Accrual system of Accounting, also known as the mercantile system of accounting, is a system of accounting wherein the transactions are recognized and recorded when revenue is earned and the expenses are reported when they are incurred. Taxpayers following ‘Accrual basis of accounting’ are required to make provisions of various expenses viz., audit fees, other professional fees and various other expenses at the year-end of the accounting year.
At the end of the reporting period which is month-end or quarter-end or year-end, business enterprises are required to make many accounting entries which as a matter of prudence are recognised in the books to reflect the true and correct state of affairs of the enterprise. The principles of various Accounting Standards and Guidance Notes issued by the Institute of Chartered Accountants of India (ICAI) in this regard is the guiding factor.
Many times, it is not possible to quantify the amount to be recognized as expenses and a provision for the expenses is made in the books of accounts on some reasonable estimates. Many a time, even the identity of the payee is not known at the time of passing the provisional entry in the books.
The accounting entry for provision of expenses is made to ascertain the true profit of the company which in turn affects the computation of taxable profits/income of the enterprise.
Under AS-29 issued by the ICAI under the title “Provisions, Contingent Liabilities and Contingent Assets”, the terms “Provision” and “Liability” are defined as under:-
A Provision is a liability which can be measured only by using a substantial degree of estimation.
A liability is a present obligation of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits
The Accounting Standard further states as to when a provision should be recognised. It is stated as under:
A provision should be recognised when:-
(a) an enterprise has a present obligation as a result of past event;
(b) it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and
(c) a reliable estimate can be made of the amount of the obligation.
If these conditions are not met, no provision should be recognised.
The article analyses the issue of the applicability of TDS on such year-end provisions of expenses and consequently allowability of such provisions for expenses for tax purposes. The law on the subject matter is discussed with the help of judicial precedents.
Legislative framework of TDS
Under the Income Tax Act, 1961, a person is required to deduct tax at source at the prescribed rate if the certain payments or credit exceeds specified threshold limits in a financial year. Certain provisions require deduction of tax where any income 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 the credit of such income to the account of the payee and the respective TDS provisions shall apply accordingly.
The charging section, section 4 of the Income Tax Act, 1961 provides for the basis of charge of income tax on the total income of a previous year. According to section 4(1), where any Central Act enacts that income-tax shall be charged for any assessment year at any rate or rates, income-tax at that rate or those rates shall be charged for that year in accordance with, and subject to the provisions (including provisions for the levy of additional income-tax) of, this Act in respect of the total income of the previous year of every person.
The proviso to sub-section (1) provides that where by virtue of any provision of this Act income-tax is to be charged in respect of the income of a period other than the previous year, income-tax shall be charged accordingly.
Sub-section (2) of section 4 provides that in respect of income chargeable under sub-section (1), income-tax shall be deducted at the source or paid in advance, where it is so deductible or payable under any provision of this Act.
Therefore, from the plain language of section 4(1), income-tax is a charge on total income of a previous year of a person. As per section 4(2), such income tax shall be paid by way of advance tax or TDS. In case of TDS, the deduction shall apply only when the same is deductible under any provisions of the Income Tax Act.
Further, section 190(1) provides that the tax on total income shall be inter-alia payable by deduction or collection at source in accordance with the provisions of Chapter XVII. Section 190(2) makes it clear that the provisions of section 190(1) would not prejudice the charge of tax under the provisions of Section 4(1) of the Act which signifies that the deduction or collection of tax is only a mode of payment or recovery of tax payable by a person on his total income of the previous year.
Deduction of tax assumes importance because of various penal provisions enumerated in the Act. According to section 201, where a person is required to deduct tax or fails to deposit the tax into the government account shall be deemed to be an assessee-in-default. Such a person shall be liable to pay interest as per the provisions of section 201(1A). Further, such a person shall be liable for other penalty and prosecution proceedings under this Act.
Further, failure to deduct tax attracts disallowance under section 40(a)(ia).
It should be remembered that one of the conditions of treating a person shall be deemed to be an assessee-in-default when the person does not deduct tax when the person is required to do so. A question thus arises whether a person is required to deduct tax (TDS) on the amount of year-end provision of expenses under the following circumstances-
1. When the payee is known but the amount of payment is not certain
2. When the identity of the payee is not ascertained
There are certain situations where the payer credits the income or makes a provision of expenses but the identity of the payee or the receiver of income is not known. In such a case, it is not possible for the assessee to deduct the tax on the provisions of expenses. This is because the TDS is nothing but the payment of tax by the deductor on behalf of the deductee/payee. And if the identity of the payee is not known then the tax cannot be depicted in the name of the payee.
Consider a case where a Bank has accepted fixed deposits in the name of Registrar General of the High Court and issued a fixed deposit receipt in compliance with a direction passed by the court in relation to certain proceedings.
The issue under consideration is whether the bank is required to deduct tax at source on the amount of interest paid or payable on fixed deposits in the name of Registrar General of High Court.
Under section 194A, a bank is obliged to deduct tax at source in respect of any credit or payment of interest on deposits made with it if it exceeds the threshold limit.
The expression "payee' under section 194A would mean the recipient of income whose account is maintained by the person paying interest. However, in this case, the actual payee is not ascertainable and the person in whose name the interest is credited is not a person liable to pay tax under the Act. The Registrar General is recipient of neither the amount credited to his account nor to interest accruing thereon. Therefore, he cannot be considered as a 'payee' for the purposes of section 194A. In the absence of a payee, the machinery provisions for deduction of tax from the interest credited become ineffective. The credit by the bank in the name of the Registrar General would, thus, not attract the provisions of section 194A.
As per the scheme of TDS under Chapter XVII-B Section 199, the credit for the TDS is to be given to the deductee. Thus, the identification of the person from whose account income tax was deducted at source is a prerequisite condition so as to make the provision for Chapter XVII-B workable. Tax deducted at source is considered to be tax paid on behalf of the person from whose income the deduction was made and, therefore, the credit for the same is to be given to such person. When the payee is not identifiable, to whose account the credit for such TDS is to be given. Section 203(1) lays down that for all tax deductions at source, the tax deductor has to furnish a certificate to the person to whose account such credit is to be given. Therefore, when the tax deductor cannot ascertain the payee who is the beneficiary of a credit of tax deduction at source, the mechanism of Chapter XVII-B cannot be put into service.
This issue came up before the Delhi High Court in the case of UCO Bank vs. DCIT (2014) 369 ITR 335.
In this case, the Court had directed one of the Parties to the Suit to deposit certain sums in the High Court. The amount was invested in Fixed Deposit by the Registrar General of the High Court with UCO Bank. On such fixed deposits the interest was credited by UCO Bank in its books in the name of Registrar General of the High Court. The TDS wing of the Income Tax Department in the survey proceedings held the Bank to be an assessee-in-default for non-deduction of tax u/s 194A of the Act since the Bank did not deduct any tax from the interest on FDs.
It was the Bank's case that since the Registrar General was merely a custodian of the funds on behalf of the High Court and Registrar General per se was neither an assessee nor he was beneficiary entitled to receive any interest on the fixed deposits, the Bank had no obligation to deduct tax at source because the Registrar General was not the payee of the interest.
Upholding the contention of the Bank, the Court observed that the deposits kept with the Bank under the Court's order essentially were the funds in custodia-legis and therefore even the interest credited in the name of Registrar General formed part of the funds under the custody of the Court & therefore not liable to be taxed as income of the Registrar General in whose name the fixed deposit was made. The Court therefore held that the Bank had no obligation to deduct tax at source.
It was held that the words "credit of such income to the account of the payee" occurring in Section 194A of the Act have to be ascribed meaning in conformity with the scheme of the Act and that would necessarily imply that deduction of tax bears nexus with the income of an assessee.
Therefore for making the machinery provisions for deduction of tax-effective, it is imperative that there must be payment or credit of income and assessee or person to whom such payment or credit is being made. In absence of an ascertainable assessee, the machinery of recovering tax by deduction of tax at source breaks down because it does not aid the charge of tax under Section 4 but takes a form of a separate levy, independent of other provisions of the Act which is impermissible.
Similarly, in the case of Dishnet Wireless Ltd. vs. DCIT (2015) 154 ITD 827 (Chennai - Trib.), it was held that when the tax deductor cannot ascertain the payee who is the beneficiary of credit of tax deduction at source, the mechanism of Chapter XVII-B cannot be put into service. If the payee is identifiable and the amount payable to him is ascertainable, then the assessee would be required to deduct tax at source in respect of such provision. However, in case payee is not identifiable, the provision of Chapter XVII-B related to deduction at source, cannot be pressed into service and, therefore, the assessee is not required to deduct tax at source in such a case.
In this case, the assessee made provision for expenses for dismantling towers and restoration of site to its original position after the termination of lease period but the ultimate payees could not be identified on the last day of the financial year.
Followed in Devesh N Jani vs. ACIT (ITA No. 6391/MUM/2014) decided on 11/04/2017. In this case, an ad-hoc provision of expenses of Rs. 1.15 crores were made on the basis of probable work to be done as certified by the architect on 31.03.2011. Payee for the said expenses was not determined as on 31.03.2011. The learned CIT(A) observed that in the AO had not disputed that the questioned amounts represented provision. Therefore, the said amounts could not have been credited to any individual payee's account nor could have been paid as the concerned payee, till the end of the financial year was not identified and an exact amount in respect of such payee was not quantified. In view of the above, the learned CIT(A) deleted the disallowance of Rs. 43,64,515/- made by the AO u/s 40(a)(ia) of the Act.
The ITAT Mumbai restored the matter to the file of the AO with a direction to verify whether the payee is identifiable and the amount payable to him is ascertainable. Then the assessee would be required to deduct tax at source in respect of such provision. However, in case payee is not identifiable, the provision of Chapter XVII - B i.e. tax deduction at source cannot be pressed into service and, therefore, the assessee is not required to deduct tax at source in such a case. The AO had to adjudicate the issue afresh after examining the above facts.
Further, in the case of Industrial Development Bank of India vs. ITO [2007] 107 ITD 45 (Mum.-Trib.) it was held as follows-
"the liability of tax deduction at source is in the nature of a vicarious or substitutionary liability, which presupposes existence of a principal or primary liability. Chapter XVII-B is titled: 'Collection and recovery of tax - deduction of tax at source: This title also indicates that the nature of tax deduction at source obligation is obligation for collection and recovery of tax. Under the Act, tax is on the income and it is in the hands of the person who receives such income, except in the case of dividend distribution tax which is levied under section 115-0, a section outside the Chapter providing for collection and recovery mechanism and set out under a separate chapter 'Determination of tax in certain special cases - special provision relating to tax on distributed profits of domestic companies: A plain reading of section 190 and section 191, which are first two sections under the Chapter XVII, and of sections 199, 202 and 203(1), would show this underlying feature of the tax deduction at source mechanism. Section 190 makes it clear that the scheme of tax deduction at source is one of the methods of recovering the tax due from a person and it is notwithstanding the fact that the tax liability may only arise in a later assessment year. The tax liability is obviously in the hands of the person who earns the income and tax deduction at source mechanism provides for method to recover such tax liability. Therefore, this tax deduction at source liability is a sort of substitutionary liability. Section 191 further makes this position clear when it lays down that in a situation TDS mechanism is not provided for a particular type of income or when the tax has not been deducted at source in accordance with the provisions of Chapter XVII, income tax shall be payable by assessee directly. This provision, thus, shows that tax deduction liability is a vicarious liability and the principal liability is of the person who is taxable in respect of such income. Section 199 makes it even more clear by laying down that the credit for taxes deducted at source can only be given to the person from whose income the taxes are so deducted. Therefore, when tax deductor cannot ascertain beneficiaries of a credit, the tax deduction mechanism cannot be put into service. Section 202 lays down that tax deduction at source provisions are without any prejudice to any other mode of recovery from assessee, which again points out to the tax deduction liability being vicarious liability in nature. Section 203(1) then lays down that for all tax deductions at source, the tax deductor has to furnish to the person to whose account such credit is given or to whom such payment is made or the cheque or warrant it issued which presupposes that at the stage of tax deduction the tax deductor knows the name of person to whom the credit is to be given, though whether by way of credit to the account of such person or by way credit to some other account. This again shows that tax deduction at source liability is a vicarious liability to pay tax on behalf of the person who is to be a beneficiary of the payment or credit, with a corresponding right to recover such tax payable from the person to whom credit is afforded or payment is made. Thus the whole scheme of tax deduction at source proceeds on the assumption that the person whose liability is to pay an income knows the identity of the beneficiary or the recipient of the income. It is a sine qua non for a vicarious tax deduction liability that there has to be a principal tax liability in respect of the relevant income first, and a principal tax liability can come into existence when it can be ascertained as to who will receive or earn that income, because the tax is on the income and in the hands of the person who earns that income. Therefore, tax deduction at source mechanism cannot be put into practice until identity of the person in whose hands it is includible as income can be ascertained. It is indeed correct that Explanation to section 193 lays down that even when an income is credited to any account 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, but the fact that the credit to any account is to be deemed to be credit of the payee's account also presupposes that identify of the payee can be ascertained. Therefore, this deeming fiction can only be activated when the identity of the payee can be ascertained. Therefore, the Explanation to section 193 cannot be invoked in a case where the person who is to receive the payment cannot be identified at the stage at which the provision for interest accrued but not due is made. This position is also accepted by the CBDT in its letter dated 5-7-1996 addressed to the Tata Iron & Steel Co. Ltd (Letter No.257/126 IT(B). In the instant case, the regular return bonds being transferable on simple endorsement and delivery and the relevant registration date being a date subsequent to the closure of books of account, assessee could not have ascertained the payees at the point of time when the provision for "interest accrued but not due" was made. Accordingly, no tax was required to be deducted at source in respect of the provision for interest payable made by assessee which reflected provision for interest accrued but not due" in a situation where the ultimate recipient of such 'interest accrued but not due' could not have been ascertained at the point of time when the provision was made. Assessee had duly deducted the tax source at the time of payment i.e. on 9.6.1994 and there was no loss of revenue as such. Therefore, assessee did not have any liability to deduct tax at source in respect of provision for interest accrued but not due in respect of regular return bonds, made on 31.3. 1994. When there was no obligation to deduct tax at source, there could not be any question of levy of penalty or interest."
Further, in Alliance Media & Entertainment Ltd. vs. ITO (2017) 163 ITD 627 (Mum. Trib.)/ITA Nos. 5947 & 5570/MUM/2014, the ITAT allowed the appeal of the assessee held that provisions made for payments to artists in connection with a movie and where assessee could not identify the artists, i.e., payees to whom amounts to be paid, and also quantum of amounts to be paid to artists was not fully crystallised and was subject to negotiation, assessee had no liability to deduct tax at source in respect of provision so made.
On the contrary, the Cochin Bench of ITAT in the case of Abad Builders (P) Ltd. vs. ACIT (ITA 140/COCH/2012) decided on 06.11.2013 : 128/62 SOT 106 has held that tax is to be deducted even in respect of provision for expenses. The learned Members of the ITAT held as under:
"6.2 A careful reading of the provisions of sec. 194C would show that any person responsible for paying any sum to any resident for carrying out any work in pursuance of a contract, shall deduct the tax at source either at the time of credit of the same to the account of the contractor or at the time of payment thereof, whichever is earlier. It is further provided in Explanation 2 of sec. 194C, which existed at the relevant point of time, that the said TDS liability would arise even if the amount is credited to any account whether called suspense account or called by any other name. In the instant case, the ld.CIT(A) has observed that the assessee's claim for deduction of very same amount in the succeeding year was allowed, since the assessee had deducted tax at source thereon in that year. This fact shows that the assessee is accepting the position that the provision for expenses so made is susceptible for deduction of tax at source. Further, the provisions of sec. 194C clearly states that the assessee is liable to deduct tax at source either at the time of credit to the account of the contractor or at the time of payment thereof, whichever is earlier. It is further provided that the said liability would arise even if the amount is credited to any other account whether called "Suspense Account" or by any other name. Hence, in our view, the assessee would be liable to deduct tax at source u/s 194C on the amount provided under the head "provision for expenses". Hence, we reject the contentions of the assessee that the TDS provisions shall not apply to the provision for expenses."
This case is distinguishable from the above-referred cases on the following merits-
1. The nature of provision for expenses was not clear. In this case, the assessee had made provision for expenses at the year-end on which no tax was deducted. The provision for expenses so made was included in the work-in-progress. On this, the ITAT observed that both the parties had not specified the nature of the expenses so provided for. However, the provision for expenses so made was included in “Work in Progress” and from this submission; it could be understood that the provision made by the assessee should be related to the Construction expenses.
2. The assessee had claimed the very same amount as a deduction in two assessment years - AY 2007-08 which is in the appeal and in the subsequent assessment year 2008-09 in which the assessee deducted and paid the TDS amount. Since the assessee had claimed deduction of the very same amount in the assessment year 2008-09 and the same has been accepted by the AO in that year. The assessee cannot claim double deduction for the very same amount.
3. Similarly, there is no discussion on the identity of the payee whether the same is known and available to the deductor/assessee or not.
4. The decision was rendered without distinguishing the Industrial Development Bank of India case (supra) wherein it was held that where the party is not identifiable, no TDS is deductible. Instead, applicability of TDS on provision for expenses was solely made on the basis of the explanation embodied in section 194C. As per the said Explanation, TDS liability would arise even if the amount is credited to any account - whether called suspense account or called by any other name. The scheme of Chapter XVII-B of the Income-tax Act, 1961 was not taken into account while decking the issue.
Later, in the case of Apollo Tyres Ltd. vs. DCIT (2017) 163 ITD 177 : [2017] 78 taxmann.com 195, ITAT Delhi had the occasion to distinguish the decision of ITAT Cochin in the case of Abad Builders (supra) with the decisions in Dishnet Wireless Ltd. (supra) and Industrial Development Bank of India (supra).
In Apollo Tyre’s case (supra), a TDS survey was conducted by ACIT, TDS Circle, Gurgaon at the premises of the assessee company at Gurgaon. The Assessing Officer passed an order u/s 201 and 201(1A) holding that it failed to deduct the TDS in respect of provisions made under several heads of income. Ld. CIT(A) also upheld the order of the AO that it failed to deduct TDS on provision for expenditure made at the year-end in its financials. On further appeal, the Tribunal held in favour of the assessee observing that:
As per the scheme of Chapter XVII-B of the Income-tax Act, 1961, there is a provision for deduction of tax at source. Ordinarily, the deduction is to be made at the time of payment or the credit of the amount to the account of payee. However, as per provision of section 194C(2), the tax is to be deducted even if the amount is not credited to the account of the payee but to a suspense account.
Tax deducted at source is considered to be tax paid on behalf of the person from whose income the deduction was made and, therefore, the credit for the same is to be given to such a person. Thus identification of the person is imperative.
Also, the Tribunal made a reference to Section 203(1) where the tax deductor has to furnish a certificate to the person to whose account such credit was to be given. Therefore, when the tax deductor cannot ascertain the payee. the provisions of Chapter XVII-B cannot be followed.
Taking reference to Dishnet Wireless Ltd. (supra), the Tribunal concluded that tax has to be deducted on provision for expenditure where the payee can be ascertained and provisions of Chapter XVII-B cannot be affected if the payee is not identifiable.
In another case of IBM India P.Ltd. [2015] 128 DTR (Trib) 25 (Bang) : ITA Nos. 749 to 752/Bang/2012 & 1588 to 1591/Bang/2012 decided on 14.05.2015 which was decided against the assessee on the issue of application of TDS provisions on provision of expenses, it was held that the liability to tax deduction at source exist when the amount in question is credited to a “suspense Account” or any other account by whatever name called, which will also include a “Provision” created in the books of accounts. This decision was rendered on the exclusive and peculiar facts of the case.
In this case, the assessee was booking those expenses in the profit and loss account for which invoices had been submitted or the payments had become due. Such expenses were accounted for and if TDS was found to be applicable on these expenses, the same was accounted for.
However, in respect of expenses on which only service/work had been provided/performed by the vendors, but for which the invoices had not been furnished or in respect of which the payments had not fallen due for payment to the vendors, a provision for such expenses was made in the books of account recognising the liability that had been incurred.
Such expense provisions were however created on reliable estimates of the payment that was expected to be made on the settlement dates in future, that fell in the next accounting year. In the subsequent financial years, 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 in time taxes were withheld at source and paid to the Government in the due course.
During the year under consideration, the assessee debited the expenses to the profit and loss account and the provisions were credited to a provision account and not to the vendor accounts as these had not fallen due for payment. While filing return of income, the assessee disallowed the amounts in the computation of income because in terms of section 40(a)(i) and section 40(a)(ia), the above amounts were not allowable as deduction.
In this case, it was stated that the assessee made provision for certain expenses in its books of account, in respect of certain expenses, in relation to which only service/work had been provided/performed by the vendors, but for which the invoices had not been furnished or in respect of which, the payments had not fallen due for the vendors. Thus, a provision for such expenses was made in the books of account, recognizing the liability that had been incurred. The expenses were debited to the Profit and Loss Account and the provisions were credited to a provision account and not to the vendor account, as this had not fallen due for payment. Such expense provisions were created on reliable estimates of the payment that was expected to be made on the settlement dates in future that fell in the next accounting year. In the subsequent FYs, the provision entries were reversed and on receipt of invoices in respect of the respective invoices, the same were recorded as liabilities due to the respective parties, at which point in time taxes were withheld at source and paid to the Government in due course.
The Tribunal held that the Assessee had admitted its default u/s. 40(a)(i) and u/s. 40(a)(ia), cannot in proceedings u/s.201(1) of the Act, be heard to say that there was no default under chapter XVII-B of the Act. The disability u/s.40(a)(i) & 40(a)(ia) of the Act, and the liability and Sec.201(1) of the Act cannot be different and they arise out of the same default. Once there is a disallowance u/s.40(a)(i) & 40(a)(ia) of the Act, it is not possible to argue that there was no liability under chapter XVII-B of the Act and therefore the provisions of Sec.201(1) of the Act will not be attracted.
The CIT(A) has rightly held that under the mercantile system of accounting accrual of liability for any expenditure is not dependent of receipt of invoice from the person to whom payment for expenditure has to be made and that accounting practice followed by the Assessee was contrary to the mercantile system of accounting. The claim of the Assessee that it creates provision in the books of account on an estimated basis in some cases, on a historical basis in others and using some sort of arithmetic or geometric progression in some other cases was not acceptable to the Hon’ble Members of the Bench.
The argument that TDS provisions operate on income and not on payment, in the facts and circumstances of the present case, is erroneous.
Sections 194C, 194J and 195 do not use the expression, “Income”. These sections use the expression “Sum” and tax deduction has to be on the “sum so paid”. Section 194H and Section 194-I deal with TDS obligation on payment of commission and rental income. These payments by its nature are specific and the entire payment is attributable to commission or rent and therefore the commission and rent paid is treated as “income” and therefore the expression income by way of commission or rent is found in these sections.
Moreover, as the person responsible for making payment, it is the duty of the Assessee to deduct tax at source. Sec.194C, 194-J, 194-H and 194-I do not use the expression “Chargeable to tax”.
The Tribunal discussed the explanation to section 194C which clarifies that tax is required to be deducted even if credited to a ‘Suspense Account”. It is held that from the statutory provisions it was clear that the liability to tax deduction at source exists when the amount in question is credited to a “suspense Account” or any other account by whatever name called, which will also include a “Provision” created in the books of accounts. Therefore it is not possible for the Assessee to argue that there was no accrual of expenditure in accordance with the mercantile system of account and therefore the TDS obligations do not get triggered.
Interestingly, prior to rendering of the decision of IBM’s case (supra), a contrary decision was given by the ITAT Mumbai in the case of Pfizer Ltd. vs. ITO (2013) 55 SOT 277 (Mum.)(Trib.) : (2012) 28 taxmann.com 17. (Mum.) : ITA No.1667 & 1765/Mum/2010 decided on 31.10.2012 under similar facts.
In this case, the assessee made a provision of certain expenses in respect of payment due to various parties but did not deduct TDS thereon. It is the practice of the assessee to make provision for expenses at the end of the year as it has multifarious locations and innumerable transactions and since all the bills would not be received, without making specific entries into accounts of the parties, makes provision for expenses. Next year the entire provision of expenses was written back and the actual amounts paid to the respective parties were credited to their respective accounts and TDS as per the provisions are being made.
The entire amount of provision so made was disallowed under section 40(a)(i)/(ia) while filing the return of income by the assessee itself
The Assessing Officer held that despite such disallowance, the assessee was liable under section 201 as an assessee-in-default for failure to deduct TDS.
It was held by the Tribunal that:
(i) In view of the decision of the coordinate bench in Industrial Development Bank of India’s case (supra), since the payee is not identifiable in this case also at the time of making provision, no TDS need to be made on the above amount. Further the entire provision has been written back in the next year and the actual amounts paid/credited were subjected to TDS as per the detailed statements filed before the authorities on which there is no dispute. Therefore, assessee is following the provisions of TDS as and when the amounts are paid/credited to respective parties.
The whole scheme of TDS proceeds on the assumption that the person whose liability is to pay an income knows the identity of the beneficiary or the recipient of the income. The TDS mechanism cannot be put into practice until identity of the person in whose hands it is includible as income can be ascertained. [IDBI v. ITO (2007) 107 ITD 45(Mum) followed]
(ii) Demand of tax under section 201 & interest under section 201(1A) cannot be raised once the entire amount has been disallowed in the computation of income under sections 40(a)(i) and 40(a)(ia). If the Assessing Officer’s view was accepted that the assessee was liable to pay the TDS not deducted, then a disallowance under section 40(a)(i) and 40(a)(ia) cannot be made and those provisions may become otiose.
The decision in Pfizer's case was rendered prior to the decision of IBM's case. However, there is no discussion to distinguish the former in the latter case.
In the case of Tata Sky Limited vs. ACIT (ITA Nos. 3214 & 3215/Mum/2014 decided on 10-09-2020), Mumbai ITAT ruling in favour of the tax authorities have held that once the taxpayer has made certain ad-hoc year-end provisions and claimed the expenses as a deduction by debiting it in the profit and loss account, tax on such expenses is liable to be deducted, even if not credited to the respective parties account. The Tribunal has reiterated the provision of chapter XVII-B of the Act which clearly specifies that tax is required to be deducted either at the time of payment or at the time of credit in the books of accounts (including credit in the suspense account) whichever is earlier.
In this case, the assessee made year-end provisions in respect of sale promotion, legal and professional fees, interest and programming costs. During the relevant AY 2009-10, the assessee made an ad-hoc year-end provision of expenses of Rs.56,97,54,762/- in the absence of receipt of the invoices. These provisions were debited to the profit and loss account and not added back to the computation of total income by the assessee. Since the assessee had not deducted tax in AY 2009-10 on such year-end provision, the AO has disallowed the same under section 40(a)(ia) of the Act.
The assessee argued that there was no obligation to deduct tax on the year-end provisions and accordingly, the same should not be disallowed under section 40(a)(ia) of Act for AY 2009-10. The assessee contends that the deduction for year-end provision ought to be allowed in AY 2009-10
On verification, it was found that TDS is deducted in the subsequent years pursuant to bills received and payments made and the deduction was allowed for the full amount in the next AY 2010-11.
The Tribunal held that the assessee had claimed these expenses by debiting into the profit and loss account, it needed to deduct TDS on such expenditure, even if not credited to respective parties account. Since the assessee had not deducted TDS, the expenses claimed are liable to be disallowed under section 40(a)(ia), because as per the provisions of chapter XVII-B of the Act, TDS needs to be deducted either at the time of payment or at the time of credit to the party account. Further, even in a case where credit into the suspense account is subject to TDS under the provisions of the Income Tax Act, 1961. The argument of the assessee that TDS provisions are not applicable when year-end provisions are made without crediting to respective parties account was rejected.
As regards to the claim of the assessee that in subsequent Financial Year year-end provisions have been either reversed or paid subject to deduction of TDS, does not alter the legal position in so far as the disallowance of expenses under section 40(a)(ia) for non-deduction of tax at source. The law is very clear as per which TDS is required to be deducted when credit or payment whichever is earlier.
Since the claim relating to the provision of commission payment is not ascertainable, it is not an allowable expenditure
In another case of Hardik Jigishbhai Desai vs. DCIT (ITA No 1084/Ahd/2013 dated November 5, 2016) the Ahmedabad Bench of the ITAT dealt with an issue with respect to the applicability of provisions of section 40a(ia) on year-end provisions.
The assessee was following a mercantile system of accounting. All expenditures relevant to the accounted sales/income were accounted for in the same year, whether bills of relevant parties were received or not. Wherever bills were received, it was credited to the party's account and wherever bills were not received for such expenditure entry for provision of expenditure was passed. This entry was required to arrive at a true and fair figure of profit for the said year as per normally accepted accounting principles. Entry for provision of the earlier year was duly reversed on the 1st day of the following year by crediting the expenditure account and debiting the income account.
For the AY 2009-10, the assessee made a provision of commission of Rs. 26 lacs was made on an estimated basis and following the mercantile system of accounting and claimed deduction for such expenditure in the AY 2009-10.
The assessee contended that since the names of payees were not known, the TDS was not deducted as the assessee did not know in whose account the TDS was to be credited. Further, the assessee claimed that making a provision on an estimate basis on the sales effected by the assessee, becomes an ascertained liability and thus was allowable as business expenditure.
The AO denied the deduction observing that the assessee had debited the commission expenses to the profit and loss account which had resulted in the reduction of his profit and hence TDS should have been made from such expenses. The AO thus invoked the provisions of Section 40(a)(ia) for disallowing the commission expenses. On appeal, CIT(A) upheld AO’s order and denied expense allowance invoking section 40(a)(ia).
The claim of the assessee that the practice followed by the assessee was accepted by the Department in the past year was overruled by the Tribunal holding that merely because the assessee's practice was accepted in past does not apply as res judicata inasmuch as the provision of law will take precedence over an untenable practice adopted by the assessee.
The Tribunal held that the provision of the commission payment claim by the assessee is totally unascertainable, uncrystallized and fanciful and could not assume the character of ascertained mercantile liability. Even in the case of mercantile liability, Section 40(a)(ia) clearly mandates that the expenditure cannot be allowed in the absence of corresponding TDS payment in the Government treasury. On these grounds, the Tribunal dismissed the appeal of the assessee.
The Mumbai Bench of the Income-tax Appellate Tribunal in the case of DCIT Vs. HDFC Sales Pvt. Ltd. (ITA No. 852/Mum/2019 dated 18/09/2020) dealt with an issue with respect to the allowability of year-end provision for expenditure without deduction of TDS.
The assessee has made provision in respect of expenditure pertaining to the previous year ending 31 March 2015 (Assessment Year: 2015-2016). It was the contention of the assessee that none of the provisions represents ad hoc provisions or for any unascertained liability and these provisions of year-end expenses are ascertained liabilities which are paid at the actual rate in subsequent years and are not subject to disallowance under section 37.
The AO disallowed the provision of expenses by taking view that the provisions made by the assessee are ad hoc provisions made at the end of the year. These provisions are contingent in nature and have to be disallowed in computing the income. The ld. CIT(A) granted relief to the assessee by taking view that the assessee is regularly following the practice of making provision for various expenses for the month of March, which is reversed on 1st April of next year and that expenses are considered on the basis of actual payment in the subsequent year. The ld. CIT(A) also concluded that these provisions cannot be held to be contingent expenditure as the expenditure have already been incurred and the provision has been made on the certain basis for each head of expenses so that the accounts adopted by the assessee represent true and fair affairs of business and is with consistent of accounting standard.
On the issue of non-deduction of TDS, the ld. CIT(A) agreed with the submission of the assessee that no disallowance can be made under section 40(a)(ia) as the scheme of TDS proceed on the assumption that the person whose liability is to pay income knows the identity of the beneficiary or recipient of the income and that amount of payment should be exactly quantified.
The Tribunal has distinguished the case of Hardik Jigishbhai Desai (supra) in the following words:
“In Hardik Jigishbhai Desai (supra), the assessee debited the provision of commission expenses to the Profit & Loss Account without making TDS. The Assessing Officer disallowed. the expenses by taking view that debiting the commission expenses resulted in deduction of profit and TDS should have been made on such expenses. The ld. CIT(A) confirmed the disallowance made by Assessing Officer. On appeal before the Tribunal, the disallowance was maintained. In the said case, the recipient of commission was identifiable.”
Finally, the Bench held that the fact of the present case is quite different. The Assessing Officer had not brought any fact on record that recipients were certain or identifiable. The Assessing Officer has not examined whether the provision made for the month of March 2015 was not a reliable estimate on account of past obligations. In the case at hand, no such recipient was identifiable. The assessee made provision of Rs. 10.24 crore and ultimately made expenses of Rs. 10.46 crore, which clearly demonstrates that the assessee made the provision after due diligence which cannot be said to be an ad hoc provision.
In contrast, in the case of Inter Globe Aviation Ltd. vs. ACIT (2020) 181 ITD 225 (Delhi-Trib.): ITA No. 5347/Del/2012 decided on 07/01/2020, the Delhi Tribunal has held that the assessee was liable to deduct tax at source on year-end provisions since the payees were identifiable and the provisions were for ascertained liabilities.
In the present case, the provision for expenses was made under the specified head, provision was also made on a certain basis thereby ascertaining the amount. It was not the case of the assessee that it had made an ad hoc provision. Thus it cannot be said that the payee is not identified. Therefore, it was held that the tax was required to be deducted on the year-end provisions made by the assessee which are ascertained liabilities.
Hon’ble Karnataka High Court in the case of Karnataka Power Transmission Corporation Ltd vs. DCIT (TDS) [2016] 383 ITR 59 (Karn) noted that subsequently after making the provision it was noticed that the said interest would never be paid to suppliers and the corresponding reversal entries were made in the books of account. In these facts, the Hon'ble Karnataka High Court has held that tax was not required to be deducted as no income was accrued to the recipient.
In the case of Toyota Kirloskar Motor (P.) Ltd. vs. ITO (TDS) [2021] 128 taxmann.com 266 (Karnataka): IT Appeal No. 245 of 2018 the Karnataka High Court held that in absence of any accrual of income, there is no obligation on part of the assessee to deduct tax at source and consequently the proceeding under section 201 and 201(1A) could not have been initiated. In this case, the assessee, a subsidiary of Japanese Company, had made provision towards marketing, overseas and general expenses during the year and reversal of entry were also made in the same accounting year.
Bangalore Bench of the Tribunal in the case of DCIT vs. Telco Construction Equipment Co. Ltd. in ITA No.478/Bang/2012 and the ITAT Delhi in ITO vs. DLF Southern Homes Pvt. Ltd reported in 2017 SCC Online ITAT 148 : ITA No. 3239/Del/2015 held that TDS was not practically feasible to be deducted by the assessee on the provision of brokerage expenses as neither the names of the brokers nor the amounts to be paid to them on account of brokerage was a determinable and as and when the payments were made to the brokers, TDS was deducted and remitted to Government. Further, the assessee neither claimed nor availed any benefit of the provision made for expenses and paid due tax in full and upheld the decision of CIT(A) in cancelling the penalty levied under section 271C by the Assessing Officer. Followed in ACIT vs. Parsons Brinckershoff India Pvt. Ltd. ITA No.2207/DEL/2018, ITAT Delhi decided on 28.02.2022.
Conclusion
Whether tax is required to be withheld on year-end provisions is a subject matter of controversy. All the businesses which follow the mercantile system of accounting are required to create a year-end provision of expenses to reflect a true and fair view of the financial statements.
On analyzing the above decisions, it can be concluded that in case, the deductor could not identify the name, address, PAN of the deductee and not in a position to quantify the amount payable, the mechanism of tax deduction fails. The assessee while computing income from business or profession is required to ensure compliance with section 40(a)(i)/(ia). Once the assessee makes voluntary disallowance u/s.40(a)(i)/(ia) for non-deduction of tax at source, he cannot be subject to TDS provisions again so as to make the assessee liable to pay the tax u/s. 201 and interest u/s. 201(1A).
In the absence of any identifiable payee or the quantification of the duly ascertained amount of the liability, the provisions of TDS could not be made applicable. Thus, to be brief and explicit, if no income is attributable to the payee, there is no liability on the part of the Company to deduct tax at source on such year-end provisions of expenses.
One can enumerate the following guidelines for ascertaining the liability of the deductor to deduct TDS on the year-end provision of expenses-
1. No tax is required to be deducted at source from the general provisional entries which are made in respect of various expenses on an estimated basis as on the last day of the financial year.
2. Next year, on the 1st day of the new financial year, the provisional entries need to be reversed.
3. Once the bills or invoices are received in the next year, tax should be deducted and paid to the government in the next year. The deduction should be taken in the next year when the tax is actually deducted and paid.
4. It should be kept in mind that the TDS provisions fail to apply only when the identity of the deductee is not known precisely.
5. Apart from the identity of the payees, the quantum of the amount payable is also unascertained or undetermined. It should be an ad hoc provision.
6. The tax auditor should disclose the facts of non-deduction of tax under the circumstances in his Tax Audit Report with reasons.
In my view, if tax is required to be deducted when the payee is not known or if it is so interpreted to force the deductor to deduct TDS under the circumstances, it would amount to a separate levy of tax on payment rather than a tax on income which is ulterior to the provisions of the charge of tax as enumerated in section 4. There is no separate charge of tax on the payments to unknown payees in the Income Tax Act, 1961.
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