Disallowance of salary u/s 37(1), on the basis of non compliance with provisions of esi

AO disallowed 30% of salary expenditure citing that only 15 out of 32 employees were registered under ESI. All payment is made to employees through a/c payee cheque and fully related to business. Is AO's contention is valid in doing so or Is there any case law available?? 

Our contention is that we are ready to pay penalties for non compliance of ESI and same penalties would be disallowed not the salary.