New Explanations to section 36(1)(va) and 43B could provide hardship to genuine assessee’s

Finance Minister Nirmala Sitharaman proposed many new measures in the Budget 2021 to prop up the declining economy amid the Covid-19 pandemic and boost spending across sectors. Budget 2021 focused on the seven pillars for reviving the economy – Health and Wellbeing, Physical and Financial Capital and Infrastructure, Inclusive Development for Aspirational India, Reinvigorating Human Capital, Innovation and R&D, and Minimum Government Maximum Governance. Several direct taxes and indirect taxes amendments were also proposed.

Salaried employees form the major chunk of the overall taxpayers in the country and the contribution they make to the tax collection is quite significant. Income tax deductions offer a gamut of opportunities for saving tax for the salaried class. With the help of these deductions and exemptions and, one could reduce his/her tax substantially. One such exemption pertained to exemption on investment of provident fund, which was to a certain extend removed by Budget 2021.

Let us understand the provisions of law prior to Budget 2021 before we move forward:

Section 2(24) of the Income Tax Act, 1961 provides an inclusive definition of the income. Section 2(24)(x) provides that income to include any sum received by the assessee from his employees as contribution to any provident fund or superannuation fund or any fund set up under the provisions of ESI Act or any other fund for the welfare of such employees.

Section 36 of the Act pertains to the other deductions. Section 36(1)(va) provides for deduction of any sum received by the assessee from any of his employees to which the provisions of section 2(24)(x) apply, if such sum is credited by the assessee to the employee’s account in the relevant fund or funds on or before the due date.

Explanation to the said clause provides that, for the purposes of this clause, “due date to mean the date by which the assessee is required as an employer to credit an employee’s contribution to the employee’s account in the relevant fund under any Act, rule, order or notification issued there-under or under any standing order, award, contract of service or otherwise.

Section 43B specifies the list of deductions that are admissible under the Act only upon their actual payment. According to section 43B(b), if any sum towards employer’s contribution to any provident fund or superannuation fund or gratuity fund or any other fund for the welfare of the employees is actually paid by the assessee on or before the due date for furnishing the return of the income under section 139(1), assessee would be entitled to deduction under section 43B and such deduction would be admissible for the accounting year.

This provision does not cover employee contribution referred to in section 36(1)(va).

Section 36(1)(va) and section 43B(b) operate in different fields, i.e., former takes care of employee’s contribution and later the employer’s contribution. Therefore, an assessee is entitled to get benefit of deduction under section 43B(b) as provided under the proviso thereto only with regard to portion of amount paid by the employer to contributory fund. So far as the employee’s contribution is concerned, the assessee is entitled to get deduction of amounts as provided under section 36(1)(va) only if amounts so received from the employee is credited in specified account within due date as provided under relevant statute.

What was proposed by Budget 2021?

Budget 2021 has proposed to amend the provisions of section 36(1)(va) and section 43B as follows:

It is proposed to insert Explanation 2 to Section 36(1)(va) so as to clarify that the provisions of section 43B shall not apply and shall be deemed never to have been applied for the purposes of determining the “due date” under the said clause.
It is proposed to insert Explanation 5 to the Section 43B(b) so as to clarify that the provisions of that section shall not apply and shall be deemed never to have been applied to a sum received by the assessee from any of his employees to which the provisions of section 2(24)(x) apply.
These amendments will take effect from 1st April, 2021 and will, accordingly, apply in relation to the assessment year 2021-2022 and subsequent assessment years.

What would be the effects of these amendments?

The employer has to disallow the expenditure on account of employees’ contribution to respective funds if they are not deposited within the due dates.
Unlike section 43B of the Act which allows deduction in the year of payment, no deduction will be allowed u/s 36(1)(va) even when employees contributions are deposited at a later date.
Therefore, the employer will not have to create any deferred tax assets on this as per Accounting Standard 22 or Ind AS 12, as these disallowances are not timing difference.
Clause (va) of sub-section (1) of Section 36 of the Act was inserted to the Act vide Finance Act 1987 as a measure of penalizing employers who mis-utilize employee’s contributions.
It seems that the intent of this provision was to penalize employers who get unjustly enriched by mis-utilizing employees’ contribution.
However, straight away amendment in section 36(1)(va) will cover every case of delay in deposit which may even arise due to financial constrain of employer or technical glitch on portal.
The language of new provisos suggests that the amendment is retrospective in nature. This could impact even cases of those assesses who have got favourable ruling at lower forums but their cases are still open at upper forums.
The tax department may argue that the intent of legislature was never to apply the provision of section 43B on section 36(1)(va), hence, assessee should not be allowed deduction.

Though the clarifications provided would ease the process of tax computation, they contain severe provisions as it would lead to permanent disallowance of expenditure arising on account of employees’ even where there is delay in deposit by a single day. These penal provisions could create hardship to genuine employers even though the intent of the amendment appears to ensure timely deposit of employees’ contribution.

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