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PETITIONER: COMMISSIONER OF INCOME TAX, DELHI (CENTRAL-I)

       Vs.

RESPONDENT: M/S. CONTINENTAL CONTRACTION LTD.

DATE OF JUDGMENT:       03/02/1998

BENCH: SUJATA V. MANOHAR, S.S.M. QUADRI

ACT:

HEADNOTE:

JUDGMENT:                       J U D G M E N T Mrs. Sujata V.Manohar, J.      The appeals  pertain to  assessment year  1983-84.  The following question of law was referred to the High Court for determination at the instance of the Revenue :      "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 had 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?" Facts:      The respondent-assessee is a civil construction company which has executed a large number of projects outside India. Its overseas  projects include irrigation and hydle projects in Libya,  a fibre  board factory  at Abu-Sukhir in Iraq and the Karkh  Water Supply  Project, Banghdad which had a total value of 534 million dollars.      For the  assessment year 1983-84, the assessee had paid a sum  of Rs. 14,0074,570/- to its Directors as remuneration and commission.  The Income-tax  officer disallowed a sum of Rs. 13,94,98,570/- being excess amount over the limit of Rs. 72,000/- per  Director prescribed  under Section  40(C)  and Section  40A(5)   (a)  of  the  Income-tax  Act,  1961.  The respondent  did   not  dispute   the  disallowance   of  Rs. 7,61,05,230/- payable  to  the  tow  India  based  Directors subject tot he allowance of Rs. 72,00/- each as laid down in Section 40(c)  and 40A  (5)(a). The  dispute related  to the remuneration  paid  to  the  Directors  who  were  stationed outside India in connection with the work of the respondent- assessee. According  to the  assessee the amount paid to its employee-Directors in  respect of  their employment  outside

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India was not to be taken into account while calculating the ceiling under Section 40A(5) or Section 40(c).      The assessee filed an appeal before the Commissioner of Income-tax who  modified the order of the Income-tax Officer and held  that any remuneration paid to employee - Directors in respect  of any  period of their employment outside India should not  be taken  into  account  while  calculating  the expenditure subject  to the  ceiling limit  of Rs.  72,000/- under Section  40(c) and 40A(5)(a). The department preferred an  appeal  before  the  Tribunal  from  the  order  of  the Commissioner  of  Income-tax.  The  Tribunal  dismissed  the appeal.      On the  application  of  the  department  the  Tribunal referred the  question set out above as a question of law to the High  Court. The High Court by its impugned judgment and order  dated   24.5.1990  answered   the  question   in  the affirmative and against the Revenue. The present appeals are filed on  a certificate granted by the High Court of fitness to appeal.      The  relevant   provisions  of  Section  40(c)  are  as follows:      "Section  40:  Notwithstanding.....      the following  amounts shall not be      deducted in  computing  the  income      chargeable under  the head ‘Profits      and   gains    of    business    or      profession’,      (a)............      (b)............      (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.........      (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-clauses (i) shall, in no      case, exceed-      (A)  where   such  expenditure   or           allowance related  to a period           exceeding    eleven     months           comprised  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

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         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 employe 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 b e;"      Section 40(c),  therefore, deals with the remuneration, benefit or  amenity to  a Director  of a  company (and other persons described there in) and any expenditure or allowance in respect of any asset of the company used, inter alia, b y a Director.  The ceiling  of allowable expenditure which can be deducted is fixed at Rs 72,000/- when such expenditure or allowance relates  to a  period exceeding  eleven months. If the period  is less  than eleven  months  then  the  ceiling expenditure is to be excluded at the rate of Rs. 6,000/- per months. Under the proviso set out above, certain expenditure is of  the kind  referred to in clauses (i), (ii), (iii) and (iv) of  the second  proviso to Section 40A (5) (a). Section 40A(5) relates  to expenditure  relating to  payment of  any salary or  providing any  perquisite to  an  employee  or  a former employee  of the  assessee. There  is  a  ceiling  on deductible expenditure of this nature which is provide under Section 40A(5).  The relevant  provisions of Section 40A (5) are as follows:      "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  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,      than, subject  to the provisions or      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 be allowed as a deduction:           Provided   that    where   the      assessee is  a company,  so much of      the aggregate of-      (a)   the expenditure and allowance           referred to in sub-clauses (i)

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         and (ii) of this clause; and      (b)   the expenditure and allowance           referred to in sub-clauses (i)           and (ii)  of  clauses  (c)  of           section 40,      in respect  of  an  employee  or  a      former employee,  being a  director      or a  person who  has a substantial      interest  in   the  company   or  a      relative of the director or of such      person, as  is excess of the sum of      seventy-two thousand  rupees, shall      in  no   case  be   allowed  as   a      deduction:           Provided   further   that   in      computing the  expenditure referred      to  in  computing  the  expenditure      referred to  in sub-clause  (i)  or      the expenditure (ii) of this clause      or the  aggregate  referred  to  in      sub-clause (ii)  of this  clause or      the aggregate  referred to  in  the      foregoing  proviso,  the  following      shall not  be taken  into  account,      namely :-      (i)  the   value  to   any   travel           concession    or    assistance           referred to  in clauses (5) of           section 10;      (ii) passage moneys or the value of           any   free   or   concessional           passage referred  to  in  sub-           clause (i)  of clause  (8)  of           section 10;      (iii)any  payment  referred  to  in           clauses (iv)  or clause (v) of           sub-section (1) of section 36;      (iv) any expenditure referred to in           clause (ix) or sub-section (1)           of section 36.      (b)   Nothing in  clause (a)  shall      apply   to   any   expenditure   or      allowance in relation to-      (i)  any employee in respect of any           period   of   his   employment           outside India;      (ii)   any    employee   being   an           individual referred to in sub-           clause  (vii)   or  sub-clause           (vii-a)  of   clause  (6)   of           section 10  in respect  of any           period during  which  h  e  is           entitled  to   the   exemption           under sub-clause  (vii) or, as           the case  may  be,  sub-clause           (vii-a) aforesaid;      (iii)any  employee   whose   income           chargeable  under   the   head           "Salaries" is  seven  thousand           an  five   hundred  rupees  or           less."            [underlining ours]      The permissible  limit  of  deduction  for  expenditure falling under  sub-clauses (i)  and (ii)  of Section 40A (5) (a) is laid down in clause (c). In respect of salaries to an

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employee or former employee, the permissible deduction is up to an  amount at  a rate or Rs. 5,000/- per month during the period of  an   employee’s employment  in India  during  the previous year.  In respect  of  expenditure  on  perquisites under clause  (a) (ii),  the permissible  deduction is up to 1/5th of the amount of the salary payable to the employee or an amount  calculated at  the rate  of Rs.  1,000/- for each month or part thereof comprising the period of employment in India of the employee during the previous year, whichever is less. Thus  ceiling for expenditure deductible under clauses a(i) is  Rs. 60,000/-  and clause  a(ii)  is  Rs.  12,000/-. However, in  the case  of an employee or former employee who is also  a Director  of the  company, the proviso to Section 40A(5) (a)  provides that  the ceiling  for deduction  is an overall  ceiling  of  Rs.  72,000/-  in  respect  of  a  sum allowance referred  to in  Section 40A(5)(a)(i)  and    (ii) which cover expenditure on an employee, plus expenditure and allowances referred  to Section  40(c)(1) and    (ii)  which relate, inter alia, to a Director.      In the  case of an employee, however, section 40A(5)(b) provides that while calculating the expenditure or allowance in relation  to an employee under Section 50A(5)(a), certain expenditure will  not be  taken into account. This includes, inter alia,  any expenditure  or allowance in relation to an employee in  respect of any period of his employment outside India. The  question we  have to  consider is  whether  such expenditure when incurred in connection with an employee who is  also  a  Director,  will  be  similarly  excluded  while calculating the  aggregate  of  expenditures  under  Section 40A(5)(a)(i) and  (ii) plus expenditure and allowances under Section 40(c)  (i) and (ii) incurred in connection with that employee-Director. According  to the  department, so long as the employee  is also  a Director,   expenditure of the kind referred to  in Section  40A(5)(b) cannot  be excluded  from expenditure  while   calculating  the  ceiling  limit  under Section 40(c)  or  Section  40A(5)(a).  The  department  has submitted that  such an exclusion is permissible only in the case of  an employee  who is  not a Director at the relevant time when the expenditure was incurred.      The  question   of  interpreting  the  provisions  o  f Sections 40(c) and 40A(5) in connection with persons who are both employees  and Directors of the company has come up for consideration in a number of cases before the High Court and before this Court. In the impugned judgment before us (which is reported in 185 ITR 178), the Delhi High Court has looked at the  legislative history  of these  two provisions with a view  to   examining  their  effect.  Section  40(c)  as  it originally stood  and the  amendments made  in Section 40(c) have been  set out in the High Court’s judgment. Originally, Section 40(c) itself contained sub-clause (iii) dealing with expenditure which  results directly  or  indirectly  in  the provision of  any remuneration  or  benefit or amenity to an employee. The  ceiling prescribed  was Rs. 5,000/- per month for any  period of  employment after  29th day  of February, 1963. The expenditure on perquisites with a ceiling of 1/5th of the  amount of  the salary  payable to  the employee  was subsequently also added. The expenditure on employees is now removed from  Section  40(c)  and  incorporated  in  Section 40A(5).      The two  Sections 40(c)  and 40A(5)  are, however,  not mutually exclusive.  In  section  40(c),  the  proviso,  for example, referees  to a case where the Director (or a person who had  a substantial interest in the company or a relative of the  Director or  of such  person) is also an employee of the company  for any period prescribed in the previous year.

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In that  situation, expenditure of the nature referred to in clauses (i),  (ii), (iii)  and (iv) of the second proviso to clause (a) of Section 40A(5) shall not be taken into account for the  purpose of  calculating the  ceiling under  Section 40(c).   These excluded items are items such as the value of any travel concession, passage money, payment referred to in Section 36(1)(iv)  and (v)  and expenditure  referred to  in Section 36(1)(ix).  These items  in  Section  36  deal  with contribution towards  provident fund, approved gratuity fund and promotion  of family  planning. Similarly Section 40A(5) does not  deal only  with  employees.  It  also  deals  with employee-Directors  in  the  first  proviso  to  sub-section (5)(a).  In   the  case  of  employee-Directors  both  these sections are applicable.      There   have been a number of cases in the various High Courts as  well as  that is  Court which have dealt with the question: which  ceiling applies  when a  person  holds  the positions both  of a Director and an employee. Section 40(c) prescribes an overall ceiling or Rs, 72,000/- on expenditure covered in  Section 40(c). Under Section 40A (5), there is a ceiling of  Rs, 60,000/- on expenditure in respect of salary and Rs,  12,000/- in  respect of  perquisites totalling  Rs, 72,000/-. This  Court considered  t his question in the case of Commissioner  of Income-tax   v.   Indian Engineering and Commercial Corporation  Pvt. Ltd.[1993  (201) ITR 723]. This Court has  held (page 728) that in the case of Directors who are also  employees both these sections will be attracted an the higher  of the  two ceiling  has to be applied. The same view had  earlier been  taken   by the  Andhra Pradesh  High Court  in   the  case   Commissioner  of   Income-tax     v. D.B.R.Mills [172  ITR 366],  and by the Bombay High Court in the case  of Commissioner  of   Income-tax  v. Hico Products Pvt.  Ltd.  [201  ITR  567]  where  the  Bombay  High  Court emphasised the  first proviso to Section 40A(5) (a) where an express provision  is made  that if  an employee  is also  a Director  or   a  person  specified  in  Section  40(c)  the aggregate of expenditure and allowances specified in Section 40(c), sub-clauses  (i) and  (ii) as well as expenditure and allowances specified  in Section 40A(5)(a)(i) and (ii) shall not  exceed   Rs.  72,000/-.   In  other  words,  the  total emoluments  and   perquisites  of  Directors  who  are  also employees will be allowed up to the limit of Rs. 72,000/- as a deductible  expenditure. In  such cases, therefore, though the Directors  are also  employees,  the  separate  callings prescribed of  Rs. 60,000/-  and Rs.  12,000-/ under Section 40A(5)(c) will  not apply.  The contrary  view taken  by the Kerala High Court in Travancore Rayons Ltd.  v. Commissioner of Income-tax  [162 ITR  732] is,  therefore, no longer good law.      We need  not, in  this connection, refer to the earlier judgments  of   the  Gujarat  High  Court  which  have  been discussed at  length in  the impugned  judgment.  After  the decision of  this Court  in  the  case  of  Commissioner  of Income-tax     v.  Indian     Engineering   and   Commercial Corporation (supra),  the Gujarat High Court has now, in the case of  Commissioner of  Income-tax V. Synpol Products Pvt. Ltd. [217  ITR 154]  held that  in the case of Directors who are also  employees, both  the provisions will be attracted. The higher of the two ceilings will have to be applied.      We have  now to  consider in  this  light  whether  the provisions of  Section 40A(5) (b) will apply for the purpose of  calculating   the  expenditure   so  covered   when  the expenditure is incurred in connection with a Director who is also an  employee. Under  Section  40A(5)(b)(i)  nothing  in clause (a)  which deals  with expenditure  on  salaries  and

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perquisites of  an employee  shall apply, inter alia, to any expenditure in  relation to  an employee  in respect  of any period of  his  employment  outside  India.  Therefore,  for example, in  calculating the expenditure on the salary of an employee, the  salary paid  in  respect  of  his  employment outside the expenditure which is subject to a ceiling limit. Under Section  40A(5)(b)(ii) and  (iii),  similarly  certain other expenditures  in connection  with an employee are also excluded from  the ceiling  limit. The  question is  whether such expenditure  will be excluded from the ceiling limit of a Director-employee.  If  for  the  purpose  of  ceiling  on expenditure, both  Sections 40(c)  and 40A(5)  are  to  b  e applied to  employee-Directors, there  is no  reason why for the purpose  of deciding  what is  to be  excluded from  the expenditure subject  to  such  ceiling,  both  the  sections cannot be  taken into  account. Both  sections constitute  a composite scheme.  In the  case of  employee-Directors, both will operate.  After  all,  the  purpose  of  prescribing  a ceiling on  expenditure in  connection  with  Directors  and employees under  Section 40(c)  and Section  40A(5),  is  to discourage  a   company  or   an  organisation  from  paying excessive salaries,  remuneration, perquisites  etc. to  its employees and/or  Directors. If it does so, the organisation will  not  be  able  to  claim  the  entire  expenditure  as deduction, b  ut only  expenditure up  to the ceiling limit. However,  from   this  ceiling   limit,  certain   kinds  of expenditure on  employees  have  been  excluded-  presumable because this  kind  of  an  expenditure  was  considered  as reasonable and permissible. One such category of expenditure is expenditure  on an  employee in  respect of his period of employment outside  India. Presumably  the organisation  may have to  pay to  an employee  posted outside  India  amounts which may  be much higher than what he may be entitled to in India in  view of  the exigencies  of  the  saturation,  his requirements at the p lace of posting and  the fact that the amount any  have to  be para  in  a  foreign  country.  This expenditure is,  therefore, not  subject to  a ceiling.  The same considerations  would apply to a Director-employee also who is posted outside the country in the course of his work. A Director-employee does not cease to be an employee nor his requirements less  than those  of an employee. Therefore, in his case  also what  the Act itself has viewed as reasonable allowable expenditure, should b e allowed. We do not see any reason to  hold that  Section 40A(5)(b)  will not  apply  to employee-Directors when this Court, in the case of employee- Directors has  held,  both  Sections  40(c)  and  40A(5)  as applicable. For  determining the ceiling, the higher ceiling has to  be taken  into account.  Similarly, for  determining permissible expenditure  which is  outside the ceiling limit also, both  the sections will have to be applied. Therefore, expenditure under  Section  40A(5)(b) which is excluded from the expenditure  on which  a ceiling is placed under Section 40A(5)(a), will  have to  be excluded  in  the  case  of  an employee-Director  also.   Under  the   proviso  to  Section 40A(5)(a), in  the case  of  an  employee-Director  for  the purposes of  ceiling, expenditure which has to be taken into account is  both under  Section 40A(5)(a)  as well  as under Section(40(c).   For   calculating   the   expenditure   and allowances under  Section 40A(5)(a),  one has to exclude the expenditure and allowances referred to in Section 40A(5)(b). Therefore, in  the  case  of  Director-employee  also  while calculating  the  expenditure  and  allowances  spent  on  a Director-employee under Section 40A(5)(a) and Section 40(c), expenditure of the kind referred to in Section 40A(5)(b) had to be necessarily excluded.

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    A similar  view has been taken by the Madras High Court in the  case of  Commissioner of  Income-tax   V.  Lucas TVS Ltd. [226 ITR 281]. The Madras High Court was concerned with foreign technicians  working under  a contract  in India and falling   under    Section   10(6)(vii-a).   Under   Section (40A(5)(b)(ii) expenditure  incurred in  relation to such an employee is  to be excluded from the expenditure for which a ceiling is  prescribed under  Section 40A(5)(a).  The Madras High Court  held that in the case of a Director-cum-employee also,  if  he  is  covered  by  Section  10(6)(vii-a),  such expenditure  would   be  excluded  from  the  ceiling  limit prescribed under Section 40(c) as well as Section 40A(5)(a). The Madras  High Court  has rightly observed (page 291) that there is  nothing to  suggest that the remuneration which is excluded from  the scope of consideration for the purpose of Section 40(c)  of the  Act. Both  Sections 40(c)  and 40A(5) have  to   be  read  together  in  determining  the  ceiling prescribed under  Section 40A(5)  of the  Act which includes ceiling prescribed  for Director-employees.  Also if certain items go out of reckoning in Section 40A(5) of the Act, then on the  principle of  harmonious construction, the same will have to  go out of reckoning in calculating a common ceiling prescribed for  Director-employees both  under Section 40(c) and 40A(5)(a) proviso.      The Delhi High Court was, therefore, right in coming to the conclusion  that  any  expenditure  covered  by  Section 40A(5)(b)(i) in respect of an employee-Director shall not be taken into  account for  the  purposes  of  calculating  the aggregate  of  expenditure  under  the  proviso  to  Section 40A(5)(a)  for   the  application   of  the   ceiling  limit prescribed there.      The question, therefore, is answered in the affirmative and in  favour of  the assessee.  The appeals  are dismissed with costs.