Facts of the Case

The assessee, engaged in the business of manufacturing and exporting garments and accessories, claimed expenditure amounting to ₹3,19,66,460/- paid to M/s Aakriti Creation Pvt. Ltd., a sister concern, during Assessment Year 2008–09.

The assessee contended that the payment represented reimbursement of raw material costs procured by the sister concern and did not involve any profit element.

The Assessing Officer disallowed the expenditure under Section 40(a)(ia) on the ground that no tax had been deducted at source under Section 194C.

The Commissioner of Income Tax (Appeals) granted relief to the assessee, and the Income Tax Appellate Tribunal upheld the same. Aggrieved, the Revenue filed an appeal before the Delhi High Court.

Issues Involved

  1. Whether reimbursement payments made to a sister concern attract TDS under Section 194C?
  2. Whether disallowance under Section 40(a)(ia) can be made where the payee has already disclosed the receipt in its return and paid tax thereon?
  3. Whether the second proviso to Section 40(a)(ia) has retrospective application?

Petitioner’s Arguments (Revenue’s Contentions)

  • The Revenue argued that the provisions of Section 40(a)(ia) are mandatory and any failure to deduct tax at source would automatically result in disallowance.
  • It was contended that the assessee could not unilaterally determine that a payment was merely reimbursement and outside the purview of TDS.
  • The Revenue submitted that the second proviso to Section 40(a)(ia), inserted with effect from 01.04.2013, could not be applied retrospectively.

Respondent’s Arguments (Assessee’s Contentions)

  • The assessee submitted that the payment was purely reimbursement of raw material expenses without any income element.
  • It was argued that where the recipient had already accounted for such receipts in its return and paid tax, disallowance would amount to double taxation.
  • Reliance was placed on earlier judicial precedents affirming retrospective application of the second proviso to Section 40(a)(ia).

Court Findings / Observations

The Delhi High Court observed that where the payee has already disclosed the amount received in its return and the same has been assessed, disallowance of the same expenditure in the hands of the payer would result in taxing the same income twice.

The Court reaffirmed that the insertion of the second proviso to Section 40(a)(ia) is curative and declaratory in nature and therefore operates retrospectively.

The Court emphasized that Section 40(a)(ia) is intended to ensure tax compliance and not to punish the assessee where there is no loss to the Revenue.

Court Order / Final Decision

The Delhi High Court remanded the matter back to the Assessing Officer for verification of the exact nature of payments made to M/s Aakriti Creation Pvt. Ltd.

It directed that if the Assessing Officer finds that the payments are pure reimbursements without any income component, then the provisions of Section 40(a)(ia) would not apply.

The appeal of the Revenue was partly allowed.

Important Clarifications

  • Pure reimbursement without profit element may not attract TDS.
  • Section 40(a)(ia) is compensatory and not penal in nature.
  • Where tax has already been paid by the recipient, disallowance should not result in double taxation.
  • The second proviso to Section 40(a)(ia) is retrospective in operation.

Sections Involved

  • Section 194C – Tax Deduction at Source on Payments to Contractors
  • Section 40(a)(ia) – Disallowance of Expenditure for Non-Deduction of TDS
  • Section 201 – Consequences of Failure to Deduct Tax at Source
  • Section 195(2) – Application for Determination of Appropriate Proportion for TDS
  • Section 271C – Penalty for Failure to Deduct Tax

Link to download the order - https://delhihighcourt.nic.in/app/case_number_pdf/2017:DHC:456-DB/NAW24012017ITA4362016.pdf

Disclaimer

This content is shared strictly for general information and knowledge purposes only. Readers should independently verify the information from reliable sources. It is not intended to provide legal, professional, or advisory guidance. The author and the organisation disclaim all liability arising from the use of this content. The material has been prepared with the assistance of AI tools.