Background and facts
Section 15 of the Indian Tax Laws (ITL) includes the following incomes as chargeable to tax under the head “Income from Salary” (Salary head):
Salary that is “due” from an employer or a former employer, whether paid or not
Salary that is “paid or allowed” to an employee by or on behalf of an employer or a former employer, though not due or before it becomes due
Any “arrears of salary” paid or allowed to an employee by or on behalf of an employer or a former employer, if not earlier charged to income tax
The Taxpayer was engaged in the business of owning, operating and managing hotels. The Tax Authority discovered, in a survey action on the Taxpayer, that the Taxpayer was not withholding tax on distribution of tips received from customers through credit cards.
The Tax Authority took the position that such tips constituted salary income of the waiters and the Taxpayer had an obligation to withhold tax thereon. The Tax Authority treated the Taxpayer as assessee-in-default and sought to recover the shortfall of tax, with interest. Furthermore, it also levied a penalty on the Taxpayer for not withholding tax.
Issues before the Supreme Court
Whether tips received by waiters from customers constitute “Salary Income” or “Income from Other Sources” in their hands
Whether the employer has withholding obligation on tips received from customers through credit cards and, subsequently, disbursed to waiters
Taxpayer’s contentions
Salary taxation is attracted only if payment is received from employer under a contract of employment, pursuant to which, the employee has a legal right to claim such amount from the employer
Tips are received by waiters directly from customers out of their own volition for the quality of service provided to them and for courteous behaviour. The waiters, as employees, have no legal right to claim the same from the employer
Tax Authority’s contentions
Tips received from customers constitute salary income of the waiters as “profits in lieu of salary”. The Taxpayer may not have a withholding obligation on tips received directly from customers by the waiters. However, the Taxpayer, as an employer, has a withholding obligation on tips collected from customers on credit cards and paid to the waiters.
SC’s Ruling
The SC ruled in favour of the Taxpayer and held that the Taxpayer was not liable to withhold tax, since tips received by the employees do not constitute salary income. Consequently, the Taxpayer cannot be treated as assessee in-default and thereby no interest can be levied for non-withholding of tax. The SC adopted the following reasoning for its conclusion:
Salary withholding obligation is on “any person responsible” for paying salary to employees which, in the context of salary income, is the employer
In the present case, tips are received from customers and not the employer. There is no dispute that such tips constitute taxable income of the employees. The dispute is on the head of income, whether “Salary Income” or “Income from Other Sources”. If it is not taxable as salary, the employer has no withholding obligation
Based on an analysis of the provisions dealing with salary income taxation, it is clear that payment received from an employer (whether current or former), under a contract of employment, alone is taxable as salary. Furthermore, there should be vested right in the employee to claim such payment from the employer. Reliance was placed in this regard on an SC ruling in the case of CIT v. L.W. Russel, which held that although the term “allowed” has a wide meaning, it cannot be said that the employer has “allowed” a perquisite to an employee if the employee has no legal right to the same. In other words, it cannot apply to contingent payments to which an employee has no vested right till the contingency occurs. Tips, being purely voluntary in nature and paid by customers on their volition, the employee does not have the right to claim the same from the employer.
The author can also be reached at rjt.garg68@gmail.com
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