Budget 2022| Clarification on ‘health and education cess’ to end conflicting interpretation of tax law: Experts

Tax experts have said that the clarification by finance minister Nirmala Sitharaman that health and education cess cannot be treated as a business expenditure would bring the curtains down on a long-pending tax problem that was the result of conflicting interpretation of the law by some high courts.

Though the clarification takes effect retrospectively and will require some companies to pay additional taxes for the years they claimed the cess as an expenditure, tax professionals have welcomed the move by the finance ministry.

The cess, levied at 4 percent of the tax payable, is imposed as an additional surcharge on taxpayers for funding select government welfare programmes, specifically primary and secondary education, and health infrastructure.

In the memorandum explaining the provisions in the Financial Bill, 2022, the government has said that corporates can’t claim a deduction for taxes paid as cess.

Rajiv Chugh, partner, EY welcomed the step, saying it provides much-needed clarity. “In view of the decision of Hon’ble Supreme Court in the case of CIT vs. K Srinivasan (1972) 83 ITR 346, the government has clarified and said that the intention of the legislation was to always show the cess as a tax, and that amount payable is not a tax deduction,” Chugh said.

The government has also brought in an amendment to the income-tax Act that restricts companies from doing so and retrospectively seeks to tax all instances of education cess being claimed as deduction.

A tax deduction lowers a person’s or an organisation’s tax liability by lowering their taxable income.

The amendment will take effect retrospectively from April 1, 2005, and will accordingly apply from the assessment year 2005-06.

The education cess was introduced in the budget for 2004-05 by finance minister P Chidambaram. The cess was initially meant to finance primary education under the Sarva Shiksha Abhiyan. Subsequently, it was raised to provide resources for secondary education and to augment the health infrastructure.

“A controversy had emerged vis-à-vis claim of deduction of education cess as allowable business expenditure. The judiciary had provided conflicting views thereon. This specific amendment (which has been made with retrospective effect) demystifies the legal position and will curb the litigation surrounding the issue,” said Himanshu Parekh, partner, tax, KPMG in India.

“If a taxpayer pays income tax on profits of the business, the tax can’t be a deductible expenditure while computing the profits. It has now been clarified that a surcharge or cess which is levied on income tax takes the same colour as income tax and, hence, it would not be deductible for tax purposes," he said.

The story so far

Multiple court cases have been fought by companies against the government, with notable plaintiffs being Sesa Goa Ltd and Chambal Fertilizers and Chemicals Ltd.

The litigants have also secured wins at the Bombay High Court and Rajasthan High Court, both of which upheld their claim that claiming a deduction was legal.

Both high courts had relied upon a Central Board of Direct Taxes Circular dated May 18, 1967, which held that ‘education cess’ can be claimed as an allowable deduction while computing the income chargeable under the heads ‘profits and gains of business or profession’.

Subsequently, tax tribunals in various judgments have followed the reasoning in the high court rulings, and have allowed a deduction on account of payment of cess.

Government rebuttal

However, the government has said that cess is imposed not only by the central government through the Finance Act for a financial year but also by various state governments.

“It is pertinent to mention that in the referred circular of CBDT, there is no reference to the ‘Cess’ imposed by the Central Government through Finance Act for a particular year,” the budget memorandum.

“This CBDT circular needs to be seen from the perspective that ‘Education Cess’ imposed by Finance Act 2004 and subsequent Acts and then designated as ‘Education and Health Cess’ are actually tax in the form of additional surcharge, as stated clearly in each of the relevant Finance Act imposing such Cess," it said.

Parekh added that there are very few retrospective amendments made by the government in recent years. “Over the past few years, the government has been extremely reluctant to bring in retrospective amendments; however, this amendment will have retrospective effect from April 1, 2005,” he said.

Impact on corporates

Chugh, who leads EY India’s policy advisory and speciality services, said not all companies have tried to claim a deduction on the education cess. “If the issue of claiming education cess deduction was clear, everyone would have claimed it. But in reality, only a few companies claimed it, especially those who could take the technical argument forward that cess is not in the nature of tax and deduction was allowed by various tribunals/high courts,” he said.

Chugh added that the issue has had little impact on corporations, in general. “Presently, education cess is levied at 4 percent (earlier 2 percent or 3 percent, as applicable) and is calculated on the amount of tax and surcharge payable. Therefore, generally, it translates to a relatively low amount,” he said.

However, Parekh said that owing to some favourable judicial precedents, many companies had begun to claim the deduction and would have to now recalculate their taxes, including those they now owe to the government retrospectively.