Education cess leaves you with a TDS problem

BANGALORE: The introduction of education cess at 2% with effect from April 1, ‘04, has created a peculiar situation.

Tax payers who are required to deduct tax at source (TDS) will have to take into account both the surcharge and the education cess while computing their TDS obligations.

Where is the problem, one may ask? The President gave his assent to Finance Bill, 2004, only on September 10. In fact, the imposition of the education cess was announced by the finance minister in his Budget speech in July.

If payments on the tax that is required to be deducted at source, have been made prior to the date of assent of the Bill, it is likely that the education cess has not been calculated.

In case of payments of a continuous nature, such as salary or rent, tax payers may have been cautious and taken education cess into consideration for TDS purposes, after the Budget proposals were announced.

Tax is required to be deducted at source on a wide range of payments, the rate varying on the nature of payment.

To arrive at the final rate at which tax is to be withheld, it is not just the basic prescribed rate that applies: the tax payer has to consider the surcharge of 2.5% and the 2% education cess (this cess is calculated on the gross tax liability after including the surcharge).

The liability to deduct tax at source arises at the time of making the payment or passing a credit entry in favour of the payee, whichever is earlier.

Penal consequences for non-deduction of tax at source are high, and in some cases, may even lead to prosecution.

Points out Nitin Karve, partner, Bharat S Raut & Co, “The education cess is effective from April 1 and it applies, even where the tax has been deducted or paid prior to the date of assent of the Finance Bill.

If the payments are of a continuing nature, such as periodic payments under a yearly contract, it would be advisable to deduct the arrears of education cess from the next payment.�

For example, if a payment was made during May to XYZ Ltd and tax was duly withheld at source at the rate of 2.05% (2% plus surcharge of 2.5%), but such tax deducted did not take into consideration the education cess liability, then, if another payment is due in November, the arrears of the education cess should be considered while calculating the TDS component.

In certain instances, the transaction may have been solitary and there would be no future payments during this financial year to the same party. “In such instances, the tax payer cannot be penalised,� adds Mr Karve.

Padamchand Khincha, a chartered accountant, points out, “A similar situation was faced a few years ago, when the earthquake relief cess was imposed.

Courts ruled in favour of the tax payer, holding that if the time of deduction of tax in respect of a solitary transaction was prior to the enactment of the Finance Bill, the tax payer could not have imagined the additional cess.�