Case: UNION OF INDIA &amp; ORS Vs. M/S EXIDE INDUSTRIES LIMITED &amp; ANR

2. The stated clause (f) was inserted in the already existing Section 43B vide Finance Act, 2001 with effect from 1.4.2002, in order to provide for a tax disincentive in cases of deductions claimed by the assessee from income tax in lieu of liability accrued under the leave encashment scheme but not actually discharged by the employer. This clause made the actual payment of liability to the employees as a condition precedent for extending the benefit of deduction under the 1961 Act. With the application of clause (f), the eligibility for deduction arises in the previous year in which the abovesaid payment is actually made and not in which provision was made in that regard, irrespective of the system of accounting followed by the assessee3. The respondents, being liable to pay income tax upon the profits and gains of their business, found themselves aggrieved with the inclusion of clause (f) in Section 43B and contended that Section 145 of the 1961 Act offers them the choice of method of accounting and accordingly, they computed their profits and gains of business in accordance with the mercantile system. As per the mercantile system, income and expenditure are determined on the basis of accrual or provision and not on the basis of actual receipt/payment. The respondents further contended that Section 43B has been carved out as an exception to the afore-stated general rule of accrual for determination of liability, as it subjects deductions in lieu of certain kinds of liabilities to actual payment. According to the respondents, the exception under Section 43B comes into operation only in a limited set of cases covering statutory liabilities like tax, duty, cess etc. and other liabilities created for the welfare of employees and therefore, the liability under the leave encashment scheme being a trading liability cannot be subjected to the exception under Section 43B of the 1961 Act.  4. It is the case of the respondents that the judgment of this Court in Bharat Earth Movers vs. Commissioner of Income Tax, Karnataka (2000) 6 SCC 645 holds the field of law as far as the nature of the liability of leave encashment is concerned. The said judgment, while dealing with the principles of accounting under Section 37, conclusively holds that if a business liability has arisen definitely, deduction may be claimed against the same in the previous year in which such liability has accrued, even if it has not been finally discharged. The Court further held that the liability in lieu of leave encashment scheme is a present and definite liability and not a contingent liability. As regards the nature of the leave encashment liability, the respondents urge that this liability is carved in the nature of a beneficial provision and leave can only be encashed by the employees in accordance with the terms and conditions of employment. It is further contended that since the due date for encashment of leave does not arise in the same accounting year in which provision is made, there is no question of subjecting the deductions against such liability upon actual payment.  5. Having stated that all the clauses under Section 43B, barring clause (f), cover liabilities of a statutory nature and those driven by concerns of employees welfare, the respondents would urge that the liability covered by clause (f) is of a completely distinct nature and without specifying clear objects and reasons for the inclusion of this liability under Section 43B, it cannot be slipped into the main section. Further, the nature of this liability is neither in sync with the objects and reasons of the original section nor with those of other clauses enacted from time to time in different assessment years.  6. The respondents also urge that the enactment of clause (f) was driven by the sole consideration of subjugating the legal position expounded by this Court in Bharat Earth Movers (supra) without removing the basis thereof. Such enactment would fall foul of the scheme of the Constitution. It would be an inroad into the sphere reserved exclusively for the judiciary and thereby violate the essential principles of separation of powers.  7. The validity of clause (f) faced judicial scrutiny first before the single Judge of the High Court. The clause passed the constitutional muster of the Court, which had observed thus:Thus the position of law existing at the date of insertion of cl. (f) did not oblige the employer to actually pay the leave encashment benefit either to his employee or to any fund or to any third party, though the liability was an accrued one. If the employer, of his own accord, maintained a fund, he maintained it for his own convenience, and not because of any legal obligation. But in view of the mercantile system of accounting followed he was justified in showing the accrued liability and claiming deduction. There was nothing to prevent him from enjoying the benefit of deduction and at the same time from controlling and using the amount for his own benefit, till he was compelled to give the benefit of the leave in question to the employee concerned. It is evident that the clause was inserted to curb the abuse of existing law and protect the interests of the employeeAddressing the argument that the insertion of the said clause was solely intended to defeat the judgment of this Court in Bharat Earth Movers (supra), the learned single Judge stated thus:… It is true that the action neutralized the effect of the apex court decision in Bharat Earth Movers case, but I do not agree that it has amounted to encroachment upon the powers of the judiciary. Once the existing legal position was explained by their Lordships, I think, it was quite natural for the legislature to examine the situation and legislate according to the need. The binding decision of the highest court was not nullified in the process; only the position of law was changed prospectively8. The decision of the learned single Judge was appealed and came to be reversed by the Division Bench of the High Court. The Division Bench, while holding clause (f) as unconstitutional, observed thus:... While inserting sub-section (f) no special reasons were disclosed. His Lordship held that such disclosure was not mandatory. We do not have any reason for disagreement on such issue provided the subject amendment could be termed as in furtherance to widen the scope of original section on the identical objects and reasons as disclosed at the time of enacting the original provision. As we find, the original section was incorporated to plug in deductions claimed by not discharging statutory liabilities. We also find that provision was subsequently made to restrict deductions on account of unpaid loan to the financial institutions. Leave encashment is neither statutory liability nor a contingent liability. It was a provision to be made for the entitlement of an employee achieved in a particular financial year. An employee earns certain amount by not taking leave which he or she is otherwise entitled to in that particular year. Hence, the employer is obliged to make appropriate provision for the said amount. Once the employee retires he or she has to be paid such sum on cumulative basis which the employee earns throughout his or her service career [sic] unless he or she avails the leave earned [sic] by him or her. That, in our view, could not have any nexus with the original enactment. An employer is entitled to deduction for the expenditure he incurs for running his business which includes payment of salary and other perquisites to his employees. Hence, it is a trading liability. As such he is otherwise entitled to have deduction of such amount by showing the same as a provisional expenditure in his accounts. The legislature by way of amendment restricts such deduction in case of leave encashment unless it is actually paid in that particular financial year. The legislature is free to do so after they disclose reasons for that and such reasons are not inconsistent with the main object of the enactment. We are deprived of such reasons for our perusal ...  (emphasis supplied)It also held that the subject matter of clause (f) was inconsistent with the original Section 43B and observed as follows:… We also do not find such enactment consistent with the original provision being Section 43B which was originally inserted to plug in evasion of statutory liability. The Apex Court considered the situation in the case of Bharat Earth Movers (Supra) when sub-section (f) was not there. The Apex Court, considering all aspect as disclosed by us hereinbefore, rejected the contention of the Revenue and granted appropriate deduction to the concerned assessee. The legislature to get rid of the decision of the Apex Court brought out the amendment which would otherwise nullify the judge made law. The Apex Court decisions are judge made law and are applicable to all under the Constitution…It is noteworthy that the High Court did not question the existence of power of the legislature to enact the subject clause, as can be discerned from the following observations:… We, not for a single moment, observe that legislature was not entitled to bring such amendment. They were within their power to bring such amendment. However, they must disclose reason which would be consistent with the provisions of the Constitution and the laws of the land and not for the sole object of nullifying the Apex Court decision.

Reasoning: Constitutional validity of clause (f)13. In the present case, the legislative power of the Parliament to enact clause (f) in the light of Article 245 is not doubted at all.It is no more res integra that the examination of the Court begins with a presumption in favour of constitutionality. This presumption is not just borne out of judicial discipline and prudence, but also out of the basic scheme of the Constitution wherein the power to legislate is the exclusive domain of the Legislature/Parliament. This power is clothed with power to decide when to legislate, what to legislate and how much to legislate. Thus, to decide the timing, content and extent of legislation is a function primarily entrusted to the legislature and in exercise of judicial review, the Court starts with a basic presumption in favour of the proper exercise of such powerWith the passage of time, the legislature inserted more deductions to Section 43B including cess, bonus or commission payable by employer, interest on loans payable to financial institutions, scheduled banks etc., payment in lieu of leave encashment by the employer and repayment of dues to the railways. Thus understood, there is no oneness or uniformity in the nature of deductions included in Section 43B. It holds no merit to urge that this section only provides for deductions concerning statutory liabilities. Section 43B is a mix bag and new and dissimilar entries have been inserted therein from time to time to cater to different fiscal scenarios, which are best determined by the government of the day. It is not unusual or abnormal for the legislature to create a new liability, exempt an existing liability, create a deduction or subject an existing deduction to override regulations or conditions19. The leave encashment scheme envisages the payment of a certain amount to the employees in lieu of their unused paid leaves in a year. The nature of this payment is beneficial and pro- employee. However, it is not in the form of a bounty and forms a part of the conditions of service of the employee. An employer seeking deduction from tax liability in advance, in the name of discharging the liability of leave encashment, without actually extending such payment to the employee as and when the time for payment arises may lead to abhorrent consequences. When time for such payment arises upon retirement (or otherwise) of the employee, an employer may simply refuse to pay. Consequently, the innocent employee will be entangled in litigation in the evening of his/her life for claiming a hard-earned right without any fault on his part. Concomitantly, it would entail in double benefit to the employer – advance deduction from tax liability without any burden of actual payment and refusal to pay as and when occasion arises. It is this mischief clause (f) seeks to subjugate20. The argument advanced by the respondents that the nature of leave encashment liability is such that it is impossible to make the actual payment in the same year, adds no weight to the claim of invalidity of the clause. We say so because the thrust of the provision is not to control the timing of payment, rather, it is strictly targeted to control the timing of claiming deduction in the name of such liability. The mischief sought to be remedied by this clause, as discussed above, clarifies the position21. Be it noted that the interpretation of a statute cannot be unrelated to the nature of the statute. In line with other clauses under Section 43B, clause (f) was enacted to remedy a particular mischief and the concerns of public good, employees welfare and prevention of fraud upon revenue is writ large in the said clause. In our view, such statutes are to be viewed through the prism of the mischief they seek to suppress, that is, the Heydons case (1584) 3 Co Rep 7 principle. In CRAWFORD, Statutory Construction CRAWFORD, Statutory Construction p. 508 , it has been gainfully delineated that an enactment designed to prevent fraud upon the revenue is more properly a statute against fraud rather than a taxing statute, and hence should receive a liberal construction in the governments favourNon-disclosure of objects and reasons24. The objects and reasons behind the enactment of a statute signify the intention of the legislature behind the enactment of a statutory provision. Indubitably, the purpose or underlying aim of a law can be discerned when interpreted in the light of stated objects and reasons. Inasmuch as, the settled canon of interpretation is to deduce the true intent of the legislature, as the will of the people is constitutionally bestowed in the legislature. It is true that an express objects and reasons would be useful in understanding the import of an enacted provision as and when the Court is called upon to interpret the same28. The Division Bench of the High Court, in the present case, plainly glossed over the fundamental presumption of constitutionality in favour of clause (f) and based its judgment upon the absence of objects and reasons as striking at the root of its validity. In our view, this approach is flawed for at least three reasons. First, it steers clear from the necessary attempt to discover any constitutional infirmities in the enacted provision. Second, it makes no attempt to dissect the text of the provision so as to display the need to go beyond the text. Third, it goes into the background of the enactment and ventures into a sphere which is out of bounds for the Court as long as the need for interpretation borne out of any ambiguity arises29. The process of testing validity is not to sneak into the prudence or proprieties of the legislature in enacting the impugned provision. Nor, is it to examine the culpable conduct of the legislature as an appellate authority over the legislature. The only examination of the Court is restricted to the finding of a constitutional infirmity in the provision, as is placed before the Court. Thus, the non-disclosure of objects and reasons per se would not impinge upon the constitutionality of a provision unless the provision is ambiguous and the possible interpretation violate Part III of the Constitution. In the absence of any finding of any constitutional infirmity in a provision, the Court is not empowered to invalidate a provision30. To hold a provision as violative of the Constitution on account of failure of the legislature to state the objects and reasons would amount to an indirect scrutiny of the motives of the legislature behind the enactment. Such a course of action, in our view, is unwarranted. The raison detre behind this self- imposed restriction is because of the fundamental reason that different organs of the State do not scrutinise each others wisdom in the exercise of their duties. In other words, the time- tested principle of checks and balances does not empower the Court to question the motives or wisdom of the legislature, except in circumstances when the same is demonstrated from the enacted lawWe have noted that the High Court has characterised clause (f) as arbitrary and unconscionable while imputing it with unconstitutionality. It is pertinent to note that the High Court reaches this conclusion without undertaking an actual examination of clause (f). Instead, the declaration is preceded by an enquiry into the circumstances leading upto the enactment. As discussed above, the constitutional power of judicial review contemplates a review of the provision, as it stands, and not a review of the circumstances in which the enactment was made. Be it noted that merely holding an enacted provision as unconscionable or arbitrary is not sufficient to hold it as unconstitutional unless such infirmities are sufficiently shown to exist in the form, substance or functioning of the impugned provision. No such infirmity has been exhibited and adverted to in the impugned judgmentInconsistency of clause (f) and absence of nexus with Section 43B31. The High Court has supported its finding of invalidity by recording two observations vis-a-vis the previously existing (unamended) clauses of Section 43B – first, that clause (f) is inconsistent with other clauses and nature of deduction targeted in clause (f) is distinct from other deductions. Second, that clause (f) has no nexus with the objects and reasons behind the enactment of original Section 43B and therefore, the objects and reasons attributed to Section 43B cannot be used to deduce the object and purpose of clause (f)32. At the outset, we observe that both the grounds are ill- founded. In the basic scheme of Section 43B, there is no direct or indirect limitation upon the power of legislature to include only particular type of deductions in the ambit of Section 43B. To say that Section 43B is restricted to deductions of a statutory nature would be nothing short of reading the provision in a purely imaginative manner. As already discussed above, from 1983 onwards, Section 43B had taken within its fold diverse nature of deductions, ranging from tax, duty to bonus, commission, railway fee, interest on loans and general provisions for welfare of employees. An external examination of this journey of Section 43B reveals that the legislature never restricted it to a particular category of deduction and that intent cannot be read into the main Section by the Court, while sitting in judicial review. Concededly, it is a provision to attach conditionality on deductions otherwise allowable under the Act in respect of specified heads, in that previous year in which the sum is actually paid irrespective of method of accounting33. Further, it be noted that the broad objective of enacting Section 43B concerning specified deductions referred to therein was to protect larger public interest primarily of revenue including welfare of the employees. Clause (f) fits into that scheme and shares sufficient nexus with the broad objective, as already discussed hitherto34. Before stepping into the next ground, we are inclined to observe that the approach of constitutional courts ought to be different while dealing with fiscal statutes. It is trite that the legislature is the best forum to weigh different problems in the fiscal domain and form policies to address the same including to create a new liability, exempt an existing liability, create a deduction or subject an existing deduction to new regulatory measures. In the very nature of taxing statutes, legislature holds the power to frame laws to plug in specific leakages. Such laws are always pin-pointed in nature and are only meant to target a specific avenue of taxability depending upon the experiences of tax evasion and tax avoidance at the ground level. The general principles of exclusion and inclusion do not apply to taxing statutes with the same vigour unless the law reeks of constitutional infirmities. No doubt, fiscal statutes must comply with the tenets of Article 14. However, a larger discretion is given to the legislature in taxing statutes than in other spheres. In Anant Mills Co. Ltd. vs. State of Gujarat & Ors. (1975) 2 SCC 175 ,  this Court noted thus:25. ...But, in the application of the principles, the courts, in view of the inherent complexity of fiscal adjustment of diverse elements, permit a larger discretion to the Legislature in the matter of classification so long as it adheres to the fundamental principles underlying the said doctrine. The power of the Legislature to classify is of wide range and flexibility so that it can adjust its system of taxation in all proper and reasonable waysViewed thus, the reason weighed with the Division Bench of the High Court in the impugned judgment is untenableDefeating the dictum in Bharat Earth Movers case35. We shall now examine clause (f) on the ground that it defeats the judgment of this Court in Bharat Earth Movers (supra). We have carefully analysed the decision in Bharat Earth Movers (supra) and note that the Court was sitting in appeal over the nature of liability under the leave encashment scheme and held such liability to be a present liability. Resultantly, it became deductible from the profit and loss account of the assessee in the same accounting year in which provision against the same is made37. It is no doubt true that the legislature cannot sit over a judgment of this Court or so to speak overrule it. There cannot be any declaration of invalidating a judgment of the Court without altering the legal basis of the judgment - as a judgment is delivered with strict regard to the enactment as applicable at the relevant time. However, once the enactment itself stands corrected, the basic cause of adjudication stands altered and necessary effect follows the same. A legislative body is not supposed to be in possession of a heavenly wisdom so as to contemplate all possible exigencies of their enactment. As and when the legislature decides to solve a problem, it has multiple solutions on the table. At this stage, the Parliament exercises its legislative wisdom to shortlist the most desirable solution and enacts a law to that effect. It is in the nature of a trial and error exercise and we must note that a law-making body, particularly in statutes of fiscal nature, is duly empowered to undertake such an exercise as long as the concern of legislative competence does not come into doubt. Upon the law coming into force, it becomes operative in the public domain and opens itself to any review under Part III as and when it is found to be plagued with infirmities. Upon being invalidated by the Court, the legislature is free to diagnose such law and alter the invalid elements thereof. In doing so, the legislature is not declaring the opinion of the Court to be invalid39. Reverting to the true effect of the reported judgment under consideration, it was rendered in light of general dispensation of autonomy of the assessee to follow cash or mercantile system of accounting prevailing at the relevant time, in absence of an express statutory provision to do so differently. It is an authority on the nature of the liability of leave encashment in terms of the earlier dispensation. In absence of any such provision, the sole operative provision was Section 145(1) of the 1961 Act that allowed complete autonomy to the assessee to follow the mercantile system. Now a limited change has been brought about by the insertion of clause (f) in Section 43B and nothing more. It applies prospectively. Merely because a liability has been held to be a present liability qualifying for instant deduction in terms of the applicable provisions at the relevant time does not ipso facto signify that deduction against such liability cannot be regulated by a law made by Parliament prospectively. In matter of statutory deductions, it is open to the legislature to withdraw the same prospectively. In other words, once the Finance Act, 2001 was duly passed by the Parliament inserting clause (f) in Section 43B with prospective effect, the deduction against the liability of leave encashment stood regulated in the manner so prescribed. Be it noted that the amendment does not reverse the nature of the liability nor has it taken away the deduction as such. The liability of leave encashment continues to be a present liability as per the mercantile system of accounting. Further, the insertion of clause (f) has not extinguished the autonomy of the assessee to follow the mercantile system. It merely defers the benefit of deduction to be availed by the assessee for the purpose of computing his taxable income and links it to the date of actual payment thereof to the employee concerned. Thus, the only effect of the insertion of clause (f) is to regulate the stated deduction by putting it in a special provision40. Notably, this regulatory measure is in sync with other deductions specified in Section 43B, which are also present and accrued liabilities. To wit, the liability in lieu of tax, duty, cess, bonus, commission etc. also arise in the present as per the mercantile system, but assessees used to defer payment thereof despite claiming deductions thereagainst under the guise of mercantile system of accounting. Resultantly, irrespective of the category of liability, such deductions were regulated by law under the aegis of Section 43B, keeping in mind the peculiar exigencies of fiscal affairs and underlying concerns of public revenue. A priori, merely because a certain liability has been declared to be a present liability by the Court as per the prevailing enactment, it does not follow that legislature is denuded of its power to correct the mischief with prospective effect, including to create a new liability, exempt an existing liability, create a deduction or subject an existing deduction to new regulatory measures. Strictly speaking, the Court cannot venture into hypothetical spheres while adjudging constitutionality of a duly enacted provision and unfounded limitations cannot be read into the process of judicial review. A priori, the plea that clause (f) has been enacted with the sole purpose to defeat the judgment of this Court is misconceived41. The position of law discussed above leaves no manner of doubt as regards the legitimacy of enacting clause (f). The respondents have neither made a case of non-existence of competence nor demonstrated any constitutional infirmity in clause (f).