Full Judgment Text
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PETITIONER:
SASSOON J. DAVID & CO. (P) LTD., BOMBAY
Vs.
RESPONDENT:
C.I.T., BOMBAY
DATE OF JUDGMENT03/05/1979
BENCH:
VENKATARAMIAH, E.S. (J)
BENCH:
VENKATARAMIAH, E.S. (J)
UNTWALIA, N.L.
CITATION:
1979 AIR 1441 1979 SCR (3) 878
ACT:
Indian Income Tax Act 1922-Section 10(2) (xv)-Scope of-
Retrenchment compensation paid to employees whose services
were terminated-If an allowable deduction-"Wholly and
exclusively" meaning of-Benefit to third party-Whether a
consideration for not allowing deduction.
HEADNOTE:
In January, 1956 the assessee company whose assets had
been valued at Rs. 155 lacs as on December 31, 1955 decided
to terminate the services of 22 of its employees with effect
from 31st March, 1956 and to pay them retrenchment
compensation and compensation for termination of employment.
Thereafter Davids, who held the shares of the company
entered into an agreement with Tatas to sell to them all the
shares for Rs. 155 lacs. The agreement provided that
compensation and gratuity payable to the Directors and
employees whose services had been terminated and the annuity
payable to the managing director should be deducted from the
purchase consideration. The assessee claimed deduction under
s. 10(2)(xv) of the Indian Income Tax Act, 1922 of a sum of
Rs. 1.64 lakhs paid by way of retrenchment compensation and
compensation for termination of service during the
assessment year 1957-58 and a sum of Rs. 16,885 which was
the amount of annuity paid to the managing director in each
of the three succeeding assessment years.
The Income Tax officer disallowed the amounts on the
ground that the services of the directors and employees had
been terminated not as business expediency but because the
purchasers of the shares made it a condition under the
agreement.
On appeal the Appellate Assistant Commissioner,
affirming the view of the Income Tax Officer, held that the
decision to pay compensation could not be said to have been
taken solely with a view to the business requirement of the
company.
Dismissing the assessee’s appeal the Appellate Tribunal
held that the expenses had not been incurred for the purpose
of the company but purely as a result of the bargain between
Davids and Tatas and assuming that the payments were
beneficial to the assessees by reason of the reduction in
its establishment expenses, no deduction could be allowed
under s. 10(2) (xv) since the payment was made to the
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benefit of a third party.
Relying principally upon the decision of this Court in
Gordon Woodroffee Leather Manufacturing Co. v. The Commr. of
Income-tax, [1962] Supp. 2 SCR 211, the High Court held that
the amount involved in the case did not satisfy the test
applicable to the expenditure allowable under s. 10(2)(xv)
of the Act and, therefore, disallowed the expenditure of Rs.
1.27 lakhs out of a sum of Rs. 1.64 lakhs on the ground that
it had not been incurred for commercial expediency. The High
Court also disallowed the annuity paid to the managing
director in the succeeding three assessment years.
879
Allowing the assessee’s appeals
^
HELD: 1(a) The three tests laid down by this Court in
Gordon Woodroffee’s case viz., (1) that the payment should
have been made as a matter of practice which affected the
quantum of salary, (ii) that there was an expectation by the
employee of getting a gratuity and (iii) that the sum of
money was expended on the ground of commercial expediency
and in order indirectly to facilitate the carrying on of the
business of the assessee have to be read disjunctively. So
read the present case which satisfied the third test fell
under s. 10(2) (xv) of the Act. The High Court was in error
in holding that the amount in question did not satisfy any
of the tests applicable to the expenditure allowable under
the section. [893H]
(b) In order to claim deduction under the section an
assessee has to show that the expenditure in question (1)
was not an allowance of the nature described in any of the
clauses (i) to (xiv) of the section, (ii) was not in the
nature of a capital expenditure or personal expenses of the
assessee and (iii) had been laid out or expended wholly and
exclusively for the purposes of his business, profession or
vocation. [891G]
(c) Even assuming that the motive behind the payment of
retrenchment compensation was that the terms of the
agreement of the sale of shares should be satisfied, as long
as the amount had been laid out or expended wholly and
exclusively for the purpose of the business of the assessee
there could be no good reason for denying the benefit of
this section if there was no other impediment to do so.
[891H]
In the instant case the assessee company was neither
dissolved nor was its business undertaking sold. It
continued to exist as a juristic entity and continued to
function even after the transfer of its shares to Tatas. The
expenditure was laid out for the purpose of the assessee
company’s own trade and not for the trade of Tatas who were
only shareholders of the company. As a result of the
expenditure the company was benefited and it was possible
for it to earn more profits as a consequence of the
reduction in the wage bill. It cannot be said that Tatas
were in any way benefited financially by reason of reduction
in the consideration payable by them for the shares. [893B-
C]
Gordon Woodroffae Leather Manufacturing Co. v. The
Commissioner of Income-tax, Madras, [1962] Supp. 2 SCR 211,
applied.
(i) Commissioner of Inland Revenue v. Patrick Thomson,
Ltd. (in Liquidation),
(ii) Commissioners of Inland Revenue v. J. & R. Allan,
Ltd. (In liquidation),
(iii) Commissioners of Inland Revenue v. Pattigrew &
Stephens, Ltd., 37 T. C. 145, referred to.
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Commissioner of Income-tax, Gujarat v. Laxmi Cement
Distributors (P) Ltd., 104 ITR 711, Commissioner of Income-
tax, Bombay City I v. Fairdeal Corporation (P) Ltd., 108 ITR
280; Commissioner of Income-tax, Bombay City I v. Patel
Cotton Co. Pvt. Ltd., 108 ITR 846; approved.
880
(d) Moreover it is too late in the day whatever might
have been the position about two decades ago, to treat the
expenditure incurred by the management in paying reasonable
sums by way of gratuity and retrenchment compensation or
compensation for termination of services as not business
expenditure. Such expenditure would ordinarily fall within
the scope of s. 10(2)(xv) of the Act. [889C]
2. The argument that since there was no necessity to
retrench the services of all the employees, the expenditure
could not be treated as one laid out wholly and exclusively
for the purpose of business has no force. The expression
"wholly and exclusively" does not mean "necessarily".
Ordinarily it is for the assessee to decide whether any
expenditure should be incurred in the course of his or its
business. Such expenditure may be incurred voluntarily and
without any necessity and if it is incurred for promoting
the business and to earn profits the assessee can claim
deduction under the section even though there was no
compelling necessity to incur such expenditure. The fact
that somebody other than the assessee was also benefited by
the expenditure should not come in the way of an expenditure
being allowed by way of deduction under the section, if it
satisfies otherwise the test laid down by law. [894D-G]
In the instant case the company thought that its
business could be carried on with a smaller number of
employees and the only way to reduce the number was to
terminate the services of all employees by paying
compensation and to re-employ only some of them. Thereby the
company reduced its expenditure on wages payable to its
employees. It could not therefore be said that compensation
was paid with an oblique motive and without regard to
commercial considerations or expediency. [895F]
JUDGMENT:
CIVIL APPELLATE JURISDICTION: Civil Appeal No. 2501 of
1972.
From the Judgment and order dated 5-2-1970 of the
Bombay High Court in Income Tax Reference No. 58/73.
AND
CIVIL APPEAL NOS. 2502-2504 OF 1972
From the Judgment and Order dated 25th/26th Feb. 1971
of the Bombay High Court in Income Tax Ref. No. 87/63.
V. S. Desai, Dinesh Vyas, K. J. John and Sree Narain
for the Appellants in all the appeals.
Hardyal Hardy, Champat Rai, B. B. Tawekley and Miss A
Subhashini for the Respondent in all the appeals.
The Judgment of the Court was delivered by
VENKATARAMIAH, J.-Since these appeals by certificate
involve a common question of law, we find it convenient to
dispose them of by this common judgment.
881
Civil Appeal No. 2501 of 1972 is filed against the
Judgment of the High Court of Bombay in Income Tax Reference
No. 58 of 1963 and Civil Appeals Nos. 2502-2504 of 1972 are
filed against the judgment of that High Court in Income Tax
Reference No. 87 of 1965. The assessee, M/s Sasoon J. David
& Co. Pvt. Ltd. (hereinafter referred to as ’the Company’)
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is the appellant in all these cases and the assessment years
are 1957-58, 1958-59, 1959-60 and 1960-61, the relevant
calendar years being 1956, 1957, 1958 and 1959 respectively.
The Company is 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 (hereinafter collectively referred to as ’Davids’).
The issued capital of the Company consisted of 1000 ordinary
shares of the face value of Rs. 10,000/- each. According to
the valuation made by the auditors, the assets of the
Company were worth Rs. 155 lacs as on December 31, 1955. At
a meeting of the directors of the Company held on December
2, 1955, a resolution was passed recommending that the
employees of the Company whose names were set out in the
statement attached thereto be paid certain sums or annuity
as set out against the names of each of them as and by way
of retrenchment compensation and compensation for
termination of employment and also for long and faithful
services rendered by them to the Company in the past and
that their services might be terminated. It was also
resolved to call an extra-ordinary general meeting of the
shareholders of the Company to consider and if thought fit
to approve the recommendation made by the directors as
stated above. Accordingly an extra ordinary general meeting
of the shareholders of the Company was held on January 17,
1956 but it was adjourned to January 25,1956. On the
adjourned date, the meeting passed a resolution approving
the recommendation made by the directors to pay the
employees retrenchment compensation and compensation for
termination of employment and also additional retrenchment
compensation and compensation for termination of employment
in the case of some of them and to terminate their services
on or after April 1, 1956. Thereafter an agreement was
entered into between Davids and Tata Sons Ltd. (hereinafter
referred to as ’the Tatas’) on March 23, 1956 agreeing to
sell the 1000 shares held by Davids or their nominees in the
Company in favour of Tatas or their nominees for a sum of
Rs. 155 lacs. 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 upto and inclusive of March 31, 1956 and a further
amount of
882
Rs. 16,188/- payable to the Managing Director, Mr. Mathalone
should be paid in accordance with the resolution by the
Company and the amount so paid should be deducted from the
purchase price of Rs. 155 lacs agreed upon. It also provided
that Davids should arrange to terminate the services of all
employees with effect from March 31, 1956 and also to
arrange that all directors (including the Managing Director)
resign their offices and Tatas or their nominees should
thereafter be entitled to appoint or elect all or any of the
members of the staff and directors (including existing
directors and members of the staff) of the Company as they
deemed fit.
Of the 22 employees covered by the resolution of the
directors dated December 2, 1955 followed by the
confirmation at the extra-ordinary general meeting of
January 25, 1956, 9 were re-employed and 13 persons were not
re-employed. In the books of the assessee, there was a debit
for a total sum of Rs. 1,64,899/- during the accounting year
1956, the details for which were as follows:-
Amount payble to the 22 employees as per
resolution dated 2-12-1955 and 25-1-1956
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Rs 1,04,626/-
Amount described as "additional retrechment
compensation and compensation for termination
of employment and also for long and faitful
services", as per resolutin No. 2 dated Rs 6,000/-
Compensation for termiantion of pension Rs 21,200/-
Annuity of Shri A.E. Joseph, former Director
as per resolsution dated 2-12-1956 Rs 16,885/-
Amount described as "compensation for loss of
office. Managing Director Mr. R. Mathalone" Rs 16,188/-
-------------
Total : Rs 1,64,899/-
-------------
It should be mentioned here that A.E. Joseph, the
former Director of the Company had to be paid as per the
resolution of the Company Rs. 16,885/- by way of annuity
during a period of five years commencing with 1956.
During the assessment year 1957-58, the relevant
previous year being 1956, the Company claimed deduction of
Rs. 1,64,899/- referred to above before the Income-tax
Officer under section 10(2) (xv) of the
883
Indian Income-tax Act, 1922 (hereinafter referred to as ’the
Act’). During each of the three succeeding assessment years
with which we are concerned, the Company claimed deduction
of Rs. 16,885/- being the annuity paid to Mr. A. E. Joseph
pursuant to the resolution. During the assessment year 1957-
58, the claim in respect of the entire sum of Rs. 1,64,899/-
was disallowed by the Income-tax Officer on the ground that
the services of the directors and employees had been
terminated not because of business expediency but because
Tatas, the purchasers of the shares made it a condition
under the agreement. The relevant part of the order read as
follows:-
"Thus, it emerges that the expenditure of the type
of gratuity would be allowable u/s 10(2) (xv) only if the
persons retiring had such expectancy or they accepted lower
salaries in such expectation and hence it was an incentive
to existing employees of future employees. As against that
we find that here even before the Tatas took up the
management of the company, services of the employees and
directors were terminated and the amount of compensation
fixed. The fact that there was no expectancy or custom of
such gratuity with the company is clearly borne out by the
fact that many of the employees whose services are
terminated had put in a number of years of service in some
cases even going upto 40 years. As against this the assessee
has been pleading that most of the employees were very old
and that as a result of change of staff the Company was able
to effect considerable economy. However, I understand that
some of the old employees were reinstated and as stated the
whole transaction was a part of the overall transaction of
purchase of shares and passing over of control. The manner
in which the services of all the employees under the old
management were terminated is also significant. Thus I am
unable to see how this expenditure can fall u/s. 10(2) (xv).
I am unable to find any distinction between compensation
paid to employees and those paid to directors and also any
distinction between outright compensation paid to a director
and annuity paid to a director. None of the expenses are
allowable and I add the whole amount claimed by way of
gratuity, compensation for loss of employment and annuity or
compensation for loss of office to a director or former
director."
Aggrieved by the decision of the Income-tax Officer,
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the Company filed an appeal before the Appellate Assistant
Commissioner of
884
Income-tax. The Appellate Assistant Commissioner after
taking into account the records before the Income-tax
Officer and the statement filed by the Company before him
found that the Income-tax Officer was right in disallowing
the claim even though he was of opinion that the Company had
by the termination of services of the directors and the
employees by payment of gratuity and/or compensation been
benefited. The relevant part of his order was as follows:-
"The only contention remaining to be considered is
that the Income-tax Officer was wrong in disallowing a sum
of Rs. 1,64,899/- paid to certain employees and directors as
compensation for termination of services. The circumstances
leading to the payment of this compensation have been
narrated in detail in the order of the Income-tax Officer.
It is strongly urged that the termination of the services of
the persons concerned was of great benefit to the Company
even considering the payment of the compensation since the
establishment expenses were very substantially reduced as a
result. From the information furnished to me, this statement
is no doubt quite justified. However, it is seen that the
termination of the services and the payment of compensation
were not done wholly with a view to the business
requirements of the company, but were bound up with the
changing of hands of the shares of the company. According to
the agreement for the sale of all the shares of the company
the sellers had to arrange to terminate the services of all
the employees and also arrange that all directors resigned
their offices. It is expressly stated that this requirement
was to enable the purchasers to appoint or elect all members
of the staff and directors. As a matter of fact some of the
persons to whom compensation had been paid for termination
of services were immediately re-employed by the Company. The
decision to pay compensation cannot in the circumstances be
said to have been taken solely with a view to the business
requirement of the company though incidentally the company
might have been benefited by it. In view of what has been
stated above. I feel that the Income-tax Officer was
justified in his action. The appellant has referred to the
Bombay High Court decision in the case of F.E. Dinishaw
Ltd., but the facts in the present case are not identical
with those of the case mentioned."
On further appeal to the Tribunal by the Company, the
Tribunal affirmed the order of the Appellate Assistant
Commissioner holding
885
that the inference drawn by the Income-tax Officer that the
payments in question were motivated by the reorganisation of
share-holding had not been challenged by the Company; that
the reference made to the said payments in the agreement of
sale of shares led to such an inference and that the
expenditure had not been incurred for the purpose of the
Company but purely as a result of the bargain between Davids
and Tatas. It was further held by the Tribunal that even
assuming that the payments were beneficial to the Company,
no deduction could be allowed since they had been made to
benefit third parties. Accordingly the Tribunal dismissed
the appeal.
An application made under section 66(1) of the Act
before the Tribunal was rejected. Thereafter the Company
filed an application before the High Court of Bombay under
section 66(2) of the Act and the High Court directed the
Tribunal to state a case and to refer the following
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questions of law for its opinion:-
"(1) Whether the Tribunal erred in law disallowing
the amount of Rs. 1,64,899/- as a deduction under section 10
of the Indian Income-tax Act, 1922 ?
(2) Whether there was any evidence to justify the
Tribunal’s finding that the payment of Rs. 1,64,899/- or any
part thereof was made in view of and in order to effectuate
the agreement entered into between the old shareholders and
the new shareholders and that the payment had no commercial
purpose behind it ?
(3) Whether in any event the sum of Rs. 16,188/-
paid to the Managing Director by way of pay in lieu of six
months’ notice was allowable as a deduction under section 10
of the Indian Income-tax Act, 1922 ?"
Accordingly, the Tribunal drew up a statement of the
case and referred the above questions. Later on the Tribunal
referred under section 66(1) the following question of law
arising out of the orders of assessment for the assessment
years 1958-59, 1959-60 and 1960-61 in respect of the annuity
paid to Mr. A. E. Joseph:-
"Whether in computing the assessee’s business
income of the accounting years 1957, 1958 and 1959, relevant
for the assessment years 1958-59, 1959-60 and 1960-61, the
sum of Rs. 16,885/- is an admissible deduction under section
10(2)(xv) of the Act?
886
It is not necessary to refer to the other matters
involved in the orders of assessment of the years 1958-59,
1959-60 and 1960-61 and to the various stages of the cases
until they reached the High Court.
Income-tax Reference No. 58 of 1963 arising out of the
assessment proceedings of the year 1957-58 was heard by a
Division Bench of the High Court of Bombay and decided on
February 5, 1970. The High Court found that out of Rs.
1,64,899/- referred to in question No.1 only a sum of Rs.
21,200/- which was commutation of liability for payment of
pension to some retired employees and/or widows of such
employees and a sum of Rs. 16,188/- paid to Mr. Mathalone,
Managing Director in lieu of six months notice that had to
be given prior to termination of his service were allowable
as deductions and that the Company was not entitled to claim
deduction of the remaining sum of Rs. 1,27,511/-. It
accordingly answered question No.1 in the negative in so far
as the sum of Rs. 1,27,511/- (excluding two items of Rs.
21,000/- and Rs. 16,188/-) was concerned, question No. 2 in
the affirmative in so far as the amount aggregating to Rs.
1,27,511/- (excluding the two items of Rs. 21,200/- and Rs.
16,188/-) was concerned and question No. 3 in the
affirmative. The High Court was of the view that the
expenditure of the sums amounting to Rs. 1,27,511/- paid to
the employees and a director of the Company by way of
retrenchment compensation or compensation for termination of
service had not been incurred by the Company for commercial
expediency and/or considerations. It accordingly disallowed
the claim made by the Company to the extent indicated above.
The Income-tax Reference case arising from the assessment
orders relating to assessment years 1958-59, 1959-60 and
1960-61 came before another Division Bench of the High Court
and that Division Bench following the decision rendered by
the High Court earlier disallowed the claim of the Company
for deduction in respect of the payment of Rs. 16,885/- to
Mr. A. E. Joseph in each of the accunting years relative to
the assessment years in question. Aggrieved by the judgments
of the High Court of Bombay, the Company has filed these
appeals.
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We are concerned in these appeals with the claim of the
Company in respect of a sum of Rs. 1,27,511/- out of Rs.
1,64,899/- referred to in questions Nos. 1 and 2 in the
reference relating to the assessment year 1957-58 and the
claim in respect of payment of Rs. 16,885/- made to Mr. A.
E. Joseph during each of the three succeeding years. The
undisputed facts of the case are: The shares of the Company
887
were held by Davids or their nominees till they were
transferred to Tatas; that according to the valuation made
by the auditors of the Company, its assets were worth Rs.
155 lacs as on December 31, 1955; that at a meeting of the
directors held on December 2, 1955, it had been resolved
that the services of 22 employees should be terminated by
paying retrenchment compensation; that on January 25, 1956
at the extra-ordinary general meeting of the shareholders of
the Company, it was resolved that the employees of the
Company be paid certain sums or annuity set out against the
names of each of them and their services should be
terminated with effect from April 1, 1956; that an agreement
was entered into between Davids and Tatas on March 23, 1956
regarding the sale of the shares in favour of the Tatas;
that the said agreement referred to the resolution passed at
the meeting of the shareholders of the Company; that the
Company paid retrenchment compensation according to the said
resolution and that the Tatas deducted from the purchase
price the sum payable by the Company in accordance with the
resolution of the Company from out of the consideration of
Rs. 155 lacs which they had agreed to pay under the
agreement dated March 23, 1956 to Davids. Apart from the
resolution of the Board of Directors of the Company dated
December 2, 1955, the resolutions passed at the extra-
ordinary general meeting of the shareholders of the Company
held on January 25, 1956, the agreement dated March 23, 1956
entered into between Davids and Tatas, the books of account
of the Company showing payments made by the Company by way
of retrenchment compensation and the fact that 9 of the 22
employees whose services had been terminated had been
reemployed, there was no other evidence before the Income-
tax Officer. The Income-tax Officer presumably because of
the proximity of the dates of the resolutions, the date of
the agreement and the dates on which retrenchment
compensation was paid to the employees came to the
conclusion that the retrenchment of the employees had been
effected as a part of the bargain entered into between
Davids and Tatas and therefore compensation paid to the
employees on retrenchment of their services and to the
director on the termination of his service had not been paid
in the course of the business of the Company by way of
commercial expediency. He accordingly disallowed the claim
of the Company under section 10(2) (xv) of the Act. Although
the Appellate Assistant Commissioner in the course of his
order observed that the Company had been benefited by reason
of the retrenchment of the service of the employees as it
had resulted in the reduction of the expenditure on the
establishment, he disallowed the claim on the very same
ground on which the Income-tax Officer had rejected it. The
Triunal proceeded to dispose of the case before it on the
basis that
888
the inference drawn by the Income-tax Officer that the
payments were motivated by the re-organisation in the
shareholding had not been questioned by the Company either
before the Appellate Assistant Commissioner or before it. We
do not find in the order of the Appellate Assistant
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Commissioner that any concession had been made by the
Company to the effect that the finding of the Income-tax
Officer referred to above was correct. In the grounds of
appeal before the Tribunal, the Company had stated that the
Appellate Assistant Commissioner erred in holding that "the
decision to pay compensation cannot in the circumstances be
said to have been taken solely with a view to the business
requirement of the Company though incidentally the Company
might have benefited by it." The appellants submitted before
the Tribunal that the above amount was expended wholly and
exclusively for the purpose of their business and as such it
should have been deducted as an admissiable expense in
computing their income liable to income-tax. The Tribunal
while deciding the question whether the sums paid by way of
compensation were deductible or not observed that the fact
that a reference to payment to the staff of compensation had
been made in the agreement led to the inference that such
payment was a part of the bargain between Davids and Tatas;
that on account of such payment, the purchasers had actually
been benefited while the Company had to make payment in
order to give effect to the agreement and therefore there
was no commercial purpose involved in making the said
payment. The Tribunal also held that even assuming that the
Company was benefited by payment of compensation by reason
of reduction in its establishment expenses, since the
payment had been made as a result of the bargain between
Davids and Tatas, it could not be allowed as a deductible
expenditure. It should be stated here that the Tribunal did
not reverse the finding of the Appellate Assistant
Commissioner that the Company had been benefited by such
payment. In fact it did not go into the question whether the
payment had really resulted in any benefit to the Company.
The High Court, however, in the course of its judgment found
that on account of the retrenchment of the employees and re-
employment of only 9 of them, the yearly wage bill of the
Company for salaries was reduced from Rs. 1,14,197/- in 1955
to Rs. 67,268/- in 1956 and thereafter in 1957 and 1958
respectively to Rs. 54,124/- and Rs. 54,960/-.
In the instant case, it is necessary to bear in mind
that the Company was neither dissolved nor was its business
undertaking sold. It continued to exist as a juristic entity
even after the transfer of its
889
shares by Davids to Tatas. On account of such transfer of
shares, the transferees no doubt gained control on the
Company. But one important fact of the case which was lost
sight of by the High Court and the Tribunal was that neither
Davids nor Tatas derived any direct benefit out of the
payment of retrenchment compensation to the employees even
though such retrenchment might have facilitated the transfer
of shares. It is also not the case of the Department that
the payment was excessive. That there was a substantial
reduction in the wage bill in the future years as a
consequence of retrenchment was also not disputed. It is too
late in the day now, whatever may have been the position
about two decades ago, to treat the expenditure incurred by
a management in paying reasonable sums by way of gratuity,
bonus, retrenchment compensation or compensation for
termination of service as not business expenditure. Such
expenditure would ordinarily fall within the scope of
section 10 (2) (xv) of the Act which authorised the
deduction of any expenditure not being in the nature of
capital expenditure or personal expenses of the assessee
laid out of expended wholly and exclusively for the purpose
of business or profession or vocation.
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The High Court, however, declined to allow the
deduction of the sums referred to above in these cases
principally relying upon the decision of this Court in
Gordon Woodroffee Leather Manufacturing Co. v. The
Commissioner of Income-tax, Madras(1). The facts of that
case were briefly thus: One J. H. Phillips was the Director
of the assessee Company in that case from the year 1940. On
March 22, 1949, he wrote a letter to the assessee expressing
his intention to resign from its Board as from April 4, 1949
and requested that his resignation be accepted. On March 24,
1949, the Board of Directors of the assessee passed a
resolution that his resignation be accepted and in
appreciation of his long and valuable services to the
assessee he be paid a gratuity of Rs. 50,000/- out of which
the assessee was to pay Rs. 40,000/- and its Managing Agent
was to pay Rs. 10,000/-. Subsequently the resolution was
approved at the extra-ordinary general meeting of the
assessee. Accordingly a sum of Rs. 40,000/- was paid by the
assessee to Mr. J. H. Phillips. The assessee claimed
deduction of the said sum of Rs. 40,000/- under section
10(2) (xv) of the Act. The Income-tax Officer as well as the
Appellate Assistant Commissioner disallowed the said claim
on the ground that the Company had no pension scheme; that
the payment was voluntary and that the entry in the
assessee’s books clearly indicated that the payment was
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a capital payment. The Tribunal upheld the order of the
Appellate Assistant Commissioner. It held that according to
the resolution the gratuity was paid "for long and valuable
services to the assessee", that there was nothing to
indicate that Mr. J. H. Phillips had accepted a lower salary
in expectation of getting a gratuity at the end of his
service; that there was no such practice in the assessee-
company; that during the course of his service, he was being
remunerated at a graduated scale of salary and a commission
of 2 1/2% on the profits; that there was no "expectancy"
that at the end of the service there would be recompense for
faithful and efficient service and that he had been suitably
rewarded by being given a commission on the profits "in
order to whip up his enthusiasm". It was also found by the
Tribunal that in the books of the assessee, the amount had
not been debited in the profit and loss account but was
debited to the appropriation account thereby indicating that
it was an extra payment or a payment made in the nature of a
capital expense. On a reference under section 66(1) of the
Act, the High Court of Madras answered the question relating
to the above item of expenditure against the assessee. On
appeal, this Court affirmed the decision of the High Court.
While holding that the claim made by the assessee did not
satisfy the proper tests for claiming exemption under
section 10(2) (xv) of the Act, this Court observed as
follows:-
"In our opinion the proper test to apply in this
case is, was the payment made as a matter of practice which
affected the quantum of salary or was there an expectation
by the employee of getting a gratuity or was the sum of
money expended on the ground of commercial expediency and in
order indirectly to facilitate the carrying on of the
business. But this has not been shown and therefore the
amount claimed is not a deductible item under s. 10(2)
(xv)."
After quoting in the course of its judgment the above
passage, the High Court proceeded to observe as follows:-
"Having regard to the test applicable in
connection with the contentions made by Mr. Palkhiwala, what
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required to be investigated is whether the payments in
question were made as a matter of practice which had
affected the quantum of salary or whether there was an
expectation by the employees (whose employment was
terminated) of getting a gratuity or, in the alternative,
the above sums were expended on the
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ground of commercial expediency and in order indirectly
to facilitate the carrying on of the business."
After making the above observation, the High Court held
that the Company had not placed any evidence to show that
there was a practice in the Company to pay compensation even
though its attention was drawn that in the past i.e. between
1946 and 1952, the Company had paid such compensation in two
cases on the basis of one month’s basic salary for each year
of service. It also rejected the case of the Company that
the amount involved had been expended on the ground of
commercial expediency and in order indirectly to facilitate
the carrying on of the business of the Company even though
it observed that the yearly wage bill of the Company was
reduced after such payment. The High Court held that the
consideration of reduction of the wage bill was foreign to
the decision taken by the Company to terminate the services
of the employees and to pay them retrenchment compensation
and observed that the purpose of the payment so far as could
be ascertained from the contents of the resolutions of the
Board of Directors and the Company when read with the
relevant contents of the agreement for sale was the carrying
out of the obligation arising under the agreement. It also
held that the fact the expenses became reduced was
insufficient to record a finding that the amount of
retrenchment compensation was paid for commercial
considerations or expediency. From the perusal of the
judgment of the High Court it becomes clear that the High
Court placed more emphasis on the motive with which the
amount was expended than the fact that the expenditure had
been incurred in connection with the business of the Company
and that such expenditure resulted in the reduction of the
annual wage bill of the Company in the future years.
In order to claim deduction under section 10(2) (xv) of
the Act, an assessee has to show that the expenditure in
question (i) was not an allowance of the nature described in
any of the clauses (i) to (xiv) of section 10(2); (ii) was
not in the nature of a capital expenditure or personal
expenses of the assessee and (iii) had been laid out or
expended wholly and exclusively for the purposes of his
business, profession or vocation. Even assuming that the
motive behind the payment of retrenchment compensation was
that the terms of the agreement of the sale of shares should
be satisfied, as long as the amount had been laid out or
expended wholly and exclusively for the purpose of the
business of the assessee, there appears to be no good reason
for denying
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the benefit of section 10(2) (xv) of the Act to the Company
if there is no other impediment to do so.
The facts of these cases are very close to the facts
found in (i) Commissioners of Inland Revenue v. Patrick
Thomson Ltd. (in liquidation), (ii) Commissioners of Inland
Revenue v. J. & R. Allan, Ltd. (in liquidation), (iii)
Commissioners of Inland Revenue v. Pettigrew & Stephens
Ltd.(1). The respondent-companies in the said cases were
subsidiaries of a Company called Scottish Drapery
Corporation Ltd., the control of which was acquired by the
House of Fraser Ltd. Changes of organisation which were made
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in accordance with the policy of the House of Fraser Ltd.
involved the termination of the contracts of service of the
Managing Directors of the respondent-companies and also the
eventual liquidation of those companies. Certain sums were
paid by the companies to the managing directors in
connection with the cancellation of their contracts, the
payments being expressed in the first two cases to be in
satisfaction of rights to future remuneration, and in the
third to be in lieu of notice. Before the Special
Commissioners, the companies contended that the payments
made by them to the Managing Directors in connection with
the cancellation of their contracts had been made to relieve
them from onerous contracts and were allowable deductions.
The Crown contended that the payments were not expenses of
the companies’ businesses but were incidental to the schemes
by which those businesses were acquired by the House of
Fraser Ltd. and were made primarily for the benefit of that
company. The Commissioners, however, decided that the
deductions claimed were allowable. Upholding the findings of
the Commissioners, the Lord President observed at page 156:-
"In my opinion the contention put forward by the
Crown is unsound and the Special Commissioners were correct
in rejecting it. Admittedly in this case no question arises
in regard to the words "wholly and exclusively", and if the
Crown’s contention is unsound it is not disputed that the
disbursement in question falls within section 137(a). To
succeed in their contention the Crown must establish two
matters. In the first place it must show that the
liquidation involved a discontinuance of the trade carried
on prior to it by the Respondent Company and the subsequent
operation of a new trade carried on by House of Fraser. In
the second place it must show that the expenditure in
question was laid
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out for the purposes of the new trade. Without both
these steps, its argument fails. In my opinion neither step
in the argument is made out."
In the present case also, it is seen that the Company
continued to function even after its control passed on to
the hands of Tatas and the expenditure in question was laid
out for the purpose of the Company’s own trade and not for
the trade of Tatas who were only the shareholders of the
Company. We cannot overlook the distinction between the
Company and its shareholders. As a result of the expenditure
in question, the Company was in fact benefited and it was
possible for it to earn more profits as a consequence of the
reduction in the wage bill. It was suggested in the course
of the arguments before us that Tatas were actually
benefited by the payment in question because the price
payable by them for the shares was reduced by the amount
spent by the Company. We do not find any substance in this
contention. Admittedly the assets of the Company had been
valued as on December 31, 1955 at Rs. 155 lacs. Naturally
the total value of the shares of the Company would be Rs.
155 lacs which Tatas had agreed to pay. Subsequent to
December 31, 1955, the Company had by passing the resolution
incurred the liability to pay retrenchment compensation and
compensation for termination of service as stated above. On
account of the said resolution, the total value of the
assets of the Company was reduced by the amount payable to
the employees by way of compensation. It is natural that the
purchaser of the shares would ordinarily claim reduction in
the consideration payable for the shares by the amount which
the Company had undertaken to pay as assets of the Company
became reduced to that extent. It cannot, therefore, be said
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that the Tatas were in any way benefited financially by
reason of the reduction in the consideration payable by them
for the shares. We feel that the expenditure in respect of
which deduction is claimed by the Company in this case falls
within the third test laid down by this Court in the case of
Gordon Woodroffee Leather Manufacturing Co. v. The
Commissioner of Income-tax, Madras (supra) viz. that the sum
of money had been expended on the ground of commercial
expediency and in order indirectly to facilitate the
carrying on of the business. We are of the view that the
three tests laid down by this Court in the above case viz.
(i) that the payment should have been made as a matter of
practice which affected the quantum of salary; (ii) that
there was an expectation by the employee of getting a
gratuity and (iii) that the sum of money was expended on the
ground of commercial expediency and in order indirectly to
facilitate the carrying on of the business of the
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assessee have to be read disjunctively and if they are so
read, the present case which satisfies the third test should
be held as falling under section 10(2)(xv) of the Act. The
High Court of Gujarat in Commissioner of Income-tax, Gujarat
v. Laxmi Cement Distributors Pvt. Ltd. (1) and the High
Court of Bombay in Commissioner of Income-tax, Bombay City I
v. Fairdeal Corporation Pvt. Ltd.(2) and in Commissioner of
Income-tax, Bombay City I v. Patel Cotton Co. Pvt. Ltd.(3)
have also understood the principle underlying the decision
of this Court in Gordon Woodroffee Leather Manufacturing Co.
v. The Commissioner of Income-tax, Madras (supra) in the
same way. The High Court was, therefore, in error in holding
that the amount involved in the case did not satisfy the
test applicable to the expenditure allowable under section
10(2) (xv) of the Act.
The next contention urged on behalf of the Department
was that since Davids and Tatas were indirectly benefited by
the retrenchment of the services of the employees of the
Company and payment of compensation to them and since there
was no necessity to retrench the services of all the
employees, the expenditure in question could not be treated
as an expenditure laid out wholly and exclusively for
business purposes of the Company. It has to be observed here
that the expression "wholly and exclusively" used in section
10(2)(xv) of the Act does not mean ’necessarily’. Ordinarily
it is for the assessee to decide whether any expenditure
should be incurred in the course of his or its business.
Such expenditure may be incurred voluntarily and without any
necessity and if it is incurred for promoting the business
and to earn profits, the assessee can claim deduction under
section 10(2) (xv) of the Act even though there was no
compelling necessity to incur such expenditure. It is
relevant to refer at this stage to the legislative history
of section 37 of the Income-tax Act, 1961 which corresponds
to section 10(2) (xv) of the Act. An attempt was made in the
Income-tax Bill of 1961 to lay down the ’necessity’ of the
expenditure as a condition for claiming deduction under
section 37. Section 37(1) in the Bill read "any
expenditure....laid out or expended wholly, necessarily and
exclusively for the purposes of the business or profession
shall be allowed ...." The introduction of the word
’necessarily’ in the above section resulted in public
protest. Consequently when section 37 was finally enacted
into law, the word ’necessarily’ came to be dropped. The
fact that somebody other than the assessee is also benefited
by the
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expenditure should not come in the way of an expenditure
being allowed by way of deduction under section 10(2) (xv)
of the Act if it satisfies otherwise the tests laid down by
law. This view is in accord with the following observations
made by this Court in The Commissioner of Income-tax, Madras
v. Chandulal Keshavlal & Co. Petlad(1)
"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 inure to
the benefit of a third party (Usher’s Wiltshire Brewery Ltd.
v. Bruce) (6 T. C. 388). 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. The Commissioner of Income-tax, West
Bengal) (1951) S.C.R. 594. But in every case it is a
question of fact whether the expenditure was expended wholly
and exclusively for the purpose of trade or business of the
assessee."
In the instant case, it was the case of the Company
that many of the employees were old and superfluous and the
business could be carried on with a smaller number and the
only way in which they could reduce the number was to
terminate the services of all the employees by paying them
compensation and thereafter re-employing some of them only.
If the Company felt that that was a method which would inure
to its benefit, it cannot be said that the payment of
compensation was made with an oblique motive and without
regard to commercial considerations or expediency. The High
Court, therefore, erred on the facts and in the
circumstances of the case in holding that the sum of Rs.
1,27,511/- was not deductible under section 10(2) (xv) of
the Act and in answering questions Nos. (1) and (2) referred
to it in Income-tax Reference No. 58 of 1963 arising out of
the assessment
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order for the year 1957-58 against the assessee and in
favour of the Department to the extent of Rs. 1,27,511/-.
Similarly it erred in disallowing the claim made in respect
of Rs. 16,885/- for each of the three succeeding assessment
years.
We, therefore, allow these appeals and hold that Rs.
1,27,511/- was also deductible under section 10(2)(xv) of
the Act during the assessment year 1957-58 and sum of Rs.
16,885/- referred to above was allowable as a deduction
during each of the three succeeding assessment years. The
Department shall pay costs to the appellant. (Hearing fee
one set only).
P.B.R. Appeals allowed.
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