| SooperKanoon Citation | sooperkanoon.com/732577 |
| Subject | Direct Taxation |
| Court | Kerala High Court |
| Decided On | Oct-25-1999 |
| Case Number | IT Reference No. 37 of 1996 25 October 1999 |
| Reported in | [2000]109TAXMAN91(Ker) |
| Appellant | P. Balakrishnan, Commissioner of Income Tax |
| Respondent | N. Radhakrishnan, Travancore CochIn Chemicals Ltd. |
| Advocates: | P.K.R. Menon and George K. George, for the Applicant P. Balachandran, for the Respondent |
Rajendra Babu, J.
This reference is at the instance of the revenue. The Commissioner, Kochi, has referred the following questions arising out of the order of the Tribunal dated 7-6-1994 in IT Appeal No. 1286 (Coch.) of 1987 for the assessment year 1985-86.
2. The questions referred to are:
'1. Whether, on the facts and in the circumstances of the case and also going by the principles laid down in CIT v. India Tobacco Co. Ltd : [1978]114ITR182(Cal) and 162 ITR 66, the payment of Rs. 5,34,406 to FACT School is an allowable deduction ?
2. Whether, on the facts and in the circumstances of the case, the Tribunal is right in law and fact in finding an understanding with the assessee and is not the above finding or consequential finding and conclusion, unsupported by an iota of evidence, material, based on surmises and conjunctures ?
3. Whether, on the facts and in the circumstances of the case, should not the Tribunal have equated the contribution to FACT with the contribution to the Government School, Eloor, (vide paragraph 7 of the order) and considered and decided the ground accordingly ?
4. Whether, on the facts and in the circumstances of the case and also in the light of the provisions of section 145(1), read with the decision of the Supreme Court in British Paints India Ltd : [1991]188ITR44(SC) , the Tribunal is right in law and fact in deleting the addition of Rs. 9 lakhs made to the closing stock ?
5. Whether, on the facts and in the circumstances of the case and also f the reasons stated in the enclosure to the R.A., the assessee is right in I and fact in changing the method of valuation of closing stock
3. The facts are as follows:
The assessee is a public sector unit engaged in the manufacture and sale of certain chemicals like caustic soda, chlorine, etc. During the previous year, the assessee had made payments of Rs. 5,34,406 to FACT school. The claim of the assessee was that the above amount should be included under the welfare expenditure. The assessing officer held that the above payment had no direct relation with the business activity of the assessee and was more or less in the nature of a donation and, therefore, disallowed the claim. The assessing officer further noticed that the assessee had been valuing its closing stock till the previous year by including interest as an element of cost of production. But while valuing the closing stock for the above assessment year 1985-86, the assessee had excluded the interest from the cost of production. The assessing officer was of the view that the opening stock and closing stock have to be valued following the same principle of method of valuation adopted for the earlier years, Due to the deviation from the method of valuation adopted by the assessee, there was an under-valuation of Rs. 9 lakhs in valuing the closing stock and, accordingly, an addition of Rs. 9 lakhs was made to the closing stock.
4. On appeal by the assessee, the Commissioner (Appeals) confirmed the disallowance of expenditure made by the assessing officer under section 40A(9) of the Income Tax Act, 1961 ('the Act'). Further, the order of the assessing officer in revaluing the closing stock was also upheld. But the Tribunal in second appeal held that the assessee's contribution to the FACT school was for the assessee's business purpose and allowed deduction thereof. Further, the Tribunal accepted the change in the method of valuation in the closing stock as the change was effected at the instance of the Accountant General (Audit), Kerala, Trivandrum.
5. The learned senior counsel appearing for the revenue, argued that the Tribunal had gone wrong in allowing the deduction of the amount paid to the FACT school as it had no direct relationship with the business activities of the company and it can be treated only as a donation to the school and has to be disallowed under section 40A(9). The learned counsel for the assessee argued that the expenditure met towards the FACT school was not a donation but it was in the form of reimbursement of the proportionate expenditure met for the running of the school where the children of the employees of the assessee were having their education and such an expenditure was wholly and exclusively for the welfare of the employees of the assessee and also it was an expenditure for the business purpose of the assessee. It was further argued that the above expenditure shall not come within the purview of section 40A(9) and the expenditure made by the assessee for the welfare of the employees of the assessee is allowable under section 40A(10) and also section 37(1). It would be relevant to extract sub-sections (9) and (10) of section 40A.
Section 40A(9). reads:
'(9) No deduction shall be allowed in respect of any sum paid by the assessee as an employer towards the setting up or formation of, or as contribution to, any fund, trust, company, association of persons, body of individuals, society registered under the Societies Registration Act, 1860 (21 of 1860), or other institution for any purpose, except where such sum is so paid, for the purposes and to the extent provided by or under clause (iv) or clause (y) of sub-section (1) of section 36, or, as required by or under any other law for the time being in force.'
Sub-section (9) of section 40A is intended to impose restrictions on the expenditure towards setting up or formation of or contribution to any fund or trust, or to association, etc., except in respect of the contribution to any recognised provident fund or as required under any other law.
Section 40A(10) reads:
'Notwithstanding anything contained in sub-section (9),' where the Income Tax Officer is satisfied that the fund, trust, company, association of persons, body of individuals, society or other institution referred to in that sub-section has, before the 1st day of March, 1984, bona fide laid out or expended any expenditure (not being in the nature of capital expenditure) wholly and exclusively for the welfare of the employees of the assessee referred to in sub-section (9) out of the sum referred to in that sub-section, the amount of such expenditure shall, in case no deduction has been allowed to the assessee in respect of such sum and subject to the other provisions of this Act, be deducted in computing the income referred to in section 28 of the assessee of the previous year in which such expenditure is so laid out or expended, as if such expenditure had been laid out or expended by the assessee.'
Sub-section (10) of section 40A is intended to take in such expenditure which was spent wholly and exclusively for the welfare of the employees of the assessee, notwithstanding the restrictions imposed in sub-section (9). The object of introducing sub-sections (9) and (10) of section 40A was to avoid tax evasion in the guise of donation to trusts and the flow back of the same amount to the employer again in the form of deposit and as a measure for combating tax avoidance. Paragraphs 35 and 36 of the Memo explaining the introduction of the above provisions in the Finance Bill, 1984, would make it clear, which reads:
'35. Sums contributed by an employer to a recognised provident fund, an approved superannuation fund and an approved gratuity fund are deducted in computing his taxable profits. Expenditure actually incurred on the welfare of employees is also allowed as deduction. Instances have come to notice where certain employers have created irrevocable trusts, ostensibly for the welfare of employees, and transferred to such trusts substantial amounts by way of contribution. Some of these trusts have been set up as discretionary trusts with absolute discretion to the trustees to utilise the trust property in such manner as the fit for the benefit of the employees, without any scheme or safeguards for the proper disbursement of these funds. Investment of trust funds has also been left to the complete discretion of the trustees. Such trusts are, therefore, intended to be used as a vehicle for tax avoidance by claiming deduction in respect of such contributions, which may even flow back to the employer in the form of deposit.
36. With a view to discouraging the creation of such trusts, the Bill seeks to make a provision that no deduction shall be allowed in the computation of taxable profits in respect of any sums paid by the taxpayer as ail employer towards the setting up of, or as contribution to, any fund or trust for any purpose, except where such sum is paid or contributed (within the limits laid down under the relevant provisions) to a recognised provident fund or an approved gratuity fund or an approved superannuation fund or for the purposes of and to the extent required under any other law.'
The object and reasons for the introduction of sub-sections (9) and (10) in the Act would make it clear that any expenditure met by an assessee wholly and exclusively for the welfare of the employees of the assesee is an allowable deduction in computing the income of the assessee.
Section 37(1) reads:
'General-(I) Any expenditure (not being expenditure of the nature described in sections 30 - 36 and section 80VV and not being in the nature of capital expenditure or personal expenses of the assessee), laid out or extended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head 'Profits and gains of business or profession'.'
The expenditure met wholly and exclusively for the welfare of the employees of the assessee not covered under sections 30 - 36, and section 80VV of the Act and not in the nature of capital expenditure or personal expenses is allowable under section 37(1). In the present case, the expenditure is made towards contribution of the share of expenditure in running of the FACT school, wherein the children of the employees were studying. Annexure D, communication from the FACT to the assessee dated 13-6-1985, would make it clear that the expenditure of Rs. 5,34,406.58 was towards the proportionate share of expenses of the assessee for the running of the school for the above academic year. The above communication would further reveal that 282 students of the above school were the children of the employees of the assessee and the above expenditure was wholly and exclusively for the welfare of the employees of the assessee.
6. The learned counsel for the assessee argued that for the functioning of that FACT school the assessee was contributing a portion of the expenditure every year and the said expenditure was essential for the smooth running of the assessee's business. The learned counsel for the assessee placed reliance on the decision of the Karnataka High Court in Mysore KirloskarLtd. v. CIT : [1987]166ITR836(KAR) , That was a case where the assessee-company had established a school for the education of the children of the employees of the assessee and the company constituted an Educational Trust and started the school. The assessee company had been donating every year certain sum to meet the expenses of the school. For the relevant year, the assessee donated Rs. 62,000 and claimed out of it 61 per cent by way of deduction under section 37(1), on the ground that 61 per cent of the school children were the children of the employees and the ex-employees of the assessee. There it was held:
'(i) that the words 'for the purpose of the business' used in section 37(1) should not be limited to the meaning of 'earning profit alone'. Business expediency or commercial expediency might require providing facilities like schools, hospitals, etc., for the employees or their children or for the children of the ex-employees. Any expenditure laid out or expended for their benefit, if it satisfied the other requirements, must be allowed as a deduction under section 37(1) of the Act. The fact that somebody other than the assessee was also benefited or incidentally took advantage of the provision made, should not come in the way of the expenditure being allowed as a deduction under section 37(1) of the Act. Nevertheless, it is an expenditure allowable as deduction under the Act.' (p. 838)
7. The Supreme Court in CIT v. Bombay Dyeing & Mfg. Co. Ltd : [1996]219ITR521(SC) , held that the amount contributed to the State Housing Board for constructing tenements for the workers of the assessee was for carrying on the business of the assessee's-company more effectively by having a contended labour force and was in the form of revenue expenditure. There the assessee contributed an amount of Rs. 2,25,000 to the Maharashtra Housing Board towards construction of tenements for the workers of the company. The assessee contended that the above expenditure was incurred wholly and exclusively for the welfare of the employees and, therefore, constituted legitimate business expenditure. The Income Tax Officer as well as the Appellate Assistant Commissioner rejected the claim of the assessee. But the Tribunal held that the expenditure was not in the nature of a capital asset to the assessee-company as the tenements remained the property of the Housing Board and there was no obligation on the assessee-company to provide its workers tenements constructed by the Housing Board and that the benefit of better and cheaper housing obtained by the industrial workers of the assessee-company did not constitute a direct benefit of an enduring nature of the assessee. The Tribunal held that the expenditure was incurred merely with a view to carry on the business of the assessee-company more efficiently by having contended labour force. The High Court held that no question of law arose for reference from the order of the Tribunal. There the Supreme Court held that, on the facts of the case, the amount constituted revenue expenditure and, thus, it was an allowable expenditure.
8. The learned senior counsel for the revenue placed reliance on the decision of the Calcutta High Court in CIT v. India Tobacco Co. Ltd : [1978]114ITR182(Cal) . There the assessee-company constructed a hospital. At the time when the hospital was ready, the Employees State Insurance Scheme came into operation and the Government of Bihar acquired the hospital. Some negotiations had taken place between the assessee and the Government and also the workers union. On the basis of the said settlement, the assessee had given an amount of Rs. 50,000 to the Government for the purchase of equipments for the hospital. The company had two kinds of employees, viz-, those who were covered by the provisions of the Employees Insurance Scheme which provides for hospital benefits and employees who were not covered by the scheme. By making the payment of Rs. 50,000, the company obtained a privilege of getting its employees, who were not covered by the provisions of the Employees Insurance Scheme, treated in the above hospital. There it was held that the assessee by making the above one lumpsum payment, not only got rid of a liability to make recurring annual payments for the treatment of its workers who were not covered by the State Insurance Scheme at the hospital of the Government but also obtained this advantage or privilege for an indefinite period and, hence, the expenditure in question was capital in character and, hence, not admissible for deduction under section 37(1). The facts of the above case do not have any similarity with the facts of the present case and the principles laid down in the above case have no application. In the case at hand, the expenditure met by the assessee was wholly and exclusively for the welfare of its employees and also for carrying on the business of the assessee-company more efficiently by having a contended labour force. it was neither a donation covered under section 40A(9) nor of capital in nature not covered by section 37(1). Hence, the Tribunal is fully justified in allowing the above expenditure towards contribution for the running of the FACT school, as an expenditure for the smooth functioning of the business of the assessee and also an expenditure wholly and exclusively for the welfare of the employees of the assessee and, thus, allowable under section 37(1) as well as section 40A(10). Thus, question Nos. I to 3 are answered in favour of the assessee and against the revenue.
9. The assessee had valued its opening stock by including interest as an element of cost of production in the same way as the earlier years closing stock had been valued. In valuing the closing stock for the assessment year 1985-86, the assessee excluded the interest as an element of cost. The change in the method of valuation was adopted by the assessee to comply with a direction from the Comptroller and Auditor General of India. The assessing officer was of the view that the opening stock and the closing stock have to be revalued using the same principle of method of valuation and, accordingly, an addition of Rs. 9 lakhs was made towards the value of the closing stock. The above addition was upheld by the appellate authority. But, in the second appeal, the claim of the assessee was accepted by the Tribunal by following a decision of the Madras High Court in CIT v. Carborandum Universal Ltd. (1984) 149 ITR 159 : 16 Taxman 25. That was a case where the assessee modified the system of accounting and adopted the direct cost method. There it was held:
'... In view of the finding of the Tribunal that the adoption of the direct cost method was bona fide and was a permanent arrangement with the intention to follow the same method year after year, the change would have to be accepted notwithstanding the fact that during the assessment year in question, which was the first year when the change of method was brought about, a prejudice or detriment might be caused to the revenue. As the method of valuation adopted by the assessee had obtained recognition from practising accountants and the commercial world for valuation of stock-in-trade, the adoption of that method could not be questioned by the revenue unless the adoption of that method was found to be not bona fide or restricted to a particular year. If the assessee is called upon to apply the new method of valuation to the opening stock of the accounting year as well, the value of the closing stock of the year previous to the accounting year will also have to get altered which will result in a modification of the assessment of that previous year. The Tribunal was, therefore, right in its conclusion that the assessee was entitled to alter its method of valuation of closing stock and, consequently, the difference between the valuation, according to the old method and according to the new method, could not be included for assessment.' (p. 760)
10. The learned senior counsel for the revenue placed reliance on the decision of the Supreme Court in CIT v. British Paints India Ltd. : [1991]188ITR44(SC) . That was a case where the assessee-company, as a consistent practice, valued its goods in process and finished products exclusively at cost of raw materials totally excluding overhead expenditure. The assessee adopted the above method on the ground that the goods being paints had limited storage life and if not quickly disposed of, were liable to lose market value. The Tribunal held that there was no evidence to show that the goods in stock deteriorated in value and there was no justification for excluding the overhead expenditure in valuing the stock. The High Court reversed the decision of the Tribunal holding that having regard to the consistent practice of the assessee, the Tribunal was not justified in rejecting the method of valuation of the stock-in-trade. The Hon'ble Supreme Court reversed the decision of the High Court and held that the assessee was not following the correct system of accounting and the method of valuation in the stock-in-trade was likely to result in a distorted picture of the true state of business for the purpose of computing the chargeable income. There it was held that even if the assessee had adopted a regular system of accounting, it was the duty of the assessing officer under section 145 to consider whether the correct profits and gains could be deduced from the accounts so maintained. If he was of the opinion that the correct profits could not be deducted from the accounts, he was obliged to have recourse to the proviso to section 145. The above decision has no application in the present case. Here the assessee had been including interest as an element of cost of production for valuation of the closing stock. But the Accountant General (Audit), Kerala, in the comments under section 619(4) of the Companies Act commented that the clusion of interest charges for valuation of closing stock of finished foods resulted in overstatement of profits. It was in the above circumstances that the assessee charged the method of valuation of closing stock and it was a bona fide change to be consistently followed for the subsequent years. In Melmould Corpn. v. CIT : [1993]202ITR789(Bom) , the High Court of Bombay held:
'Under section 145 of the Income Tax Act, 1961, the assessee can adopt a method of valuation which is to be followed by it regularly. It is an accepted principle of accountancy that value of the stock can be determined at cost price or market price, whichever is lower. The two principles applicable with regard to the valuation of stock are that the assessee is entitled to value the closing stock either at cost price or market value, whichever is lower, and that the closing stock must be the value of the opening stock in the succeeding year. It is, thus, clear that irrespective of the basis adopted for valuation in the earlier years, the assessee has the option to change the method of valuation of the closing stock at cost or market price, whichever is lower, provided the change is bona fide and followed regularly thereafter. Whenever there is a change in the method of valuation, there is bound to be some distortion in the calculation of profits in the year in which the change takes place. But, if the change is brought about bona fide and is in accordance with the normally accepted accounting practice, there is no reason why such a change should not be permitted. The change has to be effected by adopting the new method for valuing the closing stock which will, in its turn, become the value of the opening stock of the next year. If, instead, a procedure is adopted for changing the value of the opening stock also, it will lead to a chain reaction of changes in the sense that the closing value of the stock of the year preceding will also have to change and correspondingly the value of the opening stock of that year and so on.' (p. 789)
The assessee was compelled to change the method of valuation at the instance of the Accountant General (Audit), Kerala. The assessee had followed the same changed method of valuation in the subsequent year. Whenever there is a change in the method of valuation, there is bound to be some distortion in the calculation of profits in the year in which the change takes place. The change adopted by the assessee was bona fide and intended to be followed in the future years and it was not adopted for the same assessment year only but to be consistently followed in the subsequent years. Hence, the revised method of valuation of closing stock was rightly accepted by the Tribunal and we find no reason to interfere with the order of the Tribunal. Hence, the question Nos. 4 and 5 are to be answered in favour of the assessee and against the revenue.
11. In the result, question Nos. I to 5 are answered in favour of the assessee and against the revenue.