[By Tanmay Doneria & Varsha Tanwar]
The authors are students of Rajiv Gandhi National University of Law, Punjab.
Introduction
The intersection of taxation and religion is a multifarious and contentious matter. It is vital to navigate this delicate landscape having far-reaching implications. The Hon’ble Supreme Court of India is set to adjudicate a significant legal question in the Institute of Franciscan Missionary of Mary v. UOI (SLP No. 10456 of 2019). The current SLP inter-alia has been filed to review the judgement rendered by the Hon’ble Madras High Court in Union of India v. The Society of Mary Immaculate. The case hinges on the issue of whether State governments are obligated to deduct Tax Deducted at Source (TDS) under Section 192 of the Income Tax Act, 1961 (“Act”) while making grant-in-aid payments captioned as salary directly to the individual members of religious congregations, such as nuns, who render their services in educational institutions.
The present case presents a unique situation as the nuns and missionaries live in a state of civil death, they take a vow of poverty due to which they do not have any proprietary rights and their income is surrendered in entirety to the congregation. This has been argued before the Madras High Court stating that in accordance with the same, they should not be subject to TDS. However, rejecting this argument the Court held that Section 192 of the Act is a-religious and apolitical thus, the payments made to the nuns will be subject to TDS.
This article analyses the fundamental question, which was overlooked by the Hon’ble Madras High Court, of whether the payments made by the State government to nuns will qualify as “salary” under the Act thereby triggering the requirement of TDS under Section 192 of the Act. Furthermore, it will delve into the nuanced concept of ‘diversion of income,’ positing that the congregation’s overriding title to the nuns’ income, as dictated by their religious tenets, renders the payments made to them as diverted income.
The Payments made by the State Government does not fall within the ambit of ‘Salary’ under the Act
No payment can be considered within the ambit of salary as defined under Section 15 of the Act unless there exists an employer-employee relationship between the payer and the payee. Furthermore, as Section 192 of the Act only applies to payments made under the head of salary, it can be stated that in order to attract the provisions of Section 192 of the Act, it is imperative that the payments must arise out of an employer-employee relationship. Therefore, in specific circumstances of the case at hand, there must be an employer-employee relationship between the State Government and the missionaries/nuns.
It is important to note that the Madras High Court did not adequately discuss the preliminary issue of whether these payments arise out of an employer-employee relationship. The Court had remarked that “Section 15, read with Section 192, obligates the State Government or the employer, be it educational institution or the State to deduct income tax at source.” This blanket statement is erroneous as it merely creates an assumption that the State Government can be considered as an employer of individual missionaries.
To shed light on this matter, we should examine the recent ruling of the Hon’ble Tripura High Court in Aparna Chowdhury Reang v. State of Tripura. Wherein, the court unequivocally established that an employee of a grant-in-aid school cannot be considered to be a government employee. On applying this precedent to the case under consideration, it can be argued that even though the nuns (payee) were receiving payments directly from the State Government (payer) as grant-in-aid through the Electronic Clearing Scheme (ECS), there exists no employer-employee relationship between the State Government and the individual missionaries. Consequently, in the absence of any employer-employee relationship, the TDS provisions under Section 192 of the Act would not be applicable in this scenario. Therefore, failing to qualify the preliminary requirement of an employer-employee relationship, the provisions under Section 192 of the Act cannot be attracted at all.
Surrender of Remuneration to the Congregation Constitutes Diversion of Income
The concept of diversion of income, as outlined in Section 4 of the Income Tax Act, 1961, involves the diversion of income at its source before it reaches the assessee. This refers to instances where the income is re-directed to another entity having an overriding title, thereby preventing it from being subjected to tax under the Act. The test to determine the diversion of income was recently laid down in the case of National Co-operative Development Corporation v. Commissioner of Income Tax, wherein the Apex Court held that if a “portion of income arising out of a corpus held by the assessee consumed for the purposes of meeting some recurring expenditure arising out of an obligation imposed on the assessee by a contract or by statute or by own volition or by the law of the land and if the income before it reaches the hands of the assessee is already diverted away by a superior title the portion passed or liable to be passed on is not the income of the assessee.” Essentially, to apply the doctrine of diversion of income, there must be, firstly, an obligation on the Assessee by a contract, statute, law of the land or by own violation resulting in a recurring expenditure and secondly, income must be passed on or liable to be passed on by a superior or overriding title.
In the present case, the nuns are under an obligation to surrender their entire income to the congregation, this obligation is imposed on them by their own violation i.e., by taking their vow of poverty in accordance with the canonical law. Furthermore, their vow of poverty creates an overriding title of the congregation over any income earned by the Nuns/missionaries and thus, any income credited to the individual account of the nuns is liable to be passed to the congregation by virtue of this overriding title. It is evident that all the conditions to apply the doctrine of diversion of income as laid down in the aforementioned judicial precedent stand fulfilled in the present case.
Interestingly, it was noted by the Hon’ble Madras High Court that until 2015, the State Government paid the remuneration of nuns to the congregation directly and not the individual accounts of the nuns. Therefore, mere alteration in the payment method of the remuneration cannot be said to diminish the congregation’s overriding title to such remuneration.
Furthermore, in lieu of circulars and instructions of 1944 and 1977 (as reproduced in the judgement), fees received by the missionaries in their fiduciary capacity are exempt, this position has not been disputed by the Revenue. In consonance with the same, it can be argued that all the payments received by the missionaries are received only in a fiduciary capacity as they are bound to surrender the same to the congregation. Hence, this would clearly establish an overriding title of the congregation over any payments received by the missionaries on account of their religious vows.
Diversion of Income vis-à-vis Doctrine of Substance Over Form
The doctrine of substance over form, in taxation, refers to a situation where the actual nature of the transaction is considered rather than its mere legal form or the way it is structured. In the realm of taxation, it is the substance of a transaction that determines its taxability and not its form. Generally, it is applied as an anti-abuse provision that allows the courts to ignore the legal form of the transaction that is structured in such a manner as to reduce the tax liability of the Assessee and ascertain the substance of the transaction. Although it is a tool that is applied against the Assessee to unearth their tax evasion schemes. But in principle, it is still a fundamental doctrine of tax law that can be applied anywhere as already stated it is the economic substance of the transaction that determines the taxability and not the form.
In the present situation, the transaction in form is between the missionaries and the State Government as the payment is being made by the State Government directly to the accounts of the nuns. But in substance, the transaction is between the State Government and the congregation as the missionaries are bound by their religious vows to surrender their entire remuneration to the congregation and on the opposite end the congregation also has an overriding title over the income of the missionaries due to the same religious vows.
Now let us consider the same in consonance with the principle of diversion of income. As stated above, it is an accepted position of law that any receipt of income by the missionaries in their fiduciary capacity should be considered as income of the congregation and not an income in the hands of individual missionaries. In furtherance of the same, as argued above any receipt of income by the individual missionary is always in a fiduciary capacity on behalf of the congregation. Accordingly, the economic substance of the transaction is that the missionaries only act as a conduit for the transaction between the State Government and the congregation. This further substantiates that the income in its entirety is being diverted to the congregation on account of its overriding title arising out of religious vows. Hence, the provisions of Section 192 of the Act are manifestly inapplicable to the instant case.
Conclusion
The judgement of the Hon’ble Madras High Court has been subject to serious debate. The oversight of the Madras High Court with respect to considering the relationship of employer-employee between the State Government and the individual missionaries is fatal to the validity of the judgement. As already stated, until such a relationship can be established the provisions under Section 192 of the Act cannot be attracted.
Furthermore, with respect to the principle of diversion of income, from the aforementioned arguments, it is clear that an overriding title of the congregation on the income of the missionaries can be established. Upon considering the same in consonance with the doctrine of substance over form, it can be effectively argued that the underlying transaction is effectively between the congregation and the State Government, rather than between the individual missionaries and the State Government. Hence, the provisions outlined in Section 192 of the Act are entirely inapplicable to the present case. Ultimately, the resolution of this dispute hinges on the decision of the Supreme Court. The Court’s decision will have far-reaching implications and will shape the future course of discourse on the intersection of religious laws and the Act.