Is Education Cess on Income Tax a Deductible Expenditure under section 40(a)(ii): There is always a dispute between the income tax department and the assessee in respect of allowability of deduction of ‘Education Cess’ on income-tax. The contention of the department is that cess is a permanently disallowable expenditure under section 40(a)(ii) of the Income Tax Act, 1961 (“Act”) whereas the assessee contends that ‘cess’ is not a ‘tax’ and hence is allowed under section 37(1) of the Act.
The legal position of deductibility of education cess or cess on income tax is discussed at length in this article.
Cess is levied for a specific purpose. The usage of the fund created out of cess is restricted to specific purposes only.
The Education Cess on Income Tax and other indirect taxes was introduced by the Finance Act, 2004 as an additional surcharge. The then Finance Minister Mr. P. Chidambaram while presenting the Union Budget 2004 announced that providing basic education to all children is the government's highest priority. He then proposed to levy a cess called education cess of 2 per cent on income tax, corporation tax, excise duties, customs duties and service tax which will be earmarked for education to include providing a nutritious cooked midday meal.
Presently, the Education Cess is replaced by Health and Education Cess by Finance Act, 2018.
While computing the taxable business income under the Act, various deductions are allowed for expenses that are incurred for the purpose of the business. Certain deductions are allowed on the satisfaction of certain conditions.
Among these, expenses which are in the nature of ‘rate’ or ‘tax’ are specifically disallowed under section 40(a)(ii) of the Act while computing the business income.
Therefore, a question arises as to whether ‘cess’ on income tax would be considered as a ‘tax’ so as to qualify for an item of disallowance under section 40(a)(ii) or it is separate from ‘tax’ and hence is an allowable expenditure from computing business income.
This question arises in the context of provisions of section 40(a)(ii) which inter alia provides that notwithstanding anything to the contrary in sections 30 to 38 of the IT Act, 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 -
(ia)...........................
(ib)................................
(ic) …............................
(ii) any sum paid on account of any rate or tax levied on the profits or gains of any business or profession or assessed at a proportion of, or otherwise on the basis of, any such profits or gains.
[Explanation 1.—For the removal of doubts, it is hereby declared that for the purposes of this sub-clause, any sum paid on account of any rate or tax levied includes and shall be deemed always to have included any sum eligible for relief of tax under section 90 or, as the case may be, deduction from the Indian income-tax payable under section 91.]
[Explanation 2.—For the removal of doubts, it is hereby declared that for the purposes of this sub-clause, any sum paid on account of any rate or tax levied includes any sum eligible for relief of tax under section 90A;]
Recently, a question came up before the Goa Bench of Bombay High Court in the case of SesaGoa Limited vs JCIT in Tax Appeal No. 17/2013.
Therefore, the question which came up before the Hon’ble High Court was to determine whether the expression “any rate or tax levied” as it appears in Section 40(a)(ii) of the Act includes “cess”.
It was contended by the assessee that the expression does not include “cess” and therefore, the amounts paid towards “cess” are liable to be deducted in computing the income chargeable under the head “profits and gains of business or profession” whereas the Revenue contended that “cess” is also included in the scope and import of the expression “ any rate or tax levied” and consequently, the amounts paid towards the “cess” are not liable for deduction in computing the income chargeable under the head “profits and gains of business or profession”.
There are several decisions which lay down the rule that the provision for deduction, exemption or relief should be interpreted liberally, reasonably and in favour of the assessee and it should be so construed as to effectuate the object of the legislature and not to defeat it. Further, the interpretation cannot go to the extent of reading something that is not stated in the provision [AGS Tiber vs. CIT 233 ITR 207].
While ruling in favour of the assessee their Lordship stated that applying the aforesaid principles, we found that the legislature, in Section 40(a)(ii) has provided that “any rate or tax levied” on “profits and gains of business or profession” shall not be deducted in computing the income chargeable under the head “profits and gains of business or profession”. There is no reference to any “cess”. Obviously therefore, there is no scope to accept Ms. Linhares's (D/R) contention that “cess” being in the nature of a “Tax” is equally not deductible in computing the income chargeable under the head “profits and gains of business or profession”. Acceptance of such a contention will amount to reading something in the text of the provision which is not to be found in the text of the provision in Section 40(a)(ii) of the Income Tax Act.
The Bench further observed that if the legislature intended to prohibit the deduction of amounts paid by an assessee towards say, “education cess” or any other “cess”, then, the legislature could have easily included reference to “cess” in clause (ii) of Section 40(a).
By not doing so means that the legislature did not intend to prevent the deduction of amounts paid by an assessee towards the “cess”, when it comes to computing income chargeable under the head “profits and gains of business or profession”.
The Bench further noted the legislative history of the section 40(a)(ii) of the Income Tax Bill, 1961 as introduced in the Parliament which categorically included any cess, rate or tax and therefore specifically included ‘cess’ as a separate item from ‘tax’.
However, the Select Committee of the Parliament decided to omit the word “cess” from the aforesaid clause from the Income Tax Bill, 1961. The effect of the omission of the word “cess” is that only any rate or tax levied on the profits or gains of any business or profession are to be deducted in computing the income chargeable under the head “profits and gains of business or profession”. Therefore, the deletion of the word ‘cess’ is a deliberate action and hence the same cannot be reintroduced in Section 40(a)(ii) of the Act under the guise of interpretation of taxing statute.
CBDT Circular No. F. No.91/58/66-ITJ(19), dated 18th May, 1967 also iterates that the effect of omission of the expression ‘cess’ from the final provision of section 40(a)(ii) is that only taxes paid are to be disallowed in the assessments for the years 1962-63 and onwards. The circular was issued to avoid litigation on the matter.
The High Court appreciated that CBDT Circulars are binding upon the Income Tax authorities and that this circular is consistent with the principles of interpretation of taxing statute.
In the Income Tax Act, 1922, Section 10(4) had banned allowance of any sum paid on account of 'any cess, rate or tax levied on the profits or gains of any business or profession '.
In the corresponding Section 40(a)(ii) of the Income Tax Act, 1961 the expression “cess” is quite conspicuous by its absence.
In fact, legislative history bears out that this expression was in fact to be found in the Income Tax Bill, 1961 which was introduced in the Parliament. However, the Select Committee recommended the omission of expression “cess” and consequently, this expression finds no place in the final text of the provision in Section 40(a)(ii) of the Income Tax Act, 1961.
The effect of such omission is that the provision in Section 40(a)(ii) does not include, “cess” and consequently, “cess” whenever paid in relation to business, is allowable as deductible expenditure.
The deduction in relation to “cess” as claimed by the assessee was allowed in this case.
Before arriving at the conclusion, the High Court also referred to various judicial precedents on the issue and also discussed various principles for interpreting taxing statutes.
The Division Bench of the Rajasthan High Court (Jaipur Bench) in Income Tax Appeal No. 52/2018 decided on 31st July, 2018 in the case of Chambal Fertilisers and Chemicals Ltd. Vs CIT has also ruled in favour of the taxpayer on this issue relying on the aforesaid CBDT circular.
In the following three decisions of the ITAT in which, the decision of the Rajasthan High Court was followed and it was held that the amounts paid by the Assessee towards the 'education cess' were liable for deduction in computing the income chargeable under the head of “profits and gains of business or profession”-
(i) DCIT Vs Peerless General Finance and Investment and Co. Ltd. (ITA No.1469 and 1470/Kol/2019) decided on 5th December, 2019 by the ITAT, Calcutta;
(ii) DCIT Vs Graphite India Ltd. (ITA No.472 and 474 Co. No.64 and 66/Kol/2018 decided on 22nd November, 2019 )by the ITAT, Calcutta;
(iii) DCIT Vs Bajaj Allianz General Insurance (ITA No.1111 and 1112/PUN/2017 decided on 25th July, 2019) by the ITAT, Pune.
Whether ‘Tax’ includes ‘Cess’
The Bench has analysed the order of the ITAT which disallowed the claim of the assessee related to ‘cess’ as business expenditure on the ground that since “cess” is collected as a part of the income tax and fringe benefit tax, therefore, such “cess” is to be construed as “tax”. The High Court did not concur with the reasoning of the ITAT and held that even, though, “cess” may be collected as a part of income tax, that does not render such “cess”, either rate or tax, which cannot be deducted in terms of the provisions in Section 40(a)(ii) of the Act. The mode of collection is really not determinative in such matters.
The High Court also distinguished the Supreme Court decision in the case of M/s Unicorn Industries Vs Union of India and others, 2019 SCC Online SC 1567 wherein it was held that “cess” is nothing but “tax”. It was held that the issue involved in this case was not in the context of provisions in Section 40(a)(ii) of the Income Tax Act. Rather, the issue involved was whether the 'education cess, higher education cess and National Calamity Contingent Duty (NCCD)' on it could be construed as “duty of excise”.
In this case, the issue that the High Court had decided was that the levy of education cess, higher education cess and NCCD could not be included in the expression “duty of excise” and consequently, the amounts paid towards such cess or NCCD did not qualify for exemption under the exemption Notification. This view of the High Court was upheld by the Apex Court.
The Revenue also raised an additional ground so as to disallow the claim of the assessee of allowability of deduction of ‘cess’ on the ground that the assessee did not claim the same in the return of income so filed by the assessee and relied upon the decision in the case of Goetze (India) Ltd. Vs Commissioner of Income Tax (2006) 284 ITR 323 (SC). However, such deduction was claimed by the assessee before the CIT(A) and ITAT. The High Court rejected the claim following the following decisions-
The Revenue also raised an additional ground so as to disallow the claim of the assessee of allowability of deduction of ‘cess’ on the ground that the assessee did not claim the same in the return of income so filed by the assessee and relied upon the decision in the case of Goetze (India) Ltd. Vs Commissioner of Income Tax (2006) 284 ITR 323 (SC). However, such deduction was claimed by the assessee before the CIT(A) and ITAT. The High Court rejected the claim following the following decisions-
(i) Ahmedabad Electricity Co. Ltd Vs CIT (199 ITR 351)
(ii) CIT Vs Pruthvi Brokers & Shareholders Pvt. Ltd. (349 ITR 336)
and distinguished the case of Goetze (supra) and held that in Goetze (supra), the Hon'ble Apex Court was not dealing with the extent of the powers of the appellate authorities but the observations were in relation to the powers of the assessing authority.
After discussing the SesaGoa case, it is imperative to touch upon certain nuances of the issue-
Cess under Other Acts
The Supreme Court held in Jaipuria Samla Amalgamated Collieries Ltd Vs CIT [82 ITR 580] that the expression 'profits or gains of any business or profession' has reference only to profits and gains as determined in accordance with Section 29 of this Act and that any rate or tax levied upon profits calculated in a manner other than that provided by section 29 could not be disallowed under this sub-clause. This implies that cess paid on other taxes under other Acts other than income-tax viz., service tax, excise duty, etc., are allowed as business expenditure while computing the profits or gains of any business or profession.
In Jaipuria’s case (supra), the Hon’ble Supreme Court allowed cess paid under the Bengal Cess Act, 1880, and education cess under the Bengal (Rural 'Primary Education Act, 1930, in relation to the coal mines which the assessee company had taken on lease as deductible expenditure for determining the profits under the Indian Income Tax Act, 1922.
Similarly, in Dehra Dun Tea Co. Ltd. v. CIT [1973] 88 ITR 197, the Supreme Court held that the tax paid by the appellants, tea companies, on their tea garden lands under the U. P. Large Land Holdings Tax Act, 1957, was deductible under section 10(2)(xv) of the Indian Income-tax Act, 1922, in computing their business income and such tax was not a wealth-tax or any of the other taxes referred to in the Explanation to sub-clause (iia) inserted in section 40(a) of the Income-tax Act, 1961, by section 2 of the Income-tax (Amendment) Act, 1972.
Hence, it is a settled principle that ‘cess’ paid under other Acts other than Income Tax is allowed as deduction while computing the profits or gains of any business or profession under the Income Tax Act, 1961.
Deduction of surtax: In Molins of India Ltd. v. CIT [1983] 144 ITR 317, the Calcutta High Court held that the tax imposed by the Companies (Profits) Surtax Act, 1964, was essentially of the same character as income-tax or excess profits tax and liability to pay this tax depends upon whether profits are made or not.
It was held that taxes such as these are not paid for the purposes of earning profits of the trade, but they are an application of those profits after they have been earned.
The Division Bench of the Calcutta High Court also held that surtax was not also allowable in view of the provisions of section 40(a)(ii) of the Income-tax Act, 1961, and the term "tax" in the said provision could not be understood to mean only income-tax. It was held that the tax sought to be imposed on a company by the Companies (Profits) Surtax Act comes within the mischief of section 40(a)(ii).
The other decision is CIT v. International Instruments P. Ltd. [1983] 144 ITR 936 (Kar). The Division Bench of the Karnataka High Court held that the surtax levied on the chargeable profits under the Companies (Profits) Surtax Act, 1964 (hereinafter referred to as the "Surtax Act") was nothing but an additional tax on the profits and gains of an assessee's business and since surtax was a charge on the profits and gains of the business of companies, the company was not entitled to claim deduction of surtax payable by it in computing its total income under the Income-tax Act. This decision does not refer to the decision of the Calcutta High Court and the conclusions have been independently arrived at.
Meaning of the term ‘Tax’: With reference to the definition of "tax" in section 2(43), it was contended that the definition section commences with the usual phraseology "unless the context otherwise requires". Thus, according to the learned counsel for the Revenue, the term "tax" must be given a wide meaning and should not be restricted to mean only "income-tax".
The decision of Madras High Court in the case of Sundaram Industries Ltd. vs CIT reported in (1986) 159 ITR 646 is noteworthy to consider.
The relevant paras from the above judgment is reproduced below-
13. With regard to the construction of section 40(a)(ii), the Calcutta High Court pointed out that the preamble of the Surtax Act stated that the Act was to impose a special tax on the profits of certain companies. It was held that the surtax imposable has to be calculated on the basis of the total income of the assessee-company after making statutory adjustments and if the tax that is sought to be imposed is not on the profits or gains of the business of the assessee, it is certainly levied on the basis of the profits or gains made by the assessee-company in its business and, therefore, it could not be said that the tax sought to be imposed by the Surtax Act will not come within the mischief of section 40(a)(ii) of the Income-tax Act. The decision of the Calcutta High Court is a well considered decision. The Calcutta High Court also negatived the argument which is advanced before us now by Mr. Subramaniam that the definition of "tax" in section 2(43) must be read in section 40(a)(ii) of the Act. The relevant observations are as follows (p. 328 of 144 ITR) :
"We are unable to accept the contention that 'tax' in s. 40(a)(ii) must be understood to mean only income-tax. The definition given in s. 2(43) only will apply 'unless the context otherwise requires'. The expression 'any rate or tax' in s. 40(a)(ii) means any rate or any tax and not income-tax only. That the section is not confined to income-tax only is made clear by the words 'levied on the profits or gains of any business or profession or assessed at a proportion of or otherwise on the basis of any such profits or gains'."
14. The decision of the Calcutta High Court is a well-considered decision and unless it is shown that the view taken by the Calcutta High Court is not at all possible to be taken, we would normally accept that view.
31. It is true that the word "tax" has been defined in section 2(43) as already indicated. But having regard to the purpose and the context in which that word is used in section 40, it is obvious that the words "any rate or tax levied" must be read as "any rate or any tax levied". The word "any" will, therefore, qualify both "rate" and "tax" and once we hold that the word "any" will qualify "tax" also, then "any tax" will necessarily take in taxes other than the tax under the Income-tax Act also. It is also true that the Legislature by a specific amendment brought in by the Income-tax (Amendment) Act, 1972, made wealth-tax also non-deductible by adding a new clause after clause (a) in section 40 follows :
"(iia) any sum paid on account of wealth-tax....." ("Explanation" is not relevant for our purpose).
32. This amendment has given rise to an argument that where the Legislature contemplated that certain taxes should not be deducted for the purpose of computation of total income, which has been specifically so enacted, and since reference is made only to wealth-tax, the other taxes, if any, must necessarily be considered as deductible. The argument cannot be accepted because we have to construe section 40(a) and its clauses harmoniously and if in view of the general provision in section 40(a)(ii) it would not be permissible to allow surtax to be deducted, merely because wealth-tax alone is mentioned by an amendment, the scope of the general provision in section 40(a)(ii) cannot in any way be restricted. Having considered the arguments of the learned counsel for both the assessees, we must, therefore, hold that the amount of surtax paid or payable by the assessee-company was not deductible under section 37 and further that section 40(a)(ii) also prohibited such a deduction.
Hence, the term ‘surtax’ under the Surtax Act is a tax for the purpose of section 40(a)(ii) and hence is not allowable as a deduction from computing the profits or gains of any business or profession.
Tax paid in another country
Finance Act, 2006 inserted an Explanation 1 to section 40(a)(ii) of the Income Tax Act,1961 to clarify that any rate or tax includes any sum eligible for relief of tax under section 90 or deduction from the Indian income-tax payable under section 91 is not allowable as a deduction under section 40(a)(ii) of the Income Tax Act.
In other words, tax paid on foreign income outside India is not allowed as a deduction under section 40(a)(ii).
Section 90 deals with the situation where there is DTAA with the foreign country and section 91 deals with foreign tax credit where there is no DTAA with the other country.
However, taxpayers will be eligible for tax credit in respect of Income Tax paid on foreign income in a foreign country in accordance with the provisions of section 90 or section 91.
Prior to the 2006 amendment, there were judicial conflicts as to whether tax paid in a foreign country is allowed as a deduction under section 37(1) or is covered within the meaning of ‘tax’ under section 40(a)(ii). The amendment has brought an end to such judicial conflicts.
ITAT Ahmedabad Bench in the case of DCIT vs Elitecore Technologies Private Limited (ITA No. 508/Ahd/2016) held that income-tax deducted outside India, cannot be allowed as a deduction under Section 37(1) of the Income-tax Act, 1961 (the Act) since the same is covered under the disabling provisions of Section 40(a)(ii) of the Act.
On the contrary, in another case, DCIT v. Mastek Limited [2013] 36 taxmann.com 384 (Ahd) the same ITAT Ahmedabad Bench held that taxes paid abroad can be allowed as a deduction under Section 37(1) of the Act. without taking note of the decision of the Bombay High Court in the case of Lubrizol India Limited v. CIT [1991] 187 ITR 25 (Bom), which has been approved by the Supreme Court in the case of Smithkline & French India Ltd v. CIT [1996] 219 ITR 581 (SC), or even decision in the case of DCIT v. Tata Sons Ltd [1991] 9 ITR (Trib) 154 (Bom).
Tax referred to in Section 40(a)(ii)
In the case of Lubrizol India Ltd. v. CIT [1991] 187 ITR 25(Bom) their Lordships have observed as follows-
It is significant to note that the word "tax'; is used in conjunction with the words "any rate or tax", The word "any" goes both with the rate and tax. The expression is further qualified as a rate or tax levied on the profits or gains of any business or profession or assessed at a proportion of, or otherwise on the basis of, any such profits or gains. If the word "tax" is to be given the meaning assigned to it by s. 2(43) of the Act, the word "any" used before it will be otiose and the further qualification as to the nature of levy will also become meaningless. Furthermore, the word "tax" as defined in s. 2(43) of the Act is subject to "unless the context otherwise requires". In view of the discussion above, we hold that the words "any tax" herein refers to any kind of tax levied or leviable on the profits or gains of any business or profession or assessed at a proportion of, or otherwise on the basis of, any such profits or gains.
The High Court rejected the contention of the assessee that the ‘tax’ referred to in section 40(a)(ii) only refers to ‘income-tax’ as defined in section 2(43) of the Income Tax Act, 1961.
Tax includes Cess in case of MAT u/s 115JB
Explanation 1 to section 115JB requires to add back the amount of income-tax to the book profit as determined under section 115JB(1).
Explanation 2 to Section 115JB clarifies that the said amount of income-tax shall inter alia include ‘Education Cess’.
Hence, in case of Minimum Alternative Tax (MAT), the term ‘tax’ includes ‘cess’ in view of specific provision in the Act.
This further fortifies the view that if the legislation intends to include ‘cess’ in ‘tax’, express provision should have been made in the statute.
Conclusion
The term ‘tax’ is very wide in concept and is not limited to income-tax only. Further, the term ‘tax’ is subject to different interpretations under different circumstances.
The Supreme Court in the case of CIT v. K. Srinivasan (83 ITR 346) held that the words "income-tax" would include surcharge and additional surcharge namely, super-tax. However, this decision was rendered in the context on the applicability of surcharge and super-tax on income-tax under the Finance Act, 1964 with reference to sub-section 2(a) and sub-section 2(b) of section 2 of the Finance Act 1964. It was not related to ‘cess’ and ‘cess’ is different from ‘surcharge’, although super-tax was levied as an additional surcharge. Presently, ‘Cess’ is also introduced as an “additional surcharge”.
Section 40(a)(ii) refers to any rate or any tax which gives it a wider scope in meaning. Though the Bombay High Court and the Rajasthan High Court has favoured the issue in favour of the assessee however it may be noted that the question is not out of litigation. Therefore, one should study carefully his own case before availing any advantage of these decisions.
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