Facts

D, holding directly or through his nominees, entire shares of the assessee- company, entered into an agreement with T, in terms of which D sold his shares in the assessee company to T. The agreement provided for termination of services of employees and managing director and for payment of retrenchment compensation, commutation of pension and compensation to managing director. The appellant paid Rs. 1,64,899, which amount, inter alia, included Rs. 16,188 paid to the managing director in lieu of six months’ notice, Rs. 21,200 paid towards compensation for termination of pension allowance, and Rs. 16,885, the first of five annual payments as compensation to the director. These amounts were claimed as a deduction under section 37(1). These payments resulted in a substantial reduction in the wage bill as a consequence of the retrenchment.

The ITO denied the deduction on the ground that the services of the managing director and the employees were terminated not because of business expediency but because T made it a pre-condition under the agreement and therefore, it could not be considered as allowable under section 37(1). The additions were confirmed by the Commissioner (Appeals). The Tribunal confirmed that the expenditure was not incurred for the purpose of the business and further held that no deduction could be allowed since it was made to benefit the  third party.  On  a  reference, the High Court held that only the two amounts of Rs. 21,200 and Rs. 16,188  were allowable as deductions and that the balance of Rs. 1,27,511 paid to the employees and a director was not allowable as a deduction since the expenditure had notbeen incurred by the company for commercial reasons.

 

Issue

Whether the said payments of Rs. 1,27,511 made by the assessee company     to the employees and the director by way of retrenchment compensation or compensation for termination of service were allowable as business expenditures under section 37(1)?

 

 

View

The assessee-company was neither dissolved nor was its business undertaking sold. It continued to exist as a juristic entity even after the transfer of its shares     by D in favour of T. No doubt that on account of such transfer of shares, the transferees gained control on the assessee company, but neither D nor T derived any direct benefit out of the payment of retrenchment compensation even though such retrenchment might have facilitated the transfer of shares. The High Court wrongly placed more emphasis on the motive with which the amount was expended than the fact that the expenditure was incurred in connection with the business of the assessee company.

 

Held

On appeal reversing the judgement of the High Court, the Supreme Court held    that even assuming that the motive behind the payment of the compensation was that the terms of the agreement between the D and T for the sale of the shares should be satisfied, as long as the amount of Rs. 1,27,511 was laid out wholly    and exclusively for the purpose of the business of the appellant, there was no reason for denying the deduction. The appellant company continued to function even after its control passed on to the T and the expenditure in question was    laid out for the purpose of the company’s own trade and not for the trade of the      T who was only its shareholder. As a result of the expenditure, the appellant company was in fact benefited by reduction in its wage bill. It could not be said that the T was in any way benefited financially because of the deduction in the consideration payable by it for the shares.

The expression ‘wholly and exclusively’ does not mean ‘necessarily’. Ordinarily,  it  is for the assessee to decide whether any expenditure should be incurred in the course of his or its business. The fact that somebody other than the assessee is    also benefited by the expenditure should not come in the way of an expenditure being allowed by way of deduction if it satisfies otherwise the test laid down by law.

The sum of Rs. 1,27,511 was, therefore, held to be expended by the appellant      on the ground of commercial expediency and in order to indirectly facilitate the carrying on of its business, and was, therefore, allowable as a deduction. (AY. 1957-58, 1958-59, 1959-60and 1960-61) (CA Nos. 2501 and 2502-2504 of 1972

dt. 3-5-1979).

Facts

D, holding directly or through his nominees, entire shares of the assessee- company, entered into an agreement with T, in terms of which D sold his shares in the assessee company to T. The agreement provided for termination of services of employees and managing director and for payment of retrenchment compensation, commutation of pension and compensation to managing director. The appellant paid Rs. 1,64,899, which amount, inter alia, included Rs. 16,188 paid to the managing director in lieu of six months’ notice, Rs. 21,200 paid towards compensation for termination of pension allowance, and Rs. 16,885, the first of five annual payments as compensation to the director. These amounts were claimed as a deduction under section 37(1). These payments resulted in a substantial reduction in the wage bill as a consequence of the retrenchment.

The ITO denied the deduction on the ground that the services of the managing director and the employees were terminated not because of business expediency but because T made it a pre-condition under the agreement and therefore, it could not be considered as allowable under section 37(1). The additions were confirmed by the Commissioner (Appeals). The Tribunal confirmed that the expenditure was not incurred for the purpose of the business and further held that no deduction could be allowed since it was made to benefit the  third party.  On  a  reference, the High Court held that only the two amounts of Rs. 21,200 and Rs. 16,188  were allowable as deductions and that the balance of Rs. 1,27,511 paid to the employees and a director was not allowable as a deduction since the expenditure had notbeen incurred by the company for commercial reasons.

 

Issue

Whether the said payments of Rs. 1,27,511 made by the assessee company     to the employees and the director by way of retrenchment compensation or compensation for termination of service were allowable as business expenditures under section 37(1)?

 

 

View

The assessee-company was neither dissolved nor was its business undertaking sold. It continued to exist as a juristic entity even after the transfer of its shares     by D in favour of T. No doubt that on account of such transfer of shares, the transferees gained control on the assessee company, but neither D nor T derived any direct benefit out of the payment of retrenchment compensation even though such retrenchment might have facilitated the transfer of shares. The High Court wrongly placed more emphasis on the motive with which the amount was expended than the fact that the expenditure was incurred in connection with the business of the assessee company.

 

Held

On appeal reversing the judgement of the High Court, the Supreme Court held    that even assuming that the motive behind the payment of the compensation was that the terms of the agreement between the D and T for the sale of the shares should be satisfied, as long as the amount of Rs. 1,27,511 was laid out wholly    and exclusively for the purpose of the business of the appellant, there was no reason for denying the deduction. The appellant company continued to function even after its control passed on to the T and the expenditure in question was    laid out for the purpose of the company’s own trade and not for the trade of the      T who was only its shareholder. As a result of the expenditure, the appellant company was in fact benefited by reduction in its wage bill. It could not be said that the T was in any way benefited financially because of the deduction in the consideration payable by it for the shares.

The expression ‘wholly and exclusively’ does not mean ‘necessarily’. Ordinarily,  it  is for the assessee to decide whether any expenditure should be incurred in the course of his or its business. The fact that somebody other than the assessee is    also benefited by the expenditure should not come in the way of an expenditure being allowed by way of deduction if it satisfies otherwise the test laid down by law.

The sum of Rs. 1,27,511 was, therefore, held to be expended by the appellant      on the ground of commercial expediency and in order to indirectly facilitate the carrying on of its business, and was, therefore, allowable as a deduction. (AY. 1957-58, 1958-59, 1959-60and 1960-61) (CA Nos. 2501 and 2502-2504 of 1972

dt. 3-5-1979).

Editorial: Earlier and Subsequent decisions on the issue may be referred Calcutta & Co. v. CIT (1959) 37 ITR 1 (SC), CIT v. Travancore Sugar  Chemicals Ltd (1973) 88 ITR 1 (SC), Eastern Investment Ltd v. CIT (1951) 20 ITR 1 (SC), Alembic Chemical works v.  CIT (1989) 177 ITR 377 (SC). In Shahzada Nand      & Sons v.  CIT (1977) 108 ITR 358(SC) the Court held that the reasonableness       of the payment has to be judgement not on any subjective authority standard of assessing authority but from the point of view of commercial expediency.

“Truth is by nature self-evident. As soon as you remove the cobwebs of ignorance that surround it, it shines clear.”

– Mahatma Gandhi