Consequence of failure to deduct tax: Revisiting Mahindra & Mahindra decision (SB)


Introduction

As per the provisions of section 40(a)(i)/(ia) of the Income-tax Act, 1961 (hereinafter "IT Act"), where any expenditure is incurred on which tax is deductible at source under the provisions of Chapter XVII-B of the IT Act (TDS / Withholding tax provisions) and such tax has not been deducted or, after deduction the same has not been deposited with the Government treasury, on or before the due date of filing of return of income, it shall not be allowed deduction (disallowance restricted to 30% in case expenditure is incurred towards a resident) in the computation of income under the head ‘Profits and gains of business or profession’. Further, owing to such failure to withhold / deposit taxes, the payer is deemed to be an assessee in default as per section 201(1) of the IT Act. 

However, the first proviso to section 201(1) of the IT Act states that the payer shall not be deemed to be an assessee in default in cases where the resident payee to whom payment has been made/ to be made without deducting tax has furnished its return of income after taking into account such sum on which taxes have not been withheld and pays the appropriate tax due thereon. 

Further the second proviso to section 40(a)(ia) of the IT Act provides that the payer would not be considered as an assessee in default according to the first proviso to section 201(1) of the IT Act and taxes shall be deemed to have been deducted and paid, on the date on which the tax return is furnished by the ‘resident’ payee.

For the purposes of this post, the analysis is limited to analyzing liability u/s 201 of the IT Act.

Triggering liability u/s 201 of the IT Act

In case of Mahindra & Mahindra v. DCIT (Special Bench and Bombay High Court) certain services were rendered by a tax non-resident (hereinafter “NR”) to an Indian tax resident (hereinafter “R”). The resident payer did not deduct tax at source (hereinafter “TDS”) since it regarded the said payment as business income which in absence of a business connection (according to the domestic law) is not exigible to tax. However, the tax department re-characterized the transaction in the nature of Fees for technical services (hereinafter “FTS”) and chargeable to tax. 

While the proceedings u/s 201 of the IT Act were initiated within a reasonable time frame (before the expiry of the assessment time limit in the hands of NR) the Revenue Authorities did not take any steps to recover the tax amount from the recipients and according to the time lapsed for the said recovery. The question framed in this regard is whether the Assessing Officer (hereinafter “AO”) has the jurisdiction to make an order u/s 201 where the assessment cannot be initiated against the NR. To answer this question, the Special Bench Order has answered it in two prongs. Firstly, Whether the Order u/s 201 of the IT Act was passed within a reasonable time and; secondly, did the AO have the jurisdiction to pass an Order u/s 195 read with S. 201 of the IT Act? The analysis of this post is confined to the latter question of law. 

The basis of the Special Bench decision on the question of jurisdictions rests on the obligation of the payer to deduct and deposit such taxes to the Government treasury. The liability arises in the hands of the payer only should the income is assessable to tax in hands of the payee/recipient in India. Where no assessment can be made against the payee for a period of limitation against assessment has expired the proceedings u/s 201 of the IT Act cannot be launched.

A curious case may flow from the aforesaid ratio wherein since the primary liability vested on the payee and that stands time-barred (should?) the tax is refunded back to him. The Hon’ble Mumbai Tribunal in Merchant Shipping Services [2011] 129 ITD 109 (Mum) held that:

“The liability of the person responsible is dependent upon the deductee failing or otherwise to pay such tax directly. Thus the action under section 201(1) is dependent on the outcome of the assessment of the payee and the time-limit for passing order under section 201(1) has to be viewed in the light of the fate of the assessment in the hands of the recipient. Logically the person responsible for paying sum chargeable to tax can be treated as assessee in default at any time prior to the assessment of the payee or the time available for the making of the assessment of the payee. If the persons responsible is deemed to be an assessee in default after the assessment of the payee or the time available for making assessment has expired then such amount of tax will be incapable of adjustment against tax liability of the payee and would require return to such person who has been treated as assessee in default. Thus both the initiation of proceedings under section 201(1) as well as the completion of such proceedings by passing order have to be prior to the time-limit within which the tax can be determined in the hands of the payee. It cannot be beyond such period.”

Notwithstanding the above, prosecution risk survives. Further, the correctness of the above claim is doubted in the light that where if the payee would not be entitled to refund of TDS if there is no assessment as held by the Apex Court in CIT v. Shelly Products wherein the assessee preferred refund of income-tax paid by them (by way of advance tax and self-assessment tax) in the event of assessment framed being nullified by the Tribunal on the ground of jurisdiction and there being no possibility of framing a fresh assessment. Following the same, it is highly unlikely that payer would be entitled to claim a refund. 

The decision in Shelly Products (supra) provides for a ratio that the assessee would be entitled to claim a refund of only that part of the tax which is paid in excess of the income returned. The charge of TDS does not fail if there is no computation of Income. Section 4 creates such a charge on advance tax and TDS. The ITAT in Mahindra & Mahindra (supra) held that liability does not extinguish for want of action of the Government against its recovery. 

Conclusion

The Special Bench Order (supra) was appealed before the Hon’ble High Court of Bombay (supra) however, the limited issue before the Hon’ble Court was whether reasonable time can be read into (?) a provision where the provision does not envisage for time limit. The High Court returned in affirmative. The SLP on the same is pending before the Supreme Court. 

Therefore where assessment is not time-barred the Special Bench Order (supra) may not have any applicability. 

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