Gujarat High Court
Gujarat Steel Tubes Ltd. vs Commissioner Of Income-Tax on 19 October, 1993
Author: M.B. Shah
Bench: J.M. Panchal, M.B. Shah
JUDGMENT M.B. Shah, J.
1. The assessee is a public limited company engaged in the business of manufacture of and dealing in galvanised pipes. For the assessment year 1975-76, it claimed certain deductions. The disputed deduction are as under :
(a) The company claimed deduction of Rs. 21,85,104 being the amount of the company's liability for surtax for the assessment year.
(b) The company had reimbursed to its two managing directors, Shri Shantilal Mangaldas and Apporva Shantilal, medical expenses to the tune of Rs. 20,695 and Rs. 4,311.
(c) It paid Rs. 5,00,500 to the Gujarat Steel Tubes Employees' Welfare Fund.
(d) The company claimed allowance in respect of the expenditure of Rs. 24,125 incurred for the issue of bonus shares as revenue expenditure.
(e) It also claimed deduction for Rs. 90,000 under section 37 as it paid the premium of Rs. 45,000 on the lives of each of the two directors for purchase of deferred annuity.
2. Out of the aforesaid claims, certain claims made by the company were not allowed and certain claims were allowed finally by the Income-tax Appellate Tribunal.
3. Being aggrieved and dissatisfied by the said order passed by the Tribunal, the assessee as well as the Revenue filed applications for making reference to this court. On the basis of the said applications, at the instance of the assessee and the Revenue, the Income-tax Appellate Tribunal has referred the question for our opinion under section 256 of the Income-tax Act.
Re. Question No. 1 :
4. The question referred is as under :
"Whether the surtax liability of Rs. 21,85,104 is deductible in computing the total income of the assessee?"
5. This question is concluded by the decision of this court in the case of S. L. M. Maneklal Industries Ltd. v. CIT (1988) 172 ITR 176, where it is held that surtax stands on the same footing as income-tax inasmuch as it is also a tax on the total income computed under the Income-tax Act after its adjusted under the Companies Profits (Surtax) Act, 1964. Therefore, surtax is not an expenditure laid out wholly and exclusively for the purpose of business and is not an allowable deduction under section 37 of the Income-tax Act. Hence, question No. 1 is answered in favour of the Revenue and against the assessee.
Re : Question No. 2 :
6. The question is as under :
"Whether reimbursement of medical expense of Rs. 20,695 and Rs. 4,311 incurred by the directors can be said to be provision of benefit or amenity to a director within the meaning of section 40(c)(i) of the Income-tax Act, 1961?"
7. This question pertains to reimbursement of medical expenses. The Income-tax Officer disallowed the said claim by holding that it is covered by the definition of "perquisite". The aforesaid view of the Income-tax Officer was reversed by the Appellate Assistant Commissioner by referring to the Departmental Circular No. 33 of 1955, dated August 1, 1955. The Tribunal set aside the said order by holding that under the circular the value of amenities of ordinary medical facilities and the reimbursement of such medical expenses of the employee cannot be included in the total income of the employee, but the circular does not help the assessee in support of its contention that reimbursement of medical expenses could not be treated as a perquisite. Mr. Soparkar, learned counsel for the assessee, for this purpose, relied upon the decision of this court in the case of CIT v. New India Industries Ltd (1993) 201 ITR 208.
7. For appreciating the contention, it would be necessary to refer to the relevant portion of section 40(c) as it stood at the relevant time which reads as under :
"40. Notwithstanding anything to the contrary in sections 30 to 39, the following amounts shall not be deducted in computing the income chargeable under the head 'Profit and gains of business or profession',-....
(c) in the case of any company -
(f) any expenditure which results directly or indirectly in the provision of any remuneration or benefit or amenity to a director or to a person who has a substantial interest in the company or to a relative of the director or of such person, as the case may be,
(ii) any expenditure or allowance in respect of any of the company used by any person referred to in sub-clause (i) either wholly or partly for his own purpose or benefit, if in the opinion of the Income-tax Officer any such expenditure or allowance as is mentioned in sub-clauses (i) and (ii) is excessive or unreasonable having regard to the legitimate business needs of the company and the benefit derived by or accruing to it therefrom, so, however, that the deduction in respect of the aggregate of such expenditure and allowance in respect of any one person referred to in sub-clause (i) shall, in no case, exceed -
(A) where such expenditure or allowance relates to a period exceeding eleven months comprised in the previous year, the amount of seventy-two thousand rupees;
(B) where such expenditure or allowance relates to a period not exceeding eleven months comprised in the previous year, an amount calculated at the rate of six thousand rupees for each month or part thereof comprised in that period."
8. We are required to consider the case of the assessee under the provisions of section 40(c)(i) which, inter alia, provides that in the case of any company any expenditure which results directly or indirectly in the provision of any remuneration or amenity to a director or to a person who has a substantial interest interest in the company or to a relative of the aggregate of such expenditure and allowance in respect of any one person exceeds Rs. 72,000 per year. Hence, this section prescribes the ceiling of Rs. 72,000 for the permissible deduction of the expenditure incurred by the company which results directly or indirectly in the provision of "any remuneration, benefit or amenity" to a director. The phrase "any remuneration, benefit or amenity" is of wide amplitude and it covers benefit or amenity in cash or in kind. So any expenditure beyond the ceiling of Rs. 72,000 would not be allowable expenditure. The sub-clause (i) also empowers the Income-tax Officer to determine whether any such expenditure or allowance as is mentioned in the said clause was excessive or unreasonable having regard to the legitimate business needs of the company and the benefits derived by or accruing to it therefrom. In the present case, we are not concerned with this aspect because admittedly the Income-tax Officer has disallowed the expenditure beyond the ceiling, i.e., Rs. 72,000. Hence, in view of the clear language of sub-clause (i), cash medical reimbursement would be covered by sub-clause (i) of section 40(c). Admittedly, the Income-tax Officer has worked out the total benefits on the basis of sub-clause (i) of section 40(c). For this, there is no dispute.
9. In the case of CIT v. New India Industries Ltd. [1993] 201 ITR 208, this court dealt with the disallowance under section 40(a)(v) which was equivalent to section 40(c)(ii) which stands deleted. The court was not required to deal with the question involved in this matter or sub-clause (i) of section 40(c). The court dealt with section 40(c)(iii) wherein the language used by the Legislature was totally different and by comparing and contrasting the language used in sub-clause (iii) and sub-clause (i) of section 40(c), the court has interpreted sub-clause (iii). In that sub-clause (iii), the Legislature had omitted the word "remuneration" and, therefore, the court held that the Legislature did not intend to include cash emoluments in any of the words "benefit", "amenity" or "perquisite". The court also held that the Legislature had added the words "whether convertible into money or not". With regard to sub-clause (i) of section 40(c) the case is different. This would be clear from the following observations made by the court (at page 219) :
"It may be noted that, in the amendment which was effected by the amendment of Finance Act, 1964, the word 'remuneration' was dropped from the relevant phrase giving an indication that the Legislature did not intend to include cash emoluments in any of the words 'benefit, amenity and perquisite'. Secondly, by the said amendment of 1964, the Legislature also added the words 'whether convertible into money or not'. Thirdly, it is also pertinent to note that in sub-clause (i) of the said clause (c) of section 40, the word 'remuneration' was retained along with the other words 'benefit or amenity' even after the aforesaid amendment of sub-clause (iii). This has also manifested that the Legislature was conscious of the distinction between the relevant words and keeping in mind the said distinction between the relevant words and keeping in mind the said distinction, the Legislature has deliberately chosen to delete the expression 'remuneration' from sub-clause (iii)."
10. From the aforesaid observations, it is apparent that the court has not interpreted the phrase "remuneration, benefit or amenity" used in sub-clause (i). On the contrary, applying the reasoning adopted by the court for interpreting sub-clause (iii) in the context of sub-clause (i), it would be clear that sub-clause (i) is very wide. It includes remuneration, benefit or amenity given either in cash or kind.
11. Further, the Tribunal rightly held that the Appellate Assistant Commissioner has erroneously applied Circular No. 33 of 1955, dated August 1, 1955. It is applicable only in the case of an assessee who is the recipient of money for the purpose of computing his income from salary. It is not applicable to the assessee-company which pays the amount by way of medical reimbursement.
12. It is, therefore, required to be held that reimbursement of medical expenses of Rs. 20,695 and Rs. 4,311 incurred by the directors is a benefit to a director within the meaning of section 40(c)(i) of the Income-tax Act. Hence question No. 2 is answered in the affirmative, in favour of the Revenue and against the assessee.
Re : Question No. 3 :
13. The question is as under :
"Whether the sum of Rs. 5 lakhs said to have been paid by the assessee to the Gujarat Steel Tubes Employees' Welfare Fund was rightly disallowed ?"
14. It is the contention of the assessee-company that on January 7, 1975, for constituting a fund known as the "Gujarat Steel Tubes Employees' Welfare Fund" for the benefit of the employees of the company, an irrevocable deed of trust was executed to promote contentment and to ensure continuance of cordial relations between the company and its employees. For this purpose, the board of directors of the company had passed a resolution on December 10, 1974, and the company had transferred a sum of Rs. 500 as the initial contribution to the fund. As per the rules framed the trustees were empowered to utilise the moneys of the fund for making payment to the employee in certain circumstances such as payment of lump sum amount to the heirs of a deceased employee who dies during his service, paying scholarships and providing fees, books and other educational aids to the members of the families, reimbursement of medical expenses incurred by an employee for any serious illness of himself or members of his family, providing subside to employee's co-operative consumer or credit societies for the benefit of the company's employees and their families and for running or subsidising the running of cheap grain and provision shops for the benefit of the employee and their families. It is the contention of the company that on the basis of a resolution passed by the board of directors in the meeting held on March 25, 1975, the said amount was credited in the Gujarat Steel Tubes Employees' Welfare Fund by an entry dated March 25, 1975. On the same day, in the company's books of account it was debited to other welfare expenses. The Income-tax Officer rejected the claim of the company for the deduction of the said amount by holding that the actual payment has not been done during the period from April 1, 1974, to March 31, 1975. The actual payment to the fund has been made as under :
Rs.
500 on June 2, 1975 5,00,000 on June 17, 1975.
18. He further held that the trust was not registered under the Public Trusts Act, not any application had been made to the Commissioner of Income-tax for recognition under section 80G of the Act. He also held that for the relevant period at the most it can be said that the said amount was a mere provision as no actual payments were made. He further observed that there is not statutory obligation on the part of the company to make any payment to such type of funds. Therefore, he disallowed the claim for deducting Rs. 5 lakhs and Rs. 500 the Appellate Assistant Commissioner set aside the order passed by the Income-tax Officer by holding that the mere fact that the actual payment were made after the close of accounting year relevant to the assessment year 1975-76 would not make any difference to the legal position because the books of account of the company were kept according to the mercantile system and both the amounts were credited in the account of the Gujarat Steel Tubes Employee's Welfare Fund before the end of the relevant accounting year and the assessee-company became legally liable on the date on which the entries were made to pay three amounts to the trustees of the fund. The Appellate Assistant Commissioner further held that the expenditure was revenue expenditure. He, therefore, directed the Income-tax Officer to allow deduction of Rs. 5 lakhs under section 37 of the Act. The Tribunal reversed the said finding by holding that merely by debiting the sum of Rs. 5 lakhs to the account of the company on March 26, 1975, it cannot be held that the amount is paid to the trust because it was open to the company to make a debit entry which would wipe out the effect of the credit entry which was not made pursuant to any resolution. The Tribunal observed that only Rs. 14,376.17 were paid by the assessee-company to the Gujarat Steel Tubes Employee's Welfare Fund on March 31, 1975. The Tribunal relied upon the decision of the Supreme Court in the case of Indian Molasses Co. (P.) Ltd. v. CIT [1959] 37 ITR 66.
19. In order to decide this question, it would be necessary to refer to undisputed facts. It is admitted that the board of directors of the assessee-company decided by its resolution dated December 10, 1974, to set up a trust for the welfare of its employees. On January 6, 1975, Rs. 500 were set apart by posting an entry providing the initial corpus of the trust. On January 7, 1975, the trust deed was executed. Thereafter, on March 25, 1975, the board of directors of the company passed a resolution to contribute Rs. 5 lakhs towards the fun of the trust. On March 26, 1975, as stated earlier, two entries were posted in the accounts of the company. By the first entry Rs. 5 lakhs were credited in the account of the Gujarat Steel Tubes Employee's Welfare Fund and simultaneously a debit entry was posted for the said sum showing it as expenses for staff welfare fund. It is also mentioned that this entry was posted in pursuance of the resolution on March 26, 1975, passed by the board of directors of the company. It is also disputed that the company is maintaining accounts as per the "mercantile" method of accounting.
20. From the aforesaid facts, Mr. Soparkar, learned counsel for the assessee, vehemently submitted that the Tribunal ought to have held that the amount of Rs. 5 lakhs was paid to the trust on March 26, 1975, and in any case it ought to have held that the said amount was laid out at least on that date. He further submitted that as the assessee-company is maintaining accounts as per the mercantile method of accounting which would mean that when it had posted the credit entry in favour of the trust, that amount is paid to the trust even though actual payment is made by cheque only on June 17, 1975. He, therefore, submitted that the Tribunal erroneously relied upon the decision of the Supreme Court in the case of Indian Molasses Co. [1959] 37 ITR 66.
21. In the case of Indian Molasses Co. [1959] 37 ITR 66 (SC), the assessee-company had executed a trust deed in favour of three trustees to whom the company paid a sum of $8,208-19-0 (Rs. 1,09,643) and further undertook to pay annually Rs. 4,364 for six consecutive years, and the trustees agreed to execute a declaration of trust. The trustees undertook to hold that said sums upon trust to spend the same in taking out a deferred annuity policy with the Norwich Union Life Insurance Society in the name of the trustees but on the life of the managing director of the assessee-company (Mr. John Bruce Richard Harvey) under which $270 per annum were payable to Harvey for life from the date of his superannuation. It also provided for taking out by the trustees of a deferred longest life policy, with the said insurance company, in their names, but in favour of Harvey and Mrs. Harvey. After considering the various decisions, the court laid down various tests for determining whether the expenditure is of revenue nature or of capital nature. The relevant part is as under (at page 75) :
"From these cases, there are deducible certain principles of a fundamental character. The first is that capital expenditure cannot be attributed to revenue and vice versa. Secondly, it is equally clear that a payment in a lump sum does not necessarily make the payment a capital one. It may still possess revenue character in the same way as a series of payments. Thirdly, if there is a lump sum payment but there is no possibility of a recurrence, it is probably of a capital nature, though this is by no means a decisive test. Fourthly, if the payment of a lump sum it may generally by regarded as payment of a revenue character (Anglo-Persian Oil Co. Ltd. v. Dale [1932] 1 KB 124; [1931] 16 TC 253 (CA)), and lastly, if the ownership of the money whether in point of fact or by a resulting trust be still in the taxpayer, then there is acquisition of a capital asset and not an expenditure of a revenue character.
Side by side with these principles, there are others which are also fundamental. The Income-tax law does not allow as expenses all the deductions a prudent trader would make in computing his profit. The money may be expended on grounds of commercial expediency but not of necessity. The test of necessity is whether the intention was to earn trading receipts or to avoid future recurring payments of a revenue character. Expenditure in this sense is equal to disbursement which, to use a homely phrase, means something which comes out of the trader's pocket. Thus, in finding out what profits there be, the normal accountancy practice may be to allow as expense any sum in respect of liabilities which have accrued over the accounting period and to deduct such sums from profits. But the income-tax laws do not take every such allowance as legitimate for purposes of tax. A distinction is made between an actual liability in praesenti and a liability de futuro which, for the time being, is only contingent. The former is deductible but not the latter. The case which illustrates this distinction is Peter Merchant Ltd. v. Stedeford [1948] 30 TC 496 (CA). No doubt, that case was decided under the system of income-tax laws prevalent in England, but the distinction is real. What a prudent trader sets apart to meet a liability, not actually present but only contingent, cannot bear the character of expense till the liability becomes real."
22. After considering the decision in the case of Southern Railway of Peru Ltd. v. Owen [1957] 32 ITR 737 (HL), the court observed that if the pension itself be not payable as an obligation, and if there be a possibility that no such payment may be necessary in the future, the whole of the amount cannot be deducted but only the present value of the future liability, if it can be estimated. The court thereafter considered the meaning of the word "expenditure" and observed that "expenditure" is thus what is "paid out or away" and is something which is gone irretrievably. In that context, the court examined the provision of the trust deed and posed the question "was the money spent in so far as the assessee company was concerned ?" The court held that at the relevant time Harvey was alive and it was not known if any pension to him would be payable at all. Harvey might not have lived to be 55 years. He might even have abandoned his service or might have been dismissed. Till September 20, 1955, the assessee-company had dominion through the grantees over the premia paid, at least in two circumstances. They are to be found in the special provision, and the third clause of the second schedule of the policy. Thereafter the court held that to be a payment which is made irrevocably, there should be no possibility of the money forming, once again, a part of the funds of the assessee-company. If this condition is not fulfilled and there is a possibility of there being a resulting trust in favour of the company, then the money has not been spent, i.e., paid out or away, but the amount must be treated as set apart to meet a contingency.
23. Applying the ratio of the aforesaid judgment, it would be clear that if the amount is paid irrevocably in a sense that there is no possibility of the money forming a part of the funds of the company, then it would be considered to be money spent or expended. In the present case, it is not the case of the Department that there was any clause or any provision in the trust deed which empowered the company to get back the said amount at any point of time. Quoting the words of the Supreme Court, "if the ownership of the money whether in point of fact or by a resulting trust be still in the taxpayer, then there is acquisition of a capital asset and not an expenditure of a revenue character". Irrevocable trust is executed by the company in favour of the trustees and on the basis of the resolution passed by the board of directors on March 25, 1975, the sum of Rs. 5 lakhs is set apart by posting a credit entry in favour of the trust on March 26, 1975. The assessee-company was not entitled to get back the said sum donated to the trust. Hence, in our view, the Tribunal erred in relying upon the aforesaid decision for negating the claim for deduction by holding that merely because an entry was made in the books of account of the assessee, it could not be said that money was paid out or paid away.
24. Further, it would be difficult to say that it was mere posting of an entry and, therefore, there was no payment. In the mercantile system of accounting it is well-established that posting of such type of entries brings into credit what is due immediately. This method of accounting is explained in various decisions of the Supreme Court.
25. In the case of Keshav Mills Ltd. v. CIT [1953] 23 ITR 230 (SC), the court has held as under (at page 239) :
"The mercantile system of accounting or what is otherwise known as the double entry system is opposed to the cash system of book keeping under which a record is kept of actual cash receipts and actual cash payments, entries being made only when money is actually collected or disbursed. That system brings into credit what is due, immediately it becomes legally due and before it is actually received and it brings into debit expenditure the amount for which a legal liability has been incurred before it is actually disbursed. The profits or gains of the business which are thus credited are not realised but having been earned are treated as received though in fact there is nothing more than an accrual or arising of the profits at that stage. They are book profits. Receipt being not the sole test of chargeability and profits and gains that have accrued or arisen or are deemed to have accrued or arisen being also liable to be charged to income-tax the assessability of these profits which are thus credited in the books of account arises not because they are received but because they have accrued or arisen."
26. The aforesaid principle is relied upon by the Supreme Court in the case of Calcutta Co. Ltd. v. CIT [1959] 37 ITR 1. This aspect is also considered by the Supreme Court in the case of Metal Box Co. of India Ltd. v. Their Workmen [1969] 73 ITR 53. In that case the court held that in the case of an assessee maintaining his accounts on the mercantile system, a liability already accrued, though to be discharged at a future date, would be a proper deduction while working out the profits and gains of his business regard being had to the accepted principles of commercial practice and accountancy and that it was not as if such deduction was permissible only in case the amounts are actually expended or paid. The court further observed (at page 63 of 73 ITR) :
"Just as receipts, though not actual receipts but accrued due are brought in for income-tax assessment, so also liabilities accrued due would be taken into account while working out the profits and gains of the business."
27. The definition of the word "paid" given in section 43(2) of the Act incorporates the aforesaid principle. It is as under :
"'paid' means actually paid or incurred according to the method of accounting upon the basis of which the profits or gains are computed under the head 'Profits and gains of business or profession';"
28. Therefore, the word "paid" would cover cases where liabilities are incurred according to the method of accounting even though actually the amount is not paid. Hence, it can be held that in the present case according to the method of accounting followed by the assessee-company by posting a credit entry in favour of the trust and by posting a corresponding debit entry, it would mean that it has paid the amount to the trust on March 26, 1975, even though actually the amount is paid on June 17, 1975.
29. In the result, the Tribunal erroneously held that the amount of Rs. 5 lakhs was not deductible under section 37 of the Income-tax Act because the said amount was not paid by the assessee-company to the trust during the relevant assessment year. The claim for deduction of the sum of Rs. 5 lakhs paid by the assessee to the Gujarat Steel Tubes Employees' Welfare Fund ought to have been allowed even though the actual amount is paid on June 17, 1975, i.e., in the next assessment year. Therefore, the question is answered in the negative, in favour of the assessee and against the Revenue. Re : Question No. 4 :
30. The question is as under :
"Whether the expenditure of Rs. 24,125 incurred for the issue of bonus shares is allowable as revenue expenditure?"
31. The question with regard to expenditure incurred for the issue of bonus shares is also covered by the decision of this court in the case of Ahmedabad Mfg. and Calico Pvt. Ltd. v. CIT [1986] 162 ITR 800 wherein the court has held that expenses incurred in connection with the issue of bonus shares are incurred by the company for its permanent structure and is directly connected with the acquisition of capital and advantages of an enduring nature. It is not allowable as revenue expenditure. Therefore, this question is answered in favour of the Revenue and against the assessee.
Re : Questions Nos. 5 and 6 :
32. The questions are as under :
"5. Whether, on the facts and in the circumstances of the case, the premium of Rs. 45,000 in respect of the purchase of deferred annuity on the lives of each of the two directors was not includible in the total income in view of the provisions of section 40(c) of the Act ? 6. Whether, on the facts and in the circumstances of the case, the amount of Rs. 90,000 being the premium paid in respect of the purchase of deferred annuity on the lives of the two directors of the assessee-company is allowable under section 37 of the Income-tax Act, 1961?"
33. These questions are inter-connected. They pertain to the amount of premium paid in respect of purchase of deferred annuity on the lives of the two directors of the assessee-company. For deciding the said questions it would be necessary to refer to the averments made by the assessee-company. For our perusal, Mr. Soparkar, learned counsel for the assessee-company, has produced a resolution dated March 7, 1974, passed by the board of directors. As per the said resolution, the company had decided to take a single premium policy for the two managing directors by paying premium limited to a sum calculated at the rate of one per cent. of the net profit subject to a maximum of Rs. 45,000. On March 25, 1975, a similar resolution was also passed by the board of directors. It is as under :
"RESOLVED THAT the company do effect a single premium deferred annuity policy in respect of each Shri Shantilal Mangaldas and Shri Apoorva Shantilal Shah for the financial year 1974-75. The policies shall be the property of the company during the deferment period and neither the managing director nor dependants shall be entitled to any benefit or any right, lien or interest until the date of the first payment of the annuity."
34. On the basis of the said resolution, the company had purchased deferred annuity policies by laying out the amount of Rs. 45,000 from the Life Insurance Corporation. It is averred by filing a written reply before the Income-tax Officer that -
"(a) this policy is the property of the company;
(b) the managing director concerned has no vested right or interest in the policy except a contingent interest;
(c) it is not a remuneration to the managing director;
(d) the managing director had no enforceable right against the company to commission (at the rate of one per cent. of the net profit) as soon as the contract for commission was varied and as no right in the policy had been created for the benefit of the managing director, there is no linking so as to regard the purchase of the policy as the outlay of commission;
(e) the company has also the right of cash option immediately before the annuity vests;
(f) it is a financial operation by which the company has provided itself with funds at a future date, should it desire then to make any retirement payment to the managing director; and
(g) the amounts which would be received by it, may constitute income at the stage but the amount laid out at present is clearly a business expenditure."
35. From the aforesaid facts, Mr. Thakore, learned counsel for the Department, vehemently submitted that it would be difficult to hold that the assessee-company has incurred any expenditure. It is his contention that the company has set apart its capital for paying an annuity to its managing director in future if it so desires at the relevant time. He further submitted that in any set of circumstances it cannot be said to be a revenue expenditure deductible under section 37 of the Income-tax Act. According to his contention, it would be capital expenditure. For this purpose, he heavily relied upon the passage which we have reproduced above from the case of Indian Molasses Co. [1959] 37 ITR 66 (SC). He submitted that in the present case, there is a lump sum payment by the assessee-company for the purchase of the annuity and that there is no possible recurrence and that the ownership of the money as contended by the assessee vests in the company. Therefore, it is the acquisition of a capital asset and not an expenditure of revenue nature.
36. In our view, the submission of learned counsel for the Revenue is well-founded. In the present case, it would be difficult to hold that the company has incurred revenue expenditure by purchase of the deferred annuity policy. This would be clear from the copy of the insurance policy which is produced for our perusal by learned counsel, Mr. Soparkar. As per the said policy, the proposer and annuitant is Messrs. Gujarat Steel Tubes Ltd. The policy is for deferred annuity without profits guaranteed for five years. In the column "To whom annuity payable" it is mentioned that it is payable to the proposer. On the same policy there is an endorsement to the effect that the policy can be surrendered by the person entitled to receive the annuity or death benefits, for cash at any time before the date on which the annuity vests and after the deferment period for an amount equal to 90 per cent. of the single premium mentioned in the schedule to the policy. This also would mean that the company would have complete control on the money for which the policy is taken by it. This is also borne out by the submission made by the assessee before the Income-tax Officer which we have quoted above. Further, nothing is pointed out on record to show that there was any binding contract between the managing directors and the company for payment of such amount. Nor is there any such statutory obligation.
37. From the aforesaid facts, it can be stated that -
(a) it is difficult to hold that the assessee had made any provision for "a liability already accrued". It was neither spent in fact nor incurred as debt at that time. It may be a prospective liability which may be satisfied at another point of time at the discretion of the assessee. There was an absolute discretion with the assessee-company to make payment to its managing directors after the specified period. In certain circumstances, it may or may not pay.
(b) As a matter of fact the ownership of the money (the deferred annuity policy) remains with the company.
(c) The amount invested by the assessee-company remains an integral part of its capital and, in any case, is not used for the working capital of the assessee-company.
(d) After the deferred annuity policy matures, the benefit is derived by the assessee-company - the benefit may be of secured payment for a particular time with interest or bonus. Hence, presuming that the assessee-company has expended the said amount by purchasing the deferred annuity policy, yet it amounts to acquisition of capital and has the advantage of enduring nature, may be after the lapse of five years or ten years as per the terms of the policy.
38. Therefore, it would be difficult to hold that the amount expended for purchase of the deferred annuity policy is revenue expenditure for which deduction can be granted under section 37 of the Income-tax Act.
39. Mr. Soparkar, learned counsel for the assessee, relied upon the decision of the Supreme Court in the case of Empire Jute Co. Ltd. v. CIT [1980] 124 ITR 1, for contending that the expenditure for purchase of the deferred annuity policy is of revenue nature. In our view, whether expenditure is of revenue nature or capital nature is required to be determined by considering all the relevant criteria. In that very judgment, the court has observed that the decided cases have, from time to time, evolved various tests for distinguishing between capital and revenue expenditure but no test is paramount or conclusive. Every case is to be decided on its own facts, keeping in mind the broad picture of the whole operation in respect of which the expenditure has been incurred. Thereafter, the court referred to the few tests formulated by the courts including that of Lord Cave L. C. in Atherton v. British Insulated and Helsby Cables Ltd. [1925] 10 TC 155, 192 (HL), where the learned Law Lord stated (at page 10 of 124 ITR) :
".. . . when an expenditure is made, not only once and for all, but with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade, I think that there is very good reason (in the absence of special circumstances leading to an opposite conclusion) for treating such an expenditure as properly attributable not to revenue but to capital."
40. Applying the aforesaid test in the present case, it is clear that the expenditure is made once and for all with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade; the amount so invested is to remain capital of the assessee till the particular time. The managing directors who may get the annuity as per the policy have admittedly no right till the company decides to pay it or till the particular date. It is for the enduring benefit of the company because it is contended by the assessee-company that the said policy insures the company for its future contingent payment. Hence, by applying the aforesaid test, it can be stated that the amount paid by the assessee for purchase of the deferred annuity policy is in the nature of capital expenditure and not revenue expenditure.
41. In that case, the court has also considered another test applied by Lord Haldane in the leading case of John Smith and Son v. Moore [1921] 72 TC 266, 282 (HL), where the learned Law Lord drew the distinction between fixed capital and circulating capital in words which have almost acquired the status of definition. He said (at page 11 of 124 ITR) "Fixed capital is what the owner turns to profit by keeping it in his own possession; circulating capital is what he makes profit of by parting with it and letting it change masters."
42. Applying the aforesaid test also in this case, it can be said that the assessee-company has circulated its capital by parting with it for purchasing the deferred annuity policy.
43. The court has considered a further test which is as under (at page 13 of 124 ITR) :
"The question must be viewed in the larger context of business necessity or expediency. If the outgoing expenditure is so related to the carrying on or the conduct of the business that it may be regarded as an integral part of the profit-earning process and not for acquisition of an asset or a right of a permanent character, the possession of which is a condition of the carrying on of the business, the expenditure may be regarded as revenue expenditure. See Bombay Steam Navigation Co. (1953) P. Ltd. v. CIT [1965] 56 ITR 52 (SC). The same test was formulated by Lord Clyde in Robert Addie and Sons' Collieries Ltd. v. IRC [1924] 8 TC 671, 676 (C. Sess.) in these words : 'Is it a part of the company's working expenses? - Is it expenditure laid out as part of the process of profit-earning ? - or, on the other hand, is it a capital outlay ? - Is it expenditure necessary for the acquisition of property or of rights of a permanent character, the possession of which is a condition of carrying on its trade at all ?'"
44. Applying the aforesaid test also in this case, it cannot be said that the outgoing or expenditure is related to the carrying on or the conduct of the business. Nothing is pointed out by the company that as per the contract with the managing directors such policies were required to be purchased for conducting the business. It cannot be said that it is part of the company's working expenses. On the contrary, it can be said that the capital is set apart by acquiring the deferred annuity policy.
45. Learned counsel Mr. Soparkar further relied upon the decision of the Supreme Court in the case of CIT v. Associated Cement Companies Ltd. [1988] 172 ITR 257. In that case, the company was the manufacturer of cement. On the basis of a tripartite agreement, a sum of Rs. 2,09,459 was spent for laying of the pipelines, installations and other accessories pertaining to the water supply, of which the municipality became the owner under the agreement, as it was agreed that the company was not to pay municipal rates and taxes for a period of 15 years. The Supreme Court held that the advantage which was secured by the assessee by making the expenditure in question was the securing of immunity from liability to pay municipal rates and taxes under normal conditions for a period of fifteen years. The liability to pay municipal rates and taxes would have been on revenue account and hence the advantage secured was in the field of revenue and not capital. In our view, the aforesaid decision would hardly advance the contention raised by learned counsel for the assessee in the present case. As contended by the assessee-company, the company had no obligation to purchase deferred annuity policies for the benefit of the managing directors. It is not pointed out by the assessee that for the work done by the managing directors or for their future work, the deferred annuity policies were required to be purchased. The managing directors were not having any right in the said policy till the specified period is over.
46. Learned counsel, Mr. Soparkar, next contended that it is for the assessee-company to decide as to whether expenditure should be incurred for purchase of deferred annuity policy in the course of its business and such expenditure can be incurred voluntarily and without any necessity and, if it is incurred for the purpose of promoting business and to earn profits, the assessee is entitled to deduction under section 37 of the Income-tax Act, even though there was no compelling necessity to incur such expenditure. For substantiating this contention, he relied upon the decision of the Supreme Court in the case of Sassoon J. David and Co. P. Ltd. v. CIT [1979] 118 ITR 261. In that case, the assessee-company was an investment company and its shares were originally held either directly or through their nominees by Sir Percival David, Lady David and Mr. V. P. David. Thereafter, an agreement was entered into between the Davids and Tata Sons Ltd. to sell 1,000 shares held by the Davids or their nominees in the company in favour of Tatas or their nominees for a sum of Rs. 155 lakhs. The said agreement, inter alia, provided that the sum voted by the company for payment of gratuities and/or as compensation for loss of employment to existing directors and employees of the company with respect to their services up to and inclusive of March 31, 1956, and a further amount of Rs. 16,188 payable to the managing director should be paid in accordance with the resolution by the company and the amount so paid should be deducted from the purchase price of Rs. 155 lakhs agreed upon. On the basis of the said agreement, in the books of account of the assessee, there was a debit for a total sum of Rs. 1,64,899 during the accounting year 1956. The assessee-company claimed deduction of the said amount under section 10(2)(xv) of the Indian Income-tax Act, 1922. The Income-tax Officer disallowed it. The Appellate Assistant Commissioner and the Tribunal dismissed the appeal filed by the assessee-company. On a reference, the High Court of Bombay held that the expenditure of the sums amounting to Rs. 1,27,511 paid to the employees and a director of the company by way of retrenchment compensation or compensation for termination of service had not been incurred by the company for commercial expediency and/or consideration. The High Court of Bombay, therefore, disallowed the claim made by the assessee-company to that extent. In the context of the aforesaid facts, the Supreme Court observed (at page 275) :
"Ordinarily, it is for the assessee to decide whether any expenditure should be incurred in the course of his or its business. Such expenditure may be incurred voluntarily and without any necessity and if it is incurred for promoting the business and to earn profits, the assessee can claim deduction under section 10(2) (xv) of the Act even though there was no compelling necessity to incur such expenditure."
47. In our view, the aforesaid observations of the Supreme Court would have no bearing in the present case, because, admittedly, the amount is not paid to the managing directors. The managing directors were not having any interest in the said amount, as contended by the assessee itself. We may at this stage notice that we are not required to discuss the motive behind the purchase of the deferred annuity policies, as it was sought to be contended by Mr. Thakore, learned counsel for the Revenue, and that the motive was only of circumventing the operation of section 40(c)(i) of the Income-tax Act. Still, however, we note that in that case itself the Supreme Court has referred to the following observations made by it in CIT v. Chandulal Keshavlal and Co. [1960] 38 ITR 601, 610 (SC) (at page 276 of 118 ITR) :
"Another fact that emerges from these cases is that if the expense is incurred for fostering the business of another only or was made by way of distribution of profits or was wholly gratuitous or for some improper or oblique purpose outside the course of business then the expense is not deductible. In deciding whether a payment of money is a deductible expenditure one has to take into consideration questions of commercial expediency and the principles of ordinary commercial trading. If the payment or expenditure is incurred for the purpose of the trade of the assessee it does not matter that the payment may ensure to the benefit of a third party (Usher Wiltshire Brewery Ltd. v. Bruce [1914] 6 TC 399 (HL)). Another test is whether the transaction is properly entered into as a part of the assessee's legitimate commercial undertaking in order to facilitate the carrying on of its business; and it is immaterial that a third party also benefits thereby (Eastern Investments Ltd. v. CIT [1951] SCR 594; 20 ITR 1 (SC)). But in every case, it is a question of fact whether the expenditure was expended wholly and exclusively for the purpose of the trade or business of the assessee."
48. In this view of the matter, in our view, the aforesaid judgment also would be of no assistance to the contention of the assessee that the amount expended by it for purchasing the deferred annuity policies should be allowed as expenditure under section 37 of the Income-tax Act.
49. Learned counsel, Mr. Soparkar, lastly relied upon the decision of the Bombay High Court in the case of CIT v. Tata Oil Mills Co. Ltd. [1990] 182 ITR 130 and contended that the amount spent by the assessee-company for purchase of deferred annuity policies on the lives of the directors should be allowed as expenditure under section 37. In our view, factually, the aforesaid submission is incorrect because as per the policy also, the proposer and annuitant is the assessee-company. The column "to whom the annuity is payable" specifically provides that it was payable to the proposer. Apart from this, in that case, the court considered the provisions of section 40A(5) of the Income-tax Act, 1961, in the context of the fact that the assessee-company had paid a sum of Rs. 53,749 to the Life Insurance Corporation of India for the purchase of deferred annuity policies upon the lives of its directors. In that context, the Tribunal held that the directors had no present right to the said sum and that it did not represent a present benefit or amenity to them, it being receivable only upon the termination of their services. Therefore, the provisions of section 40A(5) were not applicable. The court approved the said finding of the Tribunal by holding that the directors of the assessee-company had no present right to the said sum, which was provided for making payment under the contract between the assessee and the Life Insurance Corporation. Provision of the said sum did not represent any present benefit or amenity to the directors. The High Court of Bombay held that the judgment in the case of CIT v. L. W. Russel [1964] 53 ITR 91 (SC), squarely applied to that case before it. In L. W. Russel, the Supreme Court held that the expression similar to that set out above in the Indian Income-tax Act, 1922, applied only to sums in regard to which there was an obligation on the part of the employer to pay and a vested right on the part of the employee to claim; it could not apply to contingent payments to which the employee had no right until the contingency occurred. The employer's contributions towards the premia were not perquisites allowed to the employee by the employer or amounts due to him from the employer.
50. Applying the aforesaid test also, it can be said that there was no obligation on the part of the assessee to pay and there was no vested right in the directors to claim and in, future it was a contingent liability depending upon the desire of the company (as stated by it). Hence, it cannot be said that the said expenditure is allowable under section 37 of the Income-tax Act.
51. In view of the aforesaid discussion, question No. 6 is answered in the negative, i.e., in favour of the Revenue and against the assessee.
52. Question No. 5 would not require to be discussed in view of our finding that the amount of Rs. 90,000 being the premium paid in respect of the purchase of deferred annuity on the lives of the two directors of the assessee-company is not allowable under section 37 of the Income-tax Act. Once the provisions of section 37 are not applicable, there is no question of application of section 40(c). Hence, question No. 5 is not required to be answered and is left unanswered.
53. In the result, the reference stands disposed of accordingly with no order as to costs.