In a ruling with significant implications for salaried taxpayers and corporate payroll compliance, the Kerala High Court has held that an employee’s income-tax liability does not stand waived merely because the employer failed to deposit tax deducted at source (TDS) with the Income Tax Department.
The decision settles a recurring area of dispute where employees, despite suffering TDS deductions from salary, face tax demands due to employer non-remittance. The Court’s ruling reaffirms the statutory design of the TDS mechanism and draws a clear distinction between deduction of tax and credit of tax under the Income-tax Act, 1961.
Factual and Legal Background
Under the income-tax framework governing salaries:
- employers are required to deduct tax at source under Section 192, and
- remit the deducted amount to the Central Government within prescribed timelines.
In practice, disputes arise where employers deduct TDS from employees’ salaries but fail to deposit the same, either due to financial distress, negligence, or deliberate default. Employees, in turn, claim that once tax has been deducted from their salary, they should not be subjected to further tax liability.
The Kerala High Court was called upon to examine whether such an argument is legally sustainable.
Core Issue Before the Court
The central question was: Can an employee be absolved of income-tax liability solely on the ground that the employer deducted TDS but failed to remit it to the government?
Court’s Ruling and Legal Reasoning
1. Deduction and Remittance Are Distinct Legal Events
The Court emphasised that the TDS framework creates two separate statutory obligations:
- deduction of tax from salary, and
- remittance of the deducted tax to the government.
While deduction is a necessary first step, tax credit to the employee arises only upon actual remittance of the amount to the exchequer.
2. Interpretation of Sections 199 and 205
The Court’s reasoning centred on Sections 199 and 205 of the Income-tax Act, which govern:
- grant of credit for TDS, and
- protection against direct recovery from the assessee in certain circumstances.
The Court clarified that:
- credit for TDS is contingent upon deposit, and
- Section 205 does not operate as an automatic shield where tax has been deducted but not paid to the government.
This interpretation reinforces legislative intent that government revenue cannot be compromised by private contractual or employment arrangements.
3. Recovery Remedy Lies Against the Employer
While the Court held that employees remain liable for tax in the absence of remittance, it simultaneously recognised that:
- the primary defaulter is the employer, and
- the Income-tax Department’s principal recovery remedy lies against the employer, who can be treated as an assessee in default.
However, this does not extinguish the employee’s tax liability as a matter of law.
Statutory Consequences for Employers
The judgment indirectly reiterates the serious consequences employers face for TDS defaults, including:
- treatment as an assessee in default under Section 201,
- levy of mandatory interest,
- imposition of penalties equivalent to unpaid tax, and
- possible disallowance of salary expenditure for business-tax purposes.
The ruling reinforces that TDS compliance is not a procedural formality but a substantive statutory duty.
Practical Implications
For Employees
- Employees should regularly verify TDS credits in Form 26AS/ AIS.
- Mere deduction reflected in salary slips does not guarantee tax credit.
- In cases of employer default, employees may face tax demands despite no fault of their own.
For Employers
- Payroll and TDS remittance failures expose employers to significant statutory and litigation risk.
- Non-deposit of TDS can have cascading consequences affecting both tax liability and employee relations.
For Tax Practitioners
- The ruling provides clarity in disputes involving mismatch between salary TDS and Form 26AS.
- It strengthens the department’s legal position while underscoring the importance of employer-side recovery.
Conclusion
The Kerala High Court’s decision reinforces a fundamental principle of tax law: tax credit follows tax payment, not merely tax deduction. While the outcome may appear harsh from an employee-equity standpoint, it reflects the statutory architecture of the Income-tax Act, which prioritises certainty of revenue collection.
The ruling serves as a cautionary reminder that TDS compliance failures cannot be contractually or equitably shifted away from statutory consequences, and that robust employer-side compliance remains the cornerstone of the withholding tax system.
Source: OutlookMoney