The Supreme Court vide order dated 27.06.2007 in APO No. 301 of 2005 has upheld the constitutional validity of clause (f) of Section 43B of the Income Tax Act, 1961 mentioning the said clause is not arbitrary is not violative of Article 14 of the Constitution of India.
Clause (f) was inserted in the already existing Section 43B vide Finance Act, 2001 with effect from 1.4.2002. The purpose of introducing this clause was to provide for a tax disincentive in cases of deductions claimed by the assessee from income tax in lieu of liability accrued under the leave encashment scheme but not actually discharged by the employer. This meant that with the application of clause (f), the eligibility for deduction arises in the previous year in which the above said payment is actually made and not in which provision was made in that regard.
The respondents, aggrieved by the inclusion of the clause (f) contended that :
- Section 145 of the 1961 Act offers them the choice of method of accounting and accordingly, they computed their profits and gains of business in accordance with the mercantile system
- Section 43B has been carved out as an exception to the afore stated general rule of accrual for determination of liability, as it subjects deductions in lieu of certain kinds of liabilities to actual payment;
- Exception under Section 43B comes into operation only in a limited set of cases covering statutory liabilities like tax, duty, cess etc. and other liabilities created for the welfare of employees; and
- Therefore, the liability under the leave encashment scheme being a trading liability cannot be subjected to the exception under Section 43B of the 1961 Act.
The Bench noted that the legislative power of the Parliament to enact clause (f) in the light of Article 245 is not doubted at all and stated,
“That brings us to the next step of examination i.e. whether the said clause contravenes any right enshrined in Part III of the Constitution, either in its form, substance or effect. It is no more res integra that the examination of the Court begins with a presumption in favour of constitutionality. This presumption is not just borne out of judicial discipline and prudence, but also out of the basic scheme of the Constitution wherein the power to legislate is the exclusive domain of the Legislature/Parliament.” observed the Bench. The Justices explained that this power to legislate is clothed with power to decide ‘when to legislate, what to legislate and how much to legislate.’
The bench further noted,
“Sub section (1) of Section 145 explicitly provides that the method of accounting is a prerogative falling in the domain of the assessee and an assessee is well within its rights to follow the mercantile system of accounting. Be that as it may, it is noteworthy that the right flowing from sub section (1) is “subject to the provisions of sub section (2)”, which unambiguously empowers the Central Government to prescribe income computation and disclosure standards for accounting. Concededly, sub section (2) is an enabling provision. It signifies that the general principle of autonomy of the assessee in adopting a system of accounting, is controlled by the regulation notified by the Central Government and must be adhered to by the class of assessee governed thereunder.”
The Bench said that the clause merely operates as an additional condition for the availment of deduction qua the specified head. Section 43B opens with a non obstante clause, and thus, assumes an overriding character against any other provision of general application and observed
“Out of the allowable deductions, the legislature consciously earmarked certain deductions from time to time and included them in the ambit of Section 43B so as to subject such deductions to conditionality of actual payment. Such conditionality may have the inevitable effect of being different from the theme of mercantile system of accounting on accrual of liability basis qua the specific head of deduction covered therein and not to other heads. But that is a matter for the legislature and its wisdom in doing so.”
The Justices explained that clause (f) involving the mitigation of a mischief i.e. the absence of this clause would entail in a double benefit to the employer- advance deduction from tax liability without any burden of actual payment and refusal to pay as and when occasion arises.
The respondents’ challenge to the constitutional validity of the said clause has primarily been accepted on three grounds:
- Non disclosure of objects and reasons behind its enactment and insertion into section 43B;
- Inconsistency of clause (f) with other clauses of Section 43B and absence of nexus of the clause with the original enactment;
- Enactment has been triggered solely to nullify the dicta of this Court in Bharat Earth Mover .
The Justices declared that to hold a provision as violative of the Constitution on account of failure of the legislature to state the objects and reasons would amount to an indirect scrutiny of the motives of the legislature behind the enactment. “Such a course of action, in our view, is unwarranted. The raison d’etre behind this self imposed restriction is because of the fundamental reason that different organs of the State do not scrutinise each other’s wisdom in the exercise of their duties. In other words, the timetested principle of checks and balances does not empower the Court to question the motives or wisdom of the legislature, except in circumstances when the same is demonstrated from the enacted law.” declared the Court.
The Court observed that in the basic scheme of Section 43B, there is no direct or indirect limitation upon the power of legislature to include only particular type of deductions in the ambit of Section 43B.
The further remarked,
“To say that Section 43B is restricted to deductions of a statutory nature 30 would be nothing short of reading the provision in a purely imaginative manner……. that the legislature never restricted it to a particular category of deduction and that intent cannot be read into the main Section by the Court, while sitting in judicial review.”
The Bench also noted that the approach of constitutional courts ought to be different while dealing with fiscal statute, it is trite that the legislature is the best forum to weigh different problems in the fiscal domain and form policies to address the same including to create a new liability, exempt an existing liability, create a deduction or subject an existing deduction to new regulatory measures and that in the very nature of taxing statutes, legislature holds the power to frame laws to plug in specific leakages.
“No doubt, fiscal statutes must comply with the tenets of Article 14. However, a larger discretion is given to the legislature in taxing statutes than in other spheres. “
While defeating the dictum of Bharat Earth Movers case, the court said,
The Court opined that it is no doubt true that the legislature cannot sit over a judgment of this Court or so to speak overrule it and that there cannot be any declaration of invalidating a judgment of the Court without altering the legal basis of the judgment as a judgment is delivered with strict regard to the enactment as applicable at the relevant time and Justice Khanwilkar said,
“A legislative body is not supposed to be in possession of a heavenly wisdom so as to contemplate all possible exigencies of their enactment………….the Parliament exercises its legislative wisdom to shortlist the most desirable solution and enacts a law to that effect. It is in the nature of a ‘trial and error’ exercise and we must note that a law making body, particularly in statutes of fiscal nature, is duly empowered to undertake such an exercise as long as the concern of legislative competence does not come into doubt.”
The Bench noted that the judgment(Bharat Earth Movers case is an authority on the nature of the liability of leave encashment in terms of the earlier dispensation and in absence of any such provision, the sole operative provision was Section 145(1) of the 1961 Act that allowed complete autonomy to the assessee to follow the mercantile system.
The bench noted “This regulatory measure is in sync with other deductions specified in Section 43B, which are also present and accrued liabilities………irrespective of the category of liability, such deductions were regulated by law under the aegis of Section 43B, keeping in mind the peculiar exigencies of fiscal affairs and underlying concerns of public revenue.”
The Bench clarified that, a priori, merely because a certain liability has been declared to be a present liability by the Court as per the prevailing enactment, it does not follow that legislature is denuded of its power to correct the mischief with prospective effect, including to create a new liability, exempt an existing liability, create a deduction or subject an existing deduction to new regulatory measures and concluded
“The position of law discussed above leaves no manner of doubt as regards the legitimacy of enacting clause (f). The respondents have neither made a case of non-existence of competence nor demonstrated any constitutional infirmity in clause (f).”
