Tax component of tax free salary is taxable as salary u/s 195A, not income from other sources-HC

Tax component of tax free salary is taxable as salary not income from other sources under section 195A which provides for grossing up-High Court

Recently Hon’ble High Court has held that tax component on tax free salary paid by the employer is part of salary and not assesseble as income from other sources

ABCAUS Case Law Citation:
ABCAUS 2150 (2017) (12) HC

Tax component of tax free salary

Prelude:
Section 195A of the Income Tax Act, 1961 (the Act) deals with tax deduction at source where income is to be paid net of taxes. The section provides that in such cases, income shall be accordingly grossed up so that the actual payment made corresponds to the amount which is equal to the gross payment less TDS at applicable rates.

The Text of section 195A is as under:

Income payable “net of tax”.

195A. In a case other than that referred to in sub-section (1A) of section 192, where under an agreement or other arrangement, the tax chargeable on any income referred to in the foregoing provisions of this Chapter is to be borne by the person by whom the income is payable, then, for the purposes of deduction of tax under those provisions such income shall be increased to such amount as would, after deduction of tax thereon at the rates in force for the financial year in which such income is payable, be equal to the net amount payable under such agreement or arrangement.

The Section 195A was introduced by the Finance Act 1987 wef 1st June, 1987. The grossing up envisaged in the section can be explained by way of following example:

Example: Grossing up Tax Free Salary paid  (AY: 2017-18)

If tax free salary is Rs. 12,00,000/- then the grossed up amount for the purpose of deduction of tax at source would be Rs. 14,75,760/- so that the net amount paid after TDS on Rs. 14,75,760/-would be equal to Rs. 12,00,000/- as under:

Gross Salary   Rs. 14,75,760/-
Income Tax    
0-2,50,000/- Nil  
2,50,001 – 5,00,000 Rs. 25,000/-  
5,00,001-10,00,000 Rs. 1,00,000/-  
14,75,760-10,00,000 Rs. 1,42,728/-
Total Income Tax Rs. 2,67,728/-
Add: Edu. & SHE Cess Rs. 8032/-
Total I. Tax + Cess Rs. 2,75,760/-
Salary after TDS Rs. 12,00,000/-

The Challenge/Grievance:
Various income tax appeal was filed under Section 260-A of the Income Tax Act, 1961 (the Act) by assessee(s) against the order passed by the Income Tax Appellate Tribunal (Tribunal/ITAT) holding that tax component of tax free salary which was borne by the assessee employer was to be assessed as part of the salary and not as income from other sources.

Important Case Laws Cited/relied upon by the parties:
Emil Webber v. Commissioner of Income Tax – 200 ITR 483
Commissioner of Income Tax v. C.W. Steel – 1972 (86) ITR 817

Brief Facts of the Case:
A Common question was raised by foreign nationals, represented by the State State Electricity Board (Board)  which was acting as their agent.

The Board had entered into a contract of consultancy with a Canada based firm (Consultant) for carrying out a project at the sites of the Board.  As per the terms of an agreement, entered into between the Board and the Consultant, the liability to pay the salary, of the employees deputed by the Consultant to the project site, was of the Consultant itself. However, the income tax component was to be satisfied by the Board.

The petitioners, who were employees deputed by the Consultant, returned their income received in India and showed the tax component paid by the Board as “income from other sources”. However, the Assessing Officer (AO) added on the tax paid by the Board, returned as “income from other sources”, to the salary paid and computed the total salary paid as provided in Section 195A of the Act.

The AO determined the tax on the tax component of salary and deductions were made with respect to the tax paid by the Board. The balance tax was demanded from the assesses, the foreign nationals, who were in India by virtue of the contract.

The assesses filed appeals before the first Appellate Authority (FAA/CIT-A) who reversed the order of the AO and directed that the tax paid by the Board is to be taxed as “income from other sources”.

An appeal was taken by the Department to the Tribunal. The Tribunal allowed the appeal of the Department upholding the order of the AO.

Contention made on behalf of the Petitioner Assessee:
It was contended that Section 195A of the Act could be applied only when, both the salary and the tax is paid by the employer, going by the specific words employed in the provision. It was submitted that as per the agreement between the Board and the Consultant, there was no relationship of master and servant between the Board and the Consultant.

It was also submitted that as per non obstante clause 1.9.2 of the agreement, it referred to any other taxes, duties, levies etc payable by the Consultant or its personnel, in India or outside India was to be the sole liability of the Consultant, absolving the Board from such liability.

Observations made by the High Court:

The Hon’ble High Court observed that the Tribunal had relied on the non obstante clause 1.9.2 to hold that the Board was not paying the salary or the tax, but, getting it reimbursed from the Consultant. It was the finding of the Tribunal that tax liability being not the liability of the Board, both the salary and the tax was paid by the very same person. Hence, the argument of the assesses that Section 195A of the Act would be applicable only if both salary and tax is paid by the employer; cannot be sustained.  The Hon’ble High Court expressed its agreement with the above finding of the Tribunal.

Regarding the question whether Section 195A of the Act has to be employed in such cases, the Hon’ble High Court observed that the case relied upon by the assessee in which direction was issued to assess the tax component as “income from other sources” was in the context of there being no analogous provision as Section 195A in the Act at that point.

The Hon’ble High Court opined that the argument that Section 195A would be applicable only if the salary and tax is paid by the same person, i.e: the employer, cannot be countenanced as income has to be assessed at the hands of the person who received the income.

It was observed that the assesses were in India for employment in a project, as deputed by the Consultant. The assesses were, hence, in the employment of the Board and as per the consultancy agreement the salary was payable by the Consultant and the income-tax by the Board. Thus obviously, the salary of the employees deputed by the Consultant was included in the consultancy charges and the salary and income-tax were both from the Board , in whose project the assesses were employed.

The Hon’ble High Court observed that salary includes perquisites; which, by an Explanation, included any payment made by the employer in satisfaction of an obligation of the employee; which, but for the payment, would have been payable by the employee. Section 195A brings in the same effect, the absence of which prompted the Hon’ble Supreme Court to direct treatment of the tax payment as “income from other sources”.

Decision/ Conclusion/Held:
The appeal was decided in favour of the Department.

Tax component of tax free salary

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