The Finance Bill, 2022 now ‘clarifies’ that the term ‘tax’ includes surcharge and cess for the purpose of Section 40(a)(ii) of the IT Act. This amendment will take effect retrospectively from April 1, 2005 and will, accordingly, apply in relation to the assessment year 2005-2006 and subsequent assessment years^[1]. By way of an explanation, the Legislature is trying to overcome the decisions of Rajasthan High Court^[2] and Bombay High Court^[3]. Time and again, retrospective amendments have been introduced to overturn judicial precedents. Retrospective amendments should be limited to the extent of curing defect, but it should not be used as a tool to disregard and overcome Court’s judgements.

In our earlier update^[4], we had highlighted that while claiming deduction of payment made towards income-tax, surcharge is expressly prohibited but there is no specific bar towards claiming payment of cess as a deduction^[5]. Based on this understanding, and favourable decisions of High Courts and Tribunal, taxpayers had raised claims seeking deduction of payment of cess as a necessary business expense^[6]. The Legislature has tried to correct an error, which came to the attention after a judicial pronouncement. The Legislature may have the power to remove the basis or foundation of the judicial pronouncement, but the Legislature cannot overturn or set aside the judgment, that too retrospectively, by introducing a new provision^[7].

Historically, sub-clause (ii) of Section 40(a) of the IT Act, had included the word ‘cess’, but on the basis of the report of the Select Committee on the Income-tax Bill, 1961, it was not included in the section^[8]. From the year 2004, ‘Education Cess’ was levied and collected for the specific purpose to fulfil the commitment of the Government to provide and finance universalised quality basic education^[9]. The clear legal position which emerges is that when there is an impost by the Legislature for a specific purpose then it retains the character of ‘fee’ and not a tax. Thus, the judicial precedents distinguishing ‘cess’, being a fee, from ‘tax’ still hold good.^[10] By way of the proposed amendment, the Legislature has specifically added the words ‘cess’ as well as ‘surcharge’ levied on such tax to be included within the ambit of tax by way of an explanation to Section 40 of the IT Act, which is completely against the law laid down by the Supreme Court, as ‘Education Cess’ being ‘fee’ collected for a specific purpose cannot partake the character of ‘tax’.

[1]  Extract of Clause 13 of Finance Bill 2022 – “Explanation 3.–– For the removal of doubts, it is hereby clarified that for the purposes of this sub-clause, the term ‘tax’ must include and must be deemed to have always included any surcharge or cess, by whatever name called, on such tax.”.

[2]  Chambal Fertilizers and Chemicals Ltd. vs. JCIT, (2019) 107 taxmann.com 484 (Rajasthan High Court).

[3]  Sesa Goa Ltd. vs. JCIT, (2020) 423 ITR 426 (Bombay High Court).

[4]  https://www.azbpartners.com/bank/education-cess-deductible-from-taxable-income.

[5]  CBDT Circular No. 91/58/66-ITJ(19), dated May 18, 1967 clarifies this position.

[6]  The argument that is being taken is that since payment of cess is a statutory liability, non-compliance whereof leads to adverse business consequences, it has an undeniable nexus to the conduct of business and is therefore an expenditure incurred wholly and exclusively for the purposes of the business.

[7]  State of Karnataka v. Karnataka Pawn Brokers Association (2018) 255 Taxman 12 (Supreme Court).

[8]  The Select Committee recommended that “all cesses should be allowed as business expenses”. The Committee went to the extent of noting that these cesses sometimes are computed on the basis of profits but they are really in the nature of revenue expenditure.

[9]  Clause 81(1) of the Finance Bill 2004.

[10]  Hingir Rampur Coal Co. Ltd. vs. State of Orissa, AIR 1961 SC 459 (Supreme Court); Dewan Chand Builders and Contractors vs. UOI & Anr, (2012) 1 SCC 101 (Supreme Court).