Legal

Section 194N Of Income Tax Act, 1961 And Its Sustainability

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This Blog is written by Nisha Patnaik from KIIT School of Law, Odisha. Edited by Ravikiran Shukre.

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INTRODUCTION:

Section 194N was introduced in the statute by Finance No. 2 Act, 2019 with effect from 01.09.2019 to discourage cash transactions and move towards a less-cash economy. It is noted that for a somewhat similar objective, Banking Cash Transaction Tax (BCTT) was introduced by the Finance Act, 2005 whereby a type of direct tax was levied on withdrawal of cash of more than a specified limit from the bank in a day. The said BCTT was withdrawn by the Finance Act, 2008. By the Finance No. 2 Act, 2019, the very same transaction which was earlier subjected to BCTT, has been made a subject matter of ITDS.

The said section 194N of the Act is substituted within one year of its insertion by the recent Finance Act, 2020. In the original Finance Bill, 2020 as was introduced in the Parliament there was no proposal to substitute section 194N of the Act, and the same was incorporated during the course of enactment of the Finance Act only. The substituted section is to come into force w.e.f. 01.07.2020.

SECTION 194N OF INCOME TAX ACT, 1961:

Section 194N is applicable in case of cash withdrawals of more than Rs 1 crore during a financial year. This section will apply to all the sum of money or an aggregate of sums withdrawn from a particular payer in a financial year. The section will apply to withdrawals made by any taxpayer including:

An Individual, A Hindu Undivided Family (HUF), A Company, A partnership firm or an LLP A local authority, An Association of Person (AOPs) or Body of Individuals (BOIs).

The Following Payers Are Covered Under This Section:

|Any bank (private or public sector), A co-operative bank, A post office|

The tax will be deducted by the payer while making payment to any individual in cash from a taxpayer’s bank account on the amount in excess of Rs 1 crore. The limit of Rs 1 crore in a financial year is with respect to per bank or post office account and not a taxpayer’s individual account. For example, a person having three bank accounts with three different banks, he can withdraw cash of Rs 1 crore * 3 = Rs 3 crores without any TDS. The cash withdrawal made by any taxpayer from the bank accounts maintained by such recipient will only attract TDS under Section 194N. For instance, if a bank makes a cash payment of more than Rs 1 crore in an FY to its account holder (i.e. any taxpayer) from the account maintained by such taxpayer, then the bank will have to deduct TDS.

In the case of a payment made by a taxpayer through a bearer cheque issued to third party, in excess of Rs 1 crore in a financial year, the recipient of the cash is not the account holder, but a third party. In such a case, the payment is not made by the bank to the account holder.

In the above situation, there is an ambiguity that whether such bearer cheque given to any person (like vendor) to collect payment from the bank will be covered under section 194N? Whether the bank is liable to deduct tax on the funds of the account holder in respect of the bearer cheque issued to third party. Separately, in case of business payments, payment made through a bearer cheque would not be allowed as an expenditure under section 40(A)(3) of the income tax act. Any payment made exceeding Rs 10,000 per day (in a single transaction or in aggregate) is not allowed as business expenditure. The limit of Rs 1 crore will be applicable to the cash payments/withdrawals made during the FY 2019-20. The provisions of Section 194N will be applied to the payments made on or after 1 September 2019.

THE SALIENT FEATURES OF SECTION 194N:

1. It isn’t evident whether the restriction of Rs. 1 crore will apply branch-wise or bank-wise. Notwithstanding, if there should arise an occurrence of a centre banking consistent bank, apparently it is pertinent on the bank-wise premise. One can without much of a stretch break the TDS by moving assets starting with one bank then onto the next ledger and split the cash withdrawals between two or more banks.

2. TDS can be saved by not only with cash withdrawal swapping between banks, but the TDS can also be saved even within the same bank by holding different types of bank accounts. Since the provision will hit only when the cash withdrawal from one bank account exceeds Rs. 1 crore in a year. The limit proposed is per individual account basis. For example, if a person has a savings account, current account, overdraft account, then the limit will be applicable for each type of account separately.
However, there is no clarity if an individual person is holding an account in his single name as well as in the joint name, then how the threshold will be counted.
This provision will only cover the money that is already in the system and the department can easily track such a huge cash withdrawal. This provision does not control the use of cash withdrawal which is more thrilling. For the sake of argument, let us assume that a person had withdrawn Rs 2 crore in cash from a bank account
The objective of this provision is to restrict this cash withdrawal to become a part of black money. But my understanding is that this provision may fail to achieve this objective. The person can easily use the money in the cash market to earn income in cash and later on can re-deposit the cash into the bank account. On such cash earnings, no tax will be paid by the person since it is a black income.

3. From reading the objective of the provision it appears that the TDS shall apply when the account holder of the bank withdraws cash for more than Rs. 1 crore in a year. However, the manner in which the provision is drafted is somewhat different.
The provision states that a bank or a post office shall deduct TDS @ 2% on payment of cash in excess of Rs 1 crore during a previous year to a person (to be called as the recipient) from an account maintained by the recipient with the bank.
To attract the provision the recipient must be the account holder of the bank. If the recipient is not the account holder of the bank, then TDS provision will not apply. To illustrate, suppose Mr. A is the account holder of ABC Bank Ltd. If the bank makes payment in cash of Rs. 2 crores to Mr. A form the account of Mr. A then TDS under section 194N will apply otherwise not. If Mr. An issues a bearer cheque to his friend Mr. F and the bank pays the amount in cash to Mr. F from the account of Mr. A, no TDS under section 194N shall apply. This is because the payment to Mr. F is not made by the bank from the recipient’s account who is Mr. F in this case. The payment is being made from Mr. A’s account. Therefore, the recipient and the account holder are different persons. To attract the TDS u/s 194N, both must be same.
However, in case an employee withdraws cash from his employer’s account then this preposition will not apply because the employee is working on behalf of the employer and such payment will be considered as a payment to the employer who is the account holder of the bank. The separate recipient must be in an independent capacity and not as an agent of the account holder.

4. It shall apply if the aggregate amount of cash withdrawal in a financial year exceeds Rs. 1 crore from a bank account etc. If the cash withdrawal amount in a year exceeds Rs. 1 crore then TDS will apply only on the excess amount of cash withdrawal over Rs. 1 crore. For example, if the cash withdrawal is Rs. 1.10 crore then TDS will apply on Rs. 10 Lakh only. The TDS amount @ 2 percent will come to Rs. 20,000 only.

5. It is provided that the deduction shall be in the form of income-tax. The Finance Minister in her Budget Speech used the words as ‘levy of TDS’ on cash withdrawals. The Memorandum and explanatory notes also refer the term in a similar manner. The big question is whether cash withdrawals partakes the nature of income for the recipient to justify the levy of income-tax thereon. Can income-tax be levied on a receipt which is not at all an income?

6. The TDS will be reflected as TDS and the cash withdrawals as income in the Form 26AS of the taxpayer. Though the cash withdrawal is not income, unless the return of income or ITR is suitably modified, the return filing would become tedious for such a taxpayer.

7. It is applicable to all the account holders be it individual, HUF, Company, etc. except Government, banks, white-label ATM operators, etc. who withdraws cash in excess of Rs. 1 crore in a year. It covers savings account also.

8. The purpose of cash withdrawal, whether for business or personal, is irrelevant.

9. Despite the fact that the arrangement is made for TDS it works increasingly like TCS (Tax gathered at source). When a record holder will pull back money from his financial balance, would the bank pay the money after TDS? Assume, an individual need to pull back Rs. 2 crores in real money from his ledger. Would bank pay him Rs. 1.98 crore just or Rs. 2 crores and the TDS measure of Rs. 2 Lakh will be charged independently in his record. In my view, the last will become practice. This will more work like TCS rather than TDS.

VALIDITY OF SECTION 194N OF INCOME TAX ACT, 1961:

The foremost question which arises is whether provisions of Section 194N of the Act are constitutionally valid? Article 265 of the Constitution of India unequivocally prescribes that ‘No tax shall be levied or collected except by authority of law’. A deeper look into the language of Section 194N brings out that the deduction of 2% is in the form of ‘income tax’. At this juncture, a reference could be made to Section 4(2) of the Act which specifies, inter-alia, that income tax can be paid or deducted at source under the provisions of the Act. Thus, the moot point is whether the amount lying in the bank account could be construed as ‘income’ so as to attract TDS provisions. It is trite law that every receipt is not ‘income’. Undisputedly, the money lying in the bank account would have either already suffered TDS or is otherwise not eligible to TDS. In this scenario, how and in what manner, mere withdrawal of money from bank account could be regarded as income?

The provisions of Section 194N if contrasted with other TDS provisions like 194A, 194C, 194J, 194 I, 194IA etc., it would be seen that unlike Section 194 N, all other sections warrants withholding of tax at source on the amount of payment which invariably has some inbuilt component of ‘income’. At this stage, it is important to highlight that the subsequent amendments passed by Lok Sabha also included an amendment under Section 198, whereby the amount of TDS under Section 194N of the Act is not deemed to be ‘income’ received by the assesse. This further goes to show that even as per Govt., there is no income component in the entire payment which could be subjected to TDS under Section 194 N of the Act. It is also not made clear by the Govt. as to how, and in what manner, can the Assesse claim the credit of tax deducted under Section 194N of the Act.

With amendment coming in Section 198 of the Act, it is much more important to find out whether the amount deducted under Section 194N of the Act would be reflected in Form-26AS or not.

Thus, the provisions of section 194N of the Act which provides for deduction of an amount out of a non-taxable capital transaction is ultra vires to the provisions of Article 265 of the Constitution and also violates section 4 of the Act and the same also results in double taxation which is bad in law and consequently, the provision of section 194N is a misfit in the scheme of the Act and is an invalid piece of legislation.

Another issue could be that Section 194N applies when the cash is withdrawn from the account. But whether the same would be applicable even in case of Banker’s cheque(s) drawn from the account but subsequently encashed in ‘cash’?

It would thus be interesting to see how the Govt. in the forthcoming days will tackle all such open questions, so as to provide clarity on the subject before the issue landing up in Court(s).

Accordingly, the said section providing for withholding of tax on such payments by the banks, in my opinion, is not valid as per the scheme of the Act since tax is to be withheld only in case the payment made is an income of the recipient which is chargeable to tax. Here, the payment made by the bank is not the income generated through bank but is mere transfer of funds.

ANALYSIS:

The newly amended section 194N on TDS on Cash Withdrawal has two categories of persons withdrawing cash from banks, co-operative banks, and post offices-

I. Persons withdrawing cash of more than Rs. 1 crore from one or more accounts

This provision is similar to the existing provision. A twist in this category made which relates to the filing of return of income (ITR) by the recipient (The person who is withdrawing cash from the bank or post office accounts is termed as ‘recipient’ in section 194N). Hence after the amended section 194N effective from July 1, 2020, this category is better to be called as –

II. Persons withdrawing cash from bank accounts who have filed their return of income (ITR) within due dates prescribed u/s 139(1) for last three assessment years-

In this case, if such a person withdraws cash amount or the aggregate of amounts in excess of Rs. 1 crore during the previous year, from one or more accounts maintained by the recipient (drawer of cash or account holder) with the bank or post office, then the bank or post office shall deduct TDS @ 2% of such cash withdrawal.

There is no ambiguity in respect of the threshold limit of Rs. 1 crore of cash withdrawal from TDS. However, the newly amended provision has not made it clear whether TDS shall apply on the amount of cash withdrawal in excess of Rs. 1 crore or on the entire amount of cash withdrawal once the threshold limit is exceeded.

In the erstwhile provision of section 194N, it was clearly written that TDS shall apply on cash withdrawal in excess of Rs. 1 crore. The expression used ‘deduct an amount equal to two per cent of sum exceeding one crore rupees, as income-tax’ clearly establishes the fact.
In the newly amended provision, the expression used is ‘deduct an amount equal to two per cent of such sum’. What does ‘such sum’ indicate. The ‘sum’, no doubt, refers to cash withdrawal. But for deduction of tax or TDS whether ‘such sum’ refers to cash withdrawal in excess of Rs. 1 crore or entire amount of cash withdrawal in aggregate if cash withdrawal exceeds Rs 1 crore.

The objective of introducing the TDS provision on cash withdrawals is to discourage large amount of cash withdrawal from bank accounts and push the country towards a digital economy. Since the limit of cash withdrawal is kept at a large level of Rs. 1 crore it will hardly affect any genuine account holders. However, after the presentation of Budget 2019, it is reported in news media that large tea estate companies are demanding to exclude them from this provision. To mitigate the genuine hardships to any person, the provision empowers the government to exclude those persons from the applicability of the provisions of this section.
Considering various loopholes and ambiguity in the provision itself, and until they are plugged off to achieve the objective, this provision will only remain a bullet point measure to curb cash circulation or black money.

CONCLUSION:

On the basis of the Judgment of Hon’ble Supreme Court it can be answered that the Section 194N can validly be challenged in Court of law as the said section is against the basic Spirit of TDS Provisions because an account holder whenever withdraws his own money from his account question of the element of income never arises at all. And as there is no element of income involved in the withdrawal of own money from own bank account question of TDS does not arise at all and if any steps are taken to collect TDS can be held illegal. However someone can argue that whatever has been deposited in the bank is sourced from Income as well tax paid or tax borne money like Sale or receipt of service but here it cannot forget that for a certain type of payments law already have TDS mechanism through various Sections under Part-B of Chapter XVII like TDS on Salary, Interest, Rent, Contract Payment, Commission, lottery income, Dividend, Professional Fees, etc. So these deposits which have income element are very well covered under existing TDS Provisions.