Commissioner of Income Tax vs Tiam House Service Ltd.

R. Jayasimha Babu, J.—The following two questions have been referred to us at the instance of the Revenue :

(1) Whether, on the facts and in the circumstances of the case, the Income Tax Appellate Tribunal was right in holding that the medical

expenditure to the extent of Rs. 2,54,994 incurred on an employee should be allowed as a valid business expenditure in the hands of the assessee

u/s 37 of the Income Tax Act, 1961 ?

(2) Whether, on the facts and in the circumstances of the case, the Income Tax Appellate Tribunal was right in holding that the medical expenditure

to the extent of Rs. 2,54,994 incurred on an employee could not be considered to be a perquisite and, therefore, could not be disallowed u/s

40A(5) of the Income Tax Act, 1961 ?

They arose out of the assessment of the respondent company in which the public are not substantially interested, under the Income Tax Act for

the assessment year 1986-87. During the assessment year, the assessee purchased air tickets for Sri A. M. M. Arunachalam, his wife, Smt. A. R.

Lakshmi, and his relative Smt. Valli Alagappan, for their travel to the U. K. at the cost of Rs. 70,994. It also purchased demand draft and

travellers cheques in foreign currency for Sri Arunachalam''s treatment and the living expenses of Sri Arunachalam, his wife and relative in the U.

K. Their visit to the U. K. was for a by-pass surgery for Sri Arunachalam. The amount so spent was not an amount which the company was

required to spend under the terms of the contract of employment of Sri Arunachalam by the company.

It is not disputed that Sri Arunachalam had been appointed as an adviser to the company by letter dated January 17, 1981, which sets out the

terms of his employment. In terms of that letter of appointment, he was to be paid a sum of Rs. 4,250 towards monthly salary, Rs. 450 per month

towards engagement of a private servant. He was also to be provided medical facility for himself and his wife to the extent available under the

assessee company''s medical insurance scheme. In addition, the company was to reimburse to him the actual amount incurred towards medical

expenses for him and his wife, which were not reimbursed by the insurance company subject to Rs. 4,500 per annum. He was also to be provided

with a car together with a driver for private purpose and the company was to pay club subscription on his behalf for two clubs and reimburse the

entertainment expenses incurred by him in connection with the business of the company.

The said Sri Arunachalam was not a whole time adviser of the company. The Tribunal has noted the fact that he was the chairman of the board

of directors of three companies, Tube Investment of India Ltd., Carborandum Universal Ltd., and South Asian Financial Exchange Ltd. He was

also the deputy chairman of Ashok Leyland Ltd., and W. S. (India) Ltd.

On April 3, 1985, the board of directors of the assessee-company passed a resolution resolving to bear the full expenditure for the by-pass

surgery, which the said Arunachalam was required to undergo on the advice of doctors who had recommended that the surgery be done in the U.

K. The reason given by the board of directors for so resolving was for the valuable advice that the company had received from him from time to

time for the benefit of the group companies. The resolution was passed by the board by circulation. The recommended surgery was performed in

the U. K. in April, 1985. Sri Arunachalam and his wife and relative remained in U. K. for seven weeks during April and May, 1985.

It is not in dispute that Sri Arunachalam has not sought any financial help from the assessee-company.

The Income Tax Officer as also the Commissioner of Income Tax held that the amount spent by the assessee-company for the medical

treatment of the said Sri Arunachalam, and stay of his wife and his relative in the U.K. for seven weeks could not be allowed as business

expenditure u/s 37 of the Income Tax Act, in the view that the amount so spent was only a gratuitous expenditure and could not be regarded as

expenditure incurred for the purpose of the assessee''s business. They also took the view that the payment was hit by the provisions of Section

40A(5) of the Act.

The assessee having appealed against the order of the Commissioner to the Tribunal, the tribunal disagreeing with the view of the Commissioner

held that this payment did not attract Section 40A(5). It also held that the expenditure was incurred for the purpose of the assessee''s business, as

the said Sri Arunachalam had offered valuable advice to the assessee-company and the other group companies in the past and considering his

standing in the business world, the advice rendered by him was valuable.

The Revenue being aggrieved by the decision of the Tribunal, the above two questions have been referred to us at the instance of the Revenue.

We may dispose of the second question first as the true scope of Section 40A(5) of the Act has now been explained authoritatively by the

Supreme Court in the case of Commissioner of Income Tax, Bombay, etc. Vs. M/s. Mafatlal Gangabhai and Co. (P) Ltd., , wherein it has been

held that cash payments are outside the purview of Section 40A(5) of the Act. The expenditure incurred by the assessee having been incurred by

way of payments made in cash such payments do not attract Section 40A(5) of the Act. The second question referred to us, is required to be and

is answered in favour of the assessee and against the Revenue.

Learned counsel for the Revenue submitted that the expenditure incurred by the assessee-company on the medical treatment, travel and stay of

Sri Arunachalam, his wife and his relative was only a gratuitous expenditure that it was not an expenditure which could be regarded as justified on

grounds of commercial expediency and that the expenditure was not one which was wholly and exclusively or even necessarily incurred for the

purposes of the assessee''s business. It was submitted that the contract as between the assessee and Sri Arunachalam did not provide for any such

payment. The expenditure on medical expenses reimbursable as also the expenditure for the medical treatment which is available under the asses-

see-company''s medical insurance scheme have been spelt out in the letter of appointment. It was further submitted that the said Sri Arunachalam

at no point of time requested for such payment being made and it was not the case of the assessee or of the said Sri Arunachalam that the salary

that was being paid to him under the agreement was in any way affected by this sum being paid in the event of his having to undergo by-pass

surgery. The reason given by the board of directors for making the payment being the benefit obtained by the company from his services in the past

could not afford the justification for this payment. This justification for this payment cannot be regarded as sufficient for treating the expenditure as

business expenditure in the light of the decision of the Constitution Bench of the Supreme Court in the case of Gordon Woodroffee Leather

Manufacturing Co. Vs. The Commissioner of Income Tax, Madras, .

Learned counsel for the assessee, on the other hand sought to support the order of the Tribunal and submitted that having regard to the later

decision of the Supreme Court in the case of Sassoon J. David and Co. Pvt. Ltd., Bombay Vs. Commissioner of Income Tax , Bombay, , the

expenditure incurred by the assessee on the medical treatment of its adviser was required to be regarded as business expenditure.

In the case of Gordon Woodroffee Leather Manufacturing Co. Vs. The Commissioner of Income Tax, Madras, a Constitution Bench of the

apex court considered the question as to whether the payment of a sum of Rs. 40,000 as gratuity to a person who was the employee of the

managing agent of the assessee-company from 1922 to 1935 and also an employee of the assessee from 1935 and later its director from 1940,

the payment having been made to him during the previous year relevant to the assessment year 1950-51 could not be regarded as an expenditure

laid out or expended for the purpose of the business within the meaning of Section 10(2)(xv) of the Indian Income Tax Act, 1922. There also the

payment had been made to a former employee ""in appreciation of his long and valuable services to the company"". The company there did not have

any scheme for the payment of gratuity nor was the payment of gratuity a matter of practice. There was also nothing to show that the employee had

accepted a low salary in expectation of a gratuity on retirement nor was there anything to show that the gratuity was paid for the purpose of

facilitating the carrying on of the business of company or as a matter of commercial expediency.

The apex court in the case of Gordon Woodroffee Leather Manufacturing Co. Vs. The Commissioner of Income Tax, Madras, held that

(headnote): ""The proper tests to apply in a case like this are whether the payment was made as a matter of practice which affected the quantum of

salary or there was an expectation by the employee of getting a gratuity or the sum of money was paid on the ground of commercial expediency

and in order indirectly to facilitate the carrying on of the business"".

In this case also there is nothing on record to show that Sri Arunachalam had accepted a low salary in expectation of a benefit like the one now

conferred on him, his wife and his relative, by the assessee-company. There is also nothing on record to show that the payment was made for the

purpose of facilitating the carrying on of the business of the company or as a matter of commercial expediency. There is also nothing on record to

show that the company had a scheme of meeting the costs without any limit of its employees or advisers abroad and meeting the costs of the travel

and stay of their relatives as well.

In the case of Sassoon J. David and Co. Pvt. Ltd., Bombay Vs. Commissioner of Income Tax , Bombay, , a Bench of two learned judges of

the apex court held that the expression ""wholly and exclusively"" used in Section 10(2)(xv) of the Indian Income Tax Act, 1922, does not mean

necessarily"" and that 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 u/s 10(2)(xv) of the Act even though there was no compelling necessity to incur such expenditure. The court also

held that the tests laid down in the case of Gordon Woodroffee Leather Manufacturing Co. Vs. The Commissioner of Income Tax, Madras, , had

to be read disjunctively. The court in that case held that the sum of Rs. 1,27,511 paid by the assessee towards compensation for termination of

service, compensation to director and other payments were sums which were laid down wholly and exclusively for the purpose of business of the

company. The court observed that as the result of the expenditure, the appellant-company was, in fact, benefited by reduction in the wage bill.

That expenditure was held to be an expenditure on grounds of commercial expendiency and in order indirectly to facilitate the carrying on of its

business and was therefore allowable as a deduction.

The tests laid down in the case of Gordon Woodroffee Leather Manufacturing Co. Vs. The Commissioner of Income Tax, Madras, , were laid

down by the Constitution Bench of the apex court and those tests have not been varied in the case of Sassoon J. David and Co. Pvt. Ltd.,

Bombay Vs. Commissioner of Income Tax , Bombay, . The tests have been clarified to be disjunctive and that if the payment can be justified by

applying any one of the tests, such expenditure can be regarded as one incurred wholly and exclusively for the purpose of business of the assessee.

Learned counsel for the assessee invited our attention to the decision of the Madhya Pradesh High Court in the case of Commissioner of

Income Tax Vs. Steel Ingots Pvt. Ltd., and to the decision of the Bombay High Court in the case of Mehboob Productions Private Ltd. Vs.

Commissioner of Income Tax, Bombay City-I, and submitted that expenditure on the travel and medical treatment of directors having been

allowed in those cases, similar allowance in this case would be justified. On a perusal of those decisions we do not find any reference in these

decisions to the decision of the Constitution Bench of the Supreme Court in the case of Gordon Woodroffee Leather Manufacturing Co. Vs. The

Commissioner of Income Tax, Madras, , and we are unable to derive any assistance from those decisions.

The tests as laid down by the Supreme Court in the case of Gordon Woodroffee Leather Manufacturing Co. Vs. The Commissioner of

Income Tax, Madras, , as set out in the case of Sassoon J. David and Co. Pvt. Ltd., Bombay Vs. Commissioner of Income Tax , Bombay, :

(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 assessee.

Applying these tests to the facts of this case, we are unable to hold that any one of the tests has been satisfied. The payment made was not one

which had any link with the quantum of salary and other benefits to Sri Arunachalam. It is not the case of the assessee that Sri Arunachalam had

any expectation of getting the amounts that were paid to him by the assessee for the medical treatment. In fact he did not seek any such payment

and there is nothing to show that he was in need of it. The payments so made cannot be regarded as having been made on grounds of commercial

expediency and in order indirectly to facilitate the carrying on of the business of the assessee. A gratuituous payment, like the one, made by the

assessee cannot be regarded as a matter of commercial expediency, as there is nothing to show that Sri Arunachalam would have withheld his

service, if such payment had not been made and the effecting such payment was necessary or expedient in order to retain his service. The stated

reason for the payment is ""the valuable service rendered by him in the past"". The payment is, therefore, clearly in the nature of gratuitous payment

voluntarily made in appreciation of the services which he had rendered to the assessee in the past. If the payment of a sum of Rs. 40,000 as

gratuity to a person who had served the company for a period of over 27 years cannot be regarded as an expenditure which was commercially

expedient and for the purpose of facilitating the carrying on of the business of the company, the payment of a substantial sum of Rs. 2,54,994 to an

adviser who was obviously a part time adviser and to whom many valuable facilities had been provided under the agreement and who had not in

put the money from the company and was not in need of such payment, cannot also be regarded as an expenditure which was commercially

expedient and was incurred wholly and exclusively for the purpose of business of the company.

We, therefore, answer the first question referred to us in favour of the Revenue and against the assessee.