Subject : Representation on the procedure followed in disposal of applications under section 197 of the Income tax Act, 1961

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1 To, The Chairman Central Board of Direct Taxes, North Block, New Delhi August 3, 2009 Respected Sir, Subject : Representation on the procedure followed in disposal of applications under section 197 of the Income tax Act, 1961 Section 197 of the Income tax Act, 1961 (the Act) deals with applications for deduction of tax deducted at source (TDS) at a lower rate. Recently, while obtaining such certificates, a large number of assessees have faced certain difficulty on account of a different interpretation by the Assessing Officers (AOs) and thereby denying the issuance of such certificates even if the assessee is otherwise rightfully eligible to get the same. Sec.197 is meant for avoiding hardship to the assessee in cases where he has no tax liability or his tax liability is much less.. We narrate the facts hereunder: Issue Section197 of the Act provides for grant of certificate for lower rate or nil rate of TDS. Upon an application being made, the AO is empowered to issue a certificate of lower rate or nil rate in the manner provided in Rule 28AA of the Income Tax Rules, 1962 (the Rules). Normally, the AOs work out lower rate or nil rate, as the case may be, prescribed under Rule 28AA (1) of the Rules, which inter-alia pitches the word average rate of tax. Till recently, the AOs used to work out the average rate of tax on the gross amount received by the applicant as it is this amount on which Tax is deducted. To explain with a simple illustration: Amount received towards rent Say Rs.100/- TDS rate applicable 22.66% Deduction for interest paid Say Rs.20/- The approximate tax liability would work out as under :- Rental income Rs.100/- Less: (i) Interest paid 20 (ii) Standard deduction u/s Rs.50/- Taxable Income Rs.50/- Tax Due at 33.99% Accordingly, on the gross receipt, the rate would work out to %. It was usual practice to grant certificate under section 197 of the Act at such rate as ultimately that represents the actual liability for tax of the applicant. Page 1 of 5

2 Recently, the Central Board of Direct Taxes (the CBDT) has issued a clarification 1, upon the same being sought by the Chief Commissioner of Income Tax, Chandigarh, regarding interpretation of the term average rate of tax paid by the assessee in the last three years as mentioned in sub-clause (ii) of Rule 28AA of the Rules. The CBDT viewed that the average rate of tax should be considered as explicitly defined in section 2(10) of the Act to mean the rate arrived at by dividing the amount of income tax calculated on the total income, by such income. As no other interpretation of the term average rate of tax is possible, the CBDT directed that the average rate of tax should be taken with regard to total income rather than gross receipts disclosed by the assessee in the earlier years. In the above illustration, the income works out to Rs.50/- and the tax works out to /-. Applying the said clarification, the average rate of tax works out as under: x 100 = 33.99% 50 This is nothing but the tax rate applicable to corporate assesses on its taxable income. Applying this rate to the gross receipts results in a higher deduction than the actual liability of the assessee leading him/ it to apply for a certificate under section 197 of the Act. Background The relevant section 197 of the Act is reproduced hereunder, for the sake of brevity: 197. (1) Subject to rules made under sub-section (2A), where, in the case of any income of any person or sum payable to any person, income-tax is required to be deducted at the time of credit or, as the case may be, at the time of payment at the rates in force under the provisions of sections 192, 193, 194, 194A, 194C, 194D, 194G, 194H, 194-I, 194J, 194K, 194LA and 195, the Assessing Officer is satisfied that the total income of the recipient justifies the deduction of income-tax at any lower rates or no deduction of income-tax as the case may be, the Assessing Officer shall, on an application made by the assessee in this behalf, give to him such certificate as may be appropriate. (2) Where any such certificate is given, the person responsible for paying the income shall, until such certificate is cancelled by the Assessing Officer, deduct income-tax at the rates specified in such certificate or deduct no tax, as the case may be. (2A) The Board may, having regard to the convenience of assessees and the interests of revenue, by notification in the Official Gazette, make rules specifying the cases in which, and the circumstances under which, an application may be made for the grant of a certificate under sub-section (1) and the conditions subject to which such certificate may be granted and providing for all other matters connected therewith. (3) [***] 1 F. No. 275/38/2009-IT(B), dated 2 nd June 2009 Page 2 of 5

3 Section 197 of the Act provides for the power to the AO to give a certificate of nil deduction or deduction at a lower rate, so as to avoid excessive deduction of tax at source. In other words, section 197 of the Act empowers AOs to grant certificate to the persons in receipt of income on which tax is required to be deducted at source; provided that the estimated total income justifies the lower rate or nil rate of tax. Presently, such certificate can be sought on incomes derived by way of salaries, interest on securities, other interest, payment to contractors or sub-contractors, commission or brokerages, rent, fees for professional or technical services, income in respect of certain units, and compensation on acquisition of certain immoveable property. The lower rate or nil rate, if it is to be applied, shall be in respect of the aforesaid income only. This fact is evident from the terminology of section which covers income in respect of which tax is required to be deducted at source. The mechanism for giving effect to the power granted to AOs under section 197 of the Act is specified in rule 28AA of the Rules, which reads as under: Certificate of no deduction of tax or deduction at lower rates from income other than dividends. 28AA. (1) The Assessing Officer, on an application made by a person under sub-rule (1) of rule 28, may issue a certificate in accordance with the provisions of sub-section (1) of section 197 for deduction of tax at source at the rate or rates calculated in the manner specified below: (i) at such average rate of tax as determined by the total tax payable on estimated income, as reduced by the sum of advance tax already paid and tax already deducted at source, as a percentage of the payment referred to in section 197 for which the application under sub-rule (1) of rule 28 has been made; or (ii) at the average of the average rates of tax paid by the assessee in the last three years; whichever is higher. (2) The certificate shall be valid for the assessment year to be specified in the certificate, unless it is cancelled by him at any time before the expiry of the specified period. An application for a fresh certificate may be made, if required, after the expiry of the period of validity of the earlier certificate. (3) The certificate shall be valid only for the person named therein. (4) The certificate shall be issued direct to the person responsible for paying the income under advice to the applicant. (5) [* * *]. This rule inter-alia specifies the manner of calculating and arriving at nil rate or lower rate. It specifies that this rate should be higher of average rate of tax arrived by the net total tax payable (after considering advance tax already paid and tax already deducted at source) on estimated income as a percentage of payments referred to in section 197; or last 3 years average of average rate of tax. Page 3 of 5

4 The aforesaid CBDT s letter has interpreted the average of average rate of tax of last 3 years. Impact If one is to give effect to the aforesaid clarification, it may give rise to some anomalies and/or predicaments, as explained hereunder, with the result that the assessees will be saddled in the administrative turmoil. The maximum rate of income-tax would be 30%, in any case. If one were to apply for lower rate or nil rate for particular income, then applying the definition of average rate of tax, as clarified, under rule 28AA (1), the resultant rate of tax, for specified income on which lower TDS is applied, would always be at 30%, in case of corporate assessees which is higher than the rate at which TDS on different income is to be effected. This figure is the effect of being the higher of resultant rate arrived under sub-clause (i) or subclause (ii) to rule 28AA(1). The reason being that Under sub-clause (i), the rate can be applied within the range from 0% upto 20% (being maximum rate prescribed for the income on which tax is required to be deducted at source); Under sub-clause (ii), the average of average rate of tax for last 3 years would work out to 30%, in case of corporate assessees, even if there is a small portion of income The rate derived under sub-clause (ii) would always be higher than the rate derived under sub-clause (i) and hence the whole process of seeking lower rate under section 197 becomes redundant. Effectively, all Companies/Firms etc., where income is taxable at flat rate will, in most cases, never be eligible for issue of such certificate even though undisputedly their tax liability is much lower or Nil. Only covers assessees incurring or having loss The rule 28AA gives desired results to loss making companies, as the tax payable in such case would be zero. However, this rule becomes redundant for assessees having higher turnover but lower profits as aforesaid. Therefore, in all such cases, funds of the assessees will get unjustifiably blocked and they will have to claim refunds. This will also hinder assessees working on smaller margins, which will shrink their working capital due to unintended blockage of funds into government treasury. With the present situation of slow down in the economy, this has become added problem for the business community. We believe that this can never be the intention of the CBDT. Undue interest burden on the Government As the assessees would claim refund of the excess TDS as aforesaid, such refunds would also result into interest entitlement which will be an unnecessary burden on the Government treasury. Page 4 of 5

5 Further, Section 197(2A) speaks about convenience of assessees and interests of revenue. Interests of revenue cannot be harmed since the AO is expected to take into account the estimated income-tax and the advance tax / TDS already paid. However, the assessees will surely be inconvenienced if the interpretation of the CBDT is allowed to be carried through. Corrective measure As a corrective measure, it is suggested that the average rate of tax may be calculated taking into consideration the total gross receipts / turnover (that is liable for TDS) to the tax payable instead of total income. This mechanism will ensure that the legislative intent will be given effect and with the issuance of requisite certificate on that basis, undue hardship of the assessees will be removed. Moreover, in any case, as higher of sub-clause (i) or subclause (ii) is to be taken the lower rate of TDS that may be granted will never be less than the tax payable but the assessee (after considering advance tax and TDS already deducted). Since there is no loss to revenue, a harmonious and meaningful interpretation is required to be given to the provisions. The above view is also endorsed by the Chief Commissioner of Income Tax, Chandigarh through his request letter 21 for interpretation of rule 28AA of the Rules. In view of the above, there is urgent need to issue clarification on above basis and we have to request your Honour to kindly take necessary steps for the issue of much needed clarification. Since large number of genuine assessees has been affected & the TDS is deducted on an ongoing basis, an early resolution of the matter would help to solve the genuine problem faced by them. Thanking you, Sincerely yours, Ameet Patel, Kishor Karia Rajesh Shah President, Chairman, Co-chairman, Taxation Committee, Taxation Committee, Encl : Letter from CCIT & CBDT clarification 2 F. No. CC/CHD/JUDL(TDS)/0910/1571, dated Page 5 of 5