S.H. Kapadia, J.
1. The above group of References deal with common question of law which has been referred by the Tribunal to this Court under Section 256(1) of the Income Tax Act at instance of the revenue.
Whether the salary payable to the floating staff for the period of employment outside India should not be considered for the purpose of disallowance under Section 40A(5)(a) of the Income Tax Act, 1961?
2. For the sake of brevity the facts in Income Tax Reference No. 444 of 1995 are taken into consideration.
3. The assessee - M/s Indo Oceanic Shipping Company Ltd. is a limited company. While computing the amount to be disallowed under the above provision, the AO included the salary payable to the floating staff of an Indian Vessel for a period of employment outside India in respect of the Assessment Year 1978-79, The AO considered the International Law and came to the conclusion that so long as the Indian Flag was flying on the ship, the said Ship was considered to be Indian Territory and, therefore, the place of employment of the floating staff was in India irrespective of the fact as to where the Ship was sailing. The AO further came to the conclusion that there was a difference between 'Working outside India' and 'employment outside India'. He further came to the conclusion that under Section 40A, the employment outside India is not covered as the cost of living in foreign country is higher than the cost of living in India but in the case of floating staff the employees stay on board the Ship and as such they are not required to spend any amount in foreign country for their stay and, therefore, Section 40A(5) was applicable to the floating staff as if they were working in India. Consequently, the AO disallowed Rs. 3.56 lacs under Section 40A(5). Being aggrieved, the assessee went in appeal to the CIT (Appeals). The Appellate Authority, however, came to the conclusion that, on the facts of the case, Section 40A(5)(b)(i) (hereinafter referred to for the sake of brevity as 'the exclusion clause') stood attracted. The CIT (Appeals) came to be conclusion that under Section 40A(5)(b)(D for the period when the floating staff is employed outside India for which he is paid salary, the same cannot be taken into account for the purposes of computing the disallowance under Section 40A(5). The Commissioner emphasised the expression 'employment outside India' in Section 40A(5)(b)(i) and interpreted the said expression to mean outside the territorial boundaries of India. Hence, the appeal was allowed. Being aggrieved by the decision of CIT (Appeals) the Department preferred an appeal to the Tribunal. Following its decision in the case of Garware Shipping Corporation Ltd. v. ITO, reported in 7 ITD page 118, the Tribunal dismissed the appeal. Accordingly, the Department has come by way of Reference to this Court.
4. For the sake of convenience, Sections 40A(5)(a) as also 40A(5)(b) and (c) as they stood at the material time are reproduced here in below :--
'(5) (a) Where the assessee --
(i) incurs any expenditure which results directly or indirectly in the payment of any salary to an employee or a former employee, or.
(ii) incurs any expenditure which results directly or indirectly in the provision of any perquisite (whether convertible into money or not) to an employee or incurs directly or indirectly any expenditure or is entitled to any allowance in respect of any assets of the assessee used by an employee either wholly or partly for his own purposes or benefit. then, subject to the provisions of Clause (b), so much of such expenditure or allowance as is in excess of the limit specified in respect thereof in clause (c) shall not be allowed as a deduction:'
(b) Nothing in Clause (a) shall apply to any expenditure or allowance in relation to --
(i) any employee in respect of any period of his employment outside India;
(c) The limits referred to in Clause (a) are the following, namely :--'
5. The object of Section 40A(5) is to impose ceiling on remuneration of employees. Sub-section (5) was inserted in Section 40A by Finance Act, 1971 with effect from 1-4-1972. It remained operative upto Assessment Year 1988-1989, Under sub-section (5), expenditure incurred by an assessee on payment of salary was not to be allowed as deduction in computing the taxable profits to the extent that it exceeded the prescribed limit for each month or a part thereof comprised in the period of his employment in India. For this purpose, salary was defined as per Section 17(1) of the Act. However, limitations of Section 40A(5) had no application in cases of payments made to an employee in respect of any period of his employment outside India. Therefore, Section 40A(5)(b)(i), as reproduced hereinabove is an exclusionary Clause. For the purposes of deciding the present matter, we are mainly required to construe the expression 'employment outside India' under Section 40A(5)(b)(i). For that purpose, one has to keep in mind the fact that Section 40A(5) deals with deductions in the hands of an employer unlike deductions in the hands of an employee which are governed by provisions of Sections 5, 6, 9 and 192 of the Income Tax Act. Reading of Section 40A(5) shows that Section 40A(5)(a) speaks of salary, perquisites and allowances which should be disallowed in the hands of the Company subject to the provisions of Section 40A(5)(b) and keeping in mind the limits prescribed under Section 40A(5)(c). At this stage, we may also refer to the meaning of the word 'India' as defined under Section 2(25A) which reads as under :--'2. In this Act, unless the context otherwise requires:--(25A) 'India' shall be deemed to include the Union territories of Dadra and Nagar Haveli, Goa, Daman and Diu, and Pondichery,--Reading Section 2(25A), it is clear that the expression 'India' includes the Union Territories which is in consonance with the Taxation Law (Extension to Union Territories) Regulation, 1963.
6. Mr. Desai, learned Senior Counsel appearing on behalf of the Department contended that, on the facts of the present case, the Department has found that the employer - Company was registered in India. That, the Ship was an Indian Ship carrying Indian Flag. That, the contract of employment was executed in India. That, the salary was paid to the floating staff in India. That, the remuneration was paid in Indian Currency. He contended that under the provisions of Merchant Shipping Act as well as International Conventions, the nationality of the Ship is decided by the Flag it carries. He contended that, in the present case, an Indian Ship which carried an Indian Flag remains to be the territory of India even after the Ship leaves the territorial waters and even if the ship is on high seas. He contended that the Indian Ship will remain to be the territory of India wherever it goes throughout the world. He contended that a foreign going Indian Vessel will remain to be territory of India whether it is within the territorial waters or outside the territorial waters. He contended that since the contract of employment was executed in India and since the employees were paid salary in India for the work performed on the ship which was an Indian Ship, the employees cannot be said to have been employed outside India, Mr. Desai, therefore, contended that there was a difference between the expression 'Working outside India' and 'employment outside India'. He contended that these are two different terms. He contended that these are not synonymous terms. He contended that legislature has used the expression 'employment outside India' in Section 40A(5)(b)(i) and, therefore, in the present case, since the contract was executed in India and since the employees were required to go out of India to perform such a contract and since the floating staff worked on the Indian territory even outside the territory of India, the employees were employed in India and, therefore, they cannot be said to have been employed outside India. He relied upon the Judgment of the Gujarat High Court in the case of McGaw-Ravindra Laboratories (India) Ltd. v. Commissioner of Income Tax, reported in 270 ITR 1002. Accordingly, it was contended that Section 40A(5)(b)(i) was not attracted. It was urged that the legislature has not used the words 'working outside India' in Section 40A(5)(b)(i). That, the legislature has deliberately used the words 'employment outside India'. Hence, in this case, the floating staff cannot be said to have been employed outside India. Mr. Desai contended that in appropriate cases if the contract was also executed outside India and an employee was required to go abroad to carry out the contract then alone Section 40A(5)(b)(i) would apply. However, in the present case, he contended that employees entered into contract in India; that they were paid salary in India; that the salary was paid in Indian Currency and lastly, they were working on the Indian Ship which was the territory of India and, therefore, Section 40A(5)(b)(i) was not applicable.
7. Per contra, Mr. F. B. Andhyarujina, learned Counsel for the assessee contended that the Seamen employed on the ship are divided into two categories viz. floating staff and crew. That, the members of the floating staff are Officers on board the Vessel. That, Maritime Union of India is a body which represents the floating staff. That, there is no agreement separately entered into with each of the Officers. That, the company enters into a common agreement with the Maritime Union of India on behalf of the Individual floating staff Officer. That, the National Union of Seafarers is the body which represents the crew. Mr. Andhyarujina invited our attention to pages 48, 49, and 50 of the Paper-book in ITR No. 405 of 1987 which gives a complete illustration regarding the wages earned on overseas voyages. It also shows how wages representing the period of employment outside India are calculated. He contended that Section 40A(5) provides for disallowance of certain expenditure in the hands of an employer in relation to payment of salary to employees. That, this was subject to exclusion contained in Section 40A(5)(b)(i). That, this was in keeping with the limits stipulated in Section 40A(5)(c). He contended that Section 40A(5) deals with disallowance of salary payment in the hands of the employer and has nothing to do with the disallowance in the hands of the employees. He contended that the very purpose of Section 40A(5)(b)(i) was to deduct in the hands of the employer from the total wages earned by an employee in relation to his contractual obligation such portion of wages earned for a period of his employment outside India keeping in view the limits stipulated in Section 40A(5)(c). It was urged that in case of floating staff, they were required to leave India and spend substantial part of their time on high seas away from Indian Territorial waters. He contended that provisions of the Merchant Shipping Act has no application to the facts. He contended that scope of the Merchant Shipping Act is quite different from the provisions of Income Tax Act. He contended that the purpose of Income Tax Act was to tax the income and in that connection one has to consider the accrual of income, the place at which it accrues as also the provisions which deal with charging of tax in the hands of employer and in the hands of employees subject to the disallowances correspondingly in the hands of employer and in the hands of employees. He also invited our attention to the Circular issued by the Board bearing No. 586 dated 28th November, 1990. Vide para 2 of the said Circular, the Board has clarified that after the amendment made in Section 6 of the Income Tax Act 1961 by the Finance Act, 1990 with effect from 1-4-1990 an Indian citizen who is the member of a crew of an Indian Ship as defined in Section 3(18) of the Merchant Shipping Act, is regarded as resident in India only if he is in India for 182 days or more. That, for this purpose it was important to take into account the definition of the expression 'India' as defined in Section 2(25A) of the Income Tax Act. Under the above Circular, the board has clarified that the term 'India' in Section 2(25A) does not extend to Indian Ships operating beyond Indian Territorial waters. Therefore, in case of crew members of foreign-going Indian Ships who are not likely to be in India for a period extending 182 days in a year, the income which accrues outside India and the salary which is received outside India is not liable to be taxed in India and, accordingly, the Shipping Companies are directed to take these factors into account while computing the amount to be deducted as tax at source under Section 192 of the Income Tax Act. Learned Counsel for the assessee contended that in view of the above Circular issued by the Board, it is clear that the term 'India' as defined under Section 2(25A) of the Income Tax Act does not extend to foreign going Indian Ships operating beyond Indian territorial waters. He also relied upon the Board's Circular reported in 186 ITR, page 89 which indicates that if a crewman is outside India for more than 182 days on an Indian Ship, he will not be treated as resident of India. He relied upon the judgment of the Supreme Court in the case of Commissioner of Income Tax v. Continental Construction Ltd., reported : [1998]230ITR485(SC) . He also relied upon the Judgment of the Supreme Court in the case of Commissioner of Wealth-tax, Bombay v. Consolidated Pneumatic Tools Co. Ltd., reported in : [1971]81ITR752(SC) , in which it has been held that goods on the high seas in transit to India fall outside India. Basically, the above two Judgments deal with scope of Section 40A(5) of the Income Tax Act. Mr. Mehta, learned Counsel appearing for another assessee has adopted the arguments advanced by Mr. Andhyarujina. Mr. Mehta, further, has relied upon the Circular No. 356 dated 17-3-1983 issued by the Central Board. He submitted that reading of the said Circular shows that persons working on Ships outside India were entitled to claim deductions under Section 80RRA which rules out the argument of the Department that Indian Ships constituted a territory of India even outside the territorial waters of India. Mr. Mehta, therefore, contended that if the Department's argument was to be accepted then all persons working on Indian Ships outside India would not be entitled to deductions under Section 80RRA. Mr. Mehta further contended that prior to the Notification issued by the Central Government in 1983, the term 'India' referred to 12 nautical miles from the shore/based line. He contended that after the Central Government issued Notification in 1983 under the Territorial Waters, Continental Shelf, Exclusive Economic Zone and Other Maritime Act, 1976 vide deeming fiction, the extent of the territorial waters came to be extended by including continental shelf and also exclusive economic zone for a limited specific purpose as provided in the Notification dated 1-4-1983. Basically, Mr. Mehta contended that the limit of the territorial waters prior to 1-4-1983 was only 12 nautical miles. However, certain areas were found to contain oil and minerals outside the 12 nautical miles. Therefore, under the Notification issued under the Territorial Waters Act, 1976 some of these areas where oil was located came to be included as forming part of India and to those areas the Income Tax Act was applied. However, the Act was applied only to income which is derived in such areas from the activities enumerated in the Notification viz. extraction of oil, exploration of oil and minerals. Mr. Mehta accordingly contended that for the above purpose 'India' includes the exclusive economic zone. However, he argued that there is no Notification which includes foreign going Indian Ships into the term 'India' under the Territorial Waters Act read with the Notifications issued thereunder. Mr. Mehta accordingly contended that, even under the Territorial Waters Act, there is no law which includes such Ships to form part of India. Mr. Mehta contended that one has to look to the provisions of the Income Tax Act and not to the provisions of the Merchant Shipping Act or International Conventions. In the circumstances, Mr. Mehta contended that since the Indian Ships going abroad have not been notified as India under the Territorial Waters Act 1976, it cannot be said that the services rendered by the floating staff outside the territorial waters constituted services being rendered in India. Mr. Mehta vehemently contended that for the purposes of deciding the above question, the relevant test to be applied is: which is the place where income accrues in cases where the floating staff renders services outside the territorial waters. He contended that for the purposes of the Income Tax Act, execution of the contract in India, payment of salary in India, Ship bearing Indian Flag are not relevant considerations. He contended that the basic point which arises for consideration is the place where the services are rendered. He contended that the floating staff during the relevant period of employment renders services out of India when the Ship goes out of the territorial waters. In the circumstances, he contends that Section 40A(5)(b)(i) squarely applies to the facts of this case.
8. Section 40A(5) imposes ceiling on remuneration. The said Section places ceiling on the deductible amount of expenditure incurred by a tax payer on account of payment of salary to an employee. Under this provision, expenditure incurred by a tax payer on account of payment of salary to an employee in respect of the period of his employment in India during the relevant period is not allowed as deduction in computing the taxable profits of the employer to the extent it exceeds the specified limits for each month or part of a month. This aspect is very important particularly for the purposes of interpreting Section 40A(5)(a) in contradistinction to Section 40A(5)(b)(i) as it then stood. Section 40A(5)(a) states, inter alia, that the expenditure incurred by a tax payer on payment of salary to an employee in respect of the period of his employment in India during the relevant year will not be allowed as deduction in computing the taxable profits if it exceeds the prescribed ceiling. Now in contradistinction to Section 40A(5)(a), we have Section 40A(5)(b) which begins by saying that nothing in Clause (a) shall apply to any expenditure incurred by a tax payer on payment of salary to an employee in respect of the period of his employment outside India. In other words, if the tax payer incurs expenditure on payment of salary to an employee in respect of the period of his employment in India then such tax payer would be entitled to deduction for such expenses subject to it not exceeding the specified limits. To carve out an exclusion to Section 40A(5)(a), we have Section 40A(5)(b) which states that nothing in Clause (a) shall apply to any expenditure incurred by a tax payer on payment of salary to an employee in respect of the period of his employment outside India. This distinction is very important. It indicates the true meaning of the expression 'employment outside India' in Section 40A(5)(b) in contradistinction to Section 40A(5)(a). Section 40A(5)(a) puts a ceiling on the expenditure incurred by a tax payer by way of salary to an employee employed in India. Therefore, to bring in the exclusion, the legislature has provided, inter alia, that provisions of Section 40A(5)(a) which impose a ceiling on such expenditure shall not apply to an expenditure incurred by a tax payer by way of salary to an employee employed outside India. Therefore, Section 40A(5)(a) proceeds to emphasise employment in India and to carve out an exception to Section 40A(5)(a) the legislature has used the words 'employment outside India' in Section 40A(5)(b)(i) as it stood at the relevant time. Therefore, we do not find any merit in the contention advanced on behalf of the Department that the words 'employment outside India' in Section 40A(5)(b)(i) only refers to cases where a contract of employment is entered into outside India or an employee is required to work pursuant to such a contract outside India. We may further mention that under the Income Tax Act, there is a dichotomy between deductions in the hands of the employer and deductions in the hands of an employee. In this case we are concerned with the deductions in the hands of the employer. In this case, we are not concerned with the deductions in the hands of the employees. In this case, we are concerned with the scope of Section 40A(5) as it stood at the relevant time. In this case, we are not concerned with the provisions of Sections 5, 6 or 192 of the Income Tax Act. In the case of McGaw-Ravindra Laboratories (India) Ltd. v. Commissioner of Income Tax, reported in 210 ITR, page 1002, the assessee was engaged in the business of manufacture of glucose saline solution. In that matter, the salary paid by the assessee to its employee during the period exceeded the ceiling prescribed. The assessee claimed deduction. The ceiling prescribed was Rs. 72,000/-. The total remuneration paid was Rs. 1,42,500/-. The assessee claimed deduction in respect of the total remuneration of Rs. 1,42,500/- which included the value of perquisites. The assessee did not dispute that under Section 40A(5), as it stood at the relevant time (Assessment Year 1977-78), the assessee could not have claimed deduction of an amount exceeding Rs. 72,000/-. It was, however, urged that an employee was sent to foreign country for 29 days. Therefore, it was urged that the salary received by the employee during 29 days could not have been taken into consideration for the purposes of disallowance under Section 40A(5). It was not disputed that if the employee had not gone out of India his salary and perquisites could not have exceeded Rs. 72,000/-. However, on facts, it was found that the employee was employed in India. That, he incidentally happened to go to foreign country for 29 days for the business of the assessee and merely because an employee goes abroad, he cannot be said to have been employed outside India. It is in this context the Judgment of the Gujarat High Court is required to be read. In that matter, what was argued was that, because the employee happened to go abroad for 29 days he stood employed outside India. It is important to note the facts of that case. In that matter, the contract of employment never postulated working of the employee outside India. He happened to go out of India for a short period because of business exigency. On the other hand, in the present case, the employer is a Shipping Company. It employees floating staff. The contract of employment itself postulates that members of the floating staff would be required to work outside India from time to time which was not so in the case before the Gujarat High Court. In the case before the Gujarat High Court, the salary which was paid to the employee was on the footing that the employee was employed in India whereas the facts in our case show that the contract of employment itself postulated an entire different formula to calculate the salary payable on the footing that the floating staff was required to work, most of the time, outside India. The Judgment of the Gujarat High Court, therefore, is required to be read in the light of the facts of that case. The said Judgment has no application to the members of the floating staff employed by Shipping Company. As stated hereinabove, the Department will have to ascertain the facts of each case in order to decide as to whether the employee was employed in India or outside India. In each case, the Department will have to construe the terms and conditions of the contract. Merely because the contract is entered in India will not be the conclusive test to decide as to whether an employee was employed in India or outside India. The terms of the contract, the nature of the work, the nature of business and all other relevant facts arc required to be considered to decide as to whether the employment was in India or outside India. We also do not find merit in the contention advanced on behalf the Department that for the' purposes of Income Tax Act, remuneration paid to an employee working on an Indian Ship would show that the employee was employed in India and not outside India. In this connection, the Department has relied upon the provisions of the Merchant Shipping Act and also they have relied upon the International Conventions. It was urged on behalf of the Department that the Ship bearing Indian Flag constitutes Indian territory. That, an Indian Ship remains an Indian territory even when it goes outside theterritorial waters of the country. In support of the said argument, learned counselfor the Department relied upon the provisions of the Merchant Shipping Act. Wedo not find any merit in the said contention. The provisions of the MerchantShipping Act are not in pari materia to the provisions of the Income Tax Act.The said Merchant Shipping Act is not even a fiscal legislation. The provisions ofthe Merchant Shipping Act are essentially invoked in cases of accidents. Theyprovide for payment of wages and compensation to seamen in cases of accidents.They provide for contract and awards between the Union and the ShippingCompanies governing terms and conditions of employment. The internationalLaw refers to the law of Flag in order to decide the nationality of the Vessel. Onefails to understand how the said provisions apply to the provisions of the IncomeTax Act. The Income Tax Act, in the context of the present controversy, dealswith deductions in the hands of a tax payer employer. The term 'India' has beendefined under Section 2(25A) to include Union territories. Reliance in connectionwith Section 2(25A) was also placed on Sections 5 and 6 of the Income Tax Act.It was contended by Department that under Section 5, the legislature has laiddown the scope of total income of a person who is a resident so as to include allincome from whatever source it is derived. Reliance was also placed on Section 6which deals with meaning of the term 'Residence in India'. Section 6 shows thatfor the purposes of the Income Tax Act, an individual is said to be resident inIndia in any previous year if he is in India in that year for one hundred andeighty-two days or more. In the present case, as stated hereinabove, we are onlyconcerned with the question of deduction in the hands of a tax payer-employer.The provisions of Income Tax Act are required to be read strictly. Section40A(5)(a) disallows expenditure by way of salary paid by the tax payer in respectof employment in India beyond the prescribed limit. However, Section40A(5)(b)(i), as it stood at the relevant time, is an exclusionary Clause. It lays down that any expenditure incurred by the tax payer-employer by way of salary in respect of employment outside India will not come within the ambit of Section 40A(5)(a). It is in that context that the words 'employment outside India' find place in Section 40A(5)(b)(i). Therefore, Section 40A(5)(a) refers to employment in India whereas Section 40A(5)(b)(i), in contradistinction, refers to employment outside India. In each case, therefore, the Department will have to construe the terms and conditions of the contract, the performance of the contract, the place of performance of the contract, the nature of the duties required to be performed by the employee and such other connected factors in order to decide as to whether there was employment outside India. It will depend on the facts of each case. As stated above, Section 40A(5) deals with deductions in the hands of an employer. It has nothing to do with the provisions dealing with deductions in the hands of an employee under Sections 5, 6 and 9 of the Income Tax Act. On the other hand, the Circular issued by the Board bearing No. 586 dated 28th November, 1990, though in the context of deductions in the hands of employees, specifically lays down that, India, as defined under Section 2(25A) of the Income Tax Act, does not extend to Indian Ships operating beyond the Indian territorial waters. This Circular, to the above extent, supports our interpretation that Indian Ships operating beyond Indian territorial waters do not come within the term 'India' as defined in Section 2(25A) of the Income Tax Act. Similarly, the word 'India' has also been defined under the General Clauses Act under Section 2(28). It does not include Indian Ships outside territorial waters of the country. Since we are concerned with deductions in the hands of the employer, we have not gone into the provisions of Section 80RRA although they have been relied upon by Mr. Mehta, learned Counsel for the assessee.
9. In the light of our Judgment hereinabove, the above question is answered in the affirmative i.e. against the Department and in favour of the assessee.
10. Before concluding an additional question in one of the above References viz. ITR 342 of 1988 remains to be decided. The question reads as follows:--
'Whether on the facts and in the circumstances of the case, the assessee was entitled to weighted deduction under Section 35B of the Income Tax Act 1961 on brokerage and commission on freight paid in foreign countries for the Assessment Year 1977-78?
In view of the Judgment of the Supreme Court in the case of Aravinda Paramila Works v. Commissioner of Income Tax, reported in : [1999]237ITR284(SC) , the above additional question in ITR No. 342 of 1988 is answered in the negative i.e. in favour of the Department and against the assessee.
11. Accordingly, the entire group of above References and Appeal stand disposed of.
C.C. expedited.