No TDS liability on year-end provisions if payees are not identified & provision revered next year

No TDS liability on year-end provisions if payees are not identified & provision revered next year

According to a judgment delivered by the Karnataka High Court in the case of Subex Technologies Limited vs. DCIT, Bangalore, it was stipulated that if payees were not identified and year-end provisions were reversed in the following year, there would be no withholding liability for Tax Deducted at Source (TDS).

Facts of the case

The assessee, a Public Limited Company engaged in software services and product development for the Telecommunication Industry, initially filed "Nil" returns, claiming a deduction of Rs. 8,37,98,696/- under Section 10(a) of the Income Tax Act (ITA) and carried forward losses totaling Rs. 8,48,07,325. However, the assessee later filed a revised return, declaring income without claiming any carried forward losses.

As a result, the Assessing Officer (AO) transferred the case to the Transfer Pricing Officer (TPO), and a decision was made by the Dispute Resolution Panel (DRP). The Income Tax Appellate Tribunal (ITAT) upheld the relief granted by the DRP, except in relation to the year-end provisions made for legal and professional charges

Assessee’s Points

The ITAT (Income Tax Appellate Tribunal) failed to acknowledge that the provisions made by the assessee were not identifiable with respect to specific parties. In certain cases, invoices for the services were not received by the end of the relevant year (March 31), and therefore, the year-end provisions were estimated. These provisions were subsequently reversed in the books of account on the first day of the following year.

The argument presented is based on the judgments in the cases of KPTCL vs. DCIT and Toyota Kirloskar Pvt Ltd. vs. ITO, where it was held that no Tax Deducted at Source (TDS) is required for year-end provisions that have been subsequently reversed.

In the subsequent year when the accounts were credited, TDS was indeed deducted. However, it is argued that TDS should not have been applied because it is a vicarious liability and is not required unless there is actual income in the hands of the payee. This argument is supported by the judgments in the cases of Eli Lily & Co, GE India Technologies, and Bharti Airtel.

Furthermore, it is emphasized that if the income component itself is not embedded in the provided amount, then there should be no liability to deduct tax at the source.

The provisions of Section 194J of the Income Tax Act do not apply to estimated provisions made in the books of account. Additionally, in the case of payments to non-residents, the liability for Tax Deducted at Source (TDS) would need to be examined in accordance with the applicable Double Taxation Avoidance Agreement (DTAA).

In this particular scenario, the assessee had made ad hoc provisions as year-end estimates. The actual amount mentioned in the invoice, which would be approved by the assessee, could vary significantly. Since there was no definite credit to the account of the payee, the liability to pay was not crystallized. As a result, the provisions for TDS would not be applicable.

Furthermore, the identity of the payee was not certain when the provision was initially made, as the actual recipient of professional charges had not been identified at that stage.

Revenue’s Points

As per the provisions of Section 40(a)(ia) of the Income Tax Act, in conjunction with Section 194J Explanation(C), tax must be deducted at source when an amount is paid or credited to the account of the payee, whichever occurs earlier.

In this case, although the assessee credited the amount in their books of account, they did not deduct Tax Deducted at Source (TDS). The failure to deduct tax in such cases attracts disallowance under Section 40(a)(ia) of the Act.

It is important to note that the TDS provisions apply not only to amounts that constitute "income" but also to gross sums, even if the entire amount may not qualify as income or profit in India in the hands of the recipient.

Court’s Judgement

In the case of Karnataka Power Transmission Corporation Ltd. vs. Deputy Commissioner of Income Tax, which was relied upon by the assessee, the court held that if no income can be attributed to the payee, there is no obligation for the tax deductor to deduct tax at source.

According to the judgment in the case of Kedarnath Jute Mfg. Co. Ltd., the presence or absence of entries in the books of accounts is not the decisive or conclusive factor in determining the right of the assessee to claim a deduction.

Additionally, in the case of Volvo India Pvt Ltd, it was determined that disallowance under section 40(a)(ia) would not apply if the deduction for expenses made in the provision was not claimed in the submitted return and the same expenses were offered for taxation in the subsequent year after reversing the entries upon receipt of bills/invoices by the payees. The crucial aspect to consider is whether income has accrued to the payees, which would determine the requirement for tax deduction at source.

Contrarily, in the case of Palam Gas Service vs. CIT, relied upon by the revenue, it was established that taxes should be withheld, but it is important to note that the payees must be identified. However, in the present case, the payee was also not identified, distinguishing it from the circumstances of the aforementioned case.

The court upheld the appeal of the assessee, and consequently, no disallowance was made regarding the non-deduction of Tax Deducted at Source (TDS) on the reversed provision.

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