MAY 11, 2017

By Lukose Joseph, CA & Anil P Nair, CA

Executive Summary

BY virtue of Section 43B read with Section 145A of Income Tax Act, 1961 and decision in ACIT v Real Image Media Technologies - 2007-TIOL-514-ITAT-MAD if service tax is not routed through Profit and Loss Account, but is entered directly as a liability, question of disallowance/adding back does not arise unlike in the case of taxes on goods like VAT and Central Excise for nonpayment within the time limit prescribed.

Disallowance under Section 43B and unpaid Service Tax

Questions and Answers

Q: Sir,as per Section 43B of the Income Tax Act,1961 taxes will be allowed as a deduction only in the year in which they are paid. Am I right?

A: Partially right. Deduction is available if they are paid on or before the due date of filing your return.

Q: Sir, I do know that but what I want to know is a little more. The section intends that VAT will be disallowed if it is not paid as stated above. Isn't it so?

A: Yes.

Q: Sir, my question is can the AO (Assessing Officer) disallow the same if it is not claimed as expenditure in my accounts. That is VAT collected by me is directly credited to my liability account. Can AO again add VAT to income to arrive at the taxable income if it is not paid as above?

A: Income Tax Act, 1961 does not give you such latitude in accounting. Section145A (Method of accounting) directs you to include tax on goods for valuation of purchase and sales. Or, in other words, it is mandatory for you to include and route it through your income and expenditure account. Hence same will be added back even if it is not routed through such account.

Q: Sir, is the same criterion applicable for central excise duty?

A: Obviously.

Q: Oh, invariably, to Service Tax too!

A: I did not say so!The same view cannot be extended to Service Tax.

Crux of the Answer

It is important for us to delve on this given discourse and its concluding answer in detail, while examining the 'why' of its logic.

The Delhi High Court in CIT v Noble & Hewitt (I) (P) Ltd - 2007-TIOL-570-HC-DEL-IT held that if the assessee had neither debited the amount to the Profit and Loss Account as expenditure nor had claimed any deduction in respect of such amount, the issue of disallowing service tax under Section 43B would not arise. This apparently espouses the view expressed above. Is this a s simple as that? Let us lens further.

An extract of Section 43B, where certain deductions are allowed only on actual payment are as follows:

"Notwithstanding anything contained in any other provisions of this Act, a deduction otherwise allowable under this Act in respect of-

(a) Any sum payable by the assessee by way of tax, duty, cess or fee, by whatever name called, under any law for the time being in force, or….."

Any sum by way of tax by whatever name called? Isn't that Puzzling?

Here's a Land Mark Observation

In ACIT v Real Image Media Technologies - 2007-TIOL-514-ITAT-MAD, the following observation was made on Section 43B.

"From a plain reading of the above provision it becomes clear that the rigor of this provision would be attracted only in a case where an item is allowable as deduction but because of the failure to make payment such deduction will not be allowed. It can be argued that in the case of ST also the Assessee does not claim deduction since it has been held that non-payment of Sales-tax would attract provisions of  Section 43B, but that is being done on the basis of the principles laid down by the Hon'ble Supreme Court in the case of  Chowranghee Sales Bureau Ltd. v. CIT - 2002-TIOL-957-SC-IT-LB that Sales-tax is part of the trading receipt.

Further, Section 145A  clearly provides that for the purpose of determining income under the head profits and gains of business or profession, the amount of purchase and sales i.e., turnover would include any tax, duty, cess or fee. Therefore, the rigor of  Section 43B  may be applicable in the case of Sales-tax or Excise Duty but the same cannot be said to be the position in case of Service-tax because of two reasons. Firstly, the Assessee is never allowed deduction on account of service tax which is collected on behalf of the Govt., and paid to the Govt. accordingly. Therefore, a service provider is merely acting as an agent of the Govt., and is not entitled to claim deduction on account of service tax. Hence, on this account alone addition under  Section 43B  could not be made and the same has been correctly deleted by the CIT (Appeals)."

Confusion intrinsic in alternatives

Normally indirect tax collections are included in gross turnover and then shown net of tax or such tax is debited separately to Profit and Loss Account. An easy alternative was to show collected tax as a liability instead of income and such account is debited or squared up when paid without actually routing through Profit and Loss Account.

Sales Tax is part of trading receipt, observed the Court. But what does the Institute of Chartered Accountants of India (ICAI) suggest as far as accounting for VAT?

Relevant Paragraph from Guidance Note for VAT

40. In view of the above, it is recommended that the amount of tax collected from customers on sale of goods should be credited to an appropriate account, say, 'VAT Payable Account'.  Where the enterprise has not charged VAT separately but has made a composite charge, it should segregate the portion of sales which is attributable to tax and should credit the same to 'VAT Payable Account' at periodic intervals.  The amounts of VAT payable adjusted against the VAT Credit Receivable (Inputs) Account or VAT Credit Receivable (Capital Goods) Account and amounts paid in cash will be debited to this account. The credit balance in VAT Payable Account, at the year-end, should be shown on the 'Liabilities' side of the balance sheet under the head 'Current Liabilities'.

Does this follow the Supreme Court as stated in Chawranghee Case (supra)?

Let us seethe treatment of Central Excise duty.

Relevant Paragraph from Guidance Note for Central Excise

8. Amount of excise duty forming part of the sale price of the goods is required to be indicated separately in all documents relating to assessment of duty, e.g., excise invoice used for clearance of excisable goods (Section 12A). It is, however, open to a manufacturer to recover excise duty separately or not to make a separate recovery but charge a consolidated sale price inclusive of excise duty. The incidence of excise duty is deemed to be passed on to the buyer, unless contrary is proved by the payer of excise duty (Section 12B).

At the outset, the Guidance Note indicates "Amount of Excise duty forming part of the sale price of the goods…" Hence it identifies it as forming part of revenue and as such should obviously be routed through the Profit and Loss Account.

As far as Service Tax is concerned, no guidance was found on such diverging treatment.

Necessity of grossing up

However, the necessity of grossing up tax paid for goods and inventory arises out of a clear provision in Section 145A.Here is an extract of Section 145A,

"Not withstanding anything to the contrary contained in Section 145, -

(a) The valuation of purchase and sale of goods and inventory for the purposes of determining the income chargeable under the head "Profits and gains of business or profession" shall be-

(i) in accordance with the method of accounting regularly followed by the assessee; and

(ii) further adjusted to include the amount of any tax, duty, cess or fee (by whatever name called) actually paid or incurred by the assessee to bring the goods to the place of its location and condition as on the date of valuation.

Explanation.- For the purposes of this section, any tax, duty, cess or fee (by whatever name called) under any law for the time being in force, shall include all such payment notwithstanding any right arising as a consequence to such payment.

Reader may note that the above include goods and inventory and not services.

The view of the Tribunal in Real Image Media case was repeated in the case of Sri Rajeev Kant Chadda v Department Of Income Tax [I.T.A. No.516/Lkw/2011] in Lucknow Bench of the Tribunal.

It was held that since the Delhi Tribunal, in the case of Nafe Singh Gahlawat vs. ACIT - 2011-TIOL-810-ITAT-DEL has taken a consistent view that the rigor of the provision of  Section 43B   would be attracted only to a case where an item is allowable as deduction but because of the failure to make payment, such deduction would not be allowed and the rigor of Section 43B might be applicable to the case of sales tax or excise duty but the same could not be said to be the position in case of Service Tax.

Conclusion:

By virtue of Section 43B read with Section 145A and decision in ACIT v Real Image Media Technologies - 2007-TIOL-514-ITAT-MAD  if service tax is not routed through Profit and Loss Account, but is entered directly as a liability, question of disallowance/adding back does not arise unlike in the case of taxes on goods like VAT and Central Excise for non-payment within the time limit prescribed.

And what would GST bring along?