Despite the Government’s fiscal boosters, the economic outlook remains gloomy. In an indication of the stress on the economy, the overall direct tax collection for the first five months of the current fiscal grew by approximately 12 per cent, as compared to the targeted 20 per cent. The gap is made wider by the huge tax refunds and the interest payable by the Government. The delay in tax refunds only adds to the overall interest outflow. In fact, during 2010-11, the interest alone exceeded Rs 10,500 crore. This additional outgo is not budgeted for, unlike other interest paid by the Government. Hence it is paid out of current collections, adding to the overall deficit. The issue was pointed out recently by the Comptroller and Auditor General.

This additional interest burden on the exchequer could be addressed effectively through timely refunds along with the interest accrued. The income tax law provides for payment of simple interest on excess tax paid. The interest is payable at half percentage for each completed month or part thereof from the first day of the assessment year or the date of payment, whichever is relevant.

In the past, the revenue department has refunded excess taxes but not the interest accrued, causing undue hardship and cash traps for taxpayers. As the interest was payable by the tax department under statutory provisions, a controversy arose over whether the taxpayer was entitled to interest on such delayed/ held back interest. This was commonly referred to as ‘interest on interest’ payment. Revenue authorities denied the interest on the pretext that this would result in payment of compounded interest, which was not envisaged by the legislature. Further, there are no statutory provisions for computing interest on interest.

Over the years, the issue has been analysed by various courts and concluded in favour of taxpayers. In the Sandvik Asia case, the Supreme Court, while deciding in favour of the taxpayer, went ahead and stated that a copy of the ruling should be forwarded to the Finance Minister for action. In the case of H.E.G, the Supreme Court discussed the issue in detail and concluded that when a refund order was issued, it should include the interest payable too. If the refund does not include the interest payable, revenue authorities would be liable to pay interest on the shortfall. The court further clarified that even terming the payment as ‘interest on interest’ was incorrect.

The Delhi High Court reached a similar conclusion recently in the case of India Trade Promotion Organisation. Deciding in favour of the taxpayer, the High Court observed that not allowing interest on short refund would result in granting premium to the revenue department’s non-compliance of law. These rulings have benefited taxpayers, but they also added to the overall interest cost of the revenue department.

Just as the issue appeared to have been settled, the conclusion in the Sandvik Asia case was referred to a three-member bench of the Supreme Court in the Gujarat Fluoro Chemicals case. The bench observed that the decision in the Sandvik Asia case was misunderstood by taxpayers and the tax department. It clarified that the taxpayer can only claim the interest provided under the statute, and no further interest on such statutory interest.

This clarification reopens the controversy, and could result in undue hardship in genuine cases of short refund.

The author is Partner, Global International Corporate Tax

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