IN THE HIGH COURT OF GUJARAT AT AHMEDABAD INCOME TAX REFERENCE No 54 of 1993 with ITR NO. 272/93, ITR NO. 121/96, ITR NO. 15/97, ITR NO. 19/97, ITR NO. 132/96 & ITR NO. 49/97 For Approval and Signature: Hon'ble MR.JUSTICE R.K.ABICHANDANI and MR.JUSTICE KUNDAN SINGH ============================================================ 1. Whether Reporters of Local Papers may be allowed to see the judgements? 2. To be referred to the Reporter or not? 3. Whether Their Lordships wish to see the fair copy of the judgement? 4. Whether this case involves a substantial question of law as to the interpretation of the Constitution of India, 1950 of any Order made thereunder? 5. Whether it is to be circulated to the Civil Judge? --------------------------------------------------------- COMMISSIONER OF INCOME TAX, GUJARAT-III Versus KIRANBHAI H SHELAT --------------------------------------------------------- COMMISSIONER OF INCOME TAX, GUJARAT-III Versus NARANBHAI S. PATEL -------------------------------------------------------- CHIMANBHAI H. PATEL Versus COMMISSIONER OF INCOME TAX, GUJARAT-II --------------------------------------------------------- MUKESHBHAI J. BHATT Versus COMMISSIONER OF INCOME TAX, GUJARAT-II --------------------------------------------------------- DINESHCHANDRA S. SHAH Versus COMMISSIONER OF INCOME TAX, GUJARAT-I --------------------------------------------------------- DAYALJIBHAI J. PATEL Versus COMMISSIONER OF INCOME TAX, AHMEDABAD --------------------------------------------------------- Appearance: ITR Nos. 54/93 & ITR No. 272/93 Mr. P.G.Desai & Mr. Mihir Joshi with Mr.M.R.Bhatt, Advocates for the Revenue. Mr. S.N.Divetia, Advocate for the respondents. ITR Nos. 121/96, ITR No. 15/97 and ITR No. 19/97 Mr.Mukesh M. Patel, Advocate for the petitioners. Mr. P.G.Desai & Mr. Mihir Joshi with Mr.M.R.Bhatt, Advocates for the Revenue. ITR No. 132/96 Mr. S.N.Divetia, Advocate for the petitioner. Mr. P.G.Desai & Mr. Mihir Joshi with Mr.M.R.Bhatt, Advocates for the Revenue. ITR No. 49/97 Mr. S.N.Soparkar, Advocate for the petitioner. Mr. P.G.Desai & Mr. Mihir Joshi with Mr.M.R.Bhatt, Advocates for the Revenue. -------------------------------------------------------------- CORAM : MR.JUSTICE R.K.ABICHANDANI and MR.JUSTICE KUNDAN SINGH Date of decision: 27/04/98 ORAL JUDGEMENT (Per R.K.Abichandani,J.) This group of matters alongwith similar other matters was argued together and at the instance of both the sides, is being disposed of by this common judgement. The questions which have been referred to this Court by the Income Tax Appellate Tribunal under Section 256(1) of the Income Tax Act, 1961 in these references are as under:- ITR No.54/93, (At the instance of the Revenue for the Assessment Years 1984-85 to 1987-88):- "Whether, the Appellate Tribunal is right in law and on facts in directing the ITO to allow 40% of the incentive bonus as deduction and include the net amount after such deduction in the salary income?" ITR No. 272/93, (At the instance of the Revenue for the Assessment Years 1983-84 to 1987-88):- "Whether, the Appellate Tribunal is right in law and in holding that the Commissioner of Income Tax was not justified in directing the assessing officer to withdraw the deduction allowed by him at 40% of the gross receipts?" ITR Nos. 121/96, 15/97 and 19/97, (At the instance of the assessee for the Assessment Years 1987-88 to 1989-90):- "Whether the ITAT is right in law in holding that no deduction is available to the assessee as expenses out of the Incentive Bonus Commission received by him as a Development Officer of Life Insurance Corporation of India?" ITR No.132/96, (At the instance of the assessee for the Assessment Years 1986-87 to 1988-89):- "Whether on the facts and circumstances of the case, the Tribunal was justified in holding that incentive bonus earned by the assessee as Development Officer of LIC was part of salary within the ambit of Section 17 of the Act and no deduction on account of expenses were permissible?" ITR No. 49/97, (At the instance of the assessee for the Assessment Years 1987-88 to 1990-91):- "Whether in the facts and circumstances of the case the Tribunal was right in law in holding that the incentive bonus was part of the salary by virtue of Section 17(1)(iv) and the only deduction admissible is under Section 16(1) of the Income Tax Act?" 2. I.T.R No. 54/93 relates to the Assessment Years 1984-85 to 1987-88. The assessee was working as a Development Officer in the Life Insurance Corporation of India and in addition to the salary and perquisites, he was also given "incentive new business bonus" from the LIC. The assessee claimed deduction of expenses incurred for earning the incentive bonus to the tune of 50 per cent of the incentive bonus. The claim was allowed by the ITO in the original assessment years, but later the Commissioner by his common order dated 31.1.1989 passed under Section 263 of the Act, directed the ITO to withdraw the deduction of expenses on the ground that incentive bonus was part of `salary' and as such what all the assessee was entitled to, was standard deductions admissible under Section 16(1) of the Act and that the expenses incurred in earning the incentive bonus were not allowable. The assessee appealed before the Tribunal against the common order dated 31.1.1989, by which the Commissioner had directed the ITO to withdraw the expenses allowed from incentive bonus commission for these years. The Tribunal took note of the fact that the Development Officer was an employee of the Life Insurance Corporation, who was not paid incentive bonus by way of remuneration because it was expressly excluded from the definition of annual remuneration contained in Rule 2(c) of the LIC Development Officers' Service Rules 1989. It was found that the incentive bonus was not akin to the ordinary bonus given under the Payment of Bonus Act. The Tribunal held that the incentive bonus represent additional profits, which could be classified and charged as income under the head `Salaries' because of the wide definition of the term "salary" under Section 17, which included `profits in lieu of or in addition to any salary or wages'. The Tribunal followed the decision of the Bombay Tribunal in the case of ITO Vs. Narendra V. Patel, reported in (1983) 21 Taxman 45 (Trib.), in which it was laid down that the expenditure incurred for earning the incentive bonus was liable to be deducted at the starting point itself under Section 15 of the Act while determining the amount of incentive bonus, which was chargeable to tax and observed that this view was based on the principle laid down by the Hon'ble Supreme Court in the case of Bhadridas Daga Vs. CIT, reported in 34 ITR 10 and Poona Electric Supply Company Limited Vs. CIT, reported in 57 ITR 521. It was observed that the decision of the Bombay Tribunal in ITO Vs. Narendra V. Patel (supra) was followed by all the Benches of the Tribunal. In respect of the decision of the Andhra Pradesh High Court in K.A.Choudary Vs. CIT, reported in 183 ITR 29, on which reliance was placed on behalf of the Department, the Tribunal observed that in that case the Court did not consider the question whether the expenses incurred for earning the incentive bonus were liable as deduction at the starting point itself in view of the fact that incentive bonus did not represent salary in the ordinary sense but it represented salary in view of the definition given in Section 17 of the Act. It was held that, that aspect was considered by the Bombay Tribunal in ITO Vs. Narendra V. Patel (supra), in which it was held that per se it was not possible to draw an inference that the legislature had intended to take into account cases of incentive bonus without reducing it by the expenditure incurred for earning it and that the expenditure incurred by the assessee for the purpose of earning incentive bonus should be reduced therefrom at the starting point itself i.e. at the point when it is treated under the income chargeable under the head "salary". The Tribunal accordingly held that the expenses incurred for earning the incentive bonus by the development officers were allowable as deduction and that net incentive bonus alone was includible in the computation of income under the head salary. The Tribunal found on the facts of the case that there was no justification for not allowing 40% of the incentive bonus as had been allowed in several cases cited before it. The Tribunal found that there was, however, no reason to allow a higher deduction at 50 per cent, as was done by the ITO. 3. In ITR No. 272/93 which relates to the Assessment Years 1983-84 to 1987-88, similar view was taken by the Tribunal by it's order dated 7.8.92, in which the Tribunal dealing with a similar claim of the assessee Development Officer, held that the CIT was not justified in directing the Assessing Officer to withdraw the deduction allowed by him at 40 per cent of the gross receipts. 4. ITR Nos. 121/96 and 15/97 are filed by the same assessee who was also a Development Officer and had claimed deduction of 50 per cent from the incentive bonus as expenditure for earning the same, during the previous years to the assessment year - 1987-88 and 1989-90 respectively. ITR No.19/97 is also by an assessee who was a Development Officer and had claimed 50 per cent of the incentive bonus as expenditure for earning the same. In these cases, the Tribunal however took an opposite view on the identical contentions and came to a finding on the basis of the decisions of the Orissa High Court in the case of CIT Vs. Govind Chandra Pani, reported in 213 ITR 783, CIT Vs. Bijoy Kishore Kapoor (1993) 202 ITR 129; and the Andhra Pradesh High Court in K.A.Chaudhary Vs. CIT (1990) 183 ITR 29 and CIT Vs. B. Chinniah & ors (1995) 214 ITR 368 that the amount of incentive bonus received by the Development Officer was part of his salary and no deduction was to be allowed except the standard deductions under Section 16 of the Act. 5. In ITR 132/96, the assessee Development Officer had claimed in his return for the Assessment Year 1986-87 to 1988-89 that the incentive bonus received from LIC should be excluded from salary and be assessed under the head professional income. He claimed that the deduction at the rate of 50 per cent of such incentive bonus on account of expenses incurred for earning such bonus should be allowed. This claim was rejected by the AO on the ground that the incentive bonus was a part of his salary and the assessee was entitled only to standard deductions under Section 16(1) of the Act. In appeal, the Deputy Commissioner of Income Tax (Appeals) accepted the assessee's claim and held that 40 per cent of the incentive bonus was to be allowed as deduction to the assessee. Following the decisions of the Andhra Pradesh High Court in K.A.Chaudhary Vs. CIT (supra) and the Orissa High Court in the case of CIT Vs. Govind Chandra Pani (supra), the Tribunal allowed the appeal of the Revenue on this count and reversed the order of the appellate authority. 6. In ITR No. 49/97 which is made at the instance of the assessee - Development Officer in respect of Assessment Years 1987-88 to 1990-91, the assessee had claimed 50 per cent of bonus as deduction on account of expenses incurred towards such incentive bonus. The Assessing Officer however, held that the incentive bonus was a part of salary as per Section 17(1)(iv) of the Act and deductions were available only under Section 16(1) of the Act. The Deputy Commissioner (Appeals) allowed the deduction claimed, but the Tribunal, following the decisions of the Andhra Pradesh High Court in K.A.Chaudhary Vs. CIT (supra) and CIT Vs. Govindchandra Pani (supra), held that the issue was covered and set aside the order of the Deputy Commissioner, restoring the order of the Assessing Officer. 7. We first deal with certain admitted aspects of the matter. The terms and conditions of service of the Development Officers are governed by the Life Insurance Corporation of India Development Officers (Revision of Certain Terms and Conditions of Service) Rules, 1989. A copy of these Rules and certain other admitted correspondence between the Central Board of Direct Taxes (CBDT) and the Life Insurance Corporation of India, are placed on record at the instance of both the sides and their genuineness is admitted. `Development Officer' is defined in Rule 2(h) of these Rules, which were framed in exercise of the powers vested in the Central Government under Section 48 of the Life Insurance Corporation Act, 1958 and it means a whole-time salaried employee of the Corporation belonging to Class II appointed as Development Officer and includes any person who became an employee of the Corporation on the 1st day of September, 1956 and is working as a Development Officer. It is clear from this definition that the Development Officer is a whole-time employee of the LIC. As provided by Rule the Development Officer, subject to the provisions made in these Rules, shall hold office by the same tenure and in the same manner as any other class of employee in the Corporation. Then there is a provision in Rule 8 which indicates that if the Development Officer does not conform to certain norms of expense limit (as defined in Rule 2(k), his service would be liable to be terminated. There are also provisions for imposing disincentives on a Development Officer, if he does not measure upto certain standards of performance. The whole scheme appears to be result-oriented and expects the Development Officer to work in a manner that would produce results or face disincentives, which feature unfortunately is not adopted in other services. We now come to Rule 17 of the above Rules, which provides for incentive bonus. It lays down that incentive bonus under any scheme approved by the Corporation may be allowed to a Development Officer for any preceding year, if his cost ratio with reference to his annual remuneration in that year does not exceed twenty per cent of the eligible premium of that year. There was an incentive bonus scheme for Development Officers accordingly framed in the year 1978, which is also taken on record at the instance of both the sides in a common paper-book filed in these matters. The said scheme was known as "Scheme of Incentive Bonus to Development Officers of the LIC - 1978". It came into force on 30.4.1976 and, initially, was to remain in force till 31.12.1980. Admittedly, the scheme continued to operate even thereafter. Under Clause 4 of that Scheme, it was provided that incentive bonus in accordance with the scheme could be given to a Development Officer whose cost ratio (i.e. ratio of his annual remuneration in an appraisal year to the eligible premium in that year) did not exceed 20 per cent in an appraisal year. Formula for determining basic Incentive Bonus was provided in Clause 5 of the Scheme, with a rider that the quantum of basic incentive bonus determined as per the formula prescribed under clause 5 could be increased or decreased in accordance with the provisions of sub-clauses (i) to (iv). These sub-clauses provided for, increase or decrease in the actual performance from the standard norms of performance; Agency Organisation for excess or deficit of the standard number of points specified in clause 8; recruitment of agents less than the number of agents specified in clause 9, etc. As provided in clause 10, the matters relating to the `net eligible premium', `lapsed premium', `standard norms of performance' and the like in respect of a Development Officer in the first, second or third year of service and any other connected matters were to be regulated by the administrative instructions issued by the Chairman from time to time. On the subject of income-tax payable by the Development Officers on their earnings by way of additional conveyance and incentive bonus paid to them by the LIC, there was correspondence between the LIC and the CBDT, which is taken on record at the instance of and by consent of both the sides as admittedly genuine correspondence. In the letter from the LIC dated 29th September, 1986, the LIC had written to the CBDT as regards the incentive bonus as under:- "As regards Incentive Bonus, we have taken note of your clarification in the matter. We are at present designing a new Incentive Bonus Scheme for our Development Officers where it might be possible to provide for a separate allowance or for a distinct/separate element of payment in the nature of reimbursement of expenses which, we know, are necessarily to be incurred in the process or earning that Incentive Bonus. As this would take some more time, we would request you to allow some relief, in the meanwhile, to our Development Officers on this account. As you know, Incentive Bonus is a production-oriented income, inasmuch as, higher bonus becomes payable to a Development Officer on achieving higher production. When his actual performance is beyond the normal levels of performance expected of him, he has to incur expenditure in respect of items such as (i) entertainment to agents/clients (ii) prizes declared in competition amongst his agents (iii) conveyance facilities to his agents, and (iv) office expenses such as rent, secretarial assistance, printing and stationery, postage, trunkcalls and telephone charges etc. The quantum of Incentive Bonus is decided taking into account factors such as the number of policies procured by a Development Officer, his agency organisation, the nature of territory operated by him i.e. whether rural or urban etc. These very same factors also influence the size of his expenditure. We do not at present allow reimbursement or special allowance as such towards these items, it being understood that a Development Officer is required to spend a part of the Incentive Bonus on this account. It is therefore, proposed to certify, under Section 10(14), an amount upto 30% of the Incentive Bonus earned as necessary expenses that would have to be incurred and the internal system devised by us lays down guidelines to the operating offices regarding the percentage to be certified in each case having regard to factors referred to earlier. We would be grateful if you could kindly examine the points clarified in this letter and issue suitable guidelines to your offices to accept the certification given by the LIC offices both with reference to Additional Conveyance Allowance and Incentive Bonus, as above." On 28.11.1986, the Central Board of Direct Taxes while stating that necessary instructions were issued in respect of exemption under Section 10(14) of the Act for the additional conveyance allowance given to the Development Officers on the basis of a certificate appended to the salary certificate. As regards the exemption of incentive bonus the Board regretted its inability to accede to its request. However, the LIC was requested to formulate a scheme of special allowance with reference to the expenditure incurred in the course of official duties and inform the Board, so that the matter may be considered further. In the letter dated 19th December, 1996, the Central Board of Direct Taxes on the question of incentive bonus paid to Development Officers, again reiterated that the request of the LIC to notify Incentive Bonus under sub-clause (i) of clause (14) of Section 10 of the Income Tax Act, cannot be acceded to. It was stated that, "it may however, be added that the portion of the allowance certified as having been actually incurred in the performance of duties shall be exempt under the above provision". In the other admitted communication from the CBDT to the LIC dated 12th March, 1997, while again reiterating that it was not possible to notify incentive bonus for exemption under Section 10(14)(i) of the Act, the CBDT wrote as under in paragraph 3 of it's letter. "3. However, such portion of the "incentive bonus" which is actually spent by the Development Officers for duties of office can still be exempted from tax if the LIC makes the payment against the expenses incurred by the Development Officers by way of reimbursement of expenses. In that case, such reimbursement will not form a part of the "salary" of the Development Officers and only the taxable "incentive bonus" will appear in their salary certificates. In view of the above, you may kindly issue appropriate instructions for modifying the aforesaid circular of the LIC." It appears that thereafter, the Chairman of the LIC in exercise of powers conferred by Regulation 4 of the LIC of India (Staff) Regulations, 1960, issued instructions to give effect to the provisions of the Incentive Bonus Scheme - 1997 and the Reimbursement Scheme of expenses - 1997 for Development Officers of the Corporation. At the instance and by the consent of both the sides, the order alongwith the Incentive and Reimbursement Schemes are also placed on record, as admitted documents. This is relied upon, on behalf of the assessee, to show that there was in fact a reimbursement component in the Incentive Bonus Scheme right from the beginning as is reflected from the earlier correspondence, which now came to be split up by framing a separate scheme in respect of that reimbursement component of the incentive bonus. It was demonstrated from these two schemes that the reimbursement was connected with the performance of a Development Officer and both these schemes were inter-linked and further that the Development Officer was required to incur expenses for reaching the performance norms to become eligible for incentive bonus and reimbursement, for development and building of clientele contacts, for recruitment of assistants and agents, for agents' training and for conducting prize competition among agents etc. It will be noted that even in the communication dated 29th September, 1986, which was relatable to the earlier incentive bonus scheme of 1978 (which would be relevant for the purpose of all these references), admittedly there was a clear mention of the fact that the quantum of incentive bonus which was given to the Development Officers was fixed keeping in view the factors namely (i) entertainment to agents/clients, (ii) prizes declared in competition amongst agents, (iii) conveyance facilities to it's agents and (iv) office expenses such as rent, secretarial assistance, printing and stationery, postage, trunkcalls and telephone charges etc. which the Development Officer was required to incur as expenditure in his performance beyond the normal level of performance expected of him. 8. In the above factual background, it was contended on behalf of the assessees by their learned Counsel that a portion of the incentive bonus was given specifically with a view to reimburse the Development Officers who were eligible to receive the incentive bonus to the extent of the expenditure incurred by by them in discharge of the duties of their office. It was contended that all receipts were not necessarily income and the meaning of real income cannot be stretched so as to cover receipts which could not, by any stretch of imagination, be held as income. It was contended that the part of the incentive bonus which was granted to the Development Officers to meet with the necessary expenses for discharge of their duties was not income and could not be treated as a part of their salary. Reliance was placed by the learned Counsel on the decision of the House of Lords in Pook Vs. Owen, reported in 45 TC 571, in support of their contention that reimbursement of expenses could not be treated as salary. It was further argued that the Development Officer when functioning for an achievement beyond the standard norms so as to become eligible for incentive bonus, was not acting as an employee but should be treated as an agent of the LIC. It was argued that this dual capacity was borne out from the fact that in the definition of `annual remuneration' of Development Officer incentive bonus was excluded and, further that, the incentive bonus was payable under an independent scheme in respect of the achievements, which went beyond the standard norms which alone were required to be satisfied by the Development Officer when he acted as an employee. It was then argued that in any event since the portion of the incentive bonus included the expenditure component as declared by the LIC, the expenditure actually incurred by the