Small delay in depositing PF & ESI would lead to irreparable income tax loss decides Supreme Court

Most of us are under an impression that depositing Provident Fund and ESI although is a regular monthly exercise but a small delay cannot impact any Income Tax Perspective since we can claim deduction of such PF and ESI Contribution if it is deposited before the Due date of Filing Income Tax Return under Income Tax Act, 1961. But, now the Hon'ble Supreme Court has held that this is not the Case and that's why you should read on to avoid any tax loss problem.

Cutting things short before detailed discussion, the Hon'ble Apex Court in case CHECKMATE SERVICES P. LTD. VERSUS COMMISSIONER OF INCOME TAX-1 vide Order dated October 12, 2022 has held that Employee Contribution (Not Employer's Contribution) ought to be deposited within the Due Date as provided by respective PF & ESI Act's otherwise No Deduction can be claimed for such contributions and the same will be added to Assessee's Income for the respective Assessment year even if it is then subsequently deposited before the Due Date of Filing of Income Tax Return.

A. Detailed Discussion

In the above appeal before Hon'ble Supreme Court, the common question involved is with respect to the interpretation of Section 36(1)(va) and Section 43B of the Income Tax Act, 1961 (hereinafter, "IT Act"), and whether the appellant assessees are entitled to deduction of amounts deposited by them towards contribution in terms of The Employees' Provident Funds and Miscellaneous Provisions Act, 1952 (hereinafter, "EPF Act"), The Employees' Provident Funds Scheme, 1952 (hereinafter, "EPF Scheme"), The Employees' State Insurance Act, 1948 (hereinafter, "ESI Act"), The Employees' State Insurance (Central) Regulations, 1950 (hereinafter, "ESI Regulations") or any other provident or superannuation fund.

B. Adjudication Proceedings

The Assessing Officers (hereinafter, "AO") had ruled that the appellants had belatedly deposited their employees' contribution towards the EPF and ESI, considering the due dates under the relevant acts and regulations. Consequently, the AO ruled that by virtue of Section 36(1)(va) read with Section 2(24)(x) of the IT Act, such sums received by the appellants constituted "income". Those amounts could not have been allowed as deductions under Section 36(1)(va) of the IT Act when the payment was made beyond the relevant due date under the respective acts. In other words, as per the AO, as such sums were paid beyond the due dates as prescribed under the respective acts, the right to claim such sums as allowable deduction while computing the INCOME WAS LOST FOREVER. 

C. Opposite Judgments by Several High Courts on this Issue 

High Courts of Bombay, Himachal Pradesh, Calcutta, Guwahati and Delhi favouring the interpretation beneficial to the assesses on the one hand, and the High Courts of Kerala and Gujarat preferring the interpretation in favour of the Revenue on the other.

D. Relevant Statutory Provisions

1. Section (24) "income" includes --

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(x) any sum received by the assessee from his employees as contributions to any provident fund or superannuation fund or any fund set up under the provisions of the Employees' State Insurance Act, 1948 (34 of 1948), or any other fund for the welfare of such employees;…" Inserted by the Finance Act, 1987 (11 of 1987), w.e.f. 01.04.1988

2. Section 36: Other Deductions Clause (va)

(va) any sum received by the assessee from any of his employees to which the provisions of sub-clause (x) of clause (24) of section 2 apply, if such sum is credited by the assessee to the employee's account in the relevant fund or funds on or before the DUE DATE.

Explanation 1. -For the purposes of this clause, "DUE DATE" means the date by which the assessee is required as an employer to credit an employee's contribution to the employee's account in the relevant fund under any Act. rule, order or notification issued thereunder or under any standing order, award, contract of service or otherwise."

Explanation 2.-For the removal of doubts, it is hereby clarified that The Provisions Of Section 43b Shall Not Apply and shall be deemed never to have been applied for the purposes of determining the "due date" under this clause." Explanation 2 inserted by Act No. 13 of 2021, w.e.f. 01.04.2021

3. Section 43B - Certain deductions to be only on actual payment

Notwithstanding anything contained in any other provision of this Act, a deduction otherwise allowable under this Act in respect of--

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(b) any sum payable by the assessee as an employer by way of contribution to any provident fund or superannuation fund or gratuity fund or any other fund for the welfare of employees, or

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shall be allowed (irrespective of the previous year in which the liability to pay such sum was incurred by the assessee according to the method of accounting regularly employed by him) only in computing the income referred to in section 28 of that previous year in which such sum is actually paid by him:

Provided that nothing contained in this section shall apply in relation to any sum which is actually paid by the assessee on or before the due date applicable in his case for furnishing the return of income under sub-section (1) of section 139 in respect of the previous year in which the liability to pay such sum was incurred as aforesaid and the evidence of such payment is furnished by the assessee along with such return. Second proviso w.e.f. 1989

By Section 9 of the Finance Act, 1989, the following second proviso in Section 43B was added:

"Provided further that no deduction shall, in respect of any sum referred to in clause (b), be allowed unless such sum has actually been paid in cash or by issue of a cheque or draft or by any other mode on or before the due date as defined in the Explanation below clause (va) of sub-section (1) of section 36, and where such payment has been made otherwise than in cash, the sum has been realised within fifteen days from the due date."

By Section 21 of the Finance Act, 2003, the above second proviso was omitted.

Thereafter, by Finance Act, 2021 the following Explanation 5 was added, w.e.f. 01.04.2021:

"Explanation 5.-For the removal of doubts, it is hereby clarified that the provisions of this section shall not apply and shall be deemed never to have been applied to a sum received by the assessee from any of his employees to which the provisions of sub-clause (x) of clause (24) of section 2 applies."

Author's Note: Hence the Law was clarified that 43B shall not apply to Employee Contribution portion w.e.f 1.4.2021 but the above appeal is addressing this question in period prior to 1.4.2021 in accordance with provisions before 1.4.2021

E. Respective Time Limits under PF & ESI Acts

As per Section 38 of EPF Scheme employer shall within fifteen days of the close of every month pay the same to the Fund electronic through internet banking of the State Bank of India or any other Nationalised Bank or through PayGov platform or through scheduled banks in India including private sector banks authorized for collection on account of contributions and administrative charge

As per ESI Regulation 31. Time for payment of contribution - An employer who is liable to pay contributions in respect of any employee shall pay those contributions within 21 days of the last day of the calendar month in which the contributions fall due

F. Appellant's Contention as to Why Deduction should be allowed even if deposited till the Date of ITR

1. Fact that the law as existing prior to the omission of the second proviso to Section 43B restricted deductions in respect of ANY SUMS PAYABLE BY AN EMPLOYER AS CONTRIBUTION to the PF / superannuation fund etc. for employees' welfare unless they were paid within the specified due date.
2. Under the EPF Act and ESI Act, the employer was liable to MAKE A COMPOSITE PAYMENT. The liability comprised of the employer's contribution and the contribution collected from the employee. If this were to be kept in mind, the deletion of the second proviso to Section 43B, and the opening non-obstante clause in Section 43B had to be given full meaning. As a consequence, under Section 43B, at the time of paying the employers' contribution, the employer is under legal obligation to pay not only its contribution but also that of the employee, as a single payment to the PF authority under the governing law. The insistence upon payment of actual payment of employees' contribution in Explanation to Section 36(1)(va) was expressly overridden by the non obstante clause.
3. If the scheme of the IT Act were to be kept in mind, the restrictive condition in Section 36(1)(va) i.e., the stipulation that the employees' contribution must be paid within the time specified, failing which no deduction was permissible, was in fact intended to be expressly overridden by Section 43B. The philosophy behind Section 43B (which was introduced 01.04.1984) was to ensure actual payment of certain specified and statutory dues, before a particular date. These dues either by way of tax or other levies, (including interest-payment towards loan or contributions deducted by statutes such as EPF Act) were to be made within a specified date under such enactments which cast those obligations.

G. Revenue's Contention as to Why Deduction should not be allowed if deposited after Due Date of Act

1. Income Tax Act differentiated between employees' contribution and employers' contribution to PF account. With respect to employers' contribution, Section 43B was applicable. However, with respect to employees' contribution, Section 36(1)(va) was applicable, as it was specific and pointed to the kind of contribution, and when it could be made, to qualify as a deductible expense. Both the provisions i.e., Section 43B and Section 36(1)(va) operated in different fields, with respect to different contributions. Consequently, Section 43B was inapplicable and could not override Section 36(1)(va).
2. It was urged that but for the above interpretation there was no rationale to bring within the fold of "income" – by Section 2(24)(x) – employee's contribution received by the employer and providing a deduction by Section 36 (1)(va) and permitting the deduction only if that contribution were paid in accordance with the statute governing the fund (EPF/ESI Act). The second proviso to Section 43B then underwent a cosmetic change and later was deleted. There was also a new proviso added under Section 43B for permitting deduction on contributions paid before the returns were filed.
3. The Revenue further contended that in terms of provisions of Section 36(1)(va) with respect to any sum received by the assessee from any of its employees to which provision of Section 2 (24 (x) applied, if credited by the assessee to the employees' account in the relevant fund or funds on or before the due date, the assessee was entitled to the deduction. It was submitted that even the Explanation to Section 36(1) (va) made it clear that for the purpose of that provision, "due date" meant the date by which the assessee, as an employer, had to credit the employees' contribution to the employees' account in the relevant fund under any law or rule or regulation issued thereunder or under any standing order, etc. Therefore, during the relevant assessment year, if the employer did not deposit the entire amount towards employees' contribution with the PF authorities on or before the due date under the EPF/ESI Act, to the extent there was shortfall in deposit of the employees' contribution/ESI contribution, the assessee was not entitled to the deduction.

H. Supreme Court Ruling

1. When Parliament introduced Section 43B, what was on the statute book, was only employer's contribution (Section 34(1)(iv)). At that point in time, there was no question of employee's contribution being considered as part of the employer's earning. On the application of the original principles of law it could have been treated only as receipts not amounting to income.
2. That Parliament intended to retain the separate character of these two amounts, is evident from the use of different language. Section 2(24)(x) too, deems amount received from the employees (whether the amount is received from the employee or by way of deduction authorized by the statute) as income - it is the character of the amount that is important, i.e., not income earned. Thus, amounts retained by the employer from out of the employee's income by way of deduction etc. were treated as income in the hands of the employer.
3. The distinction between an employer's contribution which is its primary liability under law – in terms of Section 36(1)(iv), and its liability to deposit amounts received by it or deducted by it (Section 36(1)(va)) is, thus crucial. The former forms part of the employers' income, and the later retains its character as an income (albeit deemed), by virtue of Section 2(24)(x) - unless the conditions spelt by Explanation to Section 36(1)(va) are satisfied i.e., depositing such amount received or deducted from the employee on or before the due date. In other words, there is a marked distinction between the nature and character of the two amounts – the employer's liability is to be paid out of its income whereas the second is deemed an income, by definition, since it is the deduction from the employees' income and held in trust by the employer. This marked distinction has to be borne while interpreting the obligation of every assessee under Section 43B.
4. The non-obstante clause has to be understood in the context of the entire provision of Section 43B which is to ensure timely payment before the returns are filed, of certain liabilities which are to be borne by the assessee in the form of tax, interest payment and other statutory liability. In the case of these liabilities, what constitutes the due date is defined by the statute. Nevertheless, the assessees are given some leeway in that as long as deposits are made beyond the due date, but before the date of filing the return, the deduction is allowed. That, however, cannot apply in the case of amounts which are held in trust, as it is in the case of employees' contributions- which are deducted from their income. They are not part of the assessee employer's income, nor are they heads of deduction per se in the form of statutory pay out. They are others' income, monies, only deemed to be income, with the object of ensuring that they are paid within the due date specified in the particular law. They have to be deposited in terms of such welfare enactments. It is upon deposit, in terms of those enactments and on or before the due dates mandated by such concerned law, that the amount which is otherwise retained, and deemed an income, is treated as a deduction.

Author's Remarks: Undoubtedly, the Hon'ble Supreme Court has delivered its final Verdict to close the dichotomous issue it was. This will impact the Assessee's with demand being held correct for delay in depositing Employee portion of Contribution.

Further, this verdict also highlights how seriously the courts consider default of monies not deposited if they are third party monies being held with you in trust to be deposited by due dates like Employee contributions and even TDS deducted.