The Querist is a company incorporated under the Indian Companies Act, 1956 and is a part of a reputed MNC group. The Querist Company is engaged in the business of promoting and co-ordinating sale of group’s products as well as various installation, commissioning, repair and maintenance services.

The Querist company has reimbursed to its overseas group company various expenses/remuneration paid by the overseas group companies in respect of the Managing Director/other expatriate personnel deputed to India from time to time. An expatriate was deputed to the Querist Company in September 2001 by one of the group companies. The said expatriate rendered services in India up to October, 2004. The expatriate was tax equalized in respect of the remuneration relatable to the Indian deputation.

For the A. Y. 2003-04; i.e., F. Y. 2002-03, taxes were paid by the Querist Company on the salary paid to the expatriate during the year, but with some delay. Taxes were paid beyond the 7th of the respective month. A portion of the taxes was paid after the end of the year but before the due date for filing the return of income. The last instalment of taxes was paid after the return of income was filed. In the assessment u/s. 143(3) of the Income-tax Act, 1961 the Assessing Officer has disallowed a portion of the salary paid outside India on which taxes were not paid within the prescribed time relying on section 40(a)(iii) of the Act.

For the A. Y. 2004-05; i.e., F. Y. 2003-04 similar delay was there in payment of taxes. However all the taxes were paid before the due date for filing the return of income. The assessing officer has disallowed an amount of Rs. X relying on section 40(a)(iii), in respect of the salary paid outside India on the ground that the tax deducted at source has not been paid before the prescribed date/time.

For the A. Y. 2005-06; i.e., F. Y. 2004-05 similar delay was there in payment of taxes. A portion of the taxes was paid after filing the first return but before filing the revised return of income.

The Querist has raised the following questions:

1. Whether the disallowance u/s. 40(a)(iii) is only in respect of the salary paid outside India or in respect of the whole of the salary accrued/paid to the expatriate both in India and outside India?

2. In the instant case, whether any portion of the salary paid to the expatriate is disallowable u/s. 40(a)(iii) of the Act?

3. How the decision in the case of ANZ Grindlays Bank vs. DCIT: (2004) 88 ITD 53 (Del) would be applicable to the facts of the Querist?

Any payment, which is chargeable to tax under the head “Salaries” in the hands of the recipient, is the subject matter of disallowance u/s. 40(a)(iii) of the Act. Up to the A.Y. 2003-04, only the amount payable outside India was the subject matter of disallowance. The Finance Act, 2003 has extended the scope of disallowance even to the payments in India to a non-resident w.e.f. A. Y. 2004-05. Thus for the A. Y. 2003-04 only the salary paid outside India is the subject matter of disallowance and nothing more. For the A. Ys. 2004-05 and 2005-06 the salary paid outside India would definitely be the subject matter of disallowance. Further, the salary paid in India would also be subject matter of disallowance if the recipient expatriate is a non-resident.

Further, salary would be disallowable u/s. 40(a)(iii) only if the tax has not been paid thereon nor deducted therefrom under Chapter XVII-B of the Act. Before disallowing salary u/s. 40(a)(iii) of the Act, the Assessing Officer has to establish that this condition is satisfied. In the case of the Querist this condition is not satisfied. Therefore, there is no question of disallowance of the salary paid to the said expatriate u/s. 40(a)(iii) of the Act.

As regards the condition of payment of tax or deduction of tax at source the phrase used is ‘if the tax has not been paid thereon nor deducted therefrom under Chapter XVII-B’. Accordingly, the salary is disallowable only if tax has not been paid or deducted under Chapter XVII-B on such amount. If the tax on such salary is paid by the recipient or any other person including the Querist, then there cannot be disallowance and such amount is to be allowed as deduction. Further, even if the tax on such salary is not paid, such amount has to be allowed as deduction if tax is deducted on such amount under Chapter XVII-B of the Act. Dealing with similar provision u/s. 40(a)(i), for the A. Y.1967-68, the Jaipur Bench of the Tribunal held in ITO vs. M/s Forasol Ltd. (1976) 1 TTJ 78 (Jaipur) as under:

“Under Chapter XVII-B the payer of certain payments, as specified in sections 192 to 195, has been saddled with the responsibility of “deducting” tax on certain payments enumerated in the various sections mentioned above, and to deposit such tax in the Government treasury in accordance with sec. 200 of the I.T. Act, 1961. The deduction of tax is the first step; and the payment thereof in the Government treasury is the second step. For failure to deduct the tax, or after deducting the tax, to pay it in the Government treasury within the specified time, certain penal consequences have been prescribed by sec. 201 of the Income-tax Act, 1961. Simultaneously the legislature has also built in another coercive measure in to the statute by way of sec. 40(a)(i) of the Income-tax Act, 1961 which provides that, if an assessee has to pay interest to a person, which is chargeable under the Income-tax Act, 1961, and which is payable outside India, the assessee would not be entitled to claim the payment of interest as a deduction from its total income unless either of the two following steps have been taken:-

1. Tax on the aforesaid interest has been paid or

2. Tax payable on the aforesaid interest has been deducted.

The obligation to deduct tax has been saddled on the payer in accordance with the various provisions of Chapter XVII-B. There is therefore, no difficulty in identifying the person who should deduct the tax. But for the provisions contained therein, the payer would not be legally in a position to deduct the tax. The same is, however, not the position with regard to the payment of tax. Sub-clause (i) of clause (a) of sec. 40 does not say as to by whom tax will be paid. The non-resident payee may itself make the payment of tax directly or through its agent or alternatively the payer may pay the tax for and on behalf of the payee. He may do so without deducting the tax at source from the payment made to the non-resident. Alternatively, he may deduct the tax in accordance with the section 192 to 195 (in the present case section 195 is relevant), and then pay tax. In the latter case the deduction of tax and payment thereof would be under Chapter XVII B. In the former case, the payment of tax is not in accordance with and under Chapter XVII B. To get out of the mischief of section 40(a)(i), it is not necessary that the payer of interest etc., must show compliance with both the alternatives; i.e., (i) of deducting tax and (ii) of paying it as enjoined by Chapter XVII B. It would be enough if it shows that the tax has been “deducted.” It might or might not have been paid. Alternatively it may show that the tax has been paid. It might or might not have been deducted from the payments made to the payee before the payment of them. The use of the conjunction ‘or’ in between the verbs ‘paid’ and ‘deducted’ makes it clear that the two acts are by way of alternatives to each other and that they are not cumulative in operation. The overall and careful reading of sec. 40(a)(i), thus, shows that so long as the payer is in a position to show to the Income-tax Officer that tax on the interest payable outside India has been “paid” whether by the payee or by him, he would not be caught in the mischief of sec. 40(a)(i). The payment of the tax, thus, does not appear to us to be correlatable solely with the responsibility of the payer in terms of Chapter XVII B. The payment may be in terms of that Chapter, it may also be independent of the obligations visualized in that Chapter. We are fortified in this view of the matter by the use of the word ‘paid’ in the clause another to the word ‘deducted’ in sec. 40(a)(i). If it were the intention of the legislature that both the words ‘paid’ and ‘deducted’ were to be governed by the words ‘under Chapter XVII B,” they would not have used the conjunction word ‘paid’ first and the word ‘deducted’ later nor would they plant in the conjunction ‘Or’ in last when for them in terms of Chapter XVII B act of ‘deduction’ comes first; act of payment comes later. Besides, if mere deduction of the tax “under Chapter XVII B was enough to take a person out of the mischief of sub-clause (i) of clause (a) of sec. 40, as it is, there was no need to provide for another alternative in the said section of “payment” of the deducted tax, for the payment is dependent on “deduction”. By necessity, therefore, the second alternative has to be an independent one, and not as a natural and statutorily essential and enforceable equal to the first act of deduction of tax. We have therefore, to see the meaning of the word ‘paid’, not in terms of Chapter XVII B, but independent of it. In this view of the matter, we are convinced that the order of the learned Appellate Assistant Commissioner holding that the interest of Rs. 2,10,209/- paid to the non-resident should be allowed as a deduction because the tax payable thereon has already been paid by the assessee, in the sense that it has been recovered by the Department under section 226 was right. We accordingly uphold it on this point.”

Similarly, in Addl. CIT vs. Farasol Ltd (1987) 163 ITR 364 (Raj) the Rajastan High Court was concerned with section 40(a)(i) for the A. Y. 1966-67. The Assessing Officer had disallowed the claim for deduction of interest of Rs.2,36,007/- by applying the provisions of section 40(a)(i) on the ground that the said interest had accrued to foreign banks and the assessee has failed to deduct tax on such payment. The AAC allowed the deduction holding that after the assessment Order was passed the assessee had paid a sum of Rs.2,05,264/- to the State Bank of India towards its liability to deduct tax. The Tribunal upheld the decision of the AAC and held that the tax which the assessee was liable to deduct at source u/s. 195 of the Act has in fact been recovered by the Department and that for the purpose of section 40(a)(i), tax recovered by the Department is to be treated as tax paid. On reference the Rajasthan High Court upheld the decision of the Tribunal and held as under:

“We find ourselves in agreement with the findings recorded by the Tribunal that the amount that has been recovered from the assessee on account of tax on the aforesaid interest amount of Rs. 2,36,007 paid by the assessee as interest to the non-resident foreign banks must be treated as the tax paid under Part B of Chapter XVII for the purpose of section 40(a). We are unable to agree with Shri Surolia that the word “paid” as used in sub-clause (i) of clause (a) of section 40 should be construed to mean only voluntary payment and does not include payment made by the assessee in recovery proceedings initiated against him. In our opinion, the word “paid” in sub-clause (i) of clause (a) of section 40 is wide enough to include a payment whether made voluntarily or during the course of proceedings for recovery initiated against the assessee. As observed by the Tribunal, the object of section 40(a)(i) is to protect the interest of the revenue by ensuring that in respect of interest chargeable under the Act and payable outside India, the tax payable by the non-resident is either paid or deducted in cases where the non-resident does not have any agent in India from whom it can be recovered. From this point of view, it is immaterial whether the Revenue has received payment of the tax due either by a voluntary act on the part of the assessee or by initiation of the recovery proceedings against the assessee. It may also be observed that under the Act an involuntary payment of tax, whether by way of deduction at source or by way of recovery under the provisions of the Act, is regarded as tax paid.

In the present case, we find from the order of the Appellant Assistant Commissioner that a sum of Rs. 2,05,265 was paid by the State Bank of India, Bombay, to the Department on March 30, 1970, out of the bank guarantees furnished by the assessee towards the assessee’s liability to deduct the tax at source on payment to non-residents. From the order of the Appellate Assistant Commissioner, we further find that in their letter dated September 21, 1970, addressed to the Appellant Assistant Commissioner, the assessee had confirmed that they do not propose to object to the act of recovery already made from their guarantee, if the item of disallowance of interest paid to the non-residents is deleted from the assessment. In these circumstances, we are of the opinion that the Appellate Assistance Commissioner and the Tribunal were right in deducting the sum of Rs. 2,36,007 which was added to the income by the Income-tax Officer.”

Recently, in DCIT vs. M/s. Gulf Oil Corporation Ltd., I.T.A. No. 4139/Mum/1999, dated 28-10-2004; the Hon’ble Mumbai Bench of the Tribunal has considered and analysed the provisions of section 40(a)(i) of the Act, as applicable to A.Y. 1994-95. In this case, tax was deducted at source on interest of Rs. 27,83,712/-. The claim for deduction of the interest amount was disallowed by the Assessing Officer on the ground that the tax deducted was not paid into the Government Treasury in the relevant year. The CIT(A) allowed the claim by holding that the words used “paid” or “deducted” comprised two separate conditions and accordingly if tax is deducted at source but not paid, the deduction of interest would be allowed. In appeal before the Tribunal the Revenue contended that section 40(a)(i), in explicit terms, permits the claim of deduction only when the tax is deducted and paid in the relevant financial year as the term “deducted” or “paid” are mutually inclusive and accordingly even if tax is deducted but not paid; no deduction is available u/s. 40(a)(i) for the particular financial year. The Tribunal upheld the decision of the CIT(A) and held as under:

“The prescription of the section speaks about two things, i. e. “paid” or “deducted” under Chapter XVII-B. The word “or” is disjunctive. In the present construction it cannot be construed to be conjunctive.”

The Tribunal further observed as under:

“5. It is pertinent to note that the Legislature amended the provision, making both the requirements necessary; i.e., of deduction and payment, with effect from 1-4-2004. The amendment was effected by the Finance Act, 2003. As such, the amended provision is not applicable in the present case.”

Very recently, on 9th May, 2007 the Hon’ble Delhi High Court has taken the same view in CIT vs. M/s. Oracle Software India Ltd; (2007) 293 ITR 353 (Delhi). In this case tax was deducted at source on royalty in the relevant year but paid into the Government Treasury in the subsequent year. The Assessing Officer disallowed the claim for deduction of royalty relying on section 40(a)(i) and on the ground that the payment of tax deducted at source was made in the next year. The CIT(A) and the Tribunal allowed the claim for deduction of royalty relying on the judgment of the Hon’ble Rajasthan High Court in Addl CIT vs. Farasol Ltd (supra). Hon’ble Delhi High Court upheld the decision of the Tribunal and held that on a plain reading of section 40(a)(i) of the Act, as long as the tax was deducted within the year the provisions of section come into play and the assessee must, therefore, be entitled to its benefit.

In the instant case, the Querist has voluntarily paid the tax on the salary of the expatriate employee. Clearly the payment of tax is on behalf of the expatriate employee. Therefore, the condition that “the tax has not been paid thereon” is not satisfied. Therefore, there is no question of disallowing salary u/s. 40(a)(iii) of the Act. However, it is stated that the Assessing Officer has disallowed the salary u/s. 40(a)(iii) of the Act on the ground that the taxes have not been paid within the prescribed time. There is no such reference to payment of tax ‘within prescribed time’ in section 40(a)(iii). As observed by the Hon’ble Tribunal and the Hon’ble Rajasthan High Court even the payment of tax after assessment or by way of recovery would be sufficient to make the provisions of section 40(a)(iii) inapplicable. The Assessing Officer cannot presume a condition in section 40(a)(iii) which the legislature has not provided. The disallowance made by the Assessing Officer is on an irrelevant ground and hence without any authority in law. Such a disallowance is illegal and invalid and hence cannot be sustained in law.

In the instant case, the contractual obligation to pay tax on salary was on the Querist employer. Effectively, on payment of the salary, technically, there was tax deduction at source under Chapter XVII-B of the Act. Therefore, the condition that “nor deducted therefrom under Chapter XVII-B” is not satisfied. For this reason also, there is no question of disallowing salary u/s. 40(a)(iii) of the Act. This is also supported by the above decision of the Hon’ble Mumbai Tribunal in the case of M/s. Gulf Oil Corporation Ltd. and judgment of the Hon’ble Delhi High Court in the case of M/s. Oracle Software India Ltd.

Now it will be relevant to consider the decision of the Delhi Bench of the Appellate Tribunal in the case of ANZ Grindlays Bank vs. DCIT: (2004) 88 ITD 53 (Del) which is based on peculiar facts of that case. In this case, for the A. Y. 1991-92 the assessee had paid outside India an amount of Rs. 1,32,46,994 by way of salaries to expatriate employees for services rendered in India. The said amount was not claimed as deduction in the return of income. Accordingly the assessment was completed by an order dated 25/03/1994 without any discussion on the issue allowing deduction of the said salary amount. Subsequently, the Government found that there was default of non deduction of tax on such payment of salary outside India. CBDT issued circular granting immunity from penalty and prosecution if the tax deductible amount is paid with interest. So as to avail the benefit of immunity under the said circular the assessee paid the tax deductible amount along with interest in July 1994 and accordingly was granted immunity from penalty and prosecution. The Tribunal held that the claim for deduction was hit by section 40(a)(iii) of the Act. The Tribunal categorically observed that ‘it is not the case of the assessee that either the tax has been paid by the employees on such payments or has been deducted by the assessee from such payments under Chapter XVII-B’. The Tribunal further observed that the payment has been made under the said circular of the CBDT, which has granted immunity from penalty and prosecution but did not grant the assessee immunity from disallowance u/s. 40(a)(iii) of the Act. The conclusion drawn in this case is based on the special facts of the case and hence cannot be applied in general and in particular in the case of the Querist.

However, the observation of the Hon’ble Tribunal in paragraph 47 of the order that ‘the intention of the legislature is that disallowance is not to be made only where the tax has been deducted or paid within the prescribed time under Chapter XVII-B’ is a matter of concern. It is humbly submitted that this observation of the Hon’ble Tribunal was neither warranted nor justified. Firstly, the facts of the case and the claim made by the assessee, as observed by the Hon’ble Tribunal did not warrant such an observation. The conclusion of the Hon’ble Tribunal is not based on these observations but on the peculiar facts of the case. As such these observations do not constitute ‘ratio’ of the case but are mere ‘obiter dicta’ having no binding force. Further, the Hon’ble Tribunal has failed to consider the following material aspects:

1. The condition in section 40(a)(i) as regards the payment of tax and deduction of tax at source has been substantially changed w.e.f. A. Y. 2004-05. The relevant phrase used in section 40(a)(iii) “if the tax has not been paid thereon nor deducted therefrom under Chapter XVII-B” is similar to the phrase used in section 40(a)(i) up to the A. Y. 2003-04; i. e., ‘tax has not been paid or deducted under Chapter XVII-B’. The unamended section 40(a)(i) has been properly interpreted by the Hon’ble Tribunal in ITO vs M/s Forasol Ltd. (Jaipur) (supra) and DCIT vs. M/s. Gulf Oil Corporation Ltd. (Mum) (supra) and by the Hon’ble High Courts in Addl. CIT vs. Farasol Ltd. (Raj) (supra) and CIT vs. M/s. Oracle Software India Ltd (Del) (supra) as observed above. In the above case of ANZ Grindlays Bank vs. DCIT: (2004) 88 ITD 53 (Del) the Hon’ble Tribunal did not have the benefit of the decisions of the Hon’ble Tribunal in ITO vs. M/s Forasol Ltd. (Jaipur) (supra) and DCIT vs. M/s. Gulf Oil Corporation Ltd. (Mum) (supra) and judgments of the Hon’ble High Courts in Addl. CIT vs. Farasol Ltd. (Raj) (supra) and CIT vs. M/s. Oracle Software India Ltd. (Del) (supra) which the Hon’ble Tribunal should have followed. If these judgments were to be considered by the Hon’ble Tribunal then the observations would have been different.

2. The phrase ‘tax has not been paid or deducted under Chapter XVII-B’ in section 40(a)(i) which was in operation up to the A. Y. 2003-04 was changed to ‘on which tax has not been deducted or after deduction, has not been paid before the expiry of the time prescribed under sub-section (1) of section 200 and in accordance with other provisions of Chapter XVII-B ’, w.e.f. A. Y. 2004-05 by the Finance Act, 2003. This change has been further modified by the Finance (No. 2) Act, 2004 w.e.f. 1-4-2005; i.e., w.e.f. A. Y. 2005-06 to “on which tax is deductible under XVII-B and such tax has not been deducted or, after deduction, has not been paid during the previous year, or in the subsequent year before the expiry of the time prescribed under sub-section (1) of section 200”. As per the amended provision, the amount will be disallowed only if tax is deductible at source under Chapter XVII-B on such payment. The amount is not allowable as deduction if tax is not deducted at source or if the tax deducted at source is not paid into the Government Treasury during the previous year or in the subsequent year before the due date prescribed u/s. 200(1) of the Act. Thus a substantial change has been brought about in the intention of the Legislature as regards the conditions for disallowance u/s. 40(a)(i) of the Act. The amended condition brings out the intention of the Legislature as observed by the Hon’ble Tribunal in the above case of ANZ Grindlays Bank vs. DCIT: (2004) 88 ITD 53 (Del) and not the intention that has to be found in the unamended provision. The unamended provision has been properly interpreted by the Hon’ble Tribunal in ITO vs. M/s Forasol Ltd. (Jaipur) (supra) and DCIT vs. M/s. Gulf Oil Corporation Ltd. (Mum) (supra) and by the Hon’ble High Courts in Addl. CIT vs. Farasol Ltd. (Raj) (supra) and CIT vs. M/s. Oracle Software India Ltd. (Del) (supra) as observed above. The Legislature has amended the provision prospectively and not retrospectively. Accordingly, the legislative intent as regards the amended provision can not be attributed to the unamended provision which is clearly distinct and different.

3. Condition in section 40(a)(iii) is similar to the condition in the unamended section 40(a)(i). The Legislature amended section 40(a)(i) by the Finance Act, 2003 and the Finance (No. 2) Act, 2004 and brought out the change in the condition whereas the condition in section 40(a)(iii) has not been amended and has been retained in the old form as it is. The distinction between the conditions is very much within the knowledge of the Legislature. Therefore the intention of the Legislature as regards the condition in section 40(a)(iii) should be gathered from the Legislative intention as found by the Courts with reference to the unamended section 40(a)(i) of the Act and not the amended section 40(a)(i). Accordingly, the Hon’ble Tribunal has erred in making the said impugned observations in the said case of ANZ Grindlays Bank vs. DCIT: (2004) 88 ITD 53 (Del).

4. In making the said impugned observations in the said case of ANZ Grindlays Bank vs. DCIT: (2004) 88 ITD 53 (Del) the Hon’ble Tribunal has relied on the proviso to section 40(a)(i) providing for the deferral of the year of allowance. It is humbly submitted that such reliance by the Hon’ble Tribunal is misplaced. Section 40 and in particular section 40(a)(i) is a provision for disallowance of deduction which is otherwise allowable as deduction. The proviso cannot provide for allowance of a deduction which is otherwise not deductible. The proviso has the effect of only deferring the year of deduction, depending on the year of payment, which would have been otherwise allowable as deduction in the relevant year. In the absence of such a proviso; i. e., in the case of section 40(a)(iii) the deduction will be allowable in the relevant year itself irrespective of the year of payment.

5. It is well settled cannon of interpretation of law that wherever a provision uses plain and simple language free of ambiguity such provision should be given its plain meaning without addition or subtraction of any expression into the language of the provision. The provisions of disallowance should be strictly construed. One cannot presume a condition in section 40(a)(iii) which the legislature has not provided. Section 40(a)(iii) and the unamended section 40(a)(i) do not provide any condition of payment of tax within the prescribed time. The amended section 40(a)(i) specifically provides for the condition of payment of tax within the prescribed time. Such a condition cannot be lawfully presumed in section 40(a)(iii) or the unamended section 40(a)(i) of the Act.