Union of India vs. Exide Industries Ltd. in C.A. No. 3454/2009
Issue: The Apex Court upheld the constitutionality of clause (f) of section 43B of the income tax act, 1961 and has propounded that the deduction would be allowable only on actual payments.
Clause (f) to sec 43B was inserted by the Finance Act, 2001, w.e.f 01.04.2002, i.e., A.Y. 2002-03 to provide that any sum payable by an employer in lieu of leave at the credit of his employee shall be allowed only on actual payment. The challenge was made to the constitutionality of the provision before the Calcutta High Court in Exide Industries, (2007) 292 ITR 470 (Cal) after referring to Bharat Earth Movers vs. CIT , (2000) 245 ITR 428 (SC), and it was held that the provision made by the assessee for leave encashment cannot be disallowed u/s 43B(f) more so when liability under the leave encashment scheme is a trading liability. The challenge to constitutional validity was accepted on following three grounds:
- The High Court held the provision to be arbitrary and vulnerable, because there was no disclosure of reasons for the amendment. The High Court ruled that, while the Legislature was free to make such amendments, reasons therefor should be inferable and such reasons should be consistent with the provisions of the Constitution and the laws of the land.
- The High Court also held that the provision was unconstitutional for the reason that a) clause (f) is inconsistent with the scheme of the section, i.e. 43B and b) clause (f) has no nexus with the reasons behind the enactment of 43B.
- The High court further held that enactment has been triggered solely to nullify the dicta of Bharat Earth Movers case (supra).
Revenue challenged the said decision before the Apex Court, which ultimately upheld the constitutional validity of leave encashment disallowance u/s. 43B of the Act.
The approach of the Court in testing the constitutional validity of a provision is well settled and the fundamental concern of the Court is to inspect the existence of enacting power and once such power is found to be present, the next examination is to ascertain whether the enacted provision impinges upon any right enshrined in Part III of the Constitution. The legislative power of the Parliament to enact clause (f) in the light of Article 245 is not doubted at all. The examination of the Court begins with a presumption in favour of constitutionality. This presumption is not just borne out of judicial discipline and prudence, but also out of the basic scheme of the Constitution wherein the power to legislate is the exclusive domain of the Legislature/Parliament.
The existence of section 43B traces back to 1983 and it is noteworthy that the legislature explained the inclusion of these deductions by citing certain practices of evasion of statutory liabilities and other liabilities for the welfare of employees. It holds no merit to urge that this section only provides for deductions concerning statutory liabilities. Section 43B is a mix bag and new and dissimilar entries have been inserted therein from time to time to cater to different fiscal scenarios, which are best determined by the government of the day.
The leave encashment scheme envisages the payment of a certain amount to the employees in lieu of their unused paid leaves in a year. The nature of this payment is beneficial and pro employee. However, it is not in the form of a bounty and forms a part of the conditions of service of the employee. An employer seeking deduction from tax liability in advance, in the name of discharging the liability of leave encashment, without actually extending such payment to the employee as and when the time for payment arises may lead to abhorrent consequences. When time for such payment arises upon retirement (or otherwise) of the employee, an employer may simply refuse to pay. Consequently, the innocent employee will be entangled in litigation in the evening of his/her life for claiming a hardearned right without any fault on his part. Concomitantly, it would entail in double benefit to the employer – advance deduction from tax liability without any burden of actual payment and refusal to pay as and when occasion arises. It is this mischief clause (f) seeks to subjugate.
The thrust of the provision is not to control the timing of payment, rather, it is strictly targeted to control the timing of claiming deduction in the name of such liability. The mischief sought to be remedied by this clause, as discussed above, clarifies the position. The grounds accepted by High Court were reversed as follows:
- Non-disclosure of objects and reason
The Apex court held that objects and reasons feature in the list of external aids to interpretation and can be looked into for the limited purpose in the process of interpretation. Legislature speaks through the text and as long as it is not speaking in an equivocal manner, there is limited space for the Court to venture beyond the text. The presence or absence of objects and reasons has no impact upon the constitutional validity of a provision as long as the literal features of the provision enable the Court to comprehend its true meaning with sufficient clarity. The Court found the approach of High Court flawed for three reasons. First, it steers clear from the necessary attempt to discover any constitutional infirmities in the enacted provision. Second, it makes no attempt to dissect the text of the provision so as to display the need to go beyond the text. Third, it goes into the background of the enactment and ventures into a sphere which is out of bounds for the Court as long as the need for interpretation borne out of any ambiguity arises.
- Inconsistency of clause (f) and absence of nexus with Section 43B
The SC held that there is no direct or indirect limitation on the power of the legislature to include only a particular type of deduction in the ambit of section 43B and that after proper examination, 43B reveals that legislature never restricted it to a particular category of deduction and that the intent cannot be read into the main section by the court, while sitting in judicial review. It is a provision to attach conditionality on allowability of deductions in that previous year in which the sum is actually paid irrespective of method of accounting and it be noted that the broad objective of enacting section 43B concerning specified deductions referred to therein was to protect larger public interest primarily of revenue including welfare of the employees. Clause (f) fits into that scheme and shares sufficient nexus with the broad objective.
It was also held that while interpreting fiscal statutes, constitutional courts should weigh the intent only through the legislature, as they are pin-pointed to target a specific avenue depending on the experiences of tax evasion and tax avoidance. The general principles of exclusion and inclusion do not apply to taxing provisions unless law reeks of constitutional infirmities as a larger discretion is given to legislature in taxing statutes than in other spheres. Thus, the decision of the High Court held untenable.
- Enactment triggered to nullify the dictum in Bharat Earth Movers case (Supra)
Before the judgment in Bharat Earth Movers (supra), various tribunals and High Courts across the country were treating the liability in lieu of leave encashment as a contingent liability. . A challenge to this legal position reached before this Court in Bharat Earth Movers (supra), wherein the Court rejected that leave encashment liability is a contingent one. The court observed that the true effect of the judgment was rendered in light of general dispensation of autonomy of the assessee to follow cash or mercantile system of accounting prevailing at the relevant time, in view of sole operative provision of section 145(1) that allowed complete autonomy to the assessee to follow mercantile system and in absence of an express statutory provision to do so differently. It is an authority on the nature of the liability of leave encashment in terms of the earlier dispensation.
The amendment does not reverse the nature of the liability nor has it taken away the deduction as such. The liability of leave encashment continues to be a present liability as per the mercantile system of accounting. Further, the insertion of clause (f) has not extinguished the autonomy of the assessee to follow the mercantile system. It merely defers the benefit of deduction to be availed by the assessee for the purpose of computing his taxable income and links it to the date of actual payment thereof to the employee concerned. Thus, the only effect of the insertion of clause (f) is to regulate the stated deduction by putting it in a special provision. This regulatory measure is in sync with other deductions specified in Section 43B, which are also present and accrued liabilities and the position of law discussed above leaves no manner of doubt as regards the legitimacy of enacting clause (f).
The Apex Court upholding the constitutional validity of Sec. 43B(f) reversed the judgment of the Calcutta HC in Exide Industries Ltd. The Hon’ble Court remarked that “the broad objective of enacting Section 43B concerning specified deductions referred to therein was to protect larger public interest primarily of revenue including welfare of the employees and Clause (f) fits into that scheme and shared sufficient nexus with the broad objective.”; With respect to assessee’s strong reliance on co-ordinate bench ruling in Bharati Earth Movers case, SC accepts that the legislature cannot sit over a judgment of SC or overrule it, however, holds that “once the enactment itself stands corrected, the basic cause of adjudication stands altered and necessary effect follows the same.”