Resolutions not always sacrosanct

Is it possible to create liability for pension through a provision made possible by the board resolution of the company? Can such board resolution bypass the other specific provisions in the Income-Tax Act, 1961, laying down strict norms for the deduction of provision for pensions? This interesting question came up for detailed consideration before the Calcutta High Court in March 2011.

Brooke Bond India vs. Joint CIT

The board of directors of Brooke Bond India Ltd passed a resolution to the effect that pension liability of Rs 1,43,35,000 be created on the basis of actuarial working. The company had decided to grant pension to its executives who had retired prior to the introduction of the pension schemes and were not in receipt of any pension. Since the accounts were maintained on mercantile basis, it was claimed that the company was entitled to the deduction of the entire amount which accrued during the year as liability for the purpose of said pension. A number of rulings of the Supreme Court came to be relied upon in support of the claim.

Revenue, on the other hand, justified the disallowance of the claim relying on Section 40A (9) and also Section 36 (1) (v) of the Act. These Sections permit deduction of contributions towards a recognised provident fund or approved superannuation fund or approved gratuity fund for the exclusive benefit of the employee under an irrevocable trust.

The pension scheme created by the board resolution did not fall in the category of an approved superannuation fund. The company also relied on the Omnibus Section 37.

The question for consideration was whether a company which maintained its accounts on mercantile basis is entitled to deduction on actuarial basis for discharging any liability on account of unapproved pension scheme.

The Calcutta High Court ruled that the pensionary liability created by a board resolution for payment to executives and other employees who had already retired cannot amount to expenditure even if such liability is of the nature contemplated under Section 36. A mere board resolution will not fall under any of Sections 30 to 36 or even under Section 37. It held that expenditure in the nature of those mentioned in Sections 30 to 36 but actually not coming within their purview or in excess thereof cannot get the benefit of Section 37.

Sanctity of Board Resolution

A resolution by the board can easily by modified or reversed by a subsequent resolution.

The company cannot take the aid of an ‘avoidable' promise. It must comply with the requirements of Section 40 (A)(9). Any company, following the mercantile method of accounting by taking a fake resolution to pay pension without any intention to pay, would, for years, not actually pay the amount and may even subsequently vary such resolution and still enjoy the benefit of deduction if the company's claim were to be allowed. Upholding the disallowance, the Court decided that the liability on account of pension on the basis of board resolution was not deductible.

Unfunded liability towards pension is a charge on profits. But Section 36(1)(v) and (vi) will allow the provision only where it is an amount payable towards an approved fund. Section 40A (7) bars such deduction. Probably, the company could have availed of deduction under Section 37 by securing an insurance policy and making a provision for premia towards the accrued liability.

This procedure could have obviated the necessity for setting up an approved fund. Whether such procedure will be acceptable before High Courts is a matter for debate. The Madras High Court had held that payment of premia by an arrangement with the trust fund directly to the LIC without rooting the payment through the fund cannot be disallowed in CIT Vs. Textool Ltd, 257 ITR 39.

The Calcutta High Court itself had held that Section 40 (A) (7) should be treated as having been overridden by Section 43(B).

Actual payment, instead of a mere provision, will not be hit by any of these sections. For far too long, the courts have been relying on the ancient ruling of the Supreme Court in Shree Sajjan Mills Ltd, 156 ITR 585. Much water has flown since the ruling of the court.

Section 43 (B) should govern all such claims. The matter should be cleared beyond all reasonable doubts by the Supreme Court which had first laid down the law in such cases, including Metal Box Co of India Ltd, E.D. Sassoon and Co Ltd, Keshav Mills Ltd and Bharat Petroleum Corporation Ltd.

The Brooke Bond case took note of these rulings which were all favourable to the taxpayer but held in favour of Revenue because the provision was unapproved.

The Court did not consider the implications of Section 43 (B). All the same, the Calcutta case is significant for the light it throws on the sanctity or otherwise of resolutions of board of directors of companies in such matters.

(The author is a former Chief Commissioner of Income-Tax.)