| Mar-19-2021

The Education Cess Conundrum: A Critique of Sesa Goa and Chambal Fertilisers Decisions

Abstract

The  decisions  of  the  Bombay  and  Rajasthan  High  Courts  in  Sesa  Goa Ltd.   v.   Jt.   CIT   [2020]   117   taxmann.com   96and   in   Chambal Fertilizers   &   Chemicals   Ltd.   v.   Jt.   CIT   [   ]   102   CCH   202 respectively  have  sparked  a  new  polemic  in  tax  law  with  reference  to deductibility  of  education  cess  as  business  expenditure.  The  judgments effectively  tend  to  reduce  the  size  of  the  education  cess  pie,  which  was levied as a public policy imperative to finance educational requirements of the underprivileged. The object of this article is to examine the legal issues vis-à-vis  the  judgments  of  the  two  High  Courts  and  to  place  them  in perspective in the context of law as it exists today.

Introduction

The recent judgments of the two High Courts in Sesa Goa Ltd.1 and Chambal Fertilizers & Chemicals Ltd.2cases have created quite a controversy with the revenue gearing up to assail them before the Apex Court and the taxpayers scurrying to file additional grounds before various judicial fora to claim deduction of education cess as business expenditure. While the High Courts have attempted to trace the history of this levy, the aim of this article is to examine whether the courts have been able to correctly appreciate its historical evolution in correct

Assumption of Deductibility under section 37(1):  No  Adjudication

It may be noticed at the outset that in both the cases, the High Courts have examined the question whether ‘education cess’ is included in section 40(a)(ii) of the Income-tax Act 1961 and having answered this question in negative, both the Courts have assumed that since it is not included in section 40(a)(ii), it becomes allowable under section 37(1) of the Act. They did not examine the allowability of education cess in terms of the requirements of section 37(1) at all. For instance, the Rajasthan  High  Court in Chambal Fertilizers & Chemicals Ltd’s case (supra) was examining the following question of law:

Whether under the facts and circumstances of the case  the  Ld. ITAT has not erred in holding that the education cess is a disallowable expenditure under section 40(a)(ii) of the Act?”

Likewise, the Bombay High Court in Sesa Goa Ltd’s case (supra) framed this question in the following terms:

“17. Therefore, the question which arises for determination is whether the expression “any rate or tax levied” as it appears in Section 40(a)

(ii) of the IT Act includes “cess”. The Appellant – Assessee contends  that the expression does not include “cess” and  therefore,  the  amounts paid towards “cess” are liable to be deducted in computing  the income chargeable under the head “profits and gains of business   or profession”.”

From the above, it is manifest that the High Courts did not adjudicate on the   allowability   of   education   cess   under   section   37(1)   and   merely proceeded on the assumption that it was so allowable if it was not hit by section 40(a)(ii).

Interplay of Section 37(1) and Section 40(a)(ii)

However, when one looks at the scheme of the Act and examines the interplay of the provisions of section 40(a)(ii) and section 37(1),  it  becomes clear that in the scheme of the twin provisions, it is  the  allowability of an expenditure or an item or a claim, which has to be first examined under section 37(1) and only if the said expenditure, item  or claim is found to pass muster under section 37(1), then a further examination is to be necessarily made whether the said expenditure, item   or claim is hit by the embargo placed in section 40(a)(ii) of the Act. This is clearly evident from section 40(a)(ii) which starts with a non-obstante clause, which reads as follows:

“40. Notwithstanding anything to the contrary in sections 30 to 38,   the following amounts shall not be deducted in computing the income chargeable under the head “Profits and gains of business or profession”,—

• in the case of any assessee—
  • any sum paid on account of any rate or tax levied on the profits or gains of any business or profession or assessed at a proportion of, or otherwise on the basis of, any such profits or gains.”

The Effect of Non-obstante clause in Section 40

1. The effect of this non-obstante clause in section 40 is that the allowability of a deduction under section 40(a)(ii) shall be barred, if it is otherwise allowable under any of the provision contained in sections 30 to
2. A fortiori, if it does not pass the criteria of allowability under section 30 to 38 at the threshold, that is the end of the matter and there is no need to go back to section 40(a)(ii).

In that view of the matter, the allowability of education cess shall have    to be examined first under the terms of section 37(1) i.e. whether the said expenditure has been ‘laid out or expended wholly and exclusively for the purposes of business or profession’. The fundamental question, therefore, which arises for consideration is whether education cess is an expenditure ‘laid out or expended wholly and exclusively for the purposes of business or  profession’.  The  answer  to  this  question  is  clearly  in  negative  because ‘education  cess’  is  not  expenditure  at  all.  Rather,  it  is  a  charge  upon  the profits, similar to income tax. Any expenditure to earn a profit cannot be a part  of  the  profit  itself.  It  is  an  application  of  an  income  and  not  an expenditure ‘laid out or expended wholly and exclusively for the purposes of business or profession’ so as to pass the tests envisaged under section 37(1).  This  principle  was  enunciated  by  the  House  of  Lords  in  Ashton Gas  Company  v.  Attorney  General3.  The  following  observation  of Earl of Halsbury is illuminating in this regard:

“Profit is a plain English word; that is what is charged with income-  tax. But if you confound what is the necessary expenditure to earn that profit with the income-tax, which is a part of the profit itself, one can understand how you get into the confusion which has induced the learned counsel at such  very considerable length to point out that this is  not  a  charge upon the profits at all. The answer is that it is. The income-tax is a charge upon the profits; the thing which is taxed is the profit that is made, and you must ascertain what is the profit that is made before you deduct the tax – you have no right to deduct the income-tax before you ascertain what the profit is. I  cannot  understand how you can make the income-tax part  of  the expenditure.”

This view of the House of Lords was noted with approval by the Supreme Court in CIT v. Oriental Fire & General Insurance Co. Ltd.4

The Ashton Gas Company’s case (supra) decisionwas followed by the Gujarat High Court in L.M. Maneklal Industries Ltd. v. CIT5, wherein the question arose whether surtax was an expenditure ‘laid out or expended wholly and exclusively for the purposes of business  or  profession’ under section 37(1). Answering in negative, the  Court  held  thus:

A contention similar to the one, raised in the instant case, came up for  consideration  in  the  case  of  Ashton  Gas  Co.  v.  Attorney  General [1906]  AC  10  (HL).  That  was  a  case  in  which  it  was  statutorily provided that the profits of Ashton Gas Co. to be divided amongst the shareholders in any year should not exceed the rate of 10 per cent per annum on the ordinary share capital. The company distributed 10 per cent as dividend tax-free. It was urged on behalf of the company that the income-tax was a charge on the profits before distribution to the shareholders which had to be deducted before arriving at the profits and  calculating  the  dividend.  It  was  urged  that  the  tax  was  charged upon  the  company  and  the  company  was  entitled  to  adopt  principle on  which  it  had  acted.  Buckley,  J  adjudged  and  declared  that  the profits  ought  to  be  calculated  as  inclusive  and  not  exclusive  of  the amount  payable  for  the  year  in  respect  of  the  income-tax  on  the profits  proposed  to  be  divided.  This  decision  was  affirmed  by  the Court of Appeal. On further appeal to the House of Lords, Earl of Halsbury, L.C. observed as follows:

“Profit is a plain English word; that is what is charged with income-  tax. But if you confound what is the necessary expenditure to earn that profit with the income-tax, which is a part of the profit itself, one can understand how you get into the conclusion which has induced the learned counsel at such very considerable length to point out that this is  not  a  charge upon the profits at all. The answer is that it is. The income-tax is a charge upon the profits; the thing which is taxed is the profit made before you deduct the tax— you have no right to deduct   the income-tax before you ascertain what the profit is. I cannot understand how you can make the income-tax part of the expenditure. I share Buckley, J.’s difficulty in understanding how so plain a matter has been discussed in all the Courts at such extravagant length.”

As pointed out above, in the instant case, what is being charged is the total income of the assessee after making adjustments as provided in the Act. It is the profit which the assessee has made which is being taxed.

Applying the ratio of the decision of the Supreme Court, surtax cannot be said to be an expenditure incurred wholly and exclusively for the purpose of the business of the assessee. Payment of surtax had nothing to do with the conduct of the business of the assessee. It was not an expenditure incurred for the purpose of business or for the purpose of earning profit. It is only after the profit or income is earned that, as pointed out above, the question of payment of surtax would arise. It is an event which takes place after the income is earned and not in the course of or   in the process of earning income. It is out of the profits or income earned that surtax is to be paid. In other words, payment of surtax is application of the profits after they are earned. As discussed above, surtax is levied on excess chargeable profits computed in the manner laid down in the Act. It is a levy on    the total income computed under the Act after it is adjusted in accordance with the First Schedule to the Act. Computation of income for the purpose of the Act has to precede the assessment of surtax under the Act. Unless and until computation of total income under the Act is made, the question of chargeable profits and levy of  surtax  under the Act does not arise. Admittedly, income-tax is not an admissible deduction for the purpose of computing profits and gains   or the total income under the Act. In our opinion, surtax stands on the same footing as income-tax inasmuch as it is also a   tax on the total income computed under the Act after its adjustment under the Act. Payment of both income-tax and surtax is application of income after it is earned and not an expenditure incurred for the purpose of business. It is not a deduction before one arrives at the profits inasmuch as it is not payment for the purpose of earning profit. We are, therefore, unable to accept the assessee’s contention that payment of surtax is an expenditure laid out wholly and exclusively for the purpose of business and, therefore, allow able deduction under section

Since payment of surtax is not allowable deduction under section 37, the question whether it comes within the mischief of section 40(a)(ii) does not arise. In other words,   it is not necessary to consider whether the prohibition contained in  section  40(a)(ii) is applicable to the payment  of surtax. The view similar to the one taken by us has been taken by the Calcutta High Court in Molins of India Ltd. v. CIT [1983] 144 ITR 317, the Karnataka High Court in CIT International Instruments (P.)Ltd. [1983] 144 ITR 936, Full Bench of the Kerala High Court in A.

• Thomas &  Co.  Ltd.  v.  CIT  [1986]  159  ITR  431  and  Madras  High Court in Sundaram Industries Ltd. v. CIT [1986] 159 ITR 646. In the view which we are taking, we answer the question referred to us in the affirmative and against the assessee.”

Education Cess Fails the Test at the First Stage Itself

5. Thus, ‘education cess’ fails the test of deductibility at the first stage itself

i.e. under the terms of section 37(1) and, therefore, there is no further need to examine the embargo under section 40(a)(ii). This aspect of law was not noticed  in  Sesa  Goa  Ltd.  and  Chambal  Fertilizers  &  Chemicals Ltd’s  case  (supra)  and  their  lordships  proceeded  in  a  reverse  way  to examine  the  prohibition  contained  in  section  40(a)(ii)  and  thereafter, simply assumed the allowability of ‘education cess’ as an expenditure ‘laid out  or  expended  wholly  and  exclusively  for  the  purposes  of  business  or profession’ under section 37(1).

Prohibition Under Section 40(a)(ii)

Coming to the proscriptions mentioned in section 40(a)(ii), the question to be asked here is whether the bar contained in section 40(a)(ii) operates qua ‘education cess’, even if one were to assume the deductibility  of ‘education cess’ under section 37(1) of the Act. To put it simply, the real question would be to see whether ‘education cess’ is tax so as to fall within the mischief of section 40(a)(ii).

The Explanatory Memorandum to Finance Bill 2012

It may be noticed here that education cess was introduced as an additional surcharge as explained in the Explanatory Memorandum to Finance Bill The relevant excerpt from the said Memorandum reads as follows:

“(2)   Education   Cess   —   For   assessment   year   2012-13,   additional surcharge called the “Education Cess on income-tax” and “Secondary and Higher Education Cess on income-tax” shall continue to be levied at  the  rate  of  two  per  cent.  and  one  per  cent,  respectively,  on  the amount  of  tax  computed,  inclusive  of  surcharge,  in  all  cases.  No marginal relief shall be available in respect of such Cess.”

An ‘additional surcharge’ is, therefore, nothing but ‘tax’, as held by a three- judge Bench of the Supreme Court in CIT v. K Srinivasan6. The following words of Grover J elucidate the law in unequivocal terms:

“In our judgment it is unnecessary to express any opinion in  the  matter because the essential point for determination is whether surcharge is an additional mode or rate for charging income tax. The meaning of the word “surcharge” as given in the Webster’s New International Dictionary includes among others “to charge (one) too much  or in addition………………….. ” also “additional tax”. Thus, the meaning

of surcharge is to charge in addition or to subject to an additional or extra charge. If that meaning is applied to s. 2 of the Finance Act 1963 it  would  lead  to  the  result  that  income  tax  and  super  tax  were  to  be charged in four different ways or at four different rates which may be described  as  (i)  the  basic  charge  or  rate  (In  part  I  of  the  First Schedule); (ii) Sur- charge; (iii) special surcharge and (iv)  additional surcharge calculated in the manner provided in the Schedule. Read in this  way  the  additional  charges  form  a  part  of  the  income  tax  and super tax.”

This judgment in K Srinivasan’s case (supra), however,  was  not  considered by their lordships of the Bombay High Court and the Rajasthan High Court in Sesa Goa Ltd. and Chambal Fertilizers & Chemicals Ltd.’s case (supra).

The Select Committee Report on Income-tax Bill 1961

Coming to the Select Committee Report on Income-tax Bill 1961 dated 10th August 1961 and the subsequent circular of the CBDT F. No. 91/58/66-ITJ(19), dated 18th May, 1967), relied upon by the High Courts in Sesa Goa Ltd. and Chambal Fertilizers & Chemicals Ltd.’s case (supra),  it may be appreciated that at the relevant point in time, there was no cess  on income-tax under the old Income-tax Act ‘Cess’ was levied by different states as ‘local levies’ under state legislation. The evidence of the same is available through a plethora of cases before various judicial fora at relevant time. These items of ‘cess’ were of nominal amount and were sometimes revenue in nature. It was these kinds of ‘cess’ which were under consideration before the Select Committee on Income-tax Bill 1961, as evident from the minutes of the Select Committee meeting dated 20th  June, 1961 (when Shri B.P. Khaitan, speaking for Indian Chamber of Commerce, Calcutta, took up the issue of proposal from Income-tax Bill 1961 on clause 40(a)(ii), which is extracted herein below:

“Shri B.P. Khaitan: Coming to clause 40, item 2 in sub-clause (a) provides that any sum paid on account of any cess, rate or tax, levied as a proportion of the profits, will not be allowed to be deducted in computing business income. I submit that it should be clarified. Take, for instance, the cess on coal. That should be deducted in computing business income.
Shri Morarji Desai: We will consider this.”

11. Accordingly, when the Select Committee deliberated on the proposal, it was concerned with those state levies, which were either nominal  in  amount or were sometimes revenue in nature as evident from para 27 of   the Select Committee Report dated 10TH August, 1961 itself which is reproduced herein below for easy reference:

“27. Clause 40.—The Committee are of the view that all cesses should be  allowed  as  business  expenses  because  they  are  of  small  amounts and though sometimes computed on the basis of profits they are really of  the  nature  of  revenue  expenditure.  Therefore,  the  word  “cess” occurring in item (a) (ii) has been omitted.

The Committee further feel that in sub-clause (b) reference to Hindu undivided family, association of persons and body of individuals  should be omitted.

The clause has been amended accordingly.”

Thus, the context of the Select Committee Report and the subsequent clarification by the CBDT vide its circular F. No. 91/58/66-ITJ(19), dated 18th May, 1967 was the ‘cess’, levied under state legislation such as coal cess, state duty cess and other cesses levied by the local bodies/states, which is obviously outside the prohibition contained in section 40(a)(ii) of the Act and not the cess on Income-tax which has been introduced as surcharge as clarified in the Explanatory Memorandum to the Finance Bill, As has been stated in the preceding para, ‘education cess’ was introduced as an additional surcharge on income tax, which is income tax only in view of the law laid down by a three-judge Bench of the Supreme Court in K Srinivasan’s case (supra). The context of the Select Committee Report and the consequent clarification by the CBDT vide its  circular  F. No. 91/58/66-ITJ(19), dated 18th May, 1967 was, therefore,  not  considered by their lordships in Sesa Goa Ltd. and Chambal Fertilizers & Chemicals Ltd.’s case (supra). Thus, there is no doubt  that  presbyter  is only priest writ large, as it is said. Education cess is tax manu brevi.

The Jaipuria Samla Case

13. The Apex Court’s holding in Jaipuria Samla Amalgamated Collieries Ltd.7, which has been referred to in Chambal Fertilizers  &  Chemicals Ltd.’s case (supra) to argue and hold that ‘profits or gains of any business   or profession’ has reference only to profits as per section 28 of the Act, and any rate or tax levied upon profits not ‘assessed on the basis of profits’ should be an allowable expense. Since education cess was not levied upon profits determined as per section 28 of the Act, it was held to be an  allowable

14. This argument appears acceptable at first blush. It may, however, be noted that Jaipuria Samla Amalgamated Collieries Ltd.’s case (supra),

which  followed  the  Privy  Council  decision  in  CIT v. Gurupada  Dutta8  in the  context  of  ‘cess’  levied  under  the  Bengal  Cess  Act,  1880,  is  no  longer good law under the Income-tax Act 1961 as held by the Supreme Court in Smith  Kline  &  French  (India)  Ltd.  v.  CIT9,  where  BP  Jeevan  Reddy  J explicated the law in the following terms:

“6. The learned counsel for the appellants placed strong reliance upon the decision of this Court in Jaipuria Samla Amalgamated Collieries Ltd.  v.  CIT  [1971]  82  ITR  580  to  contend  that  a  tax  has  to  be computed in accordance with the provisions of the Act to fall within the mischief of section 40(a)(ii). Inasmuch as the surtax is computed on   a   basis   different   from   the   basis   prescribed   in   the   Act,   it   is contended, it cannot fall within the four corners of section 40(a)(ii). It is not possible to agree with this contention either. The said decision was  rendered  with  reference  to  sub-section  (4)  of  section  10  of  the Indian  Income-tax  Act,  1922  which  corresponds  to  sub-clause  (ii)  of clause (a) of section 40 of the present Act. The question therein was whether the amount payable as (i) road and public works cess levied under  the  Bengal  Cess  Act,  1880  and  (ii)  the  education  cess  levied under the Bengal (Rural) Primary Education Act, 1930 falls within the mischief of section 10(4). This Court held that they do not. A perusal of the decision shows that the road and public works cess was levied on immovable property to provide for construction and maintenance of  roads  and  other  works  of  public  utility.  Under  section  5  of  the Bengal    Cess    Act,    1880    all    immovable    property,    with    certain exceptions,  was  subjected  to  payment  of  road  cess  and  public  works cess.  Section  6  of  the  Bengal  Cess  Act  provided  that  the  said  cesses shall be assessed on the annual value of lands and, until provision to the contrary was made by Parliament, on the annual net profits from mines, quarries, tramways, railways and other immovable property at such   rates   as   were   to   be   determined   in   the   manner   prescribed. Similarly, the education cess was also levied under section 29 of the Bengal (Rural) Primary Education Act, 1930, on immovable property on which the road and public works cesses were assessed. The rate at which   the   education   cess   was   to   be   levied   depended   upon   the character  of  the  property;  in  respect  of  mines  and  quarries,  it  was leviable at the rate of three and a half pice on each rupee of annual net profits. It is thus abundantly clear that the levy of aforesaid cesses was upon the immovable properties and not on profits. It is no doubt true that the tax was measured with reference to the net profits of business but  it  is  well-settled  by  a  series  of  decisions  of  this  Court  that  the measure by which a tax is computed does not determine the character of  the  tax  vide  Union  of  India  v.  Bombay  Tyre  International  AIR 1984 SC 420 and Goodricke Tea Co. v. State of West Bengal 1995 (1) Suppl. SCC 707. It is, therefore, idle to contend that the said decision helps the assessee’s case in any manner. The cesses considered in the said  decision  were  not  taxes  ‘levied  on  the  profits  or  gains  of  any business or profession or assessed at a proportion of or otherwise on the  basis  of  any  such  profits  or  gains’  within  the  meaning  of  section 40(a)(ii)  as  explained  hereinabove.  The  learned  counsel,  however, relied upon the following observations in the said decision: “the words ‘profits  and  gains  of  any  business,  profession  or  vocation’  which  are employed in section 10(4) can, in the context, have reference only to profits or gains as determined under section 10 and cannot cover the net profits or gains arrived at or determined in a manner other than that  provided  by  section  10.  The  whole  purpose  of  enacting  sub-section (4) of section 10 appears to be to exclude from the permissible deductions  under  clauses  (ix)  and  (xv)  of  sub-section  (2)  such  cess, rate  or  tax  which  is  levied  on  the  profits  or  gains  of  any  business, profession or vocation or is assessed at a proportion or on the basis of such  profits  or  gains.  In  other  words,  sub-section  (4)  was  meant  to exclude a tax or a cess or rate the assessment of which would follow the  determination  or  assessment  of  profits  or  gains  of  any  business, profession or vocation in accordance with the provisions of section 10 of  the  Act……  These  profits  arrived  at  according  to  the  provisions  of the  two  Cess  Acts  can  by  no  stretch  of  reasoning  be  equated  to  the profits  which  are  determined  under  section  10  of  the  Act.  It  is  not possible to see, therefore, how section 10(4) could be applicable at all in the present case”. The learned counsel pointed out that this Court has in the said decision approved the decision of the Privy Council in CIT v. Gurupada Dutta [1946] 14 ITR 100  and  has  further  observed that the Parliament must be deemed to have accepted the view taken by  the  Privy  Council  by  not  changing  the  language  of  the  relevant provision in the Act [section 40(a)(ii)].

7. We are unable to see as to how these observations help the assessees herein. Firstly, it may be mentioned, section 10(4) of  the 1922 Act or section 40(a)(ii) of the present Act do not contain any words indicating that the profits and gains spoken of by them should   be determined in accordance with the provisions of the Act. All they   say is that it must be a rate or tax levied on the profits and gains of business or profession. The observations relied upon must be read in the said context and not literally or as the provisions in a statute. But  so far as the issue herein is concerned, even this literal reading of the said observations does not help the assessee. As we have pointed out hereinabove the surtax is essentially levied on the business profits of the company computed in accordance with the provisions of the Act. Merely because certain further deductions [adjustments] are provided by the Surtax Act from the said profits, it cannot be said that  the  surtax is not levied upon the profits determined or computed in accordance with the provisions of the Act. Section 4 of the Surtax Act read with the definition of ‘chargeable profits’ and the First Schedule make the position abundantly

8. We may mention that all the High Courts in the country except the Gauhati High Court have taken the view which we have taken herein. Only the Gauhati High Court has taken a contrary view in the  decisions in Makum Tea Co. (India) Ltd. CIT [1989] 178 ITR 453  and Doom Dooma Tea Co. Ltd. v. CIT [1989] 180 ITR  126.  The decision of the Gauhati High Court in Makum Tea Co. (India) Ltd.’s case (supra) is under appeal before us in Civil Appeal Nos. 3976-77 of 1995. Similarly, Civil Appeal No. 3246 of 1995 is preferred against the decision of the Gauhati High Court following the decision in Doom Dooma Tea Co. Ltd.’s case (supra). On enquiry, the  office  has informed that no Special Leave Petition/Civil Appeal has been filed against the decision in Doom Dooma Tea Co. Ltd.’s case (supra). For the aforesaid reasons, we cannot agree with the view taken by the Gauhati High Court in the aforesaid decisions.

Thus, in view of the judgment of the Supreme Court in Smith Kline & French India Ltd.’s case (supra), no requirement can be read into section 40(a)(ii) to the effect that for disallowing any rate or tax levied on profits, the said profits and gains should be determined in accordance with the provisions of the Act.

Conclusion

‘Education cess’, therefore, fails the fundamental tests of deductibility under section 37 and is also hit by the mischief of section 40(a)(ii) of the Income-tax Act, 1961 in view of law laid down in K Srinivasan and Smith Kline & French India Ltd.’s case (supra). Income-tax and ‘Education Cess’ are levied under the same provisions of the Constitution of India10under  the identical mandate provided in Article 246 thereof, which enables governments to formulate law for levy of    Sesa  GoaLtd.  and Chambal Fertilizers & Chemicals Ltd.’s case (supra), therefore, may not have been correctly decided in view of the law laid down by the Supreme Court, the statutory position and the constitutional scheme in this regard.