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 5873
AND CIVIL APPEAL NOS
2502 2504 OF 1972 From the Judgment and Order dated 25th26th Feb 1971 of the Bombay High Court in Income Tax Ref
No 8763
V section 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 Ms Sasoon J David  Co Pvt
Ltd hereinafter referred to as the Company  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 10000 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 251956
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 andor 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 16188 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 164899 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 Rs 104626 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 6000 Compensation for termiantion of pension Rs 21200 Annuity of Shri AE Joseph former Director as per resolsution dated 2 12 1956 Rs 16885 Amount described as compensation for loss of office
Managing Director Mr R Mathalone Rs 16188 Total  Rs 164899 It should be mentioned here that AE Joseph the former Director of the Company had to be paid as per the resolution of the Company Rs 16885 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 164899 referred to above before the Income tax Officer under section 102 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 16885 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 164899 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 us 102 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 section 102 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 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 andor 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 164899 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 FE 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 661 of the Act before the Tribunal was rejected
Thereafter the Company filed an application before the High Court of Bombay under section 662 of the Act and the High Court directed the Tribunal to state a case and to refer the following questions of law for its opinion 1 Whether the Tribunal erred in law disallowing the amount of Rs 164899 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 164899 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 16188 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 661 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 16885 is an admissible deduction under section 102xv 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 164899 referred to in question No1 only a sum of Rs 21200 which was commutation of liability for payment of pension to some retired employees andor widows of such employees and a sum of Rs 16188 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 127511 
It accordingly answered question No1 in the negative in so far as the sum of Rs 127511 excluding two items of Rs 21000 and Rs 16188  was concerned question No 2 in the affirmative in so far as the amount aggregating to Rs 127511 excluding the two items of Rs 21200 and Rs 16188  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 127511 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 andor 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 16885 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
We are concerned in these appeals with the claim of the Company in respect of a sum of Rs 127511 out of Rs 164899 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 16885 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 102 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 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 114197 in 1955 to Rs 67268 in 1956 and thereafter in 1957 and 1958 respectively to Rs 54124 and Rs 54960 
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
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 vs The Commissioner of Income tax Madras1
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 50000 out of which the assessee was to pay Rs 40000 and its Managing Agent was to pay Rs 10000 
Subsequently the resolution was approved at the extra ordinary general meeting of the assessee
Accordingly a sum of Rs 40000 was paid by the assessee to Mr J H Phillips
The assessee claimed deduction of the said sum of Rs 40000 under section 102 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 890 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 12 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 661 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 102 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 section 102 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 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 891 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 ie 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 102 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 102 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 892 the benefit of section 102 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 vs Patrick Thomson Ltd in liquidation ii Commissioners of Inland Revenue vs J  R Allan Ltd in liquidation iii Commissioners of Inland Revenue vs Pettigrew  Stephens Ltd1
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 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 137a
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 893 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 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 vs 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 894 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 102xv of the Act
The High Court of Gujarat in Commissioner of Income tax Gujarat vs Laxmi Cement Distributors Pvt
Ltd 1 and the High Court of Bombay in Commissioner of Income tax Bombay City I vs Fairdeal Corporation Pvt
Ltd2 and in Commissioner of Income tax Bombay City I vs Patel Cotton Co Pvt Ltd3 have also understood the principle underlying the decision of this Court in Gordon Woodroffee Leather Manufacturing Co vs 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 102 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 102xv 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 102 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 102 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 371 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 895 expenditure should not come in the way of an expenditure being allowed by way of deduction under section 102 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 vs Chandulal Keshavlal  Co Petlad1 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 vs Bruce 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 vs The Commissioner of Income tax West Bengal  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 127511 was not deductible under section 102 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 896 order for the year 1957 58 against the assessee and in favour of the Department to the extent of Rs 127511 
Similarly it erred in disallowing the claim made in respect of Rs 16885 for each of the three succeeding assessment years
We therefore allow these appeals and hold that Rs 127511 was also deductible under section 102xv of the Act during the assessment year 1957 58 and sum of Rs 16885 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
PBR Appeals allowed


Summary:
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 section 102xv of the Indian Income Tax Act 1922 of a sum of Rs 164 lakhs paid by way of retrenchment compensation and compensation for termination of service during the assessment year 1957 58 and a sum of Rs 16885 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 section 102 xv since the payment was made to the benefit of a third party
Relying principally upon the decision of this Court in Gordon Woodroffee Leather Manufacturing Co vs 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 section 102xv of the Act and therefore disallowed the expenditure of Rs 127 lakhs out of a sum of Rs 164 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 1a 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 section 102 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 vs The Commissioner of Income tax Madras 1962 Supp
2 SCR 211 applied
i Commissioner of Inland Revenue vs Patrick Thomson Ltd in Liquidation ii Commissioners of Inland Revenue vs J  R Allan Ltd In liquidation iii Commissioners of Inland Revenue vs Pattigrew  Stephens Ltd  referred to
Commissioner of Income tax Gujarat vs Laxmi Cement Distributors P Ltd  Commissioner of Income tax Bombay City I vs Fairdeal Corporation P Ltd  Commissioner of Income tax Bombay City I vs Patel Cotton Co Pvt Ltd  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 section 102xv 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