Whether an employee can claim credit for TDS even if the employer has not deposited it with the government ?

This common dilemma, where Tax Deducted at Source (TDS) appears in Form 16 and salary payslips but not in Form 26AS or the Annual Information Statement (AIS), often confuses salaried employees when filing their tax returns. In this article, we will examine the relevant sections of the Income Tax Act, 1961 ('Act') and pertinent judicial pronouncements to clarify the correct position.

What Law Says ?

Section 205 of the Act explicitly prohibits the recovery of tax directly from a taxpayer if tax has already been deducted from their income by the deductor. The provision states that a person cannot be called upon to pay taxes if tax was deductible on their income and such tax has indeed been deducted. This means that once tax has been withheld from an individual's income, their personal liability for that specific tax amount is effectively discharged.   

The language of Section 205 is crucial as it specifically uses the term "deducted" and notably omits any requirement for the tax to have been "deposited" by the deductor for this protection to apply to the assessee. This precise wording indicates a clear legislative intent that the taxpayer's obligation for that portion of income is deemed fulfilled once the deduction occurs. The responsibility for ensuring the funds reach the government treasury then shifts entirely to the deductor and, by extension, to the Revenue. This interpretation is important because it establishes that the taxpayer is not a guarantor of the deductor's compliance. Their responsibility concludes at the point of deduction, safeguarding them from penalties arising from actions beyond their control. Any subsequent failure by the deductor to remit the tax becomes a matter solely between the defaulting deductor and the Income Tax Department, not the payee.

Further reinforcing the protective shield of Section 205, Section 191 of the Act clarifies the circumstances under which an assessee is liable to make direct payment of tax. This section stipulates that a salaried person's obligation to make direct payment of tax arises "only if no tax has been deducted " from their salary. Consequently, a taxpayer is held liable to pay the tax themselves only if a particular income is not covered under TDS provisions, or if it is covered, but tax was not actually deducted. Conversely, if tax has been deducted from their income, they cannot be held liable for its non-payment to the Government by the deductor. This provision underscores that once the tax has been withheld by the deductor, the assessee is relieved of the direct payment obligation for that specific amount, placing the onus of collection and recovery squarely on the tax authorities to pursue the defaulting deductor. 

 Judicial Precedents

1. Kartik Vijaysinh Sonavane [2021] 132 Taxmann.com 293 (Gujarat)

Facts:

Kartik Vijaysinh Sonavane, a pilot, had ₹7,20,100/- and ₹8,70,757/- deducted as Tax Deducted at Source (TDS) by his employer, Kingfisher Airlines, for Assessment Years 2009-10 and 2011-12, respectively. Kingfisher Airlines failed to deposit these deducted amounts with the Central Government, leading the Income Tax Department to deny Sonavane credit for the TDS and issue recovery notices and raise demands with interest. Sonavane sought cancellation of these demands and credit for the TDS, arguing that he shouldn't be held responsible for his employer's default. An amount of ₹89,960/- was adjusted against his demand for AY 2019-2020. The department contended the petition was delayed, lacked necessary parties, and the system didn't allow credit without the deductor's deposit.

Ruling:

The Gujarat High Court, relying on its prior decision in Devarsh Pravinbhai Patel vs. Assistant Commissioner of Income Tax Circle 5(1)(1) (which itself cited Assistant Commissioner of Income Tax and Others vs. Om Prakash Gattani), ruled in favor of Kartik Vijaysinh Sonavane. The Court held that the Income Tax Department cannot deny the benefit of tax deducted at source to the assessee (employee) if the tax was indeed deducted by the employer, even if the employer failed to deposit the amount with the government. The onus of depositing the TDS lies solely with the deductor (employer), and if they default, they are deemed an "assessee in default" under Section 201 of the Income Tax Act, and recovery actions must be initiated against the deductor, not the deductee. Consequently, the Court directed the department to give credit for the tax deducted at source to Sonavane and refund any amount already recovered or adjusted with statutory interest within eight weeks.

2. Anusuya Alva [2005] 147 Taxman 1524

Facts:

The petitioner, an assessee, received a demand notice dated December 5, 2002, for income tax arrears across assessment years 1997-98 to 2001-02, totaling ₹6,70,149/-. The petitioner challenged the demands for AYs 1999-2000 to 2001-02, asserting that her tenant, M/s Krisen Development Corporation, had deducted 20% of the monthly rent (₹1,35,000) as Tax Deducted at Source (TDS) under Section 194-I of the IT Act, 1961, but failed to issue Form 16A certificates or remit the deducted amounts to the Income Tax Department. Despite informing the department, the petitioner was still being pursued for these amounts, prompting her to file a writ petition after an unsuccessful revision petition to the CIT under Section 264. The department argued that the petitioner hadn't furnished Form 16A certificates with her returns as required by Section 203 and Section 139(9), and that credit for TDS is only given when the amount is both deducted and paid to the Central Government. However, the department conceded that they had indeed initiated recovery proceedings against the tenant and realized some amount, implying the tenant had deducted but not fully remitted the tax.

Ruling:

The Court allowed the writ petition in part, quashing the demand notice for the tax amounts related to Assessment Years 1999-2000, 2000-01, and 2001-02, which had been deducted by the petitioner's tenant. The Court held that Section 205 of the IT Act, 1961, creates an absolute bar against demanding tax directly from an assessee to the extent that tax has been "deducted" from their income at source, even if the deductor (the tenant in this case) fails to remit the deducted amount to the Central Government. The Court emphasized that the word "deducted" in Section 205 does not imply "deducted and remitted," and the obligation to remit lies solely with the person making the deduction. The Court reasoned that the deductor acts as an agent of the Revenue in this process, and any failure on their part should not penalize the assessee, who has already been deprived of that portion of their income. Therefore, the Revenue is restrained from enforcing any such demand against the petitioner and must pursue recovery solely from the person who deducted the tax.

3. Court On Its Own Motion vs. CIT (Delhi High Court, Order dated 31.08.2012, further rulings March 16, 2013)

This case originated as a public interest writ petition initiated by the Delhi High Court itself, aiming to address systemic issues faced by taxpayers, including faulty processing of income tax returns, non-grant of TDS credit, and general harassment by the Income Tax Department. The Court's observations and directions in this matter are crucial for understanding the broader administrative landscape surrounding TDS credit.   

The Delhi High Court noted that the CBDT had admitted to incorrect demands being uploaded to the CPC arrears portal. The Court mandated that Assessing Officers (AOs) should proactively ( suo motu) correct their records and upload accurate data, rather than solely relying on assessees to file Section 154 applications, which incur substantial expenses and defeat the purpose of computerization. Furthermore, the Court criticized the unjustified reduction of the TDS mismatch tolerance limit (the threshold below which AOs could accept TDS claims without extensive verification) from Rs. 1 lakh to a mere Rs. 5,000. It found no logical justification for this reduction, especially since credit is typically given only if core fields match.   

Crucially, the Court unequivocally stated that an assessee "should not suffer because of fault made by deductor or inability of the Revenue to ask the deductor to rectify and correct". It emphasized that once payment is received by the Revenue, credit should be given to the assessee. The Court also expressed strong dissatisfaction with the department's perceived "helplessness" regarding taking action against non-compliant deductors. It asserted that AOs   must use their power and authority to ensure deductor compliance, rather than merely "persuading" them. This case is significant as it transcends individual disputes to address systemic inefficiencies. It highlights judicial activism in protecting taxpayers from administrative failures and reiterates the principle that the assessee should not bear the brunt of either the deductor's default or the department's operational shortcomings. It also underscores the Revenue's responsibility to pursue defaulting deductors vigorously.   

CBDT instructions dated 01-06-2015 and Office Memorandum dated 11-03-2016

The CBDT has stated that in cases where TDS is deducted by an employer or other deductor but is not subsequently deposited with the Government, Assessing Officers (AOs) are expressly prohibited from raising tax demands upon the payees. This directive was initially issued through a letter dated June 1, 2015. The instruction explicitly clarifies that Section 205 of the Income-tax Act, 1961, imposes a bar on direct demand against the assessee in such situations, and any demand arising from a tax-credit mismatch due to the deductor's non-payment of TDS cannot be coercively enforced against the payee.   

Later CBDT has issued another instructions dated March 11, 2016. This OM was issued because instances had come to the Board's notice indicating that the earlier directions from 2015 were not being strictly followed by field offices. The OM therefore re-emphasized and reiterated the contents of the previous letter, directing AOs    not to enforce demands created on account of credit mismatch resulting from the non-payment of TDS amounts to the credit of the Government by the deductor.   

These instructions are binding on all field officers of the Income Tax Department. They provide a clear administrative mandate that reinforces the judicial pronouncements, offering a strong and direct ground for taxpayers to challenge demands related to undeposited TDS. The requirement for the CBDT to reiterate its instructions due to non-compliance by field officers points to a deep-seated operational challenge within the tax administration.

Steps and Remedies for Taxpayers

For taxpayers who receive a demand notice due to undeposited TDS, a structured approach is essential to effectively challenge the demand and protect their rights.

7.1. Initial Actions Upon Receiving a Demand Notice

Upon receiving a demand notice, the immediate step for the taxpayer is to contact the deductor (e.g., employer, tenant, or other entity) to address the mismatch. Common reasons for such discrepancies include:   

• The TDS was deducted but not deposited with the Government.

• The TDS was deposited, but the TDS statement has not yet been filed.

• The deductor quoted an incorrect Permanent Account Number (PAN) in the TDS statement.

• An incorrect TDS amount was mentioned in the TDS statement.   

  
  

These errors can generally only be corrected by the deductor. Therefore, the taxpayer should promptly request the deductor to deposit the tax (if not already done) and/or file or correct the TDS statement at the earliest opportunity.   

7.2. Documentation Required for Proving TDS Deduction

To substantiate their claim that tax was indeed deducted, taxpayers must possess and submit robust documentation. Primary evidence includes:

• Salary slips or Form 16 (for salaried individuals), which clearly indicate the TDS deducted.

• Bank statements that explicitly show the credit of net salary or other income after the deduction of TDS.  

• Any other relevant correspondence, agreements, or registered documents that serve as proof that the tax component was deducted and withheld.   

  
  

It is imperative to understand that the Assessing Officer is legally bound to allow TDS credit to the taxpayer if these submitted documents are found to be correct and genuinely demonstrate that the tax was deducted from the income.   

7.3. Responding to the Demand Notice

In response to the demand notice, the taxpayer should file a detailed reply on the e-filing portal, ensuring all supporting documents are attached. The reply should not merely state the facts but also include a clear legal argument. Taxpayers should explicitly cite:

• Section 205 of the Income-tax Act, 1961, which bars direct demand on the assessee for tax already deducted.

• CBDT Instructions dated 01-06-2015 and 11-03-2016, which unequivocally direct AOs not to enforce demands created by TDS credit mismatches due to deductor non-payment.

• Relevant High Court judgments, such as Kartik Vijaysinh Sonavane and Anusuya Alva, which have consistently ruled in favor of the taxpayer in similar circumstances. Reference to the Court On Its Own Motion case can also be made to highlight systemic issues and departmental accountability.

7.4. Appellate Remedies Available

If, despite the submission of evidence and legal arguments, the Assessing Officer still does not allow the TDS credit, the taxpayer has clear appellate remedies. The immediate next step is to file an appeal before the Commissioner of Income-tax (Appeals). This is the first level of appeal within the Income Tax Department. Should the CIT(A) also fail to provide relief, further appeals can be pursued before the    

Income Tax Appellate Tribunal (ITAT) and, if a substantial question of law arises, to the respective High Court. The strong body of judicial precedents discussed in this report provides a solid foundation for such appeals.

While the law is on the taxpayer's side, the practical reality is that the burden of proving that tax was indeed deducted falls squarely on the taxpayer. The consistent emphasis in various directives and judicial observations on the necessity of "supporting documents"  underscores this point.