Interest on late TDS remittance under s. 201(1A): compensatory or penal, and whether disallowable under s. 37

The dominant issue was whether interest paid under s. 201(1A) for delayed remittance of TDS is penal in nature or represents a payment for breach of law, so as to be disallowable under s. 37. Relying on SC jurisprudence distinguishing compensatory interest from penalty where the statute separately provides for penalties, and HC/ITAT rulings treating s. 201(1A) interest as compensatory for delay rather than a sanction for illegality, the Tribunal held that such interest is not akin to income-tax or a penalty and is not hit by s. 37. Consequently, the AO was directed to delete the disallowance, and the appeal was allowed.

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1. ISSUES PRESENTED AND CONSIDERED

(i) Whether interest paid for delayed deposit of TDS is to be treated as penal payment / payment for breach of law so as to be disallowable, or as compensatory in nature and therefore allowable as business expenditure under section 37 of the Act.

2. ISSUE-WISE DETAILED ANALYSIS

Issue (i): Allowability under section 37 of interest paid on delayed deposit of TDS

Legal framework (as discussed by the Court): The Court considered the scope of section 37 of the Act in the context of expenditure said to arise from default in law, and examined whether interest paid for delayed remittance of TDS falls within the category of amounts not allowable as being in the nature of penalty or payment for breach of law. The Court also proceeded on the basis that interest for delayed deposit of TDS is levied under the mechanism applicable to such delay (referred to as interest for delayed remittance of TDS).

Interpretation and reasoning: The Court identified that there was no dispute on facts that TDS was deposited belatedly and interest was paid; the only determinative question was the character of such interest-whether it "partakes the character of a penalty" or is merely compensatory. Relying on the principle that where an enactment contains specific provisions dealing with penalty, and an additional amount becomes payable automatically (without requiring a separate penal order), such additional amount is not a penalty but compensatory, the Court treated the interest on late deposit as compensation for the time-value loss/damages caused by delay. The Court further accepted the reasoning that interest for delayed remittance of TDS is a levy of interest (and not a punishment), and therefore cannot be equated to penalty or breach-of-law payment for the purpose of disallowance under section 37. The Court also followed consistent Tribunal views holding that interest on delayed payment of TDS is in the nature of compensation/damages for late payment of statutory dues and is allowable, including on the reasoning that it is not "interest on income tax per se."

Conclusions: The Court conclusively held that interest paid on delayed deposit of TDS is compensatory and does not constitute penalty or payment for breach of law for purposes of section 37. Consequently, the disallowance made on account of such interest was directed to be deleted, and the assessee's claim was allowed.

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