2007 (6) TMI 175 - HC - Income Tax

Constitutional validity of clause (f) of Section 43B - Inconsistency of clause (f) and absence of nexus with Section 43B - actual payment of liability to the employees (leave encashment) as a condition precedent for extending the benefit of deduction under the 1961 Act - HELD THAT - On a perusal of object and reasons as disclosed by the Finance Act, 1983, for enacting section 43B, it would appear that the Legislature expressed concern about the unreasonable deduction claim on the basis of mercantile accounting method without discharging statutory liabilities. It was observed by the Legislature that there had been a trend to evade statutory liabilities on the one hand and claim appropriate benefit under the said Act of 1961 on the other hand. Hence, such enactment was necessary. While inserting clause (f) no special reasons were disclosed. His Lordship held that such disclosure was not mandatory. We do not have any reason for disagreement on such issue provided the subject amendment could be termed as in furtherance to widen the scope of the original section on the identical objects and reasons as disclosed at the time of enacting the original provision. As we find, the original section was incorporated to plug in deductions claimed by not discharging statutory liabilities. We also find that provision was subsequently made to restrict deductions on account of unpaid loan to the financial institutions. Leave encashment is neither statutory liability nor a contingent liability. It was a provision to be made for the entitlement of an employee achieved in a particular financial year. An employer is entitled to deduction for the expenditure he incurs for running his business which includes payment of salary and other perquisites to his employees. Hence, it is a trading liability. As such he is otherwise entitled to have deduction of such amount by showing the same as a provisional expenditure in his accounts. The Legislature by way of amendment restricts such deduction in the case of leave encashment unless it is actually paid in that particular financial year. The Legislature is free to do so after they disclose reasons for that and such reasons are not inconsistent with the main object of the enactment. We are deprived of such reasons for our perusal. Mr. Banerjee, appearing for the Revenue could not enlighten us on that score. We also do not find such enactment consistent with the original provision being section 43B which was originally inserted to plug in evasion of statutory liability. The apex court considered the situation in the case of Bharat Earth Movers 2000 (8) TMI 4 - SUPREME COURT , when clause (f) was not there. The apex court, considering all aspects as disclosed by us hereinbefore, rejected the contention of the Revenue and granted appropriate deduction to the concerned assessee. The Legislature to get rid of the decision of the apex court brought about the amendment which would otherwise nullify the judge-made law. The apex court decisions are judge-made law and are applicable to all under the Constitution. We do not for a single moment, observe that the Legislature was not entitled to bring such amendment. They were within their power to bring such amendment. However they must disclose reasons which would be consistent with the provisions of the Constitution and the laws of the land and not for the sole object of nullifying the apex court decision. The appeal succeeds and is allowed. Section 43B(f) is struck down being arbitrary, unconscionable and de hors the apex court decision in the case of Bharat Earth Movers. The appeal is disposed of accordingly without any order as to costs.

Summary

Issues Involved:
1. Constitutionality of Section 43B(f) of the Income-tax Act, 1961.
2. The legislative intent and object behind the introduction of Section 43B(f).
3. The applicability of the mercantile system of accounting to leave encashment provisions.
4. The judicial precedents relevant to the interpretation of Section 43B(f).

Detailed Analysis:

1. Constitutionality of Section 43B(f):
The primary issue in this case is the constitutionality of Section 43B(f) of the Income-tax Act, 1961. The appellant argued that this section is ultra vires as it mandates that deductions for leave encashment can only be claimed in the year of actual payment, which contradicts the mercantile system of accounting. The court held that Section 43B(f) is "arbitrary, unconscionable, and de hors the apex court decision in the case of Bharat Earth Movers [2000] 245 ITR 428." Consequently, the court struck down Section 43B(f).

2. Legislative Intent and Object Behind Section 43B(f):
The appellant contended that the introduction of Section 43B(f) was unreasonable and not aligned with the original intent of Section 43B, which was to prevent the evasion of statutory liabilities. The court noted that the original Section 43B was enacted to curb the practice of claiming deductions for unpaid statutory liabilities. However, leave encashment is neither a statutory nor a contingent liability but a trading liability. The court found no disclosed reasons for the amendment that would justify its consistency with the original provision's intent.

3. Applicability of Mercantile System of Accounting:
The appellant maintained that under the mercantile system of accounting, they were entitled to claim deductions for leave encashment provisions made in the balance sheet annually. The court agreed with this view, referencing the Supreme Court's decision in Bharat Earth Movers, which allowed deductions for provisions made for leave encashment in the year the liability was incurred, even if the payment was to be made in the future. The court emphasized that the liability for leave encashment is not contingent but a present liability, which can be quantified reasonably.

4. Judicial Precedents:
The court discussed several judicial precedents, including:
- Calcutta Co. Ltd. v. CIT [1959] 37 ITR 1 (SC): This case established that estimated expenditures should be considered for tax deductions to arrive at the actual profit.
- Bharat Earth Movers v. CIT [2000] 245 ITR 428 (SC): The Supreme Court ruled that a business liability incurred in an accounting year should be deductible in that year, even if the payment is made later. This case was pivotal in the court's decision to strike down Section 43B(f).
- G. C. Kanungo v. State of Orissa [1995] 5 SCC 96: This case highlighted that legislative amendments should not encroach upon judicial powers.
- Federation of Railway Officers Association v. Union of India [2003] 4 SCC 289: The court noted the limited scope of judicial review in policy matters unless the policy is arbitrary or inconsistent with the Constitution.

Conclusion:
The court concluded that Section 43B(f) of the Income-tax Act, 1961, is unconstitutional as it is arbitrary and inconsistent with the Supreme Court's decision in Bharat Earth Movers. The appeal was allowed, and Section 43B(f) was struck down. The court emphasized that legislative amendments must disclose reasons consistent with the Constitution and should not aim solely to nullify judicial decisions. The judgment was stayed for four weeks, and an urgent xerox certified copy was permitted if applied for.