A.M.KHANWILKAR,J. - (1.) In this appeal, the constitutional validity of clause (f) of Section 43B of the Income Tax Act, 1961 [For short, 'the 1961 Act'] arises for our consideration as a result of the decision of the High Court at Calcutta [For short, 'the High Court'] vide order dated 27.06.2007 in APO No. 301 of 2005, wherein it is held that the said clause is arbitrary and violative of Article 14 of the Constitution of India on various counts, as discussed hereinafter.
(2.) The stated clause (f) was inserted in the already existing Section 43B vide Finance Act, 2001 with effect from 1.4.2002, in order 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 clause made the actual payment of liability to the employees as a condition precedent for extending the benefit of deduction under the 1961 Act. With the application of clause (f), the eligibility for deduction arises in the previous year in which the abovesaid payment is actually made and not in which provision was made in that regard, irrespective of the system of accounting followed by the assessee. Before we delve into further examination, we deem it apposite to reproduce the amended Section 43B of the 1961 Act as applicable to the present case, which reads thus: "43B. Certain deductions to be only on actual payment.- Notwithstanding anything contained in any other provision of this Act, a deduction otherwise allowable under this Act in respect of - (a) any sum payable by the assessee by way of tax, duty, cess or fee, by whatever name called, under any law for the time being in force, or (b) any sum payable by the assessee as an employer by way of contribution to any provident fund or superannuation fund or gratuity fund or any other fund for the welfare of employees, or (c) any sum referred to in clause (ii) of sub-section (1) of section 36, or (d) any sum payable by the assessee as interest on any loan or borrowing from any public financial institution or a State financial corporation or a State industrial investment corporation, in accordance with the terms and conditions of the agreement governing such loan or borrowing, or (e) any sum payable by the assessee as interest on any term loan from a scheduled bank in accordance with the terms and conditions of the agreement governing such loan, or (f) any sum payable by the assessee as an employer in lieu of any leave at the credit of his employee, shall be allowed (irrespective of the previous year in which the liability to pay such sum was incurred by the assessee according to the method of accounting regularly employed by him) only in computing the income referred to in section 28 of that previous year in which such sum is actually paid by him: Provided that nothing contained in this section shall apply in relation to any sum referred to in clause (a) or clause (c) or clause (d) or clause (e) or clause (f) which is actually paid by the assessee on or before the due date applicable in his case for furnishing the return of income under sub-section (1) of section 139 in respect of the previous year in which the liability to pay such sum was incurred as aforesaid and the evidence of such payment is furnished by the assessee along with such return: Provided further that no deduction shall, in respect of any sum referred to in clause (b), be allowed unless such sum has actually been paid in cash or by issue of a cheque or draft or by any other mode on or before the due date as defined in the Explanation below clause (va) of sub-section (1) of Section 36, and where such payment has been made otherwise than in cash, the sum has been realised within fifteen days from the due date. Explanation 1.-For the removal of doubts, it is hereby declared that where a deduction in respect of any sum referred to in clause (a) or clause (b) of this section is allowed in computing the income referred to in section 28 of the previous year (being a previous year relevant to the assessment year commencing on the 1st day of April, 1983, or any earlier assessment year) in which the liability to pay such sum was incurred by the assessee, the assessee shall not be entitled to any deduction under this section in respect of such sum in computing the income of the previous year in which the sum is actually paid by him. Explanation 2.-For the purposes of clause (a), as in force at all material times, 'any sum payable' means a sum for which the assessee incurred liability in the previous year even though such sum might not have been payable within that year under the relevant law. Explanation 3.-For the removal of doubts it is hereby declared that where a deduction in respect of any sum referred to in clause (c) or clause (d) of this section is allowed in computing the income referred to in section 28 of the previous year (being a previous year relevant to the assessment year commencing on the 1st day of April, 1988, or any earlier assessment year) in which the liability to pay such sum was incurred by the assessee, the assessee shall not be entitled to any deduction under this section in respect of such sum in computing the income of the previous year in which the sum is actually paid by him. Explanation 3A.-For the removal of doubts, it is hereby declared that where a deduction in respect of any sum referred to in clause (e) of this section is allowed in computing the income referred to in section 28 of the previous year (being a previous year relevant to the assessment year commencing on the 1st day of April, 1996, or any earlier assessment year) in which the liability to pay such sum was incurred by the assessee, the assessee shall not be entitled to any deduction under this section in respect of such sum in computing the income of the previous year in which the sum is actually paid by him. Explanation 3B.-For the removal of doubts, it is hereby declared that where a deduction in respect of any sum referred to in clause (f) of this section is allowed in computing the income, referred to in section 28, of the previous year (being a previous year relevant to the assessment year commencing on the 1st day of April, 2001, or any earlier assessment year) in which the liability to pay such sum was incurred by the assessee, the assessee shall not be entitled to any deduction under this section in respect of such sum in computing the income of the previous year in which the sum is actually paid by him. Explanation 4.-For the purposes of this section,- (a) 'public financial institutions' shall have the meaning assigned to it in section 4A of the Companies Act, 1956 (1 of 1956); (aa) 'scheduled bank' shall have the meaning assigned to it in the Explanation to clause (iii) of sub-section (5) of section 11; (b) 'State financial corporation' means a financial corporation established under section 3 or section 3A or an institution notified under section 46 of the State Financial Corporations Act, 1951 (63 of 1951); (c) 'State industrial investment corporation' means a Government company within the meaning of section 617 of the Companies Act, 1956 (1 of 1956), engaged in the business of providing long-term finance for industrial projects and eligible for deduction under clause (viii) of sub-section (1) of section 36."
(3.) The respondents, being liable to pay income tax upon the profits and gains of their business, found themselves aggrieved with the inclusion of clause (f) in Section 43B and 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. As per the mercantile system, income and expenditure are determined on the basis of accrual or provision and not on the basis of actual receipt/payment. The respondents further contended that Section 43B has been carved out as an exception to the aforestated general rule of accrual for determination of liability, as it subjects deductions in lieu of certain kinds of liabilities to actual payment. According to the respondents, the 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.;