Citation Codes

Equivalent Citations

citation codes

Case Number

Tax Cases Nos. 443 of 1975 and 211 of 1976 (References Nos. 340 of 1975 and 146 of 1976)

Judges

Sethuraman
Balasubrahmanyan, JJ.

Acts

s. 37(3) of the I.T Act, 1961,
s. 33. Section 34(3)

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Smart Summary

Structured Summary of Opinion delivered by Sethuraman, J.

Factual and Procedural Background

The assessee manufactures sugar at Pennadam, South Arcot District and has its administrative office in Madras. The reference (T.C. No. 443 of 1975) concerns assessments for the years 1968-69 and 1969-70 (relevant previous years ending 30th September preceding those assessment years). For the previous year relevant to assessment year 1968-69 the assessee incurred Rs. 12,944 and for the previous year relevant to assessment year 1969-70 Rs. 12,009, described as expenditure relating to maintenance of a guest house within the factory premises. The Assessing Officer (ITO) disallowed these amounts on the ground that allowance under s. 37(3) of the Income-tax Act, 1961, required compliance with the conditions prescribed by rule 6C (notably maintenance of a register as required by cl. (3) of r. 6C); the assessee had maintained the register only from 1 February 1967. The AAC confirmed the disallowance on appeal. The case reached the Tribunal, which concluded the building was not in the nature of a guest house and that s. 37(3) did not apply; the Tribunal allowed the deduction. The Tribunal's conclusion on this point was referred as a question to the Court.

A second question was referred concerning the assessee's entitlement to development rebate for assessment year 1969-70: the assessee claimed Rs. 8,251 for new machinery but the ITO rejected the claim because no reserve was created in the accounts for the year ended 30 September 1968. The assessee relied on an existing surplus in the earlier years' development rebate reserve (Rs. 72,028). The AAC disallowed; the Tribunal directed the ITO to allow the claim by regarding the earlier surplus as available. This aspect was also referred.

Legal Issues Presented

Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that the expenditure of Rs. 12,944 for the assessment year 1968-69 and Rs. 12,009 for the assessment year 1969-70, incurred in relation to the building at Pennadam, was not expenditure on the maintenance of residential accommodation in the nature of a guest house and was, therefore, an admissible deduction?
Whether, on the facts and in the circumstances of the case, the assessee was entitled to allowance of development rebate having regard to the adequacy of the reserve as available taking into consideration the excess available in earlier years?

Arguments of the Parties

Assessee's Arguments

The expenditure did not relate to a guest house but to some other form of accommodation; therefore s. 37(3) (and the restrictions imposed by r. 6C) did not apply and the expenditure was deductible under s. 37(1).
The assessee relied on decisions about entertainment expenditure (as cited by its counsel) to support allowability, though specific citations are not detailed in the opinion.
On the development rebate point, the assessee argued that an earlier surplus in the development rebate reserve (Rs. 72,028) was available and sufficient to meet the claim of Rs. 8,251 for the relevant year; therefore, the reserve requirement of s. 34(3) should be treated as satisfied.

Revenue's Arguments (as reflected in I.T. authorities)

The ITO disallowed the guest-house maintenance expenditure because r. 6C(3) requires maintenance of a register in prescribed form for allowance of expenditure on guest-house maintenance, and the assessee did not maintain the register for the relevant periods (the register was maintained only from 1 February 1967).
The AAC upheld the disallowance.
On development rebate, the ITO held that the assessee did not create the requisite reserve in the profit and loss account for the relevant previous year (year ended 30 September 1968) as required by s. 34(3), and therefore the rebate claim was not allowable.

Table of Precedents Cited

Precedent	Rule or Principle Cited For	Application by the Court
CIT v. Sirpur Paper Mills Ltd., [1978] 112 ITR 776	Distinction between expenditure on maintenance of a guest house and expenditure in the nature of entertainment; entertainment authorities' decisions are not applicable to guest-house maintenance under s. 37(3).	The Court relied on the distinction made in that decision to hold that authorities on entertainment expenditure do not assist the assessee on the guest-house point; the Court therefore rejected the assessee's reliance on entertainment-expenditure decisions.

Court's Reasoning and Analysis

The Court divided its analysis by the two referred questions and proceeded by close textual reading of the statute and rule:

Statutory framework applied

Section 37(1) allows deduction for expenditure "wholly and exclusively for the purpose of the business". Sub-section (3) is an exception limiting allowance for certain categories of expenditure incurred after 31 March 1964, including expenditure on maintenance of residential accommodation "including any accommodation in the nature of a guest house". The allowance is to be "only to the extent, and subject to such conditions, if any, as may be prescribed."
Rule 6C (referred in the opinion as r. 6C and also cited as r. 6(c) in parts of the record) prescribes the conditions. Clause (3) of r. 6C requires the assessee to maintain a register showing specific particulars (names and addresses of employees/directors staying in guest house; whether stay was for business purposes; arrival and departure dates; amounts paid by them), failing which no allowance is to be made for guest-house maintenance expenditure.

Analysis on what constitutes a "guest house"

The term "guest house" is not defined in the Act. The Court considered ordinary dictionary meanings (an inn; a house for reception of strangers or guests) to understand the term.
The Court observed that r. 6C itself contemplates employees as a category of persons who may use the premises, which indicates the rule-making authority treated employees as potential users but did so with limits (for example, when guest houses are at places other than principal place of business they must be exclusively used by employees).
The Court reasoned that employees are not "strangers" and hence are not, in the ordinary meaning, "guests." Consequently, where accommodation is maintained at the principal place of business or factory for directors and employees who must visit for the company’s business, such accommodation does not fall within s. 37(3) as "guest house" maintenance because it is fundamentally for the company's agents through whom the company operates.
However, the Court emphasized that this conclusion depends on actual use: if the accommodation is in practice used by strangers (outsiders), it becomes accommodation "in the nature of a guest house" falling within s. 37(3).

Application to the facts — guest-house expenditure

The Court noted a lack of any proper material before it demonstrating that the guest house had been used substantially and exclusively by directors and employees and only occasionally by government officials. Because the assessee failed to produce registers or evidence required by r. 6C(3), the Court proceeded on the basis that strangers also used the accommodation.
Given that factual basis (use by strangers), the accommodation was in the nature of a guest house falling within s. 37(3), and the expenditure would be allowable only if the conditions prescribed by the rules were complied with. Non-compliance with r. 6C(3) meant that the disallowance by the I.T. authorities was proper.
The Court rejected the assessee's attempt to import authorities on entertainment expenditure, relying on the Supreme Court decision in CIT v. Sirpur Paper Mills Ltd. that distinguished guest-house maintenance from entertainment expenditure and made such authorities irrelevant on the guest-house point.

Analysis and application — development rebate

The Court examined s. 34 (conditions for depreciation allowance and development rebate under s. 33) and specifically s. 34(3), which requires that 75% of the development rebate to be actually allowed must be debited to the profit and loss account of the relevant previous year and credited to a reserve account, to be utilised over the next eight years for the business (subject to specified exclusions).
The Court noted an Explanation permitting creation of the reserve even if profits are not adequate, but emphasised that the statutory requirement is that the reserve be created by a debit to profit and loss of the relevant previous year and credited to the reserve account.
In the present case there was no such debit to profit and loss account in the relevant previous year (year ending 30 September 1968). The Tribunal's approach — that a pre-existing larger surplus in the development rebate reserve (from earlier years) could be treated as satisfying the requirement — was legally incorrect because the statute requires the specific act of debiting profit and loss in the relevant previous year. The earlier surplus therefore could not substitute for the statutory requirement.
Consequently, the Tribunal erred in directing the ITO to allow the rebate on the basis of earlier reserves.

Holding and Implications

The Court answered both referred questions against the assessee and in favour of the revenue.

Holdings

On the guest-house expenditure: The Court held that, on the available material, the accommodation at Pennadam was in the nature of a guest house within the scope of s. 37(3). Because the assessee did not comply with the conditions of r. 6C(3) (maintenance of the prescribed register), the disallowance by the I.T. authorities was proper. The question was answered in the negative and in favour of the revenue.
On the development rebate: The Court held that the assessee was not entitled to the claimed development rebate for assessment year 1969-70 because s. 34(3) requires a specific debit to profit and loss of the relevant previous year to create the reserve; an earlier surplus in the reserve account cannot substitute for that statutory requirement. The question was answered in the negative and against the assessee.

Direct consequences and costs

The Tribunal's view on both issues was reversed to the extent indicated; the I.T. authorities' disallowances on the guest-house expenditure and on the development rebate were upheld.
The Commissioner is entitled to costs; counsel's fee assessed at Rs. 500.

Broader implications

The opinion confines itself to statutory construction of s. 37(3), r. 6C and s. 34(3) and their application to the facts; it expressly rejects reliance on entertainment-expenditure authorities for guest-house claims (citing CIT v. Sirpur Paper Mills Ltd.). The Court's conclusions are applied to the parties' respective positions; the opinion does not purport to establish any broader doctrine beyond the statutory interpretations and factual applications set out above.

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Commissioner Of Income-Tax, Tamil Nadu-Iii v. Aruna Sugars Ltd.

The Judgment of the Court was delivered by

Sethuraman, J.:— The assessee is carrying on business in the manufacture of sugar in a place known as Pennadam, South Arcot District. The reference in T.C No. 443 of 1975 relates to the assessment years 1968-69 and 1969-70, the relevant previous years being the years ending on 30th September preceding the assessment years. During the previous year for the assessment year 1968-69, the assessee incurred an expenditure of Rs. 12,944 and during the relevant previous year 1969-70, a sum of Rs. 12,009 had been incurred. The expenditure is said to relate to the maintenance of a guest house in the factory premises. The assessee's administrative office is situate in Madras, and periodically there are visits of the assessee's employees and directors and others. We have no idea as to the exact nature of the expenditure or the details thereof. The assessee claimed these two amounts as deduction in the respective assessment years. The ITO took the view that the expenditure on the maintenance of guest house could be allowed as deduction only if such maintenance was for the benefit of the employees and if a register in the prescribed form had also been maintained. The assessee started maintaining the register only from first of February, 1967. The ITO was of the view that the provisions of r. 6(c) had not been complied with and he, therefore, disallowed the amounts. The AAC, on appeal, confirmed the disallowance. Thereafter the assessee appealed to the Tribunal. After referring to the relevant provisions, the Tribunal came to the conclusion that the building was not in the nature of a guest house and that the expenditure incurred therein did not fall within the scope of s. 37(3) of the I.T Act, 1961, so as to be disallowed in the manner done by the I.T authorities. On this point, the question that has been referred runs as follows:

“Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that the expenditure of Rs. 12,944 for the assessment year 1968-69 and Rs. 12,009 for the assessment year 1969-70, incurred in relation to the building at Pennadam, was not expenditure on the maintenance of residential accommodation in the nature of a guest house and was, therefore, an admissible deduction?”

2. Section 37 of the Act provides for the allowance of any expenditure laid out or expended wholly and exclusively for the purpose of the business. Sub-s. (3) is an exception to this general allowance, and it runs as follows:

“Notwithstanding anything contained in sub-section (1), any expenditure incurred by an assessee after the 31st day of March, 1964, on advertisement or on maintenance of any residential accommodation including any accommodation in the nature of a guest house or in connection with travelling by an employee or any other person (including hotel expenses or allowances paid in connection with such travelling) shall be allowed only to the extent, and subject to such conditions, if any, as may be prescribed.”

3. The relevant rule prescribing the conditions for the allowance is r. 6(c). Under that rule the allowance in respect of expenditure incurred by an assessee on the maintenance of residential accommodation in the nature of guest house is limited to the amount laid out or expended on the maintenance of a guest house or guest houses specified in the said rule. Clause (3) of the rule provides that no allowance is to be made in respect of expenditure incurred on the maintenance of any residential accommodation in the nature of a guest house unless the assessee maintained a register showing the following particulars, namely:

(1) the name and address of every employee and, in the case of an assessee being a company, of every director of the company, who had stayed in the guest house;

(2) whether his stay in the guest house was for the purpose of the business or profession of the assessee;

(3) the date of his arrival at the guest house and the date of his departure therefrom;

(4) the amount, if any, paid by him towards his lodging and boarding, in the guest house.

4. Sub-s. (3) of s. 37 contemplates two categories of accommodation main-tained by a company. One is residential accommodation and the other is accommodation in the nature of a guest house. In other words, the maintenance of residential accommodation is a wider category and the provision includes within it the maintenance of accommodation in the nature of a guest house. Ordinarily, in these guest houses maintained, three kinds of personnel stay. The first category consists of the directors of the company and its employees; the second category consists of Government officials who visit the factory in the course of their work under the customs law, sales tax law, labour laws, etc., and the third category consists of other persons, some of whom may even be persons connected with the company either by way of sellers of sugarcane or purchasers of sugar in a case like this. The section itself does not in any manner specify the kind of maintenance expenditure that is liable to be allowed. The extent and the conditions of allowance are only to be prescribed. Rule 6C(1) prescribes the allowance with reference to the maintenance of residential accommodation in the nature of a guest house. Rule 6C(1) does not apply to any residential accommodation which is not in the nature of a guest house. With reference to residential accommodation in the nature of a guest house, there are various provisions made. The guest house or houses must be at the principal place of business of the assessee in India or it must be in a place where manufacture is carried on or industrial establishment is maintained. The assessee, in the latter case, must be engaged in the manufacture of goods employing not less than 50 whole-time employees throughout the relevant year. Where the assessee maintains a guest house or guest houses at any place other than the principal place of business or where the guest house is maintained in a place other than the place where the factory is established or where the industrial establishment is maintained, then such guest house or guest houses must have been exclusively used by employees while on leave. Provision has also been made for the maintenance of guest house by a banking company at Bombay or by any other assessee at Delhi and at not more than two other places in India which may be the capital of a State Government or in any other place which is of direct importance to the business or profession of the assessee. A perusal of r. 6C would show that it specifies the places where the guest houses have to be maintained and it also prescribes that if the guest house is in a place other than the principal place of business or factory premises, then it should be exclusively used by the employees. As regards the maintenance of residential accommodation, cl. (2) prescribes that the expenditure incurred on the maintenance of such accommodation should not directly or indirectly result in the provision of any benefit or any amenity or perquisite to an employee exceeding 20 per cent. of the salary due to such an employee in respect of the period of his occupation. Clause (3) requires the maintenance of a register describing the particulars specified therein as a condition precedent for the allowance.

5. In the present case, it is common ground that the assessee had not produced the registers as contemplated by cl. (3) of r. 6C. Though the assesee has maintained the guest house at the factory premises or at the principal place of its business, the expenditure on the maintenance of the guest house is not liable to be allowed only because the assessee had not complied with the provisions of cl. (3) of r. 6C.

6. The assessee tried to get over this difficulty by contending that it is not a guest house at all and that, therefore, it does not come within the scope of s. 37(3). We have, therefore, to examine as to what a guest house is the term has not been defined in the Act. The dictionary meaning of “guest house” is “an inn, a home separate from a main dwelling for the use of guest”. In the Shorter Oxford Dictionary, 3rd Edn., the meaning of “guest house” is given as “an inn—A house or apartment for the reception of strangers or guests”. From the language of r. 6C it appears that the rule-making authority considered that even the employees of a company would be guests because provision is made for the category of employees who would use the guest house in places other than the principal place of business of the assessee or the factory premises of the assessee. In such cases, as already seen, the guest house must be maintained exclusively for the benefit of the employees (see cl. (d) of r. 6C). However, with reference to the factory premises as in this case, there is no restriction on the category of persons who alone could stay in it. This stands to reason, as in a case like this, where the factory is located away from any urban locality and where the normal facilities available for food or accommodation cannot be had, it is necessary in the interests of the business of the company to maintain a guest house. As is sometimes graphically put, a company has no body to be kicked or soul to be damned and, therefore, the company has to function only through its directors and its employees. In a case where the assessee maintains a guest house exclusively for the directors and other employees, through whom alone it can carry on business, it cannot be stated that these personnel can be taken to be outsiders so as to be called guests. Thus, in our opinion, where the guest house is maintained, either in the principal place of business or in a place where the factory is located, for the directors and other employees of the company who have to visit it for the purpose of the company's business, then any expenditure incurred for the maintenance of such accommodation cannot be brought within the scope of s. 37(3). Further, in such a case, an occasional stay by a person who visits the factory for the purpose of its business cannot also be called a guest. Any official visiting the factory for the purpose of enforcing the laws applicable to the factory cannot also be described as an outsider so that any accommodation used by him in connection with the company's work, can be treated as accommodation in the nature of a guest house. It is only with reference to the other categories, like strangers, that the accommodation which is maintained can be correctly called a guest house. In other words, the meaning of the term “guest house” as a place for the reception of strangers appears to have been accepted by the rule-making authority as the rules envisage employees staying in these premises. If employees were considered to be strangers such a provision would not have been made. It is necessary to bear in mind the legal position that the rule-making authority cannot expand the concept of the word “guest” so as to include employees if the word did not comprehend such employees. Thus, employees are not strangers so as to be guests. The result is that unless the guest house is intend for use by a complete stranger, it cannot be called a guest house which falls within the scope of s. 37(3).

7. In the present case, in the absence of any proper materials to show that the guest house had actually been used only by the directors or by the employees alone substantially and by the Government officials occasionally, we have to proceed on the basis that the guest house had been utilised by strangers also. In these circumstances the conclusion that has to follow is that the accommodation maintained is in the nature of a guest house falling within the scope of s. 37(3). The expenditure incurred in the present case would thus really fall within the scope of the expenditure contemplated by s. 37(3) and would qualify for an allowance only if it complied with the rules.

8. The learned counsel for the assessee cited certain decisions dealing with entertainment expenditure. But as pointed out by the Supreme Court in dealing with this very provision in CIT v. Sirpur Paper Mills Ltd., [1978] 112 ITR 776, the expenditure on the maintenance of a guest house is wholly different from the expenditure in the nature of entertainment. Therefore, the decision bearing on the allowability or otherwise of entertainment expenditure would be of no assistance here. As far as the allowability of expenditure on a guest house is concerned, there is no reported decision so far on the ambit or scope of s. 37(3) in so far as it relates to expenditure on the maintenance of a guest house. Consequent on the assessee not complying with the rules, the disallowance as made by the I.T authorities was proper. Therefore, the question has to be answered in the negative and in favour of the revenue.

9. The next question that has been referred runs as follows:

“Whether, on the facts and in the circumstances of the case, the assessee was entitled to allowance of development rebate having regard to the adequacy of the reserve as available taking into consideration the excess available in earlier years?”

10. This question arises only for the assessment year 1969-70. The assessee had claimed development rebate of Rs. 8,251 in respect of the new machinery installed during the accounting period. The ITO rejected the claim on the ground that the assessee had created no reserve in the accounts for the year ended 30th September, 1968, relevant for the said assessment year. The submission of the assessee was that in the earlier years they had created a larger reserve and that the surplus in the said reserve came to Rs. 72,028. As the relief claimed in this year was lower than this surplus, the assessee wanted the said amount to be taken as reserve created for this assessment year to satisfy the requirements of the statute. The ITO rejected this submission also. The AAC, on appeal, confirmed the disallowance but when the matter came before the Tribunal, it held that the surplus in the development rebate reserve created in the earlier years was at the disposal of the assessee, that the assessee could have taken it away by a journal entry and brought it back into the reserve by another journal entry and that the net result would be the same. In the view of the Tribunal, all these exercises in accountancy would become a meaningless formality and, therefore, it directed the ITO to deduct the same. It is this aspect of the matter that is referred to as stated above. Section 34 prescribes conditions for depreciation allowance and development rebate, allowable under s. 33. Section 34(3) provides that the deduction referred to in s. 33 shall not be allowed unless an amount equal to seventy five per cent. of the development rebate to be actually allowed is debited to the profit and loss account of the relevant previous year and credited to a reserve account to be utilised by the assessee during a period of 8 years next following for the purpose of the business of the undertaking. The business purpose would not include, (a) distribution by way of dividends, or (b) remittances outside India of profits, or (c) for the creation of any asset outside India. There is an Explanation which provides that the deduction referred to in s. 33 should not be denied by reason only that the amount debited to the profit and loss account of the relevant previous year and credited to the reserve account aforesaid exceeds the amount of the profit of such previous year as arrived at without making the debit aforesaid. The Explanation was brought in to provide for cases where an assessee did not have adequate profits to create the necessary amount as a reserve. This provision enabled the creation of a reserve of the requisite amount in the absence of profits or adequate profits to cover the reserve. However, what is clear from the whole provision is that the reserve is to be created out of the profits of the relevant previous year and credited to a reserve account to be utilised by the assessee for the business. In the present case, there is no such debit to the profit and loss account of the relevant previous year. The Tribunal was, therefore, in error in directing the ITO to give the allowance. The presence of a larger amount in the development rebate reserve in an earlier year cannot be taken as satisfying the specific requirements of s. 34(3)(a), viz., of a debit to the profit and loss account of the relevant previous year.

11. The result is that the question referred has to be answered in the negative and against the assessee. The Commissioner will be entitled to his costs. Counsel's fee Rs. 500 (one set).

Commissioner Of Income-Tax, Tamil Nadu-Iii v. Aruna Sugars Ltd.

Structured Summary of Opinion delivered by Sethuraman, J.

Factual and Procedural Background

Legal Issues Presented

Arguments of the Parties

Assessee's Arguments

Revenue's Arguments (as reflected in I.T. authorities)

Table of Precedents Cited

Court's Reasoning and Analysis

Holding and Implications

Commissioner Of Income-Tax, Tamil Nadu-Iii v. Aruna Sugars Ltd.

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