The authors of this article have taken up the controversy around section 40(a)(ia ) of the Income-tax Act, 1961 and have opined that in the absence of any clarification on the issue by the CBDT overburdened Courts may have to ultimately settle the controversy.

Introduction

1. Section 40(a )(ia) was introduced in the Income-tax Act, 1961 by the Finance Act, 2004 w.e.f. 1st April, 2005. The said provision was introduced to augment the revenue through the mechanism of Tax Deduction at Source, since this provision is in the nature of a penal provision. It disallows the claim of even genuine and admissible expenses claimed by an assessee under the head "Income from Business & Profession" if the assessee does not deduct TDS on such an expense. Hence, the default in deduction of TDS would result in not only penal provision getting attracted as provided for under section 202 of the Income-tax Act but would also result in disallowance of the expenditure on which such TDS was deductible.

Challenge to the Constitutionality of the said provision

2. The above introduction into the statute met with a serious backlash with the assessee challenging the constitutionality of the said provision before the Madras High Court in the case of Tube Investments of India v. Asstt. CIT [2009] 325 ITR 610/185 Taxman 458. However, the Court rejected the said challenge and upheld the validity of section 40(a)( ia) and the competence of the Legislature in enacting such a provision on the ground that the said provision had been introduced in order to augment tax through the mechanism of TDS and section 40(a)( ia) was in furtherance to the said objective.

The appellate courts have been inundated with appeals against Assessing Officer's action in invoking the provisions of section 40(a)( ia) of the Act. One of the grounds agitated against the disallowance made by invoking section 40(a)( ia) is that it is applicable only to amounts which are outstanding at the end of the year, i.e., the amounts payable. This provision cannot be applied to the expenses actually "paid" during the year. This argument is being accepted by the Courts and has the effect of taking the sting out of the provision.

The authors concur with the above view and through the medium of the present article deal with some precedents and also highlight certain additional arguments in favour of this view.

What the provision says

3. Let us see what the provision says:

"40. 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 that where in respect of any such sum, tax has been deducted in any subsequent year, or has been deducted during the previous year but paid after the due date specified in sub-section (1) of section 139, such sum shall be allowed as a deduction in computing the income of the previous year in which such tax has been paid."

The provision clearly uses the term "payable" and not "paid". Hence, as per the literal construction no word can be substituted in place of the said word nor can any new word be supplied in the provision by the Courts.

The language of the provision has thrown open the two terms "paid" and "payable" for judicial interpretation. Now let us see the meaning of terms "payable" and "paid" as defined in various judicial dictionaries.

Oxford dictionary defines the terms "payable" and "paid" as under:

u payable (pay-a-ble) adjective [ predic.]

1.(of money) required to be paid; due: interest is payable on the money owing send a check, payable to the ASPCA

2.able to be paid: it costs just $195, payable in five monthly instalments

Noun

(payables)

debts owed by a business; liabilities.

u Paid: Past and past participle of PAY.

According to Black's Law Dictionary (Seventh Edition) at p. 1150, the term 'payable' is defined as a sum of money that is to be paid. Another meaning to the term "payable" is given as under:

"An amount may be payable without being due. Debts are commonly payable long before they fall due."

According to West's Legal Thesaurus/Dictionary Paid : means pay. To discharge a debt. Payable : means Justly or legally due (payable immediately). Uncollected (Outstanding debts). Unpaid, undischarged, unsatisfied, unsettled, mature, owed, ripe, collectable, in arrears, redeemable.

Some judicial precedents

4. In view of the above discussion let us consider some precedents on the subject-matter.

In an earliest decision in the case of Teja Constructions v. Asstt. CIT [2010] 129 TTJ (Hyd.) (UO) 57 the ITAT interpreted the provisions of section 40(a)( ia) by applying the literal construction. It held that only those expenses can be disallowed which are "payable" at the end of the year, because the provision of section 40(a)(ia ) uses the term "amounts payable" and not "amounts paid". Hence, only those expenses can be disallowed, for default in deducting tax at source, which have not been actually spent by the assessee, though claimed in its books of account maintained on mercantile system of accounting. Similar view has again been taken by the Hyderabad Bench of the ITAT again in the case of K. Srinivas Naidu v. Asstt. CIT[2010] 131 TTJ (Hyd.) (UO) 17.

The above decision of the Hyderabad ITAT was followed subsequently in the case of Jaipur Vidyut Vitran Nigam Ltd. v. Dy. CIT [2009] 123 TTJ (Jp.) 888. The Jaipur ITAT held that as per the CBDT’s Circular No. 5 of 2005, dated 15th July, 2005 the purpose of introducing section 40(a )(ia) was to augment TDS compliance and to curb bogus payments. Hence, the payments which have been made and not found to be bogus cannot be disallowed by invoking section 40(a)( ia) of the Act. The ITAT held that the bare provisions of section 40(a)( ia) provide for non-deduction of amount which remains payable to a resident in respect of fees for technical services, etc. It is not applicable where expenditure is paid. It is applicable only in cases where payments are due and outstanding. The word, ‘payable’ is not defined, though the word ‘paid’ is defined under section 43(2) to mean actually paid or incurred. Hence, by implication the word "payable" does not include paid or incurred. It placed reliance upon the decision of Teja Construction’s case (supra).

In the case of Mrs. Shah Charulata Milind vide ITA No. l318/PN/2008 the Pune Bench of the Tribunal held that provisions of section 40(a)( ia) are not applicable for the reasons that they were applicable only when amount is payable. It reversed the order of the Assessing Officer and the CIT(A) who had disallowed the amount of Rs. 40,000 by invoking provisions of section 40(a)( ia).

The Revenue’s arguments

5. The Revenue argued that above interpretation will throw up an anomalous situation. As per the revenue if the disallowance under section 40(a)( ia) is restricted to amounts payable then if in the subsequent year such provision is actually paid off without deducting TDS or depositing the same the revenue would lose its right to disallow such an expense. This would render the provision of section 40(a )(ia) otiose and its avowed objective of augmenting revenue through the compliance of TDS provision would fall flat.

According to the authors this argument of the Revenue does not have any merit. Payment of earlier years' outstanding expense cannot be allowed in subsequent year, unless specifically provided for in the statute. Provision of section 40(a)( ia) lays down that the earlier years provision can be allowed in the subsequent year only if the TDS is deducted and deposited. Hence, the revenue's fear is unfounded and the provision of section 40(a)( ia) adequately covers the situation.

Another argument taken by the Revenue was that section 40(a )(ia) would fail where the assessee is maintaining books on cash system. This is because there would be no amount claimed as expense for outstanding or payable amount. The answer to this argument of the Revenue is in their argument itself. When the assessee has itself not claimed the expense which is outstanding there could be no reason to disallow the same. Secondly, the Income-tax Act, already has a precedence in section 43B of the Act which allows expenses only on payment basis. Therefore, the argument of the Revenue that section 40(a)(ia ) would become otiose in cash system of accounting was without any basis.

Differing decision of the Kolkata ITAT

6. Another view has been taken by the Kolkata ITAT in the case of Matrix Glass & Structures ( P.) Ltd. [ITA No. 658 (Kol.) 2010]. The Bench held that the argument of the counsel of the assessee that disallowance under section 40(a)( ia) can be made only on "payable" amount cannot be accepted. The Tribunal went on to hold that such an interpretation would defeat the very purpose of enacting the said provision. According to the Bench even if the sum payable is paid and TDS is not deducted and/or deposited, the provisions of section 40(a)( ia) would be attracted. It was further held that when the literal construction produces unjust or unwarranted or absurd result then such literal construction has to be given a go by for the sake of implementing the provision.

The above differing decision of the Kolkata ITAT raises a very vital controversy. On an analysis of the language of section, the dictionary meaning of the terms used and judicial precedents a question arises whether the interpretation made by the Hyderabad Bench of the ITAT and Jaipur ITAT was as intended by the Legislature or whether the Kolkata ITAT is right in its interpretation? The answer is within the pages of statute books and easily decipherable.

Proposed provision vis-à-vis its actual enactment

7. Let us look at how this provision was proposed in the Finance Bill, 2004 and compare it with what was finally enacted after the President's assent to the same in the Finance Act.

On a comparison between the proposed and the enacted provision the only conclusion which can be reached is that the Legislature consciously replaced the word "amounts credited or paid" with the word "payable" in the final enactment and such change was done with a purpose. It is a basic presumption that an enactment brought in by the Legislature is well thought of and properly worded in order to give meaning to its intent. 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 is sought to be disallowed in the event there is a default in following the obligation laid under section 195 of the Act.

Conclusion

8. Even the interpretationary tools as applied by the Kolkata Bench while dealing with the controversy around section 40(a)( ia) seems to be incomplete. The Bench has not considered the decision of the Apex Court in the case of State of Andhra Pradesh v. Andhra Provincial Potteries Ltd.,(AIR 1973 SC 2429) wherein the Court held as under:

"... where the words of the section are very clear it is unnecessary to consider whether it embodies any principle and whether that principle is consistent with the principle as embodied in certain other sections which are differently worded. In interpreting a penal provision it is not permissible to give an extended meaning to the plain words of the section on the ground that a principle recognized in respect of certain other provisions of law required that this section should be interpreted in the same way".

The above judicial controversy would settle down only if the CBDT comes out with an explanatory Circular on the said issue. However, clarifying on the controversial interpretation is not the strong point of the CBDT of late. Alas, already overburdened Courts may have to ultimately settle this controversy and till then the taxpayer will have to go through long drawn out legal battles and face pressure of demand of disputed taxes from the tax recovery officers.