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T. C. A. Ramanujam

T. C. A. Ramanujam on the need to treat compensatory interest differently from penalty

EVER since the charging of interest on tax arrears was made mandatory, harassed taxpayers have been desperate to find a way out. The hefty interest charged often exceeds the tax payable as per the return or, at times, even as per assessment. The old rule gave the officers of the Income-Tax Department the discretion to waive or reduce interest on showing reasonable cause.

The introduction of Sections 234A, 234B and 234C with effect from April 1, 1989, coincided with the deletion of Section 271(1)(a) in the I-T Act, thereby providing for both relief and liability for the taxpayer — relief because of the dropping of the provision for levy of penalty and liability because of the mandatory charging of interest.

The constitutionality of this provision was challenged before several High Courts. The affected parties had to approach the High Court for invoking its writ jurisdiction whenever they thought that interest was an unjust charge. Often, the High Courts came to their succour.

The Dr Prannoy Roy case

In this case (Dr Prannoy Roy vs CIT — 2002 167 Taxation 695 Del), Dr Roy earned substantial capital gains for the assessment year 1995-96 for which the return was due to be filed on or before October 31, 1995. It was filed on September 29, 1996, after a delay of nine months. Even before filing the return, he had paid the taxes due on September 25, 1995. The assessment was completed, with the return being accepted on January 29, 1998.

Interest was charged under Section 234A on the ground that tax paid in September 1995 cannot be reduced from the tax due on assessment. There was no such provision in Section 234 A for the reduction of tax paid in September 1995. Section 234A compensates for any delay/default in filing of return of income and not the tax. Dr Roy approached the Delhi High Court for redressal.

The court decides

The Delhi High Court pointed out that interest is compensatory and not penal. The only material difference between the law as it stood before April 1, 1989, and the law after this date is that while the old provisions conferred power to waive or reduce the levy of interest, the impugned provisions under Section 234A make the same automatic. According to the Delhi High Court, Section 234A is an amalgam of Sections 139(8), 271(1)(a) and 140A(3) of the Act.

It referred to the Supreme Court's observations to the effect that the expression "penal interest" acquired usage, but is in fact an inaccurate description of the levy. Interest is levied not by way of penalty, but by compensation.

There is a clear distinction between the two. The delay in the filing of the return results in the postponement of tax payment, thereby depriving the state of the corresponding amount of revenue for the period of the delay.

In order to compensate for the loss so occasioned, Parliament enacted the provision for payment of interest. Even penal interest, said the Delhi High Court, can be levied only in case of chronic defaulter. Interest is payable when a sum is due and not otherwise. The object of the amendment was to levy mandatory interest while return with tax is not paid.

Ultimately, the court declared;

"We are, therefore, of the opinion that interest would be payable in a case where tax has not been deposited prior to the due date of filing of the income-tax return. If tax has been paid and return is filed belatedly, interest is not chargeable."

This judgment was delivered on December 21, 2001. The court quoted a number of authorities and relied extensively on Supreme Court judgments both with regard to its approach to the problem of interpretation of statues and with regard to the nature of penal interest. The observations made by the court will have far-reaching effect.

The 2001 amendment

It is, however, a pity that the attention of the Delhi High Court was not drawn to the amendment made by the Finance Act, 2001, with regard to the provision for charging interest. Section 140A was amended and sub-section (1A) was introduced. It is now laid down that interest payable under Section 234 A shall be computed on the amount of tax on the total income as declared in the return as reduced by the advance tax, if any, paid and any tax deducted or collected at source.

Would the judgment have been different if the attention of the court had been drawn to the above retrospective amendment?

The fact that the amended law was not considered by the Delhi High Court need not necessarily whittle down the importance of the Delhi ruling. The judgment is strongly worded and repeatedly emphasises the distinction between compensatory interest and penalty for the non-filing of returns.

Though the law stands amended retrospectively, the Central Board of Direct Taxes (CBDT) can still take a lenient view at least in respect of cases where the tax is paid along with the return and on assessments where there is no fresh demand. That will reduce the hardship faced by honest taxpayers.

The law is meant to catch the errant taxpayers. The object can be achieved by fresh instructions from the CBDT to make a distinction between genuine and not-so-genuine cases.

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