TMI Blog1993 (12) TMI 39X X X X Extracts X X X X X X X X Extracts X X X X ..... gratuity amount of Rs. 90,000. But the assessee subsequently claimed before the Income-tax Officer the entire amount of Rs. 90,000 as deductible expenditure. The claim of the assessee for deduction of the said amount was rejected by the Income-tax Officer and also by the Appellate Assistant Commissioner in appeal. In the further appeal before the Tribunal, the Tribunal by its order dated July 21, 1979, held that the payment which was made by the assessee to the director was to be considered under section 40(c) of the Income-tax Act, 1961, and not under section 40A(5) of the Income-tax Act, 1961. The Tribunal further held that the amount of Rs. 90,000 incurred by the assessee as expenditure for payment of retirement gratuity to the chairman and full-time director of the assessee was not includible in determining the amount of expenditure which is inadmissible having regard to the provisions of section 40(c)(i) of the Income-tax Act. The Tribunal has followed its earlier decision in arriving at its conclusion. Hence the following questions have been referred to us under section 256(1) of the Income-tax Act, 1961 : "(1) Whether, on the facts and in the circumstances of the case, in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... (a). The prohibition under this sub-section is on the deductibility of any provision made for payment in the future to an employee of gratuity on his retirement or termination of service unless it satisfies the requirements of section 40A(7)(b). It does not deal with any actual payment of gratuity during the accounting year. The provisions of section 40A(7) have been considered by the Supreme Court in the case of Shree Sajjan Mills Ltd. v. CIT [1985] 156 ITR 585. The Supreme Court has observed that on a plain construction of clause (a) of section 40A(7) whatever is provided for future use by the assessee out of the gross profits of the year of account for payment of gratuity to its employees on their retirement or on the termination of their services would not be allowed as a deduction unless the conditions specified in clause (b) are fulfilled. The Supreme Court has construed the expression "provision made by the assessee" and has held that a provision cannot be equated with expenditure. The Supreme Court has further observed that the actual payments could have been eligible for deduction, inter alia, under section 37 of the Income-tax Act, 1961. However, in view of the non obstan ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... omprised in the previous year, the amount of seventy-two thousand rupees ; (B) where such expenditure or allowance relates to a period not exceeding eleven months comprised in the previous year, an amount calculated at the rate of six thousand rupees for each month or part thereof comprised in that period : Provided that in a case where such person is also an employee of the company for any period comprised in the previous year, expenditure of the nature referred to in clauses (i), (ii), (iii) and (iv) of the second proviso to clause (a) of sub-section (5) of section 40A shall not be taken into account for the purposes of sub-clause (A) or sub-clause (B), as the case may be." Section 40A(5) which broadly deals with payment of salary and perquisites to an employee is as follows : "S. 40A.(5)(a) Where the assessee,-- (i) incurs any expenditure which results directly or indirectly in the payment of any salary to an employee or a former employee, or (ii) incurs any expenditure which results directly or indirectly in the provision of any perquisite (whether convertible into money or not) to an employee . . . . then, subject to the provisions of clause (b), so much of such ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ub-clause (iv) and the whole of sub-clause (vii) shall be omitted ; ......" Section 40A(5), therefore, deals with expenditure which results directly or indirectly in the payment of salary to an employee or a former employee or which results in the granting of any perquisites to him. A problem, however, arises when the director of a company is also an employee of the company, i.e., when a person works in the dual capacity of a director as also an employee either throughout the previous year or a part of it. In this situation does section 40(c) apply or section 40A(5) apply ? In this connection, if we consider the provisions of both these sections, we find that both the sections will have to be applied on the principle of harmonious construction. For example, under section 40(c), the proviso which follows clause (b) clearly envisages the situation where a director is also an employee of the company for any period comprised in the previous year. It provides that certain expenditure of the nature specified under section 40A(5) set out in clauses (i), (ii), (iii) and (iv) of the second proviso thereto shall not be taken into account for the purposes of the ceiling set out in sub-claus ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... iod comprised in the previous year or any part thereof. Section 40A(5)(c) refers to salary and perquisites. The limits of expenditure under these heads are set out in sub-clause (c)(i). Sub-clause (c)(i) prescribes a limit calculated at the rate of Rs. 5,000 for each month or part thereof comprised in the period of his employment duting the previous year. This refers to expenditure under the head of salary, while sub-clause (c)(ii) refers to the limit on the expenditure incurred on account of any perquisites given to an employee which shall not exceed, inter alia, Rs. 1,000 for each month or part thereof comprised in the period of employment during the previous year. Therefore, once again, these payments must also be periodic payments relatable to the period of employment forming a part of the previous year. Any payment which is not relatable to the previous year is not covered by either of these sections. Can the payment of retirement gratuity to a retiring director-cum-employee in the relevant previous year be considered as such expenditure ? To decide this question the manner of computing such expenditure prescribed in these two sections is very relevant. Any expenditure which ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o a person mentioned in that clause.... It cannot have any reference to payments made by the assessee for all kinds of services or facilities referred to under section 40A(2)(a)". These observations of Venkataramaiah J. (as he then was) have been approved by the Supreme Court in the case of Bharat Beedi Works P. Ltd. v. CIT [1993] 201 ITR 1063. The Supreme Court considered the provisions of section 40(c) while considering the payments made by way of royalty for the use of a trade name. The same ratio applies to the provisions of section 40A(5) also, which deals with similar periodic payments made to the employees. Dr. Balasubramaniam, learned advocate, for the Revenue, has urged that these sections also cover non-periodic expenditure. He has placed emphasis on Explanation 2 of section 40A(5). The Explanation 2 says that "salary" in section 40A(5) has the meaning assigned to it in section 17(1) read with section 17(3) with some modifications as set out therein. Before we examine the definition of "salary" it is necessary to note in the first place, that section 40(c) does not make any reference to the word "salary" nor does it contain any such definition of the word "salary". Ther ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... iod covered by the previous year, cannot be taken into account for the computation of the ceiling prescribed under that section. The ceiling is to be calculated with reference to the period covered by the previous year. Including such one-time payment as forming a part of section 40A(5) would render it impossible to calculate the ceiling prescribed in that section in connection with that payment. Including such a payment would make the operation of the section impossible. Such payments, therefore, cannot be considered as forming part of the expenditure which is covered by section 40A(5). Therefore, the definition of "salary" under Explanation 2 to section 40A(5) has to be considered in the light of the provisions of section 40A(5). In the context of section 40A(5), "salary" cannot be considered as including a one-time payment in the nature of retirement gratuity. It was urged by Dr. Balasubramaniam that if the payment of gratuity cannot be considered for deduction under either of these two sections, it cannot be deducted at all. There are two fallacies in this argument : first, the assumption that unless the expenditure is covered by either section 40(c) or section 40A(5), it can ..... 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