Closure of the financial year brings a lot of work for the finance departments of corporates, as they close books of account and prepare them for audit. With the tight deadlines for Board meetings, dynamic tax laws and increasing complexities of doing business, the challenges are increasing.

In order to depict the true and fair position of their financial affairs, companies are required to make provisions for liabilities and expenses in their financial books. These could be for expenses such as consultancy charges, professional fee and contractual payments, and are based on fair estimates, often without the complete information about the vendor.

Typically, such provisions are made on the last date of the current financial year, and reversed on the first day of the new financial year.

According to the tax deduction provisions of the law, the payer should deduct taxes at source at the time of payment or credit to the recipient. Also, even if the relevant amount is credited to a suspense account, it calls for deduction of tax at source.

Further, failure to deduct appropriate taxes at source would mean that the relevant expenses shall be disallowed in the hands of the payer company for tax purposes.

Based on the above provisions, Revenue authorities argue that taxes should be deducted at source from the year-end provision made by companies. In the absence of appropriate deduction, the expenses are sought to be disallowed in the hands of the payer.

Deduction of tax at source is a mode of advance collection from the income of the recipient. Hence, a question arises whether the requirement of deduction from year-end provisions was intended by the legislature.

One possible argument could be that the year-end provisions do not result in any ‘income’ in the hands of the recipient. As deduction of taxes at source is a machinery provision, the same cannot be triggered unless any ‘income’ arises to the recipient.

Another possible argument could be that at the time of making the provisions, the identity of the payee may not be available and the amount may not be quantifiable — hence, the tax deduction mechanism fails.

The Mumbai Appellate Tribunal analysed this point in the IDBI vs. ITO case and concluded that no taxes should be deducted if the payees are not known. The tribunal observed that tax deduction at source is a method of recovering taxes from a person who earns that income, in the absence of which the taxes should be paid directly by the recipient. Thus, principal liability is that of a person who is taxable for such income.

The scheme of withholding taxes proceeds on the assumption that the deductor knows the identity of the recipient. Hence, if the deductor is unable to identify the recipients, the TDS mechanism fails and taxes need not be deducted. A similar observation was made recently in the Pfizer Ltd vs. ITO case.

A combined reading of the relevant provisions would indicate that the Mumbai Tribunal’s views are more acceptable, specifically in cases where the identity of the recipient is not known.

The author is Partner, Global International Corporate Tax, KPMG in India

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