2006 (7) TMI 248 - AT - Income Tax

Tribunal Overturns Penalty Order: No Tax Deduction on 'Interest Accrued But Not Due' Without Identifiable Payee.

The Tribunal allowed the appeal, overturning the penalty order under Section 221, as the assessee was not liable to deduct tax at source for 'interest ... Interest On Securities - expression 'interest accrued but not due' - non-deduction of tax at source - Penalty imposed u/s 221 - HELD THAT:- In the case before us, the interest is to be paid to a 'registered bondholder' as on a future date, and there cannot be any method to find out as to who will be registered bondholder on a future date. It is indeed correct that Explanation to section 193 lays down that even when an income is credited to any account in the books of account of the person liable to pay such income, such crediting shall be deemed to be credit of such income to the account of the payee and the provisions of this section shall apply accordingly, but the fact that the credit to any account is to be deemed to be credit to the payee's account also presupposes that payee can be ascertained. Therefore, this deeming fiction can only be activated when the identity of the payee can be ascertained. However, on the facts of the present case, this Explanation cannot be put into practice because the payee is not known at the stage of provision for 'interest accrued but not due' being made. It is not difficult to visualize that Explanation to section 193, which was introduced with effect from 1st June, 1989, was apparently to take care of a situation in which instead of crediting the account of the payee, some other proxy account was credited, to avoid the tax deduction at source liability being invoked. In our considered view, Explanation to section 193 cannot be invoked in a case where the person who is to receive the interest cannot be identified at the stage at which the provision for interest accrued but not due is made. This position is also accepted by the CBDT as evident from its letter dated 5th July, 1996 addressed to the Tata Iron & Steel Co. Ltd. [Letter No. 275/126/96 IT (B)]. Thus, we are of the considered view that the impugned penalty u/s 221 is unsustainable in law and on the facts of this case. We, therefore, set aside the impugned penalty order - The appeal is allowed. Issues Involved:1. Scope of Explanation to Section 193 of the Income-tax Act, 1961.2. Applicability of Section 221 for imposing penalty post insertion of Section 271C.Detailed Analysis:1. Scope of Explanation to Section 193 of the Income-tax Act, 1961:The core issue pertains to whether Section 193 of the Act requires tax to be deducted at source for 'interest accrued but not due' when the ultimate recipient of such interest cannot be ascertained at the time the provision is made. The term 'interest accrued but not due' refers to interest liability that has arisen but is not yet payable. The case involves a financial institution that issued unsecured bonds with 16% annual interest payable on June 9 each year. The bonds were transferable, and the interest was payable to the registered bondholder as of May 15 each year.The Tribunal noted that as of March 31, the assessee could not ascertain the recipients of the interest due to the transferability of the bonds. The Tribunal analyzed Section 193, which mandates tax deduction at the time of credit or payment of interest. The Explanation to Section 193 deems credit to any account as credit to the payee's account, but this presupposes that the payee can be identified. The Tribunal concluded that since the payee could not be identified at the time of making the provision for 'interest accrued but not due,' the tax deduction mechanism could not be applied.The Tribunal also referenced a CBDT letter stating that no tax deduction at source is required when the payee is not known. The Tribunal held that the assessee did not have a liability to deduct tax at source for the provision of interest accrued but not due, as the ultimate recipient could not be ascertained at the time the provision was made.2. Applicability of Section 221 for Imposing Penalty Post Insertion of Section 271C:The Tribunal addressed whether a penalty under Section 221 could be imposed for non-deduction of tax at source after the insertion of Section 271C, which specifically deals with such defaults. The Tribunal referenced a co-ordinate Bench decision in ITO v. Titagarh Steel Ltd., which held that post-April 1, 1989, penalties for non-deduction or short deduction of tax at source could only be imposed under Section 271C, not Section 221.The Tribunal noted that Section 271C was introduced to impose penalties for failure to deduct tax at source, while Section 276B dealt with prosecution for failure to pay deducted tax. The Tribunal emphasized that specific provisions (Section 271C) override general provisions (Section 221). The Tribunal also referenced a CBDT circular stating that no penalty was provided for failure to deduct tax at source before the insertion of Section 271C.The Tribunal concluded that the penalty under Section 221 was unsustainable because the default was for non-deduction of tax at source, which falls under Section 271C. Additionally, the Tribunal noted that the penalty under Section 271C could only be imposed by a Joint Commissioner, whereas the penalty under Section 221 was imposed by an Income-tax Officer, who was not competent to do so.Conclusion:The Tribunal allowed the appeal, setting aside the penalty order under Section 221, as the assessee had no liability to deduct tax at source for the provision of interest accrued but not due, and the penalty for non-deduction of tax at source could only be imposed under Section 271C, not Section 221.