9911796707
TMI Blog1993 (10) TMI 19X X X X Extracts X X X X X X X X Extracts X X X X ..... the two directors for purchase of deferred annuity. Out of the aforesaid claims, certain claims made by the company were not allowed and certain claims were allowed finally by the Income-tax Appellate Tribunal. Being aggrieved and dissatisfied by the said order passed by the Tribunal, the assessee as well as the Revenue filed applications for making reference to this court. On the basis of the said applications, at the instance of the assessee and the Revenue, the Income-tax Appellate Tribunal has referred the questions for our opinion under section 256 of the Income-tax Act. Re : Question No.1: The question referred is as under: "Whether the surtax liability of Rs. 21,85,104 is deductible in computing the total income of the assessee?" This question is concluded by the decision of this court in the case of S. L. M. Maneklal Industries Ltd. v. CIT [1988] 172 ITR 176, where it is held that the surtax stands on the same footing as income-tax inasmuch as it is also a tax on the total income computed under the Income-tax Act after its adjustment under the Companies Profits (Surtax) Act, 1964. Therefore, surtax is not an expenditure laid out wholly and exclusively for the purpose ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the legitimate business needs of the company and the benefit derived by or accruing to it therefrom, so, however, that the deduction in respect of the aggregate of such expenditure and allowance in respect of any one person referred to in sub-clause (i) shall, in no case, exceed- (A) where such expenditure or allowance relates to a period exceeding eleven months comprised in the previous year, the amount of seventy-two thousand rupees; (B) where such expenditure or allowance relates to a period not exceeding eleven months comprised in the previous year, an amount calculated at the rate of six thousand rupees for each month or part thereof comprised in that period." We are required to consider the case of the assessee under the provisions of section 40(c)(i) which, inter alia, provides that in the case of any company any expenditure which results directly or indirectly in the provision of any remuneration or benefit or amenity to a director or to a person who has a substantial interest in the company or to a relative of the director or of such person shall not be allowable deduction if that deduction in respect of the aggregate of such expenditure and allowance in respect of any ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ration' was dropped from the relevant phrase giving an indication that the Legislature did not intend to include cash emoluments in any of the words 'benefit, amenity and perquisite'. Secondly, by the said amendment of 1964, the Legislature also added the words 'whether convertible into money or not'. Thirdly, it is also pertinent to note that in sub-clause (i) of the said clause (c) of section 40, the word 'remuneration' was retained along with the other words 'benefit or amenity' even after the aforesaid amendment of sub-clause (iii). This has also manifested that the Legislature was conscious of the distinction between the relevant words and keeping in mind the said distinction, the Legislature has deliberately chosen to delete the expression 'remuneration' from sub-clause (iii)." (emphasis added). From the aforesaid observations, it is apparent that the court has not interpreted the phrase "remuneration, benefit or amenity" used in sub-clause (i). On the contrary, applying the reasoning adopted by the court for interpreting sub-clause (iii) in the context of sub-clause (i), it would be clear that sub-clause (i) is very wide. It includes remuneration, benefit or amenity given e ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... jarat Steel Tubes Employees' Welfare Fund by an entry dated March 25, 1975. On the same day, in the company's books of account it was debited to other welfare expenses. The Income-tax Officer rejected the claim of the company for the deduction of the said amount by holding that the actual payment has not been done during the period from April 1, 1974, to March 31, 1975. The actual payment to the fund has been made as under: Rs. 500 on June 2, 1975 5,00,000 on June 17, 1975. He further held that the trust was not registered under the Public Trusts Act, nor any application had been made to the Commissioner of Income-tax for recognition under section 80G of the Act. He also held that for the relevant period at the most it can be said that the said amount was a mere provision as no actual payments were made. He further observed that there is no statutory obligation on the part of the company to make any payment to such type of funds. Therefore, he disallowed the claim for deducting Rs. 5 lakhs and Rs. 500. The Appellate Assistant Commissioner set aside the order passed by the Income-tax Officer by holding that the mere fact that the actual payments were made after the close of acco ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ounts as per the "mercantile" method of accounting. From the aforesaid facts, Mr. Soparkar, learned counsel for the assessee, vehemently submitted that the Tribunal ought to have held that the amount of Rs. 5 lakhs was paid to the trust on March 26, 1975, and in any case it ought to have held that the said amount was laid out at least on that date. He further submitted that as the assessee-company is maintaining accounts as per the mercantile method of accounting which would mean that when it had posted the credit entry in favour of the trust, that amount is paid to the trust even though actual payment is made by cheque only on June 17, 1975. He, therefore, submitted that the Tribunal erroneously relied upon the decision of the Supreme Court in the case of Indian Molasses Co. [1959] 37 ITR 66. In the case of Indian Molasses Co. [1959] 37 ITR 66 (SC), the assessee-company had executed a trust deed in favour of three trustees to whom the company paid a sum of pound 8,208-19-0 (Rs. 1,09,643) and further undertook to pay annually Rs. 4,364 for six consecutive years, and the trustees agreed to execute a declaration of trust. The trustees undertook to hold the said sums upon trust to s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... over the accounting period and to deduct such sums from profits. But the income-tax laws do not take every such allowance as legitimate for purposes of tax. A distinction is made between an actual liability in praesenti and a liability de futuro which, for the time being, is only contingent. The former is deductible but not the latter. The case which illustrates this distinction is Peter Merchant Ltd. v. Stedeford [1948] 30 TC 496 (CA). No doubt, that case was decided under the system of income-tax laws prevalent in England, but the distinction is real. What a prudent trader sets apart to meet a liability, not actually present but only contingent, cannot bear the character of expense till the liability becomes real." After considering the decision in the case of Southern Railway of Peru Ltd. v. Owen [1957] 32 ITR 737 (HL), the court observed that if the pension itself be not payable as an obligation, and if there be a possibility that no such payment may be necessary in the future, the whole of the amount cannot be deducted but only the present value of the future liability, if it can be estimated. The court thereafter considered the meaning of the word "expenditure" and observed ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ount of the assessee, it could not be said that money was paid out or paid away. Further, it would be difficult to say that it was mere posting of an entry and, therefore, there was no payment. In the mercantile system of accounting it is well-established that posting of such type of entries brings into credit what is due immediately. This method of accounting is explained in various decisions of the Supreme Court. In the case of Keshav Mills Ltd. v. CIT [1953] 23 ITR 230 (SC), the court has held as under: "The mercantile system of accounting or what is otherwise known as the double entry system is opposed to the cash system of book keeping under which a record is kept of actual cash receipts and actual cash payments, entries being made only when money is actually collected or disbursed. That system brings into credit what is due, immediately it becomes legally due and before it is actually received and it brings into debit expenditure the amount for which a legal liability has been incurred before it is actually disbursed. The profits or gains of the business which are thus credited are not realised but having been earned are treated as received though in fact there is nothing ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s not paid by the assessee-company to the trust during the relevant assessment year. The claim for deduction of the sum of Rs. 5 lakhs paid by the assessee to the Gujarat Steel Tubes Employees' Welfare Fund ought to have been allowed even though the actual amount is paid on June 17, 1975, i.e., in the next assessment year. Therefore, the question is answered in the negative, in favour of the assessee and against the Revenue. Re : Question No. 4: The question is as under: "Whether the expenditure of Rs. 24,125 incurred for the issue of bonus shares is allowable as revenue expenditure?" The question with regard to expenditure incurred for the issue of bonus shares is also covered by the decision of this court in the case of Ahmedabad Mfg. and Calico Pvt. Ltd. v. CIT [1986] 162 ITR 800, wherein the court has held that expenses incurred in connection with the issue of bonus shares are incurred by the company for its permanent structure and is directly connected with the acquisition of capital and advantages of an enduring nature. It is not allowable as revenue expenditure. Therefore, this question is answered in favour of the Revenue and against the assessee. Re : Questions Nos. 5 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... fit) as soon as the contract for commission was varied and as no right in the policy had been created for the benefit of the managing director, there is no linking so as to regard the purchase of the policy as the outlay of commission; (e) the company has also the right of cash option immediately before the annuity vests; (f) it is a financial operation by which the company has provided itself with funds at a future date, should it desire then to make any retirement payment to the managing director; and (g) the amounts which would be received by it, may constitute income at the stage but the amount laid out at present is clearly a business expenditure." From the aforesaid facts, Mr. Thakore, learned counsel for the Department, vehemently submitted that it would be difficult to hold that the assessee-company has incurred any expenditure. It is his contention that the company has set apart its capital for paying an annuity to its managing director in future if it so desires at the relevant time. He further submitted that in any set of circumstances it cannot be said to be a revenue expenditure deductible under section 37 of the Income-tax Act. According to his contention,it would ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nces, it may or may not pay. (b) As a matter of fact the ownership of the money (the deferred annuity policy) remains with the company. (c) The amount invested by the assessee-company remains an integral part of its capital and, in any case, is not used for the working capital of the assessee-company. (d) After the deferred annuity policy matures, the benefit is derived by the assessee-company-the benefit may be of secured payment for a particular time with interest or bonus. Hence, presuming that the assessee-company has expended the said amount by purchasing the deferred annuity policy, yet it amounts to acquisition of capital and has the advantage of enduring nature, may be after the lapse of five years or ten years as per the terms of the policy. Therefore, it would be difficult to hold that the amount expended for purchase of the deferred annuity policy is revenue expenditure for which deduction can be granted under section 37 of the Income-tax Act. Mr. Soparkar, learned counsel for the assessee, relied upon the decision of the Supreme Court in the case of Empire Jute Co. Ltd. v. CIT [1980] 124 ITR 1, for contending that the expenditure for purchase of the deferred annuit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... capital is what he makes profit of by parting with it and letting it change masters." Applying the aforesaid test also in this case, it can be said that the assessee-company has circulated its capital by parting with it for purchasing the deferred annuity policy. The court has considered a further test which is as under : "The question must be viewed in the larger context of business necessity or expediency. If the outgoing expenditure is so related to the carrying on or the conduct of the business that it may be regarded as an integral part of the profit-earning process and not for acquisition of an asset or a right of a permanent character, the possession of which is a condition of the carrying on of the business, the expenditure may be regarded as revenue expenditure. See Bombay Steam Navigation Co. (1953) P. Ltd. v. CIT [1965] 56 ITR 52 (SC). The same test was formulated by Lord Clyde in Robert Addie and Sons' Collieries Ltd. v. IRC [1924] 8 TC 671, 676 (C. Sess.) in these words : 'Is it a part of the company's working expenses?-Is it expenditure laid out as part of the process of profit-earning?-or, on the other hand, is it a capital outlay?-Is it expenditure necessary for ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed voluntarily and without any necessity and, if it is incurred for the purpose of promoting business and to earn profits, the assessee is entitled to deduction under section 37 of the Income-tax Act, even though there was no compelling necessity to incur such expenditure. For substantiating this contention, he relied upon the decision of the Supreme Court in the case of Sassoon J. David and Co. P. Ltd. v. CIT [1979] 118 ITR 261. In that case, the assessee-company was an investment company and its shares were originally held either directly or through their nominees by Sir Percival David, Lady David and Mr. V. P. David. Thereafter, an agreement was entered into between the Davids and Tata Sons Ltd. to sell 1,000 shares held by the Davids or their nominees in the company in favour of Tatas or their nominees for a sum of Rs. 155 lakhs. The said agreement, inter alia, provided that the sum voted by the company for payment of gratuities and/or as compensation for loss of employment to existing directors and employees of the company with respect to their services up to and inclusive of March 31, 1956, and a further amount of Rs. 16,188 payable to the managing director should be paid in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... istribution of profits or was wholly gratuitous or for some improper or oblique purpose outside the course of business then the expense is not deductible. In deciding whether a payment of money is a deductible expenditure one has to take into consideration questions of commercial expediency and the principles of ordinary commercial trading. If the payment or expenditure is incurred for the purpose of the trade of the assessee it does not matter that the payment may enure to the benefit of a third party (Usher's Wiltshire Brewery Ltd. v. Bruce [1914] 6 TC 399 (HL)). Another test is whether the transaction is properly entered into as a part of the assessee's legitimate commercial undertaking in order to facilitate the carrying on of its business; and it is immaterial that a third party also benefits thereby (Eastern Investments Ltd. v. CIT [1951] SCR 594; 20 ITR 1 (SC). But in every case, it is a question of fact whether the expenditure was expended wholly and exclusively for the purpose of the trade or business of the assessee." In this view of the matter, in our view, the aforesaid judgment also would be of no assistance to the contention of the assessee that the amount expended b ..... X X X X Extracts X X X X X X X X Extracts X X X X
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