Allowability of expenditure on employees welfare

Transcription

1 Allowability of expenditure on employees welfare 1 [Expenditure on employees welfare activities, including education of children of the employees, is allowable as a deduction] [Published in 405 ITR (Journ.) p.69 (Part-3)] S.K. Tyagi Of late, a number of business entities have sought opinion in regard to the allowability of expenditure on the employees welfare activities, including education of the children of the employees. Such expenditure may take various modes, viz : (a) Contribution to Panchayat for upgrading a school, wherein an assurance is given by the school management that children of the assessee s employees would be given preference in admission to school. (b) Contribution to a school where employee s children are studying. (c) Payment made to an education society which runs the school in which children of assessee s employees are studying. (d) Money spent by the assessee in connection with the running of a school for the benefit of children of employees, ex-employees and the members of the public. - Etc. etc. In order to provide the aforesaid opinion, it will be necessary to refer to the relevant provisions of Income-Tax Act, 1961 (the Act) and the relevant legal precedents, etc. To begin with, if we look at section 14 of the Act, it lists the various heads of income for the purposes of charge of income-tax and computation of total income. As per section 14 of the Act, there are five heads of income, viz. (i) Salaries (ii) Income from house property (iii) Profits and gains of business or profession (iv) Capital gains (v) Income from other sources

2 2 It may also be stated here that computation of total income is dealt with in Chapter IV of the Act. As regards profits and gains of business or profession, the same are dealt with under Chapter IV-D of the Act. There are various sections which fall within the purview of Chapter-IV-D of the Act, viz. sections from 28 to 44DB. A number of the aforesaid sections deal with deductions in respect of specific type of expenditure, whereas section 37 is a residuary provision. It provides for deduction of all expenditure wholly and exclusively laid out or expended for the purposes of the business, where such expenditure is not expressly covered by any other specific provision of the Act. For the sake of ready reference, section 37 is reproduced as follows : 37. General. (1) Any expenditure (not being expenditure of the nature described in sections 30 to 36 and not being in the nature of capital expenditure or personal expenses of the assessee), laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head "Profits and gains of business or profession". Explanation 1. For the removal of doubts, it is hereby declared that any expenditure incurred by an assessee for any purpose which is an offence or which is prohibited by law shall not be deemed to have been incurred for the purpose of business or profession and no deduction or allowance shall be made in respect of such expenditure. Explanation 2. For the removal of doubts, it is hereby declared that for the purposes of sub-section (1), any expenditure incurred by an assessee on the activities relating to corporate social responsibility referred to in section 135 of the Companies Act, 2013 (18 of 2013) shall not be deemed to be an expenditure incurred by the assessee for the purposes of the business or profession. (2) [***] (2B) Notwithstanding anything contained in sub-section (1), no allowance shall be made in respect of expenditure incurred by an assessee on advertisement in any souvenir, brochure, tract, pamphlet or the like published by a political party. If we look at the provisions of the aforesaid section 37(1), there are certain conditions of allowance of expenditure laid down thereunder. In order to be eligible for an allowance under section 37(1), the following conditions should be satisfied. (i) The expenditure should not be governed by the provisions of sections 30 to 36

3 3 (ii) The expenditure should have been laid out wholly and exclusively for the purposes of the business of the assessee. (iii) The expenditure should not be personal in nature; and (iv) The expenditure should not be capital in nature. In view of the aforesaid conditions for deduction of an expenditure under section 37(1), the touchstone for the allowance / deduction of the expenditure on the employees welfare activities, etc. will be that the expenditure should have been laid out wholly and exclusively for the purposes of the business of the assessee. In this context, at the outset, it may be stated that any contribution made by an assessee to a public welfare fund, which is directly connected with the carrying on of assessee s business or which results in benefit to the assessee s employees, is an allowable deduction under section 37(1). There are numerous instances where such expenditure has been held to be an allowable deduction under section 37(1) of the Act in the computation of total income of an assessee who is either engaged in a business or profession. Some of the legal precedents relating to such instances are discussed as follows : 1. CIT Vs India Radiators Ltd [1999] 236 ITR 719 (Mad) : [1998] 149 CTR 400 (Mad) In this case, the assessee-company made a contribution of Rs.35,000 to the Panchayat where its factory was situated. It made the said expenditure for upgrading the elementary school of the Panchayat as High School. The assessee claimed the contribution made to the Panchayat as a revenue expenditure. The Income-Tax Officer rejected the claim. The finding of the Tribunal was that by making the contribution to the Panchayat for upgrading the elementary school, the assessee was assured by the school management that it would give preference in the matter of admission to the children of the employees of the assessee-company in the said school. It held that the expenditure was deductible. On appeal by the Department, dismissing the appeal, it was held that the employees of the assessee were given the satisfaction by the donation made by the assessee that their employers had taken care of the education of their wards and such a mental satisfaction on the part of the employees would generate goodwill and the expenditure could be regarded as staff welfare expenditure and allowable as business expenditure. The fact that the benefit had percolated to the general public would not stand in the way of the assessee getting the necessary deduction once the expenditure was held to be business expenditure.

4 2. CIT Vs Travancore Cochin Chemicals Ltd [2000] 243 ITR 284 (Ker) : 161 CTR 124 (Ker) In this case, the assessee was a public sector unit engaged in the manufacture and sale of certain chemicals like caustic soda, chlorine, etc. During the previous year the assessee had made payments of Rs.5.34 lakhs to the FACT School. The claim of the assessee was that the above amount should be included under the welfare expenditure as the children of the employees of the assessee were studying in that school. The Assessing Officer held that the payment had no direct relation with the business activity of the assessee and was more or less in the nature of a donation and therefore, disallowed the claim. The Tribunal held that the assessee s contribution to the FACT School was for the assessee s business purpose and allowed the deduction thereof. 4 On a reference, it was held by the High Court that the expenditure met by the assessee for the FACT School was wholly and exclusively for the welfare of its employees as their children were studying in that school and also for carrying on the business of the assessee-company more efficiently by having a contended labour force. It was neither a donation covered under section 40A(9), nor capital in nature. Hence, the Tribunal was fully justified in allowing the expenditure towards the contribution for the running of FACT School, as an expenditure for the smooth functioning of the business of the assessee and also as expenditure wholly and exclusively for the welfare of the employees of the assessee and thus, allowable under section 37(1). 3. Mahindra and Mahindra Ltd Vs CIT [2003] 261 ITR 501 (Bom) : 182 CTR 34 (Bom) It was, inter-alia, held in this case that payment made to an education society which runs the school in which the children of assessee's employees studied was deductible as business expenditure as it was incurred for staff welfare. 4. ITAT Vs B.Hill & Co.(P) Ltd [1983] 142 ITR 185 (All) : [1982] 29 CTR 301(All) In this case, the assessee-company had set up two schools with a view to provide educational facilities to its labourers and their children, made donations to the schools and claimed the same as business expenditure under section 37. The assessee contended that though some of the directors of the assessee-company were on the management of the schools, yet that was for the purposes of facilitating the smooth running of their business. The Tribunal held that though part of the donations were made for the purpose of constructing buildings for the schools, yet by making donations the assessee had not brought into existence any asset of enduring nature. On a reference, it was held by the High Court that the donations were made by the assesseecompany in its character as a trader with a view to facilitate the smooth running of its business. The

5 5 expenditure was incurred to give facilities to the labourers and their children and was motivated by considerations of commercial expediency and was an allowable deduction under section Mysore Kirloskar Ltd Vs CIT [1987] 166 ITR 836 (Karn) : 61 CTR 265 (Karn) In this case the assessee-company had established an industry in a backward area. In order to attract technocrats and men of managerial skill to its industry and also to make them settle in the area, the assessee had to establish a school for the education of the children of the employees and with that object in view, the assessee-company constituted an education trust and started a school. The assessee-company had been donating every year certain sums to meet the expenditure of the school. In the relevant assessment year, the assessee had donated Rs.62,000 and claimed out of it 61 per cent by way of deduction under section 37(1) of the Act, on the ground that 61 per cent of the school children were children of the employees and ex-employees of the assessee. The ITO disallowed the claim for deduction. He, however, allowed 50 per cent of the donation as deduction under section 80G of the Act. The Appellate Assistant Commissioner upheld the order of the ITO. The Tribunal held that the claim of the assessee for deduction could not be allowed for two reasons namely, (i) that section 37 was not applicable to the case of the assessee since section 80G was applicable to the donations made by the assessee to the education trust and (ii) that since the school run by the trust was also open to the children of the persons who were not the employees of the assesseecompany, the expenditure incurred by the assessee could not be said to have been incurred wholly and exclusively for the purpose of the assessee s business. On a reference, it was held by the High Court that the words for the purpose of the business used in section 37(1) should not be limited to the meaning of earning profit alone. Business expediency or commercial expediency might require providing facilities like schools, hospitals, etc., for the employees or their children or for the children of the ex-employees. Any expenditure laid out or expended for their benefit, if it satisfied the other requirements, must be allowed as a deduction under section 37(1) of the Act. The fact that somebody other than the assessee was also benefited or incidentally took advantage of the provision made, should not come in the way of the expenditure being allowed as a deduction under section 37(1) of the Act. Nevertheless, it is an expenditure allowable as deduction under the Act. 6. CIT Vs B.G.Shirke & Co. [2003] 264 ITR 83 (Bom) : 127 Taxman 245 (Bom) In this case the assessee-firm was carrying on the business of construction and structural engineers. During the accounting year, relevant to the assessment year , the assessee had created three welfare trusts for the welfare of its employees and contributed various amounts. The assessee

6 claimed the said contribution as deduction in computing the total income. The claim was rejected by the AO, but accepted by the Tribunal. 6 On a reference, it was held by the High Court that there was no material adduced by the Income-Tax Officer to establish that either the creation of the trusts was not bona fide or the funds contributed by the assessee were utilized for purposes other than the welfare of the employees. Therefore, the decision of the assessee to establish welfare trusts for the employees in the year in which the firm earned huge profits was a prudent commercial decision. The expenditure incurred by the assessee by way of contribution to the welfare trust of the employees was rightly held to be deductible under section 37. It was also held by the High Court that in view of the socio economic changes labour welfare can be treated by the assessee as a liability in its accounts. Voluntary payments made by an employer for the general welfare and benefit of the employees on grounds of commercial expediency are revenue expenditure, deductible under section 37 of the Income-Tax Act. Such expenditure has nexus with the conduct of business and the expenditure incurred for maintaining industrial peace and cordial relations with the employees is an expenditure for the carrying on of the business. Accordingly, the issue was decided in favour of the assessee and against the Revenue. 7. CIT Vs Rajasthan Spg & Wvg Mills Ltd [2006] 281 ITR 408 (Raj) : [2005] 198 CTR 96 (Raj) In this case, the assessee-company had donated a bus valued at Rs.5.12 lakhs to a school where the children of the employees of the assessee-company were receiving education. The amount spent for purchasing the bus had been debited to the Workman and Staff Welfare Account and it was claimed as expenses incurred wholly and exclusively for the purpose of assessee s business. The AO rejected the claim but the CIT(A) and the Tribunal allowed it. On a reference, it was held by the High Court that the motivation of expenditure incurred for acquiring the bus and surrendering it to the school had not been found to be other than what had been stated by the assessee, i.e. to say the expenses were incurred for the benefit of welfare of the children of staff / workmen of the company as a part of employees welfare expenses incurred for the purpose of securing healthy services of such employees. Since the assessee had not acquired any asset, it was not capital expenditure. It was deductible. It was also held that the question of claim of deduction of any amount spent by the assessee as revenue expenditure incurred or laid out wholly and exclusively for the purpose of the assessee s business is not to be decided on the basis that the assessee must be entitled to the whole benefit accruing from such expenses and nobody else should be sharing this benefit.

7 Accordingly, the appeal of the I.T. Department was dismissed CIT Vs Madura Coats Ltd [2009] 24 DTR 24 (Mad) It was held in this case that the expenditure incurred by the assessee on community assistance programme and the welfare measures undertaken in the vicinity of the manufacturing unit which also benefited its employees is allowable as business expenditure. 9. Sri Venkata Satyanarayana Rice Mill Contractors Co. Vs CIT [1997] 223 ITR 101 (SC) : 137 CTR 267 (SC) In this case, it was held by the Supreme Court that any contribution made by an assessee to a public welfare fund which is directly connected or related to the carrying on of the assessee s business or which results in benefit to the assessee s business, has to be regarded as an allowable deduction under section 37(1) of the Act. Such a donation, whether voluntary or at the instance of the authorities concerned, when made to a Chief Minister s Drought Relief Fund or a District Welfare Fund established by the District Collector or any other fund for the benefit of the public and with a view to secure benefit to the assessee s business, cannot be regarded as payment opposed to public policy. The mere fact that making of a donation for a charitable or public cause or in public interest results in the Government giving patronage or benefit can be no ground to deny the assessee a deduction of that amount under section 37(1) of the Act when such payment had been made for the purpose of the assessee s business. It was also held that what is to be seen is not whether it was compulsory for the assessee to make the payment or not but whether it was expended out of considerations of commercial expediency. As long as the payment is made for the purposes of the business and the payment made is not by way of penalty for infraction of any law, the same would be allowable as a deduction. Accordingly, the judgement of the High Court was reversed and the matter was decided in favour of the assessee. 10. CIT Vs Madras Refineries Ltd [2004] 266 ITR 170 (Mad) : 138 Taxman 261 (Mad) In this case, for the assessment year , the assessee, a public limited company, as a good corporate citizen and as a measure of gaining goodwill of the people living in and around its industry, provided funds for establishing drinking water facility to the residents in the vicinity of the refinery and also provided aid to the school run for the benefit of the children of those local residents. It incurred an expenditure of R lakhs for that purpose. The AO declined to allow the expenditure on the ground that it was not an item of expenditure incurred by the assessee for earning the income in that industry. However, the Tribunal allowed it.

8 8 On appeal to the High Court, it was held that the amount spent for bringing drinking water as also for establishing or improving the school meant for the residents of the locality in which the business was situated could not be regarded as being wholly outside the ambit of the business concerns of the assessee, especially where the undertaking owned by the assessee was one which was to some extent a polluting industry. The expenditure was deductible. It was also held that the concept of business is not static. It has evolved over a period of time to include within its fold the concrete expression of care and concern for the society at large and the people of the locality in which the business is located, in particular. Being known as a good corporate citizen brings goodwill of the local community, as also with the regulatory agencies and the society at large, thereby creating an atmosphere in which the business can succeed in a greater measure with the aid of such goodwill. 11. South Eastern Coalfields Ltd Vs JCIT [2003] 260 ITR (AT) 1 (Nag) It was, inter-alia, held in this case that the expenditure on account of contribution to various schools was not incurred by the assessee-company voluntarily but the same was incurred to discharge its obligation in terms of the National Coal Wage Agreement, entered into with the employees and the said agreement was enforceable in law under the Indian Contract Act, as well as the Industrial Disputes Act. The expenditure was deductible. 12. Kochi Refineries Ltd Vs Dy.CIT [2010] 4 ITR (Trib) 95 (Mum) In this case, the Assessing Officer disallowed the payment of Rs.2.30 lakhs made to staff club, by invoking the provisions of section 40A(9) of the Act. The assessee s contention was that the provisions of section 40A(9) did not apply to the payments made to the CRL staff club and the expenditure should be allowed under section 37(1) of the Act. In support of the aforesaid stand, reliance was placed on the judgement of Bombay High Court in the case of CIT Vs Bharat Petroleum Corporation Ltd. [2001] 252 ITR 43 (Bom), wherein it was held that reimbursement of club expenses did not constitute contribution to any funds under section 40A(9) of the Act, so as to attract restricted provisions of this section. It was held that the payments to staff club were not covered by the provisions of section 40A(9) and accordingly, the same were to be allowed as expenditure incurred wholly and exclusively for the purpose of business under section 37(1) of the Act. The AO was, accordingly, directed to allow the expenditure. As the Tribunal, in this case, had followed the aforesaid judgement of Bombay High Court, in the case of Bharat Petroleum Corporation Ltd. (BPCL), it would be appropriate to refer to the aforesaid judgement of Bombay High Court. As per the facts of the case, BPCL is a Central Government

9 9 undertaking. It had incorporated a club, essentially to carry on staff welfare activities. Under clause (28), BPCL had a right to issue directives to the club, which were binding on the club At times, the members of the club who were the employees of BPCL, took part in tournaments held outside the club premises like Times Shield in cricket. On such occasions, the assessee-corporation used to reimburse expenses incurred by the club. It was held that this was a finding of fact recorded by the Tribunal. In the circumstances, section 40A(9) was not applicable. Accordingly, the issue was decided in favour of the assessee and against the Department. Summary In the light of the law laid down by the various High Courts, as also the Supreme Court, it may be stated that the concept of business has evolved over a period of time to include within its fold the expression of care and concern for the employees of the business entity, as also for the society at large. A business entity has to conduct its affairs as a good corporate citizen and it is expected to undertake welfare measures for its employees as well as for the people living in and around its industry as a measure of providing satisfaction to its employees and also as a measure of gaining the goodwill of public at large. In this regard, the relevant general principles laid down in some of the aforesaid judgements may be discussed as follows : (i) In the case of CIT Vs India Radiators Ltd [1999] 236 ITR 719 (Mad) : [1998] 149 CTR 400 (Mad), it was observed by the Madras High Court that donation to a school where the children of the employees are studying, would provide satisfaction to the employees of the assessee and such a satisfaction would generate goodwill amongst the employees. It was also observed that the fact that the aforesaid donation had also benefited the general public, would be an irrelevant consideration. (ii) In the case of ITAT Vs B.Hill & Co.(P) Ltd [1983] 142 ITR 185 (All) : [1982] 29 CTR 301(All), it was observed by the Allahabad High Court that the donations were made by the assessee-company in its character as a trader with a view to facilitate the smooth running of its business. It was also observed that the aforesaid expenditure was incurred to provide facilities to the labourers and their children and was motivated by considerations of commercial expediency. (iii) In the case of Mysore Kirloskar Ltd Vs CIT [1987] 166 ITR 836 (Karn) : 61 CTR 265 (Karn), it was observed by the Karnataka High Court that the words for the purpose of the business used in section 37(1) should not be limited to the meaning of earning profit alone. Business or

10 commercial expediency might require providing facilities like schools, hospitals, etc. for the employees or their children or for the children of the ex-employees. 10 It was further stated that the fact that somebody other than the assessee also benefited or incidentally took advantage of the provision made, should not come in the way of the expenditure being allowed as a deduction under section 37(1) of the Act. (iv) Similarly, in the case of CIT Vs B.G.Shirke & Co. [2003] 264 ITR 83 (Bom) : 127 Taxman 245 (Bom), it was observed by the Bombay High Court that in view of the socio-economic changes, labour welfare can be treated by the assessee as a liability in its accounts. Such expenditure has nexus with the conduct of business and the expenditure incurred for maintaining industrial peace and cordial relations with the employees is an expenditure for the purposes of carrying on the business. (v) In the case of CIT Vs Madras Refineries Ltd [2004] 266 ITR 170 (Mad) : 138 Taxman 261 (Mad), it has been observed that the concept of business is not static. It has evolved over a period of time to include within its fold the concrete expression of care and concern for the society at large and the people of the locality in which the business is located. It was also observed that being known as a good corporate citizen brings goodwill of the local community, as also the regulatory agencies and thereby an atmosphere is created in which the business can succeed in a greater measure with the aid of such goodwill. (vi) In the case of CIT Vs Rajasthan Spg & Wvg Mills Ltd [2006] 281 ITR 408 (Raj) : [2005] 198 CTR 96 (Raj), it was held by the Rajasthan High Court that the claim of deduction of any amount spent by the assessee as revenue expenditure incurred or laid out wholly and exclusively for the purpose of assessee s business is not to be decided on the basis that the assessee must be entitled to the whole benefit accruing from such expenses and nobody else should be sharing this benefit. (vii) In the case of Sri Venkata Satyanarayana Rice Mill Contractors Co. Vs CIT [1997] 223 ITR 101 (SC) : 137 CTR 267 (SC), the Supreme Court has laid down that what is to be seen is not whether it was compulsory for the assessee to make the payment or not but whether it was expended out of considerations of commercial expediency. As long as the payment is made for the purposes of the business and the payment made is not by way of penalty for infraction of any law, the same would be allowable as a deduction. In the light of the aforesaid discussion, it is clearly established that an expenditure incurred by an assessee on the employees welfare activities, including the education of the children of the employees, is allowable as a deduction under section 37(1) of the Act. It may also be stated here that the expenditure incurred on the welfare of the general public associated with the business of the assessee, is also allowable as a deduction under section 37(1) of the Act.

11 11 The aforesaid guidelines may be used by the various business entities, as also their advisors, while claiming deduction in respect of an expenditure incurred on employees welfare activities, including the education of the children of the employees. S. K. TYAGI Office : (020) Flat No.2, (First Floor) M.Sc., LL.B., Advocate : (020) Gurudatta Avenue Ex-Indian Revenue Service Residence : (020) Popular Heights Road Income-Tax Advisor Website: s : tyagi@sktyagitax.com : sktyagitax@gmail.com : sktyagidt@airtelmail.in Koregaon Park PUNE