The Madras High Court recently[1] upheld constitutionality of Section 194N of the IT Act, 1961. Section 194N inserted via Finance Act, 2019 was argued by the petitioners to be unconstitutional on the grounds of it being illegal, arbitrary, and violative of their fundamental rights under Article 14 and 19(1)(g) of the Constitution. Section 194N imposes an obligation on the banks including co-operative societies carrying on banking – when paying any sum exceeding one crore rupees, increased to three crores in 2023 – to withhold a tax of 2% of the amount. The petitioner’s main argument that the amount withdrawn by co-operative societies was not income was rejected by the Madras High Court.
Facts and Arguments
The petitioner, a licensed bank, maintained accounts of co-operative societies. All the account holders were registered under the Tamil Nadu Co-operative Societies Act, 1963. When loans were sought by members of the societies, petitioner used to grant a loan via banking channels to the members. If a member did not have a bank account, the petitioner used to transfer the money to current account of the society for onward disbursement to the farmers. The societies would withdraw the cash and disburse it to the farmers. The petitioner stated that it was used a conduit between the State on one hand and societies on the other to transfer various kinds of cash support to farmers including crop loans and other gifts.
The main argument of the petitioner was that the withdrawal of money by the co-operative society was intended to be forwarded to the farmers. And that the money did not constitute income of the society. And neither was the money income in the hands of recipients since they were gifts or monetary assistance provided by the State. When the petitioner was issued a showcause notice for non-compliance with Section 194N, it replied that the provision is arbitrary and withdrawal of cash cannot be regulated in a manner proposed under Section 194N. The petitioner argued that the tax withholding provisions under Chapter XVIIB were intended to be applicable only to receipts which constituted income in the hands of the recipient. The petitioner assailed the provision as being unreasonable and that its stated aim of promoting digital payments was immaterial in determining the reasonableness of the provision.
Curiously, the petitioner also argued that a new charge was created via Section 194N and equated Section 194N to a charging provision, questioned its placement under the Chapter XVIIB of the IT Act, 1961 and termed it ‘eccentric’. (para 19)
The State, on the other hand, emphasised the objective of the provision, i.e., to promote digital payments. The State underlined its aim of creating an economy that was robust and cashless, as far as possible. And that the cash withdrawals in the co-operative banks were fraught with irregularities that led to a large portion of income escaping the tax net. (paras 31-36)
Decision
The Madras High Court did not engage with the petitioner’s main argument in a straightforward manner. It instead cited precedents to observe that the use of the word ‘sum’ instead of ‘income’ in Section 194N does not advance the petitioner’s case that the rigours of the provision would only apply if receipt constitutes taxable income in the hands of the recipient. The High Court referred to various provisions relating to withholding tax in Chapter XVII and the varied terminology used in them such as sum, amount, income and noted that the used of the terminology is not conclusive to establish if tax needs to be deducted at source. In fact, the High Court placed greater emphasis on the intent and objective and noted that the intent of the provision is equally crucial to interpret the terms used in the provision. (paras 39-51)
Next, the Madras High Court relied on some relevant precedents to negate petitioner’s argument that Section 194N was a charging provision. The High Court held that the impugned provision was clearly a machinery provision. The High Court further observed that the objective of preventing cash withdrawals from escaping tax net and promoting a digital economy were intended to be achieved through Section 194N and the legality of the provision cannot be argued to be fatal based on its placement under the IT Act, 1961.
Further, the Madras High Court relied on facts to reject the petitioner’s other argument, i.e., cash withdrawal was not income for the society. The High Court observed that there is nothing on record to show the entirety of the amount is further disbursed to the recipients of State’s cash assistance and other income support schemes. The High Court noted that one of petitioner’s argument was that the gifts were not taxable in the hands of the intended beneficiaries, and thus there was no need to deduct tax at source. But the High Court observed, the bank was not aware of the purpose at the time of withdrawal and that in many instances the withdrawal amount was more than the intended gift amounts for the beneficiaries.
Another provision, that the High Court referred to was Section 197, IT Act, 1961 which allows a payee to obtain a nil certificate on the ground that the receipt is not amenable to tax. Section 197 did not include situations incorporated in Section 194N, meaning that the petitioner could not the option provided to other payees under Section 197. (paras 73-75) While the petitioner did not have the remedy under Section 197, it could invoke Section 194N itself wherein the Central Government in consultation with RBI is empowered to issue a Notification enlisting the recipients to whom rigour of Section 194N would not apply. The High Court noted that since such a Notification has already been issued in favor of certain recipients, the proper remedy for the petitioner is to approach the Central Govt seeking an exemption rather than make a claim that the receipts in the form of cash withdrawals from banks are not taxable. The High Court was indirectly hinting that the petitioner did not make a wise decision to not comply with its statutory obligations provided in Section 194N. (paras 77-78)
Decision
The impugned decision stands on defensible if not impeccable reasoning. The High Court sufficiently emphasised the intent for introduction of Section 194N and noted that machinery provisions can be introduced to meet social objectives such as expansion of tax base and introduce transparency in the fiscal economy. The High Court referred to legislative intent to highlight that machinery provisions while not charging provisions can mandate deduction of tax on withdrawal of money even if the money is not income in the hands of the recipient. But, the High Court was unable to provide a clear and articulate reasoning as to why legislative intent should override every other consideration while interpreting a statutory provision.
[1] The Income Tax Officer, Tiruchirappalli v M/s. The Thanjavur District Central Co-operative Bank Ltd TS-821-HC-2023MAD.