Commissioner of Income-tax Vs. Mercantile Bank Ltd. (Through Successors the Hongkong and Shanghai Banking Corporation) - Court Judgment

S.H. Kapadia, J.

1. At the instance of the Department, the Tribunal has referred the following questions for the opinion of this court for the assessment year 1978-79 under Section 256(1) of the Income-tax Act, 1961 :

'(i) Whether, on the facts and in the circumstances of the case, the Tribunal is justified in holding that the assessee is not liable to be taxed in respect of the amount credited to the interest suspense account and which interest had not been credited to the profit and loss account ?

(ii) Whether, on the facts and in the circumstances of the case, the Tribunal is justified in holding that the assessee is not liable to be taxed in respect of the interest of Rs. 14,54,523 on debts of which recovery is doubtful and the interest of which the assessee has neither credited to the interest suspense account nor to the profit and loss account ?

(iii) Whether, on the facts and in the circumstances of the case, the Tribunal is right in holding that two separate limits will apply for the purposes of computing disallowance under Section 40A(5) where an employee retires and ceases to be in employment during the previous year, so much so that one limit will apply in respect of the amounts and benefits received by him as an employee and another for the amounts and benefits received by him as a former employee ?

(iv) Whether, on the facts and in the circumstances of the case, the Tribunal is right in law in holding that the expenses incurred by the assessee in respect of club membership subscription fees in respect of its employees as also the expenses incurred in respect of repairs and maintenance of the accommodation provided to the employees is not to be taken into account for the purposes of computing disallowance under Section 40A(5) ?'

2. Heard learned counsel for the parties.

3. Learned counsel for the parties agreed that questions Nos. (i), (ii) and (iv) stand covered by the judgments of this court and the apex court.

4. As far as question No. (i) is concerned, the controversy involved therein is squarely covered by the judgment of the Supreme Court in the case of State Bank of Travancore v. CIT : [1986]158ITR102(SC) , and also by the decision of this court dated February 18,1999, in the case of Banque Nationale de Paris v. CIT : [1999]237ITR518(Bom) , in I. T. R. No. 83 of 1986. Accordingly, the said question is answered in the negative, i.e., in favour of the Revenue and against the assessee.

5. As far as question No. (ii) is concerned, learned counsel for the assessee fairly stated that the assessee in the present case was maintaining accounts as per mercantile system of accounting and that there is no finding of fact recorded that the assessee was maintaining a hybrid system of accounting. In the circumstances, the judgment of the Supreme Court in the case of State Bank of Travancore v. CIT : [1986]158ITR102(SC) , is squarely applicable. Learned counsel for the assessee, however, placed reliance on the judgment of the Division Bench of this court in the case of CIT v. Citibank N. A. : [1994]208ITR930(Bom) . In view of there being no finding of fact that the assessee was maintaining accounts as per hybrid system of accounting and since the assessee was maintaining accounts as per mercantile system of accounting, on facts, I hold that the judgment of the Bombay High Court in the case of CIT v. Citibank N. A. : [1994]208ITR930(Bom) , has no application to the facts of the present case. Accordingly, question No. (ii) is answered in the negative and in favour of the Revenue.

6. As far as question No. (iii) is concerned, the short point which arises for consideration is :

'Whether, the amount in excess of Rs. 60,000 was liable to be disallowed under Section 40A(5)(c) of the Income-tax Act, as it stood during the relevant assessment year 1978-79 ?'

7. It was urged on behalf of the assessee that Section 40A(5) provides for deduction for payment made to an employee and also to a former employee with two different limits prescribed for each. It was urged on behalf of the assessee that it was entitled to deduction up to Rs. 5,000 per month in respect of salary paid up to the date of retirement and a further amount of Rs. 60,000 paid in respect of retirement benefits to the same employee. Accordingly, the assessee claimed that two separate limits have been prescribed under the above Section 40A(5)(c) and that the assessee was entitled to claim the benefits of both the limits. The Assessing Officer did not agree with the above contentions advanced on behalf of the assessee. On appeal, the Commissioner of Income-tax (Appeals) accepted the claim of the assessee by referring to a decision of the Special Bench of the Income-tax Appellate Tribunal in the case of Kodak Limited, published at3-SOT-517. In view of the judgment of the Special Bench, the Tribunal in the present case, confirmed the order of the Commissioner (Appeals). Hence, the above question has been referred to this court for opinion.

8. Learned counsel for the assessee in the present case drew our attention to the relevant provisions of the Income-tax Act, 1961, as it stood at the material time, the material parts thereof are quoted hereinafter :

'17. For the purposes of Sections 15 and 16 and of this section,--(1) 'salary' includes--. . .

(iv) any fees, commissions, perquisites or profits in lieu of or in addition to any salary or wages . . .

(3) 'profits in lieu of salary' includes-

(i) the amount of any compensation due to or received by an asses-see from his employer or former employer at or in connection with the termination of his employment or the modification of the terms and conditions relating thereto ;

(ii) any payment [other than any payment referred to in Clause 10, Clause (10A), Clause (10B), Clause (11), Clause (12), or Clause (13A) of Section 10], due to or received by an assessee from an employer or a former employer or from a provident or other fund (not being an approved superannuation fund), to the extent to which it does not consist of contributions by the assessee or interest on such contributions. 40A. (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 ; . . .

(c) the limits referred to in Clause (a) are the following, namely :--(i) in respect of the expenditure referred to in Sub-clause (i) of Clause (a), in the case of an employee, an amount calculated at the rate of five thousand rupees for each month or part thereof comprised in the period of his employment in India during the previous year, and in the case of a former employee, being an individual who ceases or ceased to be the employee of the assessee during the previous year or any earlier previous year, sixty thousand rupees ; . . .' .

9. On the basis of the above sections, it was submitted that Section 40A(5) provided for deduction for payments made to an employee and also to a former employee with two different limits prescribed for each. It wascontended that payments to an employee by way of salary and payments to a former employee at or after his retirement, both, come within the expression 'salary' in the above Section 40A(5) read with Section 17(1) and (3). It was contended that a particular person could be an employee as well as a former employee of an assessee in any particular year within the meaning of Section 40A(5)(c) and in such a case, both the limits should be taken into account for the purposes of allowing deduction prescribed under the said section. In support of his submissions, learned counsel for the assessee relied upon the judgment of the Calcutta High Court in the case of Hindustan Motors Ltd, v. CIT : [1985]156ITR223(Cal) , and another decision also of the Calcutta High Court in the case of Jeewanlal (1929) Ltd. v. CIT : [1991]187ITR709(Cal) . On the other hand, learned counsel for the Revenue contended that there was no bar on the assessee to pay any amount to his employee or his former employee, but the limit of the deductions which the assessee would be allowed was fixed in the said Section 40A(5)(c). It was further urged on behalf of the Department that on a bare reading of Section 40A(5)(a)(i) read with Section 40A(5)(c)(i) of the Income-tax Act, the legislative intent was clear, viz., that the aggregate amount of deduction should not exceed rupees sixty thousand.

10. In the light of the rival contentions, we are required to examine the relevant sections of the Income-tax Act. Section 40A(5) was introduced in the Income-tax Act, 1961, by Section 10 of the Finance (No. 2) Act, 1971, with a view to impose a ceiling on business expenses. This is clear from the non obstante clause incorporated in Section 40A(1). For the purposes of Section 40A(5), the word 'salary' has been assigned the same meaning as in Section 17 excepting for the omission of the word 'perquisite'. Thus, salary would include pension, gratuity, encashment of unavailed leave, etc. The object of Section 40A(5), therefore, is to disallow excess salary and excess perquisites. Section 40A(5)(a)(i) deals with imposition of a limit on excess salary whereas Section 40A(5)(a)(ii), imposes a limit on excess perquisite. It is in this context that limits are prescribed accordingly in Section 40A(5)(a). Section 40A(5)(a)(i) read with Section 40A(5)(c)(i) deals with excess salaries to be disallowed. Section 40A(5) deals with disallowances and its computation. It prescribes a ceiling on allowable deduction. Reading Section 40A(5)(a)(i) with Section 40A(5)(c)(i), we find that there is an aggregate amount of deduction. It is possible for a person to be an employee for a part of the relevant previous year, i.e., up to the date of his retirement. Correspondingly, the same person, on his becoming a former employee in the relevant previous year, would be entitled to receive terminal benefits like gratuity, pension, etc. Section 40A(5}, deals with two separate contingencies. We have to see the status of an employee on the last date of the relevant previous year for fixing the limit of deduction. In this context, the definition of the word 'salary' given in Explanation 2refers to the meaning assigned to it in Clause (1) read with Section 17(3), subject to certain modifications. In other words, the word 'salary' would include terminal benefits like pension and gratuity and if so read, the person who receives the terminal benefits is described by the Legislature as a former employee in juxtaposition to the employee who is in service and who receives salary. In the case of an employee who received salary before retirement during the relevant accounting year, deduction beyond Rs. 5,000 per month is disallowed whereas in the case of a former employee who retires during that year, expenditure beyond Rs. 60,000 is disallowed. However, that does not mean that two separate limits are prescribed by Section 40A(5). In fact, the figure of Rs. 5,000 in the case of an employee in service and the figure of Rs. 60,000 in the case of a former employee read with the meaning of the word 'salary' as stated herein-above, clearly shows that salary for the purposes of disallowance under Section 40A(5) includes terminal benefits like gratuity. This is particularly in view of Section 17(1)(iii) of the Act. Hence, where an employee ceases to be an employee of an assessee during the relevant previous year, the aggregate limit of Rs. 60,000 prescribed in Section 40A(5)(c)(i) applies. Therefore, the status of the person on the last date of the relevant previous year is crucial. In other words, the maximum allowable deduction is only Rs. 60,000. Under Section 40A(5)(c)(i), the expression 'employee' conies within the definition of the expression 'former employee'. As a former employee, the terminal benefits by way of gratuity paid to him by the assessee come within the definition of the word 'salary' and, therefore, the total amount including his salary and gratuity cannot exceed Rs. 60,000. In the case of Hindustan Motors Ltd. v. CIT : [1985]156ITR223(Cal) , the Calcutta High Court, on interpretation of the above section, laid down that Section 40A(5) provided for two contingencies, one with regard to the salary paid to the employee who is in their employment and the other with regard to the gratuity paid when such employee ceases to be in service and for each of the two contingencies, provisions have been separately made, viz., that in the case of an employee, the allowable deduction is Rs. 5,000 for each month whereas in the case of a former employee, the allowable deduction is Rs. 60,000 and if the employee ceases to be an employee, then the deduction will be allowed to the extent of Rs. 60,000 in respect of gratuity. It has been further laid down that under Section 40A(5)(c)(i) an upper limit is prescribed for each of the two cases. However, under Section 40A(5)(a) read with Section 40A(5)(c)(i), there is no overall ceiling prescribed. In the circumstances, the Calcutta High Court has laid down that two separate ceilings/limits have been prescribed taking into account two different contingencies, viz., payment to an employee of the salary and payment to a former employee of the terminal benefits. This judgment has been followed by the Calcutta High Court in the case ofJeewanlal (1929) Ltd. v. CIT : [1991]187ITR709(Cal) . For the reasons given here-inabeve, with respect, we do not agree with the view expressed by the Calcutta High Court. In our view, Section 40A(5) only deals with one contingency, viz., payment of salary to an employee. The word 'salary' includes terminal benefits. The expression 'former employee' is used in contradistinction to the word 'employee'. Further, looking to the object for enacting Section 40A(5), as stated hereinabove, it is clear that Section 40A(5)(a)(i) read with Section 40A(5)(c)(i) of the Act refers to an aggregate amount of deduction and the permissible limit up to which the assessee could claim deduction for payment on account of salary or terminal benefits is Rs. 60,000 during the relevant year. In the present case, we are concerned with the law as it stood during the relevant assessment year 1978-79. In the circumstances, question No. (iii) is answered in favour of the Revenue and against the assessee.

11. To facilitate the reasoning given hereinbelow and in view of the fact that part of the question is answered in favour of the Department and partly in favour of the assessee, it would be relevant to appropriately divide the question as follows :

'(iv)(a) Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that expenses incurred by the assessee in respect of club membership subscription fees and in respect of repairs of the accommodation provided to the employees are not taken into account for the purposes of computing disallowance under Section 40A(5)?(b) Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the expenses incurred by the assessee on account of maintenance of accommodation provided to the employees is not taken into account for the purposes of computing disallowance under Section 40A(5) of the Act ?'

12. As regards the abovementioned question No. (iv)(a) both the learned advocates for the parties agree that the controversy is squarely covered by the judgment of the Division Bench of this court in the case of Otis Elevator Co, (India) Ltd. v. CIT : [1992]195ITR682(Bom) . Accordingly, question No, (iv)(a) is answered in the affirmative, i.e., in favour of the assessee and against the Revenue.

13. As regards question No. (iv)(b) both the learned advocates agree that the controversy is covered by the judgment of the Division Bench of this court in the case of Lubrizol India Ltd, v. CIT [1991] 187 ITR 25. Accordingly, question No. (iv)(b) is answered in the negative, i.e., against the assessee and in favour of the Revenue.

14. Reference accordingly stands disposed of with no order as to costs,Issuance of certified copy expedited.