MERCANTILE BANK LTD., BOMBAYversusTHE COMMISSIONER OF INCOME-TAX, BOMBAY CITY-III

A                      MERCANTILE BANK LTD., BOMBAY
                                         v.
           1HE COMMISSIONER OF INCOME-TAX, BOMBAY CITY-Ill

                                   MAY I, 2006

B                  [RUMA PAL AND DAL VEER BHANDARI, JJ.]


          Income Tax Act, 1961:

          Section 36(/)(vii) read with Section 36(2)-AY 1978-79-/nterest on
C doubtful advances-Liability to tax-Held: Interest on doubtfal loans entered
    in suspense account could not be brought to tax-Central Board of Direct
    Taxes Circular, 1952.

          Section 40-A(5)-AY 1978-79-Expenses or payments-Payment of
D salary to serving and retired employees-limits of deduction---Held: Section
    40-A(5){cJ(ii) of the Act speaks of ··an amount"'.-This would indicate that
    the employer is only entitled to deduction of one amount-Therefore, only
    one limit is prescribed for deduction on account of salary whether paid to
    an employee in service or a retired employee in any one previous year.

E         Words & Phrases:

          '"Aggregate "-Meaning of-In the context of first proviso to Section
    40-A{6) of the Income Tax Act, 1961.

          In this appea~ the following question arose:-
F         (i) Whether the appellant-assessee was liable to be taxed under the
    Income Tax Act, 1961 in respect of the interest on doubtful advance credited
    to the interest suspense account?

         (ii) Whether two separate limits applied for the purposes of computing
G disallowance under Section 40-A(S) of the Income Tax Act, 1961 where an
    employee retired and ceased to be in employment during the previous year, so
    that one limit applied in respect of the amounts and benefits received by him
    as an employee and another for the amounts and benefits received by him as
    a former employee?

H                                       628
         MERCANTILE BANK LTD. BOMBAY 1·. COMMR. OF INCOME TAX BOMBAY       629

      The High Court answered both the questions in favour of the Revenue          A
and against the appellant-assessee for the Assessment year 1978-79. Hence
the appeal.

      Allowing the appeal in part, the Court

      HELD: 1.1. The Central Board of Direct Taxes had issued a Circular in        B
1952 stating that the interest on sticky loans which were entered in the
suspense account need not be included in the assessee's assessable income
provided the Income Tax Officer was satisfied that there was no real probability
of the loans being repaid. [631-G; 632-AI

     1.2. Assessment for the year 1978-79 should have been dealt with by           C
the Department in accordance with the 1952 Circular under which the interest
on doubtful could not be brought to tax. [632-G)

      UCO Bank v. Commissioner of Income Tax, (1999) 237 ITR 859, relied
on.

     State Bank of Travancore v. Commissioner of Income Tax, (1986) 156            D
ITR 102, held inapplicable.

     State Bank of Travancore v. Commissioner of Income Tax, (1977) 110
ITR 336 (Ker), overruled.

        2. The intention of the Legislature was to fix the limits of deduction     E
under the various clauses of Section 40-A(5) of the Income Tax Act, 1961,
Section 40-A(5)(c)(ii) of the Act speaks of"an amount". This would indicate
that the employer is only entitled to deduction of one amount. Clause (c)(ii)
also speaks of an employee as being not only one who has ceased to be in
employment, but one who ceases to be in employment. In respect of the later        F
it is assumed that the employee served for a period but ceases to be so employed
during the previous year in question. In such a case, the Section expressly
provides for a limit on the deduction of Rs. 60,000/-. (635-G, H; 636-AI

      Hindustan Motors Ltd. v. Commissioner of Income Tax, (1985) 156 ITR
(Cal) 223, overruled.                                                              G
      3.1. In terms of Explanation 2(a) in Section 40-A(5) of the Act there is
only one limit for all salary whatever it may be comprised whether wages or
terminal benefits. [636-G)

      3.2. Reliance on the use of the word "aggregate" in the first proviso to
                                                                                   H
    630                      SUPREME COURT REPORTS [2006] SUPP. I S.C.R.

A Section 40-A(S)(a) was inapt Both the proviso and Section 40-A(6) deal with
    different kinds of payment or expenditure which, therefore, necessitated the
    use of the word "aggregate". (636-G-HI

          3.3. Section 40-A(S) on the other hand speaks of an "amount" and
    "salary" indicating a single deduction where the use of the word "aggregate"
B   was uncalled for. (637-C-DI

          4. Only one limit is prescribed for deduction on account of salary
    whether paid to an employee in service or a retired employee in any one
    previous year. (637-D)

C         CIVIL APPELLATE JURISDICTION: Civil Appeal No. 310 of2001.

         From the Judgment/Order dated 9.3.1999 of the High Court of Judicature
    at Bombay in Income Tax Reference No. 25of1987.
                                          WITH
          Civil Appeal No. 311 of2001.
D
         R. Murlidhar, S. Balakrishnan, Sujeeta Srivastava, Atul Y Chitale and
    Suchitra Atul Chitale for the Appellant.

          Harish Chandra, SWA Qadri, Mohit Choudhary and B.V. Balaram Das
    for the Respondent.
E
          The Judgment of the Court was delivered by

          RUMA PAL, J. The assessment year in question is 1978-79. The two
    questions which are to be answered in this appeal are:

           (0     Whether the appellant is liable to be taxed under the Income Tax
F                 Act, I961 (referred to hereinafter as the "Act") in respect of the
                  interest on doubtful advances credited to the interest suspense
                  account?
           (iJ)   Whether two separate limits apply for the purposes of computing
                  disallowance under Section 40A (5) of the Act where an employee
G                 retires and ceases to be in employment during the previous year,
                  so that one limit will apply in respect of the amounts and benefits
                  received by him as an employee and another for the amounts and
                  benefits received by him as a former employee.

H        The High Court answered both the questions in favour of the Revenue
    and against the Assessee.
 MERCANTILE BANK LTD. BOMBAY'" COMMR. OF INCOME TAX BOMBAY [RUMA PAL,J.) 63}


      Being aggrieved the appellant has approached this Court.                    A
       As far as the first question is concerned; the High Court answered it
in the affirmative relying on the decision of this Court in State Bank of
Travancore v. Commissioner of Income Tax 1• In the decision of State Bank
of Travancore v. Commissioner ofIncome Tax the minority opinion expressed
by Tulzapurkar, J, was that the stickiness of advances or loans objectively B
established to the satisfaction of the Taxing Authorities by furnishing a
proper material, is sufficient to prevent the accrual of interest thereon as real
income and would have the affect of rendering such income hypothetical.
Therefore the interest cannot be brought to tax irrespective of the method of
accounting followed, provided the assessee was able to establish to the C
satisfaction of the Taxing Authority that the loans had in fact becomes sticky
during the concerned year or years by producing proper material and that the
assessee had invariably followed the practice of carrying the interest of such
loans to interest suspense account instead of crediting the same to interest
account or profit and loss account with the additional safeguard of offering
the same for taxation if and when it was subsequently realized.                   D
      The majority view, however was that carrying certain amounts which
had accrued as interest without treating it as a bad debt or irrecoverable
interest but keeping it in suspense account would be repugnant to Section
36(1)(vii) read with Section 36 (2) of the Act. Where the mercantile system of    E
accounting was followed and loans had not been written off the amounts
accrued on the loans were income assessable to tax.

       The question again arose for consideration before a bench of three
Judges in the case of UCO Bank v. Commissioner ofIncome Tax, (1999) 237
ITR 889, where the Court affirmed the minority view ofTulzapurkar J, in State     F
Bank of Travancore 's case. The assessment year in question in that case was
1981-82. The interest on loans the recovery of which was doubtful had not
in fact been recovered by the assessee bank for the last three years and had
been kept in a suspense account and had not been brought to the profit and
loss account of the assessee because the amounts were not likely to be
realized. The Court found that this method of accounting was in accordance        G
with established accounting practice. Additionally it was held that the Central
Board of Direct Taxes had issued a circular on 6th October I952 stating that
the interest on sticky loans which were entered in the suspense account ne~d

I.   (1986) 156 ITR 102: (1986) 2 sec 11.
                                                                                  H
    632                    SUPREME COURT REPORTS (2006] SUPP. I S.C.R.

A not be included in the assessee's assessable income provided the Income Tax
    Officer was satisfied that there was no real probability of the loans being
    repaid.

           Although the 1952 circular was withdrawn in June 1978 in view of the
    decision of the Kerala High Court to the contrary in State Bank ofTravancore
B   v. Commissioner of Income Tax, (1977) 110 ITR 336, the principle was
    reintroduced by the Central Board of Direct Taxes by another Circular dated
    9th October, 1984. The 1984 Circular clarified that up to the Assessment years
    1978-79 the taxability of interest on doubtful debts credited to suspense
    account would be decided in the light of the Board's earlier Circular dated 6th
C   October, 1952 as the said Circular was withdrawn only in June, 1978. With
    effect from 1979-80 the new procedure prescribed under the 1984 circular
    would apply. The procedure prescribed is not relevant for our purposes. But
    it is clear that the circular issued in 1978 was effectively set aside and
    rendered ineffective.

D          The Court in UCO Bank ·s case (supra) was of the view that these
    Circulars dated 6th October. 1952 and 9th October, 1984 were binding on the
    authorities under Section 119( I) of the Act. The Court was also of the view
    that the judges in State Bank of Travancore (supra) did not have the occasion
    to consider the 1984 circular and proceeded on the assumption that the 1978
    circular was in force. The Court did not agree with the conclusion expressed
E   by the majority in State Bank of Travancore and said:-"

           "The relevant circulars of CBDT cannot be ignored. The question is
           not whether a circular can override or detract from the provisions of
           thi: Act: the question is whether the circular seeks to mitigate the
           rigour of a particular section for the benefit of the assessee in certain
F          specified circumstances. So long as such a circular is in force it would
           be binding on the departmental authorities in view of the provisions
           of Section 119 to ensure a uniform and proper administration and
           application of the Income Tax Act". (para 18, pg.610)

          Therefore the assessment year in question in this appeal should have
G
    been dealt with by the Department in accordance with the 1952 Circular under
    which the interest on doubtful loans could not be brought to tax.

          The decision of the High Court on the first question, having been based
    on the decision in State Bank of Travancore must be held to be incom:ct in
H   view of the subsequent judgment of this Court in the case of UCO Bank v.
MERCANTILE BANK LTD. BOMBAY l'. COMMR. OF INCOME TAX BOMBAY (RUMA PAL,J.]   633

Commissioner of Income Tax.                                                         A
      As far as the second question is concerned, Section 40A (5) in so far
as it is relevant provided:-

        "40A. Expenses or payments not deductible in certain circumstances.

        (I) The provisions of this section shall have effect notwithstanding
                                                                                    B
        anything to the" contrary contained in any other provision of this Act
        relating to the computation of income under the head "Profits and
        gains of business or profession".

        (2) (a) xxx            xxx       xxx
                                                                                    c
              (b) xxx       xxx          xxx

        (3)      xxx           xxx       xxx

        (4)      xxx        xxx          xxx

        (5) (a) Where the assessee
                                                                                    D

              (i) incurs any expenditure which results directly or indirectly in
              the payment of any salary to an employee or a former employee,
              or
              (ii) xxx         xxx       xxx                                        E
       then, subject to the provision of 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;

                xxx            xxx       xxx
                                                                                    F
       (c) The limits referred to in clause

       (a) are the following, namely:-

       (i) in respect of the expenditure referred to in. sub-clause (i) of Clause
       (a), in the case of an employee, an amount calculated at the rate of         G
       five thousand rupees for each month or part thereof comprised in the
       period of his employment in India during the previous year, and in the
       case of a former employee, being an individual who ceases or ceased
       to be the employee of the assessee during the previous year or any
       earlier previous year, sixty thousand rupees:
                                                                                    H
    634                    SUPREME COURT REPORTS [2006) SUPP. I S.C.R.

A         The issue is - when an employee ceases to be in employment during
    the previous year, is the employer entitled to deduction at the rate of Rs.
    5,000/- p.m. as long as the employee was in employment and again up to the
    limit of Rs. 60,000/- when the employee retires?

          The Calcutta High Court in the case of Hindustan Motors Limited v.
B Commissioner of Income Tax, ( 1985) 156 ITR 223 construed the provisions of
  Section 40A (5) (c) came to the conclusion that for the period that an employee
  remains in service he is to be treated as an employee and all payments made
  to him as an employee would be allowed as a deduction within the permissible
  monthly limit. After that period, when such an employee retires, he is to be
C treated as a former employee and payments made to him as former employee
  again ought to be deductible within the permissible limit. The Court was of
  the view that any other construction of such section under which such an
  employee is treated only as "an employee" or as a "former employee" in the
  year in question would render one part or the other of the section nugatory.
  The Court rejected the submission on behalf of the Revenue that the status
D of the employee as on the last date of the previous year should be taken into
  consideration for the purpose of fixing the limit of deductions. The Court said
  if this contention was to be accepted then the salary paid to the employee
  while he was in employment cannot be taken into account in determining the
  ceiling of allowable deduction under Section 40A (5). The Court referred to
E Section 40A (5)(a) and noted that the first proviso thereunder provided a
  ceiling of Rs. 72,000/- on the permissible deduction or of expenditure or
  allowances consisting of the aggregate of four different types of expenses
  and allowances mentioned thereunder. Similarly, under Section 40A (6) where
  any expenditure was incurred by an assessee on payment of fees as well as
  on payment of salary to that employee, the deduction in respect of such
F expenditure was limited to Rs. 60,000/- in the aggregate. The Court noted that
  wherever the legislature had intended to limit the expenditure taking the
  different contingencies into account it has made the appropriate provision by
   prescribing an aggregate ceiling. Section 40A (5) (a), (i) read with Section
  40A(5) (c) (i) of the Act did not refer to any aggregate amount of deduction
   although two different contingencies were provided therein. The Court was
G also of the view that if the contrary interpretation were accepted, the employer
   would defer the payment of the gratuity or any other sum payable to an
   employee on his employment to the subsequent accounting year to get out
   of the mischief of the ceiling prescribed under Section 40A (5) (c) (i) of the
   Act. This could not have been the intention of the legislature. Finally, it was
H held that if a provision of a taxing statute was reasonably capable of more
 MERCANTILE BANK LID. BOMBAY v. COMMR.OF INCOME TAX BOMBAY [RUMA PAL,J.] 635

than. one interpretation, that interpretation which was favourable and beneficial   A
to the assessee must be accepted, even if it results in his obtaining a double
advantage.

       The Bombay High Court disagreed with the reasoning. It relied on the
definition of "salary" in Section 17 which included pension, gratuity and
other retiral benefits. It has also noted that under Section 45A (c) (i) the        B
expression "employee" comes within the definition of expression "former
employee". It held that the status of an "employee" on the last date of the
relevant previous year would have to be seen for fixing the limit of deduction.
It held that there were no separate limits prescribed by Section 40A (5). There
was only one limit in respect of the "salary" and, therefore, the object was        C
to limit the deduction of expenditure on account of"salary" and that limit was
the single one of Rs. 60,000/-

      Learned counsel appearing on behalf of the appellant has urged that the
view expressed by the Calcutta High Court in Hindustan. Motors v.
Commissioner of Income Tax should be accepted. As far as the respondents            D
are concerned, they have reiterated the reasoning of the Bombay High Court
and have submitted in addition that the word "and" in Section 40 A(5) (c) (i)
should be read disjunctively as "or". Several decisions have been cited in
support of this principle of interpretation.

       We are of the opinion that the opinion expressed by the Bombay High          E
Court is correct. The intention of the Legislature was to fix limits of deduction
under the various clauses of sub section (5) of Section 40A. If the view
accepted by the Calcutta High Court were to be accepted the fixation would
be meaningless.as the limits would vary depending on the date on which an
employee may retire. According to the Calcutta High Court's view if an              F
employee serves for 12 months, and retires on the last day of the previous
year, the employer would be entitled to claim a deduction of Rs.60,000/- on
account of salary paid to an employee while in service and another limit of
Rs.60,000/- on account of 'salary' paid to the employee on retirement. In other
words, the employer would be entitled to a deduction of two different amounts.
                                                                                    G
     Yet Clause (c) (ii) of sub section (5) of Section 40A speaks of "an
amount". This would indicate that the employer is only entitled to deduction
of one amount. Clause (c)(i) also speaks of an employee as being not only
one who .has ceased to be in employment, but one who ceases to be in
employment. In respect of the latter it is assumed that the employee served
for a period but ceases to be so employed during the previous year in               H
      636                     SUPREME COURT REPORTS [2006] SUPP. I S.C.R.

A question. In such a case, the section expressly provides for a limit on the
      deduction ofRs.60,000/-

            Explanation (2)(a) in sub section (5) of Section 40 A provides:

            "Explanation 2 - In this sub-section,-
B
                  (a) "Salary" has the meaning assigned to it in clause (I) read with
              clause (3) of section 17 subject to the following modifications, namely:-

                  (I) in the said clause (I), the word "perquisites" occurring in sub-
              clause (iv) and the whole of sub-clause (vii) shall be omitted;
c                 (2) in the said clause (3), the references to "assessee" shall be
              construed as references to "employee or former employee" and the
              references to "his employer or former employer" and "an employer or
              a former employer" shall be construed as references to the assessee".

            Section 17 as it then stood defined 'salary' as:
D
             (i)     wages;
             (ii)    any annuity or pension;
             (iii)   any gratuity;
E            (iv) any fees, commission, perquisites or profits in lieu of or in addition
                  to any salary or wages;
             (v) any advance of salary;
             (vi) the annual accretion to the balance at the credit of an employee
                  participating in a recognized provident fund, to the extent to
F                 which it is chargeable to tax under rule 6 of Part A of the Fourth
                  Schedule of an employee participating in a recognized provident
                  fund, to the extent to which it is chargeable to tax under sub-rule
                  (4) thereof'.

G          In terms of this there is only one limit for all salary whatever it may be
    · comprised of whether wages or terminal benefits.

           Reliance on the use of the word "aggregate" in the first provisos to
     Section 40A(5)(a) and in Section 40A(6) was inapt. Both the proviso and sub
     section (6) deal with different kinds of payment or expenditure which therefore
H    necessitated the use of the word "aggregate". Thus the first proviso refers
 MERCANTILE BANK LTD. BOMBAY 1•. COMMR. OF INCOME TAX BOMBAY [RUMA PAL,J.]    63 7

to:                                                                                  A
               "(a) the expenditure and allowance referred to in sub-clauses (i)
               and (ii) of this clause; and

               (b) the expenditure and allowance referred to in sub-clauses (i)
               and (ii) of clause (c) of section 40".
                                                                                     B
         Similarly sub section (6) refers to

               "(a) such expenditure by way of fees, or

               (b) where the assessee has also incurred in relation to such
               person any expenditure by way of salary referred to in sub-clause     C
               (i) of clause (a) of sub-section (5), the aggregate of such
               expenditure by way of fees and by way of salary".

     Sub section (5)(c) on the other hand as we have seen speaks of an
"amount" and "salary" indicating a single deduction where the use of the
word "aggregate" was uncalled for.                                                   D
       We would therefore affirm the answer given in the impugned judgment
to the second question in favour of the revenue and hold that only one limit
is prescribed for deduction on account of salary whether paid to an employee
in service or a retired employee in any one previous year.
                                                                                     E
         The appeal is accordingly partially allowed. No order as to costs.

Civil Appeal No. 311 of 2001

      This appeal is partially allowed without any order as to costs in view
of our judgment in Civil Appeal No.310 of 200 I.                                     F
V.S.S.                                                  Appeal partly allowed.