Tax Insights
from India Tax & Regulatory Services
www.pwc.in
The Supreme Court upholds
constitutional validity of clause (f) of section 43B of the Income-tax Act, 1961, relating to disallowance for sums payable in lieu of leave
April 30, 2020
In brief
Recently,1 the Supreme Court upheld the constitutional validity of section 43B(f) of the Income-tax Act, 1961 (the Act) overruling the judgement of the Calcutta High Court.
In detail
Facts
• The taxpayer challenged the constitutional validity of section 43B(f) of the Act before the Calcutta High Court.
• As per section 43B of the Act, the deduction for certain liabilities is allowed only on payment basis.
Clause (f) of the said section covers the liability
pertaining to leave encashment.
• The Divisional Bench of the Calcutta High Court reversed the Single Bench judgement of the same Court holding that section 43B(f) of the Act is unconstitutional, being arbitrary and violative of Article 14 of the
Constitution of India for the following reasons, without
1 Civil Appeal No. 3545/ 2009
2
Bharat Earth Movers v. CIT [2000] 6 SCC 645 (SC)
questioning the power of the legislature to enact the said clause:
- The legislature did not disclose the objects and reasons behind the enactment of clause (f) into section 43B of the Act.
- The original section 43B of the Act was
incorporated vide the Finance Act, 1983, to plug the evasion of payment of statutory liabilities. Clause (f) covers leave
encashment. This, being a trading liability, has no nexus with the original enactment.
- The insertion of clause (f) in section 43B of the Act is to nullify the earlier Supreme Court
judgement in the case of Bharat Earth Movers.2 Issue before the Supreme Court
Whether clause (f) of section 43B of the Act is
constitutionally valid?
Taxpayer’s contentions
• All clauses under section 43B of the Act, barring clause (f), cover liabilities of a statutory nature and those driven by concerns of employees’ welfare. The liability covered by clause (f) is of a completely different nature and without specifying clear objects and reasons for the inclusion of this liability under section 43B of the Act, it cannot be included into the main section.
• The leave encashment liability covered by clause
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(f) is not in accord with the objects and reasons of the original section nor with the other clauses enacted from time-to-time.
• The taxpayer relied on the Supreme Court’s judgment in the case of Bharat Earth Movers2, wherein it was held that liability in lieu of a leave encashment scheme is a present and definite liability, and not a contingent liability.
Relying on this principle, the taxpayer submitted that leave encashment, being a business liability should be claimed in the same previous year in which it is accrued, even though it may be paid subsequently. The taxpayer contended that clause (f) in section 43B of the Act was enacted with the sole purpose of subjugating this judgement.
This would violate the essential principles of the separation of powers.
Supreme Court’s decision Constitutional validity of clause (f) of section 43B of the Act
• Based on the two-fold and prudent approach laid down in the case of Rakesh Kohli &
Anr,3 and various other decisions, the legislature has the power to enact clause (f) in section 43B of the Act. The enactment of clause (f) does not violate any right provided in Part III of the Constitution of India.
• Section 43B of the Act does not restrict the taxpayer to adopt a particular method of accounting nor deprives it of any lawful deduction. It merely operates as an additional condition for availing the deduction qua the specified head.
• Clause (f) was inserted to curb the mischief of claiming the deduction of liability of leave encashment, i.e., advance deduction from tax liability, and refusal to pay when the event occurs, which is in line with the purpose of
introducing other clauses under section 43B of the Act.
Non-disclosure of objects and reasons
• The non-disclosure of objects and reasons has no impact upon the constitutional validity of a provision unless the provision is ambiguous.
While examining the validity of a provision, the primary concern is to interpret the literal text of the provision for its true meaning and purpose.
• The Calcutta High Court’s approach on striking down the constitutional validity was flawed on the following three counts –
i. it made no attempt to discover any
constitutional infirmity in the provision;
ii. it did not dissect the text of the provision to demonstrate the need to go beyond the text; and iii. it went into the
background of the enactment, which was not required unless the provision is ambiguous.
Inconsistency of clause (f) and absence of nexus with section 43B of the Act
• Based on a reading of the Memorandum of Finance Bill, 1983 (which introduced section 43B), and the
amendments to the provisions of section 43B of the Act over the years, the legislature never restricted the provision only to
deduction of statutory liabilities. It had taken within its fold diverse nature of deductions, ranging from tax, duty to bonus, commission, interest on loans and general provisions for welfare of employees, and there was no uniformity in the nature of deductions that were included within the ambit of this section.
• The introduction of clause (f) of section 43B of the Act fits within the broad objective of enacting the section to protect the larger public interest, primarily of revenue, and including the welfare of employees.
Defeating the dictum in the case of Bharat Earth Movers’
• While the legislature cannot overrule or invalidate a judgment of this Court, it can amend or enact a valid law on a topic within its legislative field.
• Clause (f) of section 43B of the Act neither reverses the nature of the leave encashment liability (i.e. present liability) nor has it taken away the deduction. It merely defers the benefit of deduction to be availed by the taxpayer, by linking it to the actual payment of the concerned employee. The clause was introduced with prospective effect and with the intent to regulate the deduction of leave encashment liability to curb mischief.
The takeaways
The Supreme Court’s decision affirms the legitimacy and purpose of enacting clause (f) of section 43B of the Act and upholds its constitutional validity. This decision should put to rest the ongoing litigation on this issue.
3 State of Madhya Pradesh v. Rakesh Kohli & Anr [2012] 6 SCC 312 (SC)
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