The present Covid-19 Pandemic situation has put the whole world on a grinding halt. The pandemic has ravaged the country and, indeed, the world. Our government has come out with various stimulus package and remedial steps to ease out citizens from present situation. CBDT notification are being issued from time to time granting concessions and benefits to assessee’s. More such reliefs are expected in near future. Similarly courts have passed various orders relaxing limitation periods under various laws. Certain aspect are still unclear eg. Uncertainty in payment of wages/ salary to employees, uncertainty about rent, uncertainty of completion of contract, goods in transit, unclaimed goods etc. The lockdown will have financial impacts on business and individuals, difficulty will arise in recognition of income or expenses. Financial reporting or auditing vis a vis taxability of the transaction are two different aspect, which one has to take in to consideration while computing its income. Entries in books of account cannot decide whether a receipt is taxable or not or whether expenses are allowable as deduction or not. Courts are compelled to go by the true nature of the receipts and not go by the entry in the books of account [CIT vs. India Discount Co. Ltd. (1970) 75 ITR 191 (195)(SC); Kedernath Jute Manufacturing Co Ltd. vs. CIT (1971) 82 ITR 363 (367)(SC)]. This lockdown will have direct impact on profitability / income of assessee’s. Assessee’s need to relook in their transaction and give appropriate effect in their books. Subsequent events are to be identified by the company. Subsequent events are broadly those events occurring between the date of financial statements and the date of auditor’s report. Management will have to consider the events happening during the lockdown period as the same falls within the definition of subsequent events. ICAI has issued guidance notes on subsequent events for auditing considerations. Question arises how tax officers are going to look into such arrangement / transaction. While interpreting tax provisions it is settled that tax and equities do not go together. Interpretation which creates unjust and discriminatory situation, has to be avoided K. M. Sharma vs. ITO (2002) 257 ITR 772 SC. Similarly Tax Laws have to be interpreted reasonably and in consonance with justice adopting a purposive approach [CIT vs. Gwalior Rayon Silk Manufacturing Co. Ltd. (1992) 196 ITR 149 SC; Bajaj Tempo Ltd. vs. CIT (1992) 196 ITR 188 SC]. One expects that the courts and tribunals would be taking a harmonious and liberal Interpretation. One needs to visualize special equities, in this distinct circumstances, the existence of which would justify an liberal approach by tax authorities
As courts has already taken judicial notice of the present situation and treated the same as natural calamity. Govt action of invoking Disaster Management Act, 2005 itself prove that situation is exceptional and requires a liberal approach from tax authorities. It is also necessary for assessee’s’ to record and compute its income and expenditure in just and fair manner alongwith supporting documents. In such unprecedented times, when the wheels of global and regional supply chains are clogged, it becomes imperative to have a relook at all financial affairs, so that the unintended breaches and damages/losses may be taken into consideration. The influence on this aspect will largely depend on facts and circumstances, including the degree to which a assessee / company’s operations are exposed to the impacts of the outbreak.
Before we proceed further we need to understand a legal term Force Majeure very commonly used since the beginning of this Pandemic. ‘Force majeure’, more popularly known as an ‘Act of God’. FORCE MAJEURE means contracts stands terminated as unenforceable on account of frustration, impossibility and impracticability.
Black’s Law Dictionary, 11th Edition; Page 788 defines ‘Force Majeure’ as an event or effect that can be neither anticipated nor controlled. The term includes both, acts of nature (e.g., floods and hurricanes) and acts of people (e.g., riots, strikes and wars)
The Government of India vide its office memorandum dated February 19, 2020 [Office Memorandum no. F. 18/4/2020-PPD dated February 19, 2020, issued by Ministry of Finance (Department of Expenditure – Procurement Policy Division), Government of India. May be accessed at https://doe.gov.in/sites/default/files/Force%20Majeure%20Clause%20-FMC.pdf.], has referred to the definition of ‘force majeure’ which is appearing in the Manual for Procurement of Goods, 2017, and has categorised the Covid-19 outbreak as a natural calamity.
We need to understand the utility and implications of a force majeure clause. Under Indian Contract Act, the consequences of a force majeure event are provided for u/s. 56 of the Contract Act, which states that on the occurrence of an event which renders the performance impossible, the contract becomes void thereafter.
Section 56 of the Contract Act reads as
Agreement to do impossible act.—An agreement to do an act impossible in itself is void. Contract to do act afterwards becoming impossible or unlawful—A contract to do an act which, after the contract is made, becomes impossible, or, by reason of some event which the promisor could not prevent, unlawful, becomes void when the act becomes impossible or unlawful.
In India, the Contract Act had already recognized the harsh consequences of such frustration to some extent and had provided for a limited mechanism to ameliorate the same u/s. 65 of the Contract Act. Section 65 provides as under:
Obligation of person who has received advantage undervoid agreement, or contract that becomes void:When an agreement is discovered to be void, or when a contract becomes void, any person who has received any advantage under such agreement or contract is bound to restore it, or to make compensation for it to the person from whom he received it.
The aforesaid provision provides the basis of restitution for ‘failure of contract’. We are cognizant that the aforesaid provision addresses limited circumstances wherein an agreement is void ab initio or the contract becomes subsequently void.
The Hon Delhi High Court has already considered the circumstance in case of M/s HALLIBURTON OFFSHORE SERVICES INC. vs. VEDANTA LIMITED & ANR [O.M.P. (I) (COMM) 88/2020 & I.A. 3697/2020; dt 20th April, 2020]
“The countrywide lockdown, which came into place on 24th March, 2020 was, in my opinion, prima facie in the nature of force majeure. Such a lockdown is unprecedented, and was incapable of having been predicted either by the respondent or by the petitioner……..
We are placed, today, in uncomfortably peculiar circumstances. A pandemic, of the nature which affects the world today, has not visited us during the lifetime of any of us and, hopefully, would not visit us hereinafter either. The devastation, human, economic, social and political, that has resulted as a consequence thereof, is unprecedented. The measures, to which the executive administration has had to resort, to somehow contain the fury of the pandemic, are equally unprecedented. The situation of nationwide lockdown, in which we find ourselves today, has never, earlier, been imposed on the country. The imposition of the lockdown was by way of a sudden and emergent measure, of which no advance knowledge could be credited to the petitioner – or, indeed, to anyone else. As a consequence, submits Mr. Sethi, the petitioner’s activities had to suddenly discontinue on 22nd March, 2020, and have not been able to resume ever since.
The lockdown, as imposed by the Central and State Government, is presently in place till 3rd May, 2020. Restrictions, on free movement of personnel and normal continuance of activities, had come into place even before 22nd March, 2020.”
One can also refer to the recent decision of Supreme Court in the case of SOUTH EAST ASIA MARINE ENGINEERING AND CONSTRUCTIONS LTD. (SEAMEC LTD.) vs. OIL INDIA LIMITED [CIVIL APPEAL NO. 673 OF 2012 ; 11th May, 2020] wherein the court has dealt and explained force majeure clause in detail.
In this write up we shall consider some tax issues due to the covid 19 lockdown:
Uncertainty of Rental Income /Payment :
At the outset before taking a stand a reference can be made to directions issued by government authorities to landlords asking them not to charge rent or evict the tenants during covid 19 lockdown period. Also attention is invited to the case of ALJO J. JOSEPH vs UOI (SC) Writ Petition (Civil) Diary No. 11055/2020 wherein the Petitioner, a lawyer through prayer sought exemption to lawyers from paying rentals. The SC observed that it is not inclined to pass any relief as rentals are livelihood for many landlords and the Petitioner should approach BCI or Government. The Writ Petition was dismissed as withdrawn.
The Delhi High Court in the case of RAMANAND & ORS. vs. DR. GIRISH SONI & ANR. RC. REV. 447/2017. Dt 21-05-2020. rejected the Tenant’s application for suspension of rent during COVID-19 lockdown and stated that some postponement or relaxation in the schedule of payment can be granted owing to the lockdown. The Court further observed that there is no rent agreement or lease deed between the parties and hence Section 32 of the Indian Contract Act has no applicability. The case is governed by the provisions of the Delhi Rent Control Act, 1958. Section 56 of the Indian Contract Act does not apply to tenancies. The Tenants also do not urge that the tenancy is void under Section 180 (B)(e) of the Transfer of Property Act. The tenants are also not ₹Lessees’ as an eviction decree has already been passed against them.
If the income is taxable under Head House property the Computation of Income and it taxability will be dealt by sec 22 to 24 of the Act in arriving at ALV of the property. According to me there is no scope of such arguments as uncertainty. Rent once earned having become due under valid and subsisting agreement has to be charged to tax. Subsequent waiver would not entitle any reduction in annual value chargeable to tax. The word ‘receivable’ in clause (b) to sec 23 refers to the amount of rent which is due but yet to be received. Rent which is due but could not be realised cannot be excluded. However due to unprecedented events leading to lockdown, if the tenant/licensee has expressed unwillingness to pay the whole of the amount for the lockdown period or wants to suspend the same for particularly period the parties may record the same in writing subject to tenant paying the agreed rent regularly post the period of lockdown. Subject to other conditions being fulfilled the actual rent may be computed under clause (b) to sec 23 of the Act. However, this is subject to parties have intended and preferably documented their intention to modify the agreement before the rent had accrued under the agreement.
However if the parties do not arrive at any understanding and there is a genuine dispute between the parties, from owners point of view it will be better to cancel the agreement by giving notice. In such a situation the recipient/owner can offer rent to the extend whatever he has actually received showing the change in the circumstances. However to what extent tax authority will accept the proposition needs to be tested. In a situation where the payment of rent /license fee is suspended for a particular period, the balance rent if realised in next year can be offered as unrealised rent u/s. 25A of the Act in the year whenever it is received.
25A. Special provision for arrears of rent and unrealised rent received subsequently.— (1) The amount of arrears of rent received from a tenant or the unrealised rent realised subsequently from a tenant, as the case may be, by an assessee shall be deemed to be the income from house property in respect of the financial year in which such rent is received or realised, and shall be included in the total income of the assessee under the head – Income from house propertyΠ, whether the assessee is the owner of the property or not in that financial year. (2) A sum equal to thirty per cent. of the arrears of rent or the unrealised rent referred to in sub-section (1) shall be allowed as deduction.]
As regards the licensee/ tenant is concerned they can claim the expenses to the extend it is agreed between the parties. If no such understanding is arrived at by the parties the better course could be to claim the full expenses in the books. On later date when ever the amount is settled the excess amount claimed if any can be offered to tax.
In a case where the recipient offers the rent/license fee as business income on the same principle as discussed above the rent /license fee can be offered to tax. Here the dept will have to adopt a realistic view rather than a hyper technical view while dealing with the issue. As dept cannot lose sight of the real ground situation prevailing during lockdown. However the assessee needs to keep all such material/documents available at the time of assessment.
Invoice Issued in March 2020 but Goods Not Delivered till Lockdown :
In mercantile system of accounting the income is deemed to have been accured once invoice is raised though the goods might be delivered at a later date. However in present circumstances due to lockdown there is impossibility in performance of the contract. One needs to see the terms of contract.
Subject to facts of each case vis a vis the prevailing ground reality in each area /locality, if both the parties invoke force majeure clause or decide to cancel the contract or suspend the same till normalcy is sustained, income will not be accrued nor liable to be taxed. It is advisable to place on record the actual ground reality in the area along with communication exchanged between the parties. e.g Mumbai is in red zone during lockdown and maximum business activities were closed. People were even not allowed to reach their office or godown or factory, in such a situation the normal accounting policy should not apply. Where the assessee’s contract or transaction get cancelled at year end due to exceptional situations or the transaction is not materialised, income may not accrue merely because invoice is raised. There is no performance of the contract. The assessee should preserve the records of communication with the parties.
Salary for Lockdown Period not paid when to Deduct Tax and will it Include in Case of Employee :
On March 29, 2020 The Ministry of Home Affairs (MHA) issued an order under Section 10(2)(I) of the Disaster Management Act stating : ” All employers, be it in the industry or in shops and commercial establishments, shall make payment of wages of their workers at their workplaces, on the due date, without any deduction, for the period their establishments are under closure during the lockdown.”
The constitutional validity of the above order on wages was challenged by several companies who had moved the Supreme Court. On 15/5/2020, the Supreme court asked the government not to take any coercive action against private companies who were unable to pay wages to workers. The SC was to hear the petition next week. The court, terming it as an “omnibus order”, had asked the government to re-examine it.
The Ministry of Home Affairs (MHA) had issued a fresh set of guidelines which was applicable from 18/5/2020. It had repealed the order dated March 29, 2020 which had talked about compulsory wage payment to workers during lockdown.
Considering the above factor an assessee needs to account for salary /wages what it has decided to pay. It will be better to have the decision documented as it is change in the contract between the employees or workers. However if there is any likely hood of dispute arising relating to the quantum of payment a provision to that effect maybe made. Tax have to be deducted on the actual or agreed amount. To avoid any dispute proper documentation will be necessary. Most of the companies are informing all the employees about the cut in salaries/postponement, through proper notice.
As far as employees are concerned they will account for the actual salary received.
Expenses Incurred in FY: 2019-20 but Invoice Received in FY: 2020-21 Due to Lock Down Expense of Which Year and When to Deduct Tax :
Expenses incurred in FY 2019-20 should be accounted in same year though the invoice is received in next year. Lockdown is exceptional circumstances and one can prove through documentary evidence that expense were actually incurred in FY. Further the invoice could not be raised /furnished due to lockdown.
As far as payer is concerned though invoice is raised in FY 2020-21 he can account for the expenses in FY 2019-20 if he is able to prove that same is a prior period expenses and delay in raising the invoice was beyond his control due to lockdown. Other circumstantial evidence like email correspondence can be useful to support the claim. However whenever he is raising the invoice at that time he will deduct tax and deposit the same. The CBDT has issued an Office Order dated 31st March 2020 u/s 119 of the Income-tax Act in which it has issued various directions and clarifications on the issue of certificates for lower rate/ nil deduction/collection of TDS or TCS u/s 195, 197 and 206C (9) considering the constraints of the Field Officers in disposing of the applications for lower or nil rate of TDS/ TCS and to mitigate hardships of payees and buyers /licensees /lessees.
5) Claim of depreciation for assets purchased in FY: 2019-20 but could not be used due to lockdown in that year. Additional depreciation for lockdown period:
If asset is purchased and installed but not used, depreciation shall be allowed. However if the asset is not ready to be used depreciation shall not be allowed. Additional depreciation will accordingly be allowed. One should note that if asset is not ready to be used the depreciation benefit will be available next year.
Your attention is invited to the decision of Gujarat High Court in case of PCIT v. Babul Products (P.) Ltd. (2018) 257 Taxman 100 (Guj.)(HC) [Editorial : Order in Babul Products (P.) Ltd v. ACIT (2017) 167 ITD 402 (Ahd) (Trib.) is affirmed]. Wherein it was held that the Factory could not run due to stay order of Court therefore depreciation cannot be disallowed. Dismissing the appeal of the revenue the Court held that ; as the Factory could not run due to stay order of Court, depreciation cannot be disallowed. Business is not closed permanently.
6) Payment Could Not be Made to MSME within Prescribed Period Due to Lockdown – Whether Period of Lockdown to be Excluded For Mandatory Interest.
If interest is payable on delayed payment as per the general terms of contract assessee should invoke force majeure clause and deny the payment of interest for the period of lockdown. However if the assessee feels that this could be a point of dispute at later point of time he should make a provision for the interest in the books. If at later point of time interest is not payable the amount can be reversed and offered for taxation. As mentions in the query due date is falling in lockdown period therefore I am of the view that interest would not be chargeable nor payable. Any expenditure incurred in course of business is allowable expenditure.
The occurrence of the Covid-19 outbreak does not by itself automatically entitle a party to take a plea u/s. 56 of the Contract Act. Considering that the Covid-19 pandemic is an unprecedented and unanticipated event, which has crippled the economy in its wake, it may very well be argued that the present circumstances are special and that if parties to the contract have invoked for non-performance during such period when businesses have been mandatorily closed and/ or have suffered, the tax treatment would require a different approach by the tax authorities considering the amended agreement / contract. Nevertheless, such a plea would have to be explored on a case to case basis.