Supreme Court Upholds Disallowance of Payments for Failure to Deduct TDS in Transportation Contracts (29 July 2020)

Introduction

Date of the Judgment: 29 July 2020

Citation: (2020) INSC 538

Judges: A.M. Khanwilkar, J., and Dinesh Maheshwari, J.

Can a business be denied tax deductions for payments made to transporters if they failed to deduct tax at source (TDS)? The Supreme Court of India addressed this question in a recent case involving a transport company. The core issue revolved around whether payments made to truck operators without deducting TDS could be disallowed as business expenditure under Section 40(a)(ia) of the Income Tax Act, 1961. The court examined the interplay between tax deduction obligations and the permissibility of claiming expenses.

Case Background

Shree Choudhary Transport Company, a partnership firm, had a contract with M/s Aditya Cement Limited to transport cement across India. Since the firm did not own its own transport vehicles, it hired trucks from various operators. M/s Grasim Industries Limited, the cement marketing division of M/s Aditya Cement Limited, made payments to the transport company after deducting TDS.

During the assessment year 2005-2006, the Assessing Officer (AO) found that Shree Choudhary Transport Company had not deducted TDS when making payments to the truck operators, even when payments exceeded ₹20,000 per trip. The company argued that these were not sub-contractors and that payments were made in cash for operational expenses. The AO, however, held that each trip constituted a separate contract and the truck operators were sub-contractors, thereby attracting TDS obligations.

Timeline:

Course of Proceedings

The Assessing Officer (AO) disallowed payments of ₹57,11,625 made to truck operators, citing a failure to deduct TDS under Section 194C of the Income Tax Act, 1961, and consequently, Section 40(a)(ia). The Commissioner of Income Tax (Appeals) [CIT(A)] upheld the AO’s decision, stating that the transport company had a contractual relationship with the truck operators, making them sub-contractors.

The Income Tax Appellate Tribunal (ITAT) also dismissed the company’s appeal, agreeing that each goods receipt (bilty/challan) constituted a separate contract, and the company was liable to deduct TDS. The High Court of Judicature for Rajasthan at Jodhpur summarily dismissed the appeal, affirming the decisions of the lower authorities.

Legal Framework

The case primarily revolves around the interpretation and application of the following provisions of the Income Tax Act, 1961:

✓ Section 194C: This section deals with payments to contractors and sub-contractors. It mandates that any person responsible for paying any sum to a resident contractor or sub-contractor for carrying out any work shall deduct tax at source. Explanation III of this section defines “work” to include the carriage of goods by any mode of transport other than railways.

(1) Any person responsible for paying any sum to any resident (hereafter in this section referred to as the contractor) for carrying out any work (including supply of labour for carrying out any work) in pursuance of a contract between the contractor and- … shall, at the time of credit of such sum to the account of the contractor or at the time of payment thereof in cash or by issue of a cheque or draft or by any other mode, whichever is earlier, deduct an amount equal to- … of such sum as income-tax on income comprised therein.

(2) Any person (being a contractor and not being an individual or a Hindu undivided family) responsible for paying any sum to any resident (hereafter in this section referred to as the sub-contractor) in pursuance of a contract with the sub-contractor for carrying out, or for the supply of labour for carrying out, the whole or any part of the work undertaken by the contractor or for supplying whether wholly or partly any labour which the contractor has undertaken to supply shall, at the time of credit of such sum to the account of the sub-contractor or at the time of payment thereof in cash or by issue of a cheque or draft or by any other mode, whichever is earlier, deduct an amount equal to one per cent of such sum as income-tax on income comprised therein:

✓ Section 40(a)(ia): This section specifies that certain amounts shall not be deducted while computing income from profits and gains of business or profession. Specifically, it disallows any interest, commission, brokerage, fees for professional services, or fees for technical services payable to a resident, or amounts payable to a contractor or sub-contractor, on which tax is deductible at source under Chapter XVII-B but has not been deducted or, after deduction, has not been paid.

(ia) any interest, commission or brokerage, fees for professional services or fees for technical services payable to a resident, or amounts payable to a contractor or sub-contractor, being resident, for carrying out any work (including supply of labour for carrying out any work), on which tax is deductible at source under Chapter XVII-B and such tax has not been deducted or, after deduction, has not been paid during the previous year, or in the subsequent year before the expiry of the time prescribed under sub-section (1) of section 200:

Arguments

Appellant’s Arguments:

• ✓ The appellant argued that Section 194C of the Income Tax Act, 1961, did not apply because there was no formal contract with the truck operators. They were engaged on a freelance basis, and thus, not sub-contractors.
• ✓ The disallowance under Section 40(a)(ia) should only apply to amounts “payable” and not to amounts already “paid.” The appellant contended that the word “payable” indicates that the provision is limited to outstanding amounts and not to payments already made.
• ✓ The appellant also argued that Section 40(a)(ia) was inserted into the Act with effect from 01.04.2005, and therefore, it should not apply to the assessment year 2005-2006, which pertains to the financial year 2004-2005.
• ✓ The appellant contended that the amendment to Section 40(a)(ia) by the Finance (No.2) Act, 2014, which limited disallowance to 30% of the expenditure, should be applied retrospectively.
• ✓ The appellant submitted that applying the provisions to the entire payment leads to an incongruous position where the entire receipt is treated as income without due provision for expenses.

Respondent’s Arguments:

• ✓ The revenue argued that the concurrent findings of the lower authorities should not be interfered with, as there was no perversity in their decisions.
• ✓ The revenue contended that the appellant hired trucks and made payments to operators with each trip constituting a separate contract, making them sub-contractors under Section 194C.
• ✓ The revenue relied on the Supreme Court’s decision in Palam Gas Service v. Commissioner of Income-Tax, which clarified that “payable” in Section 40(a)(ia) covers both amounts payable and amounts already paid.
• ✓ The revenue argued that the amendment to Section 40(a) with the insertion of sub-clause (ia) applies to the assessment year 2005-2006, and the appellant failed to deduct TDS from payments to sub-contractors.
• ✓ The revenue submitted that the proviso to Section 40(a)(ia) as inserted by the Finance Act, 2014, does not apply to the assessment year 2005-2006.

Submissions of Parties

Issues Framed by the Supreme Court

The Supreme Court framed the following key issues for determination:

1. Whether Section 194C of the Act does not apply to the present case?
2. Whether disallowance under Section 40(a)(ia) of the Act is confined/limited to the amount “payable” and not to the amount “already paid”; and whether the decision of this Court in Palam Gas Service v. Commissioner of Income-Tax : (2017) 394 ITR 300 requires reconsideration?
3. Whether sub-clause (ia) of Section 40(a) of the Act, as inserted by the Finance (No. 2) Act, 2004 with effect from 01.04.2005, is applicable only from the financial year 2005-2006 and, hence, is not applicable to the present case relating to the financial year 2004-2005; and, at any rate, whole of the rigour of this provision cannot be applied to the present case?
4. Whether the payments in question have rightly been disallowed from deduction while computing the total income of the assessee-appellant?

Treatment of the Issue by the Court

The following table demonstrates as to how the Court decided the issues

Authorities

The Supreme Court considered the following authorities and legal provisions:

Judgment

The Supreme Court upheld the disallowance of payments made by Shree Choudhary Transport Company to truck operators, affirming the decisions of the lower authorities. The court held that the transport company was liable to deduct tax at source (TDS) on these payments under Section 194C of the Income Tax Act, 1961, and its failure to do so justified the disallowance under Section 40(a)(ia).

What weighed in the mind of the Court?

The Supreme Court’s decision was primarily driven by the need to ensure strict compliance with tax laws, particularly those related to TDS. The court emphasized that the provisions of Section 194C and Section 40(a)(ia) are mandatory and aim to ensure that tax is deducted at source and paid to the government. The court’s reasoning focused on the following points:

• ✓ Mandatory Nature of TDS: The court stressed that the obligation to deduct tax at source is mandatory, and non-compliance attracts consequences under the law.
• ✓ Interpretation of “Payable”: The court reiterated its stance in Palam Gas Service that “payable” in Section 40(a)(ia) includes both amounts payable and those already paid, aligning with the intent to ensure tax compliance.
• ✓ Assessment Year Applicability: The court clarified that the amendment to Section 40(a)(ia) applies from the assessment year 2005-2006, not the financial year 2005-2006, thereby rejecting the appellant’s argument.
• ✓ Rejection of Retrospective Application: The court rejected the appellant’s plea for retrospective application of the 2014 amendment, stating that it was not a curative amendment in the same sense as the 2010 amendment.
• ✓ No Prejudice to Bonafide Assessees: The court noted that the proviso to Section 40(a)(ia) provides relief to bonafide assessees who deduct TDS but may face procedural delays, which the appellant had failed to avail.

Implications

The Supreme Court’s judgment has significant implications for businesses, especially those involved in transportation contracts. The ruling underscores the importance of strict compliance with TDS provisions under the Income Tax Act, 1961. Here are key implications:

• ✓ Mandatory TDS Deduction: Businesses must ensure that TDS is deducted on payments made to truck operators or other transport service providers, especially if the payment exceeds the prescribed threshold.
• ✓ Definition of Sub-Contractor: The judgment clarifies that each trip can be considered a separate contract, and truck operators can be treated as sub-contractors, even in the absence of a formal, long-term agreement.
• ✓ Disallowance of Expenses: Failure to deduct TDS can result in the disallowance of the entire expenditure under Section 40(a)(ia), impacting the business’s taxable income.
• ✓ Importance of Documentation: Businesses need to maintain proper documentation, including challans or bilty, to demonstrate the nature of payments made to operators.
• ✓ Compliance with TDS Provisions: The ruling reinforces that the provisions of Section 194C and Section 40(a)(ia) are mandatory and not merely procedural.
• ✓ Impact on Transportation Industry: The judgment will likely lead to greater compliance within the transportation sector, with businesses now more aware of their TDS obligations.

Conclusion

The Supreme Court’s judgment in Shree Choudhary Transport Company vs. Income Tax Officer reinforces the strict enforcement of TDS provisions under the Income Tax Act, 1961. The court clarified that payments made to truck operators for transportation services are subject to TDS under Section 194C, and the failure to deduct TDS can result in the disallowance of expenses under Section 40(a)(ia).

The ruling emphasizes that the term “payable” in Section 40(a)(ia) includes both amounts payable and amounts already paid. Furthermore, the court clarified that the amendment to Section 40(a)(ia) applies from the assessment year 2005-2006. This judgment serves as a reminder to businesses to adhere to TDS obligations diligently to avoid disallowances and penalties. It also highlights the importance of maintaining proper documentation and understanding the nature of contractual relationships with service providers.