Umesh Gala, Aditya Hans & Chetan Mehta
Section 40(a) of the Income Tax Act, 1961 (the IT Act) provides, inter alia, disallowance of any rate of tax levied on profits or gains of any business or profession in computing the gross total income of a taxpayer. In simple words, deduction of income tax paid on such profits and gains is not an allowable expenditure. In general parlance, the term ‘tax’ would mean tax including Education Cess and Higher and Secondary Education Cess levied under the income tax statute. Hence, generally, taxpayers disallow the income tax with surcharge and Cess in computing total income.
In a recent decision of the Hon’ble Rajasthan High Court in the case of Chambal Fertilisers and Chemicals Limited, it has been held that Education Cess is not a tax; therefore, the same is required to be added back in computing profits and gains from business as part of the gross total income of the taxpayer.
While deciding the issue in favour of the taxpayer and allowing deductions in respect of the claim of Education Cess, the Hon’ble HC agreed with the following arguments put forward by the taxpayer –
Education Cess is neither levied on the profits or gains of any business or profession nor assessed as a proportion of, or otherwise on the basis of, any such profits or gains. It is calculated as a percentage on tax.
The word ‘Cess’ present in the corresponding provisions of the erstwhile IT Act, 1922 has been cautiously omitted from the current IT Act. A 50-year old CBDT Circular dated 18-05-1967 has clarified that the effect of omission of the word ‘Cess’ is that only taxes paid, and not Cess, are to be disallowed from AY 1962-63 onwards.
Education Cess cannot be treated at par with tax.
In an earlier decision of the Mumbai Tribunal, the matter was decided against the taxpayer. However, the appeal of this taxpayer has since been admitted by the Bombay High Court in that case. The decision of Rajasthan High Court will act as a significant guide while deciding the issue in other taxpayers’ cases.
As a rule of thumb, if a claim for Education Cess is lodged by a domestic company and allowed in the assessment/appellate stage, the net tax benefit from the claim would be about 0.5% of the profits or taxable income. To elaborate further, a domestic company with profits/taxable income of INR 100 Crs. will have a tax benefit of INR 0.50 Crs., considering the newly introduced Health and Education Cess of 4% as introduced in Budget 2018 applicable for Assessment Year 2019-20 relating to Financial Year 2018-19.
Having said the above, there are some challenges in lodging the claim. One such issue would be computation of Education Cess to be claimed as allowable expenditure while computing taxable income and tax payable, which will lead to a circular reference. Another argument which may go against the taxpayer is that the 1967 CBDT circular referred to does not refer to Cess under the IT Act and it is Cess under other statutes. Education Cess is not relatable to carrying on of the business of the taxpayer, because if the taxpayer suffers a loss or does not have any chargeable profits, then no Education Cess is payable.
The claim, if attempted, needs to be lodged with full disclosure to avoid penal consequences and only after payment of taxes. However, litigation in this regard cannot be totally ruled out.
Umesh and Aditya are Partners and Chetan is Principal, Dhruva Advisors LLP