DP WORLD P. LTD, MUMBAI V. ASST CIT CIR 2(1), MUMBAI

ITA 7296/MUM/2010

• Counselvise Citation: 729619914 RSA 2010
• Duration Of Justice: 5 month(s) 18 day(s)
• Appeal Type: Income Tax Appeal
• Pronouncement Date: 13-04-2011
• Appeal Filed By: Assessee
• Order Result: Allowed
• Bench Allotted: D
• Assessment Year: 2006-2007
• Appeal Filed On: 26-10-2010
• Result in Favour of: Assessee
• Court: TRIBUNAL
• Department Lawyers: DR B SENTHIL KUMAR
• Keywords: Business expenditure; Fair market value; Commercial expediency; Revenue expenditure; Capital expenditure
• Section: 37(1)

Judgement Text

IN THE INCOME TAX APPELLATE TRIBUNAL, MUMBAI BENCH D, MUMBAI BEFORE SHRI N.V.VASUDEVAN(J.M) & SHRI B.RAMAKOTAIA H (A.M) ITA NO.7296/MUM/2010(A.Y. 2006-07) D P WORLD PVT. LTD. DARABSHAW HOUSE, LEVEL 1, N.M.MARG, BALLARD ESTATE, MUMBAI 400 001 PAN:AAACP 6133A (APPELLANT) VS. THE ACIT, CIR. 2(1), AAYKAR BHAVAN, MK ROAD, MUMBAI-20. (RESPONDENT) APPELLANT BY : SHRI RAJAN R. VORA RESPONDENT BY : DR.B.SENTHIL KUMAR ORDER PER N.V.VASUDEVAN, J.M, THIS IS AN APPEAL BY THE ASSESSEE AGAINST THE ORDE R DATED 21/9/2010 OF CIT(A)-4, MUMBAI RELATING TO ASSESSMENT YEAR 200 6-07. THE GROUNDS OF APPEAL OF THE ASSESSEE READ AS UNDER:- ON THE FACTS AND IN THE CIRCUMSTANCES OF THE CASE AND IN LAW, THE HONBLE CIT(A): 1. ERRED IN CONFIRMING THE DISALLOWANCE MADE BY THE AS SESSING OFFICER (AO) OF EX-GRATIA PAYMENT MADE TO ITS MANAGING DI RECTOR, AMOUNTING TO RS.6,41,24,475/- AND FURTHER ENHACING THE DISALLOWANCE BY RS. 4,00,00,000/- ON THE GROUND THA T THE SAME IS CAPITAL EXPENDITURE AND HENCE NOT ALLOWABLE AS A BU SINESS EXPENDITURE WHILE COMPUTING THE INCOME OF THE APPEL LANT; 2. ERRED IN NOT ADJUDICATING THE ISSUE OF DISALLOWANCE MADE BY THE AO OF EX-GRATIA UNDER THE PROVISIONS OF SECTION 40A(2) OF THE INCOME TAX ACT, 1961 (ACT) AND ADJUDICATING THE ISSUE ON AN ALTOGETHER DIFFERENT GROUND I.E. WHETHER THE EXPENDITURE CONST ITUTES CAPITAL OR REVENUE EXPENDITURE; 3. ERRED IN EXERCISING THE POWERS OF ENHANCEMENT ON AN ISSUE WHICH WAS NOT THE SUBJECT MATTER OF APPEAL RAISED BY THE APPELLANT AND ITA NO.7296/MUM/2010(A.Y. 2006-07) 2 THEREBY EXCEEDING THE SCOPE OF THE POWERS, PRESCRIB ED UNDER SECTION 251 OF THE ACT; 4. ERRED IN INCORRECTLY HOLDING THAT THE EX-GRATIA PAI D BY THE APPELLANT WAS NOT AS PER THE TERMS OF APPOINTMENT, AND FURTHE R THAT THE SAME WERE FOR THE MERGER OF THE BUSINESS WITHOUT APPRECI ATING THE FACTS AND EVIDENCES FILED ON RECORD; 5. FAILED TO APPRECIATE THAT THE EX-GRATIA WAS PAID T O THE MANAGING DIRECTOR BASED ON COMMERCIAL CONSIDERATIONS AND BUS INESS EXIGENCIES AND SINCE THE SAME WAS INCURRED IN THE C OURSE OF ITS BUSINESS WAS AN ALLOWABLE BUSINESS EXPENDITURE; 6. SHOULD HAVE FURTHER APPRECIATED THAT THE REASONABLE NESS OF THE EXPENSE INCURRED HAS TO BE JUDGED FROM THE VIEW POI NT OF A BUSINESSMAN BASED ON COMMERCIAL EXPEDIENCY AND THAT THE AO CANNOT SUBSTITUTE ITS OWN JUDGEMENT PURELY FROM A R EVENUES POINT OF VIEW. 2. THE ASSESSEE IS A COMPANY ENGAGED IN THE BUSINES S OF RENDERING PROFESSIONAL SUPPORT SERVICES IN CONNECTION WITH DE VELOPMENT OF PORT PROJECTS AND THEIR MANAGEMENT. THE ASSESSEE CLAIMED AS A DE DUCTION WHILE COMPUTING THE TOTAL INCOME A SUM OF RS. 10,41,24,4 75/- WHICH WAS AN EX- GRATIA PAYMENT TO THE MANAGING DIRECTOR, CAPT. JIMM Y H.SARBH (MR. SARBH), WHO RESIGNED FROM THE ASSESSEE COMPANY FROM NOVEMBE R, 2005. THE AO CALLED UPON THE ASSESSEE TO JUSTIFY THE AFORESAID C LAIM FOR DEDUCTION MADE BY THE ASSESSEE. THE ASSESSEE EXPLAINED THAT MR.SARBH RESIGNED FROM THE COMPANY DUE TO PERSONAL REASONS AND ALSO ESSENTIALL Y IN THE LIGHT OF THE POTENTIAL TAKE OVER OF P&O PORTS PVT. LTD. IN THE F ORESEEABLE FUTURE. IN THIS REGARD IT HAS BEEN MENTIONED THAT EARLIER THE ASSES SEE WAS KNOWN AS P&O PORTS PVT. LTD. IT HAD CHANGED ITS NAME TO D.P.WO RLD PVT. LTD. THIS IS BECAUSE OF CHANGE OF OWNERSHIP OF THE SHARES OF P&O PORTS PVT. LTD., D.P.WORLD GROUP. THE ASSESSEE ALSO POINTED OUT THA T IT HAD NOT CONTRIBUTED TO ANY LONG TERM SERVICE BENEFITS TO SARBH LIKE PRO VIDENT FUND, SUPERANNUATION, GRATUITY ETC. TAKING INTO CONSIDER ATION ALL THE ABOVE FACTORS AND THE LONG SERVICE HE HAD RENDERED TO THE ORGANIZ ATION THE AFORESAID PAYMENT WAS MADE BY THE ASSESSEE. ITA NO.7296/MUM/2010(A.Y. 2006-07) 3 3. THE A.O HOWEVER, DID NOT AGREE WITH THE SUBMISSI ONS MADE ON BEHALF OF THE ASSESSEE. ACCORDING TO HIM THERE WAS NO REA SON WHY SUCH A HUGE AND DISPROPORTIONATE TERMINATION PAYMENT HAS BEEN MADE TO MR. SARBH WHEN HE HAD RESIGNED FOR PERSONAL REASONS AND NOT DUE TO AN Y BUSINESS OR COMMERCIAL EXPEDIENCY. THE AO ALSO OBSERVED THAT I N THE LETTER OF APPOINTMENT LETTER DATED 7/10/1997 MR. SARBH WAS NO T REQUIRED TO BE PAID ANY PROVIDENT FUND, SUPERANNUATION OR GRATUITY AND, THEREFORE, THE JUSTIFICATION GIVEN BY THE ASSESSEE FOR THE PAYMENT MADE CANNOT BE ACCEPTED. THE AO ALSO FOUND THAT THE RATIO OF EX-GRATIA PAYME NT WAS IN THE FOLLOWING PROPORTION TO THE VARIOUS FINANCIAL AFFAIRS OF THE ASSESSEE. - 66% OF TOTAL CONSULTANCY FEES FOR P&O FOR A.Y 2006-07. - 111% OF TOTAL BALANCE SHEET TOTAL AS ON 31/3/2006. - 157% OF TOTAL CONSULTANCY FEES FOR P&O FOR A.Y 200 5-06 - 227% OF THE TOTAL SHARE CAPITAL AS ON 31/3/2006 - 403% OF TOTAL UNSECURED LOAN AS ON 31/3/2006 - 483% OF THE TOTAL RESERVES & SURPLUS AS ON 31/03/20 06 - 1915% OF PROFIT EARNED IN THE A.Y. 2006-07. 4. FOR ALL THE ABOVE REASONS THE AO HELD THAT THE P AYMENT MADE TO MR. SARBH WAS EXCESSIVE OR UNREASONABLE HAVING REGARD TO THE FMV OF THE GOODS, SERVICES OR FACILITIES FOR WHICH THE PAYMENT WAS MADE OR THE LEGITIMATE BUSINESS NEEDS OF THE ASSESSEE OR THE BENEFIT DERIV ED BY OR ACCRUING TO THE ASSESSEE. THE AO ALSO MADE A REFERENCE TO THE FACT THAT THE EXIT TERMS OF THE CONTRACT BETWEEN THE ASSESSEE AND MR. SARBH WAS NOT FURNISHED DESPITE REQUEST BY THE AO. THE AO INVOKED THE PROVISIONS O F SECTION 40A(2)(A) OF THE INCOME TAX ACT, 1961(THE ACT) AND WAS OF THE VIEW T HAT A SUM OF RS. 4.00 CRORES WOULD BE REASONABLE PAYMENT AND HE DISALLOWE D A SUM OF RS. 6,41,24,475/- BY OBSERVING AS FOLLOWS:- 18. NOW, IT IS TO BE DECIDED THAT WHAT WOULD BE T HE FAIR SETTLEMENT TO BE PAYABLE TO THE DIRECTOR. THE ASSESSEE COMPANY W AS PROVIDED WITH VARIOUS OPPORTUNITIES TO JUSTIFY THE PAYMENT MADE T O MANAGING ITA NO.7296/MUM/2010(A.Y. 2006-07) 4 DIRECTOR WITH SUBSTANTIAL EVIDENCE IN COMPARISON WI TH INDUSTRY STANDARDS. HOWEVER, NO SUCH DETAILS WERE PROVIDED BY THE ASSESSEE COMPANY. IN ABSENCE OF ANY SUCH JUSTIFICATION AND REASONABLENESS OF PAYMENT MADE, THE UNDERSIGNED HAS NO OPTION BUT TO TAKE BASE OF THE GROSS SALARY, PAID TO THE OUTGOING DIRECTOR. THE DETAILS OF YEAR-WISE GROSS SALARY PAID TO THE DIRECTOR, AS PER FORM 15A SUBMITTED IN THIS OFFICE ARE AS UNDER:- A.Y. 2004-05 RS. 1 ,88,20,760/-(INCL PERQUISITE) A.Y. 2005-06 RS. 1 ,97,74,315/-(INCL. PERQUISITE) 19. LOOKING TO THE TIME SPAN AND CONSIDERING THE S ERVICES RENDERED OVER THE PERIOD OF TIME BY THE OUTGOING DIRECTORS, THE ASSESSEE COMPANY IS HEREBY GIVEN BENEFIT OF DOUBLE THE PAYME NT OF LAST ANNUAL SALARY PAID INCLUDING PERQUISITES TO SUCH DIRECTOR AND ACCORDINGLY, AN AMOUNT OF RS.4,00,00,000/- IS TREATED AS REASONABLE PAYMENT BEING ONETIME SETTLEMENT INSTEAD OF RS.10,41,24,475/- C LAIMED BY THE ASSESSEE COMPANY. THUS THE BALANCE OF RS.6,41,24,4 75/- IS HEREBY DISALLOWED AND ADDED TO THE ASSESSEES TOTAL INCOME . 5. BEFORE CIT(A) THE ASSESSEE SUBMITTED THAT THE CH OICE OF MAKING THE EX- GRATIA PAYMENT TO MR. SARBH WAS A CULMINATION OF TH E FOLLOWING KEY FACTORS: - MERGER OF P&O GROUP WITH DP WORLD; - FUTURE INTEREST OF THE COMPANY; - PROFILE OF MR. SARBH - SECURITY DEPOSIT FOR THE PREMISES PROVIDED AS ACCOM MODATION TO MR. SARBH. 6. THE ASSESSEE SUBMITTED THAT DURING THE A.Y. 2005 -06. P&O GROUP WAS CONTEMPLATING MERGER WITH THE DP WORLD GROUP. HOWE VER, DURING THE INTERNAL MANAGEMENT DISCUSSIONS MR. SARBH HAD EXPRE SS A LESS SANGUINE VIEW TOWARDS THE MERGER AND WAS NOT KEEN ON SUCH A BUSINESS DECISION. GIVEN HIS STATURE IN THE ORGANIZATION, IT WAS FELT THAT CONTINUANCE OF MR. SARBH IN THE ORGANIZATION COULD POSE POTENTIAL DIFF ICULTIES TO THE MERGER TALKS. CONSIDERING THE NEED FOR MERGER WHICH WOULD ENTAIL CRITICAL SYNERGIES FOR THE TWO BUSINESS GROUPS, THE COMPANY MANAGEMENT FOUND IT PRUDENT THAT AN EXIT ROUTE TO BE PROVIDED TO MR. SARBH. KE EPING THE ABOVE IN PERSPECTIVE, THE EXIT OPTION WAS DISCUSSED WITH MR. SARBH. GIVEN HIS ITA NO.7296/MUM/2010(A.Y. 2006-07) 5 IMMENSE CONTRIBUTION INTO THE COMPANY, THE EXIT SUG GESTION ENTAILED DETAILED DISCUSSIONS AND NEGOTIATIONS BETWEEN THE COMPANY MA NAGEMENT AND MR. SARBH. PURSUANT TO SEVERAL ROUNDS OF DISCUSSIONS A ND DELIBERATIONS, EVENTUALLY MR. SARBH ACCEPTED THE PROPOSAL TO STEP DOWN FROM THE ORGANIZATION AND THE TERMS ON WHICH HE AGREED TO DO SO WAS SEALED IN THE FORM OF THE EXIT TERMS DOCUMENTED BETWEEN THE PARTI ES. THE ASSESSEE ALSO POINTED OUT THAT MR. SARBH WAS A PROFESSIONAL DIREC TOR OF THE ASSESSEE AND WAS A KEY MANAGERIAL PERSONNEL SINCE THE INCEPTION OF THE COMPANY. IT WAS DUE TO HIS EFFORTS PERSISTENCE AND GUIDANCE THAT TH E COMPANY HAD GROWN IN TERMS OF BUSINESS OVER THE YEARS AND WAS AWARE OF A LL THE BUSINESS STRATEGIES WHICH THE COMPANY HAD DEVELOPED FOR INDIA OPERATION S. ACCORDINGLY, IT WAS IN THE BEST INTEREST OF THE ASSESSEE THAT MR. SARBH AND THE ASSESSEE CORDIALLY PARTED WAYS, WITHOUT WHICH THE ASSESSEE COULD HAVE FACED SEVERE DIFFICULTIES FOR SMOOTH CONDUCT OF THE BUSINESS OF THE ASSESSEE IN INDIA. 7. IT WAS ALSO SUBMITTED THAT THE ASSESSEE HAD PROV IDED MR. SARBH WITH ACCOMMODATION AT MUMBAI. FOR LEASING THE PREMISES, AN AMOUNT OF RS.5 CRORES WAS DEPOSITED WITH THE LANDLORD AS SECURITY DEPOSIT. FOR RECEIVING BACK THE SECURITY DEPOSIT AMOUNT, IT WAS ESSENTIAL THAT THE PREMISES WERE VACATED BY MR. SARBH PEACEFULLY. REFUSAL BY MR. SA RBH TO DO SO WOULD HAVE RESULTED INTO THE FORFEITURE OF THE ENTIRE SECURITY DEPOSIT AMOUNT OR ALTERNATIVELY, INVOLVE IN LONG-DRAWN LITIGATION WIT H MR. SARBH/LANDLORD OF THE PREMISES. 8. IT WAS REITERATED THAT SARBH WAS PROFESSIONAL DI RECTOR UNDER WHOSE GUIDANCE THE COMPANY HAD EXPANDED THE INDIAN OPERAT IONS AND HE WAS ONE OF THE KEY PERSONNEL OF THE COMPANY. BEING IN SUCH A POSITION, IT WAS INEVITABLE THAT THE COMPANY REMUNERATED HIM PROPERL Y NOT ONLY FROM THE PERSPECTIVE OF HIS STATURE AND HIS CONTRIBUTION TO THE COMPANY BUT ALSO TO ENSURE THAT HE PASSES ON THE REINS TO HIS SUCCESSOR IN A MORE COMPREHENSIVE ITA NO.7296/MUM/2010(A.Y. 2006-07) 6 MANNER. IT ALSO HIGHLIGHTED THAT MR. SARBH WAS ASS OCIATED WITH THE COMPANY FOR A PERIOD OF MORE THAN 10 YEARS. 9. THE ASSESSEE ALSO SUBMITTED THAT THE PROVISIONS OF SECTION 40A(2)(A) WERE NOT APPLICABLE BECAUSE IT WAS NOT A DEVICE ADO PTED BY THE ASSESSEE FOR ARTIFICIALLY REDUCING OR DIVERTING THE PROFITS TO R ELATIVES AND ASSOCIATES. IN THIS REGARD THE ASSESSEE ALSO POINTED OUT THAT THE ASSESSEE DULY DEDUCTED TAX AT SOURCE ON THE PAYMENTS MADE TO MR. SARBH. THUS THE REVENUE HAS NOT BEEN PUT TO ANY LOSS BY REASONS OF THE PAYMENT. BE SIDES THE ABOVE THE ASSESSEE ALSO RELIED ON JUDICIAL PRONOUNCEMENTS REG ARDING CRITERIA FOR MAKING DISALLOWANCE UNDER SECTION 40A(2)(A) OF THE ACT. 10. THE CIT(A) WAS OF THE VIEW THAT THE AO SHOULD H AVE DISALLOWED THE ENTIRE PAYMENT AS A CAPITAL EXPENDITURE AND IN THIS REGARD ALSO ISSUED A NOTICE OF ENHANCEMENT TO THE ASSESSEE. THE CIT(A) ULTIMATELY HELD AS FOLLOWS: 8. I HAVE DULY CONSIDERED THE SUBMISSIONS OF TH E AUTHORIZED REPRESENTATIVE AND I FIND THAT EX-GRATIA WAS PAID T O EX-MANAGING DIRECTOR WHO RESIGNED AS HE WAS AN OBSTACLE IN THE WAY OF MERGER OF DP WORLD WITH P&O GROUP. THESE FACTS HAVE BEEN ADM ITTED BY THE AUTHORIZED REPRESENTATIVE THAT MANAGING DIRECTOR WA S ASKED TO RESIGN AS HE MAY BE AN OBSTACLE FOR SMOOTH MERGER OF BOTH THE COMPANIES. THE AUTHORIZED REPRESENTATIVE HAS ALSO ADMITTED THA T EX-GRATIA OF RS.10,41,24,475/- WAS PAID TO THE MANAGING DIRECTOR WHICH IS NOT IN ACCORDANCE WITH THE TERMS OF APPOINTMENT. IT IS O NLY TO GET RID OF THE MANAGING DIRECTOR THAT HIGH EX-GRATIA WAS PAID TO T HE M.D. IN SUCH FACTS AND CIRCUMSTANCES OF THE CASE THE PAYMENT CAN NOT BE REGARDED AS PAY6MENT ON ACCOUNT OF TERMINATION OF SERVICE B UT ONE TIME PAYMENT TO GET RID OF THE EMPLOYEE WHICH IS TO BE T REATED AS CAPITAL EXPENDITURE. RELIANCE IS PLACED ON THE DECISION O F GEMS SNOOK CO. LTD. VS. COMMISSIONER OF INHAND REVENUE (33 TC 244 (CA) WHEREIN IT WAS HELD THAT PAYMENT OF COMPENSATION TO RETIRING D IRECTOR AND AUDITORS AS CONDITION OF THE AGREEMENT FOR SALE OF CONTROLLING SHARES OF THE APPELLANT COMPANY IS NOT ALLOWABLE. SIMILARLY IN THE CASE OF TRAVANCORE TEA ESTATE P. LTD. VS. CIT 9154 ITR 745) (KER) IT WAS HELD THAT COMPENSATION PAID TO FORMER DIRECTORS WHO HAVE RESIGNED VOLUNTARILY HOLD NOT ALLOWABLE BECAUSE THE PAYMENT WAS NEITHER IN ITA NO.7296/MUM/2010(A.Y. 2006-07) 7 TERMS OF CONTRACT NOR UNDER COMPILATION OF STATUTE NOR AS A INDUCEMENT TO RESIGN. 9. IN VIEW OF THE ABOVE JUDGEMENTS I HOLD THAT THE PAYMENT MADE BY THE APPELLANT TO THE MANAGING DIRECTOR IS ONE TIME PAYMENT IN ORDER TO GET RID OF HIM AND NOT IN ACCORDANCE WITH THE TERMS OF APPOINTMENT. THE PAYMENT IS NOT FOR THE PURPOSE OF BUSINESS BUT FOR THE MERGER OF BUSINESS. THEREFORE, IT IS NOT A PERQUISITE TO A R ETIRING EMPLOYEE BT A CAPITAL EXPENDITURE NOT ALLOWABLE OUT OF THE BUSINE SS INCOME OF THE ASSESSEE. HENCE THE ADDITION MADE BY THE AO IS ENH ANCED U/S. 252(2) BY RS. 4,00,00,000/-. THE A.O IS DIRECTED TO ISSUE REVISED NOTICE OF DEMAND. 11 AGGRIEVED BY THE ORDER OF THE CIT(A) THE ASSESSE E HAS PREFERRED THE PRESENT APPEAL BEFORE THE TRIBUNAL. 12. THE LD. COUNSEL FOR THE ASSESSEE AT THE OUTSET SUBMITTED THAT THE CIT(A) WAS NOT JUSTIFIED IN INVOKING HIS POWERS OF ENHANCEMENT. ACCORDING TO HIM THE AO CONSIDERED ONLY THE REASONABLENESS OF THE PAYMENT MADE BY THE ASSESSEE AND HE DID NOT CONSIDER THE EXPENDITUR E AS CAPITAL IN NATURE. IN AN APPEAL AGAINST THE ORDER OF THE AO THE CIT(A) SHOULD NOT HAVE GONE INTO THE QUESTION OF ALLOWABILITY OF THE EXPENDITU RE AND BY DOING SO THE CIT(A) HAS BROUGHT TO TAX A NEW SOURCE OF INCOME. 13. WE HAVE CONSIDERED THIS SUBMISSION AND ARE OF T HE VIEW THAT THE SAME CANNOT BE ACCEPTED. THE AO HAD CONSIDERED THE ALLO WABILITY OF THE EX-GRATIA PAYMENT MADE TO MR. SARBH AND THOUGHT IT FIT THAT A SUM OF RS. 4.00 CRORES CAN BE ALLOWED AS DEDUCTION AS AGAINST THE CLAIM OF THE ASSESSEE FOR DEDUCTION OF A SUM OF RS. 10,41,24,475/-. IN THE A PPEAL AGAINST THE SAID ORDER THE CIT(A) HAS CONSIDERED ONLY THE SUBJECT MA TTER WHICH THE AO HAD CONSIDERED FROM THE POINT OF VIEW OF TAXABILITY. THUS IN OUR VIEW THE CIT(A) HAS NOT ENHANCED THE ASSESSMENT BY DISCOVERING NEW SOURCE OF INCOME NOT CONSIDERED BY THE AO IN THE ORDER OF ASSESSMENT. W E THEREFORE, REJECT THE ARGUMENTS RAISED BY THE ASSESSEE IN THIS REGARD. ITA NO.7296/MUM/2010(A.Y. 2006-07) 8 14. THE NEXT SUBMISSION WAS THAT THE PAYMENT WAS MA DE AS PER THE TERMS OF APPOINTMENT AND THAT THE SAME WAS ALLOWABLE AS B USINESS EXPENDITURE. IT WAS ALSO SUBMITTED THAT BY REASON OF THE PAYMENT NO ENDURING BENEFIT ACCRUED TO THE ASSESSEE. FURTHER IT WAS SUBMITTED THAT THE PAYMENT IS NOT FOR FACILITATING MERGER BUT WAS A TERMINATION PAYME NT FOR RELIEVING MR. SARBH OF HIS EMPLOYEE DUTIES, WHICH CANNOT BE CONSIDERED AS A PAYMENT IN CONNECTION WITH MERGER. IT WAS ALSO HIGHLIGHTED T HAT MR. SARBH EXITED FROM THE COMPANY IN OCTOBER 2005 WHILE GLOBALLY P&O GROU P CHANGED ITS SHAREHOLDING/MANAGEMENT TO THE DP WORLD GROUP ONLY IN MARCH, 2006, WHICH ITSELF INDICATES THAT THE PAYMENT IS NOT IN C ONNECTION WITH MERGER, BUT DUE TO CROPPING DIFFERENCES BETWEEN THE ASSESSEE CO MPANY AND MR. SARBH. IT WAS FURTHER SUBMITTED THAT THE MERGER OF A BUSIN ESS IS A CRITICAL BUSINESS DECISION FOR INCREASING THE EFFICIENCY OF THE BUSI NESS AND HAVE BUSINESS SYNERGIES AND HENCE IT WAS NECESSARY THAT A GENERAL CONSENSUS WAS ACHIEVED AMONGST ALL THE EMPLOYEES OF THE COMPANY AND EQUALL Y MORE IMPORTANT AT THE EXECUTIVE MANAGEMENT LEVEL. SINCE MR. SARBH WA S IN GENERAL NOT KEEN ON THIS BUSINESS DECISION, IT WAS FELT KEEPING IN M IND THE CIRCUMSTANCES THAT HE DEPARTS FROM THE COMPANY. HENCE, IT WAS ARGUED THAT THE EXPENDITURE IS A REVENUE EXPENDITURE ALLOWABLE UNDER SECTION 37(1) OF THE ACT, INCURRED WHOLLY AND EXCLUSIVELY IN THE CONDUCT OF ITS BUSINE SS ACTIVITIES. 15. FURTHER RELIANCE WAS PLACED ON THE DECISION OF THE HONBLE SUPREME COURT IN THE CASE OF SASOON J. DAVID & CO PVT. LTD. VS. CIT 118 ITR 261 (SC), WHERE IT WAS HELD THAT COMPENSATION PAID TO E MPLOYEE ON TERMINATION BASED ON AN AGREEMENT SHOULD BE ALLOWED AS A DEDUCT ION. OUR ATTENTION WAS ALSO DRAWN TO THE TERMS OF EMPLOYMENT AS WELL AS TH E TERMS OF RESIGNATION OF MR. SARBH AND IT WAS SUBMITTED THAT THE PAYMENT WAS IN CONSONANCE WITH THE AGREEMENT BETWEEN THE PARTIES AND DEDUCTION CL AIMED SHOULD BE ALLOWED. ITA NO.7296/MUM/2010(A.Y. 2006-07) 9 16. THE LD. D.R RELIED ON THE ORDER OF THE CIT(A). IT WAS SUBMITTED BY HIM THAT THE RESIGNATION OF MR. SARBH. WAS TO ENABLE THE TAKE OVER OF P&O PORTS PVT. LTD. BY D.P.WORLD PVT. LTD. AND, THEREFORE, TH E EXPENDITURE WAS RIGHTLY HELD TO BE A CAPITAL EXPENDITURE. RELIANCE WAS ALS O PLACED ON THE DECISION OF THE HONBLE BOMBAY HIGH COURT IN THE CASE OF GODFRE Y PHILIPS (I) LTD. VS. CIT 206 ITR 23(BOM) AND HONBLE DELHI HIGH COURT IN THE CASE OF TRIVENI ENGINEERING WORKS LTD. VS. CIT 232 ITR 639 (DEL), W HEREIN IT WAS HELD THAT LEGAL AND PROFESSIONAL CHARGES INCURRED IN CONNECTI ON WITH AMALGAMATION/MERGER OF COMPANIES WAS NOT ALLOWABLE AS A DEDUCTION. 17. WE HAVE CONSIDERED THE RIVAL SUBMISSIONS. MR. SARBH WAS APPOINTED AS PROJECT DIRECTOR W.E.F. 27/6/1999. THE AGREEMEN T BETWEEN THE ASSESSEE AND MR. SARBH IS AT PAGE 49 TO 52 OF THE ASSESSEES PAPER BOOK. MR. SARBH WAS APPOINTED AS PROJECT DIRECTOR FROM 27/6/1999 F OR A PERIOD OF 3 YEARS. CLAUSE -6 OF THE SAID AGREEMENT PROVIDES AS FOLLOWS : 6. TERMINATION: 6.1 NOTWITHSTANDING ANYTHING CONTAINED HEREIN, THIS CONTRACT SHALL BE TERMINATED BY EITHER PARTY AT MUTUALLY AGREED TERMS OF EXPARTRIATE EMPLOYMENT CONTRACT AND CONDITIONS AND IN ANY OF TH E FOLLOWING EVENTS: - THE REQUIREMENTS OF THIS CLAUSE MAY NOT APPLY IN THE EVENT THAT YOUR SUSPENDED, TERMINATED OR DISMISSED FROM SERVICE OWI NG TO DISCIPLINARY REASONS AS STATED IN CLAUSE 5 ABOVE. - ON THE COMMENCEMENT OF THE WINDING-UP (OTHERWISE THAN FOR THE PURPOSE OF EFFECTING A CHANGE IN THE NAME OF THE CO MPANY OR ON RECONSTRUCTION OR AMALGAMATION WHETHER VOLUNTARY OR OTHERWISE OF THE COMPANY.) - IN THE EVENT THE EVENT THE COMPANY CEASING TO CA RRY ON BUSINESS. 18. IT CAN BE SEEN FROM THE AFORESAID CLAUSE THAT T HE CONTRACT CAN BE TERMINATED ON MUTUALLY AGREED TERMS OF EX-PARTRIATE EMPLOYMENT. THE TERMS OF EX-PARTRIATE EMPLOYMENT HAVE NOT BEEN BROUGHT ON RECORD. IT IS HOWEVER CLAIMED THAT THE PAYMENT IN QUESTION IS IN ACCORDA NCE WITH THE AGREEMENT BETWEEN THE PARTIES. THE TENURE OF MR. SARBH WAS E XTENDED FOR A PERIOD OF 5 ITA NO.7296/MUM/2010(A.Y. 2006-07) 10 YEARS FROM 1/4/2000 TILL 31/3/2005 ON THE SAME TERM S. THE TENURE OF MR. SARBH FURTHER EXTENDED FOR A PERIOD OF FIVE YEARS ON THE ORIGINAL TERMS FROM 1/4/ 2005. AS PER THE ORIGINAL TERMS OF HIS EMPLOY MENT DATED 7/7/1997 THE SALARY AND BONUS IN INDIA PAYABLE TO MR. SARBH SHOU LD BE IN LINE WITH INTERNATIONAL ASSIGNMENT CONTRACT WITH P&O AUSTRAL IA PVT. LTD. 19. THE TERMS OF RESIGNATION OF MR. SARBH HAVE BEE N GIVEN AT PAGE NO.53 OF THE PAPER BOOK. A PERUSAL OF THE SAME SHOWS THA T MR. SARBH WAS TO RESIGN FROM ALL P&O PORT PVT. LTD. DIRECTORSHIP FR OM 6/10/2005. HE WAS TO BE PAID NORMAL REMUNERATION UPTO 20/11/2005. BESID ES THE ABOVE, HE WAS TO JHS TO RECEIVE A COMPANY SUPERANNUATION CONTRIBU TION AS SOON AS PRACTICABLE ON OR AROUND 7/10/2005 INTO HIS P&O AUS TRALIA SUPERANNUATION FUND ACCOUNT. HE WAS ALSO TO RECEIVE HIS 2005 BONU S ENTITLEMENT PRO RATA TO 30/6/2005 IN MARCH/APRIL 2006 FOLLOWING PUBLICAT ION OF AUDITED COMPANY ACCOUNTS. HE WAS TO BE PROVIDED HOUSING TI LL 30/6/07. RENT, UTILITIES AND ALL EXPENSES WERE TO BE PAID BY P&O P ORTS. ALL UTILITY BILLS WERE ALSO TO BE PAID BY THE ASSESSEE AS AND WHEN SUBMITT ED BY SARBH. THE ASSESSEE WAS ALSO REQUIRED TO CONTINUE TO PROVIDE S UPPORT AS NOW FOR DOMESTIC ISSUES EG. SERVICING OF AIR CONDITIONING, HELP/SERVICE/REPLACE WITH FAX, PHONE LINES AND COMPUTER, PRINTER EMAIL CONNEC TIVITY, POSTING/COURIER LETTERS AND BASIC SECRETARIAL SUPPORT ETC. BESIDES THE ABOVE, HE WAS TO BE PROVIDED WITH CAR FULLY MAINTAINED BY THE ASSESSEE. THE SCHOOL EXPENSES- OF CHILDREN WERE ALSO TO BE BORNE BY THE ASSESSEE. HE WAS ALSO TO BE GIVEN TWO CLUB MEMBERSHIPS WILLINGDON CLUB AND CHAMBERS TIL L 30/6/2007. FULL MEDICAL INSURANCE WAS TO CONTINUE ON PRESENT BASIS FOR SARBH AND HIS FAMILY UNTIL 30/6/07. THE TERMS OF TERMINATION OF SERVICE S OF SARBH WAS DULY CONSIDERED AND APPROVED BY THE BOARD OF DIRECTORS I N THEIR MEETING. 20. THERE IS NO MATERIAL ON RECORD TO SUGGEST THAT THE RESIGNATION OF MR.SARBH HAD TAKEN PLACE ONLY BECAUSE OF THE CHANGE OF SHARE HOLDING OF P&O GROUP TO D.P. WORLD GROUP. ULTIMATELY SUCH CHA NGE OF SHARE HOLDING ITA NO.7296/MUM/2010(A.Y. 2006-07) 11 TOOK PLACE ONLY IN THE MONTH OF MARCH 2006, WHEREAS MR. SARBH EXITED FROM THE ASSESSEE COMPANY FROM OCT. 2005. EVEN THE ASSE SSEE IN THE SUBMISSIONS BEFORE THE AO HAD ONLY MADE A REFERENCE TO FACT THAT THE RESIGNATION OF MR. SARBH WAS DUE TO THE POSSIBILITY OF CHANGE OF SHARE HOLDING OF THE P&O GROUP TO THE D.P.WORLD GROUP. W E, THEREFORE, HOLD THAT THE RESIGNATION OF MR. SARBH WAS NOT DUE TO CHANGE IN THE OWNERSHIP OF THE BUSINESS OR CHANGE IN THE SHARE HOLDING OF THE ASSE SSEE COMPANY. THE DECISIONS CITED BY THE LD. D.R. ARE THEREFORE, NOT OF ANY ASSISTANCE TO THE CASE OF THE REVENUE. 21. ON A CONSIDERATION OF THE MATERIAL ON RECORD A ND THE CIRCUMSTANCES UNDER WHICH MR.SARBH HAD TO LEAVE THE SERVICES OF T HE ASSESSEE, WE ARE OF THE VIEW THAT THE PAYMENT WAS MADE BY THE ASSESSEE IN THE INTEREST OF ITS BUSINESS. WE HAVE ALSO IN THIS REGARD TAKEN INTO CONSIDERATION THE PROFILE OF MR.SARBH AND HIS LONG ASSOCIATION WITH THE ASSESSEE . EARLIER THE THINKING WAS THAT EX-GRATIA PAYMENTS ON TERMINATION OF SERVI CE COULD NOT BE REGARDED AS WHOLLY AND EXCLUSIVELY INCURRED FOR THE PURPOSE OF BUSINESS. THAT THINKING HOWEVER NO LONGER HOLDS GOOD. THE HONBLE SUPREME COURT IN THE CASE OF M/S. SASOON J. DAVID(SUPRA) HAD TO CONSIDER A CASE WHERE SHARES OF AN ASSESSEE, AN INVESTMENT COMPANY, WERE HELD BY TH E DAVIDS. ITS ASSETS WERE WORTH RS. 155 LAKHS AS ON DECEMBER 31, 1955. O N DECEMBER 2, 1955, ITS DIRECTORS PROPOSED THAT THE SERVICES OF 22 EMPL OYEES, THE MANAGING DIRECTOR AND A DIRECTOR BE TERMINATED AND THAT THEY BE PAID COMPENSATION; AND ON JANUARY 25, 1956, THE SHAREHOLDERS ACCEPTED THE DIRECTORS' PROPOSAL. UNDER AN AGREEMENT DATED MARCH 23, 1956, THE DAVIDS AGREED TO SELL TO THE TATAS ALL THE SHARES IN THE APPELLANT COMPANY FOR R S. 155 LAKHS, THE SUM VOTED FOR PAYMENT OF COMPENSATION TO THE EMPLOYEES BEING DEDUCTIBLE THEREFROM. THE AGREEMENT ALSO PROVIDED THAT THE DAV IDS SHOULD ARRANGE TO TERMINATE THE SERVICES OF ALL EMPLOYEES WITH EFFECT FROM MARCH 31, 1956, AND ARRANGE TO HAVE ALL DIRECTORS RESIGN THEIR OFFICES SO THAT THE TATAS WOULD BE ENTITLED TO APPOINT THEIR OWN DIRECTORS OR EMPLOYER S. AFTER THE TAKE OVER, THE ITA NO.7296/MUM/2010(A.Y. 2006-07) 12 APPELLANT RE-EMPLOYED 9 OF THE 22 EMPLOYEES. THERE WAS A SUBSTANTIAL REDUCTION IN THE WAGE BILL AS A CONSEQUENCE OF THE RETRENCHMENT. THE APPELLANT PAID RS. 1,64,899 DURING THE CALENDAR YEA R 1956 RELEVANT TO THE ASSESSMENT YEAR 1957-58, WHICH AMOUNT, INTER ALIA, INCLUDED RS. 16,188 PAID TO THE MANAGING DIRECTOR IN LIEU OF SIX MONTHS ' NOTICE, RS. 21,200 PAID TOWARDS COMPENSATION FOR TERMINATION OF PENSION ALL OWANCE, AND RS. 16,885, THE FIRST OF FIVE ANNUAL PAYMENTS AS COMPENSATION T O THE DIRECTOR. THE APPELLANT CLAIMED DEDUCTION OF THE SUM OF RS. 1,64, 899 AS BUSINESS EXPENDITURE UNDER SECTION 10(2)(XV). THE APPELLATE TRIBUNAL HELD THAT THE EXPENDITURE HAD BEEN INCURRED BY THE APPELLANT NOT FOR THE PURPOSE OF THE BUSINESS BUT PURELY AS A RESULT OF THE BARGAIN BETW EEN THE DAVIDS AND THE TATAS AND THAT, EVEN ASSUMING THE PAYMENTS WERE BEN EFICIAL TO THE APPELLANT, NO DEDUCTION COULD BE ALLOWED SINCE THEY HAD BEEN MADE TO BENEFIT THIRD PARTIES. ON A REFERENCE THE HIGH COUR T HELD THAT ONLY THE TWO AMOUNTS OF RS. 21,200 AND RS. 16,188 WERE ALLOWABLE AS DEDUCTIONS AND THAT THE BALANCE OF RS. 1,27,511 PAID TO THE EMPLOY EES AND A DIRECTOR WAS NOT ALLOWABLE AS A DEDUCTION SINCE THE EXPENDITURE HAD NOT BEEN INCURRED BY THE COMPANY FOR COMMERCIAL REASONS. ON APPEAL BY TH E ASSESSEE TO THE SUPREME COURT, IT WAS HELD: ON THE FACTS, THAT, EVEN ASSUMING THAT THE MOTIVE BEHIND THE PAYMENT OF THE COMPENSATION WAS THAT THE TERMS OF THE AGREE MENT BETWEEN THE DAVIDS AND THE TATAS FOR THE SALE OF THE SHARES SHO ULD BE SATISFIED, AS LONG AS THE AMOUNT OF RS. 1,27,511 WAS LAID OUT WHO LLY AND EXCLUSIVELY FOR THE PURPOSE OF THE BUSINESS OF THE APPELLANT TH ERE WAS NO REASON FOR DENYING THE BENEFIT OF SECTION 10(2)(XV). THE A PPELLANT COMPANY CONTINUED TO FUNCTION EVEN AFTER ITS CONTROL PASSED ON TO THE TATAS AND THE EXPENDITURE IN QUESTION WAS LAID OUT FOR THE PU RPOSE OF THE COMPANY'S OWN TRADE AND NOT FOR THE TRADE OF THE TA TAS WHO WERE ONLY ITS SHAREHOLDERS. AS A RESULT OF THE EXPENDITURE, T HE APPELLANT COMPANY WAS IN FACT BENEFITED BY REDUCTION IN ITS WAGE BILL . IT COULD NOT BE SAID THAT THE TATAS WERE IN ANY WAY BENEFITED FINANCIALL Y BECAUSE OF THE DEDUCTION IN THE CONSIDERATION PAYABLE BY THE IN FO R THE SHARES. THE SUM OF RS. 1,27,511 WAS EXPENDED BY THE APPELLANT O N THE GROUND OF COMMERCIAL EXPEDIENCY AND IN ORDER INDIRECTLY TO FA CILITATE THE CARRYING ON OF ITS BUSINESS, AND WAS, THEREFORE, ALLOWABLE A S A DEDUCTION. ITA NO.7296/MUM/2010(A.Y. 2006-07) 13 22. THE HONBLE SUPREME COURT FURTHER HELD: THE EXPRESSION 'WHOLLY AND EXCLUSIVELY' USED IN SE CTION 10(2)(XV) OF THE INDIAN INCOME-TAX ACT, 1922, DOES NOT MEAN 'NEC ESSARILY'. ORDINARILY, IT IS FOR THE ASSESSEE TO DECIDE WHETHE R ANY EXPENDITURE SHOULD BE INCURRED IN THE COURSE OF HIS OR ITS BUSI NESS. SUCH EXPENDITURE MAY BE INCURRED VOLUNTARILY AND WITHOUT ANY NECESSITY AND IF IT IS INCURRED FOR PROMOTING THE BUSINESS AN D TO EARN PROFITS, THE ASSESSEE CAN CLAIM DEDUCTION UNDER SECTION 10(2)(XV ) OF THE ACT EVEN THOUGH THERE WAS NO COMPELLING NECESSITY TO INCUR S UCH EXPENDITURE. THE FACT THAT SOMEBODY OTHER THAN THE ASSESSEE IS A LSO BENEFITED BY THE EXPENDITURE SHOULD NOT COME IN THE WAY OF AN EX PENDITURE BEING ALLOWED BY WAY OF DEDUCTION UNDER SECTION 10(2)(XV) OF THE ACT IF IT SATISFIES OTHERWISE THE TESTS LAID DOWN BY LAW. CIT V. CHANDULAL KESHAVLAL AND CO. [1960] 38 ITR 601 (SC) RELIED ON. 23. THE HONBLE SUPREME COURT FURTHER HELD THAT TH E THREE TESTS LAID DOWN BY THE SUPREME COURT IN GORDON WOODROFFE LEATHER MF G. CO. V. CIT [1962] 44 ITR 551, VIZ., (I) THAT THE PAYMENT SHOULD HAVE BEE N MADE AS A MATTER OF PRACTICE WHICH AFFECTED THE QUANTUM OF SALARY, (II) THAT THERE WAS AN EXPECTATION BY THE EMPLOYEE OF GETTING A GRATUITY, AND (III) THAT THE SUM OF MONEY WAS EXPENDED ON THE GROUND OF COMMERCIAL EXPE DIENCY AND IN ORDER INDIRECTLY TO FACILITATE THE CARRYING ON OF THE BUS INESS OF THE ASSESSEE, HAVE TO BE READ DISJUNCTIVELY. IT WAS ALSO OBSERVED BY THE HONBLE SUPREME COURT THAT IT WAS TOO LATE IN THE DAY NOW, WHATEVER MAY H AVE BEEN THE POSITION ABOUT TWO DECADES AGO, TO TREAT THE EXPENDITURE INC URRED BY A MANAGEMENT IN PAYING REASONABLE SUMS BY WAY OF GRATUITY, BONUS , RETRENCHMENT COMPENSATION OR COMPENSATION FOR TERMINATION OF SER VICE AS NOT BUSINESS EXPENDITURE. SUCH EXPENDITURE WOULD ORDINARILY FALL WITHIN THE SCOPE OF SECTION 10(2)(XV) OF THE ACT. 24. IN THE LIGHT OF THE PRINCIPLES LAID DOWN BY TH E HONBLE SUPREME COURT IN THE SAME OF SASOON J. DAVID (SUPRA) WE ARE OF THE V IEW THAT THE ACTION OF THE ITA NO.7296/MUM/2010(A.Y. 2006-07) 14 CIT(A) IN DISALLOWING THE ENTIRE EXPENDITURE AS CAP ITAL EXPENDITURE CANNOT BE SUSTAINED. 25. AS FAR AS THE DISALLOWANCE MADE BY THE AO BY IN VOKING THE PROVISIONS OF SECTION 40A(2)(A) IS CONCERNED, WE FIND THAT THE ABOVE PROVISIONS WERE INTRODUCED TO CHECK EVASION OF TAX THROUGH EXCESSIV E OR UNREASONABLE PAYMENTS TO RELATIVES AND ASSOCIATE CONCERNS AND SH OULD NOT BE APPLIED IN A MANNER WHICH WILL CAUSE HARDSHIP IN BONA FIDE CASES . THE HONBLE BOMBAY HIGH COURT IN THE CASE OF CIT VS. INDO SAUDI SERVIC E TRAVEL PVT. LTD., 310 ITR 316 AFTER CONSIDERING THE CBDT CIRCULAR NO.6-P DATE D 6/7/1968 HAS TAKEN A VIEW THAT THE PROVISIONS OF SECTION 40A(2)(A) CAN B E APPLIED ONLY ON PROOF OF ATTEMPT TO EVADE PAYMENT OF TAX. WE HAVE ALREADY S EEN IN THE PRESENT CASE THAT IN THE HANDS OF MR. SARBH AMOUNTS PAID BY THE ASSESSEE HAD SUFFERED TAX. APART FROM THE ABOVE WE ALSO FIND THAT THE PA RAMETERS LAID DOWN IN SECTION 40A(2)(A) FOR MAKING THE IMPUGNED DISALLOWA NCE BY THE AO HAS NOT BEEN SATISFIED. IT HAS NOT BEEN SHOWN AS TO HOW TH E PAYMENT BY THE ASSESSEE TO MR. SARBH WAS UNREASONABLE HAVING REGAR D TO FMV FOR WHICH THE PAYMENT WAS MADE. IT HAS NOT BEEN EXPLAINED AS TO HOW THE PAYMENT IS NOT THE LEGITIMATE NEED OF THE BUSINESS OF THE ASSESSEE OR THE BENEFIT ACCRUED TO THE ASSESSEE. THE EXPLANATION GIVEN BY THE ASSESSE E HAS NOT BEEN FOUND TO BE FALSE BY THE AO. IN THESE CIRCUMSTANCES WE ARE OF THE VIEW THAT THE IMPUGNED DISALLOWANCE CANNOT BE SUSTAINED. WE, THE REFORE, HOLD THAT THE ASSESSEE IS ENTITLED TO DEDUCTION OF THE ENTIRE SUM PAID TO MR. SARBH. WE DIRECT ACCORDINGLY. 26. IN THE RESULT, THE APPEAL OF THE ASSESSEE IS AL LOWED. ORDER PRONOUNCED IN THE OPEN COURT ON TH E 13 TH DAY OF APRIL, 2011. SD/- SD/- (B.RAMAKOTAIAH ) (N.V.VASUDEVAN) ACCOUNTANT MEMBER JUDICIAL MEMBER MUMBAI, DATED. 13 TH APRIL.2011 ITA NO.7296/MUM/2010(A.Y. 2006-07) 15 COPY TO: 1. THE APPELLANT 2. THE RESPONDENT 3 . THE CIT CITY CONCERNED 4. THE CIT(A)- CONCERNED 5. THE D.RF BENCH. (TRUE COPY) BY ORDER ASST. REGISTRAR, I TAT, MUMBAI BENCHES MUMBAI. VM. ITA NO.7296/MUM/2010(A.Y. 2006-07) 16 DETAILS DATE INITIALS DESIGNATION 1 DRAFT DICTATED ON 6/4/11 SR.PS/PS 2 DRAFT PLACED BEFORE AUTHOR 7/4/11 SR.PS/PS 3 DRAFT PROPOSED & PLACED BEFORE THE SECOND MEMBER JM/AM 4 DRAFT DISCUSSED/APPROVED BY SECOND MEMBER JM/AM 5. APPROVED DRAFT COMES TO THE SR.PS/PS SR.PS/PS 6. KEPT FOR PRONOUNCEMENT ON SR.PS/PS 7. FILE SENT TO THE BENCH CLERK SR.PS/PS 8 DATE ON WHICH THE FILE GOES TO THE HEAD CLERK 9 DATE OF DISPATCH OF ORDER