1. The IAC disallowed Rs. 54,036 under Section 40A(5) of the Income-tax Act, 1961 ('the Act').
2. Two of the employees of the assessee-company, viz.; Shri T.T.Jagannathan and R. Rajagopalachari were in receipt of a total remuneration of Rs. 1,11,686 and Rs. 86,350, respectively. The IAC restricted the amount allowable under Section 40A(5) to Rs. 72,000 in each case and disallowed the balance of Rs. 39,686 and Rs. 14,350, respectively, aggregating to Rs. 54,036. Before the Commissioner (Appeals) it was urged that the IAC should not have taken into account the house rent allowance and employees' provident fund, contribution paid to the two employees as also the contribution to gratuity and personal accident insurance premium paid in respect of Shri T.T.Jagannathan. The relevant amounts are given below: T.T. Jagannathan R. Rajagopalachari(a) House rent allowance 6,000 17,950(b) Employees' provident fund 4,000 4,800(c) Contribution to gratuity 543(d) Personal accident insurance premium 945 It was submitted that house rent allowance could not be regarded as a 'perquisite' following the decision of the Karnataka High Court in CIT v. Mysore Commercial Union Ltd.  126 ITR 340. The remaining payments, it was contended, were towards statutory obligations and as such cannot be considered as 'perquisite' for the purposes of the Act.
The Commissioner (Appeals) held that Section 40(c) of the Act applied.
For the purposes of Section 40(c), what is relevant is any expenditure which has resulted directly or indirectly in the provision of any remuneration or benefit or amenity to a director or to a person who has a substantial interest in the company or to a relative of the director or of such person, as the case may be. The term 'perquisite' did not occur in this provision and the question whether house rent allowance and other cash payments, although they may not be considered as 'perquisites' have to be considered together for the purposes of applying the limit of Rs. 72,000. He then observed that the above reasoning applied to personal accident insurance premium paid in the case of Shri T.T. Jagannathan. As regards contribution to employees' provident fund and contribution to gratuity, he directed the IAC to examine the matter further, since it is to be found out whether the above payments are covered by Section 36(1)(iv) and (v) of the Act. The assessee is in appeal.
3. The arguments advanced before the Commissioner (Appeals) were repeated before us. The learned departmental representative's argument was that since Section 40(c) was applicable, the decision given by the Commissioner (Appeals) was basically correct.
4. The main question to be considered in this case is whether Section 40(c) is to be applied in this case to the entire exclusion of Section 40A(5). It is admitted that Shri T.T. Jagannathan and Rajagopalachari are employee-directors. Therefore, either Section 40A(5) or Section 40(c) is applicable. In that case, it goes without saying that the provision of law more favourable to the assessee has to be applied. In this view of the matter, we hold that the disallowance has to be examined with reference to Section 40A(5). While applying this section, the perquisites allowed to the employees will have to be taken into consideration. If any payment cannot be so characterised, it is to be left out of consideration. From this viewpoint, we find that house rent allowance cannot be taken as a 'perquisite' since it is a reimbursement in cash of the expenditure incurred by the employee. This is supported by the decision of the Karnataka High Court in the case of Mysore Commercial Union Ltd. (supra). The payment of premium towards personal accident insurance of Shri T.T. Jagannathan cannot also be called a 'perquisite' for there is no benefit to the employee. The benefit, if any, arises in the case of an accident. It is only a contingent interest. Therefore, this sum also has to be excluded from the purview of Section 40A(5). So far as contribution to the provident and gratuity are concerned, as rightly observed by the Commissioner (Appeals), they are governed by the second proviso to Section 40A(5)(a) and the Commissioner (Appeals) has asked the IAC to examine the same. There is nothing wrong in the direction given by the Commissioner (Appeals). In the result, we hold that Section 40A(5) applies in this case and not Section 40(c) and further that house rent allowance and payment of personal accident insurance premium are to be excluded for determining the overall limit of Rs. 72,000. It is further to be understood that the overall limit of disallowance is Rs. 72,000 even when Section 40A(5) applies in the light of the decision of the Karnataka High Court in the case of International Instruments (P.) Ltd. v. CIT  130 ITR 315.