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TDS - Failure to deduct or pay - vires of Sec 40a(ia) challenged : Madras HC grants interim stay
December, 05th 2007

What are the consequences of not deducting the TDS or after deducting not paying the deducted tax to the Government?

As per section 201 of Income Tax Act 1961,

Without prejudice to any other consequences, the defaulter will be deemed to be an assessee in default.

He is liable to pay an interest at 12% P.A. from the date on which the tax was deductible till the date of actual payment.

The TDS along with the interest will be a charge on all the assets of the defaulter.

He is liable to rigorous imprisonment for a term which shall not be less than 3 months, but which can extend up to 7 years and fine.

He is liable to a penalty equal to the tax not deducted.

Knowing the above liabilities, no sane person would invite the wrath of the department by not deducting TDS or after deducting not paying to the government. But there is more! A new sub clause (1 a) of Sec 40 a has been inserted into the Income Tax Act by Finance Act (No.
2) of 2004. Under this clause if on any interest, commission or brokerage, rent, royalty, fees for professionals etc., TDS is deductible and if not so deducted or after deduction not paid, the
entire expenditure will not be deducted while computing the income chargeable under Profits and gains of business or profession. Putting in English, this can be explained by the following example.

Supposing you have paid Rs. 1.00 Crore in the previous year as Interest fee etc, and you have either not deducted tax or after deducting not paid it to the Government, apart from the five consequences mentioned above, this one Crore will not be permitted as an expenditure in your profits and gains computation. With the result you may have to pay a higher rate of income tax on the entire amount of Rs. 1.00 Crores in the year of default.

Supposing your income was Rs. 2.00 Crores and your expenditure (including the fee of Rs. 1.00 Crore) was Rs. 1.80 Crores, you get a profit of Rs. 20 lakhs on which you may have to pay an income tax of Rs. 6.00 lakhs. But if this Rs. 1.00 Crore is not allowed to be deducted your income is Rs. 2.00 Crores and expenditure is Rs 0.80 Crores leaving a profit of Rs. 1.20 Crores, on which you will have to pay a tax of about Rs. 36.00 Lakhs.

This seems to be a too heavy a blow that an assessee has approached the Madras High Court challenging the constitutional validity of this new clause 1 a of Sec 40 a of Income Tax Act 1961. The Government Counsel submitted that this provision had come into force from 01.04.2005 and should not be stayed at this length of this time. The High Court has observed that it is settled law that "presumption is in favour of the statute" and so was not
inclined to grant stay of the amended provision but considering the submission of the parties, the court gave an interim relief as follows.

The assessee will file self assessment return by including the amount for which the tax is deducted at source.

The petitioner will pay tax on self assessment income.

The Dept will accept the return and is restrained from taking penal action as of now.

The filing of the return and payment of tax shall be purely provisional.

The petitioner will be liable to file modified returns and pay the due tax in the event the petitioner fails to get a final order in its favour from the High Court.

In the example given above, our hypothetical assessee, as per this order of the High Court, will have to file a return showing a taxable income of Rs. 1.20 Crores, but actually pay a tax of Rs.
6.00 lakhs , but will have to pay Rs. 30.00 Lakhs more if the case is finally lost.

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