In the present case, the constitutional validity of Section 43B (f) of the Income Tax Act, 1961 (the Act) is under-challenged, which arises out of the decision of Hon’ble Calcutta High Court (the High Court) in case of Exide Industries Ltd vs. Union of India vide order dated A.P.O. 301 OF 2005 IN W.P. NO. 2512 OF 2002 dated 27.06.2007, wherein the Respondent had filed a Writ petition contending that Section 43B (f) of the Act was ultra vires in the law of the land since the assessee being a body corporate was entitled to maintain its accounts by the mercantile system of accounting which is permissible in law.
The ruling of the High Court reached up to Apex Court (the Court) in the present case wherein the Court has analysed the Section 43B since inception along with its objects and also critically observed the intension of the legislature behind the insertion of clause (f) of Section 43B of the Act. Court has also elucidated critically on the powers of the legislature to enact any provisions in the Act in light of various judicial precedents and discussed the Constitutional validity of clause (f) of Section 43B of the Act considering the grounds on which the High Court has held clause (f) of Section 43B of the Act as unconstitutional.
The facts of the present case arise out of the decision of the High Court wherein the amount payable to the employees of Respondent as leave encashment was to be shown in the balance sheet as a liability for each and every year and the employer was entitled to have deduction not only in the year in which it was actually paid but also for the years when the provision was made. The High Court struck down Clause (f) of Section 43 of the Act and held it as arbitrary, unconscionable.
Respondent in the present case being aggrieved with the inclusion of clause (f) of Section 43 of the Act during the time of payment of income tax on the profits and gains of their business, and contended that Section 145 of the Act provides for the independent choice of method of accounting and accordingly, computation of profits and gains of business is determined in accordance with the mercantile system. Respondents further contended that as per the mercantile system, income and expenditure are determined based on accrual or provision and not based on actual receipt/payment.
The respondents further contended that Section 43B of the Act has been carved out as an exception to the afore-stated general rule of accrual basis for determination of liability, as it subjects to deductions in lieu of certain kinds of liabilities to actual payment. According to the respondents, the exception under Section 43B of the Act comes into operation only in a limited set of cases covering statutory liabilities like tax, duty, cess etc. and other liabilities created for the welfare of employees and therefore, the liability under the leave encashment scheme being a trading liability cannot be subjected to the exception under Section 43B of the 1961 Act.
DISCUSSION AND FINDINGS
Concerning issue in hand, the Court has discussed this issue in light of various cases, and judicial interpretations, wherein Court highlighted the objective behind the insertion of clause (f) in Section 43B of the Act, that the clause (f) to Section 43B of the Act came into effect vide Finance Act, 2001 dated 01.04.2002 to provide for a tax disincentive in cases of deductions claimed by the assessee from income tax in lieu of liability accrued under the leave encashment scheme but not actually discharged by the employer. Relevant part of Section 43B of the Act reads as:
Section 43B: Certain deductions to be only on actual payment. – “Notwithstanding anything contained in any other provision of this Act, a deduction otherwise allowable under this Act in respect of —
1. any sum payable by the assessee by way of tax, duty, cess or fee, by whatever name called, under any law for the time being in force, or
2. any sum payable by the assessee as an employer by way of contribution to any provident fund or superannuation fund or gratuity fund or any other fund for the welfare of employees, or
3. any sum referred to in clause (ii) of sub-section (1) of section 36, or
4. any sum payable by the assessee as interest on any loan or borrowing from any public financial institution or a State financial corporation or a State industrial investment corporation, in accordance with the terms and conditions of the agreement governing such loan or borrowing, or
5. any sum payable by the assessee as interest on any term loan from a scheduled bank in accordance with the terms and conditions of the agreement governing such loan, or
6. any sum payable by the assessee as an employer in lieu of any leave at the credit of his employee,
shall be allowed (irrespective of the previous year in which the liability to pay such sum was incurred by the assessee according to the method of accounting regularly employed by him) only in computing the income referred to in section 28 of that previous year in which such sum is actually paid by him.”
The Court regarding the issue of Constitutional validity of clause (f) of Section 43B of the Act stated that, Constitutional validity of any provision can be determined by inspecting the existence of enacting power of legislature and ascertained as to whether the enacted provision impinges upon any right enshrined in Part III of the Constitution, which is well settled given judicial precedent in case of State of Madhya Pradesh v. Rakesh Kohli & Anr.  6 SCC 312 wherein Apex Court observed that;
“This Court has repeatedly stated that legislative enactment can be struck down by Court only on two grounds, namely (i) that the appropriate legislature does not have competence to make the law, and (ii) that it does not take away or abridge any of the fundamental rights enumerated in Part III of the Constitution or any other constitutional provisions….”
Apex Court also called for prudent approach to the following principles while examining the validity of statutes on taxability wherein Court in case of Rakesh Kohli & Anr (Supra) also state that;
“While dealing with constitutional validity of a taxation law enacted by Parliament or State Legislature, the Court must have regard to the following principles:
1. there is always presumption in favour of constitutionality of a law made by Parliament or a
2. no enactment can be struck down by just saying that it is arbitrary or unreasonable or irrational but some constitutional infirmity has to be found,
3. the Court is not concerned with the wisdom or unwisdom, the justice or injustice of the law as Parliament and State Legislatures are supposed to be alive to the needs of the people whom they represent and they are the best judge of the community by whose suffrage they come into existence,
4. hardship is not relevant in pronouncing on the constitutional validity of a fiscal statute or economic law, and
5. in the field of taxation, the legislature enjoys greater latitude for classification “
Court in light of the decision in case of Rakesh Kohli & Anr (Supra) which provided two-fold approach to determine the constitutional validity of provisions, stated that; there is no doubt on legislative power of the Parliament to enact clause (f) in the light of Article 245 however, while discussing the second requirement, Court further stated that it is trite law that examination of the Court begins with a presumption in favour of constitutionality. It further specifically stated that;
“to decide the timing, content and extent of legislation is a function primarily entrusted to the legislature and in exercise of judicial review, the Court starts with a basic presumption in favour of the proper exercise of such power”.
Method of accounting vis – a – vis Section 43B of the Act
Court further explained the chargeability provisions of the Act wherein Section 145 of the Act clearly provides for the method of accounting and reads thus;
“Method of Accounting;
145. (1) Income chargeable under the head “Profits and gains of business or profession” or “Income from other sources” shall, subject to the provisions of sub-section (2), be computed in accordance with either cash or mercantile system of accounting regularly employed by the assessee.
(2) The Central Government may notify in the Official Gazette from time to time accounting standards to be followed by any class of assessees or in respect of any class of income.
(3) Where the Assessing Officer is not satisfied about the correctness or completeness of the accounts of the assessee, or where the method of accounting provided in sub-section (1) or accounting standards as notified under sub-section (2), have not been regularly followed by the assessee, the Assessing Officer may make an assessment in the manner provided in section 144.”
Court in light of averment of Respondent for selection of method of accounting under Section 145 of the Act states that; Section 145(1) provides the autonomy to the assessee for method of accounting and assessee is in is well within its rights to follow the mercantile system of accounting which is controlled by the regulation notified by the Central Government and must be adhered by the assessee. Court further states that Section 43(B) of the Act does not put any embargo on the assessee on adopting the method of accounting, nor it restricts him from availing the deduction under specific head.
Analysis of Ruling of High Court
Court observed the grounds on which the High Court had ruled Clause (f) of Section 43 as ultra-virus and unconstitutional as follows:
1. Non-disclosure of objects and reasons behind its enactment and insertion into section 43B;
2. Inconsistency of clause (f) with other clauses of Section 43B and absence of nexus of the clause with the original enactment;
3. Enactment has been triggered solely to nullify the dicta of this Court in Bharat Earth Movers v. Commissioner of Income Tax, Karnataka  6 SCC 645
Analysing the grounds on which the High Court has struck down the clause (f) of Section 43B, Court further discussed all three aforesaid mentioned grounds in detail as follows:
1. Non-disclosure of objects and reasons:
The objects and reasons behind any statute or Section signifies the tangible objective of the legislature behind its enactment. It helps in understanding the real purpose of the legislature to formulate the change in the existing Act by considering the judicial precedents and existing circumstances which compelled the legislature to enact the certain provision. However to satisfy the preposition of law regarding the powers of Courts and legislature, Court relied on the decision of Sanjeev Coke Manufacturing Company v. Bharat Coking Coal Limited and Anr.  1 SCC 147, where it noted;
“No one may speak for the Parliament and Parliament is never before the Court. After Parliament has said what it intends to say, only the Court may say what the Parliament meant to say. None else. Once a statute leaves Parliament House, the Court is the only authentic voice which may echo (interpret) the Parliament. This the Court will do with reference to the language of the statute and other permissible aids.”
Court in the present case after analysing the observation of Apex Court in case of Sanjeev Coke Manufacturing Company (Supra) held that;
“when the textual element of the provision reeks of ambiguity and is susceptible to multiple meanings, the Court enters into a proactive examination to find out the real meaning of the provision. This proactive examination by the Court offers multiple avenues and methods to achieve the ultimate purpose of interpretation. Adverting to the express objects and reasons may be useful for limited purpose to understand the surrounding circumstances at the time of enactment. The Court is not bound by such external elements, as discussed above. Therefore, the presence or absence of objects and reasons has no impact upon the constitutional validity of a provision as long as the literal features of the provision enable the Court to comprehend its true meaning with sufficient clarity.”
Thus, Court further concluded that the ruling of Division bench of the High Court has performed over and above presumption of constitutionality in favour of clause (f) and based its judgment upon the absence of objects and reasons as striking at the root of its validity.
The Court further stated that the examination of the Courts are only restricted to the findings and interpretations of the provisions of the legislations, Courts can neither sit on the chair of legislation nor are empowered to invalidate the provision enacted by the legislation merely because the objects and reasons for the enactment of the provision were not specifically provided for, hence, disagreed with the first ground of the High Court to held clause (f) of Section 43B of the Act as ultra-virus.
2. Inconsistency of clause (f) and absence of nexus with Section 43B
Court observed that the High Court has invalidate the clause (f) of Section 43(B) mainly on the basis of the following;
1. it’s in consist and distinct nature as compare to other clauses and nature of deduction mentioned Section 43B and
2. lack of nexus of cause (f) of Section 43B with the main objects and reasons behind the enactment of Section 43B
At the outset Court observed that; the aforesaid grounds on which the High Court has held the inconsistency of clause (f) of Section 43B of the Act is ill-founded. Court observed that in year of 1983 wherein for the first time Section 43B of the Act was introduced in the Act and noted that; the main objective behind enactment of Section 43B of the Act was to restrict the certain practises of evasion of statutory liabilities and other liabilities for the welfare of employees prevailing at that time. Court further observed that Section 43B of the Act is a versatile provision as there is no uniformity into it and it includes diverse nature of deduction ranging from tax, duty to bonus, commission, railway fee, interest on loans and general provisions for welfare of employees.
Thus it’s quite evident that the legislature never intended to categorised Section 43B of the Act under the particular kind of deductions, hence Court noted that main objective of enacting Section 43B of the Act concerning specified deductions was to protect larger public interest primarily of revenue including welfare of the employees and clause (f) of Section 43B of the Act which clearly fits into that scheme and shares sufficient nexus with the broad objective. Thus given the aforesaid reasoning , Court disagreed with the second ground of Division High Court to held clause (f) of Section 43B of the Act is inconsistent and without any nexus with the objects and reasoning of Section 43B of the Act
3. Defeating the dictum in case of Bharat Earth Movers (Supra)
Court observed and examined the clause (f) of Section 43B on the ground that it defeats the judgment of Apex Court in case of Bharat Earth Movers (supra) wherein it was held that;
“If a business liability has arisen definitely, deduction may be claimed against the same in the previous year in which such liability has accrued, even if it has not been finally discharged. The Court further held that the liability in lieu of leave encashment scheme is a present and definite liability and not a contingent liability.
The ruling in case of Bharat Earth Movers (Supra) concludes the liability of encashment as present liability, hence deductible from the profit and loss account of the assessee in the same accounting year in which provision against the same is made and rejected the leave encashment liability as a contingent liability. However the ruling of the Apex Court in case of Bharat Earth Movers (Supra) was on the line with mercantile system of accounting that treating the liability in lieu of leave encashment as a contingent liability does not comply with mercantile accounting system.
Court by analysing the decision of Bharat Earth Movers (Supra) and the legal stand of legislation noted that, though legislature cannot sit on the chair of the judgment of the Apex Court and overrule it, however, the judgment was delivered with strict regard to the enactment as applicable at the relevant time. Court specifically stated that;
“A legislative body is not supposed to be in possession of a heavenly wisdom so as to contemplate all possible exigencies of their enactment. As and when the legislature decides to solve a problem, it has multiple solutions on the table. At this stage, the Parliament exercises its legislative wisdom to shortlist the most desirable solution and enacts a law to that effect. It is in the nature of a ‘trial and error’ exercise and we must note that a law-making body, particularly in statutes of fiscal nature, is duly empowered to undertake such an exercise as long as the concern of legislative competence does not come into doubt. Upon the law coming into force, it becomes operative in the public domain and opens itself to any review under Part III as and when it is found to be plagued with infirmities. Upon being invalidated by the Court, the legislature is free to diagnose such law and alter the invalid elements thereof. In doing so, the legislature is not declaring the opinion of the Court to be invalid.”
Court observed that the ruling in the case of Bharat Earth Movers (supra) was elucidated in view to provide the autonomy to the assessee to follow the cash or mercantile system of accounting, prevailing at the relevant time in absence of an express statutory provision to do so differently. The legislation has inserted clause (f) in Section 43B of the Act only to the extent of limited change, and it applies prospectively. Court specifically held that;
“Merely because a liability has been held to be a present liability qualifying for instant deduction in terms of the applicable provisions at the relevant time does not ipso facto signify that deduction against such liability cannot be regulated by a law made by Parliament prospectively. In matter of statutory deductions, it is open to the legislature to withdraw the same prospectively”
Explaining further on the same line, Court stated observed that, the amendment in Section 43B of the Act by insertion of clause (f) neither amount to reverse the nature of the liability nor has it taken away the deduction as such. The liability of leave encashment continues to remain a present liability as per the mercantile system of accounting. Insertion of clause (f) to Section 43B of the Act does not take away the autonomy of the assessee to follow the mercantile system. The insertion of clause (f) to Section 43B of the Act merely defers the benefit of deduction to be availed by the assessee to compute his taxable income and links it to the date of actual payment thereof to the employee concerned.
Court finally held that;
“A priori, merely because a certain liability has been declared to be a present liability by the Court as per the prevailing enactment, it does not follow that legislature is denuded of its power to correct the mischief with prospective effect, including to create a new liability, exempt an existing liability, create a deduction or subject an existing deduction to new regulatory measures. Court cannot venture into hypothetical spheres while adjudging constitutionality of a duly enacted provision and unfounded limitations cannot be read into the process of judicial review. A priori, the plea that clause (f) has been enacted with the sole purpose to defeat the judgment of this Court is misconceived”
“In view of the clear legal position explicated above, this appeal deserves to be allowed. Accordingly, the impugned judgment of the Division Bench of the High Court is reversed and clause (f) in Section 43B of the 1961 Act is held to be constitutionally valid and operative for all purposes. No order as to costs. Pending interlocutory applications, if any, shall stand disposed of”
The Court, in the present case, had appropriately overruled the decision of the High Court and established the constitutionality validity of clause (f) of Section 43B of the Act. The Court in the present case has explained the powers of legislation to enact any particular provision of the law in light of various judicial precedents.
Court has critically examined the detailed procedure of determining the constitutional validity of particular provisions enacted by the legislation by relying on the decision of Rakesh Kohli & Anr.(Supra) which has been followed by the Apex Court in other cases. The Court has explained the procedure to determine the constitutional validity by retreating the established law i.e. “examination of the Court begins with a presumption in favour of constitutionality” This presumption is not just borne out of judicial discipline and prudence, but also out of the basic scheme of the Constitution wherein the power to legislate is the exclusive domain of the Legislature/Parliament.”
The present case has provided with versatile flavors of analysis on various aspects, another aspect which the Court has critically examine is Section 43B of the Act, wherein detailed explanation has been provided upon on the real object of legislation to enact Section 43B of the Act along with its scope and dynamism. The real crux of the case is understanding of Section 43B of the Act and object of legislation behind inserting clause (f) to Section 43B of the Act which has been very clearly explained in detail. Court also stated that that mere inclusion of clause (f) to Section 43B of the Act will not put an embargo or restrictions on the assessee to have the autonomy in the selection of the method of accounting as governing by Section 145 of the Act.
The present case may act as a yardstick for other Courts to determine the constitutional validity of provisions enacted by the legislature.
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