JUDGMENT
Mrs. Sujata Manohar, Actg. C.J.
1. The assessee, Messrs. Colgate Palmolive (India) Pvt. Ltd., is a company registered under the Indian Companies Act. Shri Kodikal was its chairman and full-time director till he retired on September 20, 1974. The assessee-company paid him on October 2, 1974, a sum of Rs. 90,000 as his retirement gratuity. We are concerned in the present case with the assessment year 1975-76. The assessee-company claimed that the amount of Rs. 90,000 which was paid as retirement gratuity was not includible in the expenditure which was required to be considered for deduction in view of the ceiling placed on such expenditure under section 40A(5) of the Income-tax Act, 1961.
2. The assessee had originally claimed a deduction of only Rs. 30,000 and had offered for tax as salary of the director a sum of Rs. 60,000 out of the gratuity amount of Rs. 90,000. But the assessee subsequently claimed before the Income-tax Officer the entire amount of Rs. 90,000 as deductible expenditure. The claim of the assessee for deduction of the said amount was rejected by the Income-tax Officer and also by the Appellate Assistant Commissioner in appeal. In the further appeal before the Tribunal, the Tribunal by its order dated July 21, 1979, held that the payment which was made by the assessee to the director was to be considered under section 40(c) of the Income-tax Act, 1961, and not under section 40A(5) of the Income-tax Act. 1961. The Tribunal further held that the amount of Rs. 90,000 incurred by the assessee as expenditure for payment of retirement gratuity to the chairman and full-time director of the assessee was not includible in determining the amount of expenditure which is inadmissible having regard to the provisions of section 40(c)(i) of the Income-tax Act. The Tribunal has followed its earlier decision in arriving at its conclusion. Hence the following questions have been referred to us under section 256(1) of the Income-tax Act, 1961 :
“(1) Whether, on the facts and in the circumstances of the case, in determining the amount of expenditure which is inadmissible, if any, of the payment made to the director, the provisions of section 40(c)(i) and not section 40A(5) are applicable ?
(2) Whether, on the facts and in the circumstances of the case, the provisions of section 40(c)(i) do not hit the expenditure incurred by the assessee for payments made to its chairman and wholetime director by way of retirement gratuity ?”
3. Under section 36 of the Income-tax Act, 1961, while computing the total income arising from profits and gains of business or profession, certain deductions are permitted as set out in that section. Under section 36(1)(v) any sum paid by the assessee as an employer by way of contribution towards an approved gratuity fund created by him for the exclusive benefit of his employees under an irrevocable trust is deductible from the income of the assessee. Section 37 is a general provision under which any expenditure not being expenditure of the nature described in sections 30 to 36 and not being in the nature of capital expenditure or personal expenses of the assessee, laid out or expended wholly and exclusively for the purposes of the business or profession of the assessee is allowed as a deduction in computing the income chargeable under the head “Profits and gains of business or profession”.
4. Section 40A(7), however, provides, inter alia, that “no deduction shall be allowed in respect of any provision made by the assessee for the payment of gratuity to his employees on their retirement or on termination of their employment for any reason”. Clause (b), however, of section 40A(7) states that this prohibition shall not apply in relation, inter alia, to :
“any provision made by the assessee for the purpose of payment of a sum by way of any contribution towards an approved gratuity fund, or for the purpose of payment of any gratuity that has become payable during the previous year;”
5. The first contention which is urged before us by Dr. Balasubramaniam, learned advocate appearing for the Revenue, is that in view of section 40A(7), the assessee in the present case cannot claim any deduction in respect of the retirement gratuity which was actually paid by the assessee-company to its full-time director on retirement during the previous year relevant to the assessment year in question. The submission is based on a misconception of section 40A(7)(a). The prohibition under this sub-section is on the deductibility of any provision made for payment in the future to an employee of gratuity on his retirement or termination of service unless it satisfies the requirements of section 40A(7)(b). It does not deal with any actual payment of gratuity during the accounting year. The provisions of section 40A() have been considered by the Supreme Court in the case of Shree Sajjan Mills Ltd. v. CIT . The Supreme Court has observed that on a plain construction of clause (a) of section 40A(7) whatever is provided for future use by the assessee out of the gross profits of the year of account for payment of gratuity to its employees on their retirement or on the termination of their services would not be allowed as a deduction unless the conditions specified in clause (b) are fulfilled. The Supreme Court has construed the expression “provision made by the assessee” and has held that a provision cannot be equated with expenditure. The Supreme Court has further observed that the actual payments could have been eligible for deduction, inter alia, under section 37 of the Income-tax Act, 1961. However, in view of the non obstante clause of sub-section (1) of section 40A which has an overriding effect over the provisions of any other section, expenditure which fall under section 40A(7)(a) will be disallowed unless covered by clause (b) of that section. Actual payment of gratuity on the retirement of an employee during the relevant previous year does not fall under section 40A(7)(a) because it is a payment which is actually made and is not a provision for payment at a later date. The Supreme Court has drawn a distinction between actual liability in praesenti which is discharged by payment and a liability de futuro which, for the time being, may be only contingent. The former is deductible but not the latter. Under clause (b), however, where an approved gratuity fund is created for the exclusive benefit of the employees under an irrevocable trust, contributions made to the fund during the year of account will be allowed to be deducted under section 36(1)(v). Hence the provisions of section 40A(7) are not attracted in the present case.
6. We have next to consider whether the expenditure which has beep incurred for payment of retirement gratuity is covered by section 40(c) or by section 40A(5). Broadly speaking, section 40(c) applies to directors while section 40A(5) applies to employees. The relevant provisions of section 40(c) are as follows :
“Section 40 :. . . . the following amounts shall not be deducted in computing the income chargeable under the head ‘Profits and gains of business or profession’, – . . . .
(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. . . .
(ii) any expenditure or allowance in respect of any assets of the company used by any person referred to in subclause (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 ease, 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.”
7. Section 40A(5) which broadly deals with payment of salary and perquisites to an employee is as follows :
“S. 40A(5)(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 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 ………… 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 – ….
(c) The limits referred to in clause (a) are the following, namely :
(i) 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,…… sixty thousand rupees;……….
(ii) in respect of the aggregate of the expenditure and the allowance referred to in sub-clause (ii) of clause (a), one-fifth of the amount of the salary payable to the employee or an amount calculated at the rate of one thousand rupees for each month or part thereof comprised in the period of his employment in India of the employee during the previous year, whichever is less.
Explanation 1. –
Explanation 2. – In this sub-section, –
(a) ‘salary’ has the meaning assigned to it in clause (1) read with clause (3) of section 17 subject to the following modifications, namely :-
(1) in the said clause (1), the word ‘perquisites’ occurring in sub-clause (iv) and the whole of sub-clause (vii) shall be omitted
8. Section 40A(5), therefore, deals with expenditure which results directly or indirectly in the payment of salary to an employee or a former employee or which results in the granting of any perquisites to him. A problem, however, arises when the director of a company is also an employee of the company, i.e., when a person works in the dual capacity of a director as also an employee either throughout the previous year or a part of it. In this situation does section 40(c) apply or section 40A(5) apply? In this connection, if we consider the provisions of both these sections, we find that both the sections will have to be applied on the principle of harmonious construction. For example, under section 40(c), the proviso which follows clause (b) clearly envisages the situation where a director is also an employee of the company for any period comprised in the previous year. It provides that certain expenditure of the nature specified under section 40A(5) set out in clauses (i), (ii), (iii) and (iv) of the second proviso thereto shall not be taken into account for the purposes of the ceiling set out in sub-clauses (A) and (B) of section 40(c). Similarly, section 40A(5) also envisages a situation where an employee is also a director of the company because the first proviso to section 40A(5)(a) prescribes a higher ceiling of Rs. 72,000 in respect of expenditure incurred on an employee who is also a director, where the aggregate of the expenditure under sub-clauses (i) and (ii) of section 40A(5)(a) as well as of the expenditure under sub-clauses (i) and (ii) of section 40(c) are involved during any previous year. Presumably this would happen in a case where an employee may be an employee only for a part of the year and may thereafter also become a director, or where an employee-director may relinquish his directorship for a part of the year. There may be other situations also where the expenditure in question would consist of expenditure enumerated both under section 40(c) and section 40A(5).
9. The Supreme Court in the case of CIT v. Indian Engineering and Commercial Corporation P. Ltd. [1993] 201 ITR 723, at page 728, has also observed : “In the case of directors who are also employees, both these sections will be attracted and the higher of the two ceilings will have to be applied”.
10. What is more important to notice for our purpose is the nature of the expenditure which is covered by both these sections. Section 40(c) deals with remuneration, benefit or amenity to a director or any expenditure or allowance in respect of any asset of the company which is used by that person. Sub-clauses (A) and (B) of section 40(c) describe and refer to such expenditure or allowances as related to a specific period during the previous year. For example, under sub-clause (A) if such expenditure or allowance relates to a period exceeding 11 months comprised in the previous year, the ceiling is fixed at Rs. 72,000. This appears to be calculated at the rate of Rs. 6,000 per month. Because in the next sub-clause (B), it is stated that if such expenditure or allowance relates to a period not exceeding 11 months composed in the previous year the ceiling amount is calculated at the rate of Rs. 6,000 for each month or part thereof comprised in that period. Therefore, the expenditure must be relating to the period comprised in the previous year or any specific part thereof.
11. Similarly, under section 40A(5)(c), the expenditure which is referred to is a periodic expenditure relating to the period comprised in the previous year or any part thereof. Section 40A(5)(C) refers to salary and perquisites. The limits of expenditure under these heads are set out in sub-clause (c) (i). Sub-clause (c) (i) prescribes a limit calculated at the rate of Rs. 5,000 for each month or part thereof comprised in the period of his employment during the previous year. This refers to expenditure under the head of salary, while sub-clause (c) (ii) refers to the limit on the expenditure incurred on account of any perquisites given to an employee which shall not exceed, inter alia, Rs. 1,000 for each month or part thereof comprised in the period of employment during the previous year. Therefore, once again, these payments must also be periodic payments relatable to the period of employment forming a part of the previous year. Any payment which is not relatable to the previous year is not covered by either of these sections.
12. Can the payment of retirement gratuity to a retiring director-cum-employee in the relevant previous year be considered as such expenditure ? To decide this question the manner of computing such expenditure prescribed in these two sections is very relevant. Any expenditure which cannot be computed in the manner laid down in these sections would not be covered by these sections. In the case of CIT v. B. C. Srinivasa Setty , the Supreme Court has observed that the charging section and the computation provisions together constitute an integrated whole. When there is a case to which the computation provisions cannot apply at all, it is evident that such a case was not intended to fall within the charging section. The same observations find a place in another decision of the Supreme Court in the case of CIT v. Official Liquidator, Palai Central Bank Ltd. [1984] 150 ITR 539. The Supreme Court in this case dealt with the provisions contained in the Super Profits Tax Act, 1963, for computing the capital and reserves of a company. It said that in the case of a company in liquidation the standard deduction contemplated by section 2(9) of the Act is incapable of ascertainment and hence the charge of super profits tax is not attracted in the case of a company in liquidation. By the same analogy, if the computation provisions contained in section 40(c) and section 40A(5) do not provide for non-periodic payments not relatable to the previous year, such payments are not contemplated as being covered by these sections. We may add that even in the proviso to section 40A(5) relating to the maximum ceiling of Rs. 72,000 which is provided where expenditures under section 40(c) and section 40A(5) are required to be considered in the case of an employee-director, there is a clear reference to the maximum ceiling provided under section 40(c) in the case of a director. The first proviso to section 40A(5)(A) merely states that in no case should this ceiling be exceeded while allowing a deduction. The maximum ceiling under section 40(c) is clearly in respect of periodic payments only. Hence payments under both the sections contemplate only periodic payments.
13. In the case of T. T. Pvt. Ltd. v. ITO [1980] 121 ITR 551, the Karnataka High Court considered business expenditure in the form of payments to selling agents which the court held, fell within section 40A(2)(A) of the Income-tax Act and not section 40(c). The court has, inter alia, considered the provisions of section 40(c) and has observed (at page 567) : “A close reading of the above provisions shows that section 40(c) refers to an expenditure incurred by making periodical payments to a person mentioned in that clause. . . . It cannot have any reference to payments made by the assessee for all kinds of services or facilities referred to under section 40A(2)(A)”. These observations of Venkataramaiah J. (as he then was) have been approved by the Supreme Court in the case of Bharat Beedi Works P. Ltd. v. CIT . The Supreme Court considered the provisions of section 40(c) while considering the payments made by way of royalty for the use of a trade name. The same ratio applies to the provisions of section 40A(5) also, which deals with similar periodic payments made to the employees.
14. Dr. Balasubramaniam, learned advocate, for the Revenue, has urged that these sections also cover non-periodic expenditure. He has placed emphasis on Explanation 2 of section 40A(5). The Explanation 2 says that “salary” in section 40A(5) has the meaning assigned to it in section 17(1) read with section 17(3) with some modifications as set out therein. Before we examine the definition of “salary” it is necessary to note in the first place, that section 40(c) does not make any reference to the word “salary” nor does it contain any such definition of the word “salary”. Therefore, we have to consider Explanation 2 only for the purpose of section 40A(5).
15. The terms “salary”, “perquisite” and “profits in lieu of salary” are defined in clauses (1), (2) and (3), respectively, of section 17. We are concerned only with clauses (1) and (3) which deal with salary and profits in lieu of salary. Under section 17(1)(iv), “salary” includes profits in lieu of salary. Clause (3) gives an extensive definition of “Profits in lieu of salary” as, inter alia, including :
“17. (3) (ii) : any payment (other than any payment referred to in clause (10), clause (10A), clause (10B), clause (11), clause (12) or clause (13A) of section 10), due to or received by an assessee from an employer or a former employer or from a provident or other fund (not being an approved superannuation fund), to the extent to which it does not consist of contributions by the assessee or interest on such contributions.”
16. Therefore, payments which are referred to in section 10, clauses (10A), (10B), (11), (12) and (13A) are not included in the definition of “profits in lieu of salary”. If one turns to section 10 and the relevant clauses one finds that these deal with payments such as death-cum-retirement gratuity, payments in commutation of pension, compensation received by workmen under the Industrial Disputes Act, payment from a provident fund or payment from an approved superannuation fund. We have referred generally to these payments to indicate that various lump sum or one-time payments are excluded from the definition of the term “profits in lieu of salary” and, therefore, from the definition of “salary” in view of section 17(1)(iv). The Department, however, has urged that under section 17(1) which gives an extensive definition of salary, sub-clause (iii) refers to “any gratuity”. It is urged before us that this would include death-cum-retirement gratuity also. But in view of the express exclusion of such payments from the definition of “profits in lieu of salary” and, therefore, from the definition of “salary” under section 17(1)(iv) “any gratuity” in section 17(1)(iii) will have to be considered as referring to any periodic payment received by an employee gratuitously.
17. Even otherwise, looking at the definition of “salary” for the purposes of section 40A(5) under the basic scheme of section 40A(5) any one-time payment or a payment which is not relatable to any period covered by the previous year, cannot be taken into account for the computation of the ceiling prescribed under that section. The ceiling is to be calculated with reference to the period covered by the previous year. Including such one-time payment as forming a part of section 40A(5) would render it impossible to calculate the ceiling prescribed in that section in connection with that payment. Including such a payment would make the operation of the section impossible. Such payments, therefore, cannot be considered as forming part of the expenditure which is covered by section 40A(5). Therefore, the definition of “salary” under Explanation 2 to section 40A(5) has to be considered in the light of the provisions of section 40A(5) In the context of section 40A(5), “salary” cannot be considered as including a one-time payment in the nature of retirement gratuity.
18. It was urged by Dr. Balasubramaniam that if the payment of gratuity cannot be considered for deduction under either of these two sections, it cannot be deducted at all. There are two fallacies in this argument : first, the assumption that unless the expenditure is covered by either section 40(c) or section 40A(5), it cannot be allowed as a deduction at all. There is no basis for this submission. As set out earlier, section 37 is a general provision under which expenditure laid out or expended wholly and exclusively for the purposes of the business or profession of an assessee can be allowed as a deduction. In the case of Shree Sajjan Mills Ltd. , the Supreme Court has itself observed that retirement gratuity paid to an employee during the previous year can be deducted in view of section 37 of the Income-tax Act, 1961.
19. The second fallacy in this argument consists in considering the payment of gratuity at the time of retirement of an employee-director as falling only under section 40(c) and/or section 40A(5), i.e., as a periodic payment relatable to any specific year of service. Gratuity which is paid at the time of retirement is undoubtedly paid on the basis of the entire length of service of an employee. But it cannot be apportioned year-wise to each of the years in question. For example, unless an employee completes a certain minimum period of service, he will not be eligible for gratuity. Secondly, the calculation of gratuity may depend upon the salary drawn by an employee at the time of his retirement and not on the basis of his salary in any specific year. Therefore, payment of gratuity at the time of retirement cannot be equated with a monthly or yearly payment of salary or monthly allowance. In the case of Shree Sajjan Mills Ltd. , the Supreme Court has considered the nature of such payment. It has observed (page 598) that the payment of gratuity is made on retirement or on termination of service. It is not for the service rendered during the year in which the payment is made but it is made in consideration of the entire length of service and its ascertainment and computation depend upon several factors. The right to receive the payment accrues to the employees on their retirement or termination of their services and the liability to pay gratuity becomes the accrued liability of the assessee, when the employees retire or their services are terminated. Until then, the right to receive gratuity is a contingent right and the liability to pay gratuity continues to be a contingent liability qua the employer.
20. Since the payment of a sum of Rs. 90,000 to the chairman-cum-full-time director as retirement gratuity cannot be looked upon as periodic payment, it is not covered by the provisions of either section 40(c) or section 40A(5) of the Income-tax Act, 1961. The ceiling, therefore, which is prescribed under these two sections on allowable expenditure will not apply to this payment. The Tribunal has allowed this payment as a deduction from the income arising to the assessee on account of profits and gains of business. We do not see any reason to take a different view. In the premises question No. 1 is answered as follows :
(a) In determining the amount of expenditure which is inadmissible out of payments made to the director who is also an employee, the provisions of both section 40(c)(i) and section 40A(5) are applicable. For the reasons set out above, the retirement gratuity paid to Mr. Kodikal, the chairman-cum-full-time director of the assessee-company is not covered by either of these sections;
(b) The second question is answered in the affirmative and in favour of the assessee.
(c) No order as to costs.