TMI Blog1990 (5) TMI 31X X X X Extracts X X X X X X X X Extracts X X X X ..... he assessment year 1983-84, the income arising from these contracts have to be brought under section 80HHB of the Income-tax Act, 1961 ? (3) Whether, on the facts of the case, the Tribunal is right in holding that the income from the entire activities under the seven agreements cannot be bifurcated and is wholly covered under section 80HHB of the Income-tax Act, 1961 ? (4) Whether, on the facts and in the circumstances of the case, the Tribunal is right in holding that the assessee-company is not an 'industrial company' as defined in the Finance Act, 1982 ? " At the instance of the respondent, the Tribunal has referred the following question of law : "Whether, on the facts and in the circumstances of the case, the Tribunal was correct in holding that, having regard to the provisions of sections 40(c) and 40A(5)(b) of the Income-tax Act, the remuneration paid to the directors in respect of their employment outside India has to be excluded from the limit of Rs. 72,000 laid down in the first proviso to section 40A(5)(a) as well as section 40(c) of the Income-tax Act, 1961?" The facts, as stated by the Tribunal, are that the assessee is a civil construction company which had ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tracts was covered by the provisions of section 80HHB of the Income-tax Act which had been introduced with effect from April 1, 1983. According to him, the contracts were civil building contracts and the total consideration was for the execution of the work. He also observed that the basic planning and specification had been made out by the various Governments or enterprises and the assessee only executed the work and he further held that there was no provision for giving any technical know-how or rendering of technical services. Having regard to the provisions of section 80HHB, the income from these projects, according to the Inspecting Assistant Commissioner, could not be considered under any other provision. In fact, he went to the extent of observing that the provisions of section 80-O were never applicable to the agreements entered into by the assessee with foreign Governments or enterprises. According to the Inspecting Assistant Commissioner, the personnel sent by the assessee abroad were mostly non-technical persons and only a few of them were so qualified. The claim of the assessee under section 80-O was, therefore, rejected and it was held that the assessee could not get t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t. The approval was for the contract and the mention of the assessment year with respect to which this approval was applicable was redundant. The Tribunal observed that though as many as seven contracts were involved in the computation of income in this year, the major submissions were made in respect of the Karkh and Diwaniyah works, firstly, because they involved the highest amount of payments and profits and, secondly, because there had been modification of the original approval and a later clarification given by the Board. Analysing the legal position, the Tribunal took note of the provisions of section 80HHB and it was found that it related to execution of foreign projects which included contracts for construction and did not exclude any such work on the basis of its being sophisticated or highly complicated. The Tribunal referred to sub-section (5) of section 80HHB and held that the language of this sub-section was absolute in its terms and it makes section 80HHB the first provision to be considered for allowance of deduction under this sub-Chapter and if it is found that the whole consideration or the income payable to the assessee for the execution of the foreign projects i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ces. In such a case, the provisions of section 80-O would still be applicable to that part. The Tribunal further rejected the plea of the assessee regarding promissory estoppel. Referring to the confusion created by the qualified approval followed by modification of that approval and the clarification given, the Tribunal held that the matter had to be decided in accordance with the provisions of law and not the confusion which might have been created due to any action taken by any authority. The Tribunal, therefore, held that the income and consideration received by the assessee in the execution of all the seven contracts in general, and the Karkh work in particular, fell under the provisions of section 80HHB as the contracts were for the execution of the projects. It was further held that in view of the provisions of section 80HHB(5), the claim of the assessee under section 80-O could not be considered in spite of the approval granted by the Board. One of the other questions which was considered by the Assessing Officer, the Commissioner of Income-tax (Appeals) and the Income-tax Tribunal was whether the assessee could be regarded as an industrial company for the purpose of dete ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... uestion of law, set out hereinabove, has been referred to this court. Pursuant to the orders of the Tribunal, applications under section 256(1) were filed by the assessee as well as the Department. The Tribunal reframed the questions and stated the case and referred the aforesaid questions of law to this court. In deciding questions Nos. 1 to 3, which are inter-related and interconnected, the main questions which arise for consideration are as to what is the full scope and effect of the provisions of sections 80HHB and 80-O of the Act and under which provision do all or any of the agreements entered into between the assessee and the foreign enterprises fall. In order to examine the rival contentions, it is first necessary to refer to the provisions of sections 80HHB and 80-O. The topic, namely, deduction in respect of royalties, etc., from certain foreign enterprises, was first dealt with by section 85C which was inserted in the Income-tax Act with effect from April 1, 1966. By the Finance (No. 2) Act, 1967, section 80-O was inserted in place of section 85C with effect from April 1, 1968. Amendments were made to the said section from time to time and during the previous yea ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eering contracts outside India, it was proposed to provide a tax relief on the profits derived by them from foreign contracts. In the Bill as presented to Parliament the section contained only four sub-sections. Thereafter, while passing the Finance Act, 1982, subsection (5) was also inserted and with effect from April 1, 1983, section 80HHB was enacted. The said section 80HHB as enacted is as follows: "80HHB. Deduction in respect of Profits and gains from projects outside India.- (1) Where the gross total income of an assessee being an Indian company or a person (other than a company) who is resident in India includes any profits and gains derived from the business of (a) the execution of a foreign project undertaken by the assessee in pursuance of a contract entered into by him, or (b) the execution of any work undertaken by him and forming part of a foreign project undertaken by any other person in pursuance of contract entered into by such other person, with the Government of a foreign State or any statutory or other public authority or agency in a foreign State, or a foreign enterprise there shall, in accordance with and subject to the provisions of this section, be all ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... er, within a period of six months from the end of the previous year referred to in clause (ii) or, where the Commissioner is satisfied (for reasons to be recorded in writing) that the assessee is, for reasons beyond his control, unable to do so within the said period of six months, within such further period as the Commissioner may allow in this behalf : Provided that where the amount credited by the assessee to the Foreign Projects Reserve Account in pursuance of clause (ii) or the amount brought into India by the assessee in pursuance of clause (iii) or each of the said amount is less than twenty-five per cent. of the profits and gains referred to in sub-section (1), the deduction under that sub-section shall be limited to the amount so credited in pursuance of clause (ii) or the amount so brought into India in pursuance of clause (iii), whichever is less. (4) If at any time before the expiry of five years from the end of the previous year in which the deduction under sub-section (1) is allowed, the assessee utilises the amount credited to the Foreign Projects Reserve Account for distribution by way of dividends or profits or for any other purpose which is not a purpose of th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... covered by the provisions of section 80HHB. On behalf of the respondents, Shri Ahuja submitted that section 80-O could not apply to a contract like the present which was a single indivisible contract. In other words, income from turnkey projects was not entitled to deduction under section 80-O of the Act. According to Shri Ahuja, the assessee could claim a deduction only under section 80HHB, provided other conditions in the said provision were complied with. In the alternative, it was submitted by Shri Ahuja that even if it be held that a turnkey project could be covered by section 80-O, nevertheless the income which would be entitled to deduction under section 80-O must be a fee, royalty or commission or similar payment and, in the present case, on a proper construction of the contracts, it was not possible to hold that the assessee had received any income of that nature. In short, the submission of Shri Ahuja was that what the assessee had received were business profits from the execution of its work outside India and that those profits could not be regarded as income which is referred to in section 80-O, namely, fee, royalty or commission. In support of his contention that a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ly, patent or a drawing. Similarly, commission is usually paid for services rendered by one person to another. A fee would also be receipt of money for services rendered, for example, by a professional engineer or an architect. The services which are to be rendered, in such a case, are in discharge of their professional functions and duties. According to the said provision, any other payment which is received should also be of a similar nature in order that a claim under section 80 can be made. Broadly speaking, the income which is contemplated under section 80-O which is entitled to the benefits under the said provision has to be either for professional services rendered or a receipt for permission to use an intellectual property of the assessee. This is evident from the fact that the section itself states that the income which is received is to be in consideration, for use outside India, of any patent, invention, model, design, secret formula, process or information concerning industrial, commercial, scientific knowledge, experience or skill. All this would fall in the category of, what is more commonly known as, "know-how". In other words, section 80-O was enacted with a view to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... "Where the gross total income of an assessee ... by way of royalty ... received by assessee from the Government of a foreign State ... in consideration for the use outside India of any patent, invention ... or information concerning ... scientific knowledge, experience or skill made available ... to such Government ... or in consideration of technical services rendered, outside India to such Government..." The section contemplates the use of any patent, invention, etc., outside India which patent, design, etc., is provided by the Indian company to such foreign Government. The section also specifies that technical services are to be of such a nature which are rendered outside India to such foreign Government. It is clear, therefore, that the information which is supplied or technical services which are rendered is meant for the benefit of, or for the use of, the foreign Government or enterprise. Regarding the supply of patent, invention, model, design, etc., for a royalty, commission or fee, there are four different types of situations which may arise and we have to consider whether section 80-O would be attracted in those situations or not. The first situation may be where th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o be executed by the company itself, though under a different contract ? It appears to us that, in such a case, the Indian company would have, in a sense, a dual entity. It will be regarded as a supplier of technical information to the foreign Government for which it will receive a royalty, fee, commission, etc., and this information, etc., which is supplied is then used by that very Indian company as an agent of the foreign Government for executing the work. If an Indian company named "A" supplies technical information and the same is used, in response to an independent contract with that foreign Government, by another Indian company called "B" who carries out the civil engineering works, then if company "A" is entitled to claim deduction under section 80-O, it would not stand to reason or logic that the benefit in respect of supply of that technical data would be lost instead of company "B" it is company "A" itself which executes the civil engineering work. For getting additional work, the Indian company "A" should not be denied the benefits of section 80-O which it would undoubtedly be entitled to receive if that civil engineering work was executed by another Indian company name ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ntitled to the benefit of section 80-O in respect of the income arising therefrom, will it be logical that the provisions of section 80-O would be inapplicable if, by a separate agreement, the technology supplied is used by the Indian company for executing the project ? In our opinion, the answer to this must be in the negative, provided the conditions contemplated by section 80-O are satisfied. If there are two distinct and separate contracts between the foreign Government or enterprise and the Indian company, one for the supply of technology for a royalty, commission or fee and another for the execution of work or project pursuant thereto, then the first contract can come within the ambit of section 80-O provided the other requirements of the said section are fulfilled. This would be for the reason that there would be a transfer of knowledge or technology by the Indian company to the foreign Government or enterprise for a royalty, commission or fee and the income which is generated at that point of time in respect of the technology so transferred would be entitled to deduction under section 80-O. We do not find any indication in section 80-O which would deprive the Indian company ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f the know-how or the technical services, etc., qualifying for section 80-O, the Board may not approve such an agreement for the purposes of section 80-O of the Act." The said circular also provided that the deduction under section 80-O would be subject to fulfilling of the other conditions laid down in the section and that the actual amount eligible for deduction will be determined by the Income-tax Officer at the time of assessment. Subsequently, another Circular No. 253 was issued by the Board in clarification of clause (ix) of paragraph 3 of the aforesaid Circular No. 187. In the new circular, it was, inter alia, stated as follows : "It was also stated in para 3(ix) of the circular dated 23-12-1975 that in the case of a composite agreement which specified a consolidated amount as consideration for purposes which included matters outside the scope of section 80-O, the Board may not approve such an agreement for the purposes of section 80-O of the Act if it was not possible to properly ascertain and determine the amount of the consideration relatable to the provision of the know-how or technical services, etc., qualifying for section 80-O. Thus, the benefit of section 80-O co ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... at certain amount of estimation was permissible. In income-tax law, it is well recognised, for example, when the books of account are rejected, that profits or income which may be subject to tax may have to be estimated. similar principle seems to have been incorporated in the later Circular No. 253. It is, however, pertinent to note that in the later Circular No. 253 it is clearly provided that what would be entitled for disallowance is the "balance of the royalty, fees, etc.". In other words, the amount which is allowable is to be in the nature of royalty and fee and not anything else. This is in consonance with the provisions of section 80-O. To put it differently, even the approximate, figure out of a consolidated amount of consideration mentioned in a composite agreement which is to be allowed as deduction under section 80-O has to be in the nature of royalty, fee or commission and not anything else. The important question, however, is, what is "a composite agreement" as understood by the Board in its Circular No. 187 and Circular No. 253 ? Paragraph 3(ix) refers to that type of "a composite agreement specifying consolidated amount as consideration for purposes which include ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e the contract was executed by the assessee itself. Section 80-O also requires that a royalty, commission, fee, etc., be paid in consideration of the patent, invention, model, design, etc., being "made available or provided or agreed to be made available or provided . . ." to the foreign Government or enterprise. The difference in the language of section 80MM and section 80-O is not of any material significance. Whereas section 80MM contemplated technical know-how assisting in the installation of the machinery, etc., section 80-O clearly provides for information being made available or provided to the foreign Government or enterprise. Just as the installation or erection of the machinery did not amount to the transfer of know-how, as held in Simon Carves' case [1979] 120 ITR 172 (Delhi), similarly, the execution of a turnkey project cannot amount to making available or providing to the foreign Government or enterprise information regarding patent, invention, design, etc. Just as in Simon Carves' case [1979] 120 ITR 172, it was held by this court that the technical know-how was used by the company itself and there was no rendering of technical know-how to the foreign party, similarl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the same from the total consideration payable and the resultant figure would be regarded as relating to matters falling within the scope of section 80-O. In the present case, while in answer to the query which had been raised by the Board it had been stated by the petitioner that the income which was received was in consideration of information concerning industrial, commercial or scientific knowledge, experience or skill made available but, during the course of arguments before the Tribunal, the emphasis was that the consideration which was received by the petitioner was in respect of technical services to be rendered to the Government of Iraq. In the present case, the project was being executed by the Indian company itself. Technical services which are rendered in the execution of a project may involve engaging architects, engineers and other skilled workmen. Section 80-O requires that the technical services should be rendered by the Indian company to the foreign Government or enterprise. If the civil and other works were being executed by the Government of Iraq or by any other nominee or agent of the said Government and the assessee had sent its engineers and other skilled per ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hnical know-how supplied or made available by the Indian company to the foreign Government or enterprise. Technical information, in the execution of a turnkey project, always remains with the Indian company and is made available to and used by itself. It was then submitted by learned counsel for the assessee that the Department cannot go behind the approval which had been granted under section 80-O by the Board. The submission was that, under section 80-O, an agreement has to be approved by the Board before deduction under section 80-O can be claimed. According to learned counsel, the Board grants the approval only after it is satisfied that the agreement in question is of the type that would fall under section 80-O. The decision of the Board is not mechanical. The Board is not a registering authority which is required to merely take note of every agreement which is entered into by the Indian company with a foreign party but the Board is, under section 80-O, obliged to apply its mind and examine the agreement and, thereafter, either to grant or refuse approval. Once approval is granted, then the subordinate authorities, specially the Income-tax Officer, have no jurisdiction to ch ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ditions set out therein had to be satisfied before recognition could be granted by the Commissioner of Income-tax. Once recognition was accorded, then it meant that all the conditions in the Fourth Schedule were satisfied and what was being paid by way of commission was in fact salary and that the Income-tax Officer could not come to a contrary conclusion. The Supreme Court made some observations with regard to the true impact of the recognition granted by the Commissioner of Income-tax. It was noted that recognition had been granted after the true nature of the commission which was paid had been considered and the grant of recognition implied that the provident fund of the assessee satisfied all the conditions laid down in Part A of the Fourth Schedule to the Act. The Supreme Court then observed that (at p. 15) "in that situation we do not think that it was open to the taxing authorities to question the recognition in any of the relevant years on the ground that the assessee's provident fund did not satisfy any particular condition mentioned in rule 4. It would be conducive to judicial discipline and the maintaining of certainty and uniformity in administering the law that the tax ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ply/use of goods like machinery, plant, equipment, vehicles, etc., and that the cost of supply of these items will be determined at the close of each year as the work progresses. It was further provided that, after taking out the net cost of machinery and equipment from the total value of the contract, the remaining amount will be the value of technical know-how and services to be rendered under the contract which would be entitled to exemption under section 80-O. It will be seen that it was not the case of the assessee that, at least in this application, the work which was awarded was a turnkey project. The Board, vide its letter dated October 28, 1983, while granting approval for the assessment year 1982-83 and onwards (the words "and onwards" having been added by virtue of the letter dated July 31, 1985), nevertheless stated that "the grant of deduction from the total income will be subject to your fulfilling the other conditions laid down in the Act in this behalf. The amount eligible for deduction will be determined by the Income-tax Officer at the time of assessment". If this letter, requiring the determination of the amount to be deducted by the Income-tax Officer, is read a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cer to determine as to what amount is allowable as deduction under section 80-O. The Income-tax Officer can come to the conclusion that there is no income which falls under the provisions of section 80-O or that, even though the contract or agreement may be providing for rendition of technical services or information, nevertheless it is not possible to conclude that any income by way of royalty, fee or commission has been paid to or received by the assessee. When, in the letter of approval, it is provided that the assessee will have to fulfil other conditions laid down in the Act in order to be entitled to the grant of deduction, the Income-tax Officer had to satisfy himself as to whether the conditions laid down in section 80-O were also fulfilled. If the Income-tax Officer finds that information or technical services have not been rendered to the foreign Government or enterprise or that the amount which is received is not in the nature of royalty, fee or commission then, by virtue of the letter of approval itself, the Income-tax Officer would be justified in coming to the conclusion that these conditions laid down in section 80-O have not been complied with or fulfilled by the as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t is only if the understanding of section 80-O by the Board shows an error of law apparent on the face of the record that the court would have to interfere with the rejection of an application. If, however, the decision of the Board is in keeping with the object of section 80-O and is a reasonable construction of the words, then the court would not be called upon to interfere under article 226. Simon Carves' case [1979] 120 ITR 172 (Delhi) has already been referred to and need not be considered afresh except to note that while the court held that in executing a turnkey project, there could be no question of transferring know-how relating to installation or erection of machinery or plant, it was observed that the said section 80MM also referred to the provision of technical know-how which was likely to assist in the manufacture or processing of goods or material. As this question had not been considered by the Board, the Board was directed to reconsider the application whether the technical drawings assisted in the manufacture, or processing of goods or material or in the working or use of design plant. In Lurgi India's case [1980] 121 ITR 287 (Delhi), the question arose as to w ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... intention of this provision. The court, in that case, was primarily concerned with the question whether there was an agreement of the assessee with the Indian company or with the foreign Government. That is not the question which arises before us and, therefore, that case is clearly distinguishable. We would, however, like to observe that the court did not consider and analyse section 80-O in detail as no arguments appear to have been addressed on the question as to whether, in turnkey project, there can be rendering of technical assistance to the foreign Government or enterprise in consideration of royalty, fee or commission. In the case of Oberoi Hotels [1982] 135 ITR 257 (Delhi), an agreement had I been entered into with the foreign company by the assessee whereby it had to manage a hotel of the foreign company at Kathmandu. The Board did not approve the agreement, inter alia, on the ground that the services which were being rendered were in the nature of managerial services and did not amount to rendering of technical services. Furthermore, it could not be said that any information concerning industrial, commercial or scientific knowledge or skill was being supplied to the fo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pursuant to a contract entered into by such other person. (4) The contract or undertaking of the project should be with foreign Government or State or public authority or agency in a foreign State or with a foreign enterprise. (5) The consideration should be payable in convertible foreign exchange. (6) Conditions specified in sub-section (3) of section 80HHB are fulfilled relating to maintaining separate account, crediting to reserve account an amount equal to 25% of the profits and gains and 25% of the profits and gains is brought by the assessee in convertible foreign exchange, within the stipulated period. The essential difference between section 80HHB and section 80-O is that whereas the income which falls under section 80-O has to be in the nature of royalty, commission or fee, under section 80HHB, the reference is to "profits" and "gains" derived from the business. If the execution of the foreign project also entails designing and planning, etc., of the project which is to be executed but the consideration, in respect thereto, which arises is in the nature of profits or gains derived from a business, then the amount of profits or gains relatable to designing and plan ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... scharging certain duties such as, for instance, of an agent, factor, broker or any other person who manages the affairs or undertakes to do some work or renders some service to another. Mostly, it was a percentage on price or value or upon the amount of money involved in any transaction of sale or service or the quantum of work involved in a transaction. It could be for a variety of services and was of the nature of recompense or reward for such services." From the aforesaid decision in Stanton and Stavely's case [1984] 146 ITR 405 (Cal), it may be reasonable to conclude that the first part of section 80-O deals with receipt of royalty, commission or fee in consideration of an intellectual property right being allowed to be used by the foreign Government or enterprise and the latter part of section 80-O refers to similar type of money being received in consideration of professional services being rendered, namely, the rendering of technical assistance. Furthermore, it appears to us that, in the agreement, there has to be definite basis for the charge of a fee, commission or royalty. Either a sum which is so charged is specified or a rate at which the royalty, fee or commission ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... template receipt of consideration in respect of drawings or technical information which may be supplied by the assessee to the foreign Government or party. The submission was that the word "project" means only a project for construction or the undertaking of civil engineering work and that planning, designing, etc., was not included in the meaning of the expression "execution of a foreign project". Laying emphasis on the word "execution", it was submitted that there must be a plan in existence which is to be executed. We are unable to agree with the aforesaid contention. We see no justification for giving a restricted meaning to the expressions "execution of foreign project" or " execution of any work". Sub-section (2)(b) of section 80HHB defines a "foreign project" as, inter alia, meaning a project for the construction of any building, road, dam, bridge or other structure outside India, assembly or installation of any machinery outside India. As per the Oxford English Dictionary, the word "project", inter alia, means "to plan, contrive, devise or design (something to be done, or some action or proceeding to be carried out) ; and "to plan, devise or design to do something". It ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... himself. The technical information or skill necessary for the execution of foreign project is not imparted by the assessee to the foreign Government or enterprise, but it is used by the assessee himself. Therefore, the execution of the work by the assessee, in the present case, falls under section 80HHB and not under section 80-O. While referring to the Karkh Water Supply contract, it was submitted by learned counsel for the assessee that the agreement was a composite agreement and was not a turnkey project. We find that this contention was neither raised nor dealt with by the Tribunal. Nevertheless, there is no merit in this submission. In the instructions to the tenderers, in clause 1.1, it has been stated as follows : "The Baghdad Water Supply invites experienced engineering consortia to submit tenders for the design, manufacture, delivery, construction or installation complete under a single contract of the works required for Stage 1 (910 MLD capacity) of the Karkh Water Supply Scheme". (emphasis added). The aforesaid clause of the invitation to tender clearly shows that the tenders are being invited for a single contract for the complete works. The contractor had to car ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... urce from any payments made from the fund which are chargeable to tax under the head 'Salaries' ; (b) in the case of any firm, any payment of interest, salary, bonus, commission or remuneration made by the firm to any partner of the firm; (c) in the case of any company (i) any expenditure which results directly or indirectly in the provision of any remuneration or benefit or amenity to a director or to a person who has a substantial interest in the company or to a relative of the director or of such person, as the case may be; (ii) any expenditure or allowance in respect of any assets of the company used by any person referred to in sub-clause (i) either wholly or partly for his own purposes or benefit, if in the opinion of the Income-tax Officer any such expenditure or allowance as is mentioned in sub-clauses (i) and (ii) is excessive or unreasonable having regard to the legitimate business needs of the company and the benefit derived by or accruing to it therefrom [so, however, that the deduction in respect of the aggregate of such expenditure and allowance in respect of any one person referred to in sub-clause (i) shall, in no case, exceed (A) where such expenditure or a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sistance referred to in clause (5) of section 10 or passage moneys or the value of any free or concessional passage referred to in sub-clause (i) of clause (b) of that section or any sum referred to in clause (vii) of sub-section (1) of section 17 or in clause (v) of sub-section (2) of that section or the amount of any compensation referred to in clause (i) or any payment referred to in clause (ii) of sub-section (3) of that section or any payment referred to in clause (iv) or clause (v) of sub-section (1) of section 36 shall not be taken into account." Further, the then existing Explanation was renumbered as Explanation 1 and, thereafter, Explanation 2 was inserted. [ Explanation 2 was omitted by ibid., with effect from 1-4-1969. The so omitted Explanation was inserted by Act 5 of 1964, with effect from April 1, 1964, and stood as under : "Explanation 2. -In sub-clause (iii), the word 'salary' shall have the meaning assigned to it in clause (h) of rule 2 of Part A of the Fourth Schedule." With effect from April 1, 1969, sub-clause (iii) to section 40(c) was omitted and in its place, sub-clause (v) was added to section 40(a). The newly added sub-clause (v) is as under: "(v) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Act, 1971, sub-clause (v) of section 40(a) was omitted and subsection (5) was inserted in section 40A. Sub-section (1) and sub-section (5) of section 40A with effect from April 1, 1972, are as under : "40A. Expenses or payments not deductible in certain circumstances.-(1) The provisions of this section shall have effect notwithstanding anything to the contrary contained in any other provision of this Act relating to the computation of income under the head 'Profits and gains of business or profession'. (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 or incurs directly or indirectly any expenditure or is entitled to any allowance in respect of any assets of the assessee used by an employee either wholly or partly for his own purposes or benefit, then, subject to the provisions of clause (b), so much of such expenditure or allowance as is in excess of the limit specified in respect thereof in clause (c) shall not ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... payment of any salary to an employee or a former employee engaged in scientific research during any one or more of the three years immediately preceding the commencement of the business and such expenditure is deemed under the Explanation to clause (i) of sub-section (1) of section 35 to have been laid out or expended in the previous year in which the business is commenced, the limit referred to in this sub-clause shall, in relation to the previous year in which the business is commenced, be an amount calculated at the rate of five thousand rupees for each month or part thereof comprised in the period of his employment in India during the previous year in which such business is commenced and in the period of his employment in India during which he was engaged in scientific research during the three years immediately preceding that previous year ; (ii) in respect of the aggregate of the expenditure and the allowance referred to in sub-clause (ii) of clause (a), one-fifth of the amount of the salary payable to the employee or an amount calculated at the rate of one thousand rupees for each month or part thereof comprised in the period of employment in India of the employee during ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tion 40A(5)) and section 40(c) of the Act. It was held by the High Court that section 40(a) applies to all assessees and sub-clause (v) thereof dealt with the expenses for providing benefit, amenity or perquisite to the employees. On the other hand, clause (c) of the section dealt with the provision of benefit, amenity or perquisite to the directors of a company. Section 40(a)(v) was held to be a general provision, while section 40(c) was regarded as a particular enactment. The Gujarat High Court, therefore, concluded that section 40(a)(v) will not be applicable to the directors of a company who are also employees of the company and only the provisions of section 40(c) would be applicable. This judgment was referred to by the Gujarat High Court in CIT v. Bharat Vijay Mills [1981] 128 ITR 633. The Gujarat High Court was, however, not concerned with the question as to whether section 40(c) or section 40A(5) applied which is the question which had arisen in Rustam Jehangir Vakil Mills Ltd.'s case [1976] 103 ITR 298 (Guj). Therefore, the said decision can be of little assistance in the present case. Another decision of the Gujarat High Court is that of CIT v. Ramesh Textile Mills Ltd ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r employee, being a director or a person who has substantial interest in the company or a relative of the director or of such person. It does not, it was observed, like the proviso to section 40(c), speak of the period for which he was a director and, therefore, section 40A(5) applied to an employee being a director during the whole year. This was held to be a special provision where the assessee is a company and where, inter alia, the person concerned is an employee being a director of the company. This case again was concerned with the question as to the limit of the remuneration which was allowable and the court had no occasion to deal with the question that where there is a conflict between section 40(c) and section 40A(5), which is the provision which will apply. The view of the Gujarat High Court in Bharat Vijay Mills' case [1981] 128 ITR 633 was dissented from by the Kerala High Court in Travancore Rayons Ltd. v. CIT [1986] 162 ITR 732. A question arose, in that case, as to whether the expenditure arising or incurred in respect of director of a company, who was also its employee during the relevant year, had to be deducted solely with reference to section 40A(5) and withou ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... any resulting directly or indirectly in making any excessive or unreasonable provision for remuneration or benefit or perquisite to a director or a person who has a substantial interest in the company, etc. 2. With effect from April 1, 1963, sub-clause (iii) was added to section 40(c) which, for the first time, brought in a restriction to the expenditure which resulted directly or indirectly in the making of provision of any remuneration, benefit, etc., in the case of an employee in excess of a stipulated amount. This sub-clause was amended in 1964 and continued to place a restriction on the amount of expenditure which is allowable as a deduction in relation to an employee. 3. With effect from April 1, 1968, section 40A was enacted. 4. With effect from April 1, 1969, sub-clause (iii) to section 40(c) was omitted and, in its turn, a similar provision was added to section 40(a) as sub-clause (v). 5. With effect from April 1, 1972, three changes were made in these two sections. Firstly, section 40(a)(v) was omitted, secondly, section 40A(5) was inserted and, thirdly, the words "so, however, that the . . . as the case may be" were added at the end of section 40(c). The pictur ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... section 40 including section 40(c) would relate to all types of directors and other disallowances. Though employee-directors would, prior to April 1, 1972, have been covered by the provisions of section 40(c), after the enactment of section 40(a)(v) and because of the non-obstante provisions of section 40A(1), it is section 40A(5), and not section 40(c), which will apply in the case of employee-directors. One of the reasons which compels us to come to this conclusion, at least in the present case, is that section 40A(5)(b) specifically deals with the question of an employee who is in employment outside India. When reference is made in section 40A(5)(b) to the provisions of clause (a) of section 40A(5), it would obviously mean that reference is also made to the employee-directors who are employed outside India. Section 40(c) does not deal with cases of employees employed outside India. That situation is dealt with only under section 40A(5). Therefore, even if it be assumed, for the sake of argument, that section 40A(5) is general and section 40(c) is specific qua the directors, nevertheless, in respect of employee-directors who are posted outside India, section 40(c) cannot and does ..... X X X X Extracts X X X X X X X X Extracts X X X X
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