TDS to be deducted on tips passed to employees by Hotel employers who have collected them from customers

Recently in the case of ITC Ltd v. CIT [2011-TIOL-287-HC-DEL-IT], the Delhi High Court (HC) held that the tips or service charges distributed to employees are to be treated as part of salary and tax is required to be withheld under section 192 of the Income-tax Act (the Act) from the same. The AO treated the value of these tips as ‘salary’ and held that the assessees were liable to withheld tax at source from such payments under section 192 of the Act.

Facts – The ITC Ltd. and CJ International hotels Ltd. (the “assessees”) own, operate and manage hotels. During the course of a survey conducted under section 133A of the Act, the assessing officer (“AO”) noted that the assessees had been paying tips to their employees without withholding tax at source. The assessees were treated as `assessee-in -default’ for not withholding tax and were issued with a demand notice for taxes to be paid under section 201(1) of the Act, along with interest under section 201(1A) of the Act. Following an appeal by the assessees, the Commissioner of Income Tax (Appeals) (“CIT(A)”), relying on the Delhi Income-tax Appellate Tribunal (the “Tribunal”) order in the case of Nehru Place Hotels Ltd v. ITO [2008] 173 Taxman 88 (Del), held that the assessees could not be treated as assessee-in -default, with the result that no interest was to be charged under section 201(1A) of the Act. Aggrieved with the order of the CIT(A), the revenue approached the Tribunal. The Tribunal dismissed the appeal, relying upon its own order issued for an earlier assessment year and the decision of Delhi Tribunal in the case of Nehru Place Hotels (above).

The Revenue took the matter to the HC.

Issue

The following issues were considered by the HC

• Whether the assessees were not an `assessee-in -default’ for not withholding of tax on account of banquet and restaurant tips collected and paid by it to its employees?
• Whether banquet and restaurant tips, paid in its capacity as employer, were profits in lieu of salary within the meaning of section 17(3)(ii) of the Act?

Revenue’s contentions

The contentions of the Revenue to the HC were as follows:

• The tips are routed through the bills as service charges and have to be paid, since they are a part of the bill. Addition of service charges in the bills cannot be considered gratuitous or even voluntary and discretionary, but is compulsory.
• The assessees have been charging service charges to customers for services rendered at banquets. Service charges collected are distributed to the employees on a regular basis.
• The tips collected from other outlets are also distributed to the employees on a regular basis.
• The employees earned the tips only by rendering services to the employer, thus establishing an employer – employee relationship. Accordingly, tips are chargeable as ‘salary’ under sections 15 and 17 of the Act.
• The assessees are now withholding tax from tips/service charges from the bills of banquets, but not from tips collected from other outlets. The assessee cannot adopt two different tax policies in their distribution of tips.
• Once bills including tips are paid by the customer, employees gain the right to claim the tips in addition to their salary;
• In the same way as their salary, tips received by employees are sourced from the hotel bills paid by the customers.

Assessee’s contentions

• Tips are gratuitous payments made by the customers directly to the employees as reward in appreciation of services rendered.
• The payment of the tips is not mandatory for customers and its value also varies.
• Merely because the assessee acts as a custodian in collecting the tips and a conduit for passing them over to the employees, the value of tips received cannot be construed as flowing from the contract of employment.
• The fact that an employee would not have earned the tips if he had not been working at the outlet cannot lead to the inference that the payment of the tips was flowing from the contract of employment.
• As the tips are neither due from employer nor constitute as a salary paid or allowed to be paid by or on behalf of the employer, the essential pre-conditions of section 15 (charging section for salary income) of the Act are not met.
• The employer’s obligation is to estimate the income of the employees honestly and in good faith and does not extend to precisely computing the income and corresponding tax.
• If there was a short deduction of tax by the employer out of the income of the employee chargeable as ‘salary’ on account of a bona fide difference of opinion, regarding the treatment of any amount received, then the employer cannot be held liable as an `assessee-in -default’ under section 201 of the Act and subjected to the penal consequences of the alleged failure (Gwalior Rayon Silk Co. Limited v. CIT. [1983] 140 ITR 832 (MP), CIT.v. Nestle India Limited [2000] 243 ITR 435 (Delhi).

High Court ruling

• The inclusive definition of ‘salary’ in section 17 of the Act widens the scope of section 15 of the Act, by not confining salary to compensation for services rendered during the course of an employer – employee relationship, but also includes benefits which may become available at the end of this relationship,
• The HC relied upon the decision in the case of All India Defence accounts Association v. Union of India. [1989] 175 ITR 494 (All) in which it was held that the scope of inclusive definition cannot be restricted to those words which occur in the definition but will extend to many other things which are not talked of in the section.
• Under section 17(1)(iv) of the Act, ‘salary’ includes profits in addition to salary or wages. The word ‘profits’ is used to convey any ‘advantage’ or ‘gain’ received by the employee. In this way, the meaning of the salary is expanded to include any advantage which is received by the employee from the employer in addition to salary or wages. Accordingly, the receipt of tips by an employee from his employer would be taxable as salary.
• The inclusive meaning given to the phrase ‘profits in lieu of salary’ would include ‘any payment’ due to or received by employees from an employer, even though it has no connection with the profits of the employer. Thus the money received as tips would be covered by the inclusive definition of salary (Karamchari Union v. Union of India and Others. [2000] 243 ITRS 143 (SC)).
• In order for tips to be regarded as a part of the salary, these must be the result of employment from which the employee acquires a vested right, enforceable under law, to receive the amount (CIT. v. L.W.Russel [1964] 53 ITR 91 (SC)).
• Tips received by the employees directly in cash would be beyond the responsibility of the employer under section 192 of the Act.
• Tips charged in the bill by the employer or indicated by the customer on the bill go to the receipts of the employer and are distributed to the employees on a regular basis. This counts as part of the employees’ salary.
• The employer, as part of the employment, allows the employee to receive tips from the customer and a vested right accrues to the employee to claim the same.
• Accordingly, the receipt of the tips constitutes ‘income’ of the recipients, taxable as ‘salary’ and the assessees were obliged to withhold tax at source from such payments, under section 192 of the Act. The additional plea of the assessees that tax was withheld from the salaries of the employees and there was no dishonest intention in not withholding tax on tips is accepted. Also the revenue did not controvert and has accepted the assessments of the assessee in the past.
• Based on this reasoning, the penalty envisaged in section 201 of the Act cannot be imposed. However the levy of interest under section 201 (IA) of the Act cannot be waived as interest is not treated as part of the penalty. (CIT. v. Majestic Hotel Ltd [2006] 155 Taxman 447 (Delhi), Bennet Coleman & Co. Ltd. v. ITO [1986] 157 ITR 812 (Bom), Prem Nath Motors (P.) Ltd. v. CIT. [2002] 120 Taxman 584 (Delhi))

Conclusion :- The HC, following the decision of the Supreme Court in the case of Karamchari Union (above), treated ‘advantage’ in terms of the payment of money received by the employee from the employer in relation to or in addition to any salary or wages as covered by the inclusive definition of the term ‘salary’. Furthermore, the HC considered the bona fide belief of the assessee for non withholding of tax at source from payments made from tips as a reasonable cause for failure to withhold tax, and waived the penalty. This decision is of relevance to the hotels which are following a similar mechanism of collecting and distributing tips to their employees and not withholding taxes under section 192 when making payment of tips. In future, they may need to withhold taxes under section 192 while paying money collected as tips.