JUDGMENT
N.V. Balasubramanian, J.
1. This is a combined reference at the instance of the assessee as well as by the Revenue. Tax Cases Nos. 1816 and 1817 of 1984, are at the instance of the assessee and T.C. No. 1818 of 1984, is at the instance of the Revenue. The assessment year involved is common for both the tax cases, viz., 1977-78. The Appellate Tribunal has forwarded a consolidated statement of case and referred the following five questions of law for the opinion of this court :
“1. Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that only the amount of income actually exempt under section 10(6)(viia) would be excluded from consideration for the purposes of disallowance under section 40(c) read with section 40A(5) in the case of director-cum-employee who is also a foreign technician ?
2. Whether, on the facts and in the circumstances of the case, surtax liability is not an admissible deduction under the provisions of the Income-tax Act ?
3. Whether, on the facts and in the circumstances of the case and having regard to the provisions of section 2(18) of the Income-tax Act, 1961, the Tribunal was right in holding that the assessee should be treated as a company in which the public are substantially interested ?
4. Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that weighted deduction under section 35B should be allowed at 1 1/2 times of the expenditure and not at one and one third of the expenditure allowed by the Income-tax Officer ?
5. Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the provisions of section 40A(5)(b)(ii) would be applicable to the provisions of section 40(c) also in respect of the remuneration paid to the director-cum-foreign technician and the remuneration exempted under section 10(6)(viia) should not be taken into account for fixing the ceiling limit of Rs. 72,000 under section 40(c) of the Act ?”
2. The answer to questions Nos. 2, 3 and 4 need not detain us as the questions are covered by decisions of the Supreme Court as well as by the earlier decisions of this court. In so far as the second question which is referred at the instance of the assessee is concerned, the point that is involved is whether the assessee would be entitled to claim surtax liability as a deduction in computing the business income under the provisions of the Income-tax Act, 1961 (hereinafter referred to as “the Act”). The Supreme Court in the case of Smith Kline and French (India) Ltd. v. CIT [1996] 219 ITR 581, has held that the surtax paid under the provisions of the Companies (Profits) Surtax Act, 1964, cannot be allowed as a deduction while computing the business income of the assessee under the provisions of the Act. Following the decision of the Supreme Court, we answer the second question of law referred to us in the affirmative and against the assessee.
3. Questions Nos. 3 and 4 are referred at the instance of the Revenue and the questions deal with the status of the assessee-company. This court, in the case of the same assessee for the earlier assessment year in CIT v. Lucas T. V. S. Ltd. [1995] 214 ITR 700, has held that the assessee-company cannot be regarded as a company in which the public are substantially interested. It is admitted by learned counsel fur the assessee that the decision of this court rendered for the earlier assessment year would equally apply to the facts of the case. Following the decision of this court in the assessee’s own case ([1995] 214 ITR 700), we answer the third question of law referred at the instance of the Revenue in the negative and in favour of the Revenue.
4. The fourth question relates to the claim of weighted deduction under section 35B of the Act and the question is whether the assessee would be entitled to 1 1/2 times of the expenditure or one and one-third of the expenditure. Since we have held that the assessee-company is a company in which public are not substantially interested, the assessee would be entitled to claim weighted deduction only at one and one-third of the expenditure as allowed by the Income-tax Officer. Accordingly, we answer the fourth question of law referred to us in the negative and in favour of the Revenue.
5. The consideration of questions Nos. 1 and 5 can be taken together and it is necessary to state the relevant facts. The assessee is a company. During the course of assessment proceedings for the assessment year 1977-78, the Income-tax Officer found that one Mr. Dougall was the managing director of the company and was also a foreign technician. He found that the total remuneration paid to Mr. Dougall was Rs. 1,24,442 and after applying the ceiling limit provided under section 40(c) of the Act, he disallowed a sum of Rs. 52,442 being the excess of total remuneration paid to Mr. J. Dougall. The assessee preferred an appeal before the Commissioner of Income-tax (Appeals) against the disallowance made by the Income-tax Officer. The Commissioner of Income-tax (Appeals), following his earlier order for the assessment year 1976-77, held that the entire amount paid to Mr. J. Dougall should be allowed as business expenditure and no part of it can be disallowed under section 40A(5) or section 40(c) of the Act. The Department preferred an appeal before the Income-tax Appellate Tribunal.
6. The Appellate Tribunal, following its earlier order, for the assessment year 1976-77, in the assessee’s own case in I.T.A. No. 1369/Mds of 1980 dated August 31, 1982, held that the provisions of section 40A(5), clauses (i) and (ii) have to be considered in determining the nature and extent of the remuneration paid to the managing director/employee for the purpose of determining the ceiling limit prescribed under section 40(c) of the Act. The Appellate Tribunal also held that to the extent to which the remuneration or tax paid in respect of the foreign technician is exempt in accordance with section 10(6)(viia) of the Act, it is not to be taken into account for the purpose of determining the quantum of remuneration on which the ceiling is to be applied under section 40(c) read with section 40A(5) of the Act. The Appellate Tribunal noticed that the exact quantum of remuneration paid to Mr. J. Dougall which was exempt under section 10(6)(viia) was not readily available, and therefore, directed the Income-tax Officer to ascertain the exact amount which was exempt, and exclude the same in arriving at the total amount of remuneration, perquisites and benefits allowed to Mr. J. Dougall and the remuneration thus arrived at should be considered for applying the ceiling under section 40(c) of the Act. The order of the Tribunal is the subject-matter of challenge in the present tax case references.
7. Mr. C. V. Rajan, learned counsel for the Revenue, submitted that section 40A(5)(b) of the Act provides that nothing in clause (a) to section 40A(5) shall apply to any expenditure or allowance in relation to any employee being an individual referred to in section 10(6)(viia) of the Act. The proviso to section 40(c) of the Act excludes from its consideration the expenditure of the nature referred to in clause (i), (ii), (iii) or (iv) of the second proviso to clause (a) to section 40A(5) of the Act. Learned counsel for the Revenue, therefore, submitted that the intention of the Legislature is clear that only some of the expenditure referred to in the second proviso to section 40A(5) of the Act are excluded from consideration of section 40(c) of the Act, but there is no specific exclusion of section 40A(5)(b) of the Act and in the absence of exclusion, section 40(c) would apply to any salary paid to the director-cum-foreign technician also. Learned counsel for the Revenue placed reliance on a decision of the Supreme Court in the case of CIT v. Indian Engineering and Commercial Corporation P. Ltd. [1993] 201 ITR 723, and submitted that though the provisions of section 40(c) as well as section 40A(5) of the Act are applicable, since both the provisions are attracted, the higher of the ceiling has to be applied. In other words, according to learned counsel for the Revenue, clause (b) to section 40A(5) of the Act is not made applicable to section 40(c) of the Act, and for the purpose of determining the ceiling limit under section 40(c), there is no scope for exclusion of the amount found under section 40A(5)(b)(ii) of the Act. Learned counsel also submitted that it is not permissible to bifurcate the expenditures, one as a payment to the director and another to a foreign technician and if such a contention is accepted, the proviso to section 40(c) of the Act would become otiose. According to learned counsel, the remuneration paid to the employees who are directors should also be taken into account in fixing the ceiling limit under section 40(c) of the Act.
8. Mr. Janarthana Raja, learned counsel for the assessee, submitted that the provisions of section 40A(5) have to be taken into account in determining the ceiling under section 40(c) of the Act. Learned counsel for the assessee submitted that the second proviso to section 40A(5) of the Act deals with certain kinds of expenditure, viz., value of travel concession, passage moneys or contributions to recognised gratuity fund and approved gratuity fund. Learned counsel for the assessee further submitted that clause (b) to section 40A(5) of the Act deals with payments to certain categories of employees, and the contention of learned counsel for the assessee is that those persons who are covered under clause (b) of section 40A(5) of the Act should be treated as a special category of employees and if they are directors/employees, and the remuneration paid to them is exempt under section 10(6)(viia) of the Act, the exemption should be taken into account in determining the ceiling limit under section 40(c) of the Act. Learned counsel, therefore, submitted that the contract service of the foreign technician is approved by the Central Government and in view of the exemption granted by section 10(6)(viia) of the Act, the salary paid to the foreign technician is exempt. He, therefore, submitted that the entire salary or remuneration paid to the foreign technician-cum-managing director should not be taken into consideration. He also submitted that the managing director functioned in two capacities, one as managing director and another as a foreign technician and the portion of the salary which is relatable to the service rendered as employee would fall under section 40A(5) of the Act, and when section 40A(5)(b) of the Act excludes the remuneration, the exclusion under section 40A(5)(b) of the Act also should be taken into account in determining the ceiling limit prescribed under section 40(c) of the Act.
9. We have carefully considered the rival contentions of the parties. Section 40(c) of the Act reads as under :
“(c) in the case of any company –
(i) 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 assets of the company used by any person referred to in sub-clause (i) either wholly or partly for his own purposes 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 :
Provided that in a case where such person is also an employee of the company for any period comprised in the previous year, expenditure of the nature referred to in clauses (i), (ii), (iii) and (iv) of the second proviso to clause (a) of sub-section (5) of section 40A shall not be taken into account for the purposes of sub-clause (A) or sub-clause (B) as the case may be.”
10. Section 40A(5)(a) and (b) of the Act in so far as it is relevant to the facts of the case, reads as under :
“(a) Where the assessee –
(i) incurs any expenditure which results directly or indirectly in the payment of any salary to an employee or a former employee, or
(ii) incurs any expenditure which results directly or indirectly in the provision of any perquisite (whether convertible into money or not) to an employee or incurs directly or indirectly any expenditure or is entitled to any allowance in respect of any assets of the assessee used by an employee either wholly or partly for his own purposes or benefit, then, subject to the provisions 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 :
Provided that where the assessee is a company, so much of the aggregate of –
(a) the expenditure and allowance referred to in sub-clauses (i) and (ii) of this clause; and
(b) the expenditure and allowance referred to in sub-clauses (i) and (ii) of clause (c) of section 40,
in respect of an employee or a former employee, being a director or a person who has a substantial interest in the company or a relative of the director or of such person, as is in excess of the sum of seventy-two thousand rupees, shall in no case be allowed as a deduction :
Provided further that in computing the expenditure referred to in sub-clause (i) or the expenditure or allowance referred to in sub-clause (ii) of this clause or the aggregate referred to in the foregoing proviso, the following shall not be taken into account, namely :-
(i) the value of any travel concession or assistance referred to in clause (5) of section 10;
(ii) passage moneys or the value of any free or concessional passage referred to in sub-clause (i) of clause (6) of section 10;
(iii) any payment referred to in clause (iv) or clause (v) of sub-section (1) of section 36;
(iv) any expenditure referred to in clause (ix) of sub-section (1) of section 36.
(b) Nothing in clause (a) shall apply to any expenditure or allowance in relation to –
(i) any employee in respect of any period of his employment outside India;
(ii) any employee being an individual referred to in sub-clause (vii) or sub-clause (viia) of clause (6) of section 10 in respect of any period during which he is entitled to the exemption under sub-clause (vii) or, as the case may be sub-clause (viia) aforesaid;
(iii) any employee whose income chargeable under the head `Salaries’ is seven thousand and five hundred rupees or less.”
11. Section 40(c) deals with the case of an employer, which is a company, and it applies to the directors and some others. Section 40A(5) is applicable to all employers, whether a company or others. The Supreme Court in the case of CIT v. Indian Engg. and Commercial Corporation P. Ltd. [1993] 201 ITR 723 held that in the case of directors, who are employees, both the provisions would be attracted and the higher of the ceiling limits has to be applied. Hence, there is no difficulty in accepting the contention of learned counsel for the Revenue that both the provisions of section 40(c) and 40A(5) of the Act are applicable to the facts of the case.
12. The question that immediately arises is how to determine the ceiling limit prescribed under section 40(c) as well as section 40A(5) of the Act in the case of an employee who is a director-cum-employee and is a foreign technician. The object of section 40(c) as well as section 40A(5) is to place a monetary ceiling limit in the question of the allowance of the remuneration and perquisites paid to the directors, director-cum-employees and employees by the company or by an assessee to its employees. In other words, both the sections seek to curtail the practice of paying excessive or unreasonable remuneration or perquisites to its directors or persons connected with the directors or to certain categories of employees. It is not disputed that under section 40A(5) of the Act, if an assessee employs a foreign technician, whose contract of service is approved by the Central Government, then, the salary or perquisite paid to the foreign technician shall not be taken into account in determining the monetary ceiling limit under section 40A(5) of the Act. In short, if he is so employed, then the remuneration or perquisite paid to such employee is not taken into consideration for the purpose of determining the ceiling limit under section 40A(5) of the Act. Section 40(c) of the Act, no doubt, specifically provides that the second proviso to section 40A(5) of the Act is excluded from the ambit of consideration under section 40(c) of the Act. There is no express provision in section 40(c) of the Act excluding foreign technician-cum-director to whom salary or perquisite was paid by the company. An anomalous position would arise in the case of director-cum-employee. If a foreign technician is purely an employee, then his remuneration to the extent to which it is exempt under section 10(6)(viia) of the Act, is excluded from the scope of section 40A(5) of the Act. If he is only a director, then, his case would squarely fall under section 40(c) of the Act and there is no question of applicability of section 40A(5) of the Act. But, in the case of a director-cum-employee, the Supreme Court has held that both the provisions are applicable and the higher of the ceiling limits would apply. But, in determining the ceiling limit under section 40(c) of the Act, in our view, the provisions of section 40A(5) also should be taken into account. In other words, if the employee is a foreign technician whose contract of service was approved by the Central Government, then, that part of the remuneration which is exempt under section 10(6)(viia), which is outside the scope of section 40A(5) of the Act, should not be taken into consideration in determining the ceiling under section 40(c) of the Act. That apart, section 40(c) of the Act deals with the payment to the directors, and in the nature of things, a reference to section 40A(5)(b) of the Act which deals with the payment to the employees in section 40(c) of the Act would not be appropriate, and that is one reason for the omission to refer to section 40A(5)(b) of the Act in section 40(c) of the Act. Secondly, there is nothing to suggest that the remuneration which is excluded from the scope of consideration in section 40A(5)(a) of the Act, by virtue of section 40A(5)(b) of the Act, should be taken into consideration for the purpose of section 40(c) of the Act. In our view, both sections 40(c) and 40A(5) of the Act should be read together and in determining the ceiling prescribed under section 40A(5) of the Act, if certain items go out of reckoning in section 40A(5) of the Act on the principle of harmonious construction, the same amount of income also cannot be taken into account under section 40(c) of the Act.
13. We are of the view that the proviso to section 40(c) of the Act refers to the kinds of expenditures found in the second proviso to section 40A(5) of the Act, and considering the object behind section 40A(5) as well as section 40(c) of the Act, the provisions of section 40A(5)(b) should also be taken into account. A harmonious reading of sections 10(6)(viia), 40(c) and 40A(5) would indicate that the remuneration which is exempt under the provisions of section 10(6)(viia) to the extent to which the exemption is granted cannot be said to be either unreasonable or excessive having regard to the business needs of the company. The Government of India, at the time of granting approval to the contract of service, applied its mind carefully and then, approved the payment of remuneration and also the tax paid on the salary is exempt for a specific period. The exemption is given in the case of foreign technician and when the Central Government before the commencement of service approved the contract of service, it cannot be stated that the assessee-company has paid remuneration which can be regarded as unreasonable or excessive.
14. Secondly, we are of the opinion that the persons covered under clause (b) of section 40A(5) are special classes of employees. They may be employees in respect of any period of employment outside India or foreign technician or any employee whose income chargeable under the head “Salary” is Rs. 7,500 or less, and when section 40A(5) excludes from the scope of its operation the three kinds of employees mentioned in clause (b), they must be regarded as special categories of employees and the remuneration paid to those employees should also be exempt under section 40(c) as well to the extent to which the exemption is granted. Otherwise, an anomalous result would follow In the case of director-cum-employees by the Legislature granting exemption under one provision and withdrawing the same under other provision of the Act. More or less a similar situation come up for consideration before the Delhi High Court in Continental Constriction Ltd. v. CIT [1990] 185 ITR 178 and the Delhi High Court was dealing with the case falling under sub-clause (i) of clause (b) of section 40A(5), i.e., the case of remuneration of an employee in respect of any period of his employment outside India. In that case, B. N. Kirpal I. (as his Lordship then was) considered the provisions of section 40(c) and section 40A(5) of the Act. The learned judge noticed the decisions of the Gujarat High Court in Addl. CIT v. Tarun Commercial Mills Ltd. [1978] 113 ITR 745 and CIT v. Rajesh Textile Mills Limited [1988] 173 ITR 179 (Guj), of the Punjab and Haryana High Court in CIT v. Patialal Flour Mills Co. (P.) Ltd. [1980] 123 ITR 7, of the Karnataka High Court in international Instruments Pvt. Ltd. v. CIT [1981] 130 ITR 315 of the Kerala High Court in Travancore Rayons Ltd. v. CIT [1986] 162 ITR 732 and of the Calcutta High Court in CIT v. Indian Molasses Co. (P.) Ltd. [1989] 176 ITR 473 and after considering the legislative history, held that section 40A(5)(b) specifically deals with a question of an employee who is in employment outside India and section 40(c) does not deal with the case of employee who is in employment outside India. The Delhi High Court, therefore, held that even if it be assumed, that section 40A(5) is general and section 40(c) is specific qua the directors, nevertheless, in respect of employee-directors who are posted outside India, section 40(c) cannot and does not apply and section 40(c) of the Act does not envisage the case of an employee-director who is posted out of India. The Delhi High Court, therefore, held that section 40A(5) is a specific provision and section 40(c) has to be regarded as a general provision. Applying the principles of law laid down by the Delhi High Court, we are of the opinion that the provisions of section 40A(5)(b) should also be taken into account for the purpose of determining the quantum of director’s remuneration by way of salary and other allowances. Therefore, for determining the ceiling limit, the provisions of section 40A(5)(b) should come into play and the provision has to be considered in determining the nature and extent of the remuneration paid to the director-employees for the purpose of applying the ceiling of Rs. 72,000 specified in section 40(c) of the Act. Therefore, the remuneration or tax paid to a foreign technician to the extent to which it is exempt under section 10(6)(viia) is not liable to be taken into account for the purpose of determining the quantum of remuneration on which the ceiling is to be applied under section 40(c) of the Act.
15. The Gujarat High Court in McGaw-Ravindra Laboratoriess (India) Ltd. v. CIT [1994] 210 ITR 1002 (Appex.) held that the salary paid by the company to its employee for the period during which he was in a foreign country should be taken into account for determining the disallowance under section 40A(5) of the Act. The Supreme Court in the case of CIT v. Brakes India Ltd. [1993] 201 ITR 647 considered proviso (ii) to section 40(c)(iii) of the Act before amendment, and the said proviso corresponds to Section 40A(5)(b)(iii) of the Act. The Supreme Court held that where salary paid to a foreign technical director is exempt from tax under section 10(6)(viia) of the Act, the corresponding provisions of Section 40(c) of the Act could not be invoked. A study of various decisions of the Delhi High Court, the Gujarat High Court as well as the Supreme Court clearly indicates that if the income of the foreign technical director is exempt under section 10(6)(viia) of the Act, then that part of the remuneration cannot be the subject matter of consideration under section 40A(5) of the Act. It is not open to the Revenue to contend that it is exempt only for the purpose of section 40A(5) of the Act, but, it should be taken into account for the purpose of section 40(c) of the Act. We are of the view that once the remuneration is exempt under section 10(6)(viia) of the Act, it goes out of the purview of the provisions of section 40A(5) of the Act and it cannot be again the subject matter of disallowance under section 40(c) of the Act. It can be either on the basis of the principles laid down by the Delhi High Court that section 40A(5)(b) of the Act is a special provision dealing with foreign technical director whose salary is exempt under section 10(6)(viia) or on the basis that section 40A(5) of the Act should also be taken into account in determining the ceiling limit prescribed under section 40(c) of the Act. The learned author Mr. Sampath Iyengar, in his book on Law of Income-tax, 9th edition, volume-II, at page 2816, observed as under :
“Employee-director posted outside India. – Section 40(c) does not envisage the case of an employee-director who is posted outside India such a case is dealt with only by section 40A(5)(b). This being so, at least qua employee-directors employed outside India, section 40A(5)(b) is a specific provision and section 40(c) has to be regarded as a general provision. On the principle that, if there is a general provision and there is also a special provision, then, it is the special provision which will prevail, the only conclusion possible is that the case of remuneration to employee-directors employed outside India falls under the provisions of section 40A(5) and not section 40(c). Accordingly, it was held that the remuneration to the directors in respect of their employment outside India has to be excluded from consideration for the purpose of the limit of Rs. 72,000.”
16. Mr. C. V. Rajan, learned counsel for the Revenue, on the other hand, submitted that the decision of the Delhi High Court is not applicable, because the Delhi High Court was dealing with a case under section 40A(5)(b)(i) of the Act. We are unable to accept the contention of learned counsel for the Revenue, because section 40A(5)(b), as already seen, applies to three kinds of employees and there cannot be any distinction in the treatment of exemption between one kind of employee and another falling under the same clause (b) of section 40A(5) of the Act. The principles laid down by the Delhi High Court would equally apply to sub-clause (ii) of section 40A(5)(b) of the Act.
17. The contention of learned counsel for the assessee is that the entire remuneration and tax paid by the employer to Mr. Dougall should be exempted and it should not be taken into account in determining disallowance under section 40(c) of the Act. We are unable to agree with the contention of learned counsel for the assessee. The Tribunal held that only to the extent to which the remuneration was exempt, it would be excluded in arriving at the total amount of remuneration, perquisites or benefits for the purpose of determining the ceiling under section 40(c) of the Act. Section 10(6)(viia) of the Act provides that in the case of an approved foreign technician who satisfies the prescribed conditions an exemption is granted for the remuneration due to him during the period of 24 months commencing from the date of his arrival in India up to Rs. 4,000 per month and where the tax on the excess of such remuneration over the above limit is paid to the Central Government by the employer the tax so paid by the employer is also exempt. Where he continues with the Central Government’s approval and remains in employment in India after the expiry of the period of 24 months, the tax paid by the employer to the Government on his income is exempt for a further period of 24 months. Since this is the only amount to which the Central Government applied its mind in granting the approval of contract of service between the assessee and the foreign technical director, only that portion of the amount which is exempt under section 10(6)(viia) of the Act should also not be taken into consideration for applying the ceiling under section 40(c) of the Act. It cannot be on the entire salary, remuneration or perquisite paid to the foreign director as the Central Government has not applied its mind to the entire salary that was paid to the foreign technical. The reasonable construction of section 40A(5)(b) would be to limit the allowance to the extent to which the exemption was granted by the Central Government. Therefore, the Appellate Tribunal was correct in holding that in determining the quantum of remuneration, it cannot be on the total remuneration, but the extent to which the remuneration was exempt under section 10(6)(viia) of the Act.
18. Accordingly, we answer the questions of law referred to us as under :
(i) First question of law, in the affirmative and against the assessee.
(ii) Second question of law, in the affirmative and against the assessee.
(iii) Third question of law in the negative and in favour of the Revenue.
(iv) Fourth question of law, in the negative and in favour of the Revenue.
(v) Fifth question of law, in the affirmative and against the Revenue.
19. Each party will be entitled to the costs of the reference. Costs Rs. 1,500 one set in T.C. Nos. 1816 and 1817 of 1984 and Rs. 1,500 in T.C. No. 1818 of 1984.