Case: Commissioner of Income Tax, Delhi (Central -I) Vs. Continental Construction Ltd

Facts:The respondent - assessee is a civil construction company which has executed a large number of projects outside India. Its overseas projects include Irrigation and Hydle Projects in Libya, a Fibre Board Factory at Abu-Sukhair in Iraq and the Karkh Water Supply Project, Baghdad which had a total value of 534 million dollars.2. For the assessment year 1983-84, the assessee had paid a sum of Rs. 14,0074,570/- to its Directors as remuneration and commission. The Income Tax Officer disallowed a sum of Rs. 13,94,98,570/- being excess amount over the limit of Rs. 72,000/- per Director prescribed under S.40(c) and S.40A(5)(a) of the Income Tax Act, 1961. The respondent did not dispute the disallowance of Rs. 7,61,05,230/- payable to the two India based Directors subject to the allowance of Rs. 72,000/- each as laid down in S.40(c) and 40A(5)(a). The dispute related to the remuneration paid to the Directors who were stationed outside India in connection with the work of the respondent - assessee. According to the assessee the amount paid to its employee - Directors in respect of their employment outside India was not to be taken into account while calculating the ceiling under S.40A(5) or S.40(c).3. The assessee filed an appeal before the Commissioner of Income Tax who modified the order of the Income Tax Officer and held that any remuneration paid to employee - Directors in respect of any period of their employment outside India should not be taken into account while calculating the expenditure subject to the ceiling limit of Rs. 72,000/- under S.40(c) and 40A(5)(a). The department preferred an appeal before the Tribunal from the order of the Commissioner of Income-tax. The Tribunal dismissed the appeal.4. On the application of the department the Tribunal referred the question set out above as a question of law to the High Court. The High Court by its impugned judgment and order dated 24-5-1990 answered the question in the affirmative and against the Revenue. The present appeals are filed on a certificate granted by the High Court of fitness to appeal.

Reasoning: 9. The question of interpreting the provisions of S.40(c) and 40A(5) in connection with persons who are both employees and Directors of the company has come up for consideration in a number of cases before the High Court and before this Court. In the impugned judgment before us (which is reported in 185 ITR 178 : (1990 Tax LR 729), the Delhi High Court has looked at the legislative history of these two provisions with a view to examining their effect. S.40(c) as it originally stood and the amendments made in S.40(c) have been set out in the High Courts judgment. Originally, S.40(c) itself contained sub-clause (iii) dealing with expenditure which results directly or indirectly in the provision of any remuneration or benefit or amenity to an employee. The ceiling prescribed was Rs. 5,000/- per month for any period of employment after 28th day of February, 1963. The expenditure on perquisites with a ceiling of 1/5th of the amount of the salary payable to the employee was subsequently also added. The expenditure on employees is now removed from S.40(c) and incorporated in S.40A(5).10. The two S.40(c) and 40A(5) are, however, not mutually exclusive. In S.40(c), the proviso, for example, refers to a case where the Director (or a person who had a substantial interest in the company or a relative of the Director or of such person) is also an employee of the company for any period prescribed in the previous year. In that situation, expenditure of the nature referred to in Clauses (i), (ii), (iii) and (iv) of the second proviso to Clause (a) of S.40A(5) shall not be taken into account for the purpose of calculating the ceiling under S.40(c). These excluded items are items such as the value of any travel concession, passage money, payment referred to in S.36(1)(iv) and (v) and expenditure referred to in S.36(1)(ix). These items in S.36 deal with contribution towards provident fund, approved gratuity fund and promotion of family planning. Similarly S.40A(5) does not deal only with employees. It also deals with employee - Directors in the first proviso to sub-s.(5)(a). In the case of employee - Directors both these sections are applicable.11. There have been a number of cases in the various High Court as well as this Court which have dealt with the question: which ceiling applies when a person holds the positions both of a Director and an employee. S.40(c) prescribes an overall ceiling of Rs. 72,000/- on expenditure covered in S.40(c). Under S.40A(5) there is a ceiling of Rs. 60,000/- on expenditure in respect of salary and Rs. 12,000/- in respect of perquisites totalling Rs. 72,000/-. This Court considered this question in the case of Commr. of Income Tax v. Indian Engineering and Commercial Corporation Pvt. Ltd., (1993 AIR SCW 1515). This Court has held (page 728) (of ITR) : (at p. 1619 of AIR) that in the case of Directors who are also employees both these sections will be attracted and the higher of the two ceiling has to be applied. The same view had earlier been taken by the Andhra Pradesh High Court in the case of Commr. of Income Tax v. D. B. R. Mills, (1988 Tax LR 1724), and by the Bombay High Court in the case of Commr. of Income Tax v. Hico Products Pvt. Ltd., (1994 Tax LR 219), where the Bombay High Court emphasised the first proviso to S.40A(5)(a) where an express provision is made that if an employee is also a Director or a person specified in S.40(c) the aggregate of expenditure and allowances specified in S.40(c), sub-clauses (i) and (ii) as well as expenditure and allowances specified in S.40A(5)(a)(i) and (ii) shall not exceed Rs. 72,000/-. In other words, the total emoluments and perquisites of Directors who are also employees will be allowed up to the limit of Rs. 72,000/- as a deductible expenditure. In such cases, therefore, though the Directors are also employees, the separate ceilings prescribed of Rs. 60,000/- and Rs. 12,000/- under S.40A(5)(c) will not apply. The contrary view taken by the Kerala High Court in Travancore Rayons Ltd. v. Commr. of Income-tax, (1986 Tax LR 1151), is, therefore, no longer good law.12. We need not, in this connection, refer to the earlier judgments of the Gujarat High Court which have been discussed at length in the impugned judgment. After the decision of this Court in the case of Commr. of Income Tax v. Indian Engineering and Commercial Corporation, (1993 AIR SCW 1515) (supra), the Gujarat High Court has now, in the case of Commr. of Income Tax v. Synpol Products Pvt. Ltd. (1996) 217 ITR 154, held that in the case of Directors who are also employees, both the provisions will be attracted. The higher of the two ceilings will have to be applied.13. We have now to consider in this light whether the provisions of S.40A(5) (b) will apply for the purpose of calculating the expenditure so covered when the expenditure is incurred in connection with a Director who is also an employee. Under S.40A(5)(b) (i) nothing in Clause (a) which deals with expenditure on salaries and perquisites of an employee shall apply, inter alia , to any expenditure in relation to an employee in respect of any period of his employment outside India. Therefore, for example, in calculating the expenditure on the salary of an employee, the salary paid in respect of his employment outside India will not be taken into account for the purposes of calculating the ceiling. This expenditure is outside the expenditure which is subject to a ceiling limit. Under S.40A(5)(b)(ii) and (iii), similarly certain other expenditures in connection with an employee are also excluded from the ceiling limit. The question is whether such expenditure will be excluded from the ceiling limit of a Director - employee. If for the purpose of ceiling on expenditure, both S.40(c) and 40A(5) are to be applied to employee - Directors, there is no reason why for the purpose of deciding what is to be excluded from the expenditure subject to such ceiling, both the sections cannot be taken into account. Both sections constitute a composite scheme. In the case of employee - Directors, both will operate. After all, the purpose of prescribing a ceiling on expenditure in connection with Directors and employees under S.40(c) and S.40A(5), is to discourage a company or an organisation from paying excessive salaries, remuneration, perquisites etc. to its employees and/or Directors. If it does so, the organisation will not be able to claim the entire expenditure as deduction, but only expenditure up to the ceiling limit. However, from this ceiling limit, certain kinds of expenditure on employees have been excluded - presumably because this kind of an expenditure was considered as reasonable and permissible. One such category of expenditure is expenditure on an employee in respect of his period of employment outside India. Presumably the organisation may have to pay to an employee posted outside India amounts which may be much higher than what he may be entitled to in India in view of the exigencies of the situation, his requirements at the place of posting and the fact that the amount may have to be paid in a foreign country. This expenditure is, therefore, not subject to a ceiling. The same considerations would apply to a Director - employee also who is posted outside the country in the course of his work. A Director - employee does not cease to be an employee nor are his requirements less than those of an employee. Therefore, in his case also what the Act itself has viewed as reasonable allowable expenditure, should be allowed. We do not see any reason to hold that S.40A(5)(b) will not apply to employee - Directors when this Court, in the case of employee - Directors has held, both S.40(c) and 40A(5) as applicable. For determining the ceiling, the higher ceiling has to be taken into account. Similarly, for determining permissible expenditure which is outside the ceiling limit also, both the sections will have to be applied. Therefore, expenditure under S.40A(5)(b) which is excluded from the expenditure on which a ceiling is placed under S.40A(5)(a), will have to be excluded in the case of an employee - Director also. Under the proviso to S.40A(5)(a), in the case of an employee - Director, for the purposes of ceiling, expenditure which has to be taken into account is both under S.40A(5)(a) as well as under S.40(c). For calculating the expenditure and allowances under S.40A(5)(a), one has to exclude the expenditure and allowances referred to in S.40A(5)(b). Therefore, in the case of a Director - employee also while calculating the expenditure and allowances spent on a Director - employee under S.40A(5)(a) and S.40(c), expenditure of the kind referred to in S.40A(5)(b) has to be necessarily excluded.14. A similar view has been taken by the Madras High Court in the case of Commr. of Income Tax v. Lucas TVS Ltd., (1997) 226 ITR 281. The Madras High Court was concerned with foreign technicians working under a contract in India and falling under S.10(6) (vii-a). Under S.40A(5)(ii) expenditure incurred in relation to such an employee is to be excluded from the expenditure for which a ceiling is prescribed under S.40A(5)(a). The Madras High Court held that in the case of a Director cum employee also, if he is covered by S.10(6)(vii-a), such expenditure would be excluded from the ceiling limit prescribed under S.40(c) as well as S.40A(5)(a). The Madras High Court has rightly observed (page 291) that there is nothing to suggest that the remuneration which is excluded from the scope of consideration in S.40A(5)(a) of the Act by virtue of S.40A(5)(b) of the Act, should be taken into consideration for the purpose of S.40(c) of the Act. Both S.40(c) and 40A(5) have to be read together in determining the ceiling prescribed under S.40A(5) of the Act which includes ceiling prescribed for Director - employees. Also if certain items go out of reckoning in S.40A(5) of the Act, then on the principle of harmonious construction, the same will have to go out of reckoning in calculating a common ceiling prescribed for Director - employees both under S.40(c) and 40A(5)(a) proviso.