Madras High Court

Section 194N of IT Act, 1961 is Constitutional: Madras HC

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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 The petitioner’s main argument that the amount withdrawn by co-operative societies was not income was rejected by the Madras High Court.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.  

Madras HC Holds Prescribed Time Period for Filing Returns as ‘Directory’: Interprets Section 62, CGST Act

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In a recent decision[1], the Madras High Court had to decide if an assessee loses the right to file tax returns after expiry of 30 days under Section 62(2), CGST Act, 2017. Section 62(2) provides an assessee 30 days to file returns after the proper officer passes a ‘best judgment’ assessment order. The High Court held that the assessee does not lose its right to file returns, but its interpretation of the provision is not founded on cogent reasoning. 

Facts 

In the impugned case, the asssessee failed to file its tax returns for the months of December 2022, January 2023 and February 2023. Thus, in exercise of the powers under Section 62(1), the proper officer passed best judgment assessment orders on 28.03.2023 for the month of December 2022 and on 30.04.2023 for the months of January 2023 and February 2023. Under Section 62(2), the assessee can file a valid return within 30 days of the service of best judgment assessment order passed by a proper officer under Section 62(1). And if the return is filed, the best judgment assessment order is deemed to have been withdrawn but the assessee’s liability for payment of fine and penalty continues. 

In the impugned case, the assessee did not file its return within 30 days of the passing of the best judgment assessment order and pleaded that the delay be condoned on account of financial difficulties. The Madras High Court framed the issue as: whether the assessee loses the right to file returns after expiry of 30 days or is right retained by providing sufficient reasons for non-filing of returns. (para 13) 

Decision 

The Madras High Court examined the relevant provision, i.e., Section 62, CGST Act, 2017 and stated that under Section 62(1) the proper officer has been granted a period of 5 years for completing the best judgment assessment. The 5 years are calculated from the due date of filing of annual return of the relevant financial year. Thus, the High Court deduced that in the impugned case, the proper officer could finalise the best judgment assessment order until 31.12.2029. And thereafter elaborated:

In such case, if the best judgement assessment order is passed by the respondent on 31.12.2029, which is permissible under Section 74 of the GST Act, the petitioner can file his returns within a period of 30 days therefrom i.e., on or before 30.01.2030. Hence, the time limit is available up to 30.01.2030 for the petitioner to file their returns. (para 14) 

The above paragraph is a peculiar reading of Section 62. Under Section 62(1), the proper officer has an outer time limit of 5 years to finalise the best judgment assessment order. This does not automatically extend the right of an assessee to file their tax returns to 5 years and 30 days. The assessee, under Section 62(2), must file a valid tax return within 30 days of passing of the best judgment assessment. Only because in the impugned case the proper officer finalized the best judgment assessment much before expiry of 5 years does not mean that the right of assessee extends to 5 years and 30 days. If the right of an assessee is interpreted to survive for 5 years and 30 days in all cases, then prompt passing of best judgment assessment orders would negate the 30 day outer limit as assessee can file valid returns anytime within 5 years and 30 days. The intent of the provision seems to be to allot the proper officer a window of 5 years to pass an order and the assessee 30 days once the order has been passed.    

The other issue, about condonation of delay was where the Madras High Court’s observations were on sounder footing. The High Court observed that if there is a sufficient reason for not filing returns within 30 days then the delay can be condoned. But, this does not lead to the High Court’s conclusion that ‘the limitation of 30 days period prescribed under Section 62(2) of the Act appears to be directory in nature’. (para 16) Here again, interpreting the 30-day time period allotted to the assessee as directory in nature is an opinion manufactured by the High Court without any cogent reasoning or a detailed analysis of the intent of the provision. 

Conclusion 

The Madras High Court’s conclusion that if there is delay on assessee’s part, i.e., beyond 30 days, then the delay can be condoned if sufficient reasons are presented is appreciable. However, the interpretation that the period of 30 days is only directory in nature and right of the assesse to file valid returns extends beyond 5 years lacks teeth. The High Court was remiss in not noticing that the period of 5 years was for the proper officer and not the assessee. The latter only has 30 days which commence from the service of the assessment order.    

[1] Comfort Shoes Components v Assistant Commissioner, Ambur, Vellore TS-694-HCMAD-2023-GST. 

Empty Liquor Bottles Are Not Scrap: Madras High Court

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The Madras High Court in a recent decision[1] held that empty liquor bottles do not constitute scrap under Section 206C, IT Act, 1961. Accordingly, it held that the petitioner, M/s Tamil Nadu State Marketing Corporation Ltd (‘TASMAC’), was not obliged to deduct tax at source when collecting licence fee from bar licencees who were authorized to sell empty bottles left behind by customers. 

Facts 

The petitioner, TASMAC, challenged the orders of the Income Tax Department wherein it was treated as an ‘assessee in default’ for failure to deduct tax at source under Section 206C, IT Act, 1961. The Income Tax Department contended that the petitioner should have deducted TCS on the amounts tendered by the successful bar licensee towards tax from sale of empty bottles by treating the sale of bottles as scrap. The petitioner has been given a statutory monopoly to sell – wholesale and retail – Indian Made Foreign Liquor (IMFL), in the State of Tamil Nadu. The petitioner invites tenders for running bars adjacent to its retail vending  liquor shops. It floats tenders to select third-party bar contractors to sell eatables and collect empty bottles from bars adjacent to its retail shops. As per the terms of bar licence, the licencee was allowed monetise empty bottles. The petitioner selected the winning tenders, used to retain 1% of the tender amount as agency commission and remit the remaining 99% to the State Government.  

The Income Tax Department contended that the petitioner fulfilled the conditions of being a seller under Explanation to Section 206C of the IT Act, 1961. The Department elaborated that the petitioner alone had the right over empty bottles as only it could award tenders for their sale and thus the awarding of tenders amounted to it selling scrap to winning bidders through the tendering process. 

The petitioners, on the other hand, contended that they only sold alcohol from distilleries and breweries to their ultimate customers via their retail outlets and they did not sell empty bottles to the customers. The petitioner clarified that the empty liquor bottles were sold by the licencees and they retained the entire consideration. Thus, the contention that the petitioner was seller of empty bottles and licencees the buyer was erroneous.  

High Court’s Interpretation of ‘Manufacture’ and ‘Scrap’ Proves Crucial    

The Madras High Court waxed eloquent and in a verbose manner about the role of petitioner in the State of Tamil Nadu. However, the issue that proved crucial to the fate of the case was the meaning of scrap. The Income Tax Department argued that empty bottles constituted scrap as per Explanation to Section 206C while the petitioner argued otherwise. Explanation (b) to Section 206C states that for the purpose of this Section – 

            Scrap means waste and scrap from the manufacture or mechanical working of materials which is definitely not usable as such because of breakage, cutting up, wear and other reasons; (emphasis added)

The Income Tax Department argued that the empty bottles were scrap since they were constituted via a mechanical process. The argument was that empty bottles were only generated when the liquor bottles are opened and consumed by the consumers and that the process of opening bottled liquor bottles involved them being subjected to external force beyond their yield strength to access contents of the bottle which was nothing but a mechanical process. (para 49) The petitioner described the above interpretation of the term mechanical process as absurd and unsustainable in law. (para 34)

The Madras High Court observed that while the term ‘manufacture’ had been defined under Section 2(29BA) of IT Act, 1961 the term ‘mechanical working of materials’ in the definition of scrap has not been defined separately. In the absence of a separate definition, the High Court noted that the doctrine of nocitur a sociis should be applied. The said doctrine, in its simplest version, means that when two or more words susceptible of analogous meaning are used together they must be understood in cognate sense as if they take their colour from each other. (paras 90-91) Relying on the above doctrine, the High Court opined that that an activity that does not amount to manufacture but resembles manufacture is the only activity that can be included in the expression ‘mechanical working of material.’ And accordingly, the High Court concluded that:

Mere opening, breaking or uncorking of a liquor bottle by mere twisting the seal in a liquor bottle will not amount to generation of “scrap” from “mechanical working of material” for the purpose of explanation to Section 206C of the Act. 

That apart, the activity of opening or uncorking of the bottle is also not by the petitioner. These are independent and autonomous acts of individual consumers who decides to consume liquor purchased from the Tasmac Shops of the petitioner which have a licensed premises (Bar) adjacent to them under the provisions of the Tamil Nadu Liquor Retail Vending (in Shops and Bars) Rules, 2003. (paras 99 and 100)

The Madras High Court further underlined its observations by stating that the empty water bottles were neither the property of the petitioners or of the licencees, and that the petitioner was merely regulating the sales of empty bottles and the same cannot be equated to sale of bottles by the petitioner. 

Conclusion 

The Madras High Court adopted a prudent approach in the impugned case by relying on and correctly applying the doctrine of nocitur a sociis. The said approach was a reasonable way of rebutting the Income Tax Department’s argument that opening of the liquor bottle amounted to a mechanical process, an interpretation that certainly stretched the limits of acceptable interpretation of expressions used in a tax statute.    

[1] M/s Tamil Nadu State Marketing Corporation Ltd v The Deputy Commissioner of Income Tax TS-798-HC-2023MAD. 

Madras High Court Holds that Credit Note Not Required When No Delivery of Goods

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In a recent judgment[1], the Madras High Court held that there is no requirement to issue a credit note when the goods were returned to the seller without delivery to the buyer. The High Court held that the credit note was necessary for adjustment of tax liabilities, and the said requirement did not arise when the goods were not delivered to the buyer in the first place. 

Facts and Arguments 

The petitioner, based in Chennai, had transported a consignment of solar power generating systems/solar panels of different descriptions to the buyer in Tiruppur. The goods were transported accompanied by different invoices and accompanying e-way bills. When the goods were being transported there was a heavy downpour, the solar panels got wet and the buyer refused to take delivery of the goods. The petitioner generated new e-way bills and transported goods back to the factory in Chennai, but on the way the goods were intercepted. 

The intercepting officers claimed that it was necessary for the goods to be accompanied with credit notes, and in the absence of the same presumed an intent to evade tax. accordingly, proceedings were initiated against the petitioner under Section 129, CGST Act, 2017. The petitioner paid the penalty under protest, but later challenged the initiation of proceedings under Section 129 and officer’s view that a credit note was necessary even though the buyer had not taken delivery of the goods. As per the petitioner, issuance of credit note is only necessary if the goods were delivered to the buyer in the first place.  

Madras High Court Decides 

The Madras High Court examined Section 34 and observed that: 

Thus, the goods which are being returned need not necessarily accompany a Credit Note. The Credit Note or Debit Note as the case may be are intended only for adjustment of tax liabilities on account of return of the goods and where tax charged in that tax invoice is found to exceed the taxable value or tax payable in respect of such supply. (para 23) 

The High Court stressed on the need for and rationale of credit note, and to that extent, it was correct. However, it is also important to point out that the supplier’s obligation to issue a credit note is only triggered if there is a supply of goods or services in question. 

Since the issuance of credit note was viewed as not compulsory, the Madras High Court also concluded that ‘the detention of the goods was per se illegal and unwarranted’ particularly in light of the facts that were accompanied with valid e-way bills. 

As regards the payment of penalty and interest under Section 129, CGST Act, 2017, the Madras High Court made an important observation. The High Court observed that under the system and on the GST portal, the taxpayer only had the option to make payments on a voluntary basis and there was no option to take the goods back by claiming that the payment was made under protest. The High Court concluded that: 

Therefore, the system and procedure cannot be used against the petitioner particularly in the light of the fact that the detention itself was illegal. Credit note under Section 34 is not required to be issued at the stage, when the goods were being returned without even they having been received by the recipient. Issuance of Credit Note and/or Debit Note under Section 34(1) of the CGST Act, is only for adjustment of tax liability. (para 31)

Conclusion 

The Madras High Court has made some obvious but important observations in the impugned case. The fact that credit note is to be issued only if a supply of goods or services is made to the buyer is an obvious legal position, but the intercepting officers needed a reminder of the scope of their powers and grounds for detention of goods under Section 129, CGST Act, 2017. Equally, the High Court’s observations that the system cannot be used against a taxpayer to claim that the payment was not made under protest, especially if there is no option to make such a payment in the system.  

[1] Luminous Power Technologies Ltd v State Tax Officer [2023] 153 taxmann.com 623 (Madras). 

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