TDS mechanism cannot be put into practice until identity of the person in whose hands, it is includible as income can be ascertained.

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TDS mechanism cannot be put into practice until identity of the person in whose hands, it is includible as income can be ascertained.

There are various instances when the provision for expenses is done in the books of accounts but the payee is not known. Few of the illustration where such situation could arises are as under:
  1. Rent is payable against the premises and the legal owner has died. There are litigation amongst the legal heir as to the rental income. The payer is sure that the the amount of rent is payable but the recipient in such case is uncertain.
  2. The book of accounts has been closed and the provision for audit fees is also done. But the auditor would be appointed by the Government authorities after the end of the year only.
  3. Interest on bonds is payable to the bearer of the bonds. The actual claimant of the bonds & interest will be known only at the time of maturity.
  4. And Many More such instances
Normally, deduction towards any expenses is available only if TDS applicable on such expense has been done and paid to the Government Treasury. In all above instances, the expenses is certain and need to be booked as expenses but the payee is uncertain.
Question arises as to how to comply with the TDS provisions in such cases. Deductor is not under an obligation to do TDS but also under an obligation to file the quarterly TDS returns. For both this purpose, the payee has to be an “identified” or “known” persons. TDS cannot be done if the payee is unknowns. Further, the TDS by the deductor is linked with the TDS Credit to the deductee. In short, the mechanism fails if there is only deduction and no credit visible to the deductee.
Here is an interesting judgement by the Mumbai ITAT in the case of IDBI vs ITO Mumbai ITAT, 2007 107 ITD 45 Mum, 2007 293 ITR 267 Mum, (2006),  104 TTJ Mum 230 wherein it is held that TDS mechanism cannot be put into practice until identity of the person in whose hands, it is includible as income can be ascertained.
The same view was subsequently followed in the case of
The copies of both the judgments are as under: 
I]
Income Tax Appellate Tribunal – Mumbai
Industrial Development Bank
vs
Income Tax Officer
 on 31 July, 2006
Equivalent citations: 2007 107 ITD 45 Mum, 2007 293 ITR 267 Mum, (2006) 104 TTJ Mum 230
Bench: P Kumar, R Yadav
ORDER Pramod Kumar, A.M.
  1. This is an appeal filed by the assessee and is directed against the order dt..27th Aug. 1997 passed by the CIT(A) in the matter of penalty imposed on the assessee under Section 221 r/w Section. 193 of the IT Act, 1961 (hereinafter referred to as ‘the Act’), for the asst. yr. 1994-95.
  2. The core issue requiring our adjudication in this case pertains to the scope of Explanation to Section. 193 of the Act. To be more specific issue that we are required to adjudicate here is whether or not Section. 193 of the Act requires tax deducted at source in respect of the provision for interest accrued but not due made by an assessee where the ultimate recipient of such interest accrued but not due cannot be ascertained at the point of time when the provision is made.
  3. The case before us also raises another important legal issue about the scope of Section. 221 per se, and whether a penalty under the said Section can be imposed at all, as a consequence of non-deduction of tax at source after the insertion of Section. 271C w.e.f. 1st April, 1989. That respect of the matter, however, we will deal with a little later.
  4. Coming back to the core issue, it is necessary to briefly explain the expression ‘interest accrued but not due’. The expression ‘interest accrued but not due’ is essentially an accounting expression which refers to the interest liability which has arisen in respect of the interest payable by a person but liability to pay such interest has not crystallised. The expression becomes particularly relevant when interest is payable on a date later than the date on which books of account of the assessee are closed annually and, therefore, as at the time of closure of annual accounts, the assessee has incurred a liability in respect of interest but that liability is to be discharged at a later date. To illustrate, let us take a situation in which a person, who follows financial year as his accounting year has borrowed funds aggregating to Rs. 10,00,000, as on 1st April, on interest @ 12 per cent per annum and such interest is to be paid at the end of each calendar year. On 31st December of that year, therefore, the assessee has a liability to pay Rs. 90,000 to his borrowers. Now as on 31st March of the following year, the assessee will have an interest liability incurred for the remaining three months but the liability to pay the same will crystallise only at the end of this calendar year. While, for the purposes of accounting, this interest liability of Rs. 30,000, is to be provided in the books of account as a charge on income but since liability for payment will only mature at the end of the relevant accounting year, the corresponding credit is not to be given to the respective lenders but only to an appropriate provision account. It is such an interest liability which is referred to as ‘interest accrued but not due.
  5. The facts of the case before us, however, are little more complex than the situation visualised in the above simple illustration. Let us set out the material facts first.
  6. The assessee before us is one of the pioneer financial institutions in India. The assessee follows financial year as its accounting year. In 1993 the assessee raised funds aggregating to more than Rs. 200 crores by issuance of certain unsecured bonds. One of the bonds so issued was ‘Regular Return Bond-Series II and the assessee offered 16 per cent interest p.a. payable annually on these bonds. As regards the terms for interest payment of this bond, the offer document, inter aha, describes the same as follows:
The interest will become due and payable yearly on 9th June, every year and at the time of maturity. The said interest will be payable to the bondholder registered with the IDBI on 15th May of each year. The first payment will be made on 9th June, 1994.
  1. It is also relevant to note that the bonds so issued by the assessee-company were transferable by endorsement and delivery. As regards the transferability of these bonds, the offer document stated as follows:
These bonds, being negotiable instruments, are transferable by endorsement and delivery by the transferor. The endorsement by the transferor will be made on the bond by affixing his signature at the place indicated thereon. The transferee shall also affix his signature on the bond at the appropriate place.
  1. As regards the requirement of registration of the transfer of these bonds, the same offer document further observed as follows:
… For the purpose of registration, the transferee shall intimate his/her name, address, occupation, if any, and shall deliver the bond certificate(s) to IDBI at Bombay. In case of regular return bonds, the transferees must get their names registered with the IDBI as aforesaid since the yearly interest thereon, is payable only to the registered bondholders….
  1. The above terms and conditions, so far as material for the purposes of our adjudication, can be summarized as follows:
(a) The assessee is liable to pay interest @ 16 per cent annually in respect of regular return bondholders.
(b) The interest is payable on 9th June of each calendar year, except in the year of maturity, when interest is payable on maturity.
(c) The interest, except at the time of maturity, is paid to the person whose name is registered in the records of the assessee-company as on 15th May of each calendar year.
(d) The bonds are transferable by endorsement and delivery, and the assessee does not, in any way, control such transfer of ownership.
Let us now appreciate the impact of the above terms and condition so far the issue in appeal before us is concerned. As on 31st March of the year, the assessee’s liability for ‘interest accrued but not due’ because interest is payable only once annually on a date other than the date of closure of accounts but the assessee will have no means to find out as to who could be the recipients of ‘interest due but not payable’ in respect of ‘regular return bonds’ because while assessee’s liability to pay interest @ 16 per cent is certain and is to be made as on 31st March, i.e., on the end of the relevant accounting year, the bonds in question being freely transferable, it cannot ascertain as to who will be the registered bondholder as on 15th May of that year. The assessee cannot be expected to have clairvoyance of knowing, as on 31st March, as to who will own the bonds on 15th May of that year. Therefore, in such a situation while the assessee certainly has the liability to pay the interest for the period till the end of the relevant accounting year, the assessee certainly does not know for sure as to who will be entitled to receive this interest.
  1. In the simple illustration that we had taken earlier, the assessee knows the person who is to be paid ‘interest accrued but not due’, when the same becomes payable, because the interest is to be paid to the lender and the lender obviously cannot remain unidentified. In the case before us the interest is to be paid to a ‘registered bondholder’ as on a future date, and there cannot be any method to find out as to who will be registered bondholder on a future date.
  2. Let us now take a look at the provisions of Section. 193 which are at the core of this controversy. Section 193is reproduced below for ready reference.
Chapter XVII–Collection and recovery of tax B–Deduction at source Section 193–Interest on securities–The person responsible for paying to a resident any income by way of interest on securities shall, at the time of credit of such income to the account of the payee or at the time of payment thereof in cash or by issue of a cheque or draft or any other mode, whichever is earlier, deduct income-tax at the rates in force on the amount of interest payable.
Provided … (As it is not relevant for our purposes, we are not reproducing the same).
Explanation–For the purposes of this section, where any income by way of interest on securities is credited to any account, whether called ‘interest payable account’ or ‘suspense account’ or by any other name, in the books of account of person liable to pay such income, such crediting shall be deemed to be credit of such income to the account of the payee and the provisions of this Section shall apply accordingly.
  1. Very briefly, the case of the Revenue is that in the light of Explanation to Section. 193, tax is required to be deducted at source in respect of all provisions for ‘interest accrued but not due’ because crediting of such interest to any account, by whatever name called, is to be treated as ‘credit of such income to the account of the payee’. The assessee, on the other hand, contends that unless the payee can be ascertained, there is no question of deduction of tax at source. It is contended that when the payee cannot be ascertained at the point of time when provision is made, as is the case before us, the machinery of deduction at source cannot be put into action.
  2. We may now briefly touch upon the developments giving rise to this appeal before us.
  3. At the end of the relevant previous year, the assessee-company made a provision of Rs. 55,31,68,800, for interest accrued but not due in respect of regular return bonds (series II). This provision was charged to the P&L a/c, and accordingly a deduction in respect of the same was claimed in computation of business income. The said provision was credited to the ‘interest payable account’ and was reflected as such in the balance sheet. In the course of scrutiny of TDS returns, the AO noticed that the assessee did not deduct tax at source in respect of the provision so made. The AO was of the view that in terms of the provisions of Section. 193, particularly read with Explanation thereto, the assessee was required to deduct tax at source from the credit to ‘interest payable account’ and deposit the same with the Government. The AO was of the view that the assessee knew the identity of all the bondholders as on 31st March, 1994 because the assessee was maintaining a register of bondholders, and, therefore, it could not be said that the assessee did not know the names of the persons to whom interest was to be credited. The AO thus concluded that the assessee was at fault inasmuch as the assessee did not comply with the provisions of Section. 193 read with Explanation thereto. Accordingly, the assessee was imposed a penalty of Rs. 1,49,64,354 on the ground that the assessee has committed a default without any reason under Section 201(1)on account of non-deduction of tax at source in respect of interest liability credited to ‘interest payable account’. Aggrieved, assessee carried the matter in appeal before the CIT(A) but without any success. The CIT(A) rejected all the contention of the assessee and concluded as follows:
Thus it is evident from the above facts that the appellant had credited the interest payable to interest liability account and debited the same to P&L a/c, but failed to deduct income-tax without any good or sufficient reason and in utter disregard to clear provisions of Section. 193 and Explanation below the said Section. Hence, in my considered view, it is a fit case for not only the levy of interest under Section 201(1A), but also levy of maximum penalty under Section 221 r/w Section. 201. Accordingly, ITO’s order levying the penalty is upheld.
Learned CIT(A) nonetheless modified the order of the AO so far as quantum of penalty was concerned, as the correct interest provision was Rs. 44,85,97,164 and not Rs. 55,31,68,800 as stated in the AO’s order. Based on CIT(A)’s direction to verify the facts and reduce the penalty accordingly, the penalty was finally reduced to Rs. 1,21,34,589.
  1. Not satisfied with the order of the CIT(A), the assessee is in second appeal before us.
  2. Shri Dinesh Vyas, learned senior advocate, assisted by Shri P.C. Tripathi, advocate, appeared for the assessee, and Shri N.N. Mishra, learned CIT (Departmental Representative) appeared for the Revenue. During the course of hearing and finding that the grounds of appeal did not succinctly set out the controversy actually requiring our adjudication, we asked the parties to address us on the two legal issues that we have identified earlier in this order. Rival contentions are conscientiously heard, material on record is carefully perused and factual matrix of the case as also the applicable legal position are duly considered.
  3. In our humble understanding, conceptually, liability of TDS is in the nature of a vicarious or substitutionary liability which presupposes existence of a principal or primary liability. Chapter XVII-B is titled ‘Collection and recovery of tax–Deduction of tax at source” and this title also indicates that the nature of TDS obligations are obligations for collection and recovery of tax. Under the IT Act, tax is on the income and it is in the hands of the person who receives such income, except in the case of dividend distribution tax which is levied under Section. 115-0–a Section outside the chapter providing for collection and recovery mechanism and set out under a separate chapter ‘Determination of tax in certain special cases–Special provision relating to tax on distributed profits of domestic companies’. A plain reading of Section. 190 and Section. 191, which are first two sections under the Chapter XVII, and of Sections 199, 202and 203(1)would show this underlying feature of the TDS mechanism. These sections are reproduced below for ready reference.
Collection and recovery of tax–General 190–Deduction at source and advance payment–{1) Notwithstanding that the regular assessment in respect of any income is to be made in a later assessment year, the tax on such income shall be payable by deduction or collection at source or by advance payment, as the case may be, in accordance with the provisions of this chapter.
  1. Nothing in this Section shall prejudice the charge of tax on such income under the provisions of Sub-section (1) of Section. 4.
191–Direct payment–In the case of income in respect of which provision is not made under this chapter for deducting income-tax at the time of payment, and in any case where income-tax has not been deducted in accordance with the provisions of this chapter, income-tax shall be payable by the assessee direct.
Collection and recovery of tax–Deduction at source 199–Credit for tax deducted–(1) Any deduction made in accordance with the foregoing provisions of this chapter and paid to the Central Government shall be treated as payment of tax on behalf of the person from whose income the deduction was made, or the owner of the security or the shareholder, as the case may be, and credit shall be given to him for the amount so deducted on the production of certificate furnished under Section 203 in the assessment made under this Act for the assessment year for which such income is assessable:
Provided … (As it is not relevant for our purposes, we are not reproducing the same) 202–Deduction only one mode of recovery–The power to recover tax by deduction under the foregoing provisions of this chapter shall be without prejudice to any other mode of recovery.
203–Certificate for tax deducted–(1) Every person deducting tax at source in accordance with the foregoing provisions of this chapter shall within such period as may be prescribed from the time of credit or payment of the sum, or, as the case may be, from the time of issue of a cheque or warrant for payment of any dividend to a shareholder, furnish to the person to whose account such credit is given or to whom such payment is made or the cheque or warrant is issued, a certificate to the effect that tax has been deducted, and specifying the amount so deducted, the rate at which tax is deducted and such other particulars as may be prescribed.
Section 190 makes it clear that the scheme of TDS is one of the methods of recovering the tax due from a person and it is notwithstanding the fact that the tax liability may only arise in a later assessment year. The tax liability is obviously in the hands of the person who earns the income and TDS mechanism provides for method to recover tax under such liability. Therefore, this TDS liability is, as we begun by taking note of, a sort of substitutionary liability. Section 191 further makes this position clear when it lays down that in a situation TDS mechanism is not provided for a particular type of income or when the taxes have not been deducted at source in accordance with the provisions of Chapter XVII, income-tax shall be payable by the assessee directly. This provision thus shows that TDS liability is a vicarious liability and the principal liability is of the person who is taxable in respect of such income. Section 199 makes it even more clear by laying down that the credit for taxes deducted at source can only be given to the person from whose income the taxes are so deducted. Therefore, when tax deductor cannot ascertain beneficiaries of a credit, the tax deduction mechanism cannot be put into service. Section 202 lays down that TDS provisions are without any prejudice to any other mode of recovery from the assessee, which again points out to the tax deduction liability being vicarious liability in nature. Section 203(1) then lays down that for all tax deductions at source the tax deductor has to “furnish to the person to whose account such credit is given or to whom such payment is made or the cheque or warrant is issued” which presupposes that at the stage of tax deduction the tax deductor knows the name of person to whom the credit is to be given though whether by way of credit to the account of such person or by way of credit to some other account. This again shows that TDS liability is a vicarious liability to pay tax on behalf of the person who is to be beneficiary of the payment or credit, with a corresponding right to recover such tax payable from the person to whom credit is afforded or payment is made. It would be thus seen that the whole scheme of TDS proceeds on the assumption that the person whose liability is to pay an income knows the identity of the beneficiary or the recipient of the income. It is a sine qua non for a vicarious tax deduction liability that there has to be a principal tax liability in respect of the relevant income first, and a principal tax liability can come into existence when it can be ascertained as to who will receive or earn that income because the tax on the income and in the hands of the person who earns that income. In this view of the matter, TDS mechanism cannot be put into practice until identity of the person in whose hands, it is includible as income can be ascertained.
  1. It is indeed correct that Explanation to Section 193 lays down that even when an income is credited to any account in the books of account of the person liable to pay such income, such crediting shall be deemed to be credit of such income to the account of the payee and the provisions of this Section shall apply accordingly, but the fact that the credit to any account is to be deemed to be credit to the payee’s account also presupposes that payee can be ascertained. Therefore, this deeming fiction can only be activated when the identity of the payee can be ascertained. To illustrate, in the example that we had taken in para 4 above as long as assessee knows the identity of lenders, whether the assessee credits the interest accrued but not due in the account of the assessee or in some other account, tax would continue to be deductible under Section 193by the virtue of deeming fiction set out in the Explanation to Section. 193. The liability to pay in such a case would crystallise later, i.e., on due date of 31st December, and the corresponding credit to the lender’s account will also be given on 31st December, but the assessee will still have tax deduction liability in respect of interest accrued but not due as on 31st March. However, on the facts of the present case, this Explanation cannot be put into practice because the payee is not known at the stage of provision for ‘interest accrued but not due’ being made. It is not difficult to visualize that Explanation to Section. 193, which was introduced w.e.f. 1st June, 1989, was apparently to take care of a situation in which instead of crediting the account of the payee, some other proxy account was credited, to avoid the TDS liability being invoked. For example, if at the end of the accounting year, the assessee is to make a provision for interest of Rs. 10,000 payable to Mr. X, but he creates the provision by way of credit to ‘interest payable account’. In such a situation ‘interest payable account’ is de facto a proxy account for Mr. X, either fully or to the extent of the amount payable to Mr. X. However, it could have been argued, in the absence of the Explanation to Section. 193, that since the credit is not to the account of Mr. X, the tax deduction liability cannot be invoked. The Explanation itself makes it clear that even when such a practice is adopted the credit will be deemed to be credit to the payee’s account. In our considered view, fiction embodied in the Explanation is only applicable in situations in which tax deduction liability is sought to be escaped by crediting interest to some other account other than that of recipient of interest. In our considered view, Explanation to Section. 193 cannot be invoked in a case where the person who is to receive the interest cannot be identified at the stage at which the provision for interest accrued but not due is made. This position is also accepted by the CBDT, as evident from its letter dt. 5th July, 1996 addressed to the Tata Iron and Steel Co. Ltd. (Letter No. 275/126/96 IT (B)], which, inter alia, states as follows:
I am directed to refer to your letter ref. 3A 13-21/1460 dt. 23rd May, 1996, on the above subject, and to say that difference between the issue price of Rs. 5,000 and face value of Rs. 25,500 is in the nature of interest subject to provisions of Sections 193/193A. Although the company would be making provisions for interest on year to year basis in their books of account, there will be no deduction of tax at source in each such year as the payee is not known.
(Emphasis, italicised in print, supplied by us now) We agree with the merits of the stand so taken by the CDBT. The deduction of tax at source can only be effected when payee is known. As far as the situation before us is concerned, the regular return bonds being transferable on simple endorsement and delivery and the relevant registration date being a date subsequent to the closure of books of account, the assessee could not have ascertained the payees at the point of time when the provision for interest accrued but not due was made. Accordingly, no tax was required to be deducted at source in respect of the provision for interest payable made by the assessee which reflected provision for ‘interest accrued but not due’ in a situation where the ultimate recipient of such ‘interest accrued but not due’ could not have been ascertained at the point of time when the provision is made. In the present case, interest to such bondholders is to be paid as are registered with the assessee-company as on 15th May, 1994 but there could not have been any method of ascertaining, as at the time of making the provision for ‘interest accrued but not due’, i.e., on 31st March, 1994, as to who will be registered bondholders as on 15th May, 1994. It is also important to bear in mind that taxes were duly deducted at source at the time of payment, i.e., on 9th June, 1994 and that there is no loss of revenue as such. In the light of these discussions, we hold that the assessee did not have any liability to deduct tax at source, in respect of provision for ‘interest accrued but not due’, in respect of regular return bonds made on 31st March, 1994. When there was no obligation of deduct tax at source, there cannot be any question of levy of penalty or interest. The appellant, therefore, must succeed.
  1. There is, however, one more important aspect of the matter, and that is with regard to the question whether the AO could have imposed the penalty at all under Section 221. In the case of ITO v. Titagarh Steel Ltd. (2001) 73 TTJ (Cal) 297 : (2001) 79 ITD 532 (Cal), a co-ordinate Bench of this Tribunal, dealing with the consequences of non-deduction or short-deduction of tax at source has held that post 1st April, 1989, penalty for non-deduction of tax at source or short-deduction of tax at source can only be imposed under Section 271Cof the Act. While doing so, the Tribunal, articulating its views through one of us (i.e., the AM), observed as follows:
6. That takes us to the question that in case only one penalty, i.e., either under Section 221(1)or under Section 271C, is imposable for the default of short-deduction of tax at source, under which Section can such a penalty be imposed.
7. We find that Section. 271C was inserted in the IT Actw.e.f. 1st April, 1989, by the virtue of Direct-tax Amendment Act, 1987, and that the CBDT, vide Circular No. 551, dt. 23rd Jan., 1990 [(1990) 82 CTR (St) 325], explained the insertion of this Section in following words:
16.5 Under the old provisions of Chapter XXI of the IT Act, no penalty was provided for failure to deduct tax at source. This default, however, attracted prosecution under the provisions of Section. 276B, which prescribed punishment for failure to deduct tax at source or after deducting, failure to pay the same to the Government. It was decided that the first part of default, i.e., failure to deduct the tax at source should be made liable to levy of penalty, while the second part of default i.e., failure to pay the tax deducted to the Government, which is a more serious offence, should continue to attract prosecution. The Amending Act, 1987 has accordingly inserted a new Section. 271C to provide for imposition of penalty on any person who fails to deduct tax at source as required under the provisions of Section XVII-B of the Act. The penalty is a sum equal to the amount of tax which would have been deducted at source.’
  1. It was only at the time of insertion of Section. 271C that rigours of Section. 276B were relaxed and non-deductions and short-deductions of tax at source were taken out of the purview of this Section. We may mention that until that point of time, Section. 276B provided that ‘if a person, without reasonable cause or excuse, fails to deduct or after deducting, fails to pay the tax as required by or under the provisions of Sub-section (9) of Section 80Eor Chapter XVII-B, he shall be liable to be prosecuted and, in effect, a sentence in the prison. It is thus clear that upto 31st March, 1989, only penalty which could have been imposed, if at all imposable, for the default of short-deduction of tax at source was penalty under Section 221(1). Since for our purposes it is not necessary to go further into this aspect of the matter, we leave it at that.
  2. Let us now take a look at the legal position after the insertion of Section. 271C, i.e., w.e.f. 1st April, 1989. We have already noticed that Section. 271C is a specific provision dealing with assessee’s failure of non-deduction, or short-deduction, of tax at source, It is fairly well settled in law that general provisions do not override specific provisions, as aptly described by the maxim ‘generalia specialibus non derogant’. A special provision normally excludes the operation of a general provision and we are of the view that such a principle governs the instant case also. In the case of South India Corpn. (P) Ltd. v. Secretary, Board of Revenue , Hon’ble Supreme Court had an occasion to consider whether Article 277or Article 372of the Constitution of India should govern the particular situation involved therein. Their Lordships then pointed out that ‘a special provision should be given effect to the extent of its scope, leaving the general provision to control cases where specific provisions do not apply.’ In the light of these discussions, it is clear to that to the extent a default is covered by the specific provisions of Section. 271C, such a default cannot be subject-matter of penalty under Section 221(1) of the Act. We are, therefore, of the considered view that penalty under Section 221(1) cannot be imposed for the cases of non-deduction and short-deduction of taxes at source, which are undisputedly covered by the specific provisions of Section. 271C, so far as period after 1st April, 1989 is concerned.
  3. In view of the above discussions, we are of the considered view that the very levy of penalty under Section 221(1), on the facts of this case, was unsustainable in law since the short-deduction of tax at source took place in the financial year 1990-91, i.e., much after insertion of Section. 271C w.e.f. 1st April, 1989.
The levy of penalty under Section 221(1) was thus quashed on the ground of jurisdiction. As a matter of fact, the CBDT itself has in Circular No. 551, dt. 23rd Jan., 1990, accepted that until Section. 271C was inserted in the Act ‘no penalty was provided for failure to deduct tax at source’. It is not only merely a question of mentioning a wrong section, which could perhaps be covered up by recourse to Section. 292B, it is also important to bear in mind that the impugned penalty is levied by an officer of the rank of the ITO, whereas, penalty under Section 271C could only have been levied by an officer of the rank of the Deputy (now Joint) CIT. The ITO was, from this point of view, not even competent to impose the impugned penalty. Learned Departmental Representative points out that penalty under Section 221 has been upheld by the Hon’ble Calcutta High Court in the case of Jubilee Investments and Industries Ltd. v. Asstt. CIT and therefore, Tribunal’s decision in the case of Titagarh Steel Ltd. (supra) is not good law. We don’t agree with this submission either. In fact this judgment clarifies that penalty under Section 221 is imposable when the assessee deducts the tax at source but does not deposit the same within the prescribed time-limit, whereas penalty under Section 271C is imposable in a case of assessee’s failure to deduct tax at source. While discussing this aspect of the matter at p. 651 of the report, their Lordships have also taken note of the fact that the power to impose penalty in a case of non-deduction or short-deduction of tax at source, i.e., under Section 271C, is conferred on the Jt. CIT but it is not the same case so far penalty under Section 221 is concerned. Their Lordships have also made it clear that these sections operate in mutually exclusive areas by observing that “A perusal of both the sections, i.e., Section. 221 and Section. 271C, shows that though both the penalties are penalties for default–either in deducting the TDS or after deducting TDS the assessee’s failing to deposit that amount with the Central Government within the prescribed time-limit … Thus it is clear that penalty under both the sections is on different grounds”. In the present case, even according to the Revenue, the default was on account of deduction of tax at source. Such a default for the reasons set out above, cannot be visited with penalty under Section 221. For this reason also, the impugned penalty is unsustainable in law.
  1. For the reasons set out above, we are of the considered view that the impugned penalty under Section 221is unsustainable in law and on the fact of this case. We, therefore, set aside the impugned penalty order. The aapssee gets the relief accordingly.
  2. The appeal is allowed.
In the case of Pfizer Ltd, Mumbai vs Department of Inocme Tax (ITA Nos 1667 & 1765 of 2010) also it has been held that No TDS is applicable if the payee is not-identifiable. The court relied on the riling of ITAT in the case of IDBI vs. I.T.O 107 ITD 45(Mum).
 

II]
 
Income Tax Appellate Tribunal – Mumbai 
Pfizer Ltd, Mumbai
vs
Department of Income-Tax
(ITA Nos 1667 & 1765 of 2010)
1 October, 2012
ITA Nos 1667 & 1765 of 2010 Pfizer Ltd Mumbai                                                
 IN THE INCOME TAX APPELLATE TRIBUNAL
 “C” Bench, Mumbai
          Before Shri D.K. Agarwal, Judicial Member and
            Shri B. Ramakotaiah, Accountant Member
 ITA No.1667/Mum/2010
  (Assessment year: 2007-08)
Pfizer Ltd., Pfizer Centre, Parel     Vs.   Income Tax Officer (TDS)
Centre, S.V. Road, Jogeshwari               (OSD) Range-2, KG Mittal
(West), Mumbai 400012                       Ayurvedic Hospital Building,
PAN:AAACP 3334 M                            Charni Road,
 Mumbai 400002
(Appellant)                                    (Respondent)
                      ITA No.1765/Mum/2010
                      (Assessment year: 2007-08)
Income Tax Officer (TDS) (OSD) Vs.          Pfizer Ltd., Pfizer Centre,
Range-2, KG Mittal Ayurvedic                Parel Centre, S.V. Road,
Hospital Building, Charni Road,             Jogeshwari (West),
Mumbai 400002                               Mumbai 400012
   PAN:AAACP 3334 M
(Appellant)                                     (Respondent)
                    Assessee by:   Shri Percy Pardiwalla,
                                   Ms. Vasanti Patel &
                                   Ms. Charul Toprani
                    Department by: Shri A.C. Tejpal, CIT (DR)

 

                    Date of Hearing:  01/10/2012
                    Date of Pronouncement: 31/10/2012
                               ORDER
Per B. Ramakotaiah, A.M.
These are the cross appeals by assessee and the Revenue against the orders of theCIT (A)-14 Mumbai dated 31.12.2009. The issue in this appeal is with reference to the levy of tax under Section 201(1) and interest under Section 201(1A) of the Income Tax Act on the reason that assessee defaulted on not deducting the TDS on certain expenditure/payments made by it.
  1. Briefly stated, the proceedings under section 133Awere conducted on assessee’s premises on 8.9.2008 and AO passed the order under section 201(1)& 201(1A) dated 30.12.2008 considering the following broadly categorized amounts as amounts covered by TDS provisions on which TDS was not made:
a) Provision made but tax not deducted under section 40(a)(i)& 40(a)(ia)
b) Purchase of traded goods
c) Purchase of packing material
d) Clinical Trial Expenses
3. It was the contention of AO that assessee made provision for expenses for an amount of `.10,01,98,450/- and there was short deduction of tax at `.2,06,45,686/- which is to be disallowed under section 40(a)(i)and 40(a)(ia). Assessee was required to show cause why the said amount could not be considered for determining the liability to the TDS under section 201(1)and 201(1A). After considering assessee’s objections AO determined the amount of tax to be deducted and the same was demanded from assessee under section 201(1). AO also levied interest under section 201(1A). Likewise, the amounts under three other heads were also determined by AO under the above provisions.
4. The CIT (A) after considering assessee’s detailed submissions, however, did not agree with the assessee contentions on ‘provision made but tax not deducted’ and upheld the action of AO in determining the tax and interest under section 201(1)& 201(1A). With reference to the other three items following various case law and the orders of the jurisdictional High Court, the CIT (A) deleted the demands so made by AO holding that the provisions of TDS are not applicable to the payments made under these heads. Accordingly assessee is aggrieved on the amount confirmed under item (a), whereas the Revenue is aggrieved on the amounts deleted on the items (b) to (d).
5. The learned Counsel reiterated the submissions made before AO and the CIT (A) to submit that assessee is in the practice of making provision for expenses at the end of the year as it has multifarious locations and innumerable transactions and since all the bills would not be received, without making specific entries into accounts of the parties, makes provision for expenses. Next year the entire provision of expenses was written back and the actual amounts paid to the respective parties were credited to their respective accounts and TDS as per the provisions are being made. In this context the method of accounting followed by assessee, entries made in the books of account and the reliance on the Board’s Circular No.288 of 1980 were relied upon. It was the contention that it is not a constructive payment made to any payee as per the provisions of the Act and when assessee is making payment, it was following the TDS provisions. It was further submitted that when payee is not known or determined, TDS cannot be made and relied on the order of the ITAT in the case of Industrial Development Bank of India vs. Income Tax Officer, 107 ITR 45 (Mum).
6. It was further submitted that assessee has added back the entire amount of provision made and filed copies of the computation statements as well as the orders passed by AO affirming the disallowance so made in the computation made under section 40(a)(i). The learned Counsel also placed on record the statement indicating the amount of provision made under various heads and the actual amount paid in the later year including the tax deducted at source and reconciling the amounts on this issue.
7. The learned DR, however, submitted that assessee having made provision for expenses in the books of account should have deducted the tax and therefore, the orders of AO and the CIT (A) required to be confirmed.
8. We have considered the issue. There is no dispute with reference to the fact that assessee made provision for expenses to an extent of `.10,01,98,459/- on about 23 items in the books of account. There is also no dispute to the fact that entire provision so made was disallowed in the computation under the head ‘tax deductible but not deducted on provisions as on 31st March, 2007’ in the computation of income. Therefore, the entire provision so made was disallowed under section 40(a)(i)/(ia) while filing the return of income by the itself.
9. As explained the general entries passed by Pfizer Ltd, in the books of account are as under:
“Annexure-1 Journal Entries passed by Pfizer in the books of account:
a) At the time of making the year end provision Particulars Debit (`.) Credit(`.) Expense a/c Dr. XXX To provision for expenses a/c XXX
b) At the time of reversal on first day of the next financial year Particulars Debit (`.) Credit (`.) Provision for expenses a/c Dr. XXX To Expenses a/c XXX
c) At the time of making payment to parties on the basis of the actual invoices received by Pfizer.
         Particulars                   Debit (`.)         Credit (`.)
         Expenses a/c DR.              XXX
         To party’s a/c                                       XXX
         To TDS payable a/c                               XXX”
  1. As can be seen from the above entries, when the payment/ credit was made to the individual payee identified, all the provisions of TDS are made applicable whether to a resident or to a non-resident as the case may be. In the absence of any identifiable payee, the provisions of TDS are not applicable as was held by the ITAT in the case of IDBI vs. I.T.O107 ITD 45(Mum). In that the case the facts are as under:
“The assessee, a financial institution, was following financial years as its accounting year. It issued ‘regular return bonds’. The terms and conditions for payment of interest on these bonds provided that the assessee was liable to pay interest at the rate of 16 per cent annually in respect of regular return bondholders, that the interest was payable on 9th June of each calendar year, except in the year of maturity, when interest was payable on maturity, that the interest, except at the lime of maturity, was to be paid to the person whose name was registered in the records of the assessee company as on 15th May of each calendar year, and that the bonds were transferable by endorsement and delivery, and the assessee did not, in any way, control such transfer of ownership. The assessee at the end of the relevant previous year as on 31.3.1994 made a provision for ‘interest accrued but not due” in respect of regular return bonds and claimed deduction of the same in computation of business income. The assessee further credited the said provision to the interest payable account and reflected the same in the balance sheet. The assessee did not deduct tax at source in respect of the provision so made, The Assessing Officer noticed that the assessee did not deduct tax in terms of provision so made though in terms of the provisions of section 193, particularly read with Explanation thereto, it was required to deduct tax at source from the credit to ‘interest payable account’ and deposit the same with the Government. The Assessing Officer was of view that the assessee knew the identity of all the bondholders as on 31-3-1994 because it was maintaining a register of bondholders, and, therefore, it could not be said that the assessee did not know the names of the persons to whom interest was to be credited. The Assessing Officer, therefore held that the assessee did not comply with provisions of section 193 and imposed penalty under section 201 upon the  . assessee on account of non-deduction of tax at source in respect of interest liability credited to ‘interest payable account· He also imposed the penalty under section 221 upon the assessee. On appeal, the Commissioner (Appeals) upheld the impugned order”.
It was held that “the liability of tax deduction at source is in the nature of a vicarious or substitutionary liability, which presupposes existence of a principal or primary liability. Chapter XVII-B is titled ‘Collection and recovery of tax – deduction of tax at source: This title also indicates that the nature of tax deduction at source obligation is obligation for collection and recovery of tax. Under the Act, tax is on the income and it is in the hands of the person who receives such income, except in the case of dividend distribution tax which is levied under section 115-0, a section outside the Chapter providing for collection and recovery mechanism and set out under a separate chapter ‘Determination of tax in certain special cases – special provision relating to tax on distributed profits of domestic companies: A plain reading of section 190 and section 191, which are first two sections under the Chapter XVII, and of sections 199, 202 and 203(1), would show this underlying feature of the tax deduction at source mechanism. Section 190 makes it clear that the scheme of tax deduction at source is one of the methods of recovering the tax due from a person and it is notwithstanding the fact that the tax liability may only arise in a later assessment year. The tax liability is obviously in the hands of the person who earns the income and tax deduction at source mechanism provides for method to recover such tax liability. Therefore, this tax deduction at source liability is a sort of substitutionary liability. Section 191 further makes this  . position clear when it lays down that in a situation TDS mechanism is not provided for a particular type of income or when the taxes have not been deducted at source in accordance with the provisions of Chapter XVII, income-tax shall be payable by assessee directly. This provision, thus, shows that tax deduction liability is a vicarious liability and the principal liability is of the person who is taxable in respect of such income. Section 199 makes it even more clear by laying down that the credit for taxes deducted at source can only be given to the person from whose income the taxes are so deducted. Therefore, when tax deductor cannot ascertain beneficiaries of a credit, the tax deduction mechanism cannot be put into service. Section 202 lays down that tax deduction at source provisions are without any prejudice to any other mode of recovery from assessee, which again points out to the tax deduction liability being vicarious liability in nature. Section 203(1) then lays down that for all tax deductions at source, the tad deductor has to furnish to the person to whose account such credit is given or to whom such payment is made or the cheque or warrant it issued which presupposes that at the stage of tax deduction the tax deductor knows the name of person to whom the credit is to be given, though whether by way of credit to the account of such person or by way of credit to some other account. This again shows that tax deduction at source liability is a vicarious liability to pay tax on behalf of the person who is to be beneficiary of the payment or credit, with a corresponding right to recover such tax payable from the person to whom credit is afforded or payment is made. Thus, the whole scheme of tax deduction at source proceeds on the assumption that the person whose liability is to pay an income knows the identity of the beneficiary or the recipient of the income. It is a sine qua non for a vicarious tax deduction  . liability that there has to be a principal tax liability in respect of the relevant income first, and a principal tax liability can come into existence when it can be ascertained as to who will receive or earn that income because the tax is on the income and in the hands of the person who earns that income. Therefore, tax deduction at source mechanism cannot be put into practice until identity of the person in whose hands it is includible as income can be ascertained. It is indeed correct that Explanation to section 193 lays down that even when an income is credited to any account in the books of account of the person liable to pay such income, such crediting shall be deemed to be credit of such income to the account of the payee and the provisions of this section shall apply accordingly, but the fact that the credit to any account is to be deemed to be credit to the payee’s account also presupposes that identify of the payee can be ascertained. Therefore, this deeming fiction can only be activated when the identity of the payee can be ascertained. Therefore, the Explanation to section 193 cannot be invoked in a case where the person who is to receive the interest cannot be identified at the stage at which the provision for interest accrued but not due is made. This position is also accepted by the CBDT in its letter dated 5-7-1996 addressed to the Tata Iron & Steel Co. Ltd (Letter No.257/126 IT(B). In the instant case, the regular return bonds being transferable on simple endorsement and delivery and the relevant registration date being a date subsequent to the closure of books of account, assessee could not have ascertained the payees at the point of time when the provision for “interest accrued but not due” was made. Accordingly, no tax was required to be deducted at source in respect of the provision for interest payable made by assessee which reflected provision for “interest accrued but not due” in a situation where the ultimate recipient of such ‘interest  . accrued but not due’ could not have been ascertained at the point of time when the provision was made. Assessee had duly deducted the tax source at the time of payment i.e. on 9.6.1994 and there was no loss of revenue as such. Therefore, assessee did not have any liability to deduct tax at source in respect of provision for interest accrued but not due in respect of regular return bonds, made on 31.3.1994. When there was no obligation to deduct tax at source, there could not be any question of levy of penalty or interest. The next question for consideration in the instant case was as to whether AO could have imposed the penalty at all under section 221 upon assessee. A Coordinate Bench of the Mumbai Tribunal in the case of ITO v. Titagarh Steel Ltd (2001) 79 ITD 532, dealing with the consequences of non-deduction or short deduction of tax at source, had held that post 1-4-1989, penalty for non- deduction of tax at source or short deduction of tax at source can only be imposed under section 271C. The CBDT itself had in Circular No.551, dated 23-1-1990 accepted that until section 271C was inserted in the Act, ‘no penalty was provided for failure to deduct tax at source’. It was not only merely a question of mentioning a wrong section, which could perhaps be covered by recourse to section 292B, it was also important to bear in mind that the impugned penalty was levied by an Officer of the rank of the Income Tax Officer, whereas penalty under section 271C could only have been levied by an Office of the rank of the Deputy (now Joint) Commissioner. The ITO was, from this point of view, not competent to impose the impugned penalty. Further, in the instant case, even according to the revenue, the default was on account of deduction of tax at source. Such a default could not be visited with penalty under section 221. Hence, the impugned penalty under section 221 was unsustainable in law”.
 .
  1. In view of the above decision of coordinate bench, since the payee is not identifiable in this case also at the time of making provision, no TDS need to be made on the above amount. Further the entire provision has been written back in the next year and the actual amounts paid/credited were subjected to TDS as per the detailed statements filed before the authorities on which there is no dispute. Therefore, assessee is following the provisions of TDS as and when the amounts are paid/credited to respective parties.
  2. As already explained and evidenced from the computation of income as well as the orders of AO in the assessment proceedings, the entire provision has been disallowed under section 40(a)(ia)and section 40(a)(i). Once the amount has been disallowed under the provisions of section 40(a)(i)on the reason that tax has not been deducted, it is surprising that AO holds that the said amounts are subject to TDS provisions again so as to demand the tax under the provisions of section 201 and also levy interest under section 201(1A). We are unable to understand the logic of AO in considering the same as covered by the provisions of section 194C to 194J. Assessee as stated has already disallowed the entire amount in the computation of income as no TDS has been made. Once an amount was disallowed under section 40(a)(i)/(ia) on the basis of the audit report of the Chartered Accountant, the same amount cannot be subject to the provisions of TDS under section 201(1) on the reason that assessee should have deducted the tax. If the order of AO were to be accepted then disallowance under section 40(a)(i) and 40(a)(ia) cannot be made and provisions to that extent may become otiose. In view of the actual disallowance under section 40(a)(i) by assessee having been accepted by AO, we are of the opinion that the same amount cannot be considered as amount covered by the provisions of section 194C to 194J so as to raise TDS demand again under section 201 and levy of interest under section 201(1A). Therefore,  . assessee’s ground on this issue are to be allowed as the entire amount has been disallowed under the provisions of section 40(a)(i)/(ia) in the computation of income on the reason that TDS was not made. For this reason alone assessee’s grounds can to be allowed. Considering the facts and reasons stated above assessee’s grounds are allowed.
  3. Assessee has raised one more contention that interest under section 201(1A)should be levied till the date of payment and not till the date of order. Anyhow this issue became academic in nature, as we have already held that demand under section 201cannot be raised once the entire amount has been disallowed in the computation of income under section 40(a)(i) and 40(a)(ia). In view of this even though the contention is correct being a legal issue, there is no need for adjudicating the matter as the grounds raised have been held in favour of assessee. AO is directed to delete the said demand so raised. Appeal is accordingly allowed.
ITA No.1765/Mum/2010
  1. As briefly stated above, AO raised demand on 1.purchase of traded goods, 2.purchase of packing material and 3.clinical trials. The order of the CIT (A) on the three issues are as under:
1. Finished/Traded Goods:
“11. I have carefully considered the facts of the case, various agreements with third party, submission and legal propositions made by the Appellant. From the agreement it is clear that the assessee has exercised right for quality specification and quality control as agreed by the third party. This is common practice in pharma industries, wherein the purchaser of traded goods purchases goods only when it is up to their quality requirement. Further from the agreement it is clear that all other right and Obligation is with the seller of traded goods and the property in goods passes after it is delivered to the door step of the appellant. It is also a fact that no raw material is supplied by the appellant (purchaser)  . to the manufacturers. The manufacturing activities are also carried out by the manufacturers in their own premises. The manufacturers have also paid excise duties VAT/sales tax as applicable on the goods manufactured/sold. After going through the agreement and its various clauses and facts of the case in its entirety, it is concluded that the contract with the various parties are contract for purchases of traded goods and not of the works contract. I have also noted that the above issue is covered in the favour of the Appellant by the decision of Mumbai Tribunal in case of Novartis HealthCare Pvt. Ltd. v. ITO 29 SOT 425 (Mum) and Glenmark Pharmaceuticals Ltd. v. ITO (TDS) 30 SOT 19 (Mum) wherein the Hon’ble tribunal on identical facts has held that TDS is not required to be deducted on purchase of traded goods.
Based on the above, I am of the opinion that the provisions of Chapter XVII·B of the Act cannot be said to be applicable on purchase of finished/traded goods Accordingly, there is no default on the part of tile Appellant in complying with the provisions of Chapter XVII-B of the Act while making payment for purchase of finished/traded g0o.dS without deducting tax at source This ground of appeal is allowed in favour of the appellant”.
2.Purchase of Packing Material:
“13. I have perused the facts of the case as well as the submissions of the appellant. I am of the opinion that this ground is covered in favour of the Appellant by the decision of jurisdictional High Court in the case of BDA Ltd vs. Income Tax Officer (TDS) 281 ITR 99 (Bom.) wherein the Hon’ble High Court has held that TDS is not required to be deducted under section 19cC on purchase of packing material. Based on the above, I am of the opinion that the provisions of Chapter XVII-B of the Act cannot be said to be applicable on purchase of packing material. Accordingly, there is no default on the part of the Appellant in complying with the provisions of Chapter XVII-B of the Act while making payment for purchase packing material without deducting tax at source. In the result this ground is allowed”.
 .
3.Clinical Trials “15. I have gone through the facts of the case and submissions of the appellant. As far as the appellant’s contention that the above expenditure of `.11,35,14,000/- includes an amount of `.3,66,90,204/- on which TDS is not deductible on the following grounds:
a) Purchase of various materials.
b) Expenditure on food and travelling
c) Availability of tax exemption certificate
d) Payment of regulatory fees.
Prima facie TDS is not deductible on all the four items mentioned above. However, this particular break up has not been provided to AO. I therefore, direct AO to verify the above break up given by the appellant. If the above break up of expenditure given by the appellant is found to be correct, then I hold no TDS is required to be deducted on the above payments. AO is directed accordingly”.
With regard to balance expenditure amount of `.7,68,21,907/- is concerned, the appellant has deducted TDS of `.42,45,914/- on the same. However, it is seen that payment in question is in the nature of professional fees. In order to carry out clinic trial, the person who carries out the trial must possess medical qualification and the person should be highly qualified and should possess technical expertise. Therefore, payment made in this respect is nothing but fees for professional/technical services. Accordingly, I hold that the above payment of `.7,68,21,907/- is a payment to professional fees, therefore, tax should have been deducted as per provisions of section 194J. Therefore, the action of AO is confirmed so far as the applicability of section 194J is concerned.
However, AO is directed to calculate TDS liability under section 194J. Whatever TDS liability comes under section 194J credit for taxes paid of `.42,45,914/- is to be allowed and balance amount needs to be recovered from the appellant. This ground of appeal is disposed off accordingly”.
  1. After considering the rival contentions and perusing the order of the CIT (A), we are of the opinion that there is no need to differ from the order of the CIT (A). The learned CIT (A) has followed the  . principles established by the Hon’ble High Court in the case of BDA Ltd vs. Income Tax Officer (TDS) 281 ITR 99 (Bom.) and CIT vs. Glenmark Pharmaceuticals Ltd, 324 ITR 199. Since the issues are crystallized in favour of assessee by the orders of the jurisdictional High Court, respectfully following the same we affirm the order of the CIT (A).
  2. In the result Revenue appeal is dismissed.
  3. In the result appeal filed by assessee in ITA No: 1667/Mum/2010 is allowed, while the appeal filed by the Revenue in ITA No.1765/Mum/2010 is dismissed.
Order pronounced in the open court on 31st October, 2012.
               Sd/-                                     Sd/-
          (D.K.Agarwal)                           (B. Ramakotaiah)
         Judicial Member                         Accountant Member
Mumbai, dated 31st October, 2012.
Vnodan/sps
Copy to:
  1. The   Appellant
  2. The   Respondent
  3. The   concerned CIT(A)
  4. The   concerned CIT
  5. The   DR, “C” Bench, ITAT, Mumbai
  By Order
 Assistant Registrar
Income Tax Appellate Tribunal,
Mumbai Benches, MUMBAI
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