Karnataka High Court
The Commissioner Of Income Tax vs The Margarine And Refined Oils Company ... on 7 February, 2006
Equivalent citations: (2006)202CTR(KAR)376, ILR2006KAR1436, [2006]282ITR576(KAR), [2006]282ITR576(KARN)
Author: N. Kumar
Bench: P. Vishwanatha Shetty, N. Kumar
JUDGMENT N. Kumar, J.
1. This reference ari ses under Section 256(1) of the Income Tax Act (for short hereinafter referred to as the Act) at the instance of the revenue for our opinion on the following question of law.
Whether on the facts and in the circumstances of the case, the Income Tax Appellate Tribunal is right in law in upholding the order of the CIT(A) allowing the claim of the assessee for deduction of expenditure including retrenchment compensation paid to the employees of the manufacturing unit?
2. The few facts leading to these proceedings are as under:
The assessee is engaged in the manufacture of refined oil and trading in various commodities. From the assessment year 1981-82 the assessee ceased its manufacturing activity but continued the trading activity in various commodities. The assessee paid retrenchment compensation to the employees who were employed in the manufacturing unit on their termination of service. The assessee claimed deduction of the amount incurred by way of retrenchment compensation. The assessment officer disallowed the said claim on the ground that the business had been stopped. The First Appellate Authority accepted the contention of the assessee that only the manufacturing activity had been discontinued and business of trading activity in various commodities continued. Therefore allowed the deductions sought by the assessee. The revenue preferred second appeal to the Tribunal. The Tribunal held that though the manufacturing activity had ceased, trading continued and the assessee had also leased out the manufacturing unit and was receiving the income therefrom and therefore it cannot be said that the business activity of the assessee had come to a close as a whole. In fact, it took note of the fact that in the subsequent years the assessment officer has himself allowed the claim of the assessee, They also looked into the books of profit and loss account and balance sheet for the assessment years 1981-82, 1982-83, 1984-85 which showed that the assessee had not stopped the entire business. Therefore, it was held that though the assessee had stopped the manufacturing activity, he had not stopped the business and therefore he was entitled to the deduction of expenditure which was paid by way of retrenchment compensation. Aggrieved by these two orders the revenue has sought this reference.
3. Learned Counsel appearing for the revenue submitted that the material on record shows that the manufacturing activity was closed and the entire manufacturing unit was admittedly leased out for rent and therefore when once the business is closed, the assessee is not entitled to deduction under Section 37(1) of the Act. Learned Counsel appearing for the respondent assessee sought to support the impugned orders.
4. Therefore, the short question that arise for consideration is, whether in the facts and circumstances of the case, can it be said that the assessee had closed the business of manufacturing activity and is not continuing trading business, so as to disentitle himself from the deductions under Section 37(1) of the Act?
5. The law on the point is fairly well settled, The Supreme Court in the case of B.R. Ltd. v. V.P. Gupta, Commissioner of Income Tax, Bombay 113 ITR 647 in some what similar situation where the assessee was carrying on import business, who after closure of the same, started export business and claimed deductions it was held, what is essence in such matters, is, whether there is a common management, a common business organisation, a common administration, a common fund and a common place of business which show interlacing and inter-dependence of the business carried on by the assessee which is the crucial factor. It was also noticed that the decisive test is unity of control and not the nature of the two lines of business and no decisive inference can be drawn from the fact that after the closure of one business, another may or may not conveniently be carried on.
6. Again the Supreme Court in the case of Sasson J. David and Co. P. Ltd. v. Commissioner of Income Tax, Bombay 118 ITR 261 dealing with retrenchment compensation itself held that when the company was neither dissolved nor was its business undertaking sold, it continued to exist as juristic entity, it cannot be said that the business is closed and payment of retrenchment compensation cannot be given deduction. Further, it was also observed that it is too late in the day now, whatever may have been the position about two decades ago, to treat the expenditure incurred by a management in paying reasonable sums by way of gratuity, bonus, retrenchment compensation or compensation for termination of service as not business expenditure. Such expenditure would ordinarily fall within the scope of Section 10(xv) of the Act which now corresponds to Section 37(1).
7. The Supreme Court in the case of Commissioner of Income Tax, Lucknow, v. Vikram Cotton Mills Ltd. 169 ITR 597 dealing with the income received by letting out the mills on lease held that the yield of income by a commercial asset was the profit of the business irrespective of the manner in which that asset was exploited by the owner of the business and he was entitled to exploit it to the best advantage and he might do so either by using it himself personally or by letting it out to somebody else. It was pointed out that the view that in order to constitute business income, the commercial asset must at the time it was let out be in a condition to be used as a commercial asset by the assessee himself was not correct. Further it was held that it was a part of the normal activities of the assessee's business to earn money by making use of its machinery by either employing it in its own manufacturing concern or temporarily letting it to others for making profit for that business when for the time being it could not itself run it Further it was held that the yield of income by a commercial asset irrespective of the manner in which the assets are exploited by the owner of the business would be income from business. It was emphasised that the assessee was entitled to exploit it to the best advantage and he might do so either by using it himself personally or by letting it out to somebody else.
8. Therefore it is clear, to be eligible for deductions under Section 37(1) of the Act, the expenditure should be laid down or expended wholly and exclusively for the purpose of business or profession. The expenditure incurred by the management in paying retrenchment compensation for termination of service is a business expenditure, provided, the employer continues to carry on the business after such retrenchment. However, if the retrenchment is done consequent to closure to business, then, the amount paid towards retrenchment compensation cannot be claimed a business expenditure, as on the date the retrenchment compensation is paid the assessee is not carrying on any business. But, if the assessee continues to carry on business and if one line business is stopped resulting in retrenchment of workman necessitating payment of compensation to them, the said amount paid towards compensation constitutes business expenditure. When the company or the firm continued to exist as juristic entity and carries on business, merely because one line of business is stopped it does not amount to closure of business. The decisive test is unity of control and not the nature of the two lines of business. The essence of such matters is whether there is a common management, a common business organisation, a common administration a common fund and a common place of business which show interlacing and inter dependence of the business carried on by the assessee. If after stoppage of one line of business, if that business is leased as commercial asset and it yields income even by way of rent, in essence it is profit earned by the assessee from the commercial asset. An assessee can carry on business personally by using commercial asset or he may do so by letting out to somebody else and the income by way of rent would constitute the business income. The yield of income by a commercial asset irrespective of the manner in which the assets are exploited by the owner of the business would be income from business. Therefore in such circumstances the amount of retrenchment compensation paid would be an expenditure expended wholly and exclusively for the purpose of business and the said expenditure shall be allowed to be deducted in computing the income chargeable under the head "Profits and gains of business or profession" under Section 37(1) of the Act.
9. In the instant case, the material on record and the finding recorded by the authorities clearly show that the assessee was carrying on two lines of business i.e., manufacturing and trading and he has stopped the manufacturing activity temporarily as a consequence of which he has retrenched all the employees who were employed in the manufacturing unit by paying retrenchment compensation. The said manufacturing unit which was a capital asset of the business was leased out to a lessee carrying on the very same business out of which he is deriving income by way of rent. The said rental income is income from business. The assessee has not closed its business activity. It is being continued even after closure of the manufacturing activity. Under the circumstances, the First Appellate Authority and the Tribunal were fully justified in allowing the deduction of the retrenchment compensation paid by the assessee as the expenses incurred in the course of the business. In that view of the matter, the question of law is answered in the affirmative in favour of the assessee and against the revenue.
In the aforesaid terms the reference is disposed of.