Case: Commissioner of Income-Tax, Mumbai City-Iii, Mumbai Vs. Sinnar Bidi Udyog Limited & Another

ORAL JUDGMENT H.L.Gokhale, J.Heard Mr. Desai for the Appellant. Mr. Zhaveri with Mr. Singh appears for the Respondent.2.This appeal under Section 260-A of the Income Tax Act seeks to challenge the order dated 3rd December 1998 passed by the Income Tax Appellate Tribunal confirming the order of C.I.T. (Appeal) which allowed the appeal filed by the Respondent herein to the extent of disallowance of Rs.3,70,755/- which was claimed to be deducted by the Respondent from its income under Section 37 of the Income Tax Act, 1961. The relevant assessment year is 1989-1990.3.The facts leading to this appeal are as follows : The Respondent herein is a beedi manufacturing company. It employs large number of workmen for its activities. For the assessment year 1989-90, it claimed a deduction of Rs.3,70,755/- as revenue expenditure on account of compensation paid to several workers on retirement. This amount was paid towards the period of service rendered by these workers under another company namely B.N. Sarda Ltd. This deduction as claimed under Section 37 of the Income Tax Act was disallowed by the Assessment Officer by order dated 28th February 1991. The Assessment Officer held that the assessee had on his freewill decided to distribute this amount amongst the workers on their retirement, without there being any legal liability to do so. He, therefore, held that the assessee was not entitled to claim deduction of this amount.4.The Respondent had carried the matter in appeal, as pointed out above, to the C.I.T. (Appeal). The C.I.T. (Appeal) in para 3 of his order referred to the fact that the workers concerned had joined the Respondent Company in 1974 i.e. from the inception of the Respondent company and had thereafter, rendered loyal and devoted service. Prior thereto, all of them were working in one B.N. Sarda Limited. The workers were not paid their gratuity for the services rendered in B.N. Sarda Limited. Though the Respondent Company was legally not liable to pay the gratuity to these workers for the earlier period, on a representation made by the workers and considering their hardship, the company thought it fit to pay additional compensation on retirement, considering their loyal and devoted service. This retirement compensation was calculated after considering the difference between the gratuity which they would have received if their services with the earlier employer had been considered and the gratuity which they would have otherwise received from the Appellant Company. The C.I.T. (Appeal) held in para 4 of his order as follows:"In my view, for the purpose of disallowing any expenditure, one cannot lay down a general rule that the expenditure of voluntary nature will be disallowed. In the present case, the expenditure had been incurred due to commercial expediency. By incurring this expenditure the appellant company has mitigated the hardship caused to the employees. Therefore, the expenditure is allowed as a deduction."5.The Appellant carried the matter to the Income Tax Appellate Tribunal and the Tribunal upheld the order of the C.I.T. (Appeal), by observing as follows in para 4 of its order :"In our considered view, since the expenditure has been incurred by the assessee for maintaining good relations with the employees and for the welfare of the employees, the C.I.T.(Appeal) was justified in allowing the claim of the assessee. The appeal of the revenue on this ground is accordingly dismissed.6.Being aggrieved by the order of the C.I.T.(Appeal) as confirmed by the Income Tax Appellate Tribunal, this appeal has been filed.The appeal seeks to raise the following question of law."Whether on the facts and in the circumstances of the case, the Tribunal was justified in law in holding that the expenditure of Rs.3,70,755/- incurred by the assessee as retirement compensation was for maintaining good relations with the employees and for the welfare of the employees and hence allowable as revenue expenditure "7.Mr. Desai, learned Sr. Counsel appearing on behalf of the Appellant submitted that the deduction which has been claimed, was essentially towards the unpaid gratuity which ought to have been paid by the earlier employer for the services rendered under him. The submission of Mr. Desai, therefore, was that if that was so, this would become the deduction even permissible under Section 36(1)(v) of the Income Tax Act and, therefore, cannot be permitted under Section 37 of the Act. For ready reference, we reproduce herein the clauses, relevant for our purpose, including sub-clauses of Section 36(1) and 37(1) which are as follows :"Other Deductions :36(1) The deductions provided for in the following clauses shall be allowed in respect of the matters dealt with therein, in computing the income referred to in section 28 -(i) ...(ii) any sum paid to an employee as bonus or commission for services rendered, where such sum would not have been payable to him as profits or dividend if it had not been paid as bonus or commission ;(iii) ...(iv) any sum paid by the assessee as an employer by way of contribution towards a recognised provident fund or an approved superannuation fund subject to such limits as may be prescribed for the purpose of recognising the provident fund or approving the superannuation fund, as the case may be ; and subject to such conditions as the Board may think fit to specify in cases where the contributions are not in the nature of annual contributions of fixed amounts or annual contributions fixed on some definite basis by reference to the income chargeable under the head "Salaries" or to the contributions or to the number of members of the fund ;(v) any sum paid by the assessee as an employer by way of contribution towards an approved gratuity fund created by him for the exclusive benefit of his employees under an irrevocable trust ;Section 37(1) reads as follows :General :37(1) Any expenditure (not being expenditure of the nature described in sections 30 to 36 and not being in the nature of capital expenditure or personal expenses of the assessee), laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head "Profits and gains of business or profession"." (All underlinings supplied.)8. Mr. Desai referred to and relied upon a judgment of a Division Bench of this Court in the case of Commissioner of Income Tax Vs. Rajaram Bandekar reported in (1999) 237 I.T.R. 628. In that matter, the controversy was whether the assessee was entitled to deduction of ex-gratia payment of certain amount by way of bonus to the workers. The Tribunal had allowed this claim of the assessee under Section 37 of the Income Tax Act. Mr. Desai, learned Counsel appearing in the present matter for revenue had appeared in that matter also and had submitted that in case of expenditure in the nature of bonus paid to the employees for the services rendered, Section 36(1)(ii) would apply and the allowability of the expenditure as a deduction in computing the income of the assessee can only be determined by the test laid down in that case. He had therefore, submitted that it was not permissible for the assessee to claim deduction under the general provision contained in section 37. The submission made by Mr. Desai was accepted by the Division Bench and the Tribunal was faulted for holding that the payment towards bonus in that case was allowable as deduction under section 37. The Tribunal was, however, directed to afford the assessee a reasonable opportunity of hearing to satisfy it that the conditions set out in the second proviso to section 36(1)(ii) are fulfilled and if the Tribunal was so satisfied, it may allow deduction under section 36(1)(ii) of the Act. Mr.Desai submits that the present case is comparable with Rajaram Bandekars case and, therefore, this Court should follow the same course.9.Mr. Zhaveri, learned Counsel appearing for the Respondent on the other hand stressed the fact that this payment had been made as ex-gratia retirement benefit to the employees, though the calculation was made on the basis of the unpaid gratuity which would have been payable for the services rendered under B.N.Sarda Limited. He emphasized the fact that C.I.T.(Appeal) had in terms held that the expenditure was towards commercial expediency. He pointed out that in para 3 of order of C.I.T (Appeal), it was recorded that the workers had made a representation and, thereafter this decision had been arrived at considering the loyal and dedicated services for long period rendered by them.10.Mr.Zhaveri placed before us a compilation of documents for consideration. It included a notice dated 12th January, 1977 issued by the Deputy Commissioner of Labour,Pune addressed to the Respondent. It recorded that the services of the workers had to be treated as continuous as the Respondent had taken over a going concern namely B.N. Sarda Limited. The Deputy Commissioner of Labour, therefore, sought to know as to what was the decision of the Respondent in this behalf.11.The next document from this compilation is the extract of minutes of the meeting held on 2nd February, 1997 by the Board of Directors of the Respondents. In that meeting, a resolution was passed authorising the Managing Director to negotiate with the Deputy Commissioner of Labour in the matter of and to the extent of beedi workers who chose to leave the services of B.N.Sarda Ltd. and had joined the services of the Respondents on 18th September, 1974 and they be given benefit of treating the services rendered earlier without creating any financial burden on the company, beyond the legal provisions applicable in respect of the continuity of service.12.It appears that though that resolution was passed in the year 1977, it was not acted upon and the workers were constrained to file proceedings before the Controlling Authority under the Payment of Gratuity Act, 1972. One such specimen application bearing No. 244/87 filed by one Mrs. Sugrabi Hawaldar on 12th January 1987 claiming an amount of Rs. 4,125/- for the entire period of service rendered under both the companies is brought to our notice. Thereafter, there is a pursis dated 8th December, 1988 filed before that Authority at Solapur settling the claim for Rs.1,165/- and then the order of the Authority dated 30th December, 1988 disposing of the Application in terms of the pursis. Mr. Zhaveri has also drawn our attention to another resolution dated 20th April 1987 which obviously must have been passed in view of the filing of this proceedings. That resolution reads as follows:"RESOLVED that the workers be paid compensation by ex-gratia payment in view of their loyal and dedicated service and such compensation be calculated by taking into account the gratuity that would have been due as if the services rendered to the firms of M/s. Bastiram Narayandas Maheshri or B.N. Sarda Ltd. were to be rendered to the Company itself. FURTHER RESOLVED that such ex-gratia payment that was made in the past be and are hereby ratified".13.Mr.Zhaveri has also drawn our attention to the list of workers who were paid this retirement compensation. The list runs into some 505 workmen. The name of said Mrs.Sugrabi Hawaldar appears at Serial No.1 therein. The table points out that she had put in around, 24 years of service, out of which 10 years were under earlier company, and 14 years under the Respondent. The amount of ex-gratia mentioned against her name is Rs.291/-. Mr.Zhaveri points out that this is component for the service rendered under the earlier company whereas the entire amount payable to her was Rs.1,165/-. The total amount arrived at the bottom of this list of 505 workmen is Rs.3,70,755/-. It is this amount which was claimed as a deduction before the Assessment Officer for the aforesaid assessment year i.e. 1989-90. Mr.Zhaveri submits that the payment was considered expedient to avoid unrest in the large work-force and from the workers point of view it was in a way legitimate expectation.14.Mr. Zhaveri relied upon another judgment of a Division Bench of this court in the case of Commissioner of Income Tax Vs. Associated Cement Companies Limited reported in (2001) 249 Income Tax Reports 3. In that matter the question raised was, whether gratuity paid in excess of limits prescribed by the Gratuity Act constituted allowable deduction. The Division Bench relied upon a judgment of a Division Bench of Calcutta High Court in the case of Commissioner of Income Tax Vs. Hindustan Motors Limited reported in (1989) 175 Income Tax Reports 411 (Calcutta), wherein it was held that the additional gratuity paid to monthly wage earners could not be disallowed as it constituted an expenditure under the rules of the company. The said judgment in the case of Hindustan Motors was applied by the Tribunal in the Associated Cement Companies case and the Tribunal had found that the additional gratuity was paid to the monthly earners and that was for the past assessment years, the Department had allowed deduction in respect of additional gratuity paid to such workers. Relying upon the Hindustan Motors judgment the Division Bench of this Court in the case of Associated Cement Companies Limited, dismissed the appeal and held that the additional gratuity paid to the employees in excess of the statutory limits was an allowable deduction.15.As noted above, the judgment of this Court in Associated Cement Companies Limited (Supra) had referred to a Division Bench judgment of Calcutta High Court in the case of Commissioner of Income Tax Vs. Hindustan Motors (Supra). In that matter, the question was with respect to the ex-gratia payment to a retired employee and to the widow of a deceased employee. The Tribunal had held that the pension payments to the two persons was made on considerations of commercial expediency. Further, the board of directors of the assessee-company had passed a resolution sanctioning payment of pension to the wife of the deceased employee and also indicating the reasons for such payment. The Calcutta High Court held that the benefit provided to the employee by way of pension to himself and after his death to his widow must be held to be reasonable on considerations of commercial expediency. Therefore, the pension payments were admissible business expenditure under section 37(1) of the Income Tax Act.16.The Calcutta High Court in turn in that judgment has relied upon a judgment of the Constitution Bench of the Apex Court in the case of Gordon Woodroffe Leather Mfg.Company Vs. Commissioner of Income Tax reported in (1962) 44 Income Tax Reports 551. The Apex Court has laid down three tests in that judgment, in connection with the allowability of gratuity as business expenditure under the then prevalent Section 10(2)(XV) of the Income Tax Act, 1922 which is similar to Section 37(1) of the Income Tax Act, 1961.These tests are :"(a) was the payment made as a matter of practice which affected the quantum of salary; or(b) was there an expectation by the employee of getting a gratuity ; or(c) was the sum of money expended on grounds of commercial expediency and in order indirectly to facilitate the carrying on of the business."The Calcutta High Court has commented on these tests in Hindustan Motors (supra) that these tests are not cumulative. They are alternative and independent. If any one of these tests is satisfied, the expenditure has to be allowed as revenue expenditure. The then prevalent Section 10(2)(XV) reads as follows:"(2) Such profits or gains shall be computed after making the following allowances, namely :- (XV) any expenditure (not being an allowance of the nature descried in any of the clauses (i) to (xiv) inclusive, and not being in the nature of capital expenditure or personal expenses of the assessee) laid out or expended wholly and exclusively for the purpose of such business, profession or vocation."17.In the aforesaid matter before the Apex Court, a person who was an employee of the managing agent of the assessee company from 1922 to 1935 and who was also an employee of the assessee from 1935 and also its director from 1940, was paid a gratuity of Rs. 40,000/- by the assessee company, "in appreciation of his long and valuable services to the company". The company had no scheme for payment of gratuities nor did it pay such gratuities in practice. There was nothing to show that the employee had accepted a low salary in expectation of a gratuity on retirement or that the gratuity was paid for the purpose of facilitating the carrying on of the business of the company or as a matter of commercial expediency. The Apex Court disallowed the deduction and it is in that context, the Apex Court has laid down the tests as referred to above.18.Having heard both the Counsel and having noted relevant judgments as stated above, we are of the view that as far as the present payments made to the employees are concerned, although these payments were made for the services rendered by the employees concerned for the period prior to their joining into the assessee company, the assessee company had considered their representation and thereafter, settled the matter with the employees. The Respondent assessee company had considered the fact that the affairs of the earlier company were taken over by the assessee company and the services of the employees were continuous and they had put in long valuable service over the years. Since the affairs of the earlier company were taken over and the services were continuous, the workers had legitimate expectation that their earlier service will also be considered for calculating gratuity. The employees had also initiated proceedings against the Respondent company, first before the Labour Commissioner and thereafter before the Gratuity Authority. It is, thereafter that the necessary decision was taken by the Respondent company to settle the controversy. The Respondent company accepted part of the claim by passing a resolution in the meeting of Board of Directors. Therefore, we are of the view that this payment has been made to the employees by way of commercial expediency also. In our view the second and the third test laid down by the Apex Court in the Gordon Woodroffe Leather case (supra) clearly apply in the present case.19.The preposition laid down in the case of Rajaram Bandekar has no application to the present case. In that matter, the Division Bench has squarely held that it was a case pertaining to the expenditure in the nature of bonus and, therefore, it was necessary to examine as to whether the second proviso to section 36(1)(ii) would get attracted and it is for that purpose that the Division Bench had sent back the matter to the Tribunal. In this connection, it is material to note that the proviso to section 36(1)(ii) as it then existed (and deleted with effect from 1st April, 1989) read as follows :"Provided further that the amount of the bonus (not being bonus referred to in the first proviso) or commission is reasonable with reference to -(a)the pay of the employee and the conditions of his service;(b)the profits of the business or profession for the previous year in question ; and(c)the general practice in similar business or profession".This clearly shows that the proviso was of wide ambit and it covered the expenditure in the nature of bonus in excess of the limit prescribed under the Payment of Bonus Act. That is not the case when it comes to payment in the nature of gratuity. Section 36(1)(v) of the Act quoted above referred to a sum paid by the assessee as an employer by way of contribution towards the approved gratuity fund created by him. In the instant case, it is not a payment either towards or from the gratuity fund. It is a payment in excess of the payment that would be required to be made under the Payment of Gratuity Act, though made on the basis of legitimate expectations of the workmen in the facts of the case on the one hand and the commercial expediency of the employer on the other.20.It is well settled that the legitimate business needs of an assessee must be judged from the point of view of business. It is for the assessee to consider the business expediency and whether a particular expenditure should be incurred for the business. Provision of gratuity to the employees for the continuous services rendered to the company taken over cannot be said to be either unusual or unnecessary. The workmen have come to expect such provision or their legitimate due and in the instant case they had in fact filed application before the Payment of Gratuity Authority. The resolution of the Board of Directors also accepted their legitimate dues while making it clear that, it should not create financial burden beyond legal provision on continuity of service.21.In the circumstances, we are of the view that the deduction claimed by the company would not fall under section 36(1)(v) of the Act, but would be in the nature of revenue expenditure wholly and exclusively for the purposes of business. In that view of the matter, in our view the decision arrived at by the C.I.T. (Appeal) as well as by the Income Tax Appellate Tribunal cannot be faulted and the Tribunal was justified in coming to the conclusion in the facts and circumstances of the case that the expenditure of Rs. 3,70,755/- incurred by the assessee as retirement compensation was allowable as revenue expenditure.

Decision:
0[ds]18.Having heard both the Counsel and having noted relevant judgments as stated above, we are of the view that as far as the present payments made to the employees are concerned, although these payments were made for the services rendered by the employees concerned for the period prior to their joining into the assessee company, the assessee company had considered their representation and thereafter, settled the matter with the employees. The Respondent assessee company had considered the fact that the affairs of the earlier company were taken over by the assessee company and the services of the employees were continuous and they had put in long valuable service over the years. Since the affairs of the earlier company were taken over and the services were continuous, the workers had legitimate expectation that their earlier service will also be considered for calculating gratuity. The employees had also initiated proceedings against the Respondent company, first before the Labour Commissioner and thereafter before the Gratuity Authority. It is, thereafter that the necessary decision was taken by the Respondent company to settle the controversy. The Respondent company accepted part of the claim by passing a resolution in the meeting of Board of Directors. Therefore, we are of the view that this payment has been made to the employees by way of commercial expediency also. In our view the second and the third test laid down by the Apex Court in the Gordon Woodroffe Leather case (supra) clearly apply in the presentclearly shows that the proviso was of wide ambit and it covered the expenditure in the nature of bonus in excess of the limit prescribed under the Payment of Bonus Act. That is not the case when it comes to payment in the nature of gratuity. Section 36(1)(v) of the Act quoted above referred to a sum paid by the assessee as an employer by way of contribution towards the approved gratuity fund created by him. In the instant case, it is not a payment either towards or from the gratuity fund. It is a payment in excess of the payment that would be required to be made under the Payment of Gratuity Act, though made on the basis of legitimate expectations of the workmen in the facts of the case on the one hand and the commercial expediency of the employer on the other.20.It is well settled that the legitimate business needs of an assessee must be judged from the point of view of business. It is for the assessee to consider the business expediency and whether a particular expenditure should be incurred for the business. Provision of gratuity to the employees for the continuous services rendered to the company taken over cannot be said to be either unusual or unnecessary. The workmen have come to expect such provision or their legitimate due and in the instant case they had in fact filed application before the Payment of Gratuity Authority. The resolution of the Board of Directors also accepted their legitimate dues while making it clear that, it should not create financial burden beyond legal provision on continuity of service.21.In the circumstances, we are of the view that the deduction claimed by the company would not fall under section 36(1)(v) of the Act, but would be in the nature of revenue expenditure wholly and exclusively for the purposes of business. In that view of the matter, in our view the decision arrived at by the C.I.T. (Appeal) as well as by the Income Tax Appellate Tribunal cannot be faulted and the Tribunal was justified in coming to the conclusion in the facts and circumstances of the case that the expenditure of Rs. 3,70,755/incurred by the assessee as retirement compensation was allowable as revenue expenditure.