www.pwc.com/in Sharing insights News Alert 19 April, 2011 Expenditure on voluntary retirement scheme is tax deductible even if the scheme is not in accordance with the exemption provision for the employees In brief In a recent ruling 1, the Delhi Bench of the Income-tax Appellate Tribunal ( the Tribunal ) held that deduction in respect of expenses incurred pursuant to a Voluntary Retirement Scheme ( VRS ) can be claimed under section 35DDA of the Income-tax Act, 1961 (the Act ) even if the scheme is not in accordance with the guidelines prescribed under section 10(10C) of the Act read with Rule 2BA of the Income-tax Rules, 1962 ( the Rules ). Section 35DDA of the Act provides for deduction of expenses incurred on VRS over a period of five years. However no conditions/guidelines have been prescribed as to the eligibility of VRS for the purposes of availing the deduction. Section 10(10C) of the Act provides for exemption of compensation received by an employee pursuant to VRS, provided the same is in accordance with the guidelines prescribed under Rule 2BA of the Rules. 1 Sony India Pvt. Ltd. v. ACIT [I.T.A. Nos. 4008, 4114 & 4994(Del)/2010] 1
Facts Sony India Pvt. Ltd. ( the assessee ) is engaged in manufacturing and trading business. During the financial year 2004-05, it had shut down its manufacturing operations at its unit in Dharuhera. It floated a VRS known as Employees Voluntary Retirement Scheme 2004 applicable only to the employees of the closed unit and claimed one-fifth of the VRS expenditure incurred as a deduction under section 35DDA of the Act. The Assessing Officer ( AO ) disallowed the assessee s claim on the following grounds: Section 35DDA of the Act does not prescribe the contents of VRS and hence reference must be made to Rule 2BA of the Rules which prescribe conditions in respect of VRS, on the satisfaction of which an employee can claim exemption under section 10(10C) of the Act. On comparison of terms of the scheme floated by the assessee with the conditions prescribed in the aforesaid Rule, the AO observed that the VRS of assessee did not fulfill the conditions laid down in the Rule. The AO also held that the scheme offered to the employees was not a VRS but a substitution of retrenchment compensation payable to the employees, and therefore, would not be eligible for deduction under section 35DDA of the Act. The AO held that deduction can be allowed under section 37(1) of the Act only in respect of those expenses which are incurred for the purpose of business. This pre-supposes the fact that the business continues to be carried on. Since the expenses on VRS were incurred in the process of closure of the business of the Dharuhera unit, the same could not be allowed as a deduction under section 37(1) of the Act. The Commissioner of Income Tax (Appeals) ( CIT(A) ) upheld the contentions of the assessee that the aforesaid expenditure was not in nature of retrenchment compensation and was incurred in terms of the VRS. However, the CIT(A) held that VRS of the assessee did not comply with Rule 2BA conditions and therefore expenses incurred thereon could not be allowed as a deduction under section 35DDA of the Act. Furthermore, the CIT(A) also held the expenses on VRS to be capital in nature. Assessee s contentions In the Finance Bill, 2001 leading to enactment of section 35DDA, a provision was made regarding the application of Rule 2BA of the Rules. The said portion was deleted when the Bill was passed, and thus, the conditions of this rule were not intentionally incorporated in the section. 2
Since the revenue did not challenge the finding of the CIT(A) that the expenses on VRS were not in the nature of retrenchment compensation but were on account of VRS, the aforesaid findings became final. The entire business of the assessee including business of the Dharuhera unit, constituted composite business, having common control. Therefore expenses incurred on VRS were towards carrying on of the business and therefore should be allowed as a deduction under section 37(1) of the Act. In this context, the assessee relied on the Kerala High Court decision of O E N India Ltd. 2. Revenue s contentions The expenses on VRS is in respect of closure of the business of Dharuhera unit, which is altogether a separate business, and therefore, no deduction can be allowed in view of existing jurisprudence in the matter under section 37 of the Act. The revenue also relied on various judicial precedents including the Supreme Court decisions in the case of L. M. Chhabra & Sons and Gemini Cashew Sales Corporation 3. Tribunal Observations and Ruling The Tribunal held that the assessee is eligible to claim deduction under section 35DDA in respect of expenses incurred on VRS on the following grounds: Section 35DDA and section 10(10C) of the Act deal with the payment and receipt of VRS compensation in the hands of the employer and the employee respectively, and therefore, useful guidance can be taken from section 10(10C) of the Act and Rule 2BA of the Rules for ascertaining whether the expenses incurred on VRS of the assessee are allowable under section 35DDA of the Act. Since the VRS floated by the assessee did not comply with the conditions prescribed by Rule 2BA of the Rules, expenses in respect of the same cannot be allowed as a deduction under section 35DDA of the Act. - The deletion of the conditions as originally incorporated in section 35DDA of the Act at the time of its introduction vide the Finance Bill, 2001, suggested that legislative intendment was not to incorporate the conditions of section 10(10C) in section 35DDA of the Act. - The legislature left the scheme of voluntary retirement open-ended and did not place any restriction on the scheme. Thus, the plain language of the provision of section 35DDA of the Act supports the case of the assessee. 2 CIT v. O E N India Ltd. [2010] 8 Taxman.com 246 (Ker) 3 L. M. Chhabra & Sons v. CIT [1967] 65 ITR 638 (SC), CIT v. Gemini Cashew Sales Corporation [1967] 65 ITR 643 (SC) 3
- If the revenue s arguments were to be accepted, the provisions of section 35DDA of the Act will have to be modified by incorporating a part of section 10(10C) of the Act. This interpretation is not supported by any rule of construction. - The Tribunal noted that despite the fact that separate ground of appeal had not been preferred against the findings of the CIT(A) that the assessee s expenditure is not in respect of retrenchment compensation but in respect of the VRS, the revenue could still agitate the matter by a separate plea under Rule 27 of the Appellate Tribunal Rules, 1963. Conclusion The aforesaid Ruling lays down an important principle that in order to claim deduction under section 35DDA of the Act, it is not necessary that the VRS should be in accordance with Rule 2BA of the Rules. However, it may lead to an interesting situation in respect of such VRS schemes that an employer may get a deduction on expenses incurred thereon under section 35DDA of the Act but on the other hand an employee may not get an exemption under section 10(10C) of the Act in respect of the compensation received thereunder. As regards the claim of deduction under section 37(1) of the Act, the Tribunal held that it needs to be proved that Dharuhera unit was a part and parcel of the overall business of the assessee. In order to ascertain the same, it would be inter alia necessary to prove common control and management, interlinked finances, common employees, no effect of closure of the business on other businesses, etc. In the absence of relevant material such as directors report to the shareholders at the time of starting and shutting down the Dharuhera unit for ascertaining sources and utilisation of funds, production of bank account to show common source of funds for all businesses, evidence of shifting employees from one business to another, viability of trading business in absence of a manufacturing business etc., the Tribunal did not give its finding in this regard. 4
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