Swati Dehairya and Rishiraj Singh Bhati
Union Of India & Others Vs. Exide Industries Ltd. And Another (Supreme Court): A Constitutionality Check On Section 43B(f) Of Income Tax Act, 1961.
ABSTRACT
The Income Tax Act of 1961 is a complicated fiscal law. The Act has undergone several amendments over time in order to meet the socioeconomic demands of the state. Though certain amendments may appear arbitrary to tax payers at times, but same must be understood, one must first recognize the purpose of the amendment, which is closely monitored by the Indian courts. In light of this, the current case comment intends to examine the recent Supreme Court decision in the case of Union of India & Others v. Exide Industries Ltd. and another,[1] in which the Court ruled in favour of the legality of clause (f) of Section 43B of the Income Tax Act of 1961.
Introduction
Section 43B is a mixed bag, with new and exciting items being added from time to time to accommodate various budgetary conditions as defined by the government of a day. The government can create a new obligation, exclude an existing responsibility, or add a deduction or subject a current deduction to overriding laws or restrictions. Noting to the same in recent case of U.O.I v. Exide Industries, the Supreme Court looked over the constitutionality of clause (f) of section 43B which was challenged on the grounds that it defeated the dictum of Bharat Earth Movers case [2] and shared no nexus with section 43B[3]. Thus, the present case note seeks to analyze the judgement, as well as grounds and reasoning on which the apex court has upheld the constitutionality of the provision.
Brief facts
In the present case the Exide Industry (hereinafter respondent) company was running a manufacturing business of storage batteries and adopted mercantile system of accounting for their profits and gains of business as per section 145[4] of the Income Tax Act, 1961 (hereinafter Act) which allows and offers a business enterprise to use the choice of method of accounting for their business. This mercantile system of accounting allows for determining of income and expenditure on accrual basis and not on the basis of actual payment or receipt.[5] The respondent was liable to pay income tax upon their profits and gains, found them aggrieved with the insertion of clause (f) in section 43B[6] of the Act. Further, the respondent contented that section 43B has been set as an exception to the general rule of mercantile system. However, the exception U/S 43B comes into effect only in a limited number of cases covering statutory liabilities such as tax, duty, cess etc. other such liabilities provided for the benefit of staff are wholly of different nature.[7] Thus, the liability under the leave encashment scheme, being a trading liability, is not subject to the exemption under section 43B.[8] It was also stated that since the due date for encashment of leave does not arise in the same accounting year in which provision was made, there was no question of subjecting the deductions against such liability upon actual payment.[9]
The issue was raise before the High Court and the HC characterised clause (f) in section 43B of the Act as ‘arbitrary’ and ‘unconscionable’ while imputing it with unconstitutionality.[10]
Judgement Analysis
The honourable Supreme Court, while determining the case, pronounced its decision in favour of constitutionality of clause (f) of section 43B, and thus, gave decision in three folds. Firstly the judgment discusses about constitutional validity of clause (f), secondly about non disclosure of objects and reasons and lastly, inconsistency of clause (f) and absence of nexus with section 43B.
The Court quoted the exposition of Rakesh Kohli case[11] in which it was stated that only two reasons exist for a court to overturn a legislative act, first that the competent legislature lacks the authority to enact legislation; second, it abridges or eliminates any of the fundamental rights enshrined in Part III of the Constitution or any other constitutional provisions.[12]
Thus in present case, the court stated that parliament’s power to enact clause (f) was in consonance with Art 245[13] of the C.O.I.[14] The issue that the court had to determine was that whether the provision in question infringed any of the rights established in Part III of the Constitution.
The court stated that section 43B, was enacted to allow deductions to be availed in place of liabilities accruing in previous year without making actual payment to discharge the same.[15] As a result, the aforementioned provision neither restricts the assessee’s ability to choose any method of accounting nor denies any legitimate deduction; rather, it only serves as a prerequisite for claiming a deduction under the stated head.[16]
The leave encashment scheme anticipate the payment of a certain amount to the employee in place of their unused paid leaves in a year, and the nature of this payment is beneficial and pro-employee. An employer can seek deduction for liability of such leave encashment without actually extending such payment to employee i.e. at the time of retirement when such payment arises, the employer may simply refuse. Thus, this would entail double benefit to the employer firstly the advance deduction from tax liability without making actual payment and secondly, refusal to pay the same when the occasion arises. Therefore, the mischief seeks to subjugate by clause (f) of section 43B of the Act.[17] The Court went on to say that a legislation meant to prevent revenue fraud is more appropriately legislation against fraud than taxation legislation, and hence should be given a generous interpretation in favour of the government.[18]
Supreme Court’s examination on High Court’s decision
The Supreme Court further examined the reasons given by the High Court for giving decision against the validity section 43B (f) of the Act[19] was mainly based on three grounds:
I. Non Disclosure of objects and reasons
The Court referring to various precedents observed that, the Statement of Objects and Reasons of any ratification explains the main reasons for its implementation, and it can be used to assess the real intentions of the legislature, or to determine the purpose of the said legislation of the specific Act, or to determine the appropriateness of the classification made by such Act.[20] Furthermore, the court said that if the literal interpretation of a provision is enabling the Court to comprehend the true meaning with ample clarity of a provision then in such a case the presence or absence of Objects and Reasons creates no influence on the constitutional validity of the said provision.[21]
The SC observed that the HC has discarded the fundamental principle of constitutionality in favour of the provision and based its judgement upon the absence of Objects and Reasons as striking at the roots of its validity. Thus, the said approach by the HC was said to be flawed for three reasons, firstly it steers clear from the necessary attempt to discover any constitutional infirmities in the enacted provision; secondly it makes no attempt to dissect the text of the provision so as to display the need to go beyond the text; thirdly, it goes into the background of the enactment and ventures into a sphere which is out of bounds of the Court as long as the need for interpretation borne out of any ambiguity arises[22].
Therefore, as a result, a provision’s validity is unaffected by the lack or non-disclosure of Objects and Reasons unless the provision is unclear and the alternative interpretation breaches part III of the Constitution. The Court does not have the authority to invalidate a provision unless it is found to have a constitutional flaw.[23] Thus, the SC said that HC’s conclusion for clause (f) as arbitrary and unconscionable was undertaken without an actual examination of the said clause.
II. Inconsistency of clause (f) and absence of nexus with Section 43B
The SC observed that the HC has affirmed conclusion of invalidity by noting two remarks with relation to the previously existing clauses of section 43B; firstly that clause (f) is inconsistent with other clauses and nature of deduction targeted in clause (f) is distinct from other deductions.[24] Secondly, that clause (f) has no nexus with the objects and reasons behind the enactment of original section 43B and therefore, the Objects and Reasons attributed to section 43B cannot be used to deduce the object and purpose of clause (f).[25]
The SC on this held that, the grounds given by the HC are ill-founded. The court said that to say that section 43B is restricted to deductions of statutory nature would be like reading a provision in purely imaginative manner, because as per the basic scheme of section 43B, there is no direct or indirect limitation upon the power of legislature to include any particular type of deductions in the ambit of section 43B.[26] Section 43B had taken folds of diverse nature of deductions and it reveals that legislature is never restricted the provision to a particular nature or category of deduction. It is, in effect, a provision that imposes conditionality on deductions ordinarily permissible under the Act in respect of specific headings in the earlier year in which the amounts is actually paid, regardless of accounting system. Therefore, the SC determined that the overarching objective of enacting section 43B addressing defined deductions was to safeguard the overall public interest, especially revenue and employee welfare, and that clause (f) fits into the scheme and has a sufficient nexus with it.[27]
III. Defeating the dictum in Bharat Earth Movers Case[28]
Before the decision of Bharat Earth Movers, various tribunals and High Courts were considering the liability of leave encashment as a contingent liability, which did not sit well with assesses who were using the mercantile method of accounting because they were unable to claim deductions by making a provision against such a liability without making the actual payment.[29] As a result, this was appealed to the Supreme Court. Thus, SC in the aforementioned case ruled that because leave encashment constitutes a current and definite liability rather than a contingent liability, it could be claimed on an accrual basis (even if payment was pending).[30] As a result, it has become deductible from the assessee’s profit and loss account in the same accounting year in which the provision is made. Later on clause (f) was introduced to section 43B of the Act with effect from financial year 2001-02 corresponding to assessment year 2002-03 to restrict deduction for leave encashment only on payment basis.
Thus, court on the issue that legislature has defeated the dictum of Bharat Earth Movers case by stating precedents noted that in exercising legislative power, the legislature by mere declaration, without anything more, cannot directly render the judicial decision invalid or ineffective; it can do so by enacting valid law on the topic within its legislative field fundamentally altering or changing its character retrospectively the condition on which such a decision is based.[31] Thus, the Court 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 prospective’.[32] Furthermore, the court observed that the enactment was intended to protect employees and to address the mischief of assessees who used to defer payment while claiming deductions under the pretext of the mercantile system.
Therefore, on the basis of aforementioned discussion the Supreme Court makes legal position of clause (f) under section 43B of the Act clear by upholding the constitutional validity of deduction of leave encashment on payment basis.
Comments
The Supreme Court’s decision in favour of constitutionality of section 43B (f) of the Act was commendable. Section 43B of the Act talks about certain deductions to be claimed only on payment and insertion of clause (f) i.e. regarding leave encashment was essential, solely to safeguard the overall public interest, especially revenue, as well as the welfare of employees. It must be noted that the aim and objective behind enactment of section 43B of the Act was to restrict the certain malpractice of evasion of statutory and other liabilities for the welfare of employees.
Noting to the same, clause (f) has acted as tool for tax evasion as employers can easily put up provision for leave encashment and can claim deduction for that assessment year and later, on the date of payment of that leave encashment at the time of retirement, the employer may refuse to do the same. Thus, by this the employer is getting double benefit firstly by availing deduction on tax, then later on, by refusing to make payment of the same to employee for which the deduction is availed by him. By this it is very evident that clause (f) fits into the scheme of section 43B of the Act and shares nexus with its broad objective. Also it is pertinent to note that if a competent legislature by exercising its legislative wisdom enacts a valid law particularly in statutes of fiscal nature, it is duly empowered to do so upon being invalidated by the Court, the legislature is free to diagnose such law and alter or amend the invalid elements of the said law. And by doing the same the legislature is not declaring the opinion of the Court to be invalid.[33] Therefore, insertion of clause (f) of section 43B does not render the dictum of Bharat Earth Movers Case.
The legislature is the best forum to consider various fiscal issues and formulate policies to address them, such as establishing a new liability, exempting an existing liability, establishing a deduction, or subjecting an existing deduction to new regulatory measures. The power to frame laws to plug specific leakages and loopholes is inherent in the nature of taxing statutes. Such laws are always specific in nature, and are only intended to target a specific avenue of taxation taking into account experiences of tax evasion and avoidance. Unless the law stinks of constitutional infirmities, the general principles of exclusion and inclusion do not apply to taxing statutes with the same exuberance.
Conclusion
Section 43B of the Income Tax Act provides a list of expenses allowed as deduction under the head ‘Income from business and profession’, which states some expenses that can be claimed as deduction from the business income only in the year of actual payment and not in the year when the liability to pay such expenses is incurred.[34]
The Supreme Court in the present case of Union of India v. Exide Industry Ltd.[35] upheld the constitutional validity of clause (f) of section 43B and had accurately reversed the judgment of Calcutta HC for the given case. In light of several precedents, the court in this case has clarified the power of legislation to legislate any particular kind of law, inter alia, the court has also marked that clause (f) fits with the framework and has shared sufficient nexus with the wide purpose of implementing section 43B concerning specific deductions referred to therein. The SC also observed that the insertion of clause (f) does not put an embargo on the autonomy of assessee to choose the method of accounting U/S 145 of the Act.
The court has emphasized that the insertion of clause (f) under the umbrella of section 43B is not a move of legislature to defeat the dictum of Bharat Earth Movers case. The SC agrees that legislature cannot sit over a judgment of the SC or overrule it, but the competent legislature can correct the nuances given in a law by enacting a valid law as legislature is the forum for formulating the policies and to enact a valid law which can correct the mischief if any. Thus, the SC holds that “once the enactment itself stands corrected, the basic cause of adjudication stands altered and necessary effect follows the same.”
[1] Union of India & Others v. Exide Industries Ltd. And Another, (2020) 425 ITR 1: (2020) 5 SCC 274.
[2] Bharat Earth Movers v. CIT, (2000) 6 SCC 645.
[3] The Income Tax Act, 196, Act no. 43, Acts of Parliament, § 43B (India).
[4] The Income Tax Act, 196, Act no. 43, Acts of Parliament, §145 (India).
[5]Union of India & Others v. Exide Industries Ltd. And Another, (2020) 425 ITR 1: (2020) 5 SCC 274, ¶ 4.
[6] The Income Tax Act, 196, Act no. 43, Acts of Parliament, § 43B (India).
[7]Id.
[8]Union of India & Others v. Exide Industries Ltd. And Another, (2020) 425 ITR 1: (2020) 5 SCC 274, ¶ 4.
[9]Id., ¶ 5.
[10] Exide Industries Ltd. v. Union of India, 2007 SCC OnLine Cal 932: (2007) 212 CTR 206, reversed.
[11] State of M.P. v. Rakesh Kohli, (2012) 6 SCC 312: (2012) 3 SCC (Civ) 481.
[12]Union of India & Others v. Exide Industries Ltd. And Another, (2020) 425 ITR 1: (2020) 5 SCC 274, ¶ 15.
[13] India Const. Art. 245.
[14]Union of India & Others v. Exide Industries Ltd. And Another, (2020) 425 ITR 1: (2020) 5 SCC 274, ¶ 17.
[15]Id., ¶ 20 at 2.
[16]Id.
[17]Id., ¶ 24.
[18]Id., ¶ 26, Crawford, Statutory Construction , 508.
[19] The Income Tax Act, 196, Act no. 43, Acts of Parliament, § 43B (f) (India).
[20]Union of India & Others v. Exide Industries Ltd. And Another, (2020) 425 ITR 1: (2020) 5 SCC 274, ¶ 29.
[21]Id., ¶ 34 at 3.
[22]Id., ¶ 35.
[23]Id., ¶ 36.
[24]Id., ¶ 41.
[25]Id,, ¶ 41.
[26]Id., ¶ 42, at 4.
[27]Id., ¶ 43.
[28] BharatEarth Movers v. CIT, (2000) 6 SCC 645.
[29]Union of India & Others v. Exide Industries Ltd. And Another, (2020) 425 ITR 1: (2020) 5 SCC 274, ¶ 46.
[30]Id., ¶ 51.
[31] Welfare Assn. v. Ranjit P. Gohil (2003) 9 SCC 358 p.386; see Indian Aluminium Co. v. State of Kerala (1996) 7 SCC 637; see also, State of T.N v. Arooran Sugars Ltd., (1997) 1 SCC 326.
[32]Union of India & Others v. Exide Industries Ltd. And Another, (2020) 425 ITR 1: (2020) 5 SCC 274, ¶ 51.
[33]Id., ¶ 47.
[34]The Income Tax Act, 196, Act no. 43, Acts of Parliament, § 43B (India).
[35] Union of India & others v. Exide Industries Ltd. and Anr., (2020) 425 ITR 1: (2020) 5 SCC 274.
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The article is written by Swati Dehairya and Rishiraj Singh Bhati, students of 4th year B.A.LL.B(Hons.) at Dharmashastra National Law University, Jabalpur.
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