Supreme Court directs Madras High Court to decide on validity of Section 40(a)(iib) of Income Tax Act

Supreme Court directs Madras High Court to decide on validity of Section 40(a)(iib) of Income Tax Act

The Supreme Court ordered the Madras High Court to decide the Constitutional validity of Section 40(a)(iib) of the Income Tax Act, 1961 which disallows deduction of royalty, license fees etc in case of State government undertakings under the head of profits and gains of business.

The Court delivered the judgment while hearing an appeal filed by Tamil Nadu State Marketing Corporation Limited (TASMAC) against a judgment of the Madras High Court which had declined to decide the petition on merits.

The Bench of Justices Ashok Bhushan, R Subhash Reddy and M.R. Shah said, "When the vires of Section 40(a)(iib) of the Income Tax Act were challenged, which can be decided by the High Court alone in exercise of powers under Article 226 of the Constitution of India, the High Court ought to have decided the issue with regard to vires of Section 40(a)(iib) on merits, irrespective of the fact whether the matter was sub judice before the Income Tax Authority. Vires of a relevant provision goes to the root of the matter. The High Court has observed that the issue of raising a challenge to the vires of the provision at this stage need not be entertained, as the matter is still sub judice before the Income Tax Authority, even though it is open to the aggrieved party to question the same at the appropriate moment."

The petitioner filed the aforesaid writ petition before the High Court challenging the validity of Section 40(a)(iib) of the Income Tax Act, 1961. It was the case on behalf of the original writ petitioner that the amount which is deductible in computing the income chargeable in terms of the Income Tax Act is not being allowed under the garb of the aforesaid provision.

The petitioner contended that the provision was discriminatory and violative of Article 14 of the Constitution, since many Central Government undertakings have not been subjected to any such computation of income tax and are enjoying exemption.

A show cause notice was issued by the assessing officer for the Assessment Year 2017-¬18 stating that the VAT expense levied on the appellant was an exclusive levy by the State Government and therefore squarely covered by Section 40(a)(iib) of the Income Tax Act and therefore VAT expenditure is not allowable as deduction in accordance with Section 40(a)(iib) of the Income Tax Act, while computing the income of the appellant.

The assessment order passed by the Income Tax Department was challenged before the Madras High Court which allowed the challenge on the ground of violation of natural justice. It then sent the matter back to the Assessing Officer for fresh determination.

The matter was pending before the Assessing Officer when the appellant moved another plea before the Madras High Court being ultra vires Articles 14, 19 and 265 of the Constitution of India.

The High Court has dismissed the said writ petition without deciding the validity of Section 40(a)(iib) of the Income Tax Act by observing that the issue of raising a challenge to the vires of the provision at this stage need not be entertained as the matter is still sub judice before the Income Tax Authority, even though it is open to the aggrieved party to question the same at the appropriate moment.

On appeal, the Supreme Court, disagreed with the view of the High Court stating that once the Assessing Officer issued show cause notice to TASMAC, the "appropriate moment" can be said to have arisen.

"We are of the firm opinion that the impugned judgment and order passed by the High Court is not sustainable at all. The High Court ought to have decided the issue with regard to vires of Section 40(a)(iib) on merits, irrespective of the fact whether the matter was sub -judice before the Income Tax Authority," the Supreme Court said.

Vires of a relevant provision, the apex court observed, goes to the root of the matter.

The High Court has observed that the issue of raising a challenge to the vires of the provision at this stage need not be entertained, as the matter is still sub judice before the Income Tax Authority, even though it is open to the aggrieved party to question the same at the appropriate moment. Once the show cause notice was issued by the assessing officer calling upon the appellant – authority assessee to show cause why the VAT expenditure is not allowable as deduction in accordance with Section 40(a)(iib) of the Income Tax Act, while computing the income of the appellant, it can be said that the cause of action has arisen for the appellant to challenge the vires of Section 40(a)(iib) of the Income Tax Act and the appellant may not have to wait till the assessment proceedings before the Income Tax Authority are finalised.

The Court observed that the stage at which the appellant approached the High Court and challenged the vires of Section 40(a)(iib) of the Income Tax Act can be said to be an appropriate moment. Therefore, the High Court ought to have decided the issue with respect to the challenge to the vires of Section 40(a)(iib) of the Income Tax Act on merits.

It, therefore, allowed the plea, set aside the High Court judgment and remitted the matter back to the High Court for determination of validity of Section 40(a)(iib).