TDS Default on LTC Payments Barred When Deductor Complied with Court Interim Orders — Kerala High Court

Background and Context

A significant ruling has emerged from the Kerala High Court in the matter of State Bank of India Vs CIT, where the Court examined whether a nationalised bank could be declared an assessee-in-default under Section 201(1) and Section 201(1A) of the Income Tax Act, 1961, for not deducting tax at source on Leave Travel Concession (LTC) / Leave Fare Concession (LFC) payments made to its employees during Assessment Year 2016-17.

The central question before the Court was both legally intricate and practically significant: Can a deductor be penalised for failing to deduct TDS when it was specifically directed by a competent High Court not to treat such payments as taxable income in the hands of employees?

The Kerala High Court answered this question decisively in favour of the assessee, setting aside the orders passed by the lower authorities and the Income Tax Appellate Tribunal, Cochin Bench.

Factual Matrix of the Case

Origin of the Dispute

The assessee bank had been providing LTC benefits to its employees, including reimbursement for overseas travel. However, through a circular dated 15.04.2014, the bank withdrew the overseas LTC facility for its employees.

This circular was challenged before the Madras High Court by the association of bank employees. By an initial order dated 25.04.2014, the Madras High Court stayed the operation of the circular.

The Pivotal Interim Order of the Madras High Court

Subsequently, concerns arose that despite the stay on the circular, the bank was attempting to deduct tax at source on LTC reimbursements paid to employees pursuant to the interim directions. The employees' association sought a clarification of the earlier interim order.

Accordingly, the Madras High Court issued a crucial interim order dated 16.02.2015 in W.P. No.11991 of 2014, which clarified the position in the following terms:

"5. There is no dispute that the Bank would be paying LTC amount to the concerned officers pursuant to the interim order granted by this Court. The Interim Order is subject to the result of the writ petition. The learned counsel for the petitioner is correct in his contention that the there is no taxable income for deduction at source.

6. The interim order granted by this Court is explained to the effect that any amount paid to the petitioner towards LTC or re-imbursement of LTC pursuant to the impugned order would not amount to income so as to enable the Bank to deduct tax at source. It is made clear that if the writ petition is dismissed, the employees are liable to pay tax on the amount paid by Bank."

This order operated throughout the entire financial year 2015-16, which corresponds to Assessment Year 2016-17 — the year under scrutiny in the present appeal.

Subsequent Developments

The writ petition was ultimately dismissed on 24.06.2022. Thereafter, W.A No.1653 of 2022 was filed, and an interim order dated 08.08.2022 was issued preventing the bank from making recoveries from employee salaries. By a further judgment dated 08.06.2023, the Division Bench of the Madras High Court directed reconsideration of the LTC withdrawal issue. The matter was then taken to the Supreme Court, and by an order dated 28.08.2023 in SLP (C) 16734 of 2023, the Apex Court also stayed recovery proceedings from employees during pendency.

Departmental Action and Proceedings Below

Despite the bank's explanation that LTC payments during financial year 2015-16 were made strictly in compliance with the Madras High Court's interim directions, the Assessing Officer, by order dated 30.03.2023, rejected this defence. The bank was treated as an assessee-in-default under Section 201(1) and was made liable to pay interest under Section 201(1A).

The first appellate authority confirmed the assessment. The Income Tax Appellate Tribunal, Cochin Bench, by its order dated 09.12.2024 in ITA 274/COCH/2024, dismissed the assessee's appeal. The bank thereafter approached the Kerala High Court.

Questions of Law Framed by the Kerala High Court

The High Court reframed the following questions of law for consideration: