1. In this reference at the instance of the Commissioner the following two questions have been referred to us by the Income-tax Appellate Tribunal :
'(1) Whether, on the facts and in the circumstances of the case, the amounts paid by the assessee to its employees and styled 'entertainment allowances' are admissible as deductions in the computation of its business income of the assessment years 1961-62 and 1962-63
(2) Whether, on the facts and in the circumstances of the case, was the sum of Rs. 51,361 incurred by the assessee for management expenses, over and above the limit set for it under section 40C of the Insurance Act, allowable as business expenditure in the computation of its income for the assessment year 1962-63 ?'
2. It may be mentioned that one of the assessment years in question would be governed by the Indian Income-tax Act, 1922, whereas the second of the assessment years in question would be governed by the Income-tax Act, 1961. A few facts may be stated :
The assessee, M/s. Devkaran Nanjee Insurance Company Ltd., was at all material times a company doing insurance other than life insurance business. In the two accounting years relevant to the assessment years 1961-62 and 1962-63, the assessee paid to its employees, Rs. 59,430 and Rs. 60,200, respectively, designating these payments as 'entertainment allowances'. In the computation of its business income for these years the assessee claimed deduction of the amounts. As far as some of the employees were concerned, the allowances paid were within the limit imposed by section 7(2)(ii)(b) of the Act of 1922 and section 16(2)(b) of the Act of 1961, and, hence, the allowances were allowable as deductions in the computation of the income of the recipients. The entertainment allowance paid to some of the employees, however, exceeded the said limit; hence, those amounts were liable to and actually subjected to tax in their hands and the assessee-company had, as their employer, deducted tax at source on those amounts. The Income-tax Officer was unable to find out how much of these amounts had been subjected to tax in the hands of the employees and how much had not been subjected to tax, and hence he disallowed the entire claim of the assessee for these two amounts. As far as the entertainment allowances were concerned, in appeal, the Appellate Assistant Commissioner called for details and found that Rs. 22,904 and Rs. 35,190 in the respective assessment years had suffered tax in the hands of the employees and on the footing that as these amounts had already been taxed in the hands of the employees, the Appellate Assistant Commissioner was of the opinion that taxation of these very amounts in the hands of the employers, viz., the assessee-company, would amount to double taxation and, therefore, he allowed the claim of the assessee for deduction to the extent of these two amounts. The claim, however, of the assessee as to the balance was rejected by the Appellate Assistant Commissioner, who upheld the orders of the Income-tax Officer as to these portions of the entertainment allowance. The assessee carried the matter in further appeal to the Income-tax Appellate Tribunal. Before the Tribunal it was contended on behalf of the assessee that though the amounts paid to the employees were styled and named as entertainment allowances, those were in fact part of the salary paid to them so far as the assessee was concerned. It was urged that the recipients of those amounts were neither obliged to spend out of them on actual entertainment nor were they actually accountable to the assessee in respect of the amounts received by them. Whether such allowances in the hands of the employees would be exempt from or liable to tax was, it was submitted, irrelevant as for as the question of taxation of these amounts in the hands of the employees was concerned. The Tribunal, following the decision of another Bench of the Tribunal I.T.A. No. 13646 of 1963-64 (in which a similar contention had arisen for determination), held that these amounts which had been paid by the assessee to its employees, although styled as entertainment allowance, were in fact part of the salaries of the concerned employees and that there was no scope for disallowance of any portion of the amounts under section 37(2). In the view of the Tribunal section 37(2) dealt only with the entertainment expenditure directly incurred by the company in the course of its business, whereas sections 16 and 17 were applicable to entertainment allowances received by salaried employees which may be allowed as deduction in computing the salary income earned, depending upon the quantum, of such allowance.
3. For the assessment year 1962-63 the assessee-company had incurred management expenses amounting to Rs. 10,15,944 and had claimed deduction of these expenses in the computation of its business income for the said assessment year. Under section 40C of the Insurance Act, 1938, a certain limit business been set on expenses on management in general insurance business. The Income-tax Officer found that the amount of management expenses claimed by the assessee exceeded the limit set under the Insurance Act by Rs. 51,361 and accordingly he disallowed this excess. On appeal, the Appellate Assistant Commissioner upheld the disallowance and add-back. Before the Tribunal it was urged on behalf of the assessee that the said expenditure had in fact been incurred by the assessee for the purpose of its business and it was not even contended by the department that even a single rupee had been expended for purposes other than business purposes. It was submitted that if the management expenses actually incurred exceeded the limit fixed under section 40C of the Insurance Act, 1938, it was a matter for the Controller of Insurance who could question the assessee. In fact, it was pointed out that the explanation offered by the assessee for exceeding the prescribed limit had been accepted by the Controller of Insurance for the assessment year in question. It was urged that the Income-tax Officer could not in this manner punish an assessee for committing a breach of the provisions of the Insurance Act by disallowing under the Income-tax Act part of the expenditure which had been incurred solely and exclusively for business purposes. The Tribunal was also referred to another decision of another Bench of the Tribunal (where the question had been dealt with at great length) and on the basis of the reasoning which was enunciated in the said decision the Tribunal upheld the contention of the assessee that it was not open to the income-tax authorities to add back a portion of such expenses of the assessee on the ground that it exceeded the limit prescribed under section 40C of the Insurance Act, 1938.
4. On the first question the learned counsel for the Commissioner has taken us through the relevant provisions of the Indian Income-tax Act, 1922, as well as Income-tax Act, 1961, and we are in agreement with the view of the Tribunal that the limit on entertainment expenses prescribed by section 37(2) would only apply to such expenses as could be held to have been incurred by the company and there would be no occasion for applying these provisions where certain amounts were paid to the employees which could be considered as part of their salary and where there was no obligation on the part of the recipient to spend out of them for actual entertainment nor could it be shown that they were accountable to the assessee in respect of such amounts received by them. We are also in agreement with the view accepted by the Tribunal that in such a case whether the recipients would be entitled to claim any deduction (which would depend upon whether the amounts received as such allowances were within the prescribed limit or not) would not have any relevance to the question of taxability of these amounts in the hands of the assessee. The approach of the Tribunal to this question for both the years appears to be legal and proper and there would be no warrant for holding otherwise.
5. As far as the second question is concerned, our attention was drawn by learned counsel for the Commissioner to the provisions contained in section 40B and 40C of the Insurance Act, 1938. He also pointed out that under the First Schedule to the Income-tax Act, 1961, rule 5 would apply to insurers carrying on insurance business other than life insurance business. This rule may be fully set out :
'5. Computation of profits and gains of other insurance business. - The profits and gains of any business of insurance other than life insurance shall be taken to be the balance of the profits disclosed by the annual accounts, copies of which are required under the Insurance Act, 1938 (IV of 1938), to be furnished to the Controller of Insurance, subject to the following adjustments :
(a) subject to the other provisions of this rule, any expenditure or allowance which is not admissible under the provisions of sections 30 to 43A in computing the profits and gains of a business shall be added back;
(b) any amount either written off or reserved in the accounts to meet depreciation of or loss on the realisation of investment shall be allowed as a deduction, and any sums taken credit for in the accounts on account of appreciation of or gains on the realisation of investments shall be treated as part of the profits and gains :
Provided that the Income-tax Officer is satisfied about the reasonableness of the amount written off or reserved in the accounts,as the case may be, to meet depreciation of or loss on the realisation of investment;
(c) such amount carried over to reserve for unexpired risks as may be prescribed in this behalf shall be allowed as a deduction.'
6. It is clear that the profits and gains of any business of insurance other than life insurance are required to be taken as disclosed in the annual accounts of such insurer as are furnished to the Controller of Insurance and the only adjustment as are permissible are those provided in clauses (a), (b) and (c). These do not contemplate the nature of any disallowance or addition on the footing as was done by the Income-tax Officer of the amount of Rs. 51,361. Rule 5(a) would not entitle the Income-tax Officer to disallow any item of expenditure incurred for the purpose of the business of the assessee merely on the footing that this was beyond the permissible limit as prescribed by section 40C of the Insurance Act, 1938. It was urged by learned counsel for the assessee that if there was any violation of the requirements of the Insurance Act, action could be taken under that Act; and that on the basis of such provisions it was not competent for the Income-tax Officer to disallow the excess expenditure. In this connection he drew our attention to two decisions of the Madras High Court viz., (1) Commissioner of Income-tax v. Ramakrishna Mills (Coimbatore) Ltd. : 93ITR49(Mad) and (2) Commissioner of Income-tax v. Sree Rajendra Mills Ltd. : 93ITR122(Mad) . In these matters the Madras High Court was considering certain payments made by the companies, which payments infringed certain sections of the Companies Act, and it was held that even if the payments infringed either section 348 or section 360 of the Companies Act, the company concerned would be entitled to deduction of the amounts under section 10(2)(xv) of the Indian Income-tax Act, 1922; this was on the footing that in considering the allowability of an expenditure under these provisions of the Income-tax Act, it was not permissible to travel beyond the provisions of the Income-tax Act and deny the benefit of the deduction under the appropriate section of the Income-tax Act on the ground that the payment was unauthorised or had been prohibited by some other statute.
7. In our opinion it is unnecessary to apply our mind to the provisions of the Companies Act and consider whether they are comparable with the prohibition or limits on expenses imposed by the Insurance Act, 1938. We are in agreement with the view taken by the Tribunal as to what was the adjustment permitted to the Income-tax Officer under rule 5 of the First Schedule, which rule has been fully set out hereinabove. On the clear wording of the said rule we are of opinion that it was not permissible to the Income-tax Officer to disallow the amount of Rs. 51,361 on the footing that he did and on the admitted basis that the full amount claimed as management expenses had in fact been expended by the assessee and that the expenditure was for its business purposes.
8. In this view of the matter, the questions referred to us are answered as follows :
Question No. (1) - In the affirmative and in favour of the assessee.
Question No. (2) - In the affirmative and in favour of the assessee.
9. The Commissioner will pay to the assessee the costs of this reference.