2020 (4) TMI 792 - SC - 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 - clause (f) was inserted in the already existing Section 43B vide Finance Act, 2001 with effect from 1.4.2002 - application of clause (f), the eligibility for deduction arises in the previous year in which the abovesaid payment is actually made and not in which provision was made in that regard, irrespective of the system of accounting followed by the assessee - High Court 2007 (6) TMI 175 - CALCUTTA HIGH COURT has characterised clause (f) as arbitrary and unconscionable while imputing it with unconstitutionality HELD THAT - From 1983 onwards, Section 43B had taken within its fold diverse nature of deductions, ranging from tax, duty to bonus, commission, railway fee, interest on loans and general provisions for welfare of employees. An external examination of this journey of Section 43B reveals that the legislature never restricted it to a particular category of deduction and that intent cannot be read into the main Section by the Court, while sitting in judicial review. Concededly, it is a provision to attach conditionality on deductions otherwise allowable under the Act in respect of specified heads, in that previous year in which the sum is actually paid irrespective of method of accounting. Broad objective of enacting Section 43B concerning specified deductions referred to therein was to protect larger public interest primarily of revenue including welfare of the employees. Clause (f) fits into that scheme and shares sufficient nexus with the broad objective, as already discussed hitherto. In the very nature of taxing statutes, legislature holds the power to frame laws to plug in specific leakages. Such laws are always pinpointed in nature and are only meant to target a specific avenue of taxability depending upon the experiences of tax evasion and tax avoidance at the ground level. The general principles of exclusion and inclusion do not apply to taxing statutes with the same vigour unless the law reeks of constitutional infirmities. No doubt, fiscal statutes must comply with the tenets of Article 14. A larger discretion is given to the legislature in taxing statutes than in other spheres. In Anant Mills Co. Ltd. vs. State of Gujarat Ors.S 1975 (1) TMI 62 - SUPREME COURT this Court noted in view of the inherent complexity of fiscal adjustment of diverse elements, permit a larger discretion to the Legislature in the matter of classification so long as it adheres to the fundamental principles underlying the said doctrine. The power of the Legislature to classify is of wide range and flexibility so that it can adjust its system of taxation in all proper and reasonable ways. Reason weighed with the Division Bench of the High Court in the impugned judgment is untenable. Defeating the dictum in Bharat Earth Movers case 2000 (8) TMI 4 - SUPREME COURT - Decision in Bharat Earth Movers (supra) and note that the Court was sitting in appeal over the nature of liability under the leave encashment scheme and held such liability to be a present liability. Resultantly, it became deductible from the profit and loss account of the assessee in the same accounting year in which provision against the same is made. The Court rejected that leave encashment liability is a contingent one. It is no doubt true that the legislature cannot sit over a judgment of this Court or so to speak overrule it. There cannot be any declaration of invalidating a judgment of the Court without altering the legal basis of the judgment as a judgment is delivered with strict regard to the enactment as applicable at the relevant time. However, once the enactment itself stands corrected, the basic cause of adjudication stands altered and necessary effect follows the same. Upon the law coming into force, it becomes operative in the public domain and opens itself to any review under Part III as and when it is found to be plagued with infirmities. Upon being invalidated by the Court, the legislature is free to diagnose such law and alter the invalid elements thereof. In doing so, the legislature is not declaring the opinion of the Court to be invalid. Once the Finance Act, 2001 was duly passed by the Parliament inserting clause (f) in Section 43B with prospective effect, the deduction against the liability of leave encashment stood regulated in the manner so prescribed. Be it noted that the amendment does not reverse the nature of the liability nor has it taken away the deduction as such. The liability of leave encashment continues to be a present liability as per the mercantile system of accounting. Further, the insertion of clause (f) has not extinguished the autonomy of the assessee to follow the mercantile system. It merely defers the benefit of deduction to be availed by the assessee for the purpose of computing his taxable income and links it to the date of actual payment thereof to the employee concerned. Thus, the only effect of the insertion of clause (f) is to regulate the stated deduction by putting it in a special provision. This regulatory measure is in sync with other deductions specified in Section 43B, which are also present and accrued liabilities - merely because a certain liability has been declared to be a present liability by the Court as per the prevailing enactment, it does not follow that legislature is denuded of its power to correct the mischief with prospective effect, including to create a new liability, exempt an existing liability, create a deduction or subject an existing deduction to new regulatory measures. Strictly speaking, the Court cannot venture into hypothetical spheres while adjudging constitutionality of a duly enacted provision and unfounded limitations cannot be read into the process of judicial review. A priori, the plea that clause (f) has been enacted with the sole purpose to defeat the judgment of this Court is misconceived. The position of law discussed above leaves no manner of doubt as regards the legitimacy of enacting clause (f). The respondents have neither made a case of nonexistence of competence nor demonstrated any constitutional infirmity in clause (f). In view of the clear legal position explicated above, this appeal deserves to be allowed. Accordingly, the impugned judgment of the Division Bench of the High Court is reversed and clause (f) in Section 43B of the 1961 Act is held to be constitutionally valid and operative for all purposes.

Summary

Issues Involved:
1. Constitutional validity of clause (f) of Section 43B of the Income Tax Act, 1961.
2. Whether clause (f) is arbitrary and violative of Article 14 of the Constitution of India.
3. Consistency of clause (f) with other clauses of Section 43B.
4. Nexus of clause (f) with the original enactment of Section 43B.
5. Impact of clause (f) on the judgment in Bharat Earth Movers vs. Commissioner of Income Tax.

Issue-wise Detailed Analysis:

1. Constitutional Validity of Clause (f) of Section 43B of the Income Tax Act, 1961:
The Supreme Court examined the constitutional validity of clause (f) inserted in Section 43B by the Finance Act, 2001, effective from 1.4.2002. Clause (f) mandates that deductions for leave encashment liabilities can only be claimed in the year the payment is actually made, irrespective of the accounting method followed by the assessee. The Court observed that the legislative power of Parliament to enact clause (f) under Article 245 was not in question. The Court emphasized that the presumption of constitutionality applies to legislative enactments and that the judiciary's role is to ensure that the provision does not contravene any rights enshrined in Part III of the Constitution.

2. Whether Clause (f) is Arbitrary and Violative of Article 14 of the Constitution of India:
The respondents argued that clause (f) was arbitrary and violated Article 14, as it was inconsistent with the mercantile system of accounting and was enacted solely to nullify the judgment in Bharat Earth Movers. The Court reiterated that legislative enactments cannot be struck down merely on the grounds of being arbitrary or unreasonable. It emphasized that the legislature enjoys greater latitude in the field of taxation and that hardship is not a relevant factor in determining the constitutional validity of a fiscal statute. The Court found that clause (f) was enacted to prevent potential misuse by employers who could claim deductions without making actual payments to employees, thus protecting employees' welfare and preventing fraud upon revenue.

3. Consistency of Clause (f) with Other Clauses of Section 43B:
The High Court had held that clause (f) was inconsistent with other clauses of Section 43B, which primarily dealt with statutory liabilities. The Supreme Court disagreed, noting that Section 43B includes a mix of diverse deductions, including taxes, duties, and employee welfare-related liabilities. The Court observed that the legislature had the power to include different types of deductions in Section 43B and that clause (f) shared sufficient nexus with the broad objective of protecting public interest and employees' welfare.

4. Nexus of Clause (f) with the Original Enactment of Section 43B:
The High Court had also held that clause (f) lacked nexus with the original enactment of Section 43B. The Supreme Court found this reasoning flawed, stating that Section 43B was designed to curb practices of evasion of statutory and employee welfare-related liabilities. Clause (f) was consistent with this objective, as it aimed to ensure that deductions for leave encashment liabilities were only allowed when actual payments were made, thereby preventing potential misuse by employers.

5. Impact of Clause (f) on the Judgment in Bharat Earth Movers vs. Commissioner of Income Tax:
The respondents argued that clause (f) was enacted solely to nullify the judgment in Bharat Earth Movers, which held that leave encashment liabilities were present liabilities and deductible in the year they accrued. The Supreme Court clarified that while the legislature cannot overrule a judicial decision, it can enact laws to address the issues identified by the Court. The Court noted that clause (f) did not reverse the nature of the liability or take away the deduction but merely regulated the timing of the deduction to ensure actual payment was made.

Conclusion:
The Supreme Court reversed the judgment of the Division Bench of the High Court, holding that clause (f) of Section 43B is constitutionally valid and operative. The Court emphasized that the provision was enacted to prevent potential misuse by employers and to protect employees' welfare, in line with the objectives of Section 43B. The appeal was allowed, and no order as to costs was made.