THE AMENDMENTS made in the Income Tax Act to disallow cess and surcharge as deductions retrospectively from assessment year 2005-06 will have “huge” revenue implications, two senior finance ministry officials said. The officials told The Indian Express that the retrospective nature is because the tax department wanted to insert the clarification from the date of the introduction of the cess in the Act, they said. Health and education cess is levied at 4 per cent of the tax amount.
“Revenue implication will be huge. It’s not a question of litigation. The intent has to be clear. If you are convinced that it is not an expenditure that is why it has been brought in. This was the conviction that cess could never have been allowed as an expenditure. For good legal reasons,” Central Board of Direct Taxes (CBDT) Chairman JB Mohapatra told The Indian Express.
Making a retrospective amendment to the Income-tax Act from 2005-06, the Budget clarified that cess and surcharge will not be allowed to be claimed as deductions in the form of expenditure. Citing court rulings, the tax department said the retrospective amendment is being done to correct the anomaly of cess and surcharge not being seen as a part of tax.
“…there is retrospectivity in the Bill but one has to read the context in which the retrospective provision has been kicked in here. The department strongly feels at the time of the presentation of the Bill that cess can never be part of an allowed expenditure. That’s the reason the conviction in this case is unanimous — cess could never have been allowed as an expenditure. This is at the Bill stage, there will be a lot of discussions among people who are proficient in this area. We will get a considered view after the discussions are over. But this retrospectivity in Section 40 is very different contextually from the retrospectivity in section 9. Let me clarify that,” Mohapatra said.
The change is being brought from AY 2005-06 as education cess was introduced by the Finance Act, 2004. “This amendment will take effect retrospectively from 1st April, 2005 and will accordingly apply in relation to the assessment year 2005-06 and subsequent assessment years,” the Budget documents stated.
Officials noted that even though the amendment has been worded as retrospective, its mainly aimed at clarifying the legislative intent, and will impact a handful of taxpayers and companies who are in dispute with the tax department.
“It is not retrospective, it’s just a clarity. This is there in dispute. Already the assessing officers have told them (taxpayers) that they have to pay tax on it. In few cases, it has gone to the Courts. This can never be the intention that the tax payable can itself be expenditure,” Revenue Secretary Tarun Bajaj said.
“It’s not retrospective taxation. It basically shows the intent of the legislature right from the beginning,” Bajaj stressed, adding that the government is saying don’t misinterpret the intent of the legislation. It will impact only few assesses who are in dispute. “If this thing comes out, it’s a huge amount, 4 per cent (cess as percentage),” he noted.
The court rulings differentiated between income tax and education cess on income tax, and in absence of a specific disallowance for ‘education cess’, courts had taken a view beneficial for taxpayers in many cases. In order to nullify the effect of such Court rulings and consider such rulings against the intention of law, a clarificatory amendment has been introduced in income tax law, providing that any surcharge or education cess on income tax shall not be allowed as business expenditure.
The Budget has also made changes to the I-T law making space for questioning by the tax department to explain the source of funds at the hands of the creditor. This could have an impact on funding of businesses, especially startups, if the creditor is not a venture capital fund, a venture capital company registered with SEBI.
Mohapatra said this amendment has been brought since laundering and layering was being observed for sources of funding.
“The operating section is section 68 about unexplained cash credits. If the amount in books of accounts is coming from tainted sources, then the department can ask, and can get satisfied whether the funding in your books is from right sources or illegitimate sources. Then we can make the investigation and tax it in the hands of the one who has received it. In the case of private companies, the provision was that in case of share capital, share premium and share application money, we can go behind that credit and we can ask source of source in those cases. Now we have expanded to include loans, borrowings, we can have that source of source verification. This is required in the context that there are plenty of situations in the field where there is huge layering when it comes to funding and laundering of illicit money,” he said.
“The nature and the source and legitimacy of a typical lump of money cannot be answered by looking at the first source. We have to look at the second to third to fourth to fifth (source). They layer the amount, cash will be generated at one point, and the banking channels will be routed and cheques will be from another source. Very difficult situation for the investigators and there are entry providers, those who exchange cheques for cash. So just to prevent the whole of the tax economy also getting contaminated because of these kinds of layering tactics, that is why source of source verification is also we thought would be required for loans and borrowings, not just the capital and share application money,” he said.