Is Education ‘Cess’ A Tax-Deductible Expenditure?

Cess – the word may immediately bring to one’s mind the discomfort of parting with a little more of their money upon a purchase. Being able to deduct the money spent on such a ‘cess’ from one’s taxable income would surely sweeten the blow a bit. However, whether this is possible has been a matter of some contention.

The concept of cess was introduced in the Finance Act, 2004, as “an additional surcharge” to finance the government’s commitment to universalise quality basic education—in the form of an Education Cess at a 2 percent rate (subsequently increased to 3 percent). In 2018, this education cess was replaced with a health and education cess, charged at the rate of 4 percent.

Over the years, the distinction and meaning of cess have been gaining importance. Under the Income Tax Act, 1961, a deduction from the taxable business income of a taxpayer is generally allowed for all business-related expenses, subject to certain exceptions. However, expenses in the nature of ‘rate’ or ‘tax’ are specifically disallowed—under Section 40(a)(ii) of the IT Act—while computing the business income. The question, therefore, arises as to whether, for the purpose of this provision, ‘cess’ would be considered as a ‘tax’ and accordingly, not allowed as an item of business expenditure.

Bombay High Court’s Take

Recently, a case involving Sesa Goa Ltd. in the Bombay High Court touched upon this very interesting issue. The taxpayer contended that the term ‘any rate or tax’ does not include ‘cess’ and therefore, cess should be allowed as a deduction against its business income. However, the tax department’s stand was that ‘cess’ is inherently included in the scope of the expression ‘any rate or tax’ and therefore, should not be allowed as a deduction.

The High Court ruled in favour of the taxpayer and noted the following:

• The Income Tax Bill, 1961, which introduced Section 40(a)(ii) into the IT Act, contained the expression ‘cess, rate or tax’ and therefore specifically included ‘cess’ as an item separate from tax. However, the Select Committee of the Parliament categorically omitted the term ‘cess’ under the final provisions of the IT Act.
• This issue has also been dealt with in a circular issued by the Central Board of Direct Taxes dated May 18, 1967, which specifically refers to the omission of the term ‘cess’ made by the Select Committee of the Parliament, as discussed above, and states that the effect of the omission of the word ‘cess' is that only taxes paid are to be disallowed.

Referring to judicial precedents that discuss the various principles for interpreting taxing statutes, the High Court, therefore, observed that the legislature could have included a reference to cess in the provision, and the non-inclusion of the same shows the intention to allow such cess as a deduction. A deduction in relation to cess was therefore allowed to the taxpayer in this case.

It is worth noting here that a circular issued by the CBDT is binding on tax authorities, more so when the circular confers some benefit upon the taxpayers. Additionally, the CBDT circular on this issue also provides for the income tax authorities to take note of the issue, and avoid further litigation on this account. It would also be important to mention that the Rajasthan High Court has also ruled in favour of the taxpayer on this issue, in an earlier decision, relying on the CBDT circular.

More Clarity Required

If a deduction in relation to cess is being claimed, several other nuances would also need attention such as whether the deduction would be allowable on an accrual basis or a payment basis. As regards scope, as a deduction is available against the business income of a taxpayer, the deduction, if claimed should be restricted only to cess paid on the business income of a taxpayer.

Another important aspect requiring consideration is the timing and manner of claiming this deduction, in relation to tax years for which the income tax return has already been filed. In absence of any claim made in the tax return for earlier years, the permissibility of claiming the same by way of additional grounds in ongoing tax proceedings would need to be assessed.

Does ‘Tax’ Include ‘Cess’?

While these decisions are a positive development providing some cheer to taxpayers, nevertheless, it would be pertinent to examine and seek guidance from other provisions under the IT Act as well as judicial precedents in which the term ‘tax’ has been defined or referred and whether such provisions create a distinction between ‘tax’ and ‘cess’.

In this regard, it would be important to note that the Supreme Court in the case of K. Shrinivasan (a case law in a different context regarding the tax payable on salary income earned by the taxpayer) held that the term “income tax payable” includes surcharge and additional surcharge (cess being introduced as an “additional surcharge”).

Further, several decisions in the context of the definition of “tax” in tax treaties, observe that “cess” is nothing but a “surcharge”. The interplay of these decisions with the favourable decisions of the High Courts and the CBDT circular would, therefore, warrant a more careful consideration on part of the taxpayers.

Apart from judicial precedents, some additional factors which should be borne in mind in relation to cess and whether it forms part of taxes in this context – is that no separate mode of collection or recovery of cess has been prescribed under the IT Act, and the provisions applicable to tax would apply.

A point also requiring keen attention is whether cess can be considered as an expense incurred in connection with business, or can one contend that cess is an application of income earned by a business, and not as such an expense incurred for the business. Whether these aspects may blur the line of distinction between cess and tax would, therefore, entail a comprehensive study.

On an overall basis, the decisions of the Bombay High Court and Rajasthan High Court are definitely a welcome development and provide taxpayers with the means to claim a deduction in relation to cess, this being subject to an all-round analysis of the meaning of cess and tax.

Vinita Krishnan is Director, Sneh Shah is Senior Associate, and Avin Jain is Associate, at Khaitan & Co. The views of the authors in this article are personal and do not constitute legal/professional advice of Khaitan & Co.

The views expressed here are those of the authors and do not necessarily represent the views of BloombergQuint or its editorial team.