Mercantile
Bank Ltd., Bombay Vs. The Commissioner of Income Tax
Bombay City-Iii [2006] Insc 261 (1 May 2006)
Ruma
Pal & Dalveer Bhandari
WITH C.A. NO.311 OF 2001 RUMA PAL, J.
The
assessment year in question is 1978-79. The two questions which are to be answered
in this appeal are:
-
Whether the
appellant is liable to be taxed under the Income Tax Act, 1961 (referred to
hereinafter as the "Act") in respect of the interest on doubtful
advances credited to the interest suspense account?
-
Whether two
separate limits apply for the purposes of computing disallowance under Section
40A (5) of the Act where an employee retires and ceases to be in employment
during the previous year, 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.
The
High Court answered both the questions in favour of the Revenue and against the
Assessee.
Being
aggrieved the appellant has approached this Court.
As far
as the first question is concerned, the High Court answered it in the
affirmative relying on the decision of this Court in State Bank of Travancore
vs. Commissioner of Income Tax . In the decision of State Bank of Travancore
expressed by Tulzapurkar, J, was that the stickiness of advances or loans
objectively established to the satisfaction of the Taxing Authorities by
furnishing a proper material, is sufficient to prevent the accrual of interest
thereon as real income and would have the affect of rendering such income
hypothetical. Therefore the interest cannot be brought to tax irrespective of
the method of accounting followed, provided the assessee was able to establish
to the satisfaction of the Taxing Authority that the loans had in fact becomes
sticky during the concerned year or years by producing proper material and that
the assessee had invariably followed the practice of carrying the interest of
such loans to interest suspense account instead of crediting the same to
interest account or profit and loss account with the additional safeguard of
offering the same for taxation if and when it was subsequently realized.
The
majority view, however was that carrying certain amounts which had accrued as
interest without treating it as a bad debt or irrecoverable interest but
keeping it in suspense account would be repugnant to Section 36(1)(vii) read
with Section 36 (2) of the Act. Where the mercantile system of accounting was
followed and loans had not been written off the amounts accrued on the loans were
income assessable to tax.
The
question again arose for consideration before a Commissioner of Income Tax
(1999) 237 ITR 889, where the Court affirmed the minority view of Tulzapurkar
J, in State Bank of Travancore's case. The assessment year in question in that
case was 1981-82. The interest on loans the recovery of which was doubtful had
not in fact been recovered by the assessee bank for the last three years and
had been kept in a suspense account and had not been brought to the profit and
loss account of the assessee because the amounts were not likely to be
realized. The Court found that this method of accounting was in accordance with
established accounting practice. Additionally it was held that the Central
Board of Direct Taxes had issued a circular on 6th October 1952 stating that
the interest on sticky loans which were entered in the suspense account need
not be included in the assessee's assessable income provided the Income Tax
Officer was satisfied that there was no real probability of the loans being
repaid.
Although
the 1952 circular was withdrawn in June 1978 in view of the decision of the Kerala
High Court to the contrary in State Bank of Travancore vs. Commissioner of
Income Tax (1977) 110 ITR 336, the principle was reintroduced by the Central
Board of Direct Taxes by another Circular dated 9th October, 1984. The 1984
Circular clarified that up to the Assessment years 1978-79 the taxability of
interest on doubtful debts credited to suspense account would be decided in the
light of the Board's earlier Circular dated 6th October, 1952 as the said
Circular was withdrawn only in June, 1978. With effect from 1979-80 the new
procedure prescribed under the 1984 circular would apply. The procedure
prescribed is not relevant for our purposes. But it is clear that the circular
issued in 1978 was effectively set aside and rendered ineffective.
The
Court in UCO Bank's case (supra) was of the view that these Circulars dated 6th October, 1952 and 9th October, 1984 were binding on the authorities under Section 119(1) of the
Act. The Court was also of the view that the judges in State Bank of Travancore
(supra) did not have the occasion to consider the 1984 circular and proceeded
on the assumption that the 1978 circular was in force. The Court did not agree
with the conclusion expressed by the majority in State Bank of Travancore and
said:- "The relevant circulars of CBDT cannot be ignored. The question is
not whether a circular can override or detract from the provisions of the Act:
the question is whether the circular seeks to mitigate the rigour of a
particular section for the benefit of the assessee in certain specified
circumstances. So long as such a circular is in force it would be binding on
the departmental authorities in view of the provisions of Section 119 to ensure
a uniform and proper administration and application of the Income Tax
Act".
(para
18, pg.610) Therefore the assessment year in question in this appeal should
have been dealt with by the Department in accordance with the 1952 Circular
under which the interest on doubtful loans could not be brought to tax.
The
decision of the High Court on the first question, having been based on the
decision in State Bank of Travancore must be held to be incorrect in view of
the subsequent judgment of this Court in the case of UCO Bank As far as the
second question is concerned, Section 40A (5) in so far as it is relevant
provided:-
"40A.
Expenses or payments not deductible in certain circumstances.
-
The provisions
of this section shall have effect notwithstanding anything to the contrary
contained in any other provision of this Act relating to the computation of
income under the head "Profits and gains of business or profession".
-
-
xxx xxx xxx
-
xxx xxx xxx
-
xxx xxx xxx
-
xxx xxx xxx
-
-
Where the assessee
-
incurs any
expenditure which results directly or indirectly in the payment of any salary
to an employee or a former employee, or
-
xxx xxx xxx
then, subject to the provision 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; xxx xxx xxx
-
The limits
referred to in clause (a) are the following, namely:-
-
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:
The
issue is - when an employee ceases to be in employment during the previous
year, is the employer entitled to deduction at the rate of Rs. 5,000/- p.m. as
long as the employee was in employment and again up to the limit of Rs.
60,000/- when the employee retires? The Calcutta High Court in the case of
Hindustan 156 ITR 223 construed the provisions of Section 40A (5) (c) came to
the conclusion that for the period that an employee remains in service he is to
be treated as an employee and all payments made to him as an employee would be
allowed as a deduction within the permissible monthly limit. After that period,
when such an employee retires, he is to be treated as a former employee and
payments made to him as former employee again ought to be deductible within the
permissible limit. The Court was of the view that any other construction of
such section under which such an employee is treated only as "an
employee" or as a "former employee" in the year in question
would render one part or the other of the section nugatory. The Court rejected
the submission on behalf of the Revenue that the status of the employee as on
the last date of the previous year should be taken into consideration for the
purpose of fixing the limit of deductions. The Court said if this contention
was to be accepted then the salary paid to the employee while he was in
employment cannot be taken into account in determining the ceiling of allowable
deduction under Section 40A (5). The Court referred to Section 40A (5)(a) and
noted that the first proviso thereunder provided a ceiling of Rs. 72,000/- on
the permissible deduction or of expenditure or allowances consisting of the
aggregate of four different types of expenses and allowances mentioned thereunder.
Similarly, under Section 40A (6) where any expenditure was incurred by an assessee
on payment of fees as well as on payment of salary to that employee, the
deduction in respect of such expenditure was limited to Rs. 60,000/- in the
aggregate. The Court noted that wherever the legislature had intended to limit
the expenditure taking the different contingencies into account it has made the
appropriate provision by prescribing an aggregate ceiling.
Section
40A (5) (a), (i) read with Section 40A(5) (c) (i) of the Act did not refer to
any aggregate amount of deduction although two different contingencies were
provided therein. The Court was also of the view that if the contrary
interpretation were accepted, the employer would defer the payment of the
gratuity or any other sum payable to an employee on his employment to the
subsequent accounting year to get out of the mischief of the ceiling prescribed
under Section 40A (5) (c) (i) of the Act. This could not have been the
intention of the legislature. Finally, it was held that if a provision of a
taxing statute was reasonably capable of more than one interpretation, that
interpretation which was favourable and beneficial to the assessee must be
accepted, even if it results in his obtaining a double advantage.
The
Bombay High Court disagreed with the reasoning. It relied on the definition of
"salary" in Section 17 which included pension, gratuity and other retiral
benefits. It has also noted that under Section 45A (c) (i) the expression
"employee" comes within the definition of expression "former
employee". It held that the status of an "employee" on the last
date of the relevant previous year would have to be seen for fixing the limit
of deduction. It held that there were no separate limits prescribed by Section
40A (5). There was only one limit in respect of the "salary" and,
therefore, the object was to limit the deduction of expenditure on account of
"salary" and that limit was the single one of Rs. 60,000/- Learned
counsel appearing on behalf of the appellant has urged that the view expressed
by the Calcutta High Court in be accepted. As far as the respondents are
concerned, they have reiterated the reasoning of the Bombay High Court and have
submitted in addition that the word "and" in Section 40 A(5) (c) (i)
should be read disjunctively as "or". Several decisions have been
cited in support of this principle of interpretation.
We are
of the opinion that the opinion expressed by the Bombay High Court is correct.
The intention of the Legislature was to fix limits of deduction under the
various clauses of sub section (5) of Section 40A. If the view accepted by the
Calcutta High Court were to be accepted the fixation would be meaningless as
the limits would vary depending on the date on which an employee may retire.
According to the Calcutta High Court's view if an employee serves for 12
months, and retires on the last day of the previous year, the employer would be
entitled to claim a deduction of Rs.60,000/- on account of salary paid to an
employee while in service and another limit of Rs.60,000/- on account of
'salary' paid to the employee on retirement. In other words, the employer would
be entitled to a deduction of two different amounts.
Yet Clause
(c) (ii) of sub section (5) of Section 40A speaks of "an amount".
This would indicate that the employer is only entitled to deduction of one
amount. Clause (c)(i) also speaks of an employee as being not only one who has
ceased to be in employment, but one who ceases to be in employment. In respect
of the latter it is assumed that the employee served for a period but ceases to
be so employed during the previous year in question. In such a case, the
section expressly provides for a limit on the deduction of Rs.60,000/-
Explanation (2)(a) in sub section (5) of Section 40 A provides:
"Explanation
2. In this sub-
section,-
-
"Salary"
has the meaning assigned to it in clause (1) read with clause (3) of section 17
subject to the following modifications, namely:-
-
in the said
clause (1), the word "perquisites" occurring in sub-clause (iv) and
the whole of sub-clause (vii) shall be omitted;
-
in the said
clause
-
the references
to "assessee" shall be construed as references to "employee or
former employee" and the references to "his employer or former
employer" and "an employer or a former employer" shall be
construed as references to the assessee".
Section
17 as it then stood defined 'salary' as:
-
wages;
-
any annuity or
pension;
-
any gratuity;
-
any fees, commission,
perquisites or profits in lieu of or in addition to any salary or wages;
-
any advance of
salary;
-
the annual
accretion to the balance at the credit of an employee participating in a
recognized provident fund, to the extent to which it is chargeable to tax under
rule 6 of Part A of the Fourth Schedule of an employee participating in a
recognized provident fund, to the extent to which it is chargeable to tax under
sub-rule (4) thereof".
In
terms of this there is only one limit for all salary whatever it may be
comprised of whether wages or terminal benefits.
Reliance
on the use of the word "aggregate" in the first provisos to Section 40A(5)(a)
and in Section 40A(6) was inapt.
Both
the proviso and sub section (6) deal with different kinds of payment or
expenditure which therefore necessitated the use of the word
"aggregate". Thus the first proviso refers to:
-
" the
expenditure and allowance referred to in sub- clauses (i) and (ii) of this
clause; and
-
the expenditure
and allowance referred to in sub- clauses (i) and (ii) of clause (c) of section
40".
Similarly
sub section (6) refers to
-
" such
expenditure by way of fees, or
-
where the assessee
has also incurred in relation to such person any expenditure by way of salary
referred to in sub-clause (i) of clause (a) of sub-section (5), the aggregate
of such expenditure by way of fees and by way of salary".
Sub
section (5)(c) on the other hand as we have seen speaks of an
"amount" and "salary" indicating a single deduction where
the use of the word "aggregate" was uncalled for.
We
would therefore affirm the answer given in the impugned judgment to the second
question in favour of the revenue and hold that only one limit is prescribed
for deduction on account of salary whether paid to an employee in service or a
retired employee in any one previous year.
The
appeal is accordingly partially allowed. No order as to costs.
Civil
Appeal No. 311 of 2001 This appeal is partially allowed without any order as to
costs in view of our judgment in Civil Appeal No.310 of 2001.
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