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

The Supreme Court, on Wednesday, 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 judgment was delivered by a Bench of Justices Ashok Bhushan, R Subhash Reddy and MR Shah in 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 challenge..“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 on merits. The impugned judgment passed by the High Court is, hereby, quashed and the matter is remitted to the High Court to decide the petition on merits with respect to challenge to the vires of Section 40(a)(iib)”, the apex court ruled..The High Court had dismissed the said writ petition without deciding the validity of Section 40(a)(iib) observing that the vires of the provision need not be entertained as the matter was still sub-judice before the Income Tax Authority..It was the case of the petitioner that the amount deductible in computing the income chargeable in terms of the Income Tax Act was not being allowed under the garb of the above 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..The show cause notice issued by the assessing officer for the Assessment Year 201718 had stated 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).Hence, VAT expenditure could not be allowed as deduction in accordance with Section 40(a)(iib) while computing the income of the appellant..The assessment order passed by the IT Department was challenged before the 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 challenging the vires of Section 40(a)(iib) for violation of Articles 14 (right to equality), 19 (right to profession) and 265 (no taxes to be imposed save by authority of law) of the Constitution. The High Court declined to decide the challenge citing pendency of the matter before Income Tax authority stating that it is is open to the aggrieved party to question the vires of the provision at the appropriate moment..The Supreme Court, however, disagreed 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. .“Once the show cause notice was issued by the assessing officer calling upon the appellant to show cause why the VAT expenditure is not allowable as deduction in accordance with Section 40(a)(iib), it can be said that the cause of action has arisen for the appellant to challenge the vires. 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,” the Supreme Court said..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). .[Read Judgment]