Key Takeaways: - Background of the provision - Facts of the case - Contentions of the Assessee - Constitutional validity of the amendment by the Legislature - Final Ruling of the Court

1. DEDUCTION OF LEAVE ENCASHMENT ON
PAYMENT BASIS
UNION OF INDIA VS EXIDE NDUSTRIES [2020]
116 taxmann.com 378 (SC)
CA Jugal Gala

2. RESEARCH CREDITS
Deepika S
Gracelin Lita P

3. LEGENDS USED
ITA Income Tax Act
SC Supreme Court
HC High Court
Hon’ble Honourable

4. PRESENTATION SCHEMA
Background and Facts of the
Case
Contentions of the Assessee
and High Court Ruling
Constitutional validity of Sec
43B(f)
SC’s Contentions against HC
Ruling
Conclusion

5. BACKGROUND AND FACTS OF
THE CASE

6. 1 (2000) 245 ITR 428 (SC)
BACKGROUND
The deductibility of provision of leave encashment has been a long-
standing contentious tax issue.
The Hon’ble SC settled the issue in Bharat Earth Movers1 by holding
that taxpayer can claim the provision for leave encashment in the
year in which the liability has accrued even though it has not been
finally discharged.
Section 43B of the ITA was amended (with prospective effect) by the
Finance Act, 2001 in contrast to the decision of the SC in Bharat Earth
Movers.
Clause (f) was inserted in Section 43B to provide that leave
encashment shall be allowed on payment basis only.

7. FACTS OF THE CASE
The Assessee computed their profits and gains of business in accordance with the mercantile system by way of
Section 145 of the ITA (which grants Assessee the freedom to choose the mode of accounting)
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.
Thus, the Assessee was aggrieved with the inclusion of Section 43B(f) which mandated that leave encashment
would be allowed as expenditure on “actual payment basis” and not on accrual basis
The constitutional validity of this Section 43B (f) was challenged before the Calcutta High Court in in Exide
Industries Ltd. v. Union of India1.
The Hon’ble HC held that clause (f) of Section 43B is arbitrary and unreasonable and violative of Article 14 of
the Constitution of India2
The instant case is an appeal from the order of the Calcutta High Court.
1 (2007) 212 CTR 206
2Article 14 guarantees the right to Equality and Equal protection of the laws.

8. CHRONOLOGY OF THE INSTANT CASE AND PAST RULINGS
SC holds in the case of Bharat
Movers that “leave
encashment” is a present
liability, according to which,
deduction can be availed in the
year of accrual (Year 2000)
Clause (f) inserted in Sec 43B
vide Finance Act, 2021,
disallowing leave encashment
on accrual basis
Section 43B(f) was challenged
before Single Judge Bench of
Calcutta High Court.
• Held: Section 43B(f) is valid
The order of Single Judge Bench was appealed
before the Division Bench of Calcutta High
Court.
• Held: Reverses the order of Single Judge and
declares Section 43B(f) as unconstitutional
The aggrieved party appeals this order
before the Supreme Court which decides
the constitutional validity of Section 43B(f).
• On appeal before the Hon’ble SC
The above is elaborated in further slides

9. CONTENTIONS OF THE ASSESSEE
AND HIGH COURT RULING

10. ABSENCE OF NEXUS OF CLAUSE (f) WITH SEC 43B
Section 43B of the IT Act carves out an exception to the general rule of accrual for determination of
liability, as it subjects deductions in lieu of certain kinds of liabilities to actual payment.
Exceptions under this section comes into operation in a limited set of cases covering statutory liabilities
like tax, duty, cess etc. and other liabilities created for the welfare of employees.
Liability under the leave encashment scheme being a trading liability cannot be subjected to the exception
under Section 43B of the IT Act.
Nature of liability of leave encashment not in scheme of other statutory liabilities in Sec 43B

11. NONDISCLOSURE OF OBJECTS AND REASONS BEHIND ITS
ENACTMENT AND INSERTION INTO SECTION 43B
While initially Sec 43B was inserted vide the Finance Bill, 1983, the Memorandum put forward the need
of the insertion
It was explained that the inclusion of these deductions by citing certain practices of evasion of
statutory liabilities and other liabilities for the welfare of employees
However, when new clause (f) was introduced, the Memorandum was silent in explaining the objects
and reasons
Hence, the Division Bench of the HC, plainly glossed over the fundamental presumption of
constitutionality in favour of clause (f) and based its judgment upon the absence of objects and
reasons as striking at the root of its validity

12. NULLIFICATION OF THE RULING IN BHARAT EARTH MOVERS
Assessee relied on the SC verdict in Bharat Earth Movers which discussed the nature of the liability of leave
encashment
It was held in the ruling that leave encashment, being a business liability (and when present and definite
liability), should be claimed in the same previous year in which it is accrued, even though it may be paid
subsequently.
Therefore assessee contended that the Amendment of Section 43B was done to subjugate the legal position in
Bharat Earth Movers and it violated the principle of separation of powers.*
*Principle of separation of powers: One organ of the Government should not control or interfere with the
exercise of its function by another organ (democracy between the three main organs of a Government
namely i) The Legislative; ii) The Executive and iii) The Judicial)

13. CONSTITUTIONAL VALIDITY OF
SECTION 43B(f)

14. To test the constitutional validity of a
provision, the Court performs two tests:
To inspect the existence of enacting power;
To ascertain whether the enacted provision
violates any Fundamental right preserved in
Part III of the Constitution (Fundamental
Rights).
PRINCIPLES OF TEST OF CONSTITUTIONALITY

15. SUPPLEMENTARY PRINCIPLES OF TEST OF
CONSTITUTIONALITY OF FISCAL STATUTES
There is always presumption in favour of constitutionality of a law made by Parliament or a State
Legislature.
No enactment can be struck down for it being arbitrary or unreasonable or irrational but some
constitutional infirmity has to be found
The court cannot judge the wisdom or unwisdom of the law as Parliament are supposed to be alive to
the needs of the people and are the best judge of the community by whose suffrage they come into
existence
Hardship is not relevant in pronouncing on the constitutional validity of a fiscal statute or economic law
In the field of taxation, the legislature enjoys greater latitude for classification
The Court relied on the principles laid down by the Hon’ble SC in State of M.P. v. Rakesh Kohli
on deciding the constitutional validity of Fiscal statutes

16. The Legislature has included certain deductions in the ambit of Section
43B so as to subject such deductions to conditionality of actual
payment.
It is not a provision to place any embargo upon the autonomy of the
assessee in adopting a particular method of accounting, nor deprives
the assessee of any lawful deduction.
This is a matter for the legislature and its wisdom in doing so. And it
is fully within its powers to do so.
WISDOM OF LEGISLATURE PRINCIPLE

17. The Leave encashment scheme envisages the payment of a certain amount to the employees in lieu of
their unused paid leaves in a year.
The nature of this payment is beneficial and pro-employee.
Sec 43B(f) was enacted to rectify a situation of double benefit to the employer — i.e.
• Advance deduction from tax liability without any burden of actual payment and
Refusal to pay as and when occasion arises.
The thrust of the provision is not to control the timing of payment, rather, it is to control the timing of
claiming deduction in the name of such liability.
HISTORY AND OBJECT OF SECTION 43B (f)

18. NATURE OF DEDUCTION IN SECTION 43B
• The Court finds a presumption of Constitutionality in favour of the provision.
• Broad objective of enacting Section 43B’s specified deductions was to protect larger public
interest primarily of revenue and including welfare of the employees.
• It negates the contention of Respondents that Section 43B should be restricted it to a particular
category of deduction i.e. Statutory deductions.
• The Court finds that with regard to Section 43B the legislature never restricted it to a particular
category of deduction and it was a mixed bag of deductions.
Section 43B is a mix bag of deductions. New and dissimilar entries have been inserted therein from time to
time to cater to different fiscal scenarios.

19. SC’s CONTENTIONS AGAINST HC RULING

20. NONDISCLOSURE OF OBJECTS AND REASONS BEHIND ITS
ENACTMENT AND INSERTION INTO SECTION 43B
Supreme Court’s Verdict
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.
If the text of the provision is unambiguous, the legislative intent gets fused and manifested
therefrom

21. INCONSISTENCY OF CLAUSE (f) WITH OTHER CLAUSES
OF SECTION 43B
Supreme Courts’ verdict
Based on 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 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.

22. ENACTMENT HAS BEEN TRIGGERED SOLELY TO NULLIFY
THE DICTUM IN BHARAT EARTH MOVERS
Supreme Courts’ verdict
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
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.

23. FINAL RULING
• Merely because a liability was held to be a “present liability” qualifying for instant deduction in
terms of the applicable provisions at the relevant time does not, by the very fact, signify that
deduction against such liability cannot be regulated by a law made by Parliament prospectively
• Therefore, there has not been any constitutional infirmity or violation of Fundamental Rights by
insertion of clause f in Section 43B.
• Accordingly, the impugned judgment of the Division Bench of the High Court is reversed and
clause (f) in Section 43B is held to be constitutionally valid and operative for all purposes.
.

24. CONCLUSION

25. KEY LEARNINGS
The issue of allowability of leave encashment in Section 43B(f) has been decided by the Supreme Court.
Section 43B strictly targets to ensure that the deduction is claimed on a specified expense when actually paid.
The mischief that the employer claiming the tax deduction of such a payment at a point of time and may end up
not paying the amount to the employee at all is sought to be remedied by insertion of clause (f) of Section 43B.
The Court held that clause (f) is meeting with the objectives of section 43B.
The insertion of clause (f) has not extinguished the choice of the Assessee to follow the mercantile system.
It merely defers the benefit of deduction to be availed by the assessee for the purpose of computing his taxable
income and links it to the date of actual payment thereof to the employee concerned.
Section 43B(f) is constitutionally valid

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