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Judgment
N.V. Balasubramanian, J.—The question of law referred for our consideration, at the instance of the revenue, relating to the assessee�s
assessment for its assessment year 1976-77 reads as under :
Whether, on the facts and in the circumstances of the case, the expenditure of the assessee-company which resulted in the provision of a
perquisite to the employees or benefit or amenity to a Director by reason of this being provided with cars used for both official and private
purposes, should be taken to be the actual expenditure incurred in respect of the cars amounting to Rs. 3,98,746 in respect of the employees and
Rs. 4,49,072 in respect of the Directors or at the value of the perquisite of private use of the cars estimated on the assessments of the employees
at Rs. 1,26,413 and the Directors at Rs. 3,55,988 for the purpose of making disallowance u/s 40A(5) and section 40(c)(i) of the income tax Act,
1961 ?
The question is an involved question and the facts are not so complicated. The assessee is a public limited company. The assessee is carrying on
business in spinning and weaving. The assessee for the assessment year 1976-77 returned an income from the business of Rs. 22,24,043. The
assessee while computing the income under the head, �Profits and gains of business or profession� has not taken into account a sum of Rs.
1,26,413 with reference to section 40A(5)(a)(ii) of the income tax Act, 1961 (�the Act�) and a sum of Rs. 3,55,988 with reference to section
40(c)(i) of the Act. The disallowance made by the assessee relates to the expenditure incurred by the assessee on the cars maintained for the use
of employees and its directors. The ITO, while completing the assessment, found that there should be a further disallowance of Rs. 2,72,333 with
reference to the employees, and a sum of Rs. 93,084 with reference to directors with the result the total disallowance would be Rs. 3,98,746 with
reference to section 40A(5)(a)(ii) and a sum of Rs. 4,49,072 with reference to section 40(c)(i), and determined the business income of the
assessee. The ITO, while making the further disallowance has not given any reason for such disallowance, however, the order of the ITO refers to
the amount to be further disallowed and also he made reference to sections 40A(5)(a)(iii) and 40(c)(ii) for making further disallowance. It will be
better if the ITO recorded his reasons for the disallowance because he is a quasi-judicial authority and the order passed by him is liable to be
appealed and it is imperative for the officer to record reasons for the disallowance he has made.
The assessee went in appeal against the order of assessment made to the Commissioner (Appeals). The contention urged on behalf of the
assessee before the Commissioner (Appeals) was that the major portion of the expenditure by way of maintenance inclusive of the depreciation
incurred by the company in respect of cars, even though used by the directors and employees, was mainly for the company�s business purpose
and only a portion of the expenditure should be considered as relating to the personal use of cars by the employees and directors. The
Commissioner (Appeals), following an earlier order passed by his predecessor held that only a portion of the expenditure relatable to the user of
the cars provided by the company to its employees or directors for the personal use should be disallowed as perquisite. He calculated the
perquisite value at Rs. 400 per month in the cases of employees and directors and on that basis, he came to the conclusion that insofar as section
40A(5) is concerned, the additional amount that should be disallowed over and above what had been added back by the assessee was Rs. 3,573
and he held that the assessee was entitled to the relief of Rs. 2,68,700. As regards the directors, he came to the conclusion that the amount added
back by the assessee was more than adequate and the entire disallowance was deleted.
The revenue carried the matter on appeal before the Tribunal objecting to the restriction made by the Commissioner (Appeals) on the
disallowances made under sections 40A(5) and 40(c). The Tribunal, following a decision of the Calcutta High Court in the case of Commissioner
of Income Tax Vs. Britannia Industries Co. Ltd., held that in respect of cars used for the purpose of company�s business as well as for personal
purpose of the directors, an estimated value of perquisite would represent the expenditure incurred by the company which would be disallowable
under that section. The Tribunal, in this view of the matter, upheld the order of the Commissioner (Appeals) and dismissed the appeal preferred by
the revenue. On an application filed by the revenue, the Tribunal has referred the question of law set out earlier.
The learned counsel of the revenue submitted that u/s 40(c)(ii), any expenditure or allowance in respect of any asset of the company used for the
own purpose of benefit of the Director either wholly or partly would be subject to the ceiling under that section. He submitted that the same
analogy should be employed to section 40A(5)(ii) as well and the emphasis given in both the sections is �any expenditure� or allowance in
respect of the assets used by the Director or employee either fully or partly and for considering the ceiling limit, it is only the actual expenditure that
has to be taken into account and not the total expenditure prescribed under rule 3 of the income tax Rules, 1962.
The learned counsel for the assessee, on the other hand, submitted that both sections 40(c) and 40A(5) deal with the expenditure in respect of
the assets of the company used wholly or partly for the purpose of the director or employee and if an asset has been used partly for business
purpose, the entire expenditure has to be allowed and only on the rest, ceiling limit prescribed under sections 40(c) and 40A(5) would apply.
According to him, that in estimating expenditure that would be disallowed either u/s 40(c) or u/s 40A(5). Rule 3 would apply and in the absence of
any amount being available, the amount arrived at by the application of rule 3 would be the proper amount for consideration u/s 40(c) or u/s
40A(5). The learned counsel for the assessee in support of his contention relied upon several decisions.
We have carefully considered the rival contentions. The Supreme Court in C.W.S. (India) Limited Vs. Commissioner of Income Tax,
considered the legislative history of section 40(a)(v), 40A(5) and 40(c)(iii) and observed that the provisions were enacted with a view to
discourage the assessees from incurring expenditure which resulted directly or indirectly in the provision of any benefit, amenity or perquisite to
their employees beyond a particular limit and any expenditure incurred beyond the prescribed limit is liable to be disallowed. The Apex Court in
Commissioner of Income Tax, Delhi (Central-I) Vs. M/s. Continental Construction Ltd., held that sections 40(c) and 40A(5) constituted a
composite scheme and the purpose of prescribing a ceiling on expenditure in connection with directors and employees is to discourage a company
or an organisation from paying excessive salaries, remuneration, perquisites, etc., to its employees and directors, and if it did so, the organisation
would not be able to claim the entire expenditure as deduction, but only expenditure up to the ceiling limit. The decisions of the Supreme Court
make it clear that it is only the actual expenditure that is relevant for consideration for the purpose of determining ceiling limit of allowance either u/s
40(c) or u/s 40A(5).
In Wheels India Ltd. Vs. Commissioner of Income Tax, this Court has held that in computing disallowance u/s 40(c) and section40A(5), the
actual expenditure on house rent of the employees has to be taken into consideration for the purpose of disallowance in the hands of the employer.
This Court expressly dissented from the decision of the Calcutta High Court in the case of Britannia Industries Co. Ltd. (supra) and the decision of
Punjab and Haryana High Court in Prem Nath Gangneja Vs. Edwardganj Public Welfare Association and Another, . The learned counsel for the
assessee, on the other hand, submitted that the decision of this Court in Wheels India Ltd.�s case (supra ), is concerned with the expenditure by
way of house rent and it has no application for the valuation of perquisite on the car provided by the employer to the director. We are unable to
accept the contention of the learned counsel for the assessee. There is no material difference between the use of a car and the use of a house, and
in the light of the ambit of sections 40(c) and 40A(5), the principle laid down by this Court that only the actual expenditure has to be taken will
apply in the case of use of the car also. As a matter of fact, in Commissioner of Income Tax Vs. P.R. Ramakrishnan, , this Court was considering
the use of the car and telephone of the company by the director for his personal purposes and this Court considering the provisions of section
40(c) and the relevant rule regarding the valuation of perquisite in the hands of the employee made the following observations which are applicable
to the facts of the case.
...The purposes behind the two provisions are so wholly different that it is not possible to dovetail section 40(c) into the consideration of the
assessment of the director or the person having as substantial interest in the company. We may make our idea clear by taking an example.
Supposing the company had incurred an expenditure of a sum of Rs. 1,000 per month on the provision of a motor car for a director, part of that
expenditure may have been incurred for the purpose of utilising the conveyance for the actual business needs of the company. In such a case, the
ITO is to find out as to what would be the expenditure that the company would have incurred for its own purposes and what would be the
expenditure that would have been incurred excessively or unreasonable beyond its legitimate needs. The part of the expenditure in excess of the
legitimate needs would come in for consideration u/s 40(c). But when it comes to the assessment of the director himself, what has to be found out
is what would be the expenditure that he would have incurred if he had himself maintained a motor car. If it is estimated that the maintenance of a
motor car would cost him less than what the company has spent, then to the extent to which he would have incurred his own expenditure, he would
be liable to be taxed. In other words, the test for applying section 40(c) is not what is reasonable expenditure that he was likely to incur, but what
is the unreasonable expenditure that has been incurred by the company. We have already indicated that section 2(24)(iv) falls into two parts. We
are, in the present case, considering only the second part of that provision. With reference to the first part, it may not be relevant to consider as to
what he would have incurred as his own expenditure, but for the fact that the company incurred the expenditure on his behalf. In the context of the
difference in approach pointed out above in applying the two provisions the revenue does not appear to be right in seeking to link the assessment
of the director with the disallowance in the hands of the company. As the standards are different, it may even be conceivable that a director may be
assessed on a larger figure than what has been disallowed in the hands of the company as the Officer assessing the company may have been more
liberal in applying section 40(c) to the company, or he may not have disallowed at all anything u/s 40(c)...."" (p. 555)
The above decision makes it clear that if a company claims certain expenditure for the assets used by the director either partly or wholly for his
personal use, it claim the same as its business expenditure to be deducted in the computation of its income. The ITO has to find out what would
have been the expenditure incurred for the company�s purpose and if it exceeds the ceiling limit, that amount would be disallowed. Therefore,
the question of applicability of rule 3 does not arise in determining the ceiling u/s 40(c) and 40A(5). The same view has taken by the Kerala High
Court in the case of Commissioner of Income Tax Vs. Malayalam Plantations (India) Ltd., wherein the Kerala High Court held that the objects of
section 40A(5) and rule 3(b) are distinct and different and section 40A(5) was intended to effectively check the extravagant expenditure by the
employer. The above view of the Kerala High Court was reiterated by the same Court in C.W.S. (India) Ltd. Vs. Commissioner of Income Tax,
which also deals with the perquisite value on a car provided by the employer to the employee. The same view has been taken by the same Court in
Commissioner of Income Tax Vs. Malayalam Plantations (India) Ltd., which deals with a case of motor car and Kerala High Court held that
taxability of such amount in the hands of the employee would not be a criterion for the deductibility of the same amount in the hands of the
employer u/s 40A(5).
The Orissa High Court in the case of COMMISSIONER OF INCOME TAX Vs. ELECTRO STEEL CASTINGS LTD., has also taken the
same view and held that section 17 of the Act insofar as it relates to the perquisites which cover perquisites on motor vehicles has no application to
section 40A(5) and there is no scope to apply rule 3 in computing the income in respect of the business or profession. Therefore, we are unable to
upheld the view of the Tribunal that the estimated value of perquisite under rule 3 would represent the expenditure incurred by the company which
is disallowable u/s 40A(5). The Tribunal overlooked that the Calcutta High Court in the case of Britannia Industries Co. Ltd. (supra) dealt with the
section 40(c)(ii), as it stood then. On the other hand, the objects and purposes of section 40A(5) and rule 3 are distinct and different and the
taxability of the amount in the hands of the employee would not be a criterion for deductibility of the said amount in the hands of the employer,
either u/s 40(c) or u/s 40A(5). The Kerala High Court in Commissioner of Income Tax Vs. Malayalam Plantations (India) Ltd., has discussed the
matter in great detail and held that the decision of Calcutta High Court in Britannia Industries Co. Ltd.�s case (supra) has no application in the
matter of interpretation of section 40A(5). We are in complete agreement with the view expressed by the Kerala High Court and the Tribunal has
omitted to take note of the provisions of section 40(c) and section 40A(5). So also, on the same reasoning, we are unable to agree with the
decision of Punjab and Haryana High Court in Nuchem Plastics Ltd.�s case (supra ).
The learned author Sampath Iyengar in Law of income tax, Vol. 2, Ninth edition at pages 2761 and 2762 observed as under :
The section further enacts that, in respect of any asset of the company used by such persons as aforesaid, not only expenditure thereon, but also
any allowances in respect thereto can be disallowed...
In order to render an allowance disallowable under this clause it is important that a personal benefit must have been derived by the director or the
person having a substantial interest in the company, that is the company did not, and the director or other person alone did, use that particular
asset. It is only in respect of such cases that the allowance is sought to be curtailed by sub-clause (ii) of clause (c)...
Now, it is necessary to consider the other arguments of Mr. Janarthana Raja, the learned counsel for the assessee that though rule 3 may not
be strictly applicable for the purpose of determining the expenditure to be disallowed u/s 40(c) or 40A(5), the amount determined under rule 3 can
be relied upon for the purpose of such disallowance. He strongly placed reliance on a decision of the Bombay High Court in the case of Geoffrey
Manners and Co. Ltd. Vs. Commissioner of Income Tax, wherein the Bombay High Court held as under :
Section 40A of the income tax Act, 1961, is an overriding provision which operates notwithstanding anything to the contrary contained in any
other provision of the Act relating to the computation of the income under the head �Profits and gains of business or profession�. In various
sub-sections it sets out certain expenditure or payments, which are not deductible in the computation of income under the head �Profits and
gains of the business or profession� in the circumstances set out therein. Sub-section (5) thereof deals, inter alia, with expenditure incurred, by
the assessee which results directly or indirectly in the provision of any perquisite to an employee. A plain reading of sub-clause(ii) of clause (a) of
sub-section (5) makes it clear that this provision is intended to place certain ceiling on the deductible amount of expenditure incurred by the
assessee on providing any perquisite to an employee and expenditure in respect of assets of the assessee used by an employee either wholly or
partly for his own purposes or benefit. The ceiling is 20 per cent of the amount of salary payable or an amount calculated at the rate of Rs. 1,000
for each month whichever is less, subject, however, to a further overall ceiling of salary (including the above perquisites and benefits) of Rs. 72,000
per annum. In such a case the first stage to find out the amount of disallowance would be to determine the amount of expenditure attributable to the
use of such assets by the employee directors for their personal purposes or benefit. Sub-clause (iii) of clause (c) of rule 3 of the income tax Rules,
1962, provides for the manner of valuation of the perquisite in respect of the use of the motor car by an employee for his personal use in all
conceivable types of cases. Though the above rule has been framed for determination of the value of a motor car provided by the employer to the
employee for the purpose of computing the income chargeable under the head �Salaries� there is nothing wrong in applying the same for
valuing the perquisites for the purpose of computing the disallowance u/s 40A(5) of the Act because it has been framed by the Central Board of
Revenue with a view to getting over the difficulties that might arise in determining the value of perquisites in respect of the use of the car owned and
maintained by the employer for the employee.
******
The method of valuation of perquisite in respect of motor car set out in the first part of sub-clause (ii) of clause (c) of rule 3 of the income tax Rules
would be applicable in all cases where it is possible to do so. It is only in cases where determination of the value in the manner laid down in the first
part of clause (c) (ii) is found to be difficult that the valuation should be made on the basis set out in the second part thereof and the table appended
thereto."" (p. 696)
We respectfully dissent from the judgment of the Bombay High Court. We have already noticed the decision of this Court in the case of P.R.
Ramakrishnan (supra) and the decision of this Court in Wheels India Ltd.�s case (supra ). In both the cases, this Court has taken a view that the
valuation of perquisite under rule 3 has no relevance in determining the ceiling u/s 40(c) or 40A(5). Section 40(c) deals with any expenditure or
allowance in respect of any asset of the company used by the director or any person referred to in section 40(c) either wholly or partly for his own
benefit. It is to be remembered here, that the company is claiming expenditure on the assets of the company used by such persons. If the asset has
been used wholly for business purpose, there is no difficulty including that the entire expenditure would be allowed. If it is wholly used for the
purpose of the director, there can be no quarrel from the assessee as the entire expenditure claimed would be subject to the ceiling u/s 40(c). If the
car has been used partly for business purpose of the company and partly for personal purpose of the director, then in such contingency, the ceiling
limit cannot be determined on the basis of valuation of perquisite in the hands of the director or employee. Let us visualise a case of a company
placing at the disposal of the director a motor car and the company had incurred expenditure such as fuel and also maintenance of the motor car.
In such case, when the company claims expenditure incurred as a part of the business expenditure, the amount to be disallowed cannot be based
on the valuation of the perquisite in the hands of the director in his assessment. The whole purpose of enacting section 40(c) is to curb the
extravagant expenditure. In the context of section 40(c) or 40A(5), the expenditure that is contemplated is only the actual expenditure and not the
notional value of perquisite assessed in the hands of the director or employee. It may be true that a car placed at the disposal of the director was
mostly used for the company�s purpose and was used for the personal purpose of the directors rarely and even in such case, the actual
expenditure incurred by the company will have to be subject to the ceiling u/s 40(c). In considering the deductibility of the expenditure, the section
is not concerned with the extent of the use of the asset by the director or employee for his personal use. But, the section focuses its attention on the
expenditure claimed by the assessee on its asset used by the director. In other words, the quantum of allowance or disallowance is not related to
the extent of user by the director or employee for his personal use, but once the factum of user of the asset of the company by the director or
employee for his personal purposes is found the quantum to be disallowed will be the actual expenditure claimed by the company, provided the
conditions stipulated therein are satisfied. We are in respectful agreement with the decision of the Gujarat High Court in Commissioner of Income
Tax Vs. Rajesh Textile Mills Ltd., wherein S.B. Majmudar, J. (as His Lordship then was) speaking for the Bench observed that the expenditure
incurred by the employer assessee for providing perquisites to the employee cannot be a mirror image of the evaluation of such perquisite in the
hands of the employee. The Gujarat High Court in the said decision observed as under :
...In that view of the matter, it is not possible to agree with the submission of Mr. Shah, for the assessee, that when assets of the employer are
partly used by the employee for his own purpose and partly used for the business purpose of the employer, the break-up figures of actual
expenditure incurred by the employer on the one hand and the expenses incurred for maintaining that part of the asset which is used for business
purposes on the other, would not be available and, therefore, the rule of thumb laid down by rule 3 of the income tax Rules can be projected and
can be pressed into service for the purpose of computing expenditure in such cases even in the cases covered u/s 40A(5)(a). It is easy to visualise
that figures of actual expenditure would always be available to the employer with necessary break-ups. If the employer chooses to make available
the break-up figures for the scrutiny of the taxing authority, the taxing authority can always, after due scrutiny, accept these figures with the
modifications. But these figures will always remain as figures of actual expenditure laid out by the employer-assessee for the concerned amenities
made available to the employee and they can be brought to account for the provision of section 40A(5)(a). If such break-up figures are not given,
the whole of the expenditure for providing such perquisites or for maintaining such asset which might have been used wholly or partly by the
employee for his own purposes would get covered by the sweep of section 40A(5)(a)(ii) on the assumption that entire expenditure was laid out by
the employer for providing these amenities to the employee. For such a situation, the employer has to thank himself as he chooses to keep back
from the scrutiny of the taxing authorities the facts and figures under the relevant heads of expenditure. In either of these eventualities, operation of
rule 3 would be out of question and even from the point of view of propriety, such rule cannot be brought in, as if by the back door, by the
employer-assessee on the one hand sitting tight on the details of the figures of expenditure which would be incurred by him on diverse heads and
on the other hand insisting that as break-up figures of relevant expenditure are not available on record, provision of rule 3 of the Rules should be
brought to his aid, for the purpose of computing permissible deductions of expenses u/s 40A(5)(a). In fact, such a stand on the part of the
assessee-employer would amount to taking advantage of his own wrong. That cannot be countenanced and is contra indicated by the statutory
scheme under consideration."" (p. 193)
We are in respectful agreement with the views expressed by the Gujarat High Court in the above decision. The assessee in the instant case has not
furnished the particulars as to the amount of expenditure which would be get covered under the provisions of section 40(c) or 40A(5), and it is
impermissible to bring in the provisions of rule 3 to determine the permissible ceiling limit u/s 40(c) or 40A(5). Accordingly, we answer the
question of law referred to us by holding that the actual expenditure incurred by the company should be taken into account for the purpose of
making disallowance u/s 40(c) or 40A(5). The revenue shall be entitled to costs of Rs. 750.