Case: Sassoon J. David &amp; Co. (P) Ltd., Bombay Vs. C.I.T., Bombay

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 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 s. 10(2)(xv) of the Act. The High Court of Gujarat in CIT v. Laxmi Cement Distributors P. Ltd. [1976] 104 ITR 711 and the High Court of Bombay in CIT v. Fairdeal Corporation P. Ltd. [1977] 108 ITR 280 and in CIT v. Patel Cotton Co. P. Ltd. [1977] 108 ITR 846 (Bom) have also understood the principle underlying the decision of this court in Gordon Woodroffe Leather Manufacturing Co. v. CIT [1962] 44 ITR 551 (SC) 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 s. 10(2)(xv) of the ActThe 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 s. 10(2)(xv) 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 s. 10(2)(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 s. 37 of the I.T. Act, 1961, which corresponds to s. 10(2)(xv) of the Act. An attempt was made in the I.T. Bill of 1961 to lay down the " necessity " of the expenditure as a condition for claiming deduction under s. 37. Section 37(1) 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 s. 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 expenditure should not come in the way of an expenditure being allowed by way of deduction under s.10(2)(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 CIT v. Chandulal Keshavlal & Co. [1960] 3 SCR 38 at page 48 ; 38 ITR 601, 610 (SC)" 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 of 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 (Ushers Wiltshire Brewery Ltd. v. Bruce [1914) 6 TC 399 (HL). Another test is whether the transaction is properly entered into as a part of the assessees 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 Investment Ltd. v. CIT [1951] SCR 594 ; 20 ITR 1 (SC). 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. " 10. 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. 1, 27, 511 was not deductible under s. 10(2)(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 order for the year 1957-58, against the assessee and in favour of the department to the extent of Rs. 1, 27, 511. Similarly, it erred in disallowing the claim made in respect of Rs. 16, 885 for each of the three succeeding assessment years. 11.

Decision (1 = appeal accepted, 0 = rejected): 1

Explanation:
1[ds]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 shares by Davids to Tatas. On account of such transfer of shares, the transferees no doubt gained control of 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 s. 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 or expended wholly and exclusively for the purpose of business or profession or vocationIn 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 10(2)(xv). "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 yearsIn, order to claim deduction under s. 10(2)(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 cls. (i) to (xiv) of s. 10(2), (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, the benefit of s. 10(2)(xv) of the Act to the company if there is no other impediment to do soThe facts of these cases are very close to the facts found in (i)IRC v.Patrick Thomson Ltd. ( In liquidation) :IRC v.J. & R. Allan Ltd. (In liquidation) :IRC v.In the present case also, it is seen that the company continued to function even after its control passed on to the hands of the Tatas and the expenditure in question was laid out for the purpose of the companys 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 lakhs. Naturally the total value of the shares of the company would be Rs. 155 lakhs which Tatas had agreed to pay. Subsequent to December 31, 1955, the company had by passing the resolution incurred liability to payretrenchment compensation and compensationfor 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 Woodroffe Leather Manufacturing Co. v. CIT [1962] 44 ITR 551 (SC), 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 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 s. 10(2)(xv) of the ActThe High Court of Gujarat in CIT v. Laxmi Cement Distributors P. Ltd. [1976] 104 ITR 711     and the High Court of Bombay in CIT v. Fairdeal Corporation P. Ltd. [1977] 108 ITR0 andin CIT v. Patel Cotton Co. P. Ltd. [1977] 108 ITR 846 (Bom)   have also understood the principle underlying the decision of this court in Gordon Woodroffe Leather Manufacturing Co. v. CIT [1962] 44 ITR 551 (SC) 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 s. 10(2)(xv) of the ActIn 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. 1, 27, 511 was not deductible under s. 10(2)(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 order for the year 1957-58, against the assessee and in favour of the department to the extent of Rs. 1, 27, 511. Similarly, it erred in disallowing the claim made in respect of Rs. 16, 885 for each of the three succeeding assessment years