http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 1 of 14 PETITIONER: SASSOON J. DAVID & CO. (P) LTD., BOMBAY Vs. RESPONDENT: C.I.T., BOMBAY DATE OF JUDGMENT03/05/1979 BENCH: VENKATARAMIAH, E.S. (J) BENCH: VENKATARAMIAH, E.S. (J) UNTWALIA, N.L. CITATION: 1979 AIR 1441 1979 SCR (3) 878 ACT: Indian Income Tax Act 1922-Section 10(2) (xv)-Scope of- Retrenchment compensation paid to employees whose services were terminated-If allowable deduction-"Wholly and exclusively" meaning of-Benefit to third party-Whether consideration for not allowing deduction. HEADNOTE: In January, 1956 assessee company whose assets had been valued at Rs. 155 lacs as on December 31, 1955 decided to terminate services of 22 of its employees with effect from 31st March, 1956 and to pay them retrenchment compensation and compensation for termination of employment. Thereafter Davids, who held shares of company entered into agreement with Tatas to sell to them all shares for Rs. 155 lacs. agreement provided that compensation and gratuity payable to Directors and employees whose services had been terminated and annuity payable to managing director should be deducted from purchase consideration. assessee claimed deduction under s. 10(2)(xv) of Indian Income Tax Act, 1922 of sum of Rs. 1.64 lakhs paid by way of retrenchment compensation and compensation for termination of service during assessment year 1957-58 and sum of Rs. 16,885 which was amount of annuity paid to managing director in each of three succeeding assessment years. Income Tax officer disallowed amounts on ground that services of directors and employees had been terminated not as business expediency but because purchasers of shares made it condition under agreement. On appeal Appellate Assistant Commissioner, affirming view of Income Tax Officer, held that decision to pay compensation could not be said to have been taken solely with view to business requirement of company. Dismissing assessee s appeal Appellate Tribunal held that expenses had not been incurred for purpose of company but purely as result of bargain between Davids and Tatas and assuming that payments were beneficial to assessees by reason of reduction in its establishment expenses, no deduction could be allowed under s. 10(2) (xv) since payment was made to http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 2 of 14 benefit of third party. Relying principally upon decision of this Court in Gordon Woodroffee Leather Manufacturing Co. v. Commr. of Income-tax, [1962] Supp. 2 SCR 211, High Court held that amount involved in case did not satisfy test applicable to expenditure allowable under s. 10(2)(xv) of Act and, therefore, disallowed expenditure of Rs. 1.27 lakhs out of sum of Rs. 1.64 lakhs on ground that it had not been incurred for commercial expediency. High Court also disallowed annuity paid to managing director in succeeding three assessment years. 879 Allowing assessee s appeals ^ HELD: 1(a) three tests laid down by this Court in Gordon Woodroffee s case viz., (1) that payment should have been made as matter of practice which affected quantum of salary, (ii) that there was expectation by employee of getting gratuity and (iii) that sum of money was expended on ground of commercial expediency and in order indirectly to facilitate carrying on of business of assessee have to be read disjunctively. So read present case which satisfied third test fell under s. 10(2) (xv) of Act. High Court was in error in holding that amount in question did not satisfy any of tests applicable to expenditure allowable under section. [893H] (b) In order to claim deduction under section assessee has to show that expenditure in question (1) was not allowance of nature described in any of clauses (i) to (xiv) of section, (ii) was not in nature of capital expenditure or personal expenses of assessee and (iii) had been laid out or expended wholly and exclusively for purposes of his business, profession or vocation. [891G] (c) Even assuming that motive behind payment of retrenchment compensation was that terms of agreement of sale of shares should be satisfied, as long as amount had been laid out or expended wholly and exclusively for purpose of business of assessee there could be no good reason for denying benefit of this section if there was no other impediment to do so. [891H] In instant case assessee company was neither dissolved nor was its business undertaking sold. It continued to exist as juristic entity and continued to function even after transfer of its shares to Tatas. expenditure was laid out for purpose of assessee company s own trade and not for trade of Tatas who were only shareholders of company. As result of expenditure company was benefited and it was possible for it to earn more profits as consequence of reduction in wage bill. It cannot be said that Tatas were in any way benefited financially by reason of reduction in consideration payable by them for shares. [893B- C] Gordon Woodroffae Leather Manufacturing Co. v. Commissioner of Income-tax, Madras, [1962] Supp. 2 SCR 211, applied. (i) Commissioner of Inland Revenue v. Patrick Thomson, Ltd. (in Liquidation), (ii) Commissioners of Inland Revenue v. J. & R. Allan, Ltd. (In liquidation), (iii) Commissioners of Inland Revenue v. Pattigrew & Stephens, Ltd., 37 T. C. 145, referred to. http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 3 of 14 Commissioner of Income-tax, Gujarat v. Laxmi Cement Distributors (P) Ltd., 104 ITR 711, Commissioner of Income- tax, Bombay City I v. Fairdeal Corporation (P) Ltd., 108 ITR 280; Commissioner of Income-tax, Bombay City I v. Patel Cotton Co. Pvt. Ltd., 108 ITR 846; approved. 880 (d) Moreover it is too late in day whatever might have been position about two decades ago, to treat expenditure incurred by management in paying reasonable sums by way of gratuity and retrenchment compensation or compensation for termination of services as not business expenditure. Such expenditure would ordinarily fall within scope of s. 10(2)(xv) of Act. [889C] 2. argument that since there was no necessity to retrench services of all employees, expenditure could not be treated as one laid out wholly and exclusively for purpose of business has no force. expression "wholly and exclusively" does not mean "necessarily". Ordinarily it is for assessee to decide whether any expenditure should be incurred in course of his or its business. Such expenditure may be incurred voluntarily and without any necessity and if it is incurred for promoting business and to earn profits assessee can claim deduction under section even though there was no compelling necessity to incur such expenditure. fact that somebody other than assessee was also benefited by expenditure should not come in way of expenditure being allowed by way of deduction under section, if it satisfies otherwise test laid down by law. [894D-G] In instant case company thought that its business could be carried on with smaller number of employees and only way to reduce number was to terminate services of all employees by paying compensation and to re-employ only some of them. Thereby company reduced its expenditure on wages payable to its employees. It could not therefore be said that compensation was paid with oblique motive and without regard to commercial considerations or expediency. [895F] JUDGMENT: CIVIL APPELLATE JURISDICTION: Civil Appeal No. 2501 of 1972. From Judgment and order dated 5-2-1970 of Bombay High Court in Income Tax Reference No. 58/73. AND CIVIL APPEAL NOS. 2502-2504 OF 1972 From Judgment and Order dated 25th/26th Feb. 1971 of Bombay High Court in Income Tax Ref. No. 87/63. V. S. Desai, Dinesh Vyas, K. J. John and Sree Narain for Appellants in all appeals. Hardyal Hardy, Champat Rai, B. B. Tawekley and Miss Subhashini for Respondent in all appeals. Judgment of Court was delivered by VENKATARAMIAH, J.-Since these appeals by certificate involve common question of law, we find it convenient to dispose them of by this common judgment. 881 Civil Appeal No. 2501 of 1972 is filed against Judgment of High Court of Bombay in Income Tax Reference No. 58 of 1963 and Civil Appeals Nos. 2502-2504 of 1972 are filed against judgment of that High Court in Income Tax Reference No. 87 of 1965. assessee, M/s Sasoon J. David & Co. Pvt. Ltd. (hereinafter referred to as Company ) http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 4 of 14 is appellant in all these cases and assessment years are 1957-58, 1958-59, 1959-60 and 1960-61, relevant calendar years being 1956, 1957, 1958 and 1959 respectively. Company is investment company and its shares were originally held either directly or through their nominees by Sir Percival David, Lady David and Mr. V. P. David (hereinafter collectively referred to as Davids ). issued capital of Company consisted of 1000 ordinary shares of face value of Rs. 10,000/- each. According to valuation made by auditors, assets of Company were worth Rs. 155 lacs as on December 31, 1955. At meeting of directors of Company held on December 2, 1955, resolution was passed recommending that employees of Company whose names were set out in statement attached thereto be paid certain sums or annuity as set out against names of each of them as and by way of retrenchment compensation and compensation for termination of employment and also for long and faithful services rendered by them to Company in past and that their services might be terminated. It was also resolved to call extra-ordinary general meeting of shareholders of Company to consider and if thought fit to approve recommendation made by directors as stated above. Accordingly extra ordinary general meeting of shareholders of Company was held on January 17, 1956 but it was adjourned to January 25,1956. On adjourned date, meeting passed resolution approving recommendation made by directors to pay employees retrenchment compensation and compensation for termination of employment and also additional retrenchment compensation and compensation for termination of employment in case of some of them and to terminate their services on or after April 1, 1956. Thereafter agreement was entered into between Davids and Tata Sons Ltd. (hereinafter referred to as Tatas ) on March 23, 1956 agreeing to sell 1000 shares held by Davids or their nominees in Company in favour of Tatas or their nominees for sum of Rs. 155 lacs. said agreement inter alia provided that sum voted by Company for payment of gratuities and/or as compensation for loss of employment to existing directors and employees of Company with respect to their services upto and inclusive of March 31, 1956 and further amount of 882 Rs. 16,188/- payable to Managing Director, Mr. Mathalone should be paid in accordance with resolution by Company and amount so paid should be deducted from purchase price of Rs. 155 lacs agreed upon. It also provided that Davids should arrange to terminate services of all employees with effect from March 31, 1956 and also to arrange that all directors (including Managing Director) resign their offices and Tatas or their nominees should thereafter be entitled to appoint or elect all or any of members of staff and directors (including existing directors and members of staff) of Company as they deemed fit. Of 22 employees covered by resolution of directors dated December 2, 1955 followed by confirmation at extra-ordinary general meeting of January 25, 1956, 9 were re-employed and 13 persons were not re-employed. In books of assessee, there was debit for total sum of Rs. 1,64,899/- during accounting year 1956, details for which were as follows:- Amount payble to 22 employees as per resolution dated 2-12-1955 and 25-1-1956 http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 5 of 14 Rs 1,04,626/- Amount described as "additional retrechment compensation and compensation for termination of employment and also for long and faitful services", as per resolutin No. 2 dated Rs 6,000/- Compensation for termiantion of pension Rs 21,200/- Annuity of Shri A.E. Joseph, former Director as per resolsution dated 2-12-1956 Rs 16,885/- Amount described as "compensation for loss of office. Managing Director Mr. R. Mathalone" Rs 16,188/- ------------- Total : Rs 1,64,899/- ------------- It should be mentioned here that A.E. Joseph, former Director of Company had to be paid as per resolution of Company Rs. 16,885/- by way of annuity during period of five years commencing with 1956. During assessment year 1957-58, relevant previous year being 1956, Company claimed deduction of Rs. 1,64,899/- referred to above before Income-tax Officer under section 10(2) (xv) of 883 Indian Income-tax Act, 1922 (hereinafter referred to as Act ). During each of three succeeding assessment years with which we are concerned, Company claimed deduction of Rs. 16,885/- being annuity paid to Mr. A. E. Joseph pursuant to resolution. During assessment year 1957- 58, claim in respect of entire sum of Rs. 1,64,899/- was disallowed by Income-tax Officer on ground that services of directors and employees had been terminated not because of business expediency but because Tatas, purchasers of shares made it condition under agreement. relevant part of order read as follows:- "Thus, it emerges that expenditure of type of gratuity would be allowable u/s 10(2) (xv) only if persons retiring had such expectancy or they accepted lower salaries in such expectation and hence it was incentive to existing employees of future employees. As against that we find that here even before Tatas took up management of company, services of employees and directors were terminated and amount of compensation fixed. fact that there was no expectancy or custom of such gratuity with company is clearly borne out by fact that many of employees whose services are terminated had put in number of years of service in some cases even going upto 40 years. As against this assessee has been pleading that most of employees were very old and that as result of change of staff Company was able to effect considerable economy. However, I understand that some of old employees were reinstated and as stated whole transaction was part of overall transaction of purchase of shares and passing over of control. manner in which services of all employees under old management were terminated is also significant. Thus I am unable to see how this expenditure can fall u/s. 10(2) (xv). I am unable to find any distinction between compensation paid to employees and those paid to directors and also any distinction between outright compensation paid to director and annuity paid to director. None of expenses are allowable and I add whole amount claimed by way of gratuity, compensation for loss of employment and annuity or compensation for loss of office to director or former director." Aggrieved by decision of Income-tax Officer, http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 6 of 14 Company filed appeal before Appellate Assistant Commissioner of 884 Income-tax. Appellate Assistant Commissioner after taking into account records before Income-tax Officer and statement filed by Company before him found that Income-tax Officer was right in disallowing claim even though he was of opinion that Company had by termination of services of directors and employees by payment of gratuity and/or compensation been benefited. relevant part of his order was as follows:- "The only contention remaining to be considered is that Income-tax Officer was wrong in disallowing sum of Rs. 1,64,899/- paid to certain employees and directors as compensation for termination of services. circumstances leading to payment of this compensation have been narrated in detail in order of Income-tax Officer. It is strongly urged that termination of services of persons concerned was of great benefit to Company even considering payment of compensation since establishment expenses were very substantially reduced as result. From information furnished to me, this statement is no doubt quite justified. However, it is seen that termination of services and payment of compensation were not done wholly with view to business requirements of company, but were bound up with changing of hands of shares of company. According to agreement for sale of all shares of company sellers had to arrange to terminate services of all employees and also arrange that all directors resigned their offices. It is expressly stated that this requirement was to enable purchasers to appoint or elect all members of staff and directors. As matter of fact some of persons to whom compensation had been paid for termination of services were immediately re-employed by Company. decision to pay compensation cannot in circumstances be said to have been taken solely with view to business requirement of company though incidentally company might have been benefited by it. In view of what has been stated above. I feel that Income-tax Officer was justified in his action. appellant has referred to Bombay High Court decision in case of F.E. Dinishaw Ltd., but facts in present case are not identical with those of case mentioned." On further appeal to Tribunal by Company, Tribunal affirmed order of Appellate Assistant Commissioner holding 885 that inference drawn by Income-tax Officer that payments in question were motivated by reorganisation of share-holding had not been challenged by Company; that reference made to said payments in agreement of sale of shares led to such inference and that expenditure had not been incurred for purpose of Company but purely as result of bargain between Davids and Tatas. It was further held by Tribunal that even assuming that payments were beneficial to Company, no deduction could be allowed since they had been made to benefit third parties. Accordingly Tribunal dismissed appeal. application made under section 66(1) of Act before Tribunal was rejected. Thereafter Company filed application before High Court of Bombay under section 66(2) of Act and High Court directed Tribunal to state case and to refer following http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 7 of 14 questions of law for its opinion:- "(1) Whether Tribunal erred in law disallowing amount of Rs. 1,64,899/- as deduction under section 10 of Indian Income-tax Act, 1922 ? (2) Whether there was any evidence to justify Tribunal s finding that payment of Rs. 1,64,899/- or any part thereof was made in view of and in order to effectuate agreement entered into between old shareholders and new shareholders and that payment had no commercial purpose behind it ? (3) Whether in any event sum of Rs. 16,188/- paid to Managing Director by way of pay in lieu of six months notice was allowable as deduction under section 10 of Indian Income-tax Act, 1922 ?" Accordingly, Tribunal drew up statement of case and referred above questions. Later on Tribunal referred under section 66(1) following question of law arising out of orders of assessment for assessment years 1958-59, 1959-60 and 1960-61 in respect of annuity paid to Mr. A. E. Joseph:- "Whether in computing assessee s business income of accounting years 1957, 1958 and 1959, relevant for assessment years 1958-59, 1959-60 and 1960-61, sum of Rs. 16,885/- is admissible deduction under section 10(2)(xv) of Act? 886 It is not necessary to refer to other matters involved in orders of assessment of years 1958-59, 1959-60 and 1960-61 and to various stages of cases until they reached High Court. Income-tax Reference No. 58 of 1963 arising out of assessment proceedings of year 1957-58 was heard by Division Bench of High Court of Bombay and decided on February 5, 1970. High Court found that out of Rs. 1,64,899/- referred to in question No.1 only sum of Rs. 21,200/- which was commutation of liability for payment of pension to some retired employees and/or widows of such employees and sum of Rs. 16,188/- paid to Mr. Mathalone, Managing Director in lieu of six months notice that had to be given prior to termination of his service were allowable as deductions and that Company was not entitled to claim deduction of remaining sum of Rs. 1,27,511/-. It accordingly answered question No.1 in negative in so far as sum of Rs. 1,27,511/- (excluding two items of Rs. 21,000/- and Rs. 16,188/-) was concerned, question No. 2 in affirmative in so far as amount aggregating to Rs. 1,27,511/- (excluding two items of Rs. 21,200/- and Rs. 16,188/-) was concerned and question No. 3 in affirmative. High Court was of view that expenditure of sums amounting to Rs. 1,27,511/- paid to employees and director of Company by way of retrenchment compensation or compensation for termination of service had not been incurred by Company for commercial expediency and/or considerations. It accordingly disallowed claim made by Company to extent indicated above. Income-tax Reference case arising from assessment orders relating to assessment years 1958-59, 1959-60 and 1960-61 came before another Division Bench of High Court and that Division Bench following decision rendered by High Court earlier disallowed claim of Company for deduction in respect of payment of Rs. 16,885/- to Mr. A. E. Joseph in each of accunting years relative to assessment years in question. Aggrieved by judgments of High Court of Bombay, Company has filed these appeals. http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 8 of 14 We are concerned in these appeals with claim of Company in respect of sum of Rs. 1,27,511/- out of Rs. 1,64,899/- referred to in questions Nos. 1 and 2 in reference relating to assessment year 1957-58 and claim in respect of payment of Rs. 16,885/- made to Mr. A. E. Joseph during each of three succeeding years. undisputed facts of case are: shares of Company 887 were held by Davids or their nominees till they were transferred to Tatas; that according to valuation made by auditors of Company, its assets were worth Rs. 155 lacs as on December 31, 1955; that at meeting of directors held on December 2, 1955, it had been resolved that services of 22 employees should be terminated by paying retrenchment compensation; that on January 25, 1956 at extra-ordinary general meeting of shareholders of Company, it was resolved that employees of Company be paid certain sums or annuity set out against names of each of them and their services should be terminated with effect from April 1, 1956; that agreement was entered into between Davids and Tatas on March 23, 1956 regarding sale of shares in favour of Tatas; that said agreement referred to resolution passed at meeting of shareholders of Company; that Company paid retrenchment compensation according to said resolution and that Tatas deducted from purchase price sum payable by Company in accordance with resolution of Company from out of consideration of Rs. 155 lacs which they had agreed to pay under agreement dated March 23, 1956 to Davids. Apart from resolution of Board of Directors of Company dated December 2, 1955, resolutions passed at extra- ordinary general meeting of shareholders of Company held on January 25, 1956, agreement dated March 23, 1956 entered into between Davids and Tatas, books of account of Company showing payments made by Company by way of retrenchment compensation and fact that 9 of 22 employees whose services had been terminated had been reemployed, there was no other evidence before Income- tax Officer. Income-tax Officer presumably because of proximity of dates of resolutions, date of agreement and dates on which retrenchment compensation was paid to employees came to conclusion that retrenchment of employees had been effected as part of bargain entered into between Davids and Tatas and therefore compensation paid to employees on retrenchment of their services and to director on termination of his service had not been paid in course of business of Company by way of commercial expediency. He accordingly disallowed claim of Company under section 10(2) (xv) of Act. Although Appellate Assistant Commissioner in course of his order observed that Company had been benefited by reason of retrenchment of service of employees as it had resulted in reduction of expenditure on establishment, he disallowed claim on very same ground on which Income-tax Officer had rejected it. Triunal proceeded to dispose of case before it on basis that 888 inference drawn by Income-tax Officer that payments were motivated by re-organisation in shareholding had not been questioned by Company either before Appellate Assistant Commissioner or before it. We do not find in order of Appellate Assistant http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 9 of 14 Commissioner that any concession had been made by Company to effect that finding of Income-tax Officer referred to above was correct. In grounds of appeal before Tribunal, Company had stated that Appellate Assistant Commissioner erred in holding that "the decision to pay compensation cannot in circumstances be said to have been taken solely with view to business requirement of Company though incidentally Company might have benefited by it." appellants submitted before Tribunal that above amount was expended wholly and exclusively for purpose of their business and as such it should have been deducted as admissiable expense in computing their income liable to income-tax. Tribunal while deciding question whether sums paid by way of compensation were deductible or not observed that fact that reference to payment to staff of compensation had been made in agreement led to inference that such payment was part of bargain between Davids and Tatas; that on account of such payment, purchasers had actually been benefited while Company had to make payment in order to give effect to agreement and therefore there was no commercial purpose involved in making said payment. Tribunal also held that even assuming that Company was benefited by payment of compensation by reason of reduction in its establishment expenses, since payment had been made as result of bargain between Davids and Tatas, it could not be allowed as deductible expenditure. It should be stated here that Tribunal did not reverse finding of Appellate Assistant Commissioner that Company had been benefited by such payment. In fact it did not go into question whether payment had really resulted in any benefit to Company. High Court, however, in course of its judgment found that on account of retrenchment of employees and re- employment of only 9 of them, yearly wage bill of Company for salaries was reduced from Rs. 1,14,197/- in 1955 to Rs. 67,268/- in 1956 and thereafter in 1957 and 1958 respectively to Rs. 54,124/- and Rs. 54,960/-. In instant case, it is necessary to bear in mind that Company was neither dissolved nor was its business undertaking sold. It continued to exist as juristic entity even after transfer of its 889 shares by Davids to Tatas. On account of such transfer of shares, transferees no doubt gained control on Company. But one important fact of case which was lost sight of by High Court and Tribunal was that neither Davids nor Tatas derived any direct benefit out of payment of retrenchment compensation to employees even though such retrenchment might have facilitated transfer of shares. It is also not case of Department that payment was excessive. That there was substantial reduction in wage bill in future years as consequence of retrenchment was also not disputed. It is too late in day now, whatever may have been position about two decades ago, to treat expenditure incurred by management in paying reasonable sums by way of gratuity, bonus, retrenchment compensation or compensation for termination of service as not business expenditure. Such expenditure would ordinarily fall within scope of section 10 (2) (xv) of Act which authorised deduction of any expenditure not being in nature of capital expenditure or personal expenses of assessee laid out of expended wholly and exclusively for purpose of business or profession or vocation. http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 10 of 14 High Court, however, declined to allow deduction of sums referred to above in these cases principally relying upon decision of this Court in Gordon Woodroffee Leather Manufacturing Co. v. Commissioner of Income-tax, Madras(1). facts of that case were briefly thus: One J. H. Phillips was Director of assessee Company in that case from year 1940. On March 22, 1949, he wrote letter to assessee expressing his intention to resign from its Board as from April 4, 1949 and requested that his resignation be accepted. On March 24, 1949, Board of Directors of assessee passed resolution that his resignation be accepted and in appreciation of his long and valuable services to assessee he be paid gratuity of Rs. 50,000/- out of which assessee was to pay Rs. 40,000/- and its Managing Agent was to pay Rs. 10,000/-. Subsequently resolution was approved at extra-ordinary general meeting of assessee. Accordingly sum of Rs. 40,000/- was paid by assessee to Mr. J. H. Phillips. assessee claimed deduction of said sum of Rs. 40,000/- under section 10(2) (xv) of Act. Income-tax Officer as well as Appellate Assistant Commissioner disallowed said claim on ground that Company had no pension scheme; that payment was voluntary and that entry in assessee s books clearly indicated that payment was 890 capital payment. Tribunal upheld order of Appellate Assistant Commissioner. It held that according to resolution gratuity was paid "for long and valuable services to assessee", that there was nothing to indicate that Mr. J. H. Phillips had accepted lower salary in expectation of getting gratuity at end of his service; that there was no such practice in assessee- company; that during course of his service, he was being remunerated at graduated scale of salary and commission of 2 1/2% on profits; that there was no "expectancy" that at end of service there would be recompense for faithful and efficient service and that he had been suitably rewarded by being given commission on profits "in order to whip up his enthusiasm". It was also found by Tribunal that in books of assessee, amount had not been debited in profit and loss account but was debited to appropriation account thereby indicating that it was extra payment or payment made in nature of capital expense. On reference under section 66(1) of Act, High Court of Madras answered question relating to above item of expenditure against assessee. On appeal, this Court affirmed decision of High Court. While holding that claim made by assessee did not satisfy proper tests for claiming exemption under section 10(2) (xv) of Act, this Court observed as follows:- "In our opinion proper test to apply in this case is, was payment made as matter of practice which affected quantum of salary or was there expectation by employee of getting gratuity or was sum of money expended on ground of commercial expediency and in order indirectly to facilitate carrying on of business. But this has not been shown and therefore amount claimed is not deductible item under s. 10(2) (xv)." After quoting in course of its judgment above passage, High Court proceeded to observe as follows:- "Having regard to test applicable in connection with contentions made by Mr. Palkhiwala, what http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 11 of 14 required to be investigated is whether payments in question were made as matter of practice which had affected quantum of salary or whether there was expectation by employees (whose employment was terminated) of getting gratuity or, in alternative, above sums were expended on 891 ground of commercial expediency and in order indirectly to facilitate carrying on of business." After making above observation, High Court held that Company had not placed any evidence to show that there was practice in Company to pay compensation even though its attention was drawn that in past i.e. between 1946 and 1952, Company had paid such compensation in two cases on basis of one month s basic salary for each year of service. It also rejected case of Company that amount involved had been expended on ground of commercial expediency and in order indirectly to facilitate carrying on of business of Company even though it observed that yearly wage bill of Company was reduced after such payment. High Court held that consideration of reduction of wage bill was foreign to decision taken by Company to terminate services of employees and to pay them retrenchment compensation and observed that purpose of payment so far as could be ascertained from contents of resolutions of Board of Directors and Company when read with relevant contents of agreement for sale was carrying out of obligation arising under agreement. It also held that fact expenses became reduced was insufficient to record finding that amount of retrenchment compensation was paid for commercial considerations or expediency. From perusal of judgment of High Court it becomes clear that High Court placed more emphasis on motive with which amount was expended than fact that expenditure had been incurred in connection with business of Company and that such expenditure resulted in reduction of annual wage bill of Company in future years. In order to claim deduction under section 10(2) (xv) of Act, assessee has to show that expenditure in question (i) was not allowance of nature described in any of clauses (i) to (xiv) of section 10(2); (ii) was not in nature of capital expenditure or personal expenses of assessee and (iii) had been laid out or expended wholly and exclusively for purposes of his business, profession or vocation. Even assuming that motive behind payment of retrenchment compensation was that terms of agreement of sale of shares should be satisfied, as long as amount had been laid out or expended wholly and exclusively for purpose of business of assessee, there appears to be no good reason for denying 892 benefit of section 10(2) (xv) of Act to Company if there is no other impediment to do so. facts of these cases are very close to facts found in (i) Commissioners of Inland Revenue v. Patrick Thomson Ltd. (in liquidation), (ii) Commissioners of Inland Revenue v. J. & R. Allan, Ltd. (in liquidation), (iii) Commissioners of Inland Revenue v. Pettigrew & Stephens Ltd.(1). respondent-companies in said cases were subsidiaries of Company called Scottish Drapery Corporation Ltd., control of which was acquired by House of Fraser Ltd. Changes of organisation which were made http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 12 of 14 in accordance with policy of House of Fraser Ltd. involved termination of contracts of service of Managing Directors of respondent-companies and also eventual liquidation of those companies. Certain sums were paid by companies to managing directors in connection with cancellation of their contracts, payments being expressed in first two cases to be in satisfaction of rights to future remuneration, and in third to be in lieu of notice. Before Special Commissioners, companies contended that payments made by them to Managing Directors in connection with cancellation of their contracts had been made to relieve them from onerous contracts and were allowable deductions. Crown contended that payments were not expenses of companies businesses but were incidental to schemes by which those businesses were acquired by House of Fraser Ltd. and were made primarily for benefit of that company. Commissioners, however, decided that deductions claimed were allowable. Upholding findings of Commissioners, Lord President observed at page 156:- "In my opinion contention put forward by Crown is unsound and Special Commissioners were correct in rejecting it. Admittedly in this case no question arises in regard to words "wholly and exclusively", and if Crown s contention is unsound it is not disputed that disbursement in question falls within section 137(a). To succeed in their contention Crown must establish two matters. In first place it must show that liquidation involved discontinuance of trade carried on prior to it by Respondent Company and subsequent operation of new trade carried on by House of Fraser. In second place it must show that expenditure in question was laid 893 out for purposes of new trade. Without both these steps, its argument fails. In my opinion neither step in argument is made out." In present case also, it is seen that Company continued to function even after its control passed on to hands of Tatas and expenditure in question was laid out for purpose of Company s own trade and not for trade of Tatas who were only shareholders of Company. We cannot overlook distinction between Company and its shareholders. As result of expenditure in question, Company was in fact benefited and it was possible for it to earn more profits as consequence of reduction in wage bill. It was suggested in course of arguments before us that Tatas were actually benefited by payment in question because price payable by them for shares was reduced by amount spent by Company. We do not find any substance in this contention. Admittedly assets of Company had been valued as on December 31, 1955 at Rs. 155 lacs. Naturally total value of shares of Company would be Rs. 155 lacs which Tatas had agreed to pay. Subsequent to December 31, 1955, Company had by passing resolution incurred liability to pay retrenchment compensation and compensation for termination of service as stated above. On account of said resolution, total value of assets of Company was reduced by amount payable to employees by way of compensation. It is natural that purchaser of shares would ordinarily claim reduction in consideration payable for shares by amount which Company had undertaken to pay as assets of Company became reduced to that extent. It cannot, therefore, be said http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 13 of 14 that Tatas were in any way benefited financially by reason of reduction in consideration payable by them for shares. We feel that expenditure in respect of which deduction is claimed by Company in this case falls within third test laid down by this Court in case of Gordon Woodroffee Leather Manufacturing Co. v. Commissioner of Income-tax, Madras (supra) viz. that sum of money had been expended on ground of commercial expediency and in order indirectly to facilitate carrying on of business. We are of view that three tests laid down by this Court in above case viz. (i) that payment should have been made as matter of practice which affected quantum of salary; (ii) that there was expectation by employee of getting gratuity and (iii) that sum of money was expended on ground of commercial expediency and in order indirectly to facilitate carrying on of business of 894 assessee have to be read disjunctively and if they are so read, present case which satisfies third test should be held as falling under section 10(2)(xv) of Act. High Court of Gujarat in Commissioner of Income-tax, Gujarat v. Laxmi Cement Distributors Pvt. Ltd. (1) and High Court of Bombay in Commissioner of Income-tax, Bombay City I v. Fairdeal Corporation Pvt. Ltd.(2) and in Commissioner of Income-tax, Bombay City I v. Patel Cotton Co. Pvt. Ltd.(3) have also understood principle underlying decision of this Court in Gordon Woodroffee Leather Manufacturing Co. v. Commissioner of Income-tax, Madras (supra) in same way. High Court was, therefore, in error in holding that amount involved in case did not satisfy test applicable to expenditure allowable under section 10(2) (xv) of Act. next contention urged on behalf of Department was that since Davids and Tatas were indirectly benefited by retrenchment of services of employees of Company and payment of compensation to them and since there was no necessity to retrench services of all employees, expenditure in question could not be treated as expenditure laid out wholly and exclusively for business purposes of Company. It has to be observed here that expression "wholly and exclusively" used in section 10(2)(xv) of Act does not mean necessarily . Ordinarily it is for assessee to decide whether any expenditure should be incurred in course of his or its business. Such expenditure may be incurred voluntarily and without any necessity and if it is incurred for promoting business and to earn profits, assessee can claim deduction under section 10(2) (xv) of Act even though there was no compelling necessity to incur such expenditure. It is relevant to refer at this stage to legislative history of section 37 of Income-tax Act, 1961 which corresponds to section 10(2) (xv) of Act. attempt was made in Income-tax Bill of 1961 to lay down necessity of expenditure as condition for claiming deduction under section 37. Section 37(1) in Bill read "any expenditure....laid out or expended wholly, necessarily and exclusively for purposes of business or profession shall be allowed ...." introduction of word necessarily in above section resulted in public protest. Consequently when section 37 was finally enacted into law, word necessarily came to be dropped. fact that somebody other than assessee is also benefited by 895 http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 14 of 14 expenditure should not come in way of expenditure being allowed by way of deduction under section 10(2) (xv) of Act if it satisfies otherwise tests laid down by law. This view is in accord with following observations made by this Court in Commissioner of Income-tax, Madras v. Chandulal Keshavlal & Co. Petlad(1) "Another fact that emerges from these cases is that if expense is incurred for fostering business of another only or was made by way of distribution of profits or was wholly gratuitous or for some improper or oblique purpose outside course of business then expense is not deductible. In deciding whether payment of money is deductible expenditure one has to take into consideration questions of commercial expediency and principles of ordinary commercial trading. If payment or expenditure is incurred for purpose of trade of assessee it does not matter that payment may inure to benefit of third party (Usher s Wiltshire Brewery Ltd. v. Bruce) (6 T. C. 388). Another test is whether transaction is properly entered into as part of assessee s legitimate commercial undertaking in order to facilitate carrying on of its business; and it is immaterial that third party also benefits thereby (Eastern Investments Ltd. v. Commissioner of Income-tax, West Bengal) (1951) S.C.R. 594. But in every case it is question of fact whether expenditure was expended wholly and exclusively for purpose of trade or business of assessee." In instant case, it was case of Company that many of employees were old and superfluous and business could be carried on with smaller number and only way in which they could reduce number was to terminate services of all employees by paying them compensation and thereafter re-employing some of them only. If Company felt that that was method which would inure to its benefit, it cannot be said that payment of compensation was made with oblique motive and without regard to commercial considerations or expediency. High Court, therefore, erred on facts and in circumstances of case in holding that sum of Rs. 1,27,511/- was not deductible under section 10(2) (xv) of Act and in answering questions Nos. (1) and (2) referred to it in Income-tax Reference No. 58 of 1963 arising out of assessment 896 order for year 1957-58 against assessee and in favour of Department to extent of Rs. 1,27,511/-. Similarly it erred in disallowing claim made in respect of Rs. 16,885/- for each of three succeeding assessment years. We, therefore, allow these appeals and hold that Rs. 1,27,511/- was also deductible under section 10(2)(xv) of Act during assessment year 1957-58 and sum of Rs. 16,885/- referred to above was allowable as deduction during each of three succeeding assessment years. Department shall pay costs to appellant. (Hearing fee one set only). P.B.R. Appeals allowed. 897 Sassoon J. David & Co. (P) Ltd. v. C.I.t., Bombay