S. 37 Retrenchment Compensation paid for business purpose is allowable

ACIT Vs M/s. Lumax Automotive Systems Ltd. (ITAT Delhi)

The assessee-company explained that it has closed down its Aurangabad unit due to heavy losses suffered by the assessee-company. The assessee-company in this year has declared loss of Rs.4.34 crores in the return of income and after making addition as well, the net taxable loss have been determined at Rs.3.77 crores. Therefore, the contention of the assessee-company is correct that in order to save future losses, Aurangabad unit was closed down by the assessee-company. The closure is approved by the Board of Directors and there was an Agreement executed between the Worker’s Union and the Assessee-Company for retrenchment of its employees on account of closure of the Aurangabad factory. These facts have not been rebutted by the Revenue. Therefore, it is clear that amount in question have been paid by assessee-company on account of retrenchment compensation on closure of the Aurangabad unit of the assessee-company. The amount is thus paid for business purposes only and as such, it was an allowable deduction under section 37 of the I.T. Act. Provisions of Section 35DDA applied by the A.O. are not applicable in this case because assessee-company has not paid any service compensation under any scheme of voluntary retirement.

FULL TEXT OF THE ITAT JUDGMENT

This Departmental Appeal has been directed against the Order of the Ld. CIT(A)-VIII, New Delhi, dated 07^th October, 2014, for the A.Y. 2010-2011, challenging the order of the Ld. CIT(A) in deleting the disallowance of Voluntary Retirement Scheme (“VRS”) retrenchment compensation of Rs.57,25,789/-

2. The A.O. disallowed the above amount of VRS retrenchment compensation and did not allow claim under section 35DDA of the I.T. Act, 1961.

3. The assessee filed written submissions before Ld. CIT(A) which is reproduced in the appellate order in which the assessee briefly explained that assessee-company is a manufacturing company and is engaged in the business of manufacturing of auto components, such as, filters, rear view mirrors and plastic components of different varieties for different O.E.M. vehicle manufacturers. There was also demerger of other units as per the directions of Hon’ble Delhi High Court. The assessee-company, during the assessment year, had seven manufacturing units at Faridabad, Gurgaon, Manesar, Pune and Aurangabad with Corporate/Head Office at Okhla Industrial Area, New Delhi. The assessee-company had closed down its Aurangabad unit on 31^stMarch, 2010 which was manufacturing rear view mirrors on account of lack of orders, financial problems and on account of non- modernization of plant and machinery which were very old and not competitive with the modern manufacturing units and continuing losses in the unit and on account of the same, the Directors of the Company in their Board Meeting, had decided to close down its factory unit at Aurangabad. Accordingly, Management had given a General Notice to the factory workers for closure of the unit w.e.f. 31^st March, 2010. The Company Management and the Worker’s Union had entered into an Agreement with regard to Terms of the Retrenchment Compensation and other dues to the workers. The details were filed on record. Out of 59 employees, 56 employees had taken their dues and submitted their resignation. Out of 03 left-over employees, 02 employees had taken their dues in F.Y. 2012-2013 and only one employee remained unpaid at the time of assessment proceedings. It was submitted that generally there are two ways for payment to the employees of the Company on their leaving the service of the company in mid way, other than retirement, either through retrenchment or opting the scheme of VRS in case there is any scheme of VRS enforced in the organisation. In case of VRS, the Company made terms of the offer of retrenchment and it is not obligatory on the part of the employees to accept the VRS. Section 35DDA of the I.T. Act is applicable in respect of the expenditure made in connection with the voluntary retirement. This provision is applicable when VRS is introduced by the assessee-company and payments are made by the assessee-company to its employees on their voluntary retirement. However, in the case of the assessee-company, its Aurangabad unit was closed with retrenchment of all the workers and staff as on 31^st March, 2010. The service compensation was paid to the employees of the Company which is based on 16 days wages/salary for the years of service served by them. Payments were made to the workers and staff on their retrenchment. Thus, no payment is made for VRS. It is, therefore, an allowable deduction under section 37(1) of the I.T. Act. The retrenchment compensation was paid due to business expediency. It was paid for the purpose of business to save the future business losses. The assessee-company relied upon several decisions in support of the above contention. It was also submitted that service retrenchment compensation was allowed in earlier year as well under section 37(1) of the I.T. Act.

4. The Ld. CIT(A) considering the material on record, deleted the entire addition. His findings are reproduced as under :

FINDINGS :

1 have perused that assessment order, grounds of appeal, written submission and discussed the matter with the AR very carefully. The appellant company had closed its business at Aurangabad unit for which the board resolution and nature of closure of factory notice by the employer is reproduced below:-

“CERTIFIED TRUE COPY OF THE BOARD RESOLUTION PASSED AT THE BOARD METTING OF LUMAX AUTOMOTIVE SYSTEMS LIMITED HELD ON 29TM  JANUARY 2010 AT 63-64, GHOKALE MARKET, NEW DELHI-110054

The company authorizes its board to take the decision of closer of loss making factories of the company.  RESOLVED THAT the board approved to close the C-10, MIDC, Valuj, Aurangabad factory due to shortage of funds, lack of orders in hand and non modernization of old plant and machinery.

FURTHER RESOLVED THAT Mr. Nitin Jain. Executive Director and/or Mr. J.S. Nain be and are hereby jointly or severally authorized to settle the matter with workers, and take all other necessary actions in this regard.

“Notice of closure of factory by an Employer

Same of the Employer: Lumax Automotive Systems Ltd.
Address: C10, Waluj, Aurangabad.
Dated 29^th day of January, 2010.

In accordance with provision of the Industrial Dispute Act, 1947 we hereby give notice to all concerned that it is our decision to affect the closure specified in the annexure. with effect from 31^s‘ March, 2010.

Signature

U.K. Jain

Chairman and Managing Director

This factory has been suffering heavy and perpetual losses for the 2-3 years due to various reasons, The major ones is financial problem. We have lost orders from our valued and ‘ominous customer. Further, due to losses and paucity of funds the unit is not able to upgrade machines and testing facilities, thereby adversely effected quality or our products. Dwindling quality of products and higher manufacturing cost has forced us out of the competition and ultimately loss of orders from the customers. If we still continue with this factory, the other factories will affect and the whole company will face the consequences. With a view to overcome from this problem, the management has decided to close the factory and request the workers to take their full and final settlement from the company. Management is also open to any viable suggestions from the concerned workmen.”

The closure of factory retrenchment of employees is not equivalent to voluntary retirement scheme of group of employees under the VRS scheme. Hence the provision for 35DDA is not applicable in this case. The appellants claim is made u/s 37(1) of the IT Act which is permissible in law. The appellant incurred expenditure on payments made to retired employees of closed unit as full and final settlement of their dues. Hence this is made for business purpose. It is made wholly and exclusively for business purpose of appellant company and there is no element of personal element involved in such payments to retired employees. Therefore, the AO’s addition of Rs.57,25,789/- is not proper and justified. I allow the claim of the appellant as per its computation of income u/s 37(1) of the IT Act. All the grounds of appeal relating to this one issue of allowability of retrenchment compensation of the section 37(1) are allowed.

In the result, the appeal is allowed.

5. After considering the submissions of the Ld. D.R. in the light of findings of the Ld. CIT(A), we do not find any merit in the Departmental Appeal. The assessee-company explained that it has closed down its Aurangabad unit due to heavy losses suffered by the assessee-company. The assessee-company in this year has declared loss of Rs.4.34 crores in the return of income and after making addition as well, the net taxable loss have been determined at Rs.3.77 crores. Therefore, the contention of the assessee-company is correct that in order to save future losses, Aurangabad unit was closed down by the assessee-company. The closure is approved by the Board of Directors and there was an Agreement executed between the Worker’s Union and the Assessee-Company for retrenchment of its employees on account of closure of the Aurangabad factory. These facts have not been rebutted by the Revenue. Therefore, it is clear that amount in question have been paid by assessee-company on account of retrenchment compensation on closure of the Aurangabad unit of the assessee-company. The amount is thus paid for business purposes only and as such, it was an allowable deduction under section 37 of the I.T. Act. Provisions of Section 35DDA applied by the A.O. are not applicable in this case because assessee-company has not paid any service compensation under any scheme of voluntary retirement. In the absence of any contrary material brought on record, we are of the view that no interference is called for in the matter. The Departmental Appeal stands dismissed.

6. In the result, appeal of the Department is dismissed. Order pronounced in the open Court.