TDS on out of pocket expenses, Service Tax

There are 18 Sections in Income Tax Act, 1961 that provides for Deduction of Tax at Source. Out of these 18, only 3 sections [194C, 194J and 194L] use that phrase “on income comprised therein”. Further these words appear at the end of the taxing provision and naturally can not be ignored. All the other 15 do not contain this phrase.

Now the question that arises is WHY only for these 3 sections [194C, 194J and 194L] and not for other 15. It is very very simple, because in the case of the remaining 15 sections the question of “income and non income does not and can not arise.” The very fact that this phrase “on income comprised therein” has been used naturally means that there can be non income component also being part of a payment. Further payments situation covered under these three sections alone can have both income and non-income component.

If the legislatures’ intention was to tax on the whole payment this phrase “on income comprised therein” has no place in these sections / entire Income Tax Act, 1961.

Question No. 30 of Board's Circular No. 715, dt. 8th Aug., 1995, which is reproduced below :

"Q. No. 30. Whether the deduction of tax at source under Sections 194C and 194J has to be made out of the gross amount of the bill including reimbursements or excluding reimbursement for actual expenses ?

Ans. Sections. 194C and 194J refer to any sum paid obviously, reimbursements cannot be deducted out of the bill amount for the purpose of tax deduction at source."

The departmental circular “715 of 08-08-1995” makes this phrase “on income comprised therein” redundant [or unwanted; useless], and this can not be intention of the legislature. Otherwise they could have simply said “on such payment” instead of using the phrase “on income comprised therein”

Said clarification i.e Question No. 30 as per Circular No. 715, dt. 8th Aug., 1995, applies only if there is a composite bill which does not differentiate between the reimbursement and other sum. if there was no composite bill but separate bills had been raised for fee for technical services and reimbursement of actual expenses. There being no income included in the amount of reimbursement which was on the basis of actual expenses incurred by the consultant on petrol and maintenance of the car, the same cannot be subject to TDS as part of gross bill under Section 194J.

Now the question is why only these 3 sections have this phrase “on income comprised therein”

Let us take an example (as amended by Finance Act 2010):

A CA raises a bill on his client Rs. 24,000 as Prof Fee + Rs. 4,000 towards hotel bill [bill produced as proof for reimbursement] + Rs. 2,472 towards service Tax Totalling to: Rs. 30,472.00. Then TDS is deductible. But the hotel bill which is a reimbursement and service tax can under no stretch of imagination be treated as income. Hence the TDS is to be made on Rs. 24,000.00 only (even though this alone does not exceed the threshold limit) which is the “income component” of the total bill.

But there is a case decided in favour of revenue also i.e Associated Cement Co. Limited. vs CIT(SC)
Supreme Court Decision dt.23-03-1993

In which it was observed by the court that

“It is neither possible nor permissible for the payer to determine what part of the amount paid by him to the contractor constitutes the income of the latter. It is not also possible to think that Parliament could have intended to cast such impossible burden upon the payer nor could it be attributed with the intention of enacting such an impractical and unworkable provision. Hence, on the express language employed in the sub-section, it is impossible to hold that the amount of two per cent. required to be deducted by the payer out of the sum credited to the account of or paid to the contractor has to be confined to his income component out of that sum”.

It is true that it is not the intention of the legislature to thrust on the deductor the task of finding the income component in general but any layman can say that a reimbursement that is supported with document and the indirect TAX component are not, repeat not, and can never constitute an income.

However, Currently Department insist on deduction of TDS on Gross amount which includes Service tax except in the case of Rent. In case of Rent Assessee need to deduct TDS only on Rent amount,not on service tax component (as per CIRCULAR NO. 4/2008, DATED 28-4-2008) but in case of other expenses  Assessee need to deduct TDS on service tax component also.