Judicial Restraint Precludes TDS Default: ITAT Mumbai Quashes Demands and Penalties on LFC Reimbursements

The Income Tax Appellate Tribunal (ITAT), Mumbai Bench, has delivered a comprehensive ruling addressing the intersection of employer withholding tax obligations and binding interim judicial directives. In the matter of SBI Ambernath East Br Vs ACIT (ITAT Mumbai), the Tribunal adjudicated upon a batch of 39 appeals filed by the assessee, State Bank of India (SBI), operating through its various branches and Tax Deduction Account Number (TAN) holders.

The core dispute pertained to Assessment Years (AY) 2016-17 and 2017-18. Out of the 39 appeals, 21 were directed against tax demands and interest levied under Section 201(1) and Section 201(1A) of the Income-tax Act, 1961, while the remaining 18 appeals challenged penalties imposed under Section 271C. The Tribunal ultimately ruled in favor of the assessee, holding that an employer cannot be categorized as an assessee in default for failing to deduct Tax Deducted at Source (TDS) when such deduction was explicitly prohibited by a subsisting interim order of a High Court.

The Genesis of the Dispute: LFC and the Foreign Leg

The controversy originated from the Leave Fare Concession (LFC) provided by the assessee to its employees under the State Bank of India Officers’ Service Rules, 1992. The employees in question had designated domestic destinations within India for their travel. However, their actual travel itineraries incorporated a foreign leg or a circuitous route encompassing an overseas destination before concluding the journey in India.

The assessee processed these LFC reimbursements by treating them as exempt under Section 10(5) of the Income-tax Act, 1961, read with Rule 2B of the Income-tax Rules, 1962. Consequently, the assessee did not subject these specific reimbursements to TDS under Section 192 of the Act.

During subsequent TDS verification proceedings, the respective Assessing Officers scrutinized the travel itineraries. The Revenue authorities concluded that a journey incorporating a foreign segment fundamentally disqualified the travel from the exemption ambit of Section 10(5), which strictly mandates travel within India. Based on this interpretation, the Assessing Officers classified the LFC reimbursements as taxable salary components, holding the assessee liable for non-deduction of tax. This led to the issuance of demand orders treating the assessee as an assessee in default under Section 201(1), accompanied by the levy of consequential interest under Section 201(1A). Subsequently, penalty proceedings were initiated, culminating in the imposition of penalties under Section 271C.

The primary defense mounted by the assessee before the lower authorities hinged upon an interim direction issued by the Hon’ble Madras High Court in the case of All India State Bank Officers Federation & Ors., W.P. No. 11991 of 2014. Specifically, the interim order dated 16/02/2015 explicitly restrained the assessee from treating the LFC amounts as income for the purposes of TDS deduction. The assessee argued that deducting tax in direct contravention of an active High Court order would have amounted to judicial disobedience.

Conversely, the Revenue heavily relied upon the landmark judgment in State Bank of India v. Assistant Commissioner of Income-tax (Supreme Court); Civil Appeal No. 8181 of 2022; judgment dated 04/11/2022; [2022] 144 taxmann.com 131 / 449 ITR 192 / [2023] 290 Taxman 129 (SC). In this ruling, the Supreme Court authoritatively settled the substantive legal question, declaring that LFC claims involving a foreign leg do not qualify for the Section 10(5) exemption, thereby making them taxable. The Revenue contended that this Supreme Court judgment was declaratory in nature, meaning the statutory obligation to deduct tax under Section 192 was absolute and existed at the time of payment, irrespective of the interim High Court order.