section 40(a)(ia) No disallowance of expense if Income is Exempt

By | August 26, 2015
(Last Updated On: August 26, 2015)

Section 40(a)(ia) No disallowance of expense if Income is Exempt

Q When the income of the Assessee is exempt, Whether any disallowance of expenses under section 40(a)(ia) can be made for non deduction of TDS ?

Assessee’s total income is exempt under section 10(26), for assessee’s lapse of not complying with his tax withholding obligations, there cannot be any occasion to invoke section 40(a)(ia) to treat relevant amount disallowable as an income of assessee on standalone basis.

Section 40 which is titled as ‘Amounts not deductible’ starts with a non obstante clause which states, “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”” and then sets out the amounts which are not deductible as such. Clearly, therefore, all that Section 40 does is to restrict the scope of deductions under sections 30 to 38, which, in turn, may result in determining higher income chargeable under the head business income. However, in a situation in which the business income, so determined, itself is not includible in the income chargeable to tax, such disallowances do not really matter at all. Whether business income is the same as computed on the basis of accounting principles or the artificial disallowances plus such income, it does not make any difference to the taxability in the hands of the assessee. Such disallowances are thus completely tax neutral inasmuch as whatever is the income arrived at after making these disallowances is exempt under section 10(26). The disallowances are made at the stage of the computation of business income whereas the amount eligible for exemption is computed at a much later stage of computing the total income.(Para 6)

Q Whether provisions of Section 40(a)(ia)  are penal in nature?   whether income of the Assessee is taxable or non taxable but the assesse must be penalized for  not deducting TDS  ?

Section 40(a)(ia) provision is not for the purpose of penalizing for the tax deduction at source lapses. Deincentivizing a lapse and punishing a lapse are two different things and have distinctly different, and mutually exclusive, connotations and repurcussions. There are separate specific penal provisions to that effect, such as contained in Section 271 C read with 273 B of the Income Tax Act, and there cannot even be multiple penalties for the same lapse. When there is a specific penal provisions for a lapse, which have not been invoked on the facts of this case, there cannot be any occasion to invoke section 40(a)(ia)  and treat the amount disallowable under that section as income of the assessee on standalone basis. Such a course of action is wholly devoid of any legal, or even rational, basis. (Para N0 9)

IN THE ITAT GUWAHATI BENCH

Tamchikusuk

v.

Additional Commissioner of Income-tax, Range, Tezpur, Assam

PRAMOD KUMAR, ACCOUNTANT MEMBER
AND A.D. JAIN, JUDICIAL MEMBER

IT APPEAL NO. 76 (GAU.) OF 2010
[ASSESSMENT YEAR 2006-07]

MAY  15, 2015

A. Sangma for the Respondent.

ORDER

Pramod Kumar, Accountant Member – The short issue that we are required to adjudicate in this appeal is whether or not artificial disallowances in computation of income, such as disallowance under section 40(a)(ia),will end up affecting taxable income of the assessee when the same is exempt under section 10(26) of the Income Tax Act, 1961. The appeal is filed by the assessee and it calls into question correctness of the CIT(A)’s order dated 16th February 2010 for the assessment year 2006-07.

2. The material facts of the case, giving rise to this appeal before us, are as follows. The assessee before us is an individual, belonging to a scheduled tribe in the Arunachal Pradesh, engaged in the business of carrying out contract works for construction of fencing and roads along Indo-Bangladesh Border in the State of Meghalaya and Tripura. The assessee filed its return of income on 28th March, 2008 disclosing total income of Rs. 21,42,865, including an amount of Rs.3,35,840 claimed as income exempt u/s 10(26) being the income accrued and arisen in the state of Arunachal Pradesh. In effect thus, the total income disclosed by the assessee was Rs.18,07,025 which was earned in the State of Tripura. Later on, in the course of the assessment proceedings, the assessee claimed that even the income earned outside Arunachal Pradesh, i.e. in Tripura, is also exempt under section 10(26).This claim was rejected by the Assessing Officer on the ground that while the tribe to which assessee belongs, i.e. nishidufla, is recognized as a scheduled tribe in the Arunachal Pradesh, this tribe is not recognized as a scheduled tribe in the State of Tripura. That aspect of the matter, however, not really relevant because, despite initial rejection of this claim by the Assessing Officer, the CIT(A), following the decision of Hon’ble jurisdictional High Court’s full bench decision in the case of Pradip Kr Taye v Union of India [(2010) 320 ITR 29 (Guwahati FB)], accepted the said claim and the matter rests there. Coming back to the proceedings before the Assessing Officer, it was noted that the assessee has not deducted tax at source from the payments on account of carriage inward (Rs 81,707), transportation charges (Rs 9,19,950), legal and professional fees (Rs 2,74,854) and contracts for work and labour on which provisions of Section 194C are applicable (Rs 1,31,28,038). These amounts were disallowed under section 40(a)(ia) of the Act. When the matter was carried in appeal before the CIT(A), learned CIT(A) upheld the disallowance on the ground that “in the instant case, the addition has been made under section 40(a)(ia) of the Income Tax Act, which is penal in nature and is attracted when the assessee fails to discharge certain statutory obligations which he is required to do”. He proceeded to observe that “even if the income, computed in the normal course of accounting, is exempt, the appellant was required to deduct tax on payments which attracted TDS provisions”, and, on that basis, held that “the aforesaid addition made under section 40(a)(ia) is, therefore, confirmed”. The assessee is aggrieved and is in appeal before us on the following grounds:

1.For that the order passed by the Commissioner of Income Tax (Appeals) is bad in law as well as facts.
2.For that the learned Commissioner of Income Tax (Appeals) is wrong in holding that Section 40(a)(ia) of Income Tax Act, 1961 is penal in nature and that even though the income of the assessee is exempt u/s 10(26) of Income Tax Act, 1961, additions made u/s. 40(a)(ia) are valid.
3.For that the learned Commissioner of Income Tax (Appeals) is wrong in upholding the addition of Rs. 1,31,28,038/- and Rs.16,76,111/- u/s. 40(a)(ia).

3. None appeared for the assessee but having regard to the fact that the issue in appeal lies is a simple legal issue, within a narrow compass of relevant facts, we consider it appropriate to proceed ex parte qua the assessee and decide the matter on the basis of material on record and pleadings of the learned Departmental Representative. We have heard Shri Sangma, learned Departmental Representative, perused the material on record and duly considered facts of the case in the light of the applicable legal position.

4. We consider it appropriate to begin with a quick look at Section 10(26) of the Act which, as on the material point of time as indeed now, provides as follows:

Section 10- Incomes not included in total income.

In computing the total income of a previous year of any person, any income falling within any of the following clauses shall not be included—

******

(26) in the case of a member of a Scheduled Tribe, as defined in clause (25) of article 366 of the Constitution, residing in any area specified in Part I or Part II of the Table appended to paragraph 20 of the Sixth Schedule to the Constitution or in the States of Arunachal Pradesh, Manipur, Mizoram, Nagaland, and Tripura or in the areas covered by notification No. TAD/R/35/50/109, dated the 23rd February, 1951, issued by the Governor of Assam under the proviso to sub-paragraph (3) of the said paragraph 20 [as it stood immediately before the commencement of the North-Eastern Area (Reorganisation) Act, 1971 (18 of 1971),] or in the Ladakh region of the State of Jammu and Kashmir] any income which accrues or arises to him,-

(a)from any source in the areas, or States aforesaid, or
(b)by way of dividend or interest on securities;

[“Scheduled Tribes”, as defined in Article 366(25) of the Constitution of India, “means such tribes or tribal communities or parts of or groups within such tribes or tribal communities as are deemed under Article 342 to be Scheduled Tribes for the purposes of this Constitution”!

5. A plain look at the above provision clearly shows that what is exempt from tax under section 10(26) is, inter alia, income of the eligible assessee from any source in the areas or states as specified in Section 10(26). Once an income satisfies these conditions, it is outside the scope of income which can be included in the income taxable under the Income Tax Act. As long as an income is earned by a member of the scheduled tribe resident in the specified areas or states, and such an income earned by the member of the scheduled tribe accrues or arises to him from any source within that area or state, or is by way of dividend or interest on securities, such an income is exempt from tax under section 10(26). In respect of business income, therefore, all that is to be seen is whether the income is earned by a member of the scheduled tribe resident in a specified area and whether the income is from any source within such specified area. In the present case, these conditions are admittedly fulfilled as the relief granted by the CIT(A), in respect of income sourced from Tripura, is not challenged in appeal.

6. It is in this backdrop that we need to examine the scope of disallowance under section 40(a)(ia). Section 40 which is titled as ‘Amounts not deductible’ starts with a non obstante clause which states, “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”” and then sets out the amounts which are not deductible as such. Clearly, therefore, all that Section 40 does is to restrict the scope of deductions under sections 30 to 38, which, in turn, may result in determining higher income chargeable under the head business income. However, in a situation in which the business income, so determined, itself is not includible in the income chargeable to tax, such disallowances do not really matter at all. Whether business income is the same as computed on the basis of accounting principles or the artificial disallowances plus such income, it does not make any difference to the taxability in the hands of the assessee. Such disallowances are thus completely tax neutral inasmuch as whatever is the income arrived at after making these disallowances is exempt under section 10(26). The disallowances are made at the stage of the computation of business income whereas the amount eligible for exemption is computed at a much later stage of computing the total income.

7. Shri Sangma has two quick points to make in defence of the impugned disallowance. His first point is that there is nothing to show that the disallowance pertained to the income which has accrued and arisen in the State of Arunachal Pradesh. His second point is reliance on the stand of the CIT(A) which holds that the section 40(a)(ia) is penal in nature, is a result of the lapses committed by the assessee in complying with his tax deduction at source obligations, and is, therefore, to be invoked in this case whether or not the ultimate amount of income is exempt from tax under section 10(26).

8. As for the first point made by the learned Departmental Representative, it proceeds on the fallacious assumption that income earned outside the State of Arunachal Pradesh, i.e. in the State of Tripura, is taxable in nature. That is factually incorrect. Learned CIT(A) has given a categorical finding that the assessee is also eligible for exemption under section 10(26) in respect of the income which is earned in the State of Tripura, and learned Departmental Representative has not brought on record any material to show that this finding has even been challenged in appeal by the Assessing Officer. Therefore, as the things stand on the facts of this case, whether the disallowance is in respect of the computation of business income which has accrued or arisen in the State of Arunachal Pradesh or in the State of Tripura, the disallowance under section 40(a)(ia) in respect of either of these computations of business income, even if done separately, is completely tax neutral. Of course, there is a bigger question, i.e. whether the expression “from any source in the areas, or States aforesaid” appearing in Section 10(26)(a) should be construed to mean the location of the business itself or whether it must be construed in the sense that all the activities of business must also be restricted to the specified areas of States, but then, given the CIT(A)’s unchallenged and uncontroverted findings on the facts of this case, that aspect of the matter is purely academic on the facts of this case. We need not, therefore, venture into that aspect of the matter. Suffice to say that so far as the first objection of the learned Departmental Representative is concerned, we are of the considered view that it is, on the peculiar facts of this case, untenable.

9. That takes us to the second objection, raised by the learned Departmental Representative, to the effect that section 40(a)(ia] being penal in nature and since it is triggered by the assessee’s lapse of not complying with his tax withholding obligations, taxability or no taxability, the assesse must be penalized for his lapses. This is precisely what the CIT(A) has also held in the impugned order. We are unable to uphold this objection either. On a conceptual note, justification for such a disallowance is that such a denial of deduction is to compensate for the loss of revenue by corresponding income not being taken into account in computation of taxable income in the hands of the recipients of the payments. This disallowance does deincentivize lapses in deduction of tax at source, when such tax deductions are due, but, so far as the legal framework is concerned, this provision is not for the purpose of penalizing for the tax deduction at source lapses. Deincentivizing a lapse and punishing a lapse are two different things and have distinctly different, and mutually exclusive, connotations and repurcussions. There are separate specific penal provisions to that effect, such as contained in Section 271 C read with 273 B of the Income Tax Act, and there cannot even be multiple penalties for the same lapse. When there is a specific penal provisions for a lapse, which have not been invoked on the facts of this case, there cannot be any occasion to invoke section 40(a)(ia] on this case and treat the amount disallowable under that section as income of the assessee on standalone basis. Such a course of action is wholly devoid of any legal, or even rational, basis.

10. Before parting with the matter, we must express our deep anguish at the approach adopted by the learned CIT(A) in treating the disallowance under section 40(a)(ia) as a standalone income in the hands of the assesse. All the noble work done by the Government comes to a naught when this kind of hyper technical approach, devoid of any merits, is adopted by the officers assigned with implementing the mandate of law, We leave it at that for the time being, and conclude by saying that, in view of the preceding discussions, we uphold the grievances of the assessee and direct the Assessing Officer to delete the impugned disallowances, or rather additions, under section 40(a)(ia) of the Act. The assessee gets the relief accordingly.

11. In the result, the appeal is allowed.

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