treat the payments made or credited in favour of a contractor or sub-contractor differently than the payments on account of interest, commission or brokerage, fees for professional services or fees for technical services because the words “amounts credited or paid” were used only in relation to a contractor or sub-contractor. This differential treatment was not intended. Therefore, the legislature provided that the amounts, on which tax was deductible at source under Chapter XVII-B, payable on account of interest, commission or brokerage, rent, royalty, fees for professional services or fees for technical services or to a contractor or sub-contractor should not be deducted in computing the income of an assessee in case he had not deduced, or after deduction had not paid, within the specified time. The language used by the legislature in the finally enacted law was clear and unambiguous whereas the language used in the bill was ambiguous.

•    There could be no denial that the provision in question was harsh. But that was no ground to read the same in a manner which was not intended by the legislature. The law was deliberately made harsh to secure compliance of the provisions requiring deductions of tax at source. It was not the case of an inadvertent error. The suggestion that the second proviso inserted to be made effective from

1st April, 2013 should be held to have retrospective effect, could also not be acceded to for the same reason indicated above.

For the reasons discussed above, the court held that the majority views expressed in the case of Merilyn Shipping & Transports were not acceptable and the appeal was allowed in favour of the revenue.

3.    Vector Shipping Services (P) Ltd.’s case

The issue again came up for consideration of the Allahabad High Court in the case of CIT vs. Vector Shipping Services (P) Ltd. in ITA No. 122 0f 2013, copy available on www. itatonline.org.

The assessee, a shipping service company, engaged the services of another company for ship management work, on its behalf, for which it paid an amount of Rs. 1.17 crore, without deduction of tax at source, on the ground that the said payment represented the reimbursement of expenses incurred by the service provider. The AO disagreed with the view of the assessee company and disallowed the entire payment u/s 40(a)(ia).

On appeal against the order of the AO, the CIT (A) held that “In the light of the above facts ——————– , when such type of expenses incurred by the appellant were totally paid and not remained payable as at the end of the relevant accounting period, provisions of section 40(a)(ia) of the Act are not applicable ………………………………. it is held that the AO was not justified in making addition of Rs.1,17,68,621/- on account of disallowance made under section 40 (a) (ia) of the I.T. Act, 1961. The same is directed to be deleted. Grounds Nos. 2 & 3 are allowed.”

The Tribunal, besides upholding the assessee’s claim that no tax was required to be deducted on a reimbursement, held that section 40(a)(ia) applied only to amounts that were “payable” as at the end of the year and not to amounts that had already been “paid” during the year relying on the decision of the Special Bench in the case of Merilyn Shipping and Transport Ltd 136 ITD 23 (SB) where a similar view was taken.

On appeal by the Income-tax Department, the Allahabad High Court was asked to answer the following:

“(a) Whether on the facts and in the circumstances of the case, the Hon’ble ITAT has rightly confirmed the order of the CIT (A) and thereby deleting the disallowance of Rs. 1,17,68,621/- made by the Assessing Officer under section 40(a)(ia) of the I.T. Act, 1961 by ignoring the fact that the company M/s Mercator Lines Ltd. had performed ship management work on behalf of the assessee M/s Vector Shipping Services (P) Ltd. and there was a Memorandum of Understanding signed between both the companies and as per the definition of memorandum of understanding, it included contract also.”

The Allahabad High Court, vide an order dated 09-07-2013, observed that the Revenue could not take any benefit from the observations made by the Special Bench of the tribunal in the case of Merilyn Shipping and Transport Ltd. to the effect that section 40 (a) (ia) was introduced in the Act with a view to augment the revenue through the mechanism of tax deduction at source and the provision was brought on statute to disallow the claim of even genuine and admissible expenses under the head ‘Income from Business and Profession’ in case the assessee did not deduct tax on such expenses and that the default in deduction of tax would result in disallowance of expenditure.

The court, importantly, in the context, noted that for disallowing expenses from business and profession on the ground that tax had not been deducted, the amount should be payable and not which had been paid by the end of the year.

4.    Observations

Clarity breeds confusion. The Special Bench of the tribunal in the case of Merilyn Shipping & Transports, 136 ITD 23 (SB) (Vishakhapatnam) held that the language of section 40(a)(ia) was clear and the Calcutta High Court in Crescent Exports Syndicate’s case (supra) also held that the language was clear and unambiguous, to arrive at the conflicting decisions. Now, if the language is clear how could there have been different and importantly diverse views on the meaning of the word ‘payable’? Either one of the views is wrong or there is a genuine possibility of two views on the issue under consideration. We would prefer the latter view to hold that the term ‘payable’, when read in the context and in the background of the circumstances that surrounded its use and also the subsequent insertion of the second proviso for granting relief on payment of tax by the payee, is capable of conveying two views, both of which are possible. Needless to say that when two views are possible, a view beneficial to the taxpayer should be adopted, Vegetable Products 88 ITR 192 (SC). There are no two views on this aspect of the law of interpretation.

The Calcutta High Court’s observations on the legislative intent, if there ever was one, are interesting and so are its observations bordering on the strictures when it held that the language of the law was clear and the tribunal was wrong in gathering the legislative intent. Having said so, the court itself tried to support what in its view was clear with deductive logic supported by analytical tools to provide a harmonious interpretation. No harmony is required to be infused where the language is clear. With utmost respect, it appears that the time is ripe to altogether give up on using the tool of legislative intent as an aid to interpretation. A grave notice is required to be taken of the fact that most of these legislations are passed without any debate and even understanding of the law and it may be that the persons voting in favour of passing the legislation may not even be aware of the subject matter of the vote and of the fact that such a law is being passed with their votes. There is a strong case for the courts, in the present times, to be in tune with the times and supply such interpretation which is just and harmonious and more importantly the one that identifies with common sense.

The situation has the effect of putting the tribunal in an unenviable situation. The conflicting decisions of the High Courts have once again paved the pathway for a fresh consideration of the subject by the tribunal. Usually in such cases, the tribunal charts its own course and is allowed to do so. However, the interesting part is that in the case under consideration, there already is a special bench view, not in one case but in two cases. Merilyn Shipping & Transports, 136 ITD 23 (SB) (Vishakhapatnam) and reiterated in Rajamahendri Shipping & Oilfields Pvt. Ltd. 19 ITR(T) 616 (SB) (Vishakhapatnam). Can a division bench of the tribunal ignore the decision of the special bench to take a view contrary to what has been laid down by a special bench? While the benches of the tribunal functioning within the jurisdiction of the Calcutta and Gujarat High Courts shall follow the judgments in favour of the revenue, it will be most apt for the benches in other jurisdictions to take note of the controversy and decide the case in favour of the taxpayer by following the beaten track that requires the adoption of the view that is favourable to him, applying the principle of interpretation that requires favouring the taxpayer in cases of doubt.

A view is being expressed that the decision in Vector Shipping’s case cannot be considered to be laying any law on the subject of allowability of an expenditure where no tax is deducted, once it is shown that the payment for such an expenditure is made during the year, as was held by the special bench. It is contended by the holders of this view that the question put up for consideration of the court was primarily concerned with the liability of the assessee to deduct tax at source and the court confirmed the tribunal’s findings that the assessee was not liable to deduct tax at source and refused to admit the appeal of the revenue on the ground that no question of law was involved.

Under this view, the observations of the Allahabad High Court should be treated as the obiter dicta and not a binding decision. At this point, it is apt to reproduce the exact words of the Allahabad High Court, to the extent relevant, which read as “It is to be noted that for disallowing expenses from business and profession on the ground that TDS has not been deducted, the amount should be payable and not which has been paid by the end of the year.” These words are not words that can be taken lightly by anyone seriously dealing with the interpretation of law by consigning it to the status of irrelevant observations made out of context. The court in that case has taken a detailed notice of the order of the CIT(A) and of the tribunal, both of which directly and expressly dealt with the issue of the meaning of the term ‘payable’. In fact, the issue of liability to TDS was an issue of lesser importance to the appellate authorities and perhaps to the AO, as well. The only other thing the court noted in the order, was also about addressing the argument of the revenue to the effect that the provisions of section 40(a)(ia) should be read in a manner so as to advance the case of recovery of tax. The court strongly rejected any such contention which was directly surrounding the interpretation of the word ‘payable’. These facts clearly confirmed that the issue under consideration here was duly addressed by the court in the said case, as well.

We are fully conscious that, in the times when the courts and the tribunals are more in favour of deciding an issue by following a decision of the higher court, on an application of the law of precedent, it may be difficult for a taxpayer to persuade a tribunal not to follow the Calcutta and Gujarat High Courts’ comprehensive decisions and to consider the case on merits independently. This is evident in the decision of the Tribunal in Rishti Stock & Shares Pvt. Ltd.‘s case decided by the Mumbai tribunal on 02-08-2013 in CO No. 263/M/2012 arising out of the appeal ITA 112/M/2012, where the Tribunal preferred to follow the Calcutta and Gujarat High Court decisions.

The Calcutta High Court, in Crescent Export Syndicate’s case, delivered its judgment on 03-04-2013 and followed it up in yet another decision delivered on 04-04-2013 in CIT vs. Md. Javed Hossein Mondal, 33 taxmann.com 123. The Gujarat High Court examined the issue in CIT vs. Sikandarkhan N. Tunwar, 295 CTR 75 and vide an order dated 02-05-2013 decided the issue in favour of the revenue independent of the aforesaid two decisions of the Calcutta High Court. The Allahabad High Court in Vector Shipping’s case delivered the decision on 09-07-2013, once again independent of the aforesaid three decisions. Before all this, the Andhra Pradesh High Court had stayed the operation of the Special Bench’s decision in Merilyn Shipping‘s case. Maybe the benefit of ‘2G speed’ was not available to the Department’s counsel in Vector Shipping’s case .

The decision of the Calcutta High Court, like the decision of the special bench, is an erudite decision that has comprehensively analysed the different aspects touching the issue. In comparison, the decision of the Allahabad High Court does not reveal in detail the basis that led it to hold that no disallowance was to be made of an expenditure, the payment of which was made before the year-end without deducting tax at source. The court in that case has confirmed the findings of the tribunal that the assessee was not liable to deduct tax at source on such payments. This however cannot be construed to mean that the court had not applied its mind to the law on the subject or that it had not taken a conscious note of the issue at hand. To distinguish and ignore the express observa-tions and findings on law of a High Court under the pretext that it does not represent the verdict of the court is not a very attractive proposition to any serious student of law. Such a decision deserves equal respect, more so when the reading of the contents confirms that the only issue that was discussed was about the interpretation of section. 40(a)(ia), as otherwise the court concurred with the finding of the fact of the tribunal that the tax was not deductible in the case before it .

The position on the issue under consideration has assumed significance with the decision of the Allahabad High Court in Vector Shipping’s case which has restored the issue for a fresh consideration. The issue should be taken as one that is wide open till such time as it is addressed by the apex court of the land. The Supreme Court has recently allowed the transfer of case for examining the constitutional validity of the provisions of section 40(a)(ia). Please see Maruthi Tubes (P) Ltd., 37 taxmann.com 31.