Wednesday, September 3, 2008

Are Companies Bound to Deduct TDS on Service Tax?

(The following post is contributed by V. Niranjan)

There is some doubt on the course of action that companies should take, as far as TDS on professional fees is concerned. The question, essentially, is this – should TDS be deducted on the amount of the professional fee paid, exclusive of service tax, or should TDS be deducted on the amount of the service tax as well? This issue has several legal implications, but is commercially even more important, especially when the professional fee charged is substantial.

Provisions on TDS are found in Chapter 17 of the Income Tax Act, 1961. Section 190 provides that notwithstanding the regular assessment process, the tax on such “income” shall be payable by deduction, in accordance with the provisions of Chapter 27. Chapter 27 goes on to specify various transactions where TDS is mandatory, such as salary (Section 192), interest on securities (Section 193), Dividend (Section 194) and so on. The provision governing TDS on professional fees is Section 194-J, and Section 194-I, which governs TDS on rent, is also relevant.

The language of these provisions reflects an interesting fact about Chapter 27 - the provisions in this chapter employ two kinds of terms, which appear to greatly differ in meaning. Some provide that TDS is on the “income by way of” the particular item, while others provide that it is on the “sum” paid or payable. So, for example, Section 194-C applies to any person responsible for paying any “sum” to any resident for carrying out any work, and Section 195 to a person responsible for paying a non-resident any “interest or any other sum chargeable under the provisions of this Act”. On the other hand, Section 193 applies to a person responsible for paying a resident any “income” by way of interest on securities, and Section 194-H to a person responsible for paying a resident any “income” by way of commission. “Sum” is wider than “income”, and on the face of it, it appears that “sum” is wide enough to comprehend service tax as well. The implication is that TDS will be deducted on the amount of the fee/transaction, plus on the amount of the service tax, in those provisions which use the phrase ‘sum’, but only on the amount of the fee/transaction in those provisions which use the phrase ‘income’. Section 194-J, the provision on professional fees and technical services, uses the phrase “sum by way of fees for professional services”.

These provisions always existed. What seems to have stirred the embers of controversy now is the Finance Act, 2007’s decision to extend the levy of service tax to commercial rent agreements. That is of course the subject of a constitutional challenge. But what it also did was invite the question whether TDS is deducted on merely the amount of the rent, or on the amount of the rent plus the amount of the newly introduced service tax.

The CBDT clarified that since “service tax paid by the tenant does not partake of the income of the landlord”, TDS is required to be made only on the sum of the rent, without including the service tax (CBDT Circular No. 4/2008. dt. 28-4-2008; F. No. 275/73/2007). This was widely interpreted to mean that TDS, across all provisions, applies only to the value of the transaction, and not to the value of taxes that may be imposed on the transaction. However, the CBDT recently clarified that this is not the case, because Section 194-I uses the phrase “income by way of rent”, while other provisions, such as Section 194-J, use the phrase “sum paid by way of fees for professional services”.

This seems to be an incorrect conclusion. For one, Section 190, which authorises the levy of TDS in the first place, unequivocally states that “tax on such income” shall be payable by deduction. Secondly, several decisions of the Supreme Court and of some High Courts have held that there is no question of levying TDS if the sum on which it is levied is not chargeable to income tax in the first place. There is no doubt that this is the case with service tax, for it is obviously not chargeable to income tax under Section 4. Also, the use of the word ‘sum’ cannot be taken to have made ‘by way of fees for professional services’ irrelevant. Finally, although Section 194-J uses the expression ‘sum’, it states at the end that the person paying the fee shall deduct the appropriate amount as income tax on “income comprised therein”. Therefore, the view that the CBDT has taken does not appear to be sustainable in law.

The immediate implications for companies are unclear, since most may believe that it is prudent to follow the CBDT’s view, and leave it to the assessee to later claim a TDS refund or credit. This is especially the case for purely manufacturing concerns, since the payment of service tax will typically not be separately accounted in its books, but as part of the fee. In this view, the only real solution is for a Court to declare that the CBDT’s view is incorrect, or for the legislature to amend the provision either way.

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