TDS from cash withdrawals under Section 194N of the Income Tax Act: Unconstitutional?

Dr. Ashok Saraf

The Union Finance Minister in the budget presented on July 5, 2019 had proposed 2% tax deduction at source (TDS) on one crore cash withdrawal from “an account” to discourage high value withdrawals. However, since people holding multiple accounts could have misused the provision, the Finance Bill, 2019 was amended to the effect that TDS shall be charged if the aggregate withdrawal from one or more account exceeds Rs. 1 crore. 

The amendment also clarified that TDS on cash withdrawal beyond Rs. 1 crore shall be adjusted against the total tax dues of the taxpayer and would not constitute income in the hands of the taxpayer. The said provision of Section 194N would come into effect from September 1, 2019. 

The Finance Minister in course of the debate on the Bill assured the members that if tax paying citizens have withdrawals like this, the TDS will be adjusted against the total tax dues. She also stated that the TDS was not above what one is expected to pay, but it is going to be reconciled with the total tax claims laid on an individual, and so the same was not something which was running parallel to it. 

No doubt, the aforesaid provision of 2% TDS from cash withdrawal is to discourage cash transactions and for promotion of digital payments. But the validity of Section 194N providing for 2% TDS on cash withdrawals exceeding Rs. 1 crore is doubtful. Since tax to be deducted at source is on cash withdrawals which shall not be treated as income, the question of deduction of any tax at source does not arise. When the transaction is not liable to levy of income tax, the question of deduction of income tax at source with a provision for adjustment of the same against the ultimate tax liability cannot be said to be legal. 

The Apex Court in Steel Authority of India Ltd. v. State of Orissa, while examining the validity of Section 13AA of the Orissa Sales Tax Act which provided for deduction of 4% tax at source from the entire value of amount credited or paid by the owner to the contractor, struck down the said provision, the same being beyond the purview of the State Legislature. It was held that tax could not be deducted at source for the amount credited or paid by the owner to the contractor in respect of transactions which are not liable to sales tax. 

The Apex Court in the aforesaid judgment held that the State Legislature cannot make any law levying sales tax on inter-State sales, outside sales or sales in course of import. It rejected the contention of the State by holding as under:

“There is, in our view, therefore, no doubt that the provisions of Section 13-AA are beyond the powers of the State Legislature for the State Legislature may make no law levying sales tax on inter-State sales, outside sales or sales in the course of import.

It was also contended that the deduction that was required to be made under Section 13-AA(1) was of four per cent of the amount credited or paid by the owner to the contractor, whereas the sales tax liability of the contractor thereon was eight per cent. It was contended that this requirement proceeded on the assumption that half of the amount was not liable to tax being in respect of inter-State sales, outside sales and export sales. No such assumption based on the rate of tax at any given point of time can be made. Section 13-AA should have been precisely drafted to make it clear that no tax was levied on that part of the amount credited or paid that related to inter-State sales, outside sales and sales in the course of import, particularly after the previous Section 13-AA had been struck down by the Orissa High Court for the reason that it was couched in terms wider than were permissible to the State Legislature and that judgment was accepted.”  

Similarly, in Nathpa Jhakri Joint Venture v. State of Himachal Pradesh, the Apex Court quashed Section 12A of the Himachal Pradesh General Sales Tax Act, holding that the same provided for deduction of tax at source in respect of the transactions on which no tax can be levied in terms of the enactment itself.

To ‘levy’ a tax means to impose or assess or collect under the authority of law. It is unilateral act of superior legislative power to declare the subjects and rates of taxation and to authorize the collector to proceed to collect the tax. ‘Assessment’ is official determination of the liability of a person to pay a particular tax. ‘Collection’ is the power to gather money for taxes, by enforcing payment if necessary. Levy of taxes is generally a legislative function; assessment is a quasi judicial function and collection an executive function. 

These three expressions – ‘levy’, ‘assessment’ and ‘collection’ – are of the widest significance and embrace in their broad sweep all the proceedings which can possibly be imagined for raising money in exercise of the power of taxation. Levy, therefore, means to raise or collect, as assessment, execution or order legal process.

Article 265 of the Constitution of India provides that no tax shall be levied or collected except by authority of law. The words ‘levy’ and ‘collection’ are distinct processes and are used in Article 265 in a comprehensive sense. They are intended to include the entire process of taxation commencing from taxing statute to the taking away of money from the pockets of the citizens.  

Entry 82 of List I of the 7^th Schedule to the Constitution of India empowers the Union to frame laws the levy of taxes in respect of income other than agricultural income. When the cash withdrawal made by a person has been clearly stated to be not an income, the question of levy of any income tax on the same does not arise, and consequently, the question of deduction of tax at source in respect of any transaction which is not an income also does not arise. 

Article 265 imposes a limitation on the taxing power insofar as it provides that no tax shall be levied or collected except by way of law. It has to be done by authority of law, which means valid law. For the law to be valid, the tax proposed to be levied must be within the competence of the Legislature imposing a tax and authorising the collection thereof. A law providing for levy and collection of taxes is a law within the meaning of Part- III of the Constitution and it must stand the test of law as laid down by Article 133 of the Constitution. It also must not abridge the fundamental rights declared by the Constitution.

As such, tax cannot be collected in respect of transactions which are not subject to levy of said tax. In Bhawani Cotton Mills Ltd. v. State of Punjab, the Apex Court held that if a person is not liable for payment of tax at all at any time, the collection of a tax from him with a possible contingency of refund at a later stage will not make the original levy valid. 

It was further held that if the sales or purchases are exempt from taxation altogether, they can never be taken in to account at any stage for the purpose of calculating or arriving at the taxable turnover and for levying tax. Tax collection can only be done in respect of the transaction which is liable to be taxed. Tax deducted at source is also in the nature of collection of tax. Tax can be deducted at source only in respect of transactions which are subject to levy of the said tax. Any deduction of tax at source in respect of transactions which are not liable to be taxed is unconstitutional. 

Since Section 194N provides for deduction of income tax at source on cash withdrawal exceeding Rs.1 Crore, and the said cash withdrawal is not income liable to be taxed under the Income Tax Act, the aforesaid provision of deduction of tax at source with a provision for adjustment of the same against the ultimate tax liability of the said person, in view of the decisions of the Apex Court, is clearly ultra vires and unconstitutional.

The author is a Senior Advocate of the Gauhati High Court.

Disclaimer: The views and opinions expressed in this article are those of the author’s and do not necessarily reflect those of Bar & Bench.