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Is mere provision of leave salary deductible?
August, 18th 2007

Section 43B seeks to prevent companies from getting deduction for unpaid statutory liability without discharging the same.

T. C. A. Ramanujam

There is always a presumption in favour of the constitutionality of a statute. In respect of fiscal statutes, seldom do High Court declare an amendment as unconstitutional and beyond the competence of the legislature. But one such situation has arisen with regard to deduction of leave salary.

The Finance Act, 1983 introduced Section 43B in the Income-Tax Act, 1961 with effect from April 1, 1984, for preventing companies from getting deduction for unpaid statutory liability without discharging the same.

Under the mercantile system of accounting, income and outgo are accounted for on the basis of accrual and not on the basis of actual disbursements or receipts.

Companies were found claiming deduction for statutory liabilities such as excise duty and contribution to provident funds and State insurance schemes even while disputing the claims for payment before authorities concerned. They were thus getting double benefit. Deduction on the basis of mercantile system of accounting method without actual discharge of the statutory liability was considered unreasonable.

Section 43B provided that statutory liabilities will be allowed in the tax assessments as deduction only on actual payment. The Section had undergone several changes from time to time.

Deduction on account of unpaid loan to any public financial institution was barred by an amendment made in 1990.

The 1996 amendment extended the scope for disallowance in respect of unpaid loans of scheduled banks. Finance Act, 2001 inserted sub-clause(f) barring deduction of any sum payable by the company as an employer in view of any leave at the credit of the employee.

Bharat Earth Movers case

In this case (Bharat Earth Movers vs CIT 245 ITR 428 SC), the Supreme Court considered the question of deduction for provision for leave encashment as per a scheme floated by the company.

The dispute was whether the liability was contingent or real.

The court held that if a business liability had definitely arisen in the accounting year, the deduction should be allowed although the liability may have to be quantified and discharged at a future date.

What should be certain is the incurring of the liability.

It should also be capable of being estimated with reasonable certainty though the actual quantification may not be possible. If these requirements are satisfied, the liability is not a contingent one.

The liability is in praesenti though it will be discharged at a future date. It does not make any difference if the future date on which the liability shall have to be discharged is not certain. The Supreme Court allowed the claim f or deduction for the provision for leave encashment.

The Government was not satisfied with this ruling. Sub-section (f) was introduced in Section 43(B) to annul this ruling.

Exide Industries case

Here (Exide Industries Ltd vs UOI 292 ITR 470 Kolkata), a similar claim arose before the Calcutta High Court for deduction for provision for leave encashment. Section 43B(f) was put forth on behalf of the Revenue.

The power of the amendment was challenged before the Calcutta High Court. It was pointed out that the amendment of 2001 did not disclose the object and reasons for the amendment. The Revenue argued that the legislature was not required to disclose objects and reasons for amendment of the original enactment and the object for which the original section was enacted would be applicable for the amendment too.

After all, it was contended, the amendment was only for enlarging the scope of the original section and there can be no challenge to this amendment. It was also argued that leave encashment is not an ordinary trading liability. It was for the benefit of the employees and their welfare. The legislature was entitled to protect the interests of the employees by incorporating sub-clause (f) in Section 43B.

The Calcutta High Court ruled that leave encashment is neither a statutory liability nor a contingent liability. It was a provision to be made for the entitlement of the employee achieved in a particular financial year. The employer is obliged to make appropriate provision for the amount. This was clearly a trading liability. The company is entitled to get deduction by showing the same as a provisional expenditure.

The legislature is free to amend the law to provide for disallowance of such a provision but it can do so only after disclosing the reasons for the amendment. Such reasons should not be inconsistent with the main object of Section 43B.

The amendment appears to have been brought in to nullify the judgement made in the Bharat Earth Movers case. No amendment can be made for the sole object of nullifying the apex court decision. There was no nexus between the amendmen t and the main objects behind Section 43B. The Calcutta High Court struck down Section 43B (f) as arbitrary, unconscionable and de hors the apex court decision in the Bharat Earth Movers case. This is the only judgm ent on the issue. It lays down new vistas for judging the virus vires of amendments to the tax law.

T. C. A. Ramanujam
(The author is a former Chief Commissioner of Income-Tax.)
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