The “cess” was introduced in the Finance Act, 2004, as “an additional surcharge” and the issue on deductibility of ‘education cess’ while computing income from business or professional has been a debatable one for a while now.

Author Prabhat Agarwal (Chartered Accountant), in his article, refers to the recent HC decision of SESA GOA LIMITED as reported in [TS-5087-HC-2020(BOMBAY)-O] which held that Education Cess and Higher and Secondary Education Cess is allowable as a deduction. The author highlights that HC relied heavily on circular no. F. No.91/58/66-ITJ(19), issued by the Board and intendment deciphered from the omission of word "Cess" on recommendation of Select Committee of Parliament from Income Tax Bill, 1961. Noting that the Revenue has not challenged the above ruling and other similar HC rulings in SC, the author opines that “this can be tricky and risky to conclude that the "Cess" is not in nature of Tax, hence deductible as expenditure in the year of payment”.

“Deductibility of Cess on Income Tax from the Taxable Income”

The Bombay High Court in the case of SESA GOA LIMITED vs. JOINT COMMISSIONER OF INCOME TAX [TS-5087-HC-2020(BOMBAY)-O] has recently held that Education Cess and Higher and Secondary Education Cess, collectively referred to as "cess" is allowable as a deduction for the computation of taxable Profits and Gains of Business or Profession in year of its payment.

1. Section 40(a) of the Income Tax Act, 1961 does not allow deduction of certain amounts while computing the taxable Profits and Gains of Business or Profession . One of clause thereof disallows any sum paid on account of any Rate or Tax levied on the profits and gains of Business or Profession. The relevant provision reads as under -

Notwithstanding anything to the contrary in sections 30 to 38 of the IT Act, the following amounts shall not be deducted in computing the income chargeable under the head "Prots and gains of business or profession",

(a) in the case of any assessee;

(ia) ………………………;

ib) ………………………;

(c) ………………………;

(ii) any sum paid on account of any rate or tax levied on the profits or gains of any business or profession or assessed at a proportion of, or otherwise on the basis of, any such profits or gains

Explanation 1.-For the removal of doubts, it is hereby declared that for the purposes of this sub-clause, any sum paid on account of any rate or tax levied includes and shall be deemed always to have included any sum eligible for relief of tax under section 90 or, as the case may be, deduction from the Indian income-tax payable under section 91.

Explanation 2.-For the removal of doubts, it is hereby declared that for the purposes of this sub-clause, any sum paid on account of any rate or tax levied includes any sum eligible for relief of tax under section 90A;

2. In this case, the assessee had claimed deduction of the Education and Higher Secondary cess, levied on the Income Tax payable by the assessee, from its taxable income of the Profit and Gains of Business or Profession on the ground that "Cess" is neither Tax nor Rate, hence is not disallowable u/s 40(a)(ii). The Assessing Officer did not allow the deduction of such cess while determining the taxable income of Profit and Gains of Business or Profession. On appeal, the Hon'ble Panaji Bench of ITAT {[TS-5366-ITAT-2013(PANAJI)-O] upheld AO's order assigning following reasons -

"The said payment is not a fee but is a tax. In case of fees, payment is made against getting certain benefit or services while tax is imposed by the Government and is levied for which the person who pay the tax is not promised in return to get any benefit or service. The assessee is not getting any benefit or services in return by making the payment towards the education cess and secondary higher education cess. Therefore, it cannot be said that it is an expenditure incurred wholly and exclusively for the purpose of the business and is not part of tax."

3. The order of ITAT was challenged before the Bombay High Court and amongst others, the following question was framed for adjudication by Hon'ble High Court -

" whether the expression "any rate or tax levied" as it appears in Section 40(a)(ii) of the IT Act includes "cess".

4. Before, the High Court, the assessee contended that the expression did not include "cess" and therefore, the amounts paid towards "cess" are liable to be deducted in computing the income chargeable under the head "Profits and Gains of business or profession". However, the Revenue contended that "cess" is also included in the scope and import of the expression "any rate or tax levied" and consequently, the amounts paid towards the "cess" are not liable for deduction in computing the income chargeable under the head "profits and gains of business or profession".

5. The Bombay HC allowed the deduction of cess paid on income tax on the basis of following reasoning -

a) The legislature, in Section 40(a)(ii) has provided that "any rate or tax levied" on "profits and gains of business or profession" shall not be deducted in computing the income chargeable under the head "profits and gains of business or profession". There is no reference to any "cess". If the legislature intended to prohibit the deduction of amounts paid by a Assessee towards say, "education cess" or any other "cess", then, the legislature could have easily included reference to "cess" in clause (ii) of Section 40(a) of the IT Act. The fact that the legislature has not done so means that the legislature did not intend to prevent the deduction of amounts paid by a Assessee towards the "cess", when it comes to computing income chargeable under the head "profits and gains of business or profession.

b) The word "cess" in this provision was originally included in the Income Tax Bill, but was omitted from the final Bill passed by the Legislature on recommendation of Select Committee of the Parliament and there is no question of reintroducing this expression in Section 40(a)(ii) of IT Act and that too, under the guise of interpretation of taxing statute.

c) Board's circular No. F. No.91/58/66-ITJ(19), dated 18th May, 1967 clarified that the view of the Income Tax Officer is not correct in disallowing the 'cess' paid by the assessee on the ground that there has been no material change in the provisions of section 10(4) of the Old Act and Section 40(a)(ii) of the new Act and held that this is an additional reason as to why the expression "cess" ought not to be read or included in the expression "any rate or tax levied" as appearing in Section 40(a)(ii) of the IT Act.

d) The Division Bench of the High Court in [TS-6741-HC-2018(RAJASTHAN)-O], relying on the aforesaid CBDT Circular dated 18th May, 1967 has held that the ITAT erred in holding that the "education cess" is a disallowable expenditure under Section 40(a)(ii) of the IT Act and no appeal was filed by revenue. Also, HC took note that this has been followed in case of (i) [TS-8290-ITAT-2019(KOLKATA)-O]; (ii) [TS-8803-ITAT-2019(KOLKATA)-O] (iii) [TS-8804-ITAT-2019(PUNE)-O].

e) The issue involved in the case reported in [TS-5345-SC-2019-O] was not in the context of provisions in Section 40(a)(ii) of the IT Act. Rather, the issue involved was whether the 'education cess, higher education cess and National Calamity Contingent Duty (NCCD)' on excise duty could be construed as "duty of excise" which was exempted in terms of Notication dated 9th September, 2003 in respect of goods specied in the Notication.

6. Both, the Rajasthan as well as Bombay High Court have relied heavily on circular no. F. No.91/58/66-ITJ(19), dated 18th May, 1967 issued by the Board and intendment deciphered from the omission of word "Cess" on recommendation of Select Committee of Parliament from Income Tax Bill, 1961.

7. It is important to understand the definition of term "Tax" to examine whether the Cess (Education; Senior & Higher Secondary; and Health) is in nature of Tax as stipulated u/s 40(a)(ii) or not

8. Section 2(43) of the Income Tax Act, 1961 defines "Tax" in relation to the assessment year commencing on the 1st day of April, 1965, and any subsequent assessment year means income-tax chargeable under the provisions of this Act,

...............................................;

Section 4 of the Income Tax Act, 1961 provides for levy of tax.

(1) Where any Central Act enacts that income-tax shall be charged for any assessment year at any rate or rates, income-tax at that rate or those rates shall be charged for that year in accordance with, and subject to the provisions (including provisions for the levy of additional income-tax) of, this Act in respect of the total income of the previous year of every person :

Provided that ................................

(2) .........................................

The Finance Act (Central Act) prescribes the rate of tax to be levied on the income chargeable to tax under Income Tax Act, 1961 in each assessment year. The extracts of relevant portion of section 2 of Finance Act 2018 (for sake of reference only, as these provisions under each Finance Act are similar except rate) are reproduced here under to understand the nature and character of levy -

"(11) The amount of income-tax as specified in sub-sections (1) to (3) and as increased by the applicable surcharge, for the purposes of the Union, calculated in the manner provided therein, shall be further increased by an additional surcharge, for the purposes of the Union, to be called the "Education Cess on income-tax", calculated at the rate of two per cent of such income-tax and surcharge so as to fulfil the commitment of the Government to provide and finance universalised quality basic education.

(12) The amount of income-tax as specified in sub-sections (1) to (3) and as increased by the applicable surcharge, for the purposes of the Union, calculated in the manner provided therein, shall also be increased by an additional surcharge, for the purposes of the Union, to be called the "Secondary and Higher Education Cess on income-tax", calculated at the rate of one per cent of such income-tax and surcharge so as to fulfil the commitment of the Government to provide and finance secondary and higher education.

(13) The amount of income-tax as specified in sub-sections (4) to (10) and as increased by the applicable surcharge, for the purposes of the Union, calculated in the manner provided therein, shall be further increased by an additional surcharge, for the purposes of the Union, to be called the "Health and Education Cess on income-tax", calculated at the rate of four per cent of such income-tax and surcharge so as to fulfil the commitment of the Government to provide and finance quality health services and universalised quality basic education and secondary and higher education:"

9. It is evident from above clause(s) of Section 2 of Finance Act that "Cess" is levied as Additional Surcharge in addition to Income Tax and Normal Surcharge. Section 2(1) of each year's Finance Act provides that income-tax shall be charged at the rates specified in Part I of the First Schedule and such tax shall be increased by a surcharge, for the purposes of the Union, calculated in each case in the manner provided therein. This power to levy income tax is derived from section 4 of the Income Tax Act, 1961 which prescribes that the tax rates including additional income tax shall be paid in accordance with rate(s) provided in Central Act, which is Finance Act. In other words, there are three kind of levies i.e. (i) Income Tax; (ii) Surcharge on such Income Tax; and (iii) Additional Surcharge in name of Cess. On combined reading of section 2(43) & Section 4 of Income Tax Act, 1961 and Section 2 of Finance Act, it may follow that levy of cess is income tax payable u/s 4 of the Income Tax Act, 1961.

10. In the case reported in [TS-5207-SC-2017-O], the Hon'ble Supreme Court (Two Judge), while examining the issue "whether the Education Cess and Higher Education Cess which were paid along with the excise duty were liable to be refunded along with the central excise duty in terms of the exemption notifications", elucidated on the nature of Cess levied on Excise Duty or Service Tax under Central Excise Act or Finance Tax and held it to be in nature of excise duty approving the Hon'ble Rajasthan High Court judgement in the case reported in [TS-6662-HC-2016(RAJASTHAN)-O], wherein it was held that -

"15. The very fact that the surcharge is collected as part of levy under three different enactments goes to show that scheme of levy of Education Cess was by way of collecting special funds for the purpose of Government project towards providing and financing universalised quality of basic education by enhancing the burden of Central Excise Duty, Customs Duty, and Service Tax by way of charging surcharge to be collected for the purpose of Union. But, it was made clear that in respect of all the three taxes, the surcharge collected along with the tax will bear the same character of respective taxes to which surcharge was appended and was to be governed by the respective enactments under which Education Cess in the form of surcharge is levied & collected."

11. In the case reported in [TS-5346-SC-2019-O], the Hon'ble Supreme Court (Two Judge), while deciding on the nature of Natural Calamity and Contingency Duty (NCCD) held that -

"22. We may notice that this Court, in SRD Nutrients Pvt. Ltd. gave its imprimatur to the view expressed by the Rajasthan High Court in Banswara Syntex Ltd. The rationale is that while there may be surcharges under different financial enactments to provide the Government with revenue for specified purposes, the same have been notified as leviable in the nature of a particular kind of duty. In the case of NCCD, it is in the nature of an excise duty. It has to bear the same character as those respective taxes to which the surcharge is appended. NCCD will not cease to be an excise duty, but is the same as an excise duty, even if it is levied on the product."

12. Though, the three judge bench, later on, in the case reported in [TS-5345-SC-2019-O] has held that the decision in case of SND Nutrients and Bajaj Auto Limited are per in curium of three judge bench decision in case of Union of India v. Modi Rubber Limited, (1986) 4 SCC 66, but the ratio laid down in SND Nutrients Limited and followed in Bajaj Auto Limited still holds good as the issue in Modi Rubber Limited (Supra) was whether the duty of excise payable under Central Excise Act is synonymous to excise duty payable under Central Excise Act for the purpose of exemption notifications. There was no disagreement on the point that all levies are in nature of duty of excise in that case also.

13. Although, the Revenue has not contested the decision of Hon'ble Rajasthan High Court in case of Chambal Fertilisers & Chemicals Limited (Supra) before Supreme Court, this decision is a binding precedent which is further strengthened by Bombay HC's decision in Sesa Goa Limited (Supra), this can be tricky and risky to conclude that the "Cess" is not in nature of Tax, hence deductible as expenditure in the year of payment. Still, the assessee may consider asking for this deduction in open assessment(s) considering the fact this claim is backed by judicial precedent and even if reversed later on shall not be liable for penal consequence(s). This judgement has opened pandora's box and it shall be interesting to see how Revenue deal with the implication(s) arising from this decision.