Tax Alert - EY INDIA

1. 5 May 2017 EY Tax Alert Supreme Court upholds disallowance of expenditure on default in withholding tax, irrespective of whether it is paid or payable Executive summary This Tax Alert summarizes a recent ruling of the Supreme Court (SC) in the case of Palam Gas Service[1] (Taxpayer), wherein the issue before the SC was whether disallowance of expenses for failure to withhold taxes under the Indian Tax Laws (ITL) is applicable only in respect of expenses which remain “payable” or if it also covers expenses actually “paid” during the year without withholding of taxes. Tax Alerts cover significant tax news, developments and changes in legislation that affect Indian businesses. They act as technical summaries to keep you on top of the latest tax issues. For more information, please contact your EY advisor. The ITL provides for various consequences for failure to withhold taxes, which include disallowance of expenses “payable”, on which tax is deductible at source but such tax has not been deducted or, after deduction, has not been paid on or before the due date of filing return of income (disallowance provision). Use of the expression “payable” in the disallowance provision gave rise to an issue of whether the disallowance applies only in respect of expenses remaining “payable” as on the last day of the tax year or whether it is also applicable in respect of expenses “paid” during the tax year without withholding tax. The High Courts (HC) were divided on this issue, but majority of the HCs held that disallowance is triggered even if expenses are “paid” during the tax year without withholding tax. After taking note of the conflicting rulings of the HCs on the issue, the SC upheld the majority view that disallowance is triggered regardless of whether the amounts are “payable” or are actually paid during the tax year. [1][TS-170-SC-2017]

2. Background and facts Taking note of the conflicting judicial precedents on the issue, the Central Board of Direct Taxes (CBDT) issued a Circular[6] which clarified that disallowance is triggered regardless of whether the amounts are payable as at the end of the tax year or actually paid during the tax year. In the present case, the Taxpayer was engaged in the business of trading in LPG[7] cylinders. It had paid freight charges to sub-contractors towards transportation of LPG cylinders to its customer’s place. Such payments were made without withholding of applicable taxes. The Tax Authority disallowed such payments on account of the Taxpayer’s failure to withhold taxes, by holding that disallowance is triggered even if expenses are paid during the tax year and are not outstanding as at the end of the tax year. Being aggrieved, the Taxpayer filed successive appeals before the Appellate Authorities. The First Appellate Authority, the Income Tax Appellate Tribunal and the Himachal Pradesh HC dismissed the Taxpayer’s appeal by upholding the Tax Authority’s contention. Being aggrieved, the Taxpayer preferred further appeal before the SC. [6]Circular No. 10/DV/2013 dated 16 December 2013 [7]Liquefied Petroleum Gas ► The provisions of the ITL impose a statutory obligation on a person, who is making payments of a specified nature, to withhold tax at source at the time of credit to the account of the payee or at the time of payment thereof, whichever is earlier (WHT provisions). Furthermore, such taxes withheld are required to be deposited with the Government of India (GOI) within the prescribed time. In order to augment the compliance of the WHT provisions, the ITL provides for various consequences for failure to withhold taxes, which include disallowance of expenses “payable”, on which tax is deductible at source but such tax has not been deducted or, after deduction, has not been paid on or before the due date of filing return of income. However, deduction of such expenses is permitted in the subsequent year in which a taxpayer complies with the WHT provisions and pays tax to the GOI. Use of the expression “payable” in the disallowance provision gave rise to an issue of whether the disallowance applies only in respect of expenses remaining ”payable” as on the last day of the tax year or whether it is also applicable in respect of expenses “paid” during the tax year without withholding tax. Various HCs dealt with the issue and took divergent views. While most of the HCs (viz., Calcutta[2] , Gujarat[3] and Punjab & Haryana[4] ) took the view that disallowance is triggered even if expenses are “paid”, the Allahabad HC[5] took the view that disallowance is triggered only when the withholding default is in respect of the amount which is “payable” as at the end of the tax year. [2]Commissioner of Income Tax v. Crescent Export Syndicate [(2013) 216 Taxman 258 (Calcutta)] [3]CIT v. Sikandarkhan N Tunvar [(2013) 357 ITR 0312 (Gujarat)] – Refer EY Tax Alert dated 10 May 2013, “Gujarat High Court rules expenses “paid” during the year are disallowable for withholding tax default” [4]P.M.S Diesels v. Commissioner of Income Tax – 2 [(2015) 374 ITR 562 (P&H)] [5]CIT v. Vector Shipping Services (P) Ltd. [(2013) 357 ITR 642 (All)] ► ► ► ► ► ► ► ►

3. SC’s ruling found that the WHT provisions mandate a person to withhold tax not only on the amounts payable but also when the sums are actually paid to the payee, the taxpayer which does not adhere to such statutory obligation has to suffer related consequences, which include disallowance of expenses. This is made clear by WHT provisions which provide that the consequence of a taxpayer being regarded as an “assessee-in-default” for committing withholding tax default shall be without prejudice to any other consequence under the ITL. Allahabad HC decision in the case of Vector Shipping Services overruled ► The Allahabad HC did not consider the amplitude of the WHT provisions while concluding that the disallowance provision would apply only when the amount is “payable”. Hence, the said judgement was held incorrect and overruled. ► It is true that the Special Leave Petition (SLP) of the Tax Authority against the Allahabad HC’s ruling was rejected by the SC earlier, but it is well settled that a mere rejection of an SLP does not amount to an HC ruling being confirmed by the SC[8]. [8]Reliance placed on earlier rulings of the SC in the cases of V.M. Salgaocar & Bros. (P) Ltd. v. Commissioner of Income Tax [(2000) 243 ITR 383] and Employees Welfare Association v. Union of India [(1989) 4 SCC 187], which held that the significance of an SLP rejection without a reasoned order is that the SC merely considered that question of law raised in the SLP and has no merit to be considered by the SC. Rejection of an SLP does not amount to dealing of the issue by the SC on merit. The SC upheld the view of the Tax Authority and concurred with the majority view of the HCs on the basis of the following reasoning adopted by such HCs: Applicability of the disallowance provision where expense is already “paid” and no amount remains “payable” ► The WHT provisions impose a statutory obligation on the taxpayer to withhold taxes at the time of credit of the sum to the account of the payee or at the time of payment thereof, whichever is earlier. Thus, the WHT provisions contemplate tax withholding not only on the occasion when the payment is actually made, but also at the time when the amount is credited to the account of the payee, if such credit is earlier than the payment. ► If the scheme of the WHT provisions is read holistically, it is clear that the expression “payable” used in the disallowance provision covers not only cases where the payment is yet to be made, but also cases where payment has actually been made. ► Though the expressions “payable” and “paid” denote different meanings grammatically, such distinction is irrelevant for interpretation of the disallowance provision since withholding tax is triggered in both cases. ► The disallowance provision is applicable as much to taxpayers which follow the mercantile system of accounting as to taxpayers following the cash system of accounting. By use of the expression “payable” in the disallowance provision, the Legislature included the entire accrued liability which, in the context of taxpayers following the mercantile system of accounting, will cover the amount credited to the account of the payee and, for taxpayers following the cash system of accounting, will cover the actual payment of liability. ► The purpose of the disallowance provision is to augment the compliance of WHT provisions, as also to bring more persons within the tax net. Once it is

4. Comments This SC decision puts the controversy to rest by confirming that the scope of the disallowance provision covers not only amounts payable as at the end of the tax year, but also amounts paid during the tax year. This view also fortifies the view expressed earlier in the CBDT Circular. Taxpayers which have relied on the favorable Allahabad HC decision in the case of Vector Shipping (supra) may face a challenge in pending matters. However, such taxpayers may explore the possibility of invoking a provision of the ITL which allows deduction to a taxpayer in the year in which a resident payee has filed tax return, including the amount received from the taxpayer.

5. Our offices Ahmedabad 2nd floor, Shivalik Ishaan Near C.N. Vidhyalaya Ambawadi Ahmedabad - 380 015 Tel: Fax: + 91 79 6608 3900 Bengaluru 6th, 12th & 13th floor “UB City”, Canberra Block No.24 Vittal Mallya Road Bengaluru - 560 001 Tel: Fax: + 91 80 2210 6000 Ground Floor, ‘A’ wing Divyasree Chambers # 11, O’Shaughnessy Road Langford Gardens Bengaluru - 560 025 Tel: Fax: +91 80 2222 9914 Chandigarh 1st Floor, SCO: 166-167 Sector 9-C, Madhya Marg Chandigarh - 160 009 Tel: Fax: +91 172 331 7888 Chennai Tidel Park, 6th & 7th Floor A Block (Module 601,701-702) No.4, Rajiv Gandhi Salai Taramani, Chennai - 600 113 Tel: Fax: + 91 44 2254 0120 Delhi NCR Golf View Corporate Tower B Sector 42, Sector Road Gurgaon - 122 002 Tel: Fax: + 91 124 464 4050 3rd & 6th Floor, Worldmark-1 IGI Airport Hospitality District Aerocity, New Delhi - 110 037 Tel: Fax + 91 11 6671 9999 4th & 5th Floor, Plot No 2B Tower 2, Sector 126 NOIDA - 201 304 Gautam Budh Nagar, U.P. Tel: Fax: + 91 120 671 7171 Hyderabad Oval Office, 18, iLabs Centre Hitech City, Madhapur Hyderabad - 500 081 Tel: Fax: + 91 40 6736 2200 Jamshedpur 1st Floor, Shantiniketan Building Holding No. 1, SB Shop Area Bistupur, Jamshedpur – 831 001 Tel: BSNL: +91 657 223 0441 Kochi 9th Floor, ABAD Nucleus NH-49, Maradu PO Kochi - 682 304 Tel: Fax: + 91 484 270 5393 Kolkata 22 Camac Street 3rd Floor, Block ‘C’ Kolkata - 700 016 Tel: Fax: + 91 33 2281 7750 Mumbai 14th Floor, The Ruby 29 Senapati Bapat Marg Dadar (W), Mumbai - 400 028 Tel: Fax: + 91 22 6192 1000 5th Floor, Block B-2 Nirlon Knowledge Park Off. Western Express Highway Goregaon (E) Mumbai - 400 063 Tel: Fax: + 91 22 6192 3000 Pune C-401, 4th floor Panchshil Tech Park Yerwada (Near Don Bosco School) Pune - 411 006 Tel: Fax: + 91 20 6601 5900 Ernst & Young LLP EY | Assurance | Tax | Transactions | Advisory + 91 40 6736 2000 + 91 79 6608 3800 About EY EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. +91 657 663 1000 + 91 80 4027 5000 + 91 80 6727 5000 + 91 80 2224 0696 EY refers to the global organization and may refer to one or more of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com. + 91 484 304 4000 +91 80 6727 5000 + 91 33 6615 3400 Ernst & Young LLP is one of the Indian client serving member firms of EYGM Limited. For more information about our organization, please visit www.ey.com/in. Ernst & Young LLP is a Limited Liability Partnership, registered under the Limited Liability Partnership Act, 2008 in India, having its registered office at 22 Camac Street, 3rd Floor, Block C, Kolkata – 700016. +91 172 331 7800 + 91 22 6192 0000 © 2017 Ernst & Young LLP. Published in India. All Rights Reserved. + 91 44 6654 8100 ED None This publication contains information in summary form and is therefore intended for general guidance only. It is not intended to be a substitute for detailed research or the exercise of professional judgment. Neither Ernst & Young LLP nor any other member of the global Ernst & Young organization can accept any responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication. On any specific matter, reference should be made to the appropriate advisor. + 91 22 6192 0000 + 91 124 464 4000 + 91 20 6603 6000 + 91 11 6671 8000 EY refers to global organization, and/or one or more of the independent member firms of Ernst & Young Global Limited + 91 120 671 7000 Join India Tax Insights from EY on