Judgment:
1. This appeal is directed against the disallowance made under Section 37(2A) of the Income-tax Act, 1961.
2. The assessee is a registered firm deriving income as a wholesale dealer in electrical appliances. For the assessment year 1984-85, corresponding to the previous year ended 31-3-1984, the assesssee filed a return showing an income of Rs. 1,83,070. In computing that income, the assessee had taken into account miscellaneous expenditure accounted for in its head office and three branch offices. When the I.T.O. called for information about the same, the assesssee by letter dated 15-3-1985 informed him that the miscellaneous expenditure incurred included maintenance, cleaning, stationery, labour welfare expenses, medical expenses for staff, purchase of newspaper etc. In the Madras office Rs. 9,632.45 specifically represented expenditure incurred for offering coffee, tea etc. to visitors. In the other three branches, no such specific information was available. The I.T.O., therefore, considered for disallowance the sum of Rs.9,632 in the Madras office and estimated an amount of Rs. 2000 out of Rs. 17,735 for Hyderabad branch, Rs. 1,500 out of Rs. 13,995 for Bangalore branch and Rs. 500 out of Rs. 4,393 in Ernakulam branch as entertainment exspenditure. This was confirmed on appeal. In the further appeal before us it was contended that the estimated amounts in the three branches were excessive considering that the miscellaneous expenditure covered several items. After hearing the revenue, we find that the estimate works out to roughly 10% whereas the expenditure was only for offering tea and coffee to visitors. We are of the opinion that it will be reasonable to reduce the estimate by 50% thus reducing it to Rs. 2,000 for the three branches. We direct the I.T.O. to re-compute the disallowance accordingly.
3. Another item which was considered for disallowance under Section 37(2A) was a sum of Rs. 39,363 spent for a Dealers' Conference at Madras on 4-9-1983. The actual bills were from Taj Coromandel Rs. 13,986 for lunch for 252 dealers and from Fishermancove Rs. 25,376 for dinner for 252 dealers. The I.T.O. was of the view that this must be considered to be entertainment expenditure falling within the scope of Section 37(2A). On appeal, the CIT(Appeals) was also of the view that the Explanation 2 to Section 37(2A) covered this expenditure.
4. In the further appeal before us it was contended on behalf of the assessee that this expenditure was not just for giving a lunch or dinner to the delegates but it was for all arrangements inclusive of getting the premises for holding a one-day conference. It was submitted that, therefore, the main purpose of the conference was to educate the dealers about the products dealt with by the assessee so as to promote the sales and consequently the expenditure would fall within the scope of sales promotion expenses under Section 37(3B). In the alternative, it was submitted that it should be treated as payment to a hotel under Sub-section (3B) and consequently it cannot be considered for disallowance under Sub-section (2A). Reliance was placed on the decision in the case of CIT v. Eskaps (I) (P.)Ltd. [1991] 191 ITR 674 (Cal.). It was also pointed out that Sub-section (3C) had been omitted which indicated that Sub-section (3B) prevailed over Sub-section (2A) after that omission.
5. On the other hand, it was contended on behalf of the revenue that the bills were for payment for lunch and dinner and prima facie they constituted only entertainment expenditure and could not therefore be considered for disallowance under Sub-section (3B). It was also submitted that since the expenditure was in the nature of entertainment expenditure, the fact that it was also a payment to a hotel had to be disregarded. Reliance was placed on the decision in the case of Mysodet (P.) Ltd. v. CIT [1987] 163 ITR 848 [ 1986] 27 Taxman 548 (Kar). In reply it was submitted on behalf of the assessee that even otherwise the bill indicated that a sum of Rs. 4,000 was for transporting the delegates and that amount would not fall for disallowance under Sub-section (2A).
6. We have considered the submissions of both sides and have perused the bills and considered the relevant sections of the Act. Prima facie, the bills were given for supply of lunch and dinner and a magic show along with the charges for transporting the delegates to the hotel.
Yet, it is not disputed by the revenue that this lunch and dinner were in connection with a one-day conference of the delegates held in the hotel for the purpose of business of the assessee. The hotel could have charged for the premises and given the lunch and dinner free. Instead, the hotel has given the use of the premises free and charged for the lunch and dinner. That however does not wipe out the fact that the main purpose was the holding of the conference of the dealers for educating them about the products which the assessee wanted to sell. In other words, this expenditure was really for sales promotion. The Calcutta High Court has observed in the case of Eskaps (I) (P.) Ltd. (supra) that where a dinner party was for promotion of business and not for social hospitality, it was essentially for the purpose of business and cannot be disallowed as entertainment expenditure. That case related to Sub-section (2B) as it stood before 1-4-1977 under which no allowance was to be made in respect of the expenditure in the nature of entertainment expenditure incurred by the assessee. No doubt, that section has been replaced by Sub-section (2A) which also provides for disallowance of expenditure in the nature of entertainment expenditure and Explanation 2 has been added to remove all doubts by stating that entertainment expenditure includes expenditure on provision of hospitality of every kind by the assessee. Therefore, this expenditure may now fall within the category of entertainment expenditure even though it has been laid out wholly for the purpose of the business.
7. However, Finance Act, 1983 had introduced Sub-sections (3A) to (3D) with effect from 1-4-1984 which were subsequently omitted by Finance Act,1985 with effect from 1-4-1986.
(3A) Notwithstanding anything contained in Sub-section (1), where the expenditure or, as the case may be, the aggregate expenditure incurred by an assessee on any one or more of the items specified in Sub-section (3B) exceeds one hundred thousand rupees, twenty per cent of such excess shall not be allowed as deduction in computing the income chargeable under the head 'Profits and gains of business or profession.
(3B) The expenditure referred to in Sub-section (3A) is that incurred on -- (a) the expenditure specified in clause (i) to Clause (iii) of Sub-section (3B) shall be the aggregate amount of expenditure incurred by the assessee as reduced by so much of such expenditure as is not allowed under any other provision of this Act; (b) expenditure on advertisement, publicity and sales promotion shall not include remuneration paid to employees of the assessee engaged in one or more of the said activities; (c) expenditure on running and maintenance of aircraft and motor cars shall include, (i) expenditure incurred on chartering any aircraft and expenditure on hire charges for engaging cars plied for hire; (ii) conveyance allowance paid to employees and, where the assessee is a company, conveyance allowance paid to its directors also.
(3C) Nothing contained in Sub-section (3A) shall apply in respect of expenditure incurred by an assessee, being a domestic company as defined in Clause (2) of Section 80B, or a person (other than a company), who is resident in India in respect of expenditure incurred wholly and exclusively on -- (i) advertisement, publicity and sales promotion outside India in respect of the goods, services or facilities which the assessee deals in or provides in the course of his business; (ii) running and maintenance of motor cars in any branch, office or agency maintained outside India for the promotion of the sale outside India of such goods, services or facilities.
(i) in the case of an assessee engaged in the business of operation of aircraft, in respect of expenditure incurred on running and maintenance of such aircraft; (ii) in the case of an assessee engaged in the business of running motor cars on hire, in respect of expenditure incurred in running and maintenance of such motor cars.
The Finance Minister stated in his Budget Speech (140 ITR St. 31) as follows: -- Hon'ble Members must be aware of lavish and wasteful expenditure by trade and industry, particularly on travelling, advertisement and the like. With a view to inculcating a climate of austerity and providing a disincentive, to unproductive, avoidable and ostentatious spending by trade and industry, I propose to provide that 20 per cent of such expenditure will be disallowed in computing the taxable profits. The Income-tax Act provides for the disallowance of entertainment expenses beyond a ceiling and for total disallowance of expenses on maintenance of guest houses. I propose to define the terms 'entertainment expenditure' and 'guest house' to remove doubts about the correct import of these expressions.
It is proposed to make a provision in the Income-tax Act for disallowance in the computation of profits and gains from business or profession, of 20 per cent of expenditure under specified heads to the extent such expenditure has not been disallowed under the other provisions of the Income-tax Act. The items of expenditure in respect of which such disallowance will be made are expenditure on advertisement, publicity, sales promotion; travel by rail, motor car, ship, powered craft or aircraft; running and maintenance of aircraft and motor car; and payments made to hotels.
It is of interest to note that similar sections were in force between 1978 and 1980. At that time Sub-section (3C) provided as follows: -- (3C) For the removal of doubts, it is hereby declared that nothing contained in Sub-section (3A) shall apply in relation to expenditure in the nature of entertainment expenditure incurred by an assessee in connection with advertisement, publicity or sales promotion and such expenditure shall be governed by the provisions of Sub-section (2A).
8. This doubt could have been resolved in favour of the revenue if prior to the introduction of these Sub-sections, the expenditure in question would have been fully disallowed under Sub-section (2A) itself. As we have seen above, in the light of the decision of the Calcutta High Court, the expenditure could not be regarded as entertainment expenditure prior to the introduction of these Sub-sections but for the Explanation inserted with retrospective effect on the same date. Therefore, the question arises whether the retrospective Explanation 2 would cover a case of the provision of lunch or dinner at a sales conference. The Explanation talks of expenditurre on provision of hospitality whether by way of provision of food or beverages and whether or not such provision is made by reason of any express or implied contract or custom or usage of trade. In the present case the provision of lunch and dinner was neither contractual nor customary. The main purpose was the conference and in order to retain the presence of the dealers throughout the conference, the assessee had perforce to provide lunch and dinner. In our opinion, Explanation 2 will not cover such a situation.
9. It was argued by the revenue that since an element of hospitality is present, even when an assessee provides boarding and lodging expenses for business guest, the same element of hospitality will be present if lunch and dinner is provided at a conference. The decision of the Karnataka High Court in the case of Mysodet (P.) Ltd. (supra) on which the revenue relied does not advance the case of the revenue because the provision of boarding and lodging is independent of the business transactions. It may be that foreign guests had to be lodged somewhere and fed, whether the assessee is compelled to meet the expenditure or not. On the other hand, in an on-going conference unless the lunch or dinner is provided, delegates will disperse and therefore the assessee is compelled to provide it for retaining the delegates to pursue the sales promotion programme. Thus, factually the expenditure was incurred for sales promotion and the hospitality was only incidental. The retrospective operation of the Explanation 2 to Section 37(2A) cannot make that expenditure an entertainment expenditure disregarding the main nature of that expenditure. In this view of the matter, we are convinced that the nature of the expenditure being payment to hotel and sales promotion, it will fall for disallowance under Sub-section (3A) only as they are of the nature of expenditure specifically mentioned in Sub-section (3B). Since there is no provision similar to Sub-section (3C) which existed in 1978 giving overriding effect to Sub-section (2A) over Sub-section (3A), we have to accept the case of the assessee that the disallowance must be made only under Sub-section (3A) as the expenditure is of the nature specified in Sub-section (3B) even if some entertainment element was involved in that expenditure. We therefore, direct the I.T.O. to consider the sum of Rs. 39,363 for disallowance under Section 37(3A) and re-compute the income.