Income Tax Authority Cannot Dissect An Otherwise Indivisible Contract In Absence Of Legal Provision: Allahabad High Court

The Allahabad High Court has held that an otherwise indivisible contract cannot be dissected by the authorities under the Income Tax Act, in absence of any legal provision allowing such dissection.

Agreeing with the principals laid down by the Punjab and Haryana High Court and Karnataka High Court in Pr. Commissioner of Income Tax, TDS-II, Chandigarh Vs. The Senior Manager (Finance), Bharat Heavy Electricals Ltd., Jhajjar and Commissioner of Income Tax Vs. Bangalore Metro Rail Corporation Ltd., the bench comprising of Justice Saumitra Dayal Singh and Justice Shiv Shanker Prasad held

“Unless an external (legal tool) was available to the assessing authority under any of the provisions of the [Income Tax] Act as may have allowed it the luxury to dissect an otherwise indivisible contract and/or unless an internal tool was seen to exist to allow that exercise to be made, a composite contract could not dissected by the assessing authority.”

The Court further held that it is upon the taxing authority to show the law enabling them to divide and tax and otherwise indivisible contract. The Court held that taxing authorities are not to presume or assume facts. They exist to apply tax laws to proven facts.

Factual Background

Assesee was incorporated as a Special Purpose Vehicle (“SPV”) by the State Government of Uttar Pradesh for setting up a 3 x 660 MW (Mega Watt) Super Critical Thermal Power Plant at District-Lalitpur, Uttar Pradesh. Later, its ownership was transferred to a private company. For setting up the thermal power plant, assessee entered into two sets of contracts, one with Bharat Heavy Electric Ltd. (“BHEL”) and the second with Carbery Infrastructure Pvt. Ltd. (“CIPL”).

Individual orders were passed under Section 201 of the Act describing the assessee to be in default of deduction of TDS required to be made by it at the higher rate of 10% (under Section 194J of the Act) against the lower rate of 2% (under Section 194C of the Act) applied by the assessee, to the payments made by the assessee in each year, against the two contracts for the works done under the head of “services of Transportation, Insurance, Erection, Installation, Testing and Commissioning of BTG”, awarded to BHEL and also the work done under the head of “Erection, Installation and Commissioning of BOP”, awarded to CIPL.

Subsequently, assessment order was passed by the Assistant Commissioner of Income Tax (TDS), Noida for the Assessment Years 2012-2013, 2013-2014 and 2014-2015, raising demand of short deduction of TDS and interest thereon. The Assessment Orders were confirmed in appeal by the Commissioner of Income Tax (Appeals)-I, Noida.

The Income Tax Appellate Tribunal following the decision of the Punjab and Haryana High Court in Pr. Commissioner of Income Tax, TDS-II, Chandigarh Vs. The Senior Manager (Finance), Bharat Heavy Electricals Ltd., Jhajjar, ruled in favour of the assesee.

Counsel for revenue argued that the assessing authority had passed the order after considering the facts in detail. It was found that detailed and separate records were not maintained by the assesee for the payment made under the two contracts. It was agured that the assesee was liable to deduct TDS at the rate of 10% in terms of Explanation (b) to section 194J of the Act as the payments for works performed by BHEL and CIPL fell under the head “fees for technical services” as defined under clause (b) of sub-section (1) of Section 194J of the Act, read with Explanation [2] to clause (vii) to sub-section (1) of Section 9 of the Act.

It was argued that the Tribunal had not recorded any independent reasoning to overturn the findings of the assessing authority.

Counsel for assesee submitted that the contracts awarded to BHEL and CIPL were identical to the one considered by the Punjab and Haryana High Court in Pr. Commissioner of Income Tax, TDS-II, Chandigarh Vs. The Senior Manager (Finance), Bharat Heavy Electricals Ltd., Jhajjar. It was further argued that contracts awarded to BHEL and CIPL were composite and indivisible, therefore reliance placed by the counsel for revenue on sub-components and specifications, non-specifications of the contracts was inconsequential. The Court held that a contract must be read considering its main object.

Relying on the decision of the Karnataka High Court in the case of Commissioner of Income Tax Vs. Bangalore Metro Rail Corporation Ltd. it was argued a contract cannot be divided unless there is provision in the contract or in law for dividing the same.

High Court Verdict

The Court held that the similarity in contracts between assesee and BHEL and CIPL and the contract involved in The Senior Manager (Finance), Bharat Heavy Electricals Ltd., Jhajjar was undisputed. The Court observed that in both cases, element of testing and commissioning of technical works etc. were part of the main contract to set up a thermal power plant. It included the work of Transportation, Insurance, Erection, Installation, Testing and Commissioning of BTG and also Commissioning of BOP.

“Thus, Punjab and Haryana High Court has principally reasoned that the primary/dominant object of the contract would govern or subsume the other object/clause therein,” observed the Court.

The Court held that in absence of any internal tool in the contract, it could not be deciphered that the work of Testing and Commissioning was separate or independent of the contract to set up BTG and BOP by BHEL and CIPL.

“Further, in absence of any enabling law, it never became open to the taxing authorities to overlook the dominant object of the contract and reach to a conclusion, because part of the contract involved Testing, Commissioning etc., necessarily, there would exist component of “fees for technical services”, by necessary implication.”

The Court held that in Commissioner of Income Tax Vs. Bangalore Metro Rail Corporation Ltd., the Karnataka High Court had held that an indivisible contract cannot be divided in a way to apply higher rate of tax deduction at source to one part. It was held that a contact cannot be “artificially dissected at the hands of a taxing authority, to the prejudice of the assessee.”

Accordingly, following the principles and reasoning given by the Punjab and Haryana High Court and the Karnataka High Court, the bench headed by Justice Singh held that a contract cannot be dissected unless there is a provision in law for dissecting such contract or the contract itself provides for it.

The Court held that the contracts in the present case were indivisible. Further, the Court held

“The taxing authorities exist to apply the taxing statute to the proven facts of a case. Such facts are not for the taxing authority to imagine or presume or assume. Therefore, the burden existed on the revenue authorities to establish that they were enabled in law and also that the proven facts of the case permitted them divide an otherwise indivisible/composite contracts executed by the assessee with the BHEL and CIPL. Unless that exercise had been carried out by the assessing authority, no presumption was available in law.”

The appeal was dismissed in favour of the assesee.

Case Title: The Commissioner Of Income Tax (Tds) And Another vs. Lalitpur Power Generation Co. Ltd. 2023 LiveLaw (AB) 460 [INCOME TAX APPEAL No. - 111 of 2018]

Citation: 2023 LiveLaw (AB) 460

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