Delhi High Court

J.K.Synthetics Ltd. vs C.I.T. on 21 July, 2010

Author: A.K.Sikri

                                    UNREPORTED
*   IN THE HIGH COURT OF DELHI AT NEW DELHI

%                         DATE OF DECISION: 21.07.2010

+                    ITR No.139-40/1989

      J.K. SYNTHETICS LTD.             ..... Appellant
                Through: Mr. Prem Nath Monga and Mr. Manu
                            Monga, Advocates
                     versus
      C.I.T.                                ..... Respondent
                Through: Mr. Sanjeev Sabharwal, Advocate

CORAM:
HON'BLE MR. JUSTICE A.K. SIKRI
HON'BLE MS. JUSTICE REVA KHETRAPAL

1. Whether reporters of local papers may be allowed
   to see the judgment?                                         NO

2. To be referred to the Reporter or not?                       NO

3. Whether judgment should be reported in Digest?               NO

                     J U D G M E N T (ORAL)

21.07.2010

: A.K. SIKRI, J.

1. The following seven questions are referred for decision of this Court:-

"1. Whether on the facts and in the circumstances of the case, the ITAT was right in upholding the disallowance of Rs. 29,072/- in connection with maintainance of Kamla Retreat.

2. Whether on the facts and in the circumstances of the case, the Tribunal was justified in holding that depreciation on plant and machinery installed in the premises of JK Cotton Spg. & WVG. Mills Ltd. Kanpur was allowable to the assessee only to the extent of 50%.

3. Whether on the facts and in the circumstances of the case, the Tribunal was right in

holding that the assessee was entitled only to 50% of the depreciation in respect of plant and machinery installed in the premises of M/s Plastic Products ltd.

4. Whether on the facts and in the circumstances of the case, the Tribunal was right in holding that a sum of Rs. 23,43,434/- was disallowable in terms of section 40A (8) of the Income Tax Act, 1961.?

5. Whether on the facts and in the circumstances of the case, the Tribunal was right in holding that payment of commission amounting to Rs.21,65,000/- to the directors was to be included in computing the disallowance u/s 40 © of the Income Tax Act, 1961?

6. Whether on the facts and in the circumstances of the case, the Tribunal was right in holding that the expenditure of Rs. 76,790/- being paid to a lawyer to defend a criminal case in Mauritius launched against the President of the assessee company was not an expenditure for the assessee's business?

7. Whether on the facts and in the circumstances of the case, the tribunal was right in upholding the disallowance of Rs. 1,39,991 on account of provision for the payment of gratuity?"

2. In so far as question Nos. 1 to 3 are concerned, learned counsel for

the assessee has fairly conceded that the reference in respect of these

very questions, in the case of assessee itself, was return unanswered by

this Court vide orders dated 7th January, 2008 in ITR 138 of 1988

keeping in view the negligible amounts involved. Therefore, he would

not press these issues.

3. In so far as question no.4 is concerned, it is decided against the

assessee in ITR 285 of 1987 which also pertains to this very assessee.

4. In so far as question no. 5 is concerned, Mr. Monga submitted that

this is decided in favour of the assessee by the judgment of this Court in

J.K. Synthetics Vs. C.I.T., reported as 308 ITR 237l. Therefore, this

question stands answered in favour of the assessee and against the

revenue.

5. Question no. 6 has arisen for consideration in the following

circumstances:-

The President of the Company had gone on business trip i.e. for

the purpose of business of the assessee company to Mauritius. He got

involved in a case of alleged smuggling of jewellery. Accordingly a

case was foisted upon him by the Government of Mauritius. To defend

this case, the company spent an amount of Rs. 11, 9430/- out of which

Rs. 76,790/- was paid to a Senior Counsel. The President of the

Company was ultimately acquitted in that case. In would be relevant to

mention that the involvement of the President of the assessee company

in the said case was because of mistaken identification of luggage i.e.

luggage of somebody else was taken as the luggage of the President of

the assessee company and on that basis he was charged for the offence of

smuggling. This happened when the President of the company was on

business tour to Mauritius for the purpose of carrying out the business of

the assessee. Furthermore, the involvement was coincidence of mistaken

identification of luggage. It is also important to note that the President

was totally exonerated of the said charge by the Court. It is in this

backdrop, we have to examine as to whether the Company which spent

the aforesaid amount in defending its President can claim the deduction

of the said expenditure under Section 37 of the Income Tax Act. The

said provision, inter alia, stipulates that any expenditure which is

expended wholly and exclusively for the purposes of business or

profession shall be allowed in computing the income chargeable under

the head "Profits and gains of business or profession". The deduction

was claimed by the assessee on the ground that in the circumstances as

explained above, it became important for the company to save its

reputation. More so, when the President was on a business trip; the

involvement was not due to any fault of him and; it did not relate to any

of his acts in his personal capacity, de horse, business activity.

6. We are of the opinion that in a case like this, the company had

rightfully defended its President who had visited Mauritius for

discharge of his official duties and got entangled in the aforesaid case

not by virtue of any of his acts independent of the acts related to the

business of the Company. Since we agree with the reasons given by the

CIT (Appeals), we reproduce here the discussion in the order of CIT

(Appeals) whereby he allowed this deduction:-

"As far as the next item is concerned, the expenditure involved as noted above amounting to Rs.76,790/- to a senior counsel defending the President of the company in the legal proceedings at Mauritius relating to his involvement in the case of alleged smuggling of jewellery. It is contended by the appellant that the authorities below have disallowed this payment of fee to the counsel on the ground that this amount was paid exclusively for the proceedings connected with the personal case of the President of the company and not for any

consultation or day to day conduct of the business in India. The appellant states that section 80VV covers expenditure incurred in respect of proceedings before any income-tax authority or appellate tribunal or any court relating to the determination of any liability under this Act, by way of tax, penalty or interest. In the President case, it is stated the proceedings were no doubt before the court in Mauritius. But they had no relation whatsoever to the determination of any liability under the Income-tax Act by way of tax, penalty or interest and hence the reasoning adopted by the ITO is fallacious. The appellant has cited various decisions which are in favour of the appellant's view. The case referred to are as follows:-

1. CIT v. Piara Singh(1972) 83 ITR 678 (SC)

2. CIT v. Dhanraj Girji Raja Narasingiriji (1973) 91 ITR 544 (SC)

3. Lakshmi ji Sugar Mills Co.(P) Ltd. v. CIT (1975) 98 ITR 568(Del)

4. CIT v. Delhi Safe Deposit Co. Ltd. (1982) 133 ITR 756 (SC).

According to the appellant the ratio of the decision is in favour of the appellant company insofar as these decisions uphold the allowance of expenditure in connection with saving the reputation of the company and defending the employee of the company in the course of his duties. It is stated that the view of the ITO is not justified since:

i) Provisions of Section 80VV are applicable.

ii) The President is an employee of the Company.

iii) The President was on business tour to Mauritius.

iv) He was honourably acquitted by the court in Mauritius.

v) His travelling expenses for his trip have been fully allowed as business expenditure. "

I have gone through the contention of the appellant and the view as held by the authorities below. I have also looked into the charges against the President and also seen the judgment by the judicial authorities of Mauritius. In my opinion the claim of expenditure relating to

saving of the reputation of the President was justified under the circumstances which have been shown by the appellant company and as noted from the judgments of the judicial authorities of the Mauritius. Normally an illegal expenditure or illegal act and expenditure incurred on the illegal act does not come under the jurisdiction of the business of the company. In this case it has been pointed out that the President was on business tour to Mauritius and he was unfortunate enough to get involved by co-incidence of mistaken identification of luggage due to no fault of his. In view of the circumstances, it is clear that the President was not involved in the illegal act and that he was on a business tour connected with the business of the company and as such it was imperative on the part of the company to safeguard the business interest by defending the reputation of the company's President who was totally exonerated from the alleged charge. In my opinion, the claim of expenditure to the extent of Rs.76,790/- is clearly allowable under the law."

7. We may note that the aforesaid finding of the ITAT was on the

premise that the fact that Sita Ram happened to be the President of the

company would not make his personal prosecution as one related to the

business of the assessee company. What is lost sight of is that the

aforesaid prosecution is treated as entirely independent from the assessee

company. No doubt, the President was prosecuted in his personal

capacity but the act had some causal connection with the business of the

assessee because of the manner in which the President was implicated in

the entire episode, as detailed above. It is stated at the cost of repetition

that the very purpose of the President's visit to Mauritius was in

connection with the business of the assessee company and his

involvement in the said case was not due to any of his independent

action unrelated to the business of the company. It is that aspect which

is lost sight of by the Income Tax Tribunal and this has resulted in

wrong approach being adopted by it. The judgments referred to in the

order of CIT (Appeals) squarely apply to the present case and are

wrongly distinguished by the Tribunal. We thus answer this question in

favour of the assessee and against the revenue.

8. So far as question No.7 is concerned, the appellant was not

allowed the deduction in respect of provision for payment of gratuity it

had made. The order of the A.O. reveals that the assessee had claimed

only the incremental gratuity liability of Rs.1,39,991/-. This was denied,

invoking the provision of Section 40A(7) of the Income-tax Act on the

following grounds:-

(a) No gratuity fund is established and approved by the

Commissioner as provided in Section 40A(7), and

(b) No provision is made in accounts for the liability.

9. The Tribunal in appeal affirmed the decision of the CIT (Appeals)

by referring to the judgment of the Supreme Court in the case of Shree

Sajjan Mills Ltd. v. Commissioner of Income Tax, M.P., Bhopal and

Anr., 156 ITR 585.

10. Section 40A of the Act stipulates the circumstances under which

expenses or payments will not be allowed as deductions. One such

circumstance is contained in sub-section (7), which relates to the

provision for gratuity. This reads as under:-

"(7)(a) Subject to the provisions of clause (b), no deduction shall be allowed in respect of any provision (whether called as such or by any other name) made by the assessee for the payment of gratuity to his employees on their retirement or on termination of their employment for any reason.

(b) Nothing in clause (a) shall apply in relation to any provision made by the assessee for the purpose of payment of a sum by way of any contribution towards an approved gratuity fund, or for the purpose of payment of any gratuity, that has become payable during the previous year."

11. It is clear from the above that if the assessee only makes provision

for payment of gratuity to his employees on their retirement or

termination of their employment, that would not per se entitle the

assessee to claim deduction. However, clause (b) of sub-section (7)

provides exception to the aforesaid provision and stipulates two

circumstances in which the gratuity would become entitle to deduction.

These are:-

(a) when such a provision is made by way of contribution

towards an approved gratuity fund, or

(b) for the purposes of payment of any gratuity that has become

payable during the previous year.

12. It is this principle which is clarified by the Supreme Court in

Shree Sajjan Mills Ltd. case, as is clear from the following discussion

contained in that judgment:-

"On a plain construction of clause (a) of sub-section (7) of section 40A of the Act, what it means is that whatever is provided for future use by the assessee out of the gross profits of the year of account for payment of gratuity to employees on their retirement or on the termination of their services would not be

allowed as deduction in the computation of profits and gains of the year of account. The provision of clause (a) was made subject to clause (b). The embargo is on deductions of amounts provided for future use in the year of account for meeting the ultimate liability to payment of gratuity. Clause

(b)(i) excludes from the operation of clause (a) contribution to an approved gratuity fund and amount provided for or set apart for payment of gratuity which would be payable during the year of account. Clause (b)(ii) deals with a situation where the assessee might provide by the spread-over method and provides that such provision would be excluded from the operation of clause (a) provided the three conditions laid down by the sub-clauses are satisfied.

x x x x The principle that fiscal statutes should be strictly construed does not rule out the application of the principles of reasonable construction to give effect to the purpose or intention of any particular provision as apparent from the scheme of the Act, with the assistance of such external aids as are permissible under the law."

13. From this, it clearly follows that in case provision is made by way

of contribution towards an approved gratuity fund, then the deduction

would be admissible. Intention behind such a provision is manifest. By

making provision in the books of accounts alone regarding payment of

gratuity, an employer cannot seek deduction. In that case, money still

remains with the employer. On the other hand, if the amount is actually

disbursed on the retirement or termination of an employee, that becomes

the expense. Likewise, when the amount, may be by way of provision,

is contributed towards an approved gratuity fund, the money goes out of

the hands of the assessee and is given to the said gratuity fund which is

normally in the form of a trust.

14. Mr. Monga submits that the Tribunal has merely referred to the