1. These two appeals, one each by the assessee and the ITO, relate to the assessee's assessment for the assessment year 1972-73. The assessee is a company. Its assessment for the year was originally made under Section 143(3) of the Income-tax Act, 1961 ('the Act') on 29-3-1975 computing total income at Rs. 1,19,82,982. Since, according to the ITO, the income of the assessee chargeable to tax had been underassessed on account of allowance of initial contribution to superannuation fund in full, he recorded a finding to that effect and issued notice under Section 148 read with Section 147(b) of the Act on 22-9-1975, in response to which the assessee filed its return on 28-10-1975 declaring its income at Rs. 69,72,000. Supplementary assessment was, however, completed on 16-8-1977 computing the total income at Rs. 1,43,84,542.
The additions in the impugned assessment, inter alia, were: Rs.(i) For under-valuation of stock 1,86,962(ii) Out of expenditure in Agro Aviation Division 1,25,000(iii) Out of initial contribution of Rs. 7,03,143 tothe superannuation fund holding one-fifth of 2. Besides challenging the legality of the assessment under Section 148/147(b), the assessee contested all the aforesaid three additions/disallowances. For reasons given in paragraphs 3 and 4 of his order, the AAC upheld the validity of the supplementary assessment. On merits of the additions/disallowances, however, the AAC held (vide paragraph 5) that the assessee was entitled to the allowance of initial contribution to superannuation fund at one-fifth of 100 per cent as against the allowance by the ITO at one-fifth of 80 per cent. For reasons given in paragraph 7 of the order, he limited the disallowance out of expenditure in Agro-Aviation Division to the extent of ransom paid. It is pertinent that total cash expenditure defrayed by Shri P.G.Dastur through Shri Kalidas, the man-in-charge of the job, was Rs. 1,02,200 as against which the ITO had estimated such payments at Rs. 1,25,000. According to the AAC, the disallowance of Rs. 1,02,200 alone was justified. As regards the addition of Rs. 1,86,962 for under-valuation of stock, the AAC remitted the case back to the ITO, His observations in this behalf are that the assessee is entitled to revalue its stock in respect of obsolete and slow moving items but since it was not clear whether the technical team of the company duly recommended such revaluation after due scrutiny as was done in the course of the assessment year 1973-74, it would be desirable to remit the case back to the ITO for consideration afresh after obtaining the report of the technical team relating to such revaluation of stock.
3. Both the assessee and the ITO have felt aggrieved by the aforesaid order of the AAC and, hence, both are in appeal before us. It may be mentioned that ground regarding disallowance of Rs. 1,02,200 was not taken by the assessee originally in the appeal memo and was taken by way of additional ground only on 6-3-1979. Since, however, we find that a similar ground was taken by the assessee in its appeal for the assessment year 1973-74, we accept the assessee's submissions that the ground was not taken through inadvertance only. This ground is, therefore, admitted. There are, thus, besides the ground in the assessee's appeal challenging the legality of assessment, the following three common grounds in the appeals filed by the assessee and the ITO: Assessee's appeal ITO's appeal1. The initial contribution of Rs. 7,03,143 1. The AAC should have to the superannuation fund should have confirmed allowance of one- been allowed in full.
fifth of 80 per cent of Rs. 7,03,143 only.2. The addition of Rs. 1,86,962 on account 2. The addition should of stock under-valuation should have been have been confirmed. deleted straightaway.3. The addition of Rs. 1,02,200 in Agro 3. The AAC was not justified Aviation Division out of Rs. 1,25,000 in reducing the addition by made by the ITO was not justified.
the amount Rs. 22,800.
4. Before we refer to the rival contentions, we would like to observe that though the ITO has also taken a ground against the AAC's remitting the issue of addition on account of undervaluation of closing stock to him, he has, as a matter of fact, examined the whole issue afresh in pursuance of the AAC's order and deleted the addition himself. In the circumstances, the grounds in the assessee's appeal and the ITO's appeal regarding this issue have become infructuous and required to be treated as not pressed. It may also be observed that the assessee has also not pressed ground Nos. 1 and 2 in the appeal memo challenging the legality of assessment as such. There, thus, remains two grounds in each appeal involving common issues.
5. Shri B.K. Khare, the learned counsel for the assessee, has submitted that the departmental authorities have failed to appreciate that contribution of Rs. 7,03,143 by the assessee to superannuation fund is not the initial contribution contemplated in Section 36(1)(iv) of the Act, Rules 87 and 88 of the Income-tax Rules, 1962 ('the Rules'), and Notification No. SO 3433, dated 21-10-1965, see Taxmann's Direct Taxes Circulars, Vol. 1, 1980 edn., p. 206 issued by the CBDT. Alternatively, he contended that rules and the Notifications in this behalf are in excess of the powers of rule making authority and are in conflict with the provisions of the section and, therefore, have to be ignored. The departmental representative has, on the other hand, pointed to the assessee's own description of the contribution and the provisions of Section 36(1)(iv) and the rules. He stated that the Tribunal was not competent to consider the vires of the rules and in any event the rules and the notifications serve the purpose referred to in the section rather than defeat as alleged. According to the departmental representative, but for the rules and the circular, nothing out of initial contribution would have been allowable. The allowance can be made, if at all, as laid down in the notification read with the rules.
6. For better appreciation of rival contentions, reference may first be made to the fact that the assessee has established the superannuation fund for many years and that under the scheme adopted by it, its employees become entitled to the gratuity only after they have completed a particular number of years of service. Thus, every year quite a few of its employees become entitled to gratuity for the first time. When they become so entitled, the assessee's contribution is computed with reference to past services and also for the previous year. The contribution referable to the past service is described as first contribution or the initial contribution while the contribution referable to the service of the previous year is referred to and known as annual contribution. It is, thus, evident that the contribution referable to the employees past years' services also incurs as a liability to the assessee in the previous year only when the employees become entitled to it for the first time on account of completion of a particular number of years of service. Needless to mention, this contribution is not the same thing as the contribution made initially at the time of establishing the superannuation fund.
(1) The deductions provided for in the following clauses shall be allowed in respect of the matters dealt with therein, in computing the income referred to in Section 28-- (iv) any sum paid by the assessee as an employer by way of contribution towards a recognised provident fund or an approved superannuation fund subject to such limits as may be prescribed for the purpose of recognising the provident fund or approving the superannuation fund, as the case may be; and subject to such conditions as the Board may think fit to specify in cases where the contributions are not in the nature of annual contributions of fixed amounts or annual contributions fixed on some definite basis by the reference to the income chargeable under the head 'Salaries" or to the contributions or to the number of members of the fund; The clause provides for allowance of any sum paid to a recognised provident fund or an approved superannuation fund, subject to: (a) such limits as may be prescribed for the purpose of recognising the provident fund or approving the superannuation fund, as the case may be.; and (b) such conditions as the Board may think fit to specify in cases where the contributions are not in the nature of annual contributions of fixed amounts or annual contributions fixed on some definite basis by reference to the income chargeable under the head 'Salaries' or to the contributions or to the number of members of the fund.
To our mind the limits (to be prescribed) as contemplated in the first limb are for the purpose of recognition or approval of the fund and not for the allowance of sums paid. The conditions (also to be prescribed) contemplated in the second limb, it appears, are of two types, namely, the conditions in cases: (i) where the contributions are not in the nature of annual contributions or fixed amounts; or (ii) where the contributions are not in the nature of annual contributions fixed on some definite basis by reference to the income chargeable under the head 'Salaries'; and also the conditions with reference to the contributions and to the number of members of the fund. The 'limits' mean and refer to pecuniary limits which is clear from Rules 87 and 88, while the 'conditions' mean and refer to other conditions laid down for approval of the fund. To this extent, therefore, we agree with Shri Khare, the learned counsel for the asscssee, that all limits and conditions contemplated to be prescribed in Section 36(1)(iv) refer to the limits and conditions for the establishment of the superannuation fund without which the superannuation fund will not be approved by the departmental authorities but once the fund is approved, the section as such does not contemplate prescribing of limits for the allowance. We also do not agree with the departmental representative that the contribution referable to the past years 'service' of an employee becoming entitled to gratuity for the first time during the previous year is not a liability accrued to the assessee during the previous year. To our mind, it is a liability of the year and will have to be allowed as deduction even under Section 37 of the Act in terms of the Supreme Court's decision in the case of Metal Box Co. of India Ltd. v. Their Workmen  73 ITR 53. In other words, the limits and conditions to be prescribed have no relevance to the allowance of the claim as distinct from the approval of the superannuation fund. Rules 87 and 88 reading as: 87. The ordinary annual contribution by the employer to a fund in respect of any particular employee shall not exceed twenty-five per cent of his salary for each year as reduced by the employer's contribution, if any, to any provident fund (whether recognised or not) in respect of the same employee for that year.
88. Subject to any condition on which the Board may think fit to specify under Clause (rv) of Sub-section (1) of Section 36, the amount to be allowed as a deduction on account of an initial contribution which an employer may make in respect of the past services of an employee admitted to the benefits of a fund shall not exceed twenty-five per cent of the employee's salary for each year of his past service with the employer as reduced by the employer's contribution, if any, to any provident fund (whether recognised or not) in respect of that employee for each such year.
also do not contemplate any limit for allowance except for the following phrase used in Rule 88: Subject to any condition which the Board may think fit to specify ...
This phrase also, to our mind, refers to the conditions for approval, investment and/or management of the fund and not to the allowance of any sum contributed. Otherwise prescribing of limits in the rule itself would be meaningless. The notification in question, therefore, is beyond the powers of the CBDT. No doubt, as creature of the Act, we are not competent to consider vires of the Act or may be of the rules made thereunder. However, where there is conflict between the provisions of the Act and the rules, it is a settled law that the rule must give way to the provisions of the Act, much more when the conflict is between the provisions of the section and a notification or circular issued by the Board. This is in spite of the fact that we agree with the departmental representative that the contribution by the assessee referable to the past services of an employee might be known as initial contribution within the meaning of Rule 88, Having regard to the above discussion, we are inclined to accept the submissions on behalf of the assessee that the entire sum of Rs. 7,03,143 paid by the assessee as contribution to the superannuation fund represents the assessee's allowable liability of the year.
8. As regards the second issue, it must be stated in fairness to Shri Khare that he admitted that his clients had to pay illegal money as ransom to the Tamil Nadu Government for the purpose of carrying on its Agro Aviation Division business. He, in fact, invited our attention to the findings of Sarkaria Commission of Inquiry at page 133 of the report to show that those payments had to be made by the assessee under duress but for which it would have been simply impossible for the assessee to recover for the services already rendered by it under various contracts. He, thus, contended that the expenditure incurred by the assessee was an allowable deduction. Alternatively, Shri Khare pointed out that actual payments made to the Tamil Nadu Government during the previous year amounted to Rs. 55,404 and, therefore, disallowance could be made, if at all, of Rs. 55,404 and nothing more.
In this connection, he explained that the payment made by Shri Dastur to Shri Kalidas was for various purposes including the purpose of making illegal payments to the Tamil Nadu Government. The fact that a sum of Rs. 1,02,200 was paid to him does not mean that the entire amount was paid for this purpose. The departmental representative, on the other hand, strongly relied on the order of the AAC. He, in fact, pleaded that the fact that Sarkaria Commission found the illegal payments to be Rs. 55,404 should not be taken as the total payments made. It might be more and the ITO was, therefore, fully jurtified in estimating the illegal payments at Rs. 1,25,000 for the purpose of making disallowance.
9. In order to appreciate the rival contentions, it is desirable to refer to the report of the Sarkaria Commission at page 133 of the report. The relevant and important portion reads as under: All this modus operandi was engineered by verbal instructions emanating from the Chief Minister and the Minister for Agriculture.
The operators were, by these unfair tactics, verging on fraud, first induced and trapped into a situation of no escape, then subjected to coercion till they were 'brought in line' and had no alternative but to submit to the extortionate demands of the Chief Minister and the Minister, for gratifications. They were in such a situation, that the only alternative to non-compliance with these extortionate demands was their utter ruin.
In the circumstances, there is no difficulty in holding that the assessee was helpless in the matter and that but for the payments made, it would not have been possible for the assessee to recover its dues from the Tamil Nadu Government. The question that arises for consideration is: Does these payments become less illegal just because they were made under duress To our mind, whatever may be the circumstances, illegal payments will continue to be illegal and since there was no obligation to carry on business illegally, we are inclined to hold that irrespective of the purpose the payments made in this manner cannot be allowed as deduction under Section 37. However, we agree with Shri Khare, the assessee's counsel, that the payments so made should be taken at Rs. 55,404 as found by the Sarkaria Commission.
The departmental authorities have not found any other payments made illegally to the Tamil Nadu Government. In the circumstances, there is no justification for taking the entire amount of Rs. 1,02,200 paid to Shri Kalidas or anything more on estimate as payments made by the assessee illegally. We, therefore, hold that the disallowance to the extent of Rs. 55,404 only in Agro Aviation Division is justified.
10. In the result, the assessee's appeal is partly allowed while the departmental appeal is dismissed.