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Taxing the employer for breach of employee welfare discipline – A Permanent Disallowance

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The Finance Bill 2021 has amended the provisions of section 36(1)(va) and section 43B by inserting explanations to the respective sections in order to prevent any delay in depositing employee’s contributions to the PF by the employer.

Ms. Zainab Bookwala and Ms. Risha Gandhi from Deloitte Haskins & Sells LLP write on the amendment and it’s impact on employers and employees.

Background

Taxes are normally never welcome from the lens of the taxpayers. While taxes are costs of civilization and sovereign wellbeing, sometimes it is important to realize how taxes protect welfare of people. Contribution towards social security forms the foundation for a retirement plan for most employees in India. Any loss of benefits from such contributions may impact the employees adversely. The Hon’ble Finance Minister – Mrs. Nirmala Sitharaman during her Budget 2021 Speech, has harped on this aspect and highlighted that in many cases employers delay in depositing the employee contribution towards various welfare funds such as provident fund, superannuation fund, etc. This results in loss of interest for such employees, besides causing delay in important receipts in the Government exchequer to fund development initiatives. In order to address this issue of delayed deposits of employee contributions, amendments have been proposed in the provisions under the Income-tax Act, 1961 (‘ITA’) which will lead to timely compliance by employers in depositing employee contributions to various welfare funds.

Section 2(24) of the ITA provides the definition of the term ‘income’. As per clause (x) of section 2(24), any sum received by the assessee from its employees as contributions to any employee welfare fund shall be regarded as the income of the assessee. Section 36 of the ITA currently provides for various deductions while computing income from profit and gains of business and profession. Clause (va) of section 36(1) of the ITA pertains to deduction in case of any employer in relation to employee contribution towards any employee welfare fund. The said section allows deduction of only those contribution where the monies has been deposited by the employer in respect of their employees in the relevant employee welfare funds before the due dates as specified in the relevant statute of the employee welfare laws. Thus, section 2(24)(x) would deem employees contribution towards various employee welfare funds as income in the hands of the employer at first place and then when the employer deposits such contribution within the due date as contemplated in section 36( 1)(va), it can claim a deduction for the said amount.

In contradistinction, Section 43B of the ITA currently provides for deduction on payment basis. Currently, Clause (b) of section 43B allows deduction of any sum payable by employers to the statutory funds where such sums are credited to the government account on or before the due date of filing of return of income as per section 139(1) of the ITA.

However, at the time of introduction of section 43B by Finance Act, 1987, deduction in respect of employees’ contribution towards any employee welfare fund was tax deductible only if the same was actually paid on or before the due date as defined in the explanation to section 36(1)(va). Due date as per explanation to section 36(1)(va) is the date prescribed under the relevant statute governing the employee welfare funds.

Subsequently, the second proviso to section 43B was deleted and first proviso was amended vide Finance Act, 2003. The Supreme Court in case of Alom Extrusions Ltd. [2009] 319 ITR 306 has held that deletion of the second proviso to section 43B was a curative amendment and there were many implementation issues arising on account of the said proviso. Further, the amendment to first proviso to Section 43B effected that any sum payable by the assessee as an employer by way of contribution to any employee welfare fund shall be allowed as deductible if the said sum is actually paid during the previous year on or before the due date as prescribed under Section 139(1) for filing of return of income shall be allowed.

The Supreme Court in the case of Alom Extrusions Ltd. (supra) has held that the sum payable by the assessee as an employer by way of contribution to any provident fund or superannuation fund or gratuity fund or any other fund for the welfare of employees shall be allowed as deduction under section 43B even if paid late but paid before the due date of filing the income tax return under section 139(1) of the ITA.

Post this amendment and the decision of the Supreme Court, there were diverse interpretations wherein one section of the Courts held that the Supreme Court decision is only in relation to employer’s contribution towards the employee welfare fund whereas the other section of the Courts held that the decision of Supreme Court as well as the amendment vide Finance Act 2003 relates to both employer as well as employee’s contribution towards the welfare fund.

Few of the decisions wherein the Courts have favoured the later view are listed below:
Sagun Foundry (P.) Ltd. [2017] 291 CTR 557 (Allahabad High Court)
Rajasthan State Beverages Corpn. Ltd. [2017] 84 taxmann.com 173 (Rajasthan High Court) – SLP dismissed
Bihar State Warehousing Corporation Ltd. [2016] 386 ITR 410 (Patna High Court)
Ghatge Patil Transports Ltd. [2014] 368 ITR 749 (Bombay High Court)
Hindustan Organics Chemicals Ltd. [2014] 366 ITR 1 (Bombay High Court)
Udaipur Dugdh Utpadak Sahakari Sangh Ltd [2013] 35 taxmann.com 616 (Rajasthan High Court)
AIMIL Ltd [2010] 188 Taxman 265 (Delhi High Court)

Certain Courts have observed that if the employees’ contribution is not deposited by the due date prescribed under the relevant Acts and is deposited late, the employer not only pays interest on delayed payment but can incur penalties also, for which specific provisions are made in the Provident Fund Act as well as in the ESI Act. Therefore, the amendments to provisions of section 43B by Finance Act 2003 would be appropriate considering the fact that as the employer may already be penalized under the relevant statutes governing the welfare funds, it may not be again necessary to penalize the employer by way of disallowance under the ITA. Thus, under the provisions of the ITA, the employer could get the benefit of tax deduction even if the actual payment is made after the statutory deadlines as prescribed in the respective Acts but before the income-tax return is filed.

Impact:

It was nearly a settled position in cases where there was a jurisdictional High Court ruling supporting the fact that section 43B shall be applicable for not only employer’s contribution but also employees’ contribution towards employee welfare funds. However, on account of the issue highlighted earlier of misuse of employee’s funds by the employer, in order to contain the same, the Finance Bill 2021 has made a clear distinction of treatment for deductibility of employer’s contribution and employee’s contribution. It states that employee‘s contribution is employee’s own money and the employer deposits this contribution on behalf of the employee in fiduciary capacity. Further, it is a mechanism to ensure compliance of employee welfare laws. Therefore, in order to prevent any delay in depositing employee’s contributions to the PF by the employer, Finance Bill 2021 has amended the provisions of section 36(1)(va) and section 43B by inserting explanations to the respective sections.

The new explanation clarifies that provisions of section 43B applies to employer’s contribution to the statutory funds and shall not apply to employee’s contribution. It also clarifies that section 43B is not for the purpose of determining due date. For the purpose of deduction of employee’s contribution, the condition as specified in section 36(1)(va) shall be applicable i.e. employee’s contribution has to be made on or before the due date of the relevant statute governing respective employee welfare funds. The said amendment shall be applicable from AY 2021-22 and subsequent assessment years.

It may be noted that the proposed Explanations under section 36(1)(va) and section 43B states that (provisions of section 43B shall not apply and shall be deemed never to have been applied to the sum received by the assessee from any of his employees. Based on the language used in the said provision, one may infer that it was never an intention to include employee’s contribution within the ambit of section 43B of the ITA. Accordingly, for the past years where the taxpayer may have taken a position based on various judicial precedents that employee contribution deposited after the due date as per the relevant law governing the employee welfare fund but before the due date of filing the income-tax return shall be allowed as deductible may be challenged by the tax department.

The proposed amendment is going to be applicable from assessment year 2021-22 and thus, may impact the current year’s tax computation of many organizations especially considering the fact that 10 months of the current financial year are already over. However, from an employee’s perspective, this is a welcome amendment as it shall curtail misuse of employee’s funds in many ways.


Article Contributors

Ms. Zainab Bookwala is a Senior Manager with Deloitte Haskins and Sells LLP

Ms. Risha Gandhi is a Manager with Deloitte Haskins and Sells LLP

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