Commissioner of Income Tax, Gujarat-I vs Bharat Vijay Mills Ltd.

Majmudar, J.—The Commissioner of Income Tax, Gujarat-I, has got two question of law referred to us by the Income Tax Appellate

Tribunal, Ahmedabad Bench ''A'', for our opinion as per the provision of s. 256(1) of the I.T. Act, 1961. The referred question read as follows :

Whether, on the facts and in the circumstances of the case, the Tribunal was justified in holding that the payment of Rs. 1,53,675 made to the

Textile Commissioner under the provisions of clause 21C(1)(b) or under clause 27 of the Cotton Textiles (Control), Order, 1948, was a business

expenditure allowable to the assessee ?

Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the medical benefit given to the employees

could not be treated as perquisites, for the purposes of section 40A(5) ?

The facts leading to this reference in so far as they are relevant may not be briefly stated. The assessee is a public limited company incorporated

under the Companies Act, 1956. The relevant assessment year is 1972-73. At that time, it was carrying on business of manufacturing cotton textile

goods in Kalol in Mehsana District. In filed a return of income on 24th June, 1972, declaring a total income of Rs. 9,49,483. The assessee-

company had claimed certain deduction from its total income and amongst other, one claim of deduction centered round certain medical benefits

given by the company to its two employees viz., D. B. Patel and A. P. Patel, who were two executives of the company and who were relatives of

the directors at the relevant time. Out of the total perquisites made available by the assessee-company to its aforesaid employees, the ITO

disallowed an amount of Rs. 3,554 by treating the said amount as excess perquisites which, according to the ITO, could not be allowed as per the

provision of s. 40A(5) of the Act.

The ITO further found that the assessee had paid Rs. 1,53,675 as compensation to the Textile Commissioner for non-production of controlled

variety of cloth. The ITO found that this was a payment in the nature of penalty and hence disallowed the same.

The aforesaid two amounts disallowed by the ITO are the subject-matter of controversy between the parties in the present proceedings before

us.

The assessee went up in appeal to the AAC on these and other grounds pertaining to other aspects of the case. The AAC held that

compensation paid to the Textile Commissioner for not producing specified variety of cloth was an allowable item. The AAC, however, confirmed

the view of the ITO that medical expenses were part of perquisites which could be allowed as per the provision of s. 40A(5) of the Act. Thus, the

decision of the AAC went partly in favour of the assessee and partly against it.

The revenue, being aggrieved by that part of the order of the AAC which went against it, went up in appeal to the Tribunal. The assessee filed

cross-objections challenging that part of the order which was against it.

The Tribunal passed a common order on both the appeal and the cross-objections on 21st May, 1975. By its common order, the Tribunal held

in favour of the assessee so far as the amount Rs. 1,53,675 was concerned. The Tribunal held, following its earlier decision on the point, that the

aforesaid amount paid to the Textile Commissioner by the assessee for not producing or packing the required quantity of controlled cloth was an

allowable deduction. So far as the other disputed amount of Rs. 3,554 was concerned, the Tribunal observed that it pertained to medical expenses

treated as perquisites to the executives of the assessee-company. The Tribunal noted that these were in relation to two executives, M/s. D. B.

Patel and A. P. Patel, both said to be relatives of the directors. The assessee contended before the Tribunal on this aspect that the medical benefit

should not be treated as perquisites. The Tribunal accepted the said contention and directed that the perquisites should be recalculated after

excluding the medical expenses and anything in excess thereof should be disallowed.

The revenue, thereafter, requested the Tribunal to refer five questions of law to this court as arising from the judgment of the Tribunal. The

Tribunal, however, referred only two questions of law to this court. The referred questions are already extracted by us in the earlier part of this

judgment.

So far as the first question is concerned, it is common ground between the learned advocates of the respective parties that the answer to the said

question is covered by a decision of this court in Additional Commissioner of Income Tax, Gujarat Vs. Rustam Jehangir Vakil Mills Ltd., . In the

said decision, this court has held that if the assessee was required to pay certain amounts under s. 21C(1)(b) of the Cotton Textiles (Control)

Order, 1948, as the assessee had failed to carry out the directions of the Textile Commissioner during the relevant previous year to pack the

minimum of the particular types of cloth as mentioned therein, the said amount could be claimed by the assessee by way of deductible expenses. It

was observed that this payment is an incident of the production of cloth by the manufacturer depending upon the exercise of option which he will

do in view of the technical or technological reasons of his own production machinery. Under the circumstances, the payments made under s.

21C(1)(b) can never be said to be by way of a payment extracted or required for an infraction of the law and there is not question of any amount

being paid as penalty or akin to penalty. Thus, the first question is fully covered by the aforesaid Division Bench judgment of this court and,

accordingly, it will have to be answered in the affirmative, that is, in favour of the assessee and against the revenue.

That takes us to the second question which now survives for our consideration.

Mr. N. U. Raval, learned advocate appearing for the revenue, submitted that as per the provision of s. 40A(5) read with Expln. 2(b) which

defines ""perquisite"", the medical benefits which the assessee-company as an employer has made available to its concerned employees during the

relevant previous year, were perquisites which squarely fell within the provision of s. 40A(5)(a) and hence the limits of permissible deduction under

that head as laid down by the said provision were clearly attracted.

Mr. J. P. Shah, learned advocate appearing for the assessee, combated the said submission of Mr. Raval and contended that these medical

benefits which were by way of cash reimbursement cannot be termed as perquisites and did not fall within the ambit of any of the sub-clauses of

Expln. 2(b) to s. 40A(5). Alternatively, submitted Mr. Shah, even assuming that these payments to the concerned ex-employees were perquisites,

even than as per the first proviso to s. 40A(5)(a), these amounts did not exceed the ceiling of Rs. 72,000, as provided by the aforesaid first

proviso and consequently the said amount ought to have been allowed as permissible deduction by the ITO.

As we will presently show, on a consideration of a relevant provisions of the Act, the admissibility of the disputed amount will have to be

judged in the light of the first proviso to s. 40A(5)(a) and, consequently, it is not strictly necessary for us to answer the second question referred to

us for our opinion. Even assuming that the disputed amount paid by way of medical benefits to the concerned employees amounted to ""perquisites

within the meaning of s. 40A(5)(a), Expln. 2(b), even then, the said amount will have to be considered in the light of the first proviso to s. 40A(5)

(a). In that view of the matter, it will not be strictly necessary for us to go into the wider question whether the Tribunal was right in holding that

these medical benefits represented by the disputed amount can or cannot be treated as ""perquisite"" for the purpose of s. 40A(5).

As we have already stated above, the assessee is a public limited company and during the relevant previous year, it was carrying on business

of manufacturing textile goods. Its income, therefore, was liable to be brought to tax under the head of ""Profits and gains of business or profession

as provided by s. 28 of the Act. As per s. 29 of the Act, the income referred to in s. 28 shall be computed in accordance with the provisions

contained in ss. 30 to 43A. In that group of sections falls s. 40A, with which we are directly concerned in the present case. Section 40A pertains

to expenses or payments which are not deductible in certain circumstances. Sub-section (1) thereof provides :

(1) The provisions of this section shall have effect notwithstanding anything to the contrary contained in any other provision of this Act relating to

the computation of income under the head ''Profits and gains of business or profession''.

Thus, s. 40A has overriding effect in the computation of income under the head ""Profits and gains of business or profession"". Non obstante

clause with which sub-s. (1) of s. 40A starts clearly indicates that if any other contrary provisions exist on the statute book, they have to give way

to the clear and expression provision of s. 40A. It is in the light of the aforesaid setting of sub-s. (1) of s. 40A that we have to turn to sub-s. (5)

thereof. Sub-section (5) of s. 40A is sub-divided into three sub-cls. (a), (b) and (c). It is necessary to reproduce the entire sub-s. (5) of s. 40A

with all its clauses as under :

(5)(a) Where the assessee -

(i) incurs any expenditure which results directly of indirectly in the payment of any salary to an employee or a former employee, or

(ii) incurs any expenditure which results directly or indirectly in the provision of any perquisite (whether convertible into money or not) to an

employee or incurs directly or indirectly any expenditure or is entitled to any allowance in respect of any assets of the assessee used by an

employee either wholly or partly for his own purposes or benefit,

then, subject to the provisions of clause (b) so much of such expenditure or allowance as is in excess of the limits specified in respect thereof in

clause (c) shall not be allowed as a deduction :

Provided that where the assessee is a company, so much of the aggregate of -

(a) the expenditure and allowance referred to in sub-clause (i) and (ii) of this clause; and

(b) the expenditure and allowance referred to in sub-clause (i) and (ii) of clause (c) of section 40, in respect of an employee or a former employee,

being a director or a person who has a substantial interest in the company or a relative of the director or of such persons, as is in excess of the sum

of seventy-two thousand rupees, shall in no case be allowed as a deduction :

Provided further that in computing the expenditure referred to in sub-clause (i) or the expenditure or allowance referred to in sub-clause (ii) of this

clause or the aggregate referred to in the foregoing proviso, the following shall not be taken into account, namely :-

(i) the value of any travel concession or assistance referred to in clause (5) of section 10;

(ii) passage moneys or the value of any free or concessional passage referred to in sub-clause (i) of clause (6) of section 10;

(iii) any payment referred to in clause (iv) or clause (v) of sub-section (1) of section 36;

(iv) any expenditure referred to in clause (ix) of sub-section (1) of section 36.

(b) Nothing in clause (a) shall apply to any expenditure or allowance in relating to -

(i) any employee in respect of any period of his employment outside India;

(ii) any employee being an individual referred to in sub-clause (vii) or sub-clause (viia) of clause (6) of section 10 in respect of any period during

which he is entitled to the exemption under sub-clause (vii) or, as the case may be, sub-clause (viia) aforesaid;

(iii) any employee whose income chargeable under the head ''Salaries'' is seven thousand and five hundred rupees or less.

(c) The limits referred to in clause (a) are the following, namely :-

(i) in respect of the expenditure referred to in sub-clause (i) of clause (a), in the case of an employee, an amount calculated at the rate of five

thousand rupees for each month or part thereof comprised in the period of his employment in India during the previous year, and in the case of a

former employee, being an individual who cases or cased to be the employee of the assessee during the previous year or any earlier previous year,

sixty thousand rupees :

Provided that where the expenditure is incurred on payments of any salary to any employee or a former employee engaged in scientific research

during any one or more of the three years immediately preceding the commencement of the business and such expenditure is deemed under the

Explanation to clause (i) of sub-section (1) of section 35 to have been laid out or expended in the previous year in which the business is

commenced, the limit referred to in this sub-clause shall, in relation to the previous year in which the business is commenced, be an amount

calculated at the rate of five thousand rupees for each month or part thereof comprised in the period of his employment in India during the previous

year in which such business is commenced and in the period of his employment in India during which he was engaged in scientific research during

the three years immediately preceding that previous year ;

(ii) in respect of the aggregate of the expenditure and the allowance referred to in sub-clause (ii) of clause (a), one-fifth of the amount of the salary

payable to the employee or an amount calculated at the rate of one thousand rupees for each month or part thereof comprised in the period of

employment in India of the employee during the previous year, whichever is less.

So far as clause (a) of s. 40A(5) is concerned, it provides that where the assessee incurs any expenditure which results director indirectly in the

payment of any salary to an employee or a former employee or when such assessee incurs any expenditure which results directly or indirectly in the

provision of any perquisite (whether convertible into money or not) to an employee or incurs directly or indirectly any expenditure or is entitled to

any allowance in respect of any assets of the assessee used by an employee either wholly or partly for his own purposes or benefit, then, subject to

the provision of clause (b), so much of the expenditure or allowance as is in excess of the limit specified in respect of thereof in clause (c) has to be

treated as impermissible deduction. Clause (c) of s. 40A(5) provides for general limits of expenditure by way of permissible deductions. Sub-

clause (i) of clause (c) of s. 40A(5) prescribes as upper limit so far as salaries to an employee are concerned. The said limit has to be worked out

as per the aforesaid provision at the rate of Rs. 5,000 per month or in the case of an ex-employee at the rate of Rs. 60,000 per year. So far as

perquisites are concerned, the limit of permissible deductions is provided by s. 40A(5)(c)(ii) and the said limit is to the extent of 1/5th of the

amount of the salary payable to the employee or Rs. 1,000 per month, whichever is less. Thus, the maximum limit under this provision for

permissible deductions by way of perquisites limit under this provision for permissible deductions by way of perquisites would be Rs. 12,000 per

year. But if the salary is less than Rs. 1,000 per month, deductions are permissible on the basis of 1/5th of the salary per month. But these general

limits for the permissible deduction of expenditure incurred by an employer vis-a-vis its employee by way of salary or perquisites have to be read

subject to the overriding exception laid down in clause (b) of s. 40A(5). Sub-clause (iii) of clause (b) of s. 40A(5) provides for small employees

whose income chargeable under the head ""Salaries "" is seven thousand and five hundred rupees or less, that is, for the employees getting about Rs.

625 per month or round about. If an employer has incurred any expenditure which results directly or indirectly in the provision of any perquisites to

such small employees, the entire expenditure would be available for deduction without inhibition of limits prescribed by clause (c)(ii) of s. 40A(5).

But for other highly paid employees, general limit prescribed by clause (c) of s. 40A(5) would continue to apply so far as salary and perquisites to

such employees.

We may now notice the first proviso to s. 40A(5)(a) which provides that where the assessee is a company, so much of the aggregate of

expenditure referred to in sub-cls. (i) and (ii) of clause (a) and expenditure and allowance referred to in sub-clause (i) and (ii) of clause (c) of s. 40,

in respect of an employee or a former employee, being a director or a person who has a substantial interest in the company or a relative of the

director or of such person, as is in excess of the sum of seventy-two thousand rupees, shall in no case be allowed as a deduction. Mr. Shah,

learned advocate for the assessee, contended that even assuming that the disputed amount representing medical benefits extended by the assessee-

company to its two executive employees were by way of perquisites which attracted the provision of s. 40A(5), the present case would be

squarely covered by the aforesaid first proviso. Mr. Shah submitted that both M/s. D. B. Patel, and A. P. Patel were employees of the mill-

company during the relevant assessment year and both of them were relatives of the directors. He further submitted that the AAC has noted that

each one of these employees was given by way of salary, D. A., etc., Rs. 42,070. According to Mr. Shah, even if the disputed amount of Rs.

3,554 was added to this salary amount for each of the employees, permissible upper limit of Rs. 72,000 as provided by the 1st proviso quo each

of these employees so far as the assessee-company is concerned would not be exceeded. According to Mr. Shah, the ITO had disallowed this

amount on the wrong assumption that the general limit of permissible perquisites as provided by clause (c)(ii) of s. 40A(5) would apply to the facts

of the present case. According to him, it is the firsts proviso to s. 40A(5)(a) which holds the field and if it is so, the prescribed limits for permissible

expenses on salary and perquisites as provided by the general requirements of clause (c) of s. 40A(5) would not be available to the revenue and

that the only relevant provision of law which can apply is the first proviso to s. 40A(5)(a).

In order to appreciate the aforesaid contention of Mr. Shah which was strongly opposed by Mr. Raval for the revenue, it is necessary for as to

keep in view the entire setting and texture of s. 40A(5) along with its three cls. (a), (b) and (c). The first clause (a) of s. 40A(5) refers to two

different types of expenditure which an assessee may incur qua his employee. The first type of expenditure will be one which results directly or

indirectly in the payment of any salary to an employee or a former employee, while the other type of expenditure contemplated by s. 40A(5)(a)(ii)

is one which results directly or indirectly in the provision of any perquisite to an employ or any expenditure resulting in any allowance in respect of

any assets of the assessee used by an employee either wholly or partly for his own purposes or benefit. To both these types of expenditure, subject

of course to the overriding effect of clause (b) are engrafted limits as proved by clause (c) of s. 40A(5). Clause (c) of s. 40A(5) read with clause

(a) of the said section clearly represents a general scheme of upper limits for permissible expenditure by any assessee if such expenditure falls in

category (i) or (ii) of clause (a). In the case of any assessee, if he has incurred during any relevant previous year any such expenditure, the

Legislature has provided n upper limit of such permissible expenditure for the purpose of its deductibility from the income of the assessee during the

relevant previous year. We have already indicated above that the said general limit as provided by s. 40A(5)(c) lays down two separate limits, one

for salary expenditure and another for perquisite expenses.

The first proviso to s. 40A(5)(a), on the other hand, refers to a different class of assessee who are companies and who have incurred

expenditure or have provided allowance between to in sub-cls. (i) and (ii) of clause (a) of s. 40A(5), and sub-cls. (i) and (ii) of clause (c) of s. 40.

It only cover cases of assessee that are companies that have incurred expenditure and provided allowance to their employee as is referred to in cls.

(a) and (b) of the 1st proviso to clause (a) of s. 40A(5) provided such employees or former employees of the concerned assessee-companies

happen to be directors or person who have substantial interest in company or who are relatives of the directors or of such persons. In such cases,

the first proviso puts a ceiling of Rs. 72,000 by way of aggregate permissible deduction representing such expenditure. It is pertinent to note that

the scheme of permissible deduction represented by the first proviso contemplates aggregation of four types of expenditure and allowance which

such assessee-companies may have incurred during the relevant previous year on specified class of employees encompassed by the said proviso.

Such assessee-companies vis-a-vis such specified employees, represent a distinct class for which a ceiling of Rs. 72,000 has been put by the

Legislature by way of permissible deduction of allowance to the concerned assessee-companies vis-a-vis each of such employees. In this

connection, it is also necessary to refer to s. 40(c)(i) and (ii), which provides as under :

Notwithstanding, anything to the contrary in section 30 to 39, the following amounts shall not be deducted in computing the income chargeable

under the head ''Profits and gains of business or profession'', -

(c) in the case of any company -

(i) any expenditure which results directly or indirectly in the provision of any remuneration or benefit or amenity to a director or to a person who

has a substantial interest in the company or to a relative of the director or such person, as the case my be,

(ii) any expenditure or allowance in respect of any assets of the company used by any person referred to in sub-clause (i) either wholly or partly for

his own purposes or benefit,

if in the opinion of the Income Tax Officer any such expenditure or allowance as is mentioned in sub-clause (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 -.