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Judgment
Ratnam, J.—The assessee is a private limited company. On September 15, 1973, the company passed a resolution for winding up the
company and during the previous year relevant to the assessment year 1974-75, the company retrenched its employees and paid them
retrenchment compensation of Rs. 1,06,044. In the course of the assessment proceedings for the assessment year 1974-75, the assessee claimed
the amount of retrenchment compensation as an admissible deduction and the Income Tax Officer allowed that claim. However, the Commissioner
of Income Tax, on a scrutiny of the records, found that the order of the Income Tax Officer was prejudicial to the interests of the Revenue in that
the claim of the assessee for deduction of Rs. 1,06,044 paid as retrenchment compensation to the employees was really not admissible, as the
payment was made consequent upon the closure of the business and issued a notice u/s 263 of the Income Tax Act, 1961 (hereinafter referred to
as ""the Act""). On a consideration of the objections raised by the company, the Commissioner of Income Tax, adverting to the circumstances under
which the company came to be wound up, took the view that the payment of Rs. 1,06,044 was not made in the course of carrying on the business
or for the purpose of furthering the cause of carrying on the business or to keep it going, but only because the business was closed down and,
therefore, it was not an admissible deduction u/s 37 of the Act. The Income Tax Officer was directed to disallow the claim for deduction of Rs.
1,06,044 and increase the total income of the assessee by that amount and also to take steps to determine the additional amount of Income Tax
and recover the same. Aggrieved by this, the assessee preferred an appeal before the Income Tax Appellate Tribunal and it was found that the
retrenchment compensation was paid not for the purpose of keeping the trade going generally to earn profits, but to discharge the liabilities to
facilitate the winding up and in view of that finding, the Tribunal agreed with the conclusion of the Commissioner of Income Tax that the amount in
question was not an admissible deduction. That is how, u/s 256(1) of the Act, the following question of law, at the instance of the assessee, has
been referred to this court, for its opinion :
Whether, on the facts and in the circumstances of the case, the Tribunal is right in holding that retrenchment compensation of Rs. 1,06,044 paid by
the applicant during the previous year is not an allowable deduction in computing the income of the applicant for 1974-75, since it was not incurred
for the purpose of the business""?
The assessee-company was carrying on business as distributors of calculating machines and other office equipment. At an extraordinary general
meeting held on September 15, 1973, it was resolved that the company be wound up voluntarily under the provisions of section 484 of the
Companies Act and to appoint a liquidator or liquidators for the purpose of voluntary winding up of the company. In the explanatory note u/s 173
of the Companies Act, appended to the notice for the holding of the meeting on September 15, 1973, it was stated that owing to the saddling of
the company with a dead stock of spares to the extent of two lakhs of rupees and the absence of the prospect of getting substantially higher
income, the business of the company will be greatly affected and with a view to reduce the expenditure of the company in view of the diminishing
income of the company year after year, it was thought worthwhile to wind up the company voluntarily and pay the dues to the employees and clear
the liabilities. Pursuant to the notice referred to earlier, on September 15, 1973, it was resolved to wind up the company voluntarily and to appoint
four persons as joint liquidators. After September 15, 1973, no fresh contracts were executed, but the contracts in existence on September 15,
1973, came to be performed. Since the company went into liquidation from September 15, 1973, the assessee filed two separate statements of
income and expenditure for the periods January 1, 1973, to September 15, 1973, and September 16, 1973 to December 31, 1973, and there is
no dispute that the amount of retrenchment compensation in a sum of Rs. 1,06,044 had been paid during the accounting year. The question that
arises for consideration is, whether the assessee is entitled to claim this amount as an allowable deduction u/s 37(1) of the Act in computing the
income chargeable under the head ""Profits and gains of business"".
u/s 37(1) of the Act, any expenditure laid out or expended wholly and exclusively for purposes of the business or profession shall be allowed in
computing the income chargeable under the head ""Profits and gains of business or profession"". In this case, the amount of Rs. 1,06,044 had been
paid by the assessee by way of retrenchment compensation u/s 25FFF of the Industrial Disputes Act. That liability arose on the closure of the
undertaking, whatever was the cause for such closure. The notice for the meeting on September 15, 1973 as well as the explanatory note
appended thereto, when considered in the light of the resolutions passed, to voluntarily wind up the company and to appoint liquidators, clearly
establishes that a decision had been taken to wind up the company dictated by reasons of economy, financial stringency and dwindling business.
The notices issued to the workmen referred to in paragraph 6 of the order of the Tribunal show that the decision had been taken to wind up the
business of the company and that the employees will be retrenched from the service of the company one month from the date of service of the
notice and not later than the date of completion of the winding up proceedings and the dissolution of the company. Section 484(1)(b) of the
Companies Act, 1956, provides for the winding up of a company voluntarily, if the company passes a special resolution stating that the company
be wound up voluntarily. On September 15, 1973, such a special resolution had been passed by the company. u/s 486 of the Companies Act, it is
provided that a voluntary winding up shall be deemed to commence at the time when the resolution for voluntary winding up is passed. That means,
the winding up of the assessee-company shall be deemed to have commenced on and from September 15, 1973. Section 487 of the Companies
Act declares the effect of voluntary winding up on the company and states that in the case of voluntary winding up, the company shall, from the
commencement of the winding up, cease to carry on its business, except so far as may be required for the beneficial winding up of such business.
Statutorily, therefore, the assessee-company ceased to carry on business on and from September 15, 1973. It is in the background of the
aforesaid statutory provisions that the claim of the company has to be considered.
Earlier, it has been noticed that the very object of resorting to a voluntary winding up of the company was to mitigate the financial strain and to
secure deliverance from the business activities carried on by it. Obviously, therefore, the idea was not to carry on the business of the company any
longer, but to put an end to its business activities. The decision to put an end to the business activities of the company adversely affected the
workment employed in the company by their retrenchment consequent upon the decision taken to close down the business activities of the
company. It may be that there was no wholesale retrenchment of all the workmen at the same time, but it is common ground that most of the
employees were retrenched. While deciding not to carry on its business activities, the company was also alive to its responsibilities not to turn all
the workmen adrift, except on payment of retrenchment compensation u/s 25FFF of the Industrial Disputes Act. The liability to pay retrenchment
compensation arose consequent upon the decision taken to close down the company and its business activities and not to carry on its business and
the service of notices to that effect on the employees of the company was also only in furtherance of the decision to close down and not to continue
to run the business. In other words, it is only the decision to close down the business of the company that gave rise to the need for payment of
retrenchment compensation and the issue of notices to that effect on the employees of the company and that cannot be construed in any manner as
an attempt to further the cause of business or doing something that will aid in the carrying on of the business or prolonging the life of the business
with a view to make profits. Considering the notice of the meeting, the explanatory statement, the resolutions passed and the contents of the notice
issued to workmen, it is clearly made out that the carrying on of the business of the company was farthest from the minds of those responsible for
the running of the affairs of the company and, therefore, the payment of retrenchment compensation by the assessee-company cannot be
considered to be an item of expenditure laid out or expended wholly and exclusively for the purpose of the business. The scope and content of the
expression ""for the purpose of business"" have been well brought out in the following passage of the decision of the Supreme Court in
Commissioner of Income Tax, Kerala Vs. Malayalam Plantation Ltd., (headnote) :
The purpose shall be for the purpose of the business, that is to say, the expenditure incurred shall be for the carrying on of the business and the
assessee shall incur it in his capacity as a person carrying on the business ....
Applying the aforesaid test, it is seen that the expenditure incurred by the assessee in this case cannot be said to be for the carrying on of the
business or that the assessee had incurred such expenditure as a person carrying on the business, for, the origin of liability to pay retrenchment
compensation arose out of a decision taken to close down the business and secure deliverance from business activities rather than to keep such
activities going for the purpose of carrying on of the business of the company. We are, therefore, of the view that the retrenchment compensation
paid by the assessee is not an allowable deduction u/s 37(1) of the Act.
We may now make a brief reference to the decisions relied on by counsel on both sides. Sassoon J. David and Co. Pvt. Ltd., Bombay Vs.
Commissioner of Income Tax , Bombay, , relied on by learned counsel for the assessee, does not in any manner advance the case of the assessee.
It is true that in that case the Supreme Court has observed that it is too late in the day to treat the expenditure incurred by a management in paying
reasonable sums by way of gratuity, bonus, retrenchment compensation, etc., as not business expenditure. However, that observation has to be
read and understood in the factual background which gave rise to that case and it is important to notice that in that case, the company was neither
dissolved nor was its business undertaking sold. We have earlier noticed how in this case there was a resolution to wind up the company and to
stop its business activities to contain the losses and how as a result of the operation of the provisions of the Companies Act, the company could not
carry on any business activity after resolving to voluntarily wind up. Even on the assumption that there were a few transactions after September 15,
1973, they could at best be regarded as intended to facilitate the winding up and not in furtherance of the carrying on of the business activities of
the company, earlier resolved to be wound up. We may also refer to the circumstances that after September 15, 1973, no fresh contracts were
entered into, but the prior commitments alone came to be discharged and that is attributable only to the act of the liquidators with a view to wind
up the affairs of the company, incidentally fulfilling the obligations then in existence. We are, therefore, of the view that the decision in Sassoon J.
David and Co. Pvt. Ltd., Bombay Vs. Commissioner of Income Tax , Bombay, cannot be pressed into service by counsel for the assessee. In
Commissioner of Income Tax, Kerala Vs. Gemini Cashew Sales Corporation, Quilon, , relied on by learned counsel for the Revenue, a firm stood
dissolved on the death of one of the partners and the surviving partner took over and continued the business and in the process of settling the
accounts of the firm, a certain amount was taken into account as retrenchment compensation payable to the employees u/s 25FF of the Industrial
Disputes Act arising on a transfer of ownership. The question arose whether the sum would constitute an allowable expenditure in computing the
income of the firm and the Supreme Court pointed out that the present value of commercial evaluation of money to become due in future, under a
definite obligation, will be a permissible outgoing or deduction in computing the taxable profits of a trader, even if in certain conditions the
obligation may cease to exist because of forfeiture of the right, but where however, the obligation of the trader is purely contingent, no question of
estimating the present value may arise, for, to be a permissible outgoing or allowance, there must, in the year of account, be a present obligation
capable of commercial evaluation. Considering the question whether the amounts taken into account as retrenchment compensation can be
regarded as wholly for business, the court ruled that where the liability is, during the whole of the period when the business is carried on, wholly
contingent and does not raise any definite obligation during the time when the business is carried on, it cannot fall within the expression ""expenditure
laid out or expended wholly and exclusively for the purpose of the business"". It has also been reiterated that in order to be permissible allowance
u/s 10(2)(xv) of the Indian Income Tax Act, 1922, the expenditure must be for the purpose of carrying on the business. We have earlier pointed
out that in this case, the liability to pay retrenchment compensation arose only out of the decision taken to close down the business of the company
and not to keep alive its business activities and the expenditure cannot, therefore, be regarded as one incurred for the purpose of business and we
are of the view that the principle referred to in the aforesaid decision would apply, though the decision was rendered with reference to section
25FF and not section 25FFF of the Industrial Disputes Act. In Venkatesa Colour Works Vs. Commissioner of Income Tax, , the assessee-firm
decided to close down its factory and had entered into an agreement with the workers, under which compensation was payable to the workmen.
Though the factory was originally intended to be closed from April 10, 1967, it was actually closed only on July 15, 1967, and the payment to the
workers in accordance with the agreement was made thereafter and the assessee claimed deduction of the payments so made in its assessment,
which was rejected by the departmental authorities as well as the Tribunal. On a reference u/s 256(1) of the Act, the Division Bench pointed out
that the closure of the business and the accrual or arising of the liability to pay compensation are concurrent and one cannot be separated from the
other and, therefore, the compensation payable u/s 25FFF of the Industrial Disputes Act cannot be said to be an expenditure incurred by the
assessee for carrying on the business or an expenditure laid out wholly and exclusively for the purpose of the business and further that the
expenditure incurred by the assessee was not for carrying on the business, but for closing down the business and the expenditure cannot, therefore,
be said to be exclusively or wholly laid out for the purpose of the business or an expenditure incurred for the purpose of carrying on the business.
While holding so, reference was made to Commissioner of Income Tax, Kerala Vs. Gemini Cashew Sales Corporation, Quilon, . After extracting
the passage at page 650, the Division Bench proceeded to observe that ""if the word ''closure'' is substituted for the word ''transfer'', namely, ''a
deduction which is proper and necessary for ascertaining the balance of profits and gains of the business is undoubtedly properly allowable, but
where a liability to make a payment arises not in the course of the business, not for the purpose of carrying on the business, but springs from the
closure of the business, it is not, in our judgment, a properly debitable item in its profit and loss account as a revenue outgoing''"", the decision of the
Supreme Court would govern that case also and a fortiori to a case of closure of business, the principle of the decision of the Supreme Court
would apply. We are of the view that the decision in Venkatesa Colour Works Vs. Commissioner of Income Tax, would squarely govern this case
as well. We, therefore, answer the question referred to us in the affirmative and against the assessee. The Revenue will be entitled to the costs of
this reference. Counsel''s fee Rs. 500.