Month: June

ISSUE FOR CONSIDERATION

Under the Motor Vehicles
Act, 1988 (MVA), a liability has been cast on the owner of the motor vehicle or
the insurer to pay compensation in the case of death or permanent disablement
due to a motor vehicle accident. This compensation is payable to the legal
heirs in case of death and to the victim in case of permanent disablement. For
the purposes of adjudicating upon claims for compensation in respect of motor
accidents, the Motor Accident Claims Tribunals (MACTs) have been established.
The MVA further provides that in case of death the claim may be preferred by
all or any of the legal representatives of the deceased. The quantum of
compensation is decided by taking into consideration the nature of injury in
case of an injured person and the age, monthly income and dependency in death
cases. The MVA contains the 2nd Schedule for compensation in fatal accidents
and injury cases claims. While awarding general damages in case of death, the
funeral expenses, loss of consortium, loss of estate and medical expenses are
also the factors that are considered.

The claims under the MVA may involve delay which may be due
to late filing of the compensation claim, investigation, adjudication of claim
and various other factors. A provision is made u/s. 171 of the MVA to
compensate the injured or his legal heir for the delay, which reads as under:

“Section 171. Award of interest where any claim is
allowed.

Where any Claims Tribunal allows a claim for compensation
made under this Act, such Tribunal may direct that in addition to the amount of
compensation, simple interest shall also be paid at such rate and from such
date not earlier than the date of making the claim as it may specify in this
behalf.”

CBDT circular No. 8 of 2011 requires deduction of income tax
at source on payment of the award amount and interest on deposit made under
orders of the court in motor accident claims cases. The issue has arisen before
courts as to whether tax is deductible at source u/s. 194A on such interest
awarded by the MACTs u/s. 171 of the MVA for delay.

While the Allahabad, Himachal Pradesh and Punjab and Haryana
High Courts have held that such payment is not income by way of interest as
defined in section 2(28A) and no tax is deductible at source u/s. 194A, the
Patna and Madras High Courts have taken a contrary view, holding that such
payment is interest on which tax is deductible at source u/s. 194A.

THE ORIENTAL INSURANCE CO. LTD. CASE

The issue first arose before the Allahabad High Court in the
case of CIT vs. Oriental Insurance Co. Ltd. 27 taxmann.com 28.

In this case, the
assessee, an insurance company, paid compensation and interest thereon under
the MVA to claimants without complying with the provisions of section 194A. The
assessing authority took a view that the assessee had failed to deduct income
tax on the amount of interest u/s. 194A and held that it was accordingly liable
to deposit the amount of short deduction of tax u/s. 201(1) along with interest
u/s. 201(1A) for a period of five assessment years. According to the assessing
officer, debt incurred included claims and interest on such claims was clearly
covered u/s. 2(28A). His reasoning was as below:

1. Interest paid under the MVA was a revenue receipt like
interest received on delayed payment of compensation under the Land Acquisition
Act. Since section 194A applied to interest on compensation under the Land
Acquisition Act, it also applied in respect of interest on compensation under
the MVA.

2. The interest element in a total award was different from
compensation. However, interest on such compensation was on account of delayed
payment of such compensation, and therefore it was clearly an income in the
hands of the recipient, taxable under the Income-tax Act.

3. The interest element
was different from compensation as provided in section 171 of the MVA  as that section provided that the tribunal
might direct that in addition to the amount of compensation, simple interest
should also be paid.

4. There was no exemption u/s. 194A for TDS on interest
payment by insurance companies on MACT awards.

5. The actual payer of interest was the insurance company and
the responsibility to deduct tax lay squarely on it. The provisions of section
204(iii) were very clear that the person responsible for payment meant “in the
case of credit or as the case may be, payment of any other sum chargeable under
the provisions of this Act, the payer himself, or, if the payer is a company,
the company itself including the principal officer thereof.”

6. Payment awarded under the MVA was identical to the award
under the Land Acquisition Act. Tax was deducted u/s. 194A on interest paid or
credited for late payment of compensation under the Land Acquisition Act.
Therefore, section 194A was also applicable in respect of interest paid or
credited on delayed payment of compensation under the MVA.

7. Interest under the MVA was similar to interest paid under
the Income-tax Act, as both arose by operation of law. The nature of payment
mentioned in both the Acts was “interest”. TDS on interest payment under the
Income-tax Act was not deductible in view of the specific exemption u/s. 194A(3)(viii).
Since there was no similar exemption for interest payment under the MVA, the
provisions of section 194A applied to these payments.

The Commissioner (Appeals) dismissed the appeal of the
assessee, confirming the action of the assessing authority and holding that the
interest payment awarded u/s. 171 of the MVA was nothing but interest, subject
to the provisions of section 194A.

In the second appeal before the tribunal, the Agra Tribunal
decided the issue in favour of the assessee, following its own earlier
decisions in the cases of Divisional Manager, New India Insurance Co.
Ltd., Agra vs. ITO [ITA Nos. 317 to 321/Agra/2003], which, in turn, had
followed the decision of the Delhi Tribunal in the case of Oriental
Insurance Co. Ltd. vs. ITO dated 27.9.2004, and in Oriental
Insurance Company Ltd. vs. ITO [ITA Nos. 276 & 280/Agra/2003 dated
31.1.2005].

It was argued before the Allahabad High Court on behalf of
the Revenue that it was the responsibility of the payer of interest to deduct
tax on such payment of interest, because section 2(28A) clearly envisaged that
interest meant interest payable in any manner in respect of moneys borrowed or
debt incurred (including a deposit, claim or other similar right / obligation)
and includes any service fee or other charges in respect of the money borrowed
or debt incurred, or in respect of any credit facility which had not been
utilised. It was argued that the Tribunal had not referred to the decision of
the Supreme Court in the case of Bikram Singh vs. Land Acquisition
Collector 224 ITR 551, in which it had been held that interest paid on
the delayed payment of compensation was a revenue receipt eligible to tax u/s.
4 of the Income-tax Act, 1961.

On behalf of the Revenue, reliance was placed upon the following
decisions:

a) The Karnataka High Court in the case of CIT vs.
United Insurance Co. Ltd. 325 ITR 231, where the court held that
interest paid above Rs. 50,000 was to be split and spread over the period from
the date interest was directed to be paid till its payment.

b) The Karnataka High Court in the case of Registrar
University of Agricultural Science vs. Fakiragowda 324 ITR 239 where
interest received on belated payment of compensation for acquisition of land
was held to be a revenue receipt chargeable to income tax on which tax was
deductible at source.

c) The Supreme Court, in the case of T.N.K. Govindaraju
Chetty vs. CIT 66 ITR 465, in the context of interest on compensation
awarded for acquisition of land, held that if the source of the obligation
imposed by the statute to pay interest arose because the claimant was kept out
of his money, the interest received was chargeable to tax as income.

d) The Supreme Court, in the case of K.S. Krishna Rao
vs. CIT 181 ITR 408, where interest paid on compensation awarded for
compulsory acquisition of land u/s. 28 of the Land Acquisition Act, 1894 was
held to be in the nature of income and not capital.

On behalf of the assessee, it was argued before the Allahabad
High Court that:

1. The interest paid on the award of compensation was not
interest as understood in general parlance and it was not an income of the
claimant.

2. The compensation
awarded by the MACT to the claimants was a capital receipt in the hands of the
recipients, not taxable under any provision of the Income-tax Act. Since the
award was not taxable in the hands of the recipient, it was not an income but
was a capital receipt.

3. Interest paid by the insurance company u/s. 171 of the MVA
was not interest as contemplated u/s. 194A, because interest that was contented
under that section was an income taxable in the hands of the recipient, whereas
interest received by the recipient u/s. 171 of the MVA was a capital receipt in
the hands of the recipient, being nothing but an enhanced compensation on account
of delay in the payment of compensation.

The Allahabad High Court referred to the definition of
interest u/s. 2(28A), which reads as under:

“ ‘interest’ means interest payable in any manner in
respect of any moneys borrowed or debt incurred (including a deposit, claim or
other similar right or obligation) and includes any service fee or other charge
in respect of the moneys borrowed or debt incurred or in respect of any credit
facility which has not been utilised.”

After referring to the language of section 194A, the
Allahabad High Court referred to the CBDT circular 24 of 1976 (105 ITR
24), where the concept of interest had been explained. It also referred
to clause (ix) of section 194A(3), which had been inserted by the Finance Act,
2003 with effect from 1^st June, 2003, which read as under:

“to such income credited or paid by way of interest on the
compensation amount awarded by the Motor Accidents Claims Tribunal where the
amount of such income or, as the case may be, the aggregate of the amount of
such income credited or paid during the financial year does not exceed Rs.
50,000.”

The Allahabad High Court referred to the following decisions:

1. The Punjab and Haryana High Court in the case of CIT
vs. Chiranji Lal Multani Mal Rai Bahadur (P) Ltd. 179 ITR 157, where it
had been held that interest awarded by the court for loss suffered on account
of deprivation of property amounted to compensation and was not taxable.

2. The National Consumer Disputes Redressal Commission in Ghaziabad
Development Authority vs. Dr. N.K. Gupta 258 ITR 337, where it had been
held that if proper infrastructure facilities had not been provided to a person
who was provided with a flat and was therefore entitled to refund of the amount
paid by him along with interest at 18%, the paying authority was not entitled
to deduct income tax on the amount of interest, as it was not interest as
defined in section 2(28A), but was compensation or damages for delay in
construction or handing over possession of the property, consequential loss to
the complainant by way of escalation in the price of property, and also on
account of distress and disappointment faced by him.

3. The Himachal Pradesh High Court in the case of CIT
vs. H.P. Housing Board 340 ITR 388, where the High Court had held that
payment for delayed construction of house was not payment of interest but was
payment of damages to compensate the claimant for the delay in the construction
of the house and the harassment caused to him.

4. The Supreme Court, in the case of CIT vs. Govind
Choudhury & Sons 203 ITR 881, had held that when there were
disputes with the state government with regard to payments under the contracts,
receipt of certain amount under the arbitration award and the interest for
delay in payment of amounts due to it, such interest was attributable to and
incidental to the business carried on by it. It was also held that interest
awarded could not be separated from the other amounts granted under the awards
and could not be taxed under the head “income from other sources”.

5. The Bombay High Court decision in the case of Islamic
Investment Co. vs. Union of India 265 ITR 254, where it had been held
that there was no provision under the Income-tax Act or under the Code of Civil
Procedure to show that from the amount of interest payable under a decree, tax
was deductible from the decretal amount on the ground that it was an interest
component on which tax was liable to be deducted at source.

The Allahabad High Court also referred to the decisions of
the Delhi High Court in the case of CIT vs. Cargill Global Trading (P)
Ltd. 335 ITR 94 and CIT vs. Sahib Chits (Delhi) (P) Ltd. 328 ITR
342, which had analysed the meaning of the term “interest”.

The Allahabad High Court observed that most of the rulings
relied upon by the Revenue related to interest paid on delayed payment of
compensation awarded under the Land Acquisition Act. According to the Allahabad
High Court, an award under the Land Acquisition Act and an award under the MVA
could not be equated for the simple reason that in land acquisition cases the
payment was made regarding the price of the land and on such price the
provisions of capital gains tax were attracted. On the other hand, in motor
accident claims, the payment was made to the legal representatives of the
deceased for loss of life of their bread-earner, the recipients of awards being
poor and illiterate persons who did not even come within the ambit of the
Income-tax Act, and the amount of compensation under the MVA also did not come
within the definition of “income”.

According to the Allahabad High Court, the term “interest” as
defined in section 2(28A) had to be strictly construed. The necessary
ingredient was that it should be in respect of any money borrowed or debt
incurred. The award under the MVA was neither money borrowed by the insurance
company nor debt incurred by the insurance company. The word “claim” in section
2(28A) should also be regarding a deposit or other similar right or obligation.

The Allahabad High Court observed that the intention of the
legislature was that if the assessee had received any interest in respect of
moneys borrowed or debt incurred, including a deposit, claim or other similar
right or obligation, or any service fee or other charge in respect of moneys
borrowed or debt incurred had been received, then certainly it would come
within the definition of interest. The word “claim” used in the definition may
relate to claims under contractual liability, but certainly did not cover
claims under a statutory liability, the claim under the MVA regarding
compensation for death or injury being a statutory liability.

Further, the Allahabad High Court referred to the insertion
of clause (ix) to section 194A(3), stating that it showed that prior to 1^st
June, 2003 the legislature had no intention to charge any tax on interest
received as compensation under the MVA. According to the High Court, there was
therefore no justification to cast a liability to deduct TDS on interest paid
on compensation under the MVA prior to 1^st June, 2003.

The Allahabad High Court also noted that u/s. 194A(1), tax
was deductible at source if a person was responsible for paying to a resident
any income by way of interest other than interest on securities. In the opinion
of the Allahabad High Court, the award of compensation under motor accident
claims could not be regarded as income, being compensation to the legal heirs
for the loss of life of their bread-earner. Therefore, interest on such award
also could not be termed as income to the legal heirs of the deceased or the
victim himself.

It was noted by the Allahabad High Court that an award under
the MVA was like a decree of the court, which would not come within the
definition of income referred to in section 194A(1) read with section 2(28A) of
the Income-tax Act. According to the court, proceedings regarding claims under
the MVA were in the nature of garnishee proceedings, where the MACT had a right
to attach the judgement debt payable by the insurance company. Even in the
award, there was no direction of any court that before paying the award the
insurance company was required to deduct tax at source. As held by the Supreme
Court in the case of All India Reporter Ltd. vs. Ramachandra D. Datar 41
ITR 446, if no provision had been made in the decree for deduction of
tax before paying the debt, the insurance company could not deduct the tax at
source from the amount payable to the legal heirs of the deceased.

The Allahabad High Court
observed that the different High Courts in the cases of Chiranji Lal
Multani Mal Rai Bahadur (P) Ltd. (supra), Dr. N.K. Gupta (supra), H.P. Housing
Board (supra) and Sahib Chits (Delhi) (P) Ltd. (supra),
held that if interest was awarded by the court for loss suffered on account of
deprivation of property or paid for breach of contract by means of damages or
was not paid in respect of any debt incurred or money borrowed, it would not
attract the provisions of section 2(28A) read with section 194A(1). The
Allahabad High Court, therefore, held that interest paid on compensation under motor
accident claims awards was not liable to income tax.

A similar view has been taken by the Himachal Pradesh High
Court in the case of Court on Its Own Motion vs. H.P. State Co-operative
Bank Ltd. 228 Taxmann 151, where the High Court quashed the CBDT circular
No. 8 of 2011 which required deduction of income tax on award amount and
interest accrued on deposit made under orders of the court in motor accident
claims cases, and in the case of National Insurance Co. Ltd. vs. Indra
Devi 100 taxmann.com 160, and by the Punjab and Haryana High Court in
the case of New India Assurance Co. Ltd. vs. Sudesh Chawla 80 taxmann.com
331.

THE NATIONAL INSURANCE CO. LTD. CASE

The issue again came up before the Patna High Court in the
case of National Insurance Co. Ltd. vs. ACIT 59 taxmann.com 269.

In this case, the District Judge gave an award to the
claimant under the MVA of Rs. 3,70,000 plus interest at 6% per annum from the
date of filing of the claim. The amount was to be paid within two months of the
passing of the order, failing which the further direction was to pay interest
at 9% per annum from the date of the order till the date of final payment. The
insurance company deducted and deposited TDS of Rs. 24,715 u/s. 194A while
making the payment of the amount of the award. The claimant objected to the
deduction of TDS by filing a petition before the District Judge. The District
Judge held that the deduction of Rs. 24,175 by way of TDS was not sustainable
and directed the insurance company to disburse the amount to the claimant
without TDS. The insurance company filed a writ petition in the High Court
against this order of the District Judge for seeking permission to deduct tax
at source on payment of the interest on compensation.

Before the Patna High Court, on behalf of the insurance
company, reliance was placed upon the relevant provisions of the Income-tax Act
in support of the stand that the insurance company was under a statutory
liability u/s. 194A of the Act to have made deduction of the amount of TDS
while making payment by way of interest on the compensation amount awarded by
the MACT. The total interest component under the award came to a little over
Rs. 1,20,000, and therefore, the insurance company was bound under the Act to
make deduction of TDS while making payment; accordingly, an amount of Rs.
24,175 was to be deducted as TDS.

Reliance was also placed upon a decision of the Patna High
Court in C.W.J.C. No. 5352 of 2013, National Insurance Co. Ltd. vs. CIT,
where the court had held as under:

“It appears that the Tribunal below has ignored the
statutory duty conferred upon the insurer under section 194 (1) (sic) of the
Income-tax Act. Under the said provision, the insurer is obliged to deduct tax
at source from the amount of interest paid by the insurer to the claimant. The
said amount has to be deposited with the Government of India as the income tax
deducted at source. The Tribunal below has grossly erred in directing the
insurer to pay the said sum to the claimant.”

Reliance was further placed upon a decision of the Madras
High Court in the case of New India Assurance Co. Ltd. vs. Mani 270 ITR
394, in which it had been held as follows:

“A plain reading of section 194A of the IT Act would
indicate that the insurance company is bound to deduct the income tax amount on
interest, treating it as a revenue, if the amount paid during the financial
year exceeds Rs. 50,000. In this case, admittedly, when the compensation amount
has been deposited during the financial year, including interest, the interest amount
alone exceeded Rs. 50,000 and therefore the insurance company has no other
option except to deduct the income tax at source for the interest amount
exceeding Rs. 50,000, failing which they may have to face the consequences,
such as prosecution, even. In this view alone, when the execution petition was
filed for the realisation of the award amount, deducting the income tax at
source for the interest, since it exceeded Rs. 50,000, on the basis of the
above said provision, the balance alone had been deposited, for which the court
cannot find fault.”

It was highlighted that the Madras High Court in the said
case had relied upon the decision of the Supreme Court in the case of Bikram
Singh vs. Land Acquisition Collector 224 ITR 551, where the Supreme
Court had held that interest received on delayed payment of compensation under
the Land Acquisition Act was a revenue receipt eligible to income tax. It was
explained that the Madras High Court in the said case had further held that the
trial court had not considered the actual effect of the amendment to section
194A, which came into effect from 1^st June, 2003. The Madras High
Court observed that if the claimant was not liable to pay tax, his remedy was
to approach the department concerned for refund of the amount. According to the
Madras High Court, the executing court did not have the power to direct the
insurance company not to deduct the amount and pay the entire amount, thereby
compelling the insurance company to commit an illegal act, violating the statutory
provisions.

The Patna High Court examined the provisions of sections
194A(1) and (3)(ix) of the Income-tax Act. According to the Patna High Court,
it was evident from the above provisions that any person responsible for paying
any income by way of interest (other than the interest on securities) was
obliged to deduct income tax thereon. The only exception was in case of income
paid by way of interest on compensation amount awarded by MACT, where the
amount of such income or the aggregate of the amounts of such income credited
or paid during the financial year did not exceed Rs. 50,000. The court was
therefore of the view that if the interest component of the payment to be made
during the financial year on the basis of award of the MACT exceeded Rs. 50,000,
then the person making the payment was obliged to deduct TDS while making
payment.

The Patna High Court further held that while exercising his
jurisdiction with regard to execution of the award, the District Judge had to
be conscious of the fact that any such payment would be subjected to statutory
provisions. Since there was a clear provision under the Income-tax Act with
regard to TDS, the District Judge could not have held to the contrary. The only
remedy for the claimant under such circumstances was to approach the assessing
officer u/s. 197 for a certificate for a lower rate of TDS or non-deduction of
TDS, or alternatively to approach the tax authorities for refund of the amount
in case no tax was due or payable by the claimant.

The Patna High Court therefore allowed the writ petition of
the company and set aside the order of the District Judge.

OBSERVATIONS

Section194A requires a person responsible for payment of
interest to deduct tax at source in the circumstances specified therein. Clause
(ix), inserted with effect from  1^st
June, 2003 in section 194A(3) exempted income credited or paid by way of
interest on the compensation amount awarded by the MACT where the amount of
such income or the aggregate of the amounts of such income credited or paid
during the financial year did not exceed Rs. 50,000. This clause (ix) has been
substituted by clauses (ix) and (ixa) with effect from  1^st June, 2015. The new clause
(ix) altogether exempts income credited by way of interest on the compensation
amount awarded by the MACT from the liability to deduct tax at source u/s.
194A, while clause (ixa) continues to provide for exemption to income paid by
way of interest on compensation amount awarded by the MACT where the amount of
such income or the aggregate of the amounts of such income paid during the
financial year does not exceed Rs. 50,000. In effect, therefore, no TDS is
deductible on interest on such compensation which is merely credited but not
paid, or on payment of interest where the amount of interest paid during the
financial year does not exceed Rs. 50,000. The issue of applicability of TDS
therefore is really relevant only to cases where there is payment of such
interest exceeding Rs. 50,000 during the year and that, too, when it was not
preceded by the credit thereof.

Section 2(28A) defines the term “interest” in a manner that
includes the interest payable in any manner in respect of any moneys borrowed
or debt incurred. In a motor claim award, there is obviously no borrowing of
monies. Is there any debt incurred? The “incurring” of the debt, if at
all,  may arise only on grant of the
award. Before the award of the claim, there is really no debt that can be said
to have been incurred in favour of the person receiving compensation. In fact,
till such time as a claim is awarded there is no certainty about the
eligibility to the claim, leave alone the quantum of the claim. In our
considered view, no part of the amount awarded as compensation under the MVA
till the date of award could be considered as in the nature of interest. The
amount so awarded till the time it is awarded cannot be construed as interest
even where it includes the payment of “interest” u/s. 171 of the MVA for the
reason that such “interest” cannot be construed as “‘interest” within the meaning
of section 2(28A) of the Act and as a consequence cannot be subjected to TDS
u/s. 194A of the Act.

If one looks at the award of “interest” u/s. 171 of the MVA,
typically in most cases, such interest is a part of the amount of compensation
awarded and is not attributable to the late payment of the compensation, but is
for the reasons mentioned in section 171 and at the best relates to the period
ending with the date of award. This “interest” u/s. 171 for the period up to
the date of award, would not fit in within the definition of interest u/s.
2(28A). Interest for the period after the date of award, if related to the
delayed payment of the awarded compensation, would fall within the definition
of interest, being interest payable in respect of debt incurred. It would only
be the interest for the period after the date of award which would be liable to
TDS u/s. 194A of the Income-tax Act provided, of course, that the amount being
paid is exceeding Rs. 50, 000 and was not otherwise credited to the payee’s
account before the payment.

Looked at differently, the interest up to the date of award
would also partake of the same character as the compensation awarded, being
damages for a personal loss, and would therefore not be regarded as an income
at all, opening a new possibility of contending that the provisions of section
194A may not apply to a case where the payment otherwise is not taxable in the
hands of the recipient.

In cases where the payment of the awarded compensation is
delayed, the ultimate amount of payment to be made may include interest for the
post-award period. In such a case, the ultimate amount will have to be
bifurcated into two parts, one towards compensation including interest for the
pre-award period, and the other being interest which may be subjected to TDS.
This need for bifurcation of interest into pre-award interest and post-award
interest, and the character of each, is supported by the decision of the
Supreme Court in the case of CIT vs. Ghanshyam (HUF) 315 ITR 1,
where the Supreme Court held as under in the context of interest on
compensation under the Land Acquisition Act:

“To sum up, interest is different from compensation.
However, interest paid on the excess amount under section 28 of the 1894 Act
depends upon a claim by the person whose land is acquired whereas interest
under section 34 is for delay in making payment. This vital difference needs to
be kept in mind in deciding this matter. Interest under section 28 is part of
the amount of compensation whereas interest under section 34 is only for delay
in making payment after the compensation amount is determined. Interest under
section 28 is a part of enhanced value of the land which is not the case in the
matter of payment of interest under section 34.”

One of the side questions is whether such interest included
in MACT compensation awarded under the MVA is chargeable to tax at all? There
is no doubt that the amount of compensation awarded is for the loss of a
personal nature and is therefore a capital receipt of a personal nature, which
is not chargeable to tax at all. The payment, though labelled “interest” u/s.
171 of the MVA, bears the same character of such compensation inasmuch as it
has no relation to the dent or the period and is nothing but a compensation to
an injured person determined on due consideration of the relevant factors,
including for the period during the date of injury to the date of award.

The mere fact that such income credited by way of interest on
MACT compensation awards is subjected to the provisions of section 194A and the
payer is required to deduct tax at source does not necessarily mean that such
amounts are otherwise chargeable to tax. It is important to note that section
194A, in any case, refers to a person responsible for paying to a resident “any
income” by way of interest and demands compliance only where the payment is in
the nature of income. As interpreted by the Allahabad High Court and the other
courts, such income would mean income which is chargeable to tax. If the
interest is not chargeable to tax, then the question of deduction of TDS u/s.
194A does not arise.

The question of chargeability to tax of such income has also
been recently considered by the Rajasthan High Court in case of Sarda
Pareek vs. ACIT 104 taxmann.com 76, where the High Court took the view
that on a plain reading of section 2(28A), though the original amount of MACT
compensation is not income but capital, the interest on the capital
(compensation) is liable to tax. The Supreme Court has admitted the special
leave petition against this order of the Rajasthan High Court in 104
taxmann.com 77. In the case of New India Assurance Company Ltd.
vs. Mani (supra) the Madras High Court held that the interest awarded
as a part of the compensation was income chargeable to tax; however, in a later
decision in the case of Managing Director, Tamil Nadu State Transport
Corpn. (Salem) Ltd. vs. Chinnadurai, 385 ITR 656, the High Court took a
contrary view and held that such interest awarded did not fall under the term
“income” as defined under the Income-tax Act. An SLP is admitted by the Supreme
Court against this decision, too. Therefore, clearly the issue of chargeability
of even the post-award interest to income tax is still a matter of dispute.

As observed by the Allahabad High Court, the one significant
difference between the compensation under the Land Acquisition Act and under
the MVA is that the compensation under the Land Acquisition Act may be
chargeable to tax under the head capital gains, whereas the compensation under the
MVA is not chargeable to tax at all.

One has to also keep in mind the provisions of section
145A(b), as applicable from assessment year 2010-11 to assessment year 2016-17,
which provided that notwithstanding anything to the contrary contained in
section 145, interest received by an assessee on compensation or on enhanced
compensation, as the case may be, shall be deemed to be the income of the year
in which it is received. With effect from assessment year 2017-18, an identical
provision is found u/s. 145B(1). However, the provisions of section 145A and
section 145B merely deal with how the income is to be computed and in which
year it is to be taxed, and do not deal with the issue of whether a particular
item of interest is chargeable to income tax or not. Therefore, these
provisions would apply only to interest on compensation which is otherwise
chargeable to income tax, and would not be applicable to interest which is not
so chargeable.

One also needs to refer to the provisions of section
56(2)(viii), which provides for chargeability under the head “income from other
sources” of interest received on compensation or on enhanced compensation
referred to in section 145A(b). Again, this provision merely prescribes the
head of income under which such interest would fall, provided such interest
income is chargeable to tax. It does not necessarily mean that the interest in
question is in the nature of income in the first place.

This is further clear from the fact that section 2(24), which
contains the definition of income, specifically includes receipts under various
clauses of section 56(2), such as clauses (v), (vi), (vii), (viia) and (x) –
gifts and deemed gifts, (viib) – excess premium received by a company for
shares, (ix) – forfeited advance for transfer of capital asset, and (xi) –
compensation in connection with termination or modification of terms of
employment for ensuring that such receipts so specified are treated as an
“income” for the purposes of the Act. In contrast, receipt of the nature
specified under clause (viii) of section 56(2) is not included in section 2(24)
indicating that such interest on compensation is not deemed always to be an
income.

One Mr. Amit Sahni has recently knocked the doors of the
Delhi High Court by filing a writ petition seeking quashing of the provision
which mandates deduction of tax on the interest on compensation awarded under
the MVA. The court, vide order dated 16^th April, 2019, has directed
the CBDT to pass a reasoned order latest by 30^th June, 2019 in
response to the representation made by the petitioner in this regard.

The better view, therefore, seems to be that of the
Allahabad, Himachal Pradesh and Punjab and Haryana High Courts, that no tax is
deductible in respect of interest awarded u/s. 171 of the Motor Vehicles Act,
even if such interest exceeds Rs. 50,000, unless such interest is (i)
attributable to the delay in payment of the awarded compensation and (ii)
pertains to the period after the date of the award and is (iii) calculated
w.r.t. the amount of the compensation awarded. This view is unaffected by the
fact of the insertion of clause (x) in section 194A(3), w.e.f. 1^st
June, 2003 and the substitution thereof w.e.f. 
1^st June, 2015.

Given this position, and since the issue involves TDS, which
is merely a procedural requirement, one hopes that the CBDT will come out with
a clarification explaining that the provisions of section 194A have a
restricted application to the cases involving payment of interest for the delay
in payment of awarded compensation, so that neither the insurance companies nor
the poor claimants have to unnecessarily suffer through unwarranted tax
deduction or litigation in this regard.

shailesh.kwebmaker

Issue for Consideration

Many
of the provisions casting obligation to deduct tax at source (‘TDS’) under
Chapter XVII-B require tax  deduction at
the time of credit of the specified income or sum to the account of the payee
or at the time of payment, whichever is earlier.

Each
of the relevant provisions of TDS, by way of a deeming fiction, under an
Explanation, provide  that when the
income or sum is credited to any account by any name in the books of account of
the person liable to pay it, such crediting shall be deemed to be credit of
such income or sum to the account of the payee and the provisions of the
relevant section shall apply accordingly[1].

A
question often arises as to whether tax is required to be deducted at the time
of making provision, in the books of account, 
for several expenses at the end of the accounting year under the
mercantile system of accounting.  While
a  view has been taken in some cases that
tax is not required to be deducted at source where the payee is not
identifiable,  there has arisen one more  controversy even in respect of ad-hoc or
interim provisions made, in respect of liability payable to identified payees
in future. The issue that has arisen is, whether crediting the amount to the
provision account, in such cases,  be
deemed to be credit to the account of the concerned payee attracting the
liability to TDS. The incidental issue also arises as to whether the reversal
of such provision in the subsequent period has any bearing in determining
applicability of TDS. Conflicting decisions have been rendered by the Bangalore
bench of Tribunal on this subject.

[1] 
Refer to Explanations to Section 193, 
Section 194A, Section 194C, 
Section 194H,  Section 194-I,  Section 194J.

IBM
INDIA (P) LTD.’S CASE

The
issue first came up before the Bangalore bench of the Tribunal in the case of IBM
India (P) Ltd vs. ITO 154 ITD 497.

In this case, pertaining to assessment years 2005-06 to
2009-10, the assessee,  a wholly owned
subsidiary of a U.S. based company, was following the mercantile system of
accounting. As a part of the global group accounting policy, the assessee had
to quantify its expenses every quarter, within 3 days of the end of each
quarter. The assessee made a provision in the books of account for expenses, on
such quantification,  in respect of which
service/work had been provided/performed by the vendors in the relevant quarter  but for which the invoices had not been
furnished or in respect of which the payments had not fallen due, recognising
the liability incurred. On the basis of scientific methodology, the assessee
estimated such expenses and created a provision for such expenses every quarter
within 3 days of the end of the quarter. At the time of creation of provision,
in this manner, it was not possible for the assessee to identify parties, or if
parties were identified, to arrive at the exact sum on which TDS was to be
deducted.

The
expenses were debited to the profit and loss account and the provisions were
credited to a provision account, and not to the vendor accounts, as those had
not fallen due for payment. In the subsequent financial year, the provision
entries were reversed and on receipt of invoices in respect of the respective
expenses, the same were recorded as liabilities due to the respective parties,
at which point of time taxes were deducted 
at source. The provision so made was disallowed by the assessee itself
in terms of section 40(a)(i) and 40(a)(ia) while filing its return of income.

According
to the Assessing Officer, in respect of the provision so created by the
assessee in the books of account, tax was deductible at source and the assessee
by not deducting the tax has been in default and was liable to deposit the tax
and also for interest and penalty. In response to the show cause notice issued
u/s. 201(1) & 201(1A), the assessee submitted that invoices were not
received in respect of the underlying expenses, and therefore there was neither
accrual of expenditure nor was the payee identified, as the amount was not
credited to the account of the payee, but to a suspense account. There was no
accrual of expenditure in accordance with the mercantile system of accounting,
and therefore there was no obligation on its part to deduct tax at source. The
assessee took a stand that, though  the
relevant provisions of law in Chapter XVII-B, did provide for the situation
where  an amount was credited to a
“Suspense Account”, there should be a legal liability to pay, and the
payee should be known, and only then the obligation to deduct tax at source
arose. The Assessee also submitted that the provision entries were reversed in
the subsequent financial year(s) and necessary taxes were withheld at source at
the time of actual payment (when legal liability to pay arose and the identity
of the party was known).

The
Assessing Officer rejected the assessee’s arguments on the grounds that:

1.  The
assessee did not explain as to how the expenses had been quantified;

2.  When
no invoices were received, the booking of such expenses in the accounts and
claiming them as expenditure of the previous year was erroneous; and

3.  The
procedure followed by the assessee, of reversing the entries and recording the liability
in its books of account when invoices were received, was contrary to the
accounting policy, because once expenditure was booked in the profit and loss
account, it could not be reversed;

4.  There
was no clarification as to whether tax 
was deducted on the whole of the provisional entries, so as to allow the
amount that was disallowed  u/s.
40(a)(ia), in the year in which tax  was
deducted and paid ;

5.  The
procedure followed by the assessee might 
have led to the allowing of the expenditure one year prior to the
incurring of the actual expenses;

6.  The
details of the TDS made on such provisions made at the end of the year was also
provided by the assessee on sample basis, contending that the number of entries
were huge and hence could not be provided in full within a limited period;
giving rise to non-verification of deductions claimed.

The Assessing Officer treated the assessee
as an assessee in default for  the taxes
not deducted at source, in respect of provision for expenses made in the books
of account, and also levied consequential interest.

The orders passed u/s. 201(1) and 201(1A)
were upheld by the CIT (A) for the following reasons:

1.  Under
mercantile system of accounting, accrual of liability for any expenditure was
not dependent on receipt of invoice from the person to whom payment for
expenditure had to be made. The accounting practice followed by the assessee
was contrary to the mercantile system of accounting.

2.  The
claim of the assessee that it created provision in the books of account on an
estimated basis in some cases, on a historical basis in one set of cases  and by using some sort of arithmetical or
geometric progression in other cases, was not acceptable. The assessee had not
established its plea with concrete evidence. The assessee had full knowledge of
what was due to its vendors, sub-contractors, commission agents etc. Therefore,
there was no necessity to create provisions.

3.  The
argument regarding chargeability to tax in the hands of the payee or the time
at which the payee recognised income in respect of the payment received from
the assessee was irrelevant.

Before the Tribunal, the assessee
contended that:

1.  When
payee was not identified there could  be
no charge u/s. 4(1) and therefore there could 
be no obligation to deduct tax at source;

2.  The
returns of TDS to be filed under the Income Tax Rules, 1962 contemplated
furnishing of names of payees.

3.  Judicial
decisions recognise that there could be no TDS obligation in the absence of
payee.

4.  If there was no income chargeable to tax in
the hands of the payee, there could  be
no TDS obligation. TDS obligations arose only when there was
“Income”. TDS obligations did not arise on the basis of mere payment,
without there being income and corresponding liability of the person receiving
payment from the assessee to pay tax.

5.  The
Assessee relied on CBDT Circular No. 3/2010 dated 2.3.2010, issued in the
context of the provisions of section 194A of the Act dealing with TDS
obligation of banks at the time of provision of monthly interest liability
under the Core Banking Solution software, where the CBDT had clarified that TDS
was not applicable at the time of such monthly provisioning.

6.  Reliance
was also placed by the assessee on the Delhi High Court decision in the case of
UCO Bank vs. Union of India [2014] 369 ITR 335, where the Delhi High
Court had held that no tax was deductible on deposits kept by the Registrar
General of the High Court, since the ultimate payee was not known.

The Revenue argued that:

1.  The
assessee on its own had disallowed the expenditure in question u/s. 40(a)(i)
& 40(a)(ia). Such disallowance arose only when there existed a liability to
deduct tax at source in terms of Chapter-XVII-B of the Act. The assessee having
on its own disallowed expenditure u/s. 40(a)(i) & 40(a)(ia), could not
later on  turn around and say that there
was no obligation to deduct tax at source.

2.  The
assessee did not account for expenditure on accrual basis but on receipt of
invoice  which could not  be the point of time at which accrual of
expenditure could  be said to have
happened. The system of accounting followed by the assessee was not in tune
with the mercantile system of accounting.

3.  When
the assessee credited suspense account for payments due to various persons,
such credit itself was treated as credit to the account of the payee by a
deeming fiction in the various provisions of Income tax Act. The assessee could
not therefore say that the payee was not identified. Even in such a situation,
the assessee had to comply with the TDS provisions.

4.  The
method of accounting followed by the Assessee resulted in postponement of time
at which tax had to be remitted to the credit of the Government. It  could be seen from the fact that the
assessee, in some cases, was liable to charge of interest u/s. 201(1A) for
about 84 months. The question whether the Assessee was indulging in a
deliberate exercise in this regard was irrelevant. The fact that the revenue
was put to loss by reason of the system of accounting followed by the assessee
and the fact that otherwise the money should have reached the coffers of the
revenue much earlier, was sufficient to uphold the levy of interest u/s.
201(1A) of the Act.

5.  When
the Assessee argued that the payees were not identified, it was not open to the
assessee to also contend that there was no accrual of income in the hands of
the payee or that the payment was not chargeable to tax in the hands of the
payee in India.

6.  The
CBDT circular No. 3/2010 was in the context of banks crediting interest on
fixed deposits of customers. The decisions rendered by the judicial forums
based on those circulars were  not
relevant, as they were relevant only in the case of Banks and could not be
pressed into service in other cases, such as the case of the Assessee.

The Tribunal deleted the demand for
payment of taxes raised u/s. 201(1) as the tax that was deducted  subsequently when the actual liability was
booked, was paid. However, it upheld the applicability of the provisions of TDS
at the time of making provision and the obligation to deduct tax thereon and
accordingly,  levy of interest u/s.
201(1A) on account of delay  on the part
of the assessee in complying with the TDS provisions. On the facts of the case,
the Tribunal noted that the assessee was fully aware of the payee, but
postponed credit to its account for want of receipt of invoice. Proceeding on
the basis that payees were known to the assessee, regarding applicability of
TDS on provision, the Tribunal held as under:

1.  Once
the assessee had offered disallowance in respect of provision u/s. 40(a)(i) and
40(a)(ia), it was not possible to argue that there was no liability to deduct
tax at source on the same provision. The disability u/s. 40(a)(i) &
40(a)(ia), and the liability u/s. 201(1) could not be different and they arose
out of the same default;

2.  The
liability to deduct tax at source existed when the amount in question was
credited to a “Suspense Account” or any other account by whatever
name called, which would also include a “Provision” created in the
books of account;

3.  Since
the assessee had not established with concrete evidence that provision was made
on an estimated basis, it had full knowledge of amounts payable to vendors,
sub-contractors, commission agents, etc., and there was no necessity to
create a provision;

4.  The
statutory provisions clearly envisaged collection at source de hors the
charge u/s. 4(1).

5.  The
argument that TDS provisions operated on income and not on payment, in the
facts and circumstances of the  case, was
erroneous. Section 194C & 194J used the expression “sum” and not
“income”. Further, section 194H & 194-I did not use the expression
“chargeable to tax”.

6.  The
Tribunal further held the decision of the Bangalore bench in the case of DCIT
vs. Telco Construction Equipment Co. Ltd. ITA No. 478/Bang/2012 to be sub
silentio, and, therefore, not binding. The Delhi High Court decision in the
case of UCO Bank (supra)  was also
distinguished on the ground that the assessee was fully aware of the payee in
the case before the Tribunal.

The Tribunal therefore confirmed the levy
of interest u/s. 201(1A).

BOSCH
LTD.’S CASE

The issue again came up before the
Bangalore bench of the Tribunal in the case of Bosch Ltd vs. ITO
TS-116-ITAT-2016.

This was a case relating to assessment
year 2012-13. The facts of this case were almost identical to the facts of
IBM’s case. The assessee was a company engaged in the business of manufacture
and sale of injection equipments, auto electric items, portable electric power tools, etc.

In respect of expenses amounting to  Rs.1,96,84,115, a provision was created by
the company in its books and the same was disallowed under the provisions of section
40(a)(i)(ia) in computation of total income filed for the assessment year
2012-13. Out of Rs.1,96,84,115, no invoices were received for an amount of
Rs.1,79,36,713 and the said  amount was
reversed in the beginning of the next accounting year. The assessee contended
that no tax was required to be deducted in respect of such amount for which no
invoices were received.

The contention of the assessee was not
accepted by the Assessing Officer by holding that the system of accounting
followed by the assessee was faulty and did not enable any verification. He
held that since the assessee company was following mercantile system of
accounting, tax should have been deducted on the provisions made. Accordingly,
the Assessing  Officer held that the
assessee to be an ‘assessee in default’ u/s. 201(1) of the IT Act and demanded
tax  and interest thereon.

The CIT (A) confirmed the action of the
Assessing Officer by holding that suo-moto disallowance under the
provisions of section 40(a)(ia) did not absolve the assessee from its
responsibility of deducting tax at source. However, the CIT (A) directed the
Assessing  Officer to exclude those
amounts in respect of which TDS had been made on the dates on which invoices
had been raised. 

Before the Tribunal, the assessee
submitted that, as regards the expenses for which the service provider or
vendor had not raised any invoices nor were they acknowledged by the assessee
company, it made a provision for such expenses on a scientific basis and such
provision was debited to its P&L account, in conformity with the provisions
of Accounting Standard 29- Provisions, Contingent Liabilities and Contingent
Assets (AS 29) issued by the Institute of Chartered Accountants of India
(ICAI). Such provision, which was mandatory as per AS 29, was reversed in the
beginning of the next accounting year.

It was argued that:

a.  No
income had accrued to the payees and a mere provision was made in the books of
account at the year end. The very fact that the provision was reversed in the
beginning of the next accounting year showed that no income had accrued to the
payee and therefore, there was no liability to deduct TDS on the basis of mere
provision.

b.  The
payees as well as the exact amount payable to them were not identifiable and
therefore, there was no liability to deduct tax at source.

c.  The
existence/accrual of income in the hands of payee was a pre-condition to fasten
the liability of TDS in the hands of the payer;

d.  The
provisions of section 195 stipulated that the payer had to deduct tax at source
at an earlier point of time, either at the time of crediting to the payee’s
account or at the time of payment of income to the payee. The phrase “whichever
is earlier” would mean that both the events i.e crediting the amount to the
account of payee and payment to the assessee must necessarily occur. Therefore,
when there was no payment made the question of deducting TDS at the time of
crediting did not arise.

Reliance was also placed on the CBDT’s
Instruction No.1215 (F.No.385/61/78 IT(B) dated 08-11-1978.

On behalf of the revenue, it was argued
that on a plain reading of section 195, the liability to deduct tax at source
had arisen the moment the amount was credited in the books of account,
irrespective of fact whether the amount was paid or not. It was  further submitted that the provision of
taxing statutes should be construed strictly so that there was no place for any
inference.

The Tribunal took a view that the liability
to deduct tax at source arose only when there was accrual of income in the
hands of the payee. It relied upon the decision of Supreme Court in the case of
GE India Technology Centre P. Ltd. vs. CIT 327 ITR 456. According to the
Tribunal, the fact that the provisions made at the year-end were reversed in
the beginning of the next accounting year showed that there was no income
accrued. The Tribunal observed that mere entries in the books of account did
not establish the accrual of income in the hands of the payee, as held by the
Hon’ble Supreme Court in the case of CIT vs. Shoorji Vallabhdas & Co. 46
ITR 144.

The Tribunal
accordingly concluded that there was no liability in the hands of the assessee
company to deduct tax at source, merely on the provisions made at the year end.

This order of the
Tribunal has been followed by the Bangalore bench of the Tribunal in the case
of TE Connectivity India Pvt Ltd vs. ITO (ITA 3/Bang/2015 dated 25.5.2016).

OBSERVATIONS

The objective  of inserting the Explanation has been stated
in Circular No. 3/2010 dated 2-3-2010. The relevant portion of this circular is
reproduced below:

Explanation to section 194A was introduced
with effect from 1-4-1987 by the Finance Act, 1987 to plug the loophole of
avoiding deduction of tax at source by crediting interest in the books of
account under accounting heads ‘interest payable account’ or ‘suspense account’
instead of to the depositor’s/payee’s account. (emphasis added)

It is gathered  from the above that, the Explanation applies
where   the interest (or any other amount
to which other provisions of TDS applies) is otherwise required to be credited
to the payee’s account and in order to avoid deduction of tax at source, it has
been credited to some other account, and not to the payee’s account.

A provision for an expense, by its very
nature, can not, in accountancy, be credited to any particular payee’s account;
it is rather to be credited to the Provision Account. The sum which cannot be
credited to the payee’s account as per the accounting principles cannot be
brought within the purview of Explanation so as to  deem to have been credited to the payee’s
account. The possibility to have credited a sum to the payee’s account should
first exist in order to invoke the Explanation. There is a stronger case for
non application of the  Explanation  in cases where the payee is not known in
comparision to the  cases where the payee
is known. Mere non-receipt of an invoice by the assessee cannot result in
claiming that the amount has not accrued to the service provider, particularly
when the contractual terms are also known to the assessee. The TDS provisions
in the later circumstances may be construed to have been avoided or  defeated by crediting an expenditure   to a provision account, instead of to the
payee’s account.

One view that the Explanation is intended
to apply only when the liability to pay that amount has become due is on
account of the language of the Explanation itself. The relevant provision of
section 194C [earlier it was present in the form of an Explanation II to s/s.
(2) but re-enacted as s/s. (2) with effect from 1-10-2009] is reproduced below:

Where any sum referred to in sub-section
(1) is credited to any account, whether called “Suspense account” or
by any other name, in the books of account of the person liable to
pay such income,
such crediting shall be deemed to be credit of such income to the account of
the payee and the provisions of this section shall apply accordingly. (emphasis
added)

The words used in the Explanation are
“person liable to pay such income” in contrast to the “person responsible for
paying” as used in the main provision. Therefore, as per this view, the person
should have become liable to pay the income on which tax is required to be withheld
in order to get covered by the Explanation. 
This view perhaps has a better appeal in cases of section 195 which
bases the obligation on ‘chargeability’ in the hands of the payee.
However, this view may not hold water, when one appreciates that the term
“liable to pay such income” merely qualifies the person who is required to
deduct tax, and not the point of time of deduction of tax. 

As far as disallowance u/s. 40(a)(ia) is
concerned, offering disallowance u/s. 40(a)(ia) cannot absolve the assessee
from his liability u/s. 201(1). Both the provisions, one for disallowance u/s.
40(a)(i) or 40(a)(ia) and the other for treatment of  the assessee as an assessee in default can
co-exist. The Second Proviso to section 40(a)(ia) envisages such a possibility whereby
the assessee can be proceeded against under the provisions of section 201,
apart from disallowing the relevant expenditure on account of his default in
complying with the TDS provisions.

But then, the incidental issue would be as
to whether the provision created in the books of account, for which a view is
taken that tax is not deductible on it, can be subjected  to the disallowance provisions of section
40(a)(i) or 40(a)(ia) or not. These provisions of section 40(a) apply to any sum payable
and on which tax is deductible at source under Chapter XVII-B. It is not the
case that the tax is not deductible at all from the provisions for expenses. It
is only the point of time at which tax is required to be deducted that is in
dispute. Therefore, it would be difficult to take a view that  the claim based on such provisions cannot be
disallowed u/s. 40(a)(i) or 40(a)(ia) merely because tax is not deductible at
present but in future. Otherwise, it would result into granting of deduction in
the year of making provision and making disallowance provision otiose in the
subsequent year in the absence of any claim for its deduction. However,
difficulties would certainly arise in a case where the provision is made for
liability towards unidentified payees. In such case, neither payee is known nor
his residential status is known.

One may however take notice of the
decision of the Mumbai Tribunal in the case of Pranik Shipping &
Services Ltd. vs. ACIT [2012] 135 ITD 233 wherein a view was taken that the
provision of section 40(a) would not apply in cases where the expenditure in
question was claimed in the return of income but was neither credited to the
account of payee nor provided for in the books.

If one looks at the plain reading of the
tax deduction sections, they require tax deduction at source on payment of any
income of specified nature (except in case of section 194C, which requires
payment of any sum). The chargeability to tax of such income is not a
prerequisite, except in case of section 195, which specifically requires such
sum to be chargeable to tax. Therefore, one can distinguish the provisions of
section 195 from the other tax deduction provisions, which do not specify that
such amounts have to be chargeable to tax. The reliance by the Tribunal on GE
Technology Centre’s decision (supra) in Bosch’s case, in relation to 
section 195, may be a good law and may be debatable for provisions other
than section 195.    

The assessees are advised, in the interest of
mitigating litigation to deduct tax at source 
in cases where the services are rendered and the payee is known, even
while making the provisions for expenses on an estimated basis or otherwise.

shailesh.kwebmaker