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TMI Blog1993 (10) TMI 19X X X X Extracts X X X X X X X X Extracts X X X X ..... ares as revenue expenditure. (e) It also claimed deduction for Rs. 90,000 under section 37 as it paid the premium of Rs. 45,000 on the lives of each of 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 A ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... if in the opinion of the Income-tax Officer any such expenditure or allowance as is mentioned in sub-clauses (i) and (ii) is excessive or unreasonable having regard to 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 re ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... clear from the following observations made by the court: "It may be noted that, in the amendment which was effected by the amendment of Finance Act, 1964, the word 'remuneration' 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 cou ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ontention of the company that on the basis of a resolution passed by the board of directors in the meeting held on March 25, 1975, the said amount was credited in the name of the Gujarat 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... that this entry was posted in pursuance of the resolution on March 26, 1975, passed by the board of directors of the company. It is also not disputed that the company is maintaining accounts 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 fu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... comes out of the trader's pocket. Thus, in finding out what profits there be, the normal accountancy practice may be to allow as expense any sum in respect of liabilities which have accrued 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e trust. Hence, in our view, the Tribunal erred in relying upon the aforesaid decision for negating the claim for deduction by holding that merely because an entry was made in the books of account 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 incu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y the amount is paid on June 17, 1975. In the result, the Tribunal erroneously held that the amount of Rs. 5 lakhs was not deductible under section 37 of the Income-tax Act because the said amount was 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 acquisitio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cept a contingent interest; (c) it is not a remuneration to the managing director; (d) the managing director had no enforceable right against the company to commission (at the rate of one per cent. of the net profit) 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... be satisfied at another point of time at the discretion of the assessee. There was an absolute discretion with the assessee-company to make payment to its managing directors after the specified period. In certain circumstances, 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. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he distinction between fixed capital and circulating capital in words which have almost acquired the status of definition. He said : "Fixed capital is what the owner turns to profit by keeping it in his own possession; circulating 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 T ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rned counsel, Mr. Soparkar, next contended that it is for the assessee-company to decide as to whether expenditure should be incurred for purchase of deferred annuity policy in the course of its business and such expenditure can be incurred 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 compe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... g observations made by it in CIT v. Chandulal Keshavlal and Co. [1960] 38 ITR 601, 610 (SC) : "Another fact that emerges from these cases is that if the expense is incurred for fostering the business of another only or was made by way of distribution 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 expend ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ee had no right until the contingency occurred. The employer's contributions towards the premia were not perquisites allowed to the employee by the employer or amounts due to him from the employer. Applying the aforesaid test also, it can be said that there was no obligation on the part of the assessee to pay and there was no vested right in the directors to claim and in future it was a contingent liability depending upon the desire of the company (as stated by it). Hence, it cannot be said that the said expenditure is allowable under section 37 of the Income-tax Act. In view of the aforesaid discussion, question No. 6 is answered in the negative, i.e., in favour of the Revenue and against the assessee. Question No. 5 would not require to be discussed in view of our finding that the amount of Rs. 90,000 being the premium paid in respect of the purchase of deferred annuity on the lives of the two directors of the assessee-company is not allowable under section 37 of the Income-tax Act. Once the provisions of section 37 are not applicable, there is no question of application of section 40(c). Hence, question No. 5 is not required to be answered and is left unanswered. In the ..... X X X X Extracts X X X X X X X X Extracts X X X X
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