The judgment of the court was delivered by
VENKATARAMIAH J.--Since these appeals by certificate
involve a common question of law, we find it convenient to dispose them of by
this common judgment.
Civil Appeal No. 2501 of 1972 is filed against the
judgment of the High Court of Bombay in Income-tax Reference No. 58 of 1963 and
Civil Appeals Nos. 2502-2504 of 1972 are filed against the judgment of that High
Court in Income-tax Reference No. 87 of 1965. The assessee, M/s. Sassoon J.
David & Co. Pvt. Ltd. (hereinafter referred to as " the company "
), is the appellant in all these cases and the assessment years are 1957-58,
1958-59, 1959-60 and 1960-61, the relevant calendar years being 1956, 1957, 1958
and 1959, respectively.
The company is an investment company and its shares were
originally held either directly or through their nominees by Sir Percival David,
Lady David and Mr. V. P. David (hereinafter collectively referred to as "
Davids "). The issued capital of the company consisted of 1,000 ordinary
shares of the face value of Rs. 10,000 each. According to the valuation made by
the auditors, the assets of the company were worth Rs. 155 lakhs as on December
31, 1955. At a meeting of the directors of the company held on December 2, 1955,
a resolution was passed recommending that the employees of the company whose
names were set out in the statement attached thereto be paid certain sums or
annuity as set out against the names of each of them as and by way of
retrenchment compensation and compensation for termination of employment and
also for long and faithful services rendered by them to the company in the past
and that their services might be terminated. It was also resolved to call an
extraordinary general meeting of the shareholders of the company to consider and
if thought fit to approve the recommendation made by the directors as stated
above. Accordingly, an extraordinary general meeting of the shareholders of the
company was held on January 17, 1956, but it was adjourned to January 25, 1956.
On the adjourned date, the meeting passed a resolution approving the
recommendation made by the directors to pay the employees retrenchment
compensation and compensation for termination of employment and also additional
retrenchment compensation and compensation for termination of employment in the
case of some of them and to terminate their services on or after April 1, 1956.
Thereafter, an agreement was entered into between Davids and Tata Sons Ltd.
(hereinafter referred to as " the Tatas ") on March 23, 1956, agreeing
to sell the 1,000 shares held by Davids or their nominees in the company in
favour of Tatas or their nominees for a sum of Rs. 155 lakhs. The said
agreement, inter alia, provided that the sum voted by the company for payment of
gratuities and/or as compensation for loss of employment to existing directors
and employees of the company with respect to their services up to and inclusive
of March 31, 1956, and a further amount of Rs. 16,188 payable to the managing
director, Mr. Mathalone, should be paid in accordance with the resolution by the
company and the amount so paid should be deducted from the purchase price of Rs.
155 lakhs agreed upon. It also provided that Davids should arrange to terminate
the services of all employees with effect from March 31, 1956, and also to
arrange that all directors (including the managing director) resign their
offices and Tatas or their nominees should thereafter be entitled to appoint or
elect all or any of the members of the staff and directors (including existing
directors and members of the staff) of the company as they deemed fit.
Of the 22 employees covered by the resolution of the
directors dated December 2, 1955, followed by the confirmation at the
extraordinary general meeting on January 25, 1956, 9 were re-employed and 13
persons were not re-employed. In the books of the assessee, there was a debit
for a total sum of Rs. 1,64,899 during the accounting year 1956, the details for
which were as follows :
Rs.
Amount payable to the 22 employees
as per resolution dated 2-12-1955 and
25-1-1956. 1,04,626
Amount described as " additional
retrenchment compensation and compensation
for termination of employment and also for long
and faithful services ", as per resolution No. 2
Dated 25-1-1956. 6,000
Compensation for termination of pension allowance. 21,200
Annuity of Shri A. E. Joseph, former
director, as per resolutions dated 2-12-1955
and 25-1-1956. 16,885
Amount described as " compensation
for loss of office of managing director,
Mr. R. Mathalone." 16,188
----------------
Total 1,64,899
----------------
It 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 1956.
During 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 as follows :
" 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 as follows :
" 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 appeal.
An 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
Tribunal's 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 assessee's 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 Court.
Income-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.
We are concerned in these appeals with the claim of the
company in respect of a sum of Rs. 1,27,511 out of Rs. 1,64,899 referred to in
questions Nos. 1 and 2 in the reference relating to the assessment year 1957-58
and the claim in respect of payment of Rs. 16,885 made to Mr. A. E. Joseph
during each of the three succeeding years. The undisputed facts of the case are
: The shares of the company were held by Davids or their nominees till they were
transferred to Tatas ; that according to the valuation made by the auditors of
the company, its assets were worth Rs. 155 lakhs as on December 31, 1955 ; that
at a meeting of the directors held on December 2, 1955, it had been resolved
that the services of 22 employees should be terminated by paying retrenchment
compensation ; that on January 25, 1956, at the extraordinary general meeting of
the shareholders of the company, it was resolved that the employees of the
company be paid certain sums or annuity set out against the names of each of
them and their services should be terminated with effect from April 1, 1956 ;
that an agreement was entered into between Davids and Tatas on March 23, 1956,
regarding the sale of the shares in favour of the Tatas ; that the said
agreement referred to the resolution passed at the meeting of the shareholders
of the company ; that the company paid retrenchment compensation according to
the said resolution and that the Tatas deducted from the purchase price the sum
payable by the company in accordance with the resolution of the company from out
of the consideration of Rs. 155 lakhs which they had agreed to pay under the
agreement dated March 23, 1956, to Davids. Apart from the resolution of board of
directors of the company dated December 2, 1955, the resolutions passed at the
extraordinary general meeting of the shareholders of the company held on January
25, 1956, the agreement dated March 23, 1956, entered into between Davids and
Tatas, the books of account of the company showing payments made by the company
by way of retrenchment compensation and the fact that 9 of the 22 employees
whose services had been terminated had been re-employed, there was no other
evidence before the ITO. The ITO presumably because of the proximity of the
dates of the resolutions, the date of the agreement and the dates on which
retrenchment compensation was paid to the employees, came to the conclusion that
the retrenchment of the employees had been effected as a part of the bargain
entered into between Davids and Tatas and, therefore, compensation paid to the
employees on retrenchment of their services and to the director on the
termination of his service had not been paid in the course of the business of
the company by way of commercial expediency. He, accordingly, disallowed the
claim of the company under s. 10(2)(xv) of the Act. Although, the AAC in the
course of his order observed that the company had been benefited by reason of
the retrenchment of the services of the employees, as it had resulted in the
reduction of the expenditure on the establishment, he disallowed the claim on
the very same ground on which the ITO had rejected it. The Tribunal proceeded to
dispose of the case before it on the basis that the inference drawn by the ITO
that the payments were motivated by the reorganisation in the shareholding had
not been questioned by the company either before the AAC or before it. We do not
find in the order of the AAC that any concession had been made by the company to
the effect that the finding of the ITO referred to above was correct. In the
grounds of appeal before the Tribunal, the company had stated that the AAC erred
in holding that " 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 benefited
by it ". The appellants submitted before the Tribunal that the above amount
was expended wholly and exclusively for the purpose of their business and as
such it should have been deducted as an admissible expense in computing their
income liable to income-tax. The Tribunal, while deciding the question whether
the sums paid by way of compensation were deductible or not, observed that the
fact that a reference to payment to the staff of compensation had been made in
the agreement led to the inference that such payment was a part of the bargain
between Davids and Tatas ; that on account of such payment, the purchasers had
actually been benefited while the company had to make payment in order to give
effect to the agreement and, therefore, there was no commercial purpose involved
in making the said payment. The Tribunal also held that even assuming that the
company was benefited by payment of compensation by reason of reduction in its
establishment expenses, since the payment had been made as a result of the
bargain between Davids and Tatas, it could not be allowed as a deductible
expenditure. It should be stated here that the Tribunal did not reverse the
finding of the AAC that the company had been benefited by such payment. In fact,
it did not go into the question whether the payment had really resulted in any
benefit to the company. The High Court, however, in the course of its judgment,
found that on account of the retrenchment of the employees and re-employment of
only 9 of them, the yearly wage bill of the company for salaries was reduced
from Rs. 1,14,197 in 1955 to Rs. 67,268 in 1956 and thereafter in 1957 and 1958,
respectively, to Rs. 54,124 and Rs. 54,960.
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 vocation.
The High Court, however, declined to allow the deduction
of the sums referred to above in these cases principally relying upon the
decision of this court in Gordon Woodroffe Leather Manufacturing Co. v. CIT
[1962] Supp. 2 SCR 211 ; [1962] 44 ITR 551
(SC). The facts of that case were briefly thus : One J. H. Philips was the
director of the assessee-company in that case from the year 1940. On March 22,
1949, he wrote a letter to the assessee expressing his intention to resign from
its board as from April 4, 1949, and requested that his resignation be accepted.
On March 24, 1949, the board of directors of the assessee passed a resolution
that his resignation be accepted and in appreciation of his long and valuable
services to the assessee, he be paid a gratuity of Rs. 50,000 out of which the
assessee was to pay Rs. 40,000 and its managing agent was to pay Rs. 10,000.
Subsequently, the resolution was approved at the extraordinary general meeting
of the assessee. Accordingly, a sum of Rs. 40,000 was paid by the assessee to
Mr. J. H. Philips. The assessee claimed deduction of the said sum of Rs. 40,000
under s. 10(2)(xv) of the Act. The ITO as well as the AAC disallowed the said
claim on the ground that the company had no pension scheme ; that the payment
was voluntary and that the entry in the assessee's books clearly indicated that
the payment was a capital payment. The Tribunal upheld the order of the AAC. It
held that according to the resolution the gratuity was paid for " long and
valuable services to the assessee ", that there was nothing to indicate
that Mr. J. H. Philips had accepted a lower salary in expectation of getting a
gratuity at the end of his service ; that there was no such practice in the
assessee-company ; that during the course of his service, he was being
remunerated at a graduated scale of salary and a commission of 2 1/2 % on the
profits ; that there was no," expectancy " that at the end of the
service there would be recompense for faithful and efficient service and that he
had been suitably rewarded by being given a commission on the profits " in
order to whip up his enthusiasm ". It was also found by the Tribunal that
in the books of the assessee, the amount had not been debited in the profit and
loss account but was debited to the appropriation account thereby indicating
that it was an extra payment or a payment made in the nature of a capital
expense. On a reference, under s. 66(1) of the Act, the High Court of Madras
answered the question relating to the above item of expenditure against the
assessee. On appeal, this court affirmed the decision of the High Court. While
holding that the claim made by the assessee did not satisfy the proper tests for
claiming exemption under s. 10(2)(xv) of the Act, this court observed as follows
([1962] 44 ITR 551, 555 (S.C.)) :
" In 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). "
After quoting in the course of its judgment the above
passage, the High Court proceeded to observe as follows [1972] 85 ITR 83, 94 (Bom) :
" Having regard to the test applicable in connection
with the contentions made by Mr. Palkhivala, what required to be investigated is
whether the payments in question were made as a matter of practice which had
affected the quantum of salary or whether there was an expectation by the
employees (whose employment was terminated) of getting a gratuity or, in the
alternative, the above sums were expended on the ground of commercial expediency
and in order indirectly to facilitate the carrying on of the business. "
After making the above observation, the High Court held
that the company had not placed any evidence to show that there was a practice
in the company to pay compensation even though its attention was drawn that in
the past i.e., between 1946 and 1952, the company had paid such compensation in
two cases on the basis of one month's basic salary for each year of service. It
also rejected the case of the company that the amount involved had been expended
on the ground of commercial expediency and in order indirectly to facilitate the
carrying on of the business of the company even though it observed that the
yearly wage bill of the company was reduced after such payment. The High Court
held that the consideration of reduction of the wage bill was foreign to the
decision taken by the company to terminate the services of the employees and to
pay them retrenchment compensation and observed that the purpose of the payment
so far as could be ascertained from the contents of the resolutions of the board
of directors and the company when read with the relevant contents of the
agreement for sale was the carrying out of the obligation arising under the
agreement. It also held that the fact the expenses became reduced was
insufficient to record a finding that the amount of retrenchment compensation
was paid for commercial considerations or expediency. 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 years.
In, 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 so.
The 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. Pettigrew & Stephens Ltd. [1956] 37 TC 145.
The respondent-companies in the said cases were subsidiaries of a company called
Scottish Drapery Corporation Ltd., the control of which was acquired by the
House of Fraser Ltd. Changes of organisation which were made in accordance with
the policy of the House of Fraser Ltd. involved the termination of the contracts
of service of the managing directors of the respondent-companies and also the
eventual liquidation of those companies. Certain sums were paid by the companies
to the managing directors in connection with the cancellation of their
contracts, the payments being expressed in the first two cases to be in
satisfaction of rights to future remuneration, and in the third to be in lieu of
notice. Before the Special Commissioners, the companies contended that the
payments made by them to the managing directors in connection with the
cancellation of their contracts had been made to relieve them from onerous
contracts and were allowable deductions. The Crown contended that the payments
were not expenses of the companies' businesses but were incidental to the
schemes by which those businesses were acquired by the House of Fraser Ltd. and
were made primarily for the benefit of that company. The Commissioners, however,
decided that the deductions claimed were allowable. Upholding the findings of
the Commissioners, the Lord President observed at page 156 :
" In my opinion the contention put forward by the
Crown is unsound and the Special Commissioners were correct in rejecting it.
Admittedly in this case no question arises in regard to the words ' wholly and
exclusively ', and if the Crown's contention is unsound it is not disputed that
the disbursement in question falls within section 137(a). To succeed in their
contention the Crown must establish two matters. In the first place it must show
that the liquidation involved a discontinuance of the trade carried on prior to
it by the respondent company and the subsequent operation of a new trade carried
on by House of Fraser. In the second place it must show that the expenditure in
question was laid out for the purposes of the new trade. Without both these
steps its argument fails. In my opinion neither step in the argument is made
out. "
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 company's
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 pay retrenchment
compensation and compensation for 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 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 208 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 Act.
The 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 (Usher's
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 assessee's 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. "
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.
We, therefore, allow these appeals and hold that Rs.
1,27,511 was also deductible under s. 10(2)(xv) of the Act during the assessment
year 1957-58 and the sum of Rs. 16,885 referred to above was allowable as a
deduction during each of the three succeeding assessment years. The department
shall pay costs to the appellant. (Hearing fee one set only).
Appeals allowed.
