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

Amount payable to the 22 employeesas per resolution dated 2-12-1955 and25-1-1956. 1, 04, 626Amount described as " additionalretrenchment compensation and compensationfor termination of employment and also for longand faithful services ", as per resolution No. 2Dated 25-1-1956. 6, 000Compensation for termination of pension allowance. 21, 200Annuity of Shri A. E. Joseph, formerdirector, as per resolutions dated 2-12-1955and 25-1-1956. 16, 885Amount described as " compensationfor loss of office of managing directorMr. R. Mathalone." 16, 188Total 1, 64, 899It should be mentioned here that A.E. Joseph, the former director of the company, had to be paid as per the resolution of the company Rs. 16, 885 by way of annuity during a period of five years commencing with 1956During the assessment year 1957-58, the relevant previous year being 1956, the company claimed deduction of Rs. 1, 64, 899 referred to above before the ITO under s. 10(2)(xv) of the 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. 16, 885 being the annuity paid to Mr. A. E. Joseph pursuant to the resolution. Daring the assessment year 1957-58, the claim in respect of the entire sum of Rs. 1, 64, 899 was disallowed by the ITO 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 asfollows"Thus, it emerges that the expenditure of the type of gratuity would be allowable under section 10(2)(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 or 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 up to 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 under section 10(2)(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 ITO, the company filed an appeal before the AAC of Income-tax. The AAC after taking into account the records before the ITO and the statement filed by the company before him found that the ITO 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 and/or compensation been benefited. The relevant part of his order was asfollows"The only contention remaining to be considered is that the Income-tax Officer was wrong in disallowing a sum of Rs. 1, 64, 899 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 F. E. Dinshaw 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 AAC holding that the inference drawn by the ITO that the payments in question were motivated by the reorganisation of shareholding 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 appealAn application made under s. 66(1) of the Act before the Tribunal was rejected. Thereafter, the company filed an application before the High Court of Bombay under s. 66(2) 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 in disallowing the amount of Rs. 1, 64, 899 as a deduction under section 10 of the Indian Income-tax Act, 1922 ?(2) Whether there was any evidence to justify the Tribunals finding that the payment of Rs. 1, 64, 899 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. 16, 188 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 s. 66(1) 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 assessees 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. 16, 885 is an admissible deduction under section 10(2)(xv) of the Act ? "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 CourtIncome-tax Reference No.58 of 1963 [Sassoon J. David and Co. P. Ltd. v. CIT--[1972] 85 ITR 83 (Bom)]   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. 1, 64, 399 referred to in question No. 1 only a sum of Rs. 21, 200 which was commutation of liability for payment of pension to some retired employees and/or widows of such employees and a sum of Rs. 16, 188 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. 1, 27, 511. It, accordingly, answered question No. 1 in the negative in so far as the sum of Rs. 1, 27, 511 (excluding the two items of Rs. 21, 200 and Rs. 16, 188) was concerned, question No. 2 in the affirmative in so far as the amount aggregating to Rs. 1, 27, 511 (excluding the two items of Rs. 21, 200 and Rs. 16, 188) 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. 1, 27, 511 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 and/or consideration. 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. 16, 885 to Mr. A. E. Joseph in each of the accounting years relative to the assessment years in question. Aggrieved by the judgments of the High Court of Bombay, the company has filed these appeals

Reasoning: 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