Amount Paid as Retrenchment Compensation is allowable Deduction u/s 37 of Income Tax Act: ITAT [Read Order]

The Delhi Bench of the Income Tax Appellate Tribunal ( ITAT ) in ACIT vs. M/s. Lumax Automotive held that amount paid by assessee on account of Retrenchment Compensation is paid for business purposes only and as such, it was an allowable deduction under Section 37 of the Income Tax Act, 1961.

The assessee manufactures auto components. They have many factories at various places in India. The company closed down one of its factory in Aurangabad citing financial difficulty and lack of funds to modernize the manufacturing plants. Accordingly, Management had given a General Notice to the factory workers for closure of the unit with effect from 31st March, 2010.

The Company Management and the Worker’s Union had entered into an Agreement with regard to Terms of the Retrenchment Compensation and other dues to the workers. Other than retirement there were two ways in which payment is made to employees when they leave the company mid-way, either through retrenchment or opting the scheme of VRS.

In case of VRS, the Company made terms of the offer of retrenchment and it was not obligatory on the part of the employees to accept the VRS. Section 35DDA of the I.T. Act is applicable in respect of the expenditure made in connection with the voluntary retirement. This provision is applicable when VRS is introduced by the assessee-company and payments are made by the assessee-company to its employees on their voluntary retirement.

However, in the case of the assessee-company, its Aurangabad unit was closed with retrenchment of all the workers and staff as on 31st March, 2010. Payments were made to the workers and staff on their retrenchment. Thus, no payment is made for VRS. The A.O. disallowed the amount of VRS retrenchment compensation and did not allow claim under section 35DDA of the Income Tax Act, 1961. Aggreived appeal was filed before Commissioner of Income Tax (Appeals) (CIT(A)).

Deleting the addition made by the Assessing officer, the CIT(A) observed that the expenditure incurred by the assessee on payments made to retired employees of closed unit was made wholly and exclusively for business purpose of appellant company and there was no element of personal element involved in such payments to retired employees. Revenue appealed before ITAT.

Upholding the decision of the CIT(A), the Bench comprising of Judicial Member Bhavnesh Saini and Accountant Member L.P. Sahu observed “it is clear that amount in question have been paid by assessee company on account of retrenchment compensation on closure of the Aurangabad unit of the assessee-company. The amount is thus paid for business purposes only and as such, it was an allowable deduction under section 37 of the I.T. Act. Provisions of Section 35DDA applied by the A.O. are not applicable in this case because assessee-company has not paid any service compensation under any scheme of voluntary retirement.”