Commissioner of Income Tax vs Maddi Venkataratnam and Co. (P.) Ltd.

Syed Shah Mohammed Quadri, J.—The questions referred to us u/s 256(1) of the income tax Act, 1961 (''the Act'') at the instance of the assessee, are as follows:

Whether, on the facts and in the circumstances of the case, the Appellate Tribunal is justified in holding that the expenditure of Rs. 9,974 is not disallowable u/s 37(4) of the income tax Act, 1961?

Whether, on the facts and in the circumstances of the case, the Appellate Tribunal is justified in holding that the expenditure of Rs. 5,141 on lighting charges of the guest house is not disallowable u/s 37(4) of the income tax Act?

In the assessment year 1976-77, the assessee, which is a company registered under the Companies Act, 1956 and is doing business in processing and exporting of tobacco, claimed certain expenditure of which two items were: (a) Rs. 9,974, spent on salary and bonus of the employees working in a bungalow maintained by the assessee as a guest house; and (b) Rs. 5,141, spent on lighting charges of the guest house. Those two items of expenditure were disallowed by the ITO. The assessee went in appeal to the Commissioner (Appeals) who took the view that the expenditure claimed could not be allowed. The assessee filed a second appeal before the Tribunal. Following its own earlier decision in IT Appeal Nos. 1056 and 1057 of 1979 for the earlier two assessment years in respect of the very same assessee, the Tribunal allowed the deductions. The Tribunal noted that in the assessee''s own case for the assessment year 1967-68, the Tribunal''s view allowing similar expenditure was confirmed by the High Court in Addl. Commissioner of Income Tax Vs. Maddi Venkataratnam and Co. Ltd.,

The learned standing counsel for the revenue submits that the judgment of this Court in Maddi Venkataratnam & Co. Ltd.''s case (supra) related to the assessment year 1967-68; the provisions of sub-section (4) of section 37 of the Act which came into force with effect from 1-4-1987, were not considered in that judgment, therefore, that judgment does not govern the present reference which relates to the assessment year 1976-77.

In view of the above contentions, it may be necessary to refer to the facts in Maddi Venkataratnam & Co. Ltd.''s case (supra). In the assessment year 1967-68, the assessee incurred an expenditure of Rs. 45,539 on the guests. Out of that amount, an amount of Rs. 38,756 was disallowed being the expenditure not allowable as ''entertainment expenditure''. The assessee, however, claimed that the said amount was spent on the guest house and that was in the nature of providing lodging and boarding for foreign customers and representatives who came and stayed with the assessee for effecting purchases of tobacco and that the guest houses at Chilakaluripet and Guntur were meant for that purpose. On appeal by the assessee, the AAC held that the expenditure in question was neither entertainment expenditure nor expenditure on the maintenance of the guest houses but it was an expenditure on boarding and lodging of foreign representatives which was necessary for the business, and in that view of the matter he allowed the appeal of the assessee. The revenue went in appeal before the Tribunal. The Tribunal confirmed the order of the AAC. The question there was whether the said amount could be allowed either u/s 37(2) or section 37(3). Sub-section (2) of section 37 dealt with expenditure in the nature of entertainment expenditure and sub-section (3) dealt with expenditure incurred on advertisement or maintenance of residential accommodation in the nature of a guest house. Thus, it is obvious that the above said case was not concerned with the interpretation of sub-section (4) of section 37. Indeed, sub-section (4) of section 37 was inserted by the Finance Act, 1970 with effect from 1-4-1970. We shall refer to it presently. In the abovesaid judgment, this Court held that the company was carrying on business of exporting tobacco from India and the visitors had come to India from Japan, London, Egypt and East Germany to inspect tobacco which was being exported and that in order to earn money from business these foreign visitors had to be put up and reasonable facilities for their accommodation, food, drink, etc., had to be provided within reasonable limits so that the company could carry on its business of exporting tobacco from India and as such the principle enunciated by the Gujarat High Court in Commissioner of Income Tax, Gujarat II Vs. Patel Brothers and Co. Ltd., , namely, provision of food, drinks, etc., to client was in the nature of bare necessity or by way of ordinary courtesy or as an express or implied term of the contract or employment spelled out from long-standing practice or custom of trade or business, it would not amount to entertainment. It was also pointed out therein that it was nobody''s case that the guest houses were run on a lavish scale looking particularly to the needs of customers from abroad. Therefore, this judgment cannot be an authority on the question of deductibility of the expenditure incurred on maintenance of guest house which is dealt with by sub-section (4) of section 37, brought into force with effect from 1-4-1970.

In Commissioner of Income Tax Vs. Navabharat Enterprises (P.) Ltd., , a Division Bench of this Court had to consider the scope and the meaning of the expression ''in the nature of the entertainment expenditure'' in section 37(2B).

It was held that the phrase ''in the nature of entertainment expenditure'' encompasses within its ambit entertainment expenditure proper as well as expenditure akin to it partaking of some, if not all, of the characteristics of entertainment expenditure, even lavish or frugal hospitality is nonetheless hospitality and that the income tax authorities had to minutely scrutinise the accounts in each case item-wise to verify whether the expenditure by the assessee was wholly and exclusively for the purpose of the business or profession or whether it was in the nature of entertainment expenditure. By a fastidious or lavish person, the act of hospitality with luxurious dishes and costly hot drinks might be regarded as an ordinary lunch or dinner but, to a common man, it would be a lavish meal or staggering wasteful expenditure and the test to be applied was whether the hospitality was appropriate and befitting and that the authorities should bear in mind as to whether the expenditure was reasonable. In that case the question, whether the expenditure on food and lodging of foreign customers and maintenance of guest houses for foreign customers was allowable deduction, was not answered by the Court as the Tribunal did not examine the issue as to whether the entertainment expenditure on foreign customers was lavish or extravagant or reasonable; the matter was remitted to the Tribunal.

Now, reverting to sub-section (4) of section 37 it would be useful to extract the same here:

(4) Notwithstanding anything contained in sub-section (1) or sub-section (3) --

(i) no allowance shall be made in respect of any expenditure incurred by the assessee after the 28th day of February, 1970, on the maintenance of any residential accommodation in the nature of a guest-house (such residential accommodation being hereafter in this sub-section referred as ''guest-house'') ;

(ii) in relation to the assessment year commencing on the 1st day of April, 1971, or any subsequent assessment year, no allowance shall be made in respect of depreciation of any building used as a guest-house or depreciation of any assets in a guest-house:

Provided that the aggregate of the expenditure referred to in clause (i) and the amount of any depreciation referred to in clause (ii) shall, for the purpose of this sub-section, be reduced by the amount, if any, received from person using the guest-house:

Provided further that nothing in this sub-section shall apply in relation to any guest-house maintained as a holiday home if such guest house--

(a) is maintained by an assessee who has throughout the previous year employed not less than one hundred whole-time employees in a business or profession carried on by him; and

(b) is intended for the exclusive use of such employees while on leave.

Explanation: For the purposes of this sub-section,--

(i) residential accommodation in the nature of a guest-house shall include accommodation hired or reserved by the assessee in a hotel for a period exceeding one hundred and eighty-two days during the previous year; and

(ii) the expenditure incurred on the maintenance of a guest-house shall, in a case where the residential accommodation has been hired by the assessee, include also the rent paid in respect of such accommodation.

This sub-section opens with a non obstante clause to exclude the provisions of sub-section (1) and sub-section (3) and directs that any expenditure incurred by the assessee after 28-2-1970 on the maintenance of any residential accommodation in the nature of a guest house shall not be an allowable expenditure. Clause (ii) of sub-section (4) of section 37 deals with depreciation of any building used as a guest house or depreciation of any assets in a guest house with which we are not concerned here. The first proviso to that sub-section makes an allowance for reducing the amount of expenditure, if any amount was received from the person using the guest house. The second proviso excludes the operation of clauses (i) and (ii) of sub-section (4) if the guest house was maintained as a holiday throughout the previous year for the purposes of exclusive use of employees of the assessee during the leave period of the employee and if the assessee-employer has not less than one hundred whole-time employees in the business or profession carried on by him. Thus, it is clear that if any expenditure is allowable under sub-sections (1) and (3) of section 37 but if that expenditure relates to maintenance of a guest house it would not be an allowable deduction with effect from 28-2-1970. Of course, the only exception, which we have indicated above, is that the guest house was maintained by an assessee having more than one hundred employees for the purposes of being used by the employees during their holidays. In the instant case, there is no plea by the assessee that it was maintained for the use of the employees during their holidays. In fact, the case of the assessee is that the guest house was being maintained for or used by the foreign customers. As such, the above expenditure claimed cannot be held to be an allowable deduction.

In Commissioner of Income Tax Vs. Ocean Carriers Pvt. Ltd., , a Division Bench of the Bombay High Court considered the scope of sub-sections (4) and (5) of section 37. That case dealt with the allowability of the expenditure in the assessment year 1977-78. The assessee was a company carrying on business of shipping agent for non-resident shipping companies. It owned flats and in the course of its business, the shipping crew and representatives of non-resident shipping companies which had dealings with the assessee, were put in those flats. The assessee-company incurred expenditure on maintenance of those flats. It claimed deduction of maintenance expenses and depreciation allowance on those flats in the said assessment year. Though the ITO allowed the expenditure, the Commissioner revised the order of assessment u/s 263 of the Act and held that the expenses were not allowable. On appeal by the assessee, the Tribunal upheld that order of the ITO. The Bombay High Court considered the question whether the expenditure claimed therein was not expenditure incurred on the maintenance of the residential accommodation in the nature of a guest house and was, therefore, an admissible deduction.

It was held that by providing accommodation to the members of crew as also to representatives of the assessee''s principal non-resident shipping companies, in the flats, the assessee-company had treated those flats as its own guest houses and since those guest houses were not maintained exclusively as a holiday home for employees of the assessee-company, the assessee-company was not entitled to allowance u/s 37(4) in respect of any expenditure on maintenance thereof incurred after 28-2-1970 nor was it entitled to any depreciation allowance in respect of those guest houses. We respectfully agree with the view taken by the Bombay High Court.

However, Mr. D. Manmohan, the learned counsel for the assessee relied on the judgment of the Calcutta High Court in Commissioner of Income Tax Vs. Parshva Properties Ltd., in support of his contention. In that case, the assessee has claimed deduction of expenses on maintenance of its guest house which was disallowed by the ITO. The Tribunal found that the bungalow was situated in a place which was in a remote corner of a district in Bihar and that the employees of the company, auditors, mining engineers and other Government officials went there on duty and stayed there temporarily for doing their work. The learned Chief Justice, speaking for the Bench, opined that the bungalow thus maintained could not be treated as guest house u/s 37(4). That decision turned on the finding recorded by the Tribunal referred to above so in our view that judgment does not help the assessee herein. That judgment was followed by a subsequent Bench of the Calcutta High Court in Commissioner of Income Tax Vs. Orient Paper Mills Ltd., on which also heavy reliance is placed by the learned counsel for the assessee. There the question was whether the expenditure incurred on the mill premises wherein boarding and lodging facilities were provided to the employees and the visitors who were charged for such facilities, was allowable. The assessee incurred the expenditure in the year 1971-72 and claimed the same as deductible expenditure. The claim was negatived by the ITO. However, on reference to the High Court it was observed that as a fact the assessee was provided accommodation at places where no accommodation of any kind was available and that the accommodation was obviously not meant for entertainment or relaxation and that the persons availing of the accommodation had been paying charges covering almost the entire expenditure. On those facts and following the decision in Parshva Properties Ltd.''s case (supra), it was held that the accommodation was not a guest house within the meaning of section 37(4). The expenditure was consequently held to be allowed.

On the facts noted above, that case is clearly distinguishable. Once it is found as of fact that a particular accommodation maintained by the assessee was not a guest house within the meaning of sub-section (4) of section 37, the prohibition imposed therein will not be attracted.

From the above discussion it follows that the abovesaid expenditure incurred by the assessee on the maintenance of the guest house, is within the teeth of sub-section (4) of section 37 and, therefore, cannot be claimed as permissible deduction.

For the aforementioned reasons, we answer both the questions in the negative, viz., in favour of the revenue and against the assessee. No costs.