Section 43B(f) deduction allowable only on actual payments : Supreme Court in ‘Union of India vs. Exide Industries Ltd., C.A. No. 3454/2009
As an independent body of the state, the Apex Court of the land has been working day in and day out to address the issues of national importance, even in these difficult times. It has recently in Union of India vs. Exide Industries Ltd. upheld the constitutionality of section 43B(f) and has propounded that the deduction would be allowable only on actual payments.
The said judgment will have wide implications and ramifications which have been discussed as under. But before we start analyzing the judgment of the Hon’ble Supreme Court, it is expedient to briefly address the history of the provision in question and its development, which is as follows:
A. Introduction of Section 43B(f):
This provision in consideration was inserted by the Finance Act, 2001, w.e.f 01.04.2002, i.e., A.Y. 2002-03. Clause (f) to sec 43B provides that any sum payable by an employer in lieu of leave at the credit of his employee shall be allowed only on actual payment and not on mere provision.
However, contrary to what had been stated by the legislature, the Hon’ble Supreme Court in Bharat Earth Movers vs CIT, (2000) 245 ITR 428 (SC) held that the deduction would be allowed in the year in which the provision made. The extract of the judgement reads as under:
“4. The law is settled; if a business liability has definitely arisen in the accounting year, the deduction should be allowed although the liability may have to be quantified and discharged at a future date. What should be certain is the incurring of the liability. It should also be capable of being estimated with reasonable certainty though the actual quantification may not be possible. If these requirements are satisfied the liability is not a contingent one. The liability is in praesenti though it will be discharged at a future date. It does not make any difference if the future date on which the liability shall have to be discharged is not certain.
5. In Metal Box Co. of India Ltd. vs. Their Workmen (1969) 73 ITR 53 (SC) the appellant company estimated its liability under two gratuity schemes framed by the company and the amount of liability was deducted from the gross receipts in the P&L a/c. The company had worked out on an actuarial valuation its estimated liability and made provision for such liability not all at once but spread over a number of years. The practice followed by the company was that every year the company worked out the additional liability incurred by it on the employees putting in every additional year of service. The gratuity was payable on the termination of an employee’s service either due to retirement, death or termination of service—the exact time of occurrence of the latter two events being not determinable with exactitude beforehand. A few principles were laid down by this Court, the relevant of which for our purpose are extracted and reproduced as under :
(i) For an assessee maintaining his accounts on mercantile system, a liability already accrued, though to be discharged at a future date, would be a proper deduction while working out the profits and gains of his business, regard being had to the accepted principles of commercial practice and accountancy. It is not as if such deduction is permissible only in case of amounts actually expended or paid;
(ii) Just as receipts, though not actual receipts but accrued due are brought in for income-tax assessment, so also liabilities accrued due would be taken into account while working out the profits and gains of the business;
(iii) A condition subsequent, the fulfilment of which may result in the reduction or even extinction of the liability, would not have the effect of converting that liability into a contingent liability.
(iv) A trader computing his taxable profits for a particular year may properly deduct not only the payments actually made to his employees but also the present value of any payments in respect of their services in that year to be made in a subsequent year if it can be satisfactorily estimated.
So is the view taken in Calcutta Co. Ltd. vs. CIT (1959) 37 ITR 1 (SC) : TC 16R.197 wherein this Court has held that the liability on the assessee having been imported, the liability would be an accrued liability and would not convert into a conditional one merely because the liability was to be discharged at a future date. There may be some difficulty in the estimation thereof but that would not convert the accrued liability into a conditional one; it was always open to the tax authorities concerned to arrive at a proper estimate of the liability having regard to all the circumstances of the case.
6. Applying the abovesaid settled principles to the facts of the case at hand we are satisfied that provision made by the appellant company for meeting the liability incurred by it under the leave encashment scheme proportionate with the entitlement earned by employees of the company, inclusive of the officers and the staff, subject to the ceiling on accumulation as applicable on the relevant date, is entitled to deduction out of the gross receipts for the accounting year during which the provision is made for the liability. The liability is not a contingent liability. The High Court was not right in taking the view to the contrary.
7. The appeal is allowed. The judgment under appeal is set aside. The question referred by the Tribunal to the High Court is answered in the affirmative, i.e., in favour of the assessee and against the Revenue.”
B. Present Position on Leave Encashment:
The challenge was made to the constitutionality of the provision before the Calcutta High Court in Exide Industries, (2007) 292 ITR 470 (Cal) after referring to Bharat Earth Movers vs. CIT (Supra), and it was held that the provision made by the assessee for leave encashment cannot be disallowed u/s 43B(f). The Court held the provision to be arbitrary and vulnerable, because there was no disclosure of reasons for the amendment. The High Court ruled that, while the Legislature was free to make such amendments, reasons therefor should be inferable and such reasons should be consistent with the provisions of the Constitution and the laws of the land.
However, the Revenue challenged the said decision before the Apex Court, which ultimately upheld the constitutional validity of leave encashment disallowance u/s. 43B of The Act due to the following reasons:
– Nondisclosure of objects and reason
30. To hold a provision as violative of the Constitution on account of failure of the legislature to state the objects and reasons would amount to an indirect scrutiny of the motives of the legislature behind the enactment. Such a course of action, in our view, is unwarranted. The raison d’etre behind this self-imposed restriction is because of the fundamental reason that different organs of the State do not scrutinize each other’s wisdom in the exercise of their duties. In other words, the time-tested principle of checks and balances does not empower the Court to question the motives or wisdom of the legislature, except in circumstances when the same is demonstrated from the enacted law.
We have noted that the High Court has characterised clause (f) as “arbitrary” and “unconscionable” while imputing it with unconstitutionality. It is pertinent to note that the High Court reaches this conclusion without undertaking an actual examination of clause (f). Instead, the declaration is preceded by an enquiry into the circumstances leading upto the enactment. As discussed above, the constitutional power of judicial review contemplates a review of the provision, as it stands, and not a review of the circumstances in which the enactment was made. Be it noted that merely holding an enacted provision as unconscionable or arbitrary is not sufficient to hold it as unconstitutional unless such infirmities are sufficiently shown to exist in the form, substance or functioning of the impugned provision. No such infirmity has been exhibited and adverted to in the impugned judgment.
– Inconsistency of clause (f) and absence of nexus with Section 43B
The High Court held that the provision was unconstitutional for the reason that a) clause (f) is inconsistent with the scheme of the section, i.e. 43B and b) clause (f) has no nexus with the reasons behind the enactment of 43B.
The SC held that there is no direct or indirect limitation on the power of the legislature to include only a particular type of deduction in the ambit of section 43B and that after proper examination, 43B reveals that legislature never restricted it to a particular category of deduction and that the intent cannot be read into the main section by the court, while sitting in judicial review. (Para 32)
It was also held that while interpreting fiscal statutes, constitutional courts should weigh the intent only through the legislature, as they are pin-pointed to target a specific avenue depending on the experiences of tax evasion and tax avoidance. The general principles of exclusion and inclusion do not apply to taxing provisions unless law reeks of constitutional infirmities as a larger discretion is given to legislature in taxing statutes than in other spheres. Thus, the decision of the High Court is untenable. (Para 34)
– Defeating the dictum in Bharat Earth Movers case and held as under
35. We shall now examine clause (f) on the ground that it defeats the judgment of this Court in Bharat Earth Movers (supra). We have carefully analysed the decision in Bharat Earth Movers (supra) and note that the Court was sitting in appeal over the nature of liability under the leave encashment scheme and held such liability to be a present liability. Resultantly, it became deductible from the profit and loss account of the assessee in the same accounting year in which provision against the same is made. The Court rejected that leave encashment liability is a contingent one and observed thus:
“7. Applying the above said settled principles to the facts of the case at hand we are satisfied that provision made by the appellant Company for meeting the liability incurred by it under the leave encashment scheme proportionate with the entitlement earned by employees of the Company, inclusive of the officers and the staff, subject to the ceiling on accumulation as applicable on the relevant date, is entitled to deduction out of the gross receipts for the accounting year during which the provision is made for the liability. The liability is not a contingent liability. The High Court was not right in taking the view to the contrary.”
36. Before the judgment in Bharat Earth Movers (supra), various tribunals and High Courts across the country were treating the liability in lieu of leave encashment as a contingent liability. This did not go down well with the assessees following the mercantile accounting system, as they were not able to avail deductions upon mere creation of a provision against such liability without making the actual payment. A challenge to this legal position reached before this Court in Bharat Earth Movers (supra), wherein the Court reversed the position.
37. It is no doubt true that the legislature cannot sit over a judgment of this Court or so to speak overrule it. There cannot be any declaration of invalidating a judgment of the Court without altering the legal basis of the judgment as a judgment is delivered with strict regard to the enactment as applicable at the relevant time. However, once the enactment itself stands corrected, the basic cause of adjudication stands altered and necessary effect follows the same. 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 lawmaking 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.
39. Reverting to the true effect of the reported judgment under consideration, it was rendered in light of general dispensation of autonomy of the assessee to follow cash or mercantile system of accounting prevailing at the relevant time, in absence of an express statutory provision to do so differently. It is an authority on the nature of the liability of leave encashment in terms of the earlier dispensation. In absence of any such provision, the sole operative provision was Section 145(1) of the 1961 Act that allowed complete autonomy to the assessee to follow the mercantile system. Now a limited change has been brought about by the insertion of clause (f) in Section 43B and nothing more. It applies prospectively. 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. In other words, once the Finance Act, 2001 was duly passed by the Parliament inserting clause (f) in Section 43B with prospective effect, the deduction against the liability of leave encashment stood regulated in the manner so prescribed. Be it noted that the amendment does not reverse the nature of the liability nor has it taken away the deduction as such. The liability of leave encashment continues to be a present liability as per the mercantile system of accounting. Further, the insertion of clause (f) has not extinguished the autonomy of the assessee to follow the mercantile system. It merely defers the benefit of deduction to be availed by the assessee for the purpose of computing his taxable income and links it to the date of actual payment thereof to the employee concerned. Thus, the only effect of the insertion of clause (f) is to regulate the stated deduction by putting it in a special provision.
40. Notably, this regulatory measure is in sync with other deductions specified in Section 43B, which are also present and accrued liabilities. To wit, the liability in lieu of tax, duty, cess, bonus, commission etc. also arise in the present as per them mercantile system, but assessees used to defer payment thereof despite claiming deductions there against under the guise of mercantile system of accounting. Resultantly, irrespective of the category of liability, such deductions were regulated by law under the aegis of Section 43B, keeping in mind the peculiar exigencies of fiscal affairs and underlying concerns of public revenue. 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. Strictly speaking, the 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.
41. The position of law discussed above leaves no manner of doubt as regards the legitimacy of enacting clause (f). The respondents haven either made a case of non-existence of competence nor demonstrated any constitutional infirmity in clause (f).
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 Apex Court upholding the constitutional validity of Sec. 43B(f) reversed the judgment of the Calcutta HC in Exide Industries Ltd. The Hon’ble Court remarked that “the broad objective of enacting Section 43B concerning specified deductions referred to therein was to protect larger public interest primarily of revenue including welfare of the employees and Clause (f) fit into that scheme and shared sufficient nexus with the broad objective.”; With respect to assessee’s strong reliance on co-ordinate bench ruling in Bharati Earth Movers case, SC accepts that the legislature cannot sit over a judgment of SC or overrule it, however, holds that “once the enactment itself stands corrected, the basic cause of adjudication stands altered and necessary effect follows the same.”