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Commissioner of Income-tax, Bombay City-i Vs. W.T. Suren and Co. Ltd. - Court Judgment

LegalCrystal Citation
SubjectDirect Taxation
CourtMumbai High Court
Decided On
Case NumberIncome-tax Reference No. 146 of 1971
Judge
Reported in(1982)31CTR(Bom)128; [1982]138ITR91(Bom)
ActsIncome Tax Act, 1961 - Sections 7, 10(2), 30, 37 and 37(1); Wealth Tax Act, 1957 - Sections 2
AppellantCommissioner of Income-tax, Bombay City-i
RespondentW.T. Suren and Co. Ltd.
Excerpt:
direct taxation - admissibility of deduction - section 37 (1) of income tax act, 1961 - whether payment of gratuity of certain sum which assessee-company made to 'r' was an allowable deduction - no liability actually arose against assessee-company to pay any gratuity to employees who had already taken employment with transferee-company - held, assessee not entitled to claim deduction. - - the character of payment made by the assessee-company to the transferee-company is, therefore, clearly not as gratuity. on a reference at the instance of the revenue, the high court held that the tribunal had clearly found that the liability for payment, to which the employer was subject under the gratuity act, to the workers was an expenditure wholly and exclusively laid out or expended for the.....chandurkar, j.1. the assessee-company is a private limited company incorporated under the indian companies act, 1913, and the relevant assessment year is 1960-61 for which the previous year ended on 30th april, 1959. the assessee was a wholly owned subsidiary of rallis india ltd. with effect from 21st november, 1958. the principal business of the assessed-company was the distribution of the products of traddington chemical factory private ltd., which was also another wholly owned subsidiary of rallis india ltd. the said principal business of the assessee-company was taken over by rallis india ltd. (hereinafter referred to as the 'transferee-company'), with effect from 1st may, 1959.2. a scheme for gratuity in respect of the members of the assessee-company was in force since august, 1953......
Judgment:

Chandurkar, J.

1. The assessee-company is a private limited company incorporated under the Indian Companies Act, 1913, and the relevant assessment year is 1960-61 for which the previous year ended on 30th April, 1959. The assessee was a wholly owned subsidiary of Rallis India Ltd. with effect from 21st November, 1958. The principal business of the assessed-company was the distribution of the products of Traddington Chemical Factory Private Ltd., which was also another wholly owned subsidiary of Rallis India Ltd. The said principal business of the assessee-company was taken over by Rallis India Ltd. (hereinafter referred to as the 'transferee-company'), with effect from 1st May, 1959.

2. A Scheme for gratuity in respect of the members of the assessee-company was in force since August, 1953. The qualifying period of service for earning gratuity was five years and the gratuity payable to the employees, who had put in service of 10 years and above, was at the rate of one month's basic salary for each year of service with a maximum of 15 months' salary or Rs.15,000, whichever was lower. Every year certain ad hoc amounts were transferred to the gratuity reserve by the company. On 22nd April, 1959, a notice was served by the assessee-company on its employees terminating their employment on and from 30th April, 1959, and they were intimated that the transferee-company offered, by a separate letter which was enclosed with the notice, employment with the transferee-company on and from 1st May, 1959. Any employment who did not want to accept employment with the transferee-company was free to receive retirement gratuity (on the normal scale), in addition to one month's salary in lieu of notice. The employees were to be given the benefit of continuity of service if they accepted the employment with the transferee-company. The notice of termination was intimated in the following words :

'You will see that, in their offer of employment, Rallis India Ltd. undertake that, if you accept service with them from 1st May, 1959, it shall be assumed that there has been no break or interruption in your employment and they undertake to assume liability to pay on that basis any retrenchment compensation that may become payable in the event of any subsequent retrenchment.'

3. In the letter written by the transferee-company to the employees also there was an offer to give the benefit of continuity of employment in the following words :

'As mentioned by W.T. Suren and Co. Private Ltd. in their separate letter to you of today's date, we confirm that your past service with W.T. Suren and Co. Private Ltd. shall count as continuous with future service with Rallis India Limited and that the change of employment on 1st May, 1959, shall not constitute a break in or interruption of employment and we hereby assume liability to pay on that basis any retrenchment compensation that may become payable in the event of any subsequent retrenchment.'

4. A circular was also issued to all the branches of the transferee-company that continuity of employment in respect of the employees of the assessee-company who have taken up employment with the transferee-company was to operate in all respects, including the computation of gratuity. The circular also specified that in cases in which there may be a difference between gratuity which is secured in the service of the assessee company and the gratuity as calculated under the gratuity scheme of the transferee-company be paid the gratuity accrued to them in the service of the assessee-company as it calculated on 30th April, 1959, if it is higher than the gratuity as calculated under the scheme.

5. On 29th April, 1959, pursuant to a resolution of the board of directors of the assessee-company passed on 29th April, 1959, the assessee company paid to the transferee-company a sum of Rs. 4,10,177.75 (being the aggregate amount of gratuity which would been payable to the staff of the said W.T. Suren and Co. Private Ltd. if they had all retired on 29th April, 1959), according to an affidavit filed by the chairman and the managing director of the transferee-company.

6. When the assessee-company claimed a deduction of Rs. 4,08,622 in the assessment proceedings for the assessment year 1960-61, the ITO took the view that the transferee-company alone will be entitled to claim in their assessment the amounts paid by them by way of gratuity at the time of retirement of individual staff members and, he, therefore, declined to allow the claim of the assessee-company for a deduction of gratuity to the extent of Rs. 4,08,622. The AAC, concurring with this finding of the ITO, held that there was no actual termination of the services of the employees in question and that the liability in question was capital in nature. The Appellate Tribunal, however, took a contrary view and held that gratuity would be an allowable deduction as and when it became payable, but, that so far as the assessee-company was concerned, no liability for payment to the employees directly arose as the employees would have to look forward to their claim from M/s. Rallis India Ltd. The Tribunal also held that there was a termination of employment of the employees from the service of the assessee-company and there was, therefore, a legal liability for the assessee-company and the liability had been duly discharged by payment to M/s. Rallis India Ltd. The Tribunal came to the finding that the assessee-company was still functioning and a copy of the profit and loss account found in the printed copy of the directors' report and accounts of Rallis India Ltd. showed that there has been a turnover of Rs. 82 lakhs odd. In this view, the Tribunal found that the payment was rightly claimed as an expenditure for the purpose of business. The Tribunal, however, rectified the order by substituting the figures of Rs. 1,69,821 in place of Rs. 82 lakhs odd in so far as and to the extent of the business of the assessee-company was concerned. Arising out of this order of the Tribunal, the following question has been referred under s. 66(1) of the Indian I.T. Act, 1922, to the High Court :

'Whether, on the facts and in the circumstances of the case, the payment of gratuity in the sum of Rs. 4,08,622, which the assessee-company made to M/s. Rallis India Ltd. was an allowable deduction ?'

7. The learned counsel appearing on behalf of the Revenue contended before us on the authority of the decision of Supreme Court in Standard Mills Co. Ltd. v. CWT : [1967]63ITR470(SC) , that the liability of the assessee to pay gratuity to its employees was a mere contingent liability which arose only when the employment of the employee was determined by death, incapacity, retirement or resignation and that the liability did not exist in praesenti and, therefore, notwithstanding the fact that the assessee-company has paid the amount of Rs. 4 lakhs odd to the transferee-company since it was a payment to meet the contingent liability the assessee-company was not entitled to any deduction. Another argument of the learned counsel on behalf of the Revenue was that if at all there was any liability which had arisen and which the assessee-company was called upon to meet, that liability arose on the transfer, it cannot be said to have arisen during the time the business is carried on so that it cannot be appropriately regarded as expenditure. This argument was advanced on the strength of the decision of the Supreme Court in CIT v. Gemini Cashew Sales Corporation : [1967]65ITR643(SC) . It was argued before us that the case of the assessee-company was on all fours with the reference decided by the Madras High Court in Stones Motors (South India) Ltd. v. CIT : [1975]100ITR341(Mad) , which has been followed, according to the learned counsel, by the Madras High Court in CIT v. Pathinen Grama Arya Vysya Bank Ltd. [1977] 109 ITR 789 and the latest decision of the same court in CIT v. Salem Bank Ltd. : [1979]120ITR224(Mad) .

8. The learned counsel appearing on behalf of the assessee has, however, contended that the gratuity scheme having been enforced since 31st August, 1953, the assessee-company had incurred the liability to pay gratuity and the time for making the payment of gratuity was the cessation of employment which was an event which was certain to occur and which did occur on 30th April, 1959, when the services of the employees were terminated. There was thus a liability, according to the learned counsel, which the assessee was bound to discharge on 30th April,1959. It was pointed out in respect of some employees who chose to leave the employment and not take up new employment with the transferee-company, gratuity to the tune of Rs. 23,346 had been paid and had been allowed as the deduction. But, so far as the amount of Rs.4,08,622 was concerned, the contention before us was that the liability of the assessee-company in respect of the gratuity payable to the employees who took up employment with the transferee-company, was, by virtue of the arrangement with the transferee-company, extinguished and that the transferee-company had accepted the employment of the employees in whose favour the gratuity to be paid had accepted the proposal of the assessee-company that the amount due to them would be paid to the transferee-company. The learned counsel thus contended that if the liability of the assessee-company stood extinguished by the assessee-company paying Rs. 4,08,622 to the transferee-company even the expenditure incurred by the assessee-company for extinguishing the business liability which could otherwise have had to be discharged by making actual payment to the workers. It was argued that the payment made to the transferee-company was irretrievable and was in fact an expenditure and not a mere transfer of funds. It is further pointed out that since the payment to the transferee-company was in discharge of the obligation incurred whilst the business was being carried on, it was not a payment in respect of a liability arising on or after the closure as was the case in Gemini Cashew Sales Corporation : [1967]65ITR643(SC) . The learned counsel has in addition referred to two decisions which according to him support his contention, one being a Full Bench decision of the Kerala High Court in CIT v. Standard Furniture Co. Ltd. : [1979]116ITR751(Ker) , and the other being a decision of the Madras High Court in CIT v. Sri Venkateswara Bank Ltd. : [1979]120ITR207(Mad) . The decision of the question, which is posted for consideration in this reference and which has been exhaustively argued on both sides, would essentially depend on what was the nature of the payment made by the assessee-company when the sum of Rs. 4 lakhs odd had been paid over by the assessee-company to the transferee-company and it will also have to be decided as to what exactly is the nature of the liability of an employer in whose case the scheme of gratuity as contained in the notice dated 31st August, 1953 (annex.'C' to the statement of the case) was operative.

9. Now there is no dispute on the facts of this case that the employment of the employees who were taken over by the transferee-company was to stand terminated on and from 30th April, 1959, and the argument before us proceeded on the footing that the employees would be entitled to the amount of gratuity in accordance with the operative scheme if they had not taken up employment with the transferee-company. It appears to be clear that if the employees had not taken up employment with the transferee-company with the advantage of continuity of service, they would have been entitled to the payment of gratuity. However, admittedly, no amount by way of gratuity was actually paid to the employees. The reason is very clear. Since the employees had been given the benefit of the continuity of employment, in law, there was no retirement from the employment of the assessee-company giving rise to the right in favour of the employees to claim any gratuity from the assessee-company. The liability to pay gratuity to the employees would have arisen only if there was a right which had accrued to the employees to claim gratuity. While that right could have normally accrued in favour of the employees only as a result of the cessation of the business of the assessee-company and employment with the transferee was to be treated as a fresh one. The position in the instant case was different. The facts of the present case will show that, though, technically, so far as the employer-employee relationship is concerned, that was put an end to by the assessee-company, immediately from the next date, i.e., from 1st May, 1959, the employees were taken over by the transferee-company and the benefit of continuity of service was agreed to be given to them and the period of employment with the assessee-company was agreed to be counted as a period of employment with the transferee-company for the purposes of the benefits which the employees would be entitled to get from the transferee-company. the position, therefore, is that in spite of termination of employment with the assessee-company no right had accrued to the employees to claim any gratuity from the assessee-company. If no right had accrued on 30th April, 1959, in favour of the employees whose services were terminated to claim gratuity amount from the assessee-company because of their agreeing to take up employment with the transferee-company with an advantage of continuity of employment, it is difficult to see how it could be argued that there was any liability to pay gratuity as such which had accrued against the assessee-company. The mere fact that the services of the employees were terminated by the notice dated 22nd April, 1959, with effect from 30th April, 1959, will not be conclusive of the question as to whether the right to claim gratuity had accrued in favour of the employees or whether the liability had accrued against the assessee-company to pay any gratuity amount. The question of the accrual of a right to claim gratuity and the corresponding liability against the assessee-company has to be decided in the context of the fact whether on 30th April, 1959, the employees were, as a matter of fact, entitled to claim gratuity amount from the assessee-company. As already pointed out such claim by the employees could not have been tenable because of the guarantee of continuity of employment given by the transferee-company to the employees who would take employment with the transferee-company. No liability for payment of gratuity as such to the employees thus having accrued against the assessee-company, in our view, the payment made to the transferee-company cannot be treated on the same footing as a discharge of the liability for gratuity payable to the employees.

10. There is another aspect of the question which needs to be considered. The amount in question would have become deductible from the profits of the relevant previous year only if it was paid by way of gratuity. When the payment is made by way of gratuity it is a payment made to the employees in satisfaction of the claim which is due to the employees on account of gratuity. In other words the nature of the claim must, in terms, be a claim for gratuity, if any payment is sought to be claimed as a deductible expenditure. It is clear that unless a payment is made to the employees in accordance with the gratuity scheme such payment cannot properly be described as a payment of gratuity. The payment in the instant case is made not to the employees but is paid to the transferee-company in order to enable the transferee-company to meet a future liability for payment of gratuity and it is, therefore, difficult for us to see how the payment to the transferee-company can be said to be a payment on account of gratuity.

11. It is vehemently argued before us that having regard to the documents on record, it is established that the agreement between the assessee-company, on the one hand, and the employees and the transferee-company on the other is that the payment has been made to the transferee-company for the benefit of the employees, and the very fact that they have accepted continuity of employment means that they have chosen not to take the gratuity at the time when their services with the assessee-company stood terminated, but they agreed that the amount due by way of gratuity should be handed over to the transferee-company. Now, we have already pointed out that the employees would have been entitled to gratuity only if they have such a claim on 30th April, 1959. The payment made to the transferee-company could not be described as a gratuity payment and assuming for a moment that the employees had agreed to that, the fact, in our view, will not help the assessee to characterise the said payment as gratuity for the purpose of deductibility under s. 10(2)(xv). The real character of the payment is that it is in the nature of a contribution to the fund in the hands of the transferee-company.

12. What is argued before us is that if the assessee-company had made the said payment to the employees the assessee would have been discharged from the liability to make the payment to the employees and in the instant case the same result has been achieved by paying the exact amount to the transferee-company to be paid to the employees along with such gratuity as may become due at the time when the employees finally retired. Now, what we are concerned with in the present case is the character and nature of the payment and if by virtue of the fact that the employees have been taken over by the transferee-company with the benefit of continuity of employment on and from 30th April, 1959, strictly speaking with no right to claim the gratuity, it is difficult for us to see how the payment which is made to the transferee-company could be really treated as a payment of gratuity. It was also not correct to say that the assessee-company has been discharged of the liability to pay gratuity by virtue of the fact that certain payments has been made to the transferee-company. What has really happened in the instant case in that the liability which would have accrued to the assessee-company in case the employees had accepted the termination of the employment, either really did not arise at all or if it did technically arise on the 30th April, 1959, had immediately ceased with effect from 1st May, 1959, not by virtue of any payment to the transferee-company but by virtue of the fact that the right which would otherwise accrue to the employees to claim the gratuity from the assessee-company ceased to be effective the moment the employment was taken with the transferee-company with the benefit of continuity of employment. All that can be said to correctly describe the payment made by the assessee-company to the transferee-company is that it was in the nature of a contribution which is made by it voluntarily to the transferee-company in order to provide funds to it (the transferee-company) in respect of the payment of gratuity which could be claimed by the employees from the transferee-company in respect of the period of the employment with the assessee-company. So far as the transferee-company is concerned, neither the employees nor the company itself, could make any distinction in respect of the gratuity claimable for the period of employment with the assessee-company and the period of employment with the transferee-company. No such break-up would be permissible either with reference to the claim under the 1957 agreement or under the provisions of the Payment of Gratuity Act. Having chosen to give the advantage of the continuity of employment to the employees of the assessee-company, the liability of the transferee-company would be for the entire period of employment, which would include the period of employment with the assessee-company, irrespective of whether the assessee-company paid or did not any amount to the transferee-company in respect of the gratuity claimable by the employees for the earlier period of employment. The entire liability for the total period of employment including the employment with the assessee-company would be that of the transferee-company. The character of payment made by the assessee-company to the transferee-company is, therefore, clearly not as gratuity.

13. Our attention has been invited to a series of decisions in which a view has been taken that liability to pay gratuity is not a contingent liability and on the basis of those decisions the argument advanced on behalf of the assessee-company was that the liability to pay gratuity was a liability in praesenti. Now, strictly speaking, we need not go into the question as to whether the liability to pay gratuity is a contingent liability as held by the Supreme Court in Standard Mills Co. Ltd. v. CWT : [1967]63ITR470(SC) or whether the liability, is in the nature of a liability in praesenti as contended on the basis of the later decision of the Supreme Court in Metal Box Company of India Ltd. v. Their Workmen : (1969)ILLJ785SC and the decision of this court in Tata Iron & Steel Co. Ltd. v. D.V. Bapat, ITO : [1975]101ITR292(Bom) . The Supreme Court in Standard Mills Co. Ltd.'s case : [1967]63ITR470(SC) , while considering the question as to whether gratuity payable to an employee under the awards of the industrial court and the Labour Appellate Tribunal, made before the relevant valuation date for the purpose of the W.T. Act, 1957, was liable to be deducted for the purpose of determination of net wealth, had observed that the liability of the assessee to pay gratuity to its employees on determination of employment was a mere contingent liability which arose only when the employment of the employee was determined by death, incapacity, retirement or registration and the liability did not exist in praesenti and, therefore, the amount claimed to be payable by way of gratuity could not be deducted as a 'debt' in computing the net wealth of the assessee. In the Metal Box Company's case : (1969)ILLJ785SC the Supreme Court was required to consider as to whether for the purposes of the Payment of Bonus Act, 1965, the audited balance-sheet and the profit and loss account of the company in which provision is made for payment of gratuity would be taken to have been properly made for the determination of the net profit as shown in the profit and loss account and the contention was that the amount which can be debited to the profit and loss account was only the amount which was actually paid by way of gratuity and the questions which the Supreme Court was called upon to decide were (p. 62) :

'(1) Whether it is legitimate in such a scheme of gratuity to estimate the liability on an actuarial valuation and deduct such estimated liability in the P.& L. account while working out its net profits; and (2) if it is, whether such appropriation amounts to a reserve or a provision.' We need not refer to the second question, but so for as the first question is concerned, the Supreme Court held thus (head note) : 'Contingent liabilities discounted and valued as necessary, can be taken into account as trading expenses if they are sufficiently certain to be capable of valuation and if profits cannot be properly estimated without taking them into consideration.'

14. It was held that the estimated liability under a scheme of gratuity, if properly ascertainable and its present value is discounted, is deductible from the gross receipts while preparing the profit and loss account and this was recognised in trade circles and there was nothing in the Bonus Act which prohibited such practice. What was therefore, held in that case was that the present value of the contingent liability was permissible to be shown as trading liability in order to arrive at the correct figure of profits. The third decision of the Supreme Court is a short decision in Bombay Dyeing & . v. CWT : [1974]93ITR603(SC) , in which the Supreme court reiterated the view taken in the Standard Mills' case : [1967]63ITR470(SC) , and held that in computing the : net wealth' of the company as defined in s. 2(m) of the W.T. Act, 1957, or in assessing the net value of the assets under s. 7(2), the estimated liability of the company in respect of gratuity in terms of industrial court awards for the benefit of its employees in respect of their periods of service up to the valuation date was not deductible. Having followed the Standard Mills' case : [1967]63ITR470(SC) , the Supreme Court further went on to consider the contention that the decision in the Standard Mills' case should be reconsidered in view of the decision in the Metal Box Company's case : (1969)ILLJ785SC , and the Supreme Court pointed out that in the Metal Box Company's case the decision was under the Bonus Act and the Standard Mills' case was distinguished and there was no conflict between the two decisions. Now the question as to whether for the purposes of the I.T. Act, 1961, the discounted value of the liability to pay gratuity can be properly taken into account as a trading liability in a commercial accounting was considered at length in a Division Bench decision of this court in Tata Iron & Steel Co. Ltd. v. D. V. Bapat, ITO : [1975]101ITR292(Bom) . The three earlier cases of the Supreme court referred to above were considered in extenso. In addition to these three decisions, this court also considered the decision of the Allahabad High Court in Madho Mahesh Sugar Mills (P.) Ltd. v. CIT [1973] 92 ITR 503, the decision of the Delhi High Court in Delhi Flour Mills Co. Ltd. v. CIT : [1974]95ITR151(Delhi) and the decision of this court in India United Mills Ltd. v. CIT : [1975]98ITR426(Bom) and on a review of these decisions, it was observed by the Division Bench in Tata Iron & Steel Co. Ltd.'s case : [1975]101ITR292(Bom) , that permissible deductions are not restricted to those indicated in ss. 30 to 37 of the I.T. Act, 1961, and the amount representing gratuity liability, if scientifically estimated, was not a provision for a contingent liability but must be properly regarded as a provision for a present liability which is allowable in the case of an assessee which keeps its accounts on the mercantile system. The Divisions Bench followed the view taken in the Indian United Mills' case : [1975]98ITR426(Bom) . In that case, the industrial court had by an award directed the payment of gratuity to workmen of the assessee-company in accordance with the scale provided therein, the amount of gratuity being dependent on the wages at that time and the number of years of service put in by the workmen. In order to implement this the assessee-company set apart during the year 1951, an amount of Rs. 21,77,359 for a gratuity fund made up of Rs. 19,11,658 on account of initial contribution and Rs. 2,65,701 on account of annual contribution for the year 1951. The initial contribution was calculated on the basis of gratuity to which existing employees were entitled up to the beginning of 1951, by reference to the number of years put in by each employee while the annual contribution was calculated by reference to the additional liability which arose by reason of the service put in by each employee during the year of account. A trust was created by the company to hold the funds contributed to the gratuity fund and made payments to the trustees of the fund during the accounting year 1951-52, and the question was whether the assessee-company was entitled to a deduction of the initial contribution of Rs. 19,11,658 and the yearly contribution to the gratuity fund under s. 10 of the Indian I.T. Act, 1922, for the assessment year 1952-53 or 1953-54. The Division Bench held that in order to ascertain the quantum of liability as on the date the order came into effect, the past services of the employees had also to be taken into account and every businessman would make provisions every year for his liability under the award. It was pointed out that though no part of the gratuity might have been payable by the assessee in any of the earlier years, the past services of the employees had to be taken into account to arrive at the quantum of the liability which became payable under the award and the liability for payment of such gratuity ascertained by actuarial calculations, in which all contingencies are taken into consideration, is a liability in praesenti and is capable of ascertainment and, therefore, the amount set apart was a permissible expenditure in the assessment year concerned. The Divisions Bench observed that under the mercantile system of accounting, an expenditure is admissible not when it is actually paid but when the liability for the expenditure is incurred and it is legitimate in such a scheme of gratuity of estimate the liability by actuarial valuation and deduct such estimated liability in the profit and loss account while working out the net profits. The Division Bench further pointed out that while working out the net profits a trader can also provide for his liability to pay a certain sum for every year of service which he receives from his employees and that this can be done if such liability is properly ascertainable and it is possible to arrive at a proper discounted present value. In so arriving at this conclusion, reliance was placed by the Division Bench on the following observations in the Metal Box Company's case : (1969)ILLJ785SC .

'The question that concerns us is whether, while working out the net profits, a trader can provide from his gross receipts his liability to pay a certain sum for every additional year of service which he receives from his employees. This, in our view, he can do, if such liability is properly ascertainable and it is possible to arrive at a proper discounted present value. Even if the liability is a contingent liability, provided its discounted present value is ascertainable, it can be taken into account. Contingent liabilities discounted and valued as necessary can be taken into account as trading expenses if they are sufficiently certain to be capable of valuation and if profits cannot be properly estimated without taking them into account. Contingent rights, if capable of valuation, can similarly be taken into account as trading receipts where it is necessary to do so in order to ascertain the true profits.'

15. We have referred at length to this decision because it is vehemently urged before us that a liability in respect of gratuity has always been considered as a liability in praesenti and, therefore, according to the learned counsel, not only was there a liability for payment of gratuity in respect of each year of account but that even in the year of account 1959 there was a liability and according to the learned counsel it has been held that such a liability could be treated as a trading liability for the purposes of ascertaining true profits. Now, it is clear that the question which we are dealing with is not whether for the purpose of ascertaining the correct quantum of trading profits the present discounted value of the contingent liability for gratuity should be treated as a liability in praesenti. All the cases to which a reference has been made except the Standard Mills' case : [1967]63ITR470(SC) , with which we are concerned deal with the limited question as to whether in a commercial system of accounting in order to find out the true picture of the trading profits of the year, allowance should be made for the amount determined by actuarial valuation in respect of the liability to pay gratuity to the employees who may retire from time to time. the principle on which these decisions are based is that in a commercial system of accounting once a liability has accrued that must be treated as a trading liability and, secondly, that profits correct cannot be determinate in a given case unless there is a correct picture of the trading liability. The foundation of most of the cases which hold that it is permissible in the commercial system of accounting to make a provision in the trading (account for the) liability in respect of the gratuity payment payable in future if it is correctly and scientifically estimated is the decision of the House of Lords in Southern Railway of Peru Ltd. v. Owen (Inspector of Taxes) [1957] 32 ITR 737. In that decision, Lord MacDermott observed as follows :

'My Lords, as a general proposition, it is, I think, right to say that in computing his taxable profits for a particular year, a trader, who is under a definite obligation to pay his employees for their services in that year an immediate payment and also a future payment in some subsequent year, may properly deduct, not only the immediate payment, but the present value of the future payment, provided such present value can be satisfactorily determined or fairly estimated. Apart from special circumstances, such a procedure, if practicable, is justified because it brings the true costs of trading in the particular year into account of that year and thus promotes the ascertainment of the 'annual profits or gains arising or accruing from' the trade.'

16. It may, however, be pointed out that in that case though it was held that the company was entitled to charge against each year's receipts the cost of making a provision for the retirement payments which would ultimately be payable as it had the benefit of the employee's services during that year, provided the present value of the future payments could be fairly estimated, since it was found that in calculating the amount which the company claimed to deduct in each year the company had ignored the factor of discount, the claim for deduction was rejected. Now merely because for the purposes of commercial accounting the discounted value of the liability to pay gratuity is deductible for working out the net profits the payment made by the assessee-company to the transferee-company cannot be said to amount to a payment of a gratuity. The question with which we are really concerned is whether as a result of the notice of termination, issued by the assessee, there was any liability which had accrued against the assessee-company to pay any gratuity and if any liability had so accrued, did it stand discharged by payment of any amount to the employees The answer to the question has to be in the negative because by virtue of the employees being taken over with the continuity of employment by the transferee-company no claim could have been made by the employees against the assessee-company on the day on which their services with the assessee-company stood terminated. The employees had voluntarily accepted the new employment with the advantage of continuity of employment with the result that they did not have any cause of action for a claim for gratuity against the assessee-company.

17. The learned counsel for the Revenue has placed reliance on a decision of the Supreme Court and two decisions of the Madras High Court in support of the contention that where gratuity becomes payable on a transfer of business, the liability arises from the transfer and any payment made to discharge such a liability cannot be said to be expenditure laid out or expended wholly and exclusively for the purposes of the business. This decision of the Supreme Court in CIT v. Gemini Cashew Sales Corporation : [1967]65ITR643(SC) , on which reliance is place on behalf of the Revenue. That was a case in which a partnership was dissolved on the death of one of the partners and the business was taken over by the other partner on his own account. The assessee had claimed a deduction in respect of an amount which was taken into account under the head 'Gratuity payable to workers of the business' in setting the accounts of the firm till 24th August, 1957, with effect from which date the partnership stood dissolved by the death of the partner. Though the claim was rejected both by the ITO and the AAC, the Appellate Tribunal took view that since there was a dissolution of the partnership and the undertaking was transferred to one of the partners, the workmen had become entitled to retrenchment compensation, which the firm was liable to pay and thus a sum of Rs. 1,41,506 was allowed as deductible on that account in the computation of income in the assessment year 1958-59. The matter was taken to the Kerala High Court by way of reference and the Kerala High Court took the view that in the determination of taxable profits of the firm till its dissolution, considerations about the liability to pay retrenchment compensation devolving upon the succeeding partner as the assignee of the business for valuable consideration were irrelevant, and since the firm was maintaining accounts on mercantile system, the firm could claim as a permissible outgoing the amount for which liability was incurred though no actual payment was made to the workmen. The Commissioner appealed against the order of the High Court. While pointing out that under s. 10(2)(xv) of the Indian I.T. Act, 1922, in the computation of taxable profits 'any expenditure laid out or expended wholly and exclusively for the purpose of such business, profession or vocation' was a permissible allowance, it was observed that to be a permissible allowance the expenditure must be for the purpose of carrying on the business and the Supreme Court held that a liability to pay retrenchment compensation arose under s. 25FF of the Industrial Disputes Act, 1947, when there is a transfer of the ownership or management of an undertaking resulting in retrenchment of the workmen. It was observed that the liability did not arise before the transfer of the undertaking. It was pointed out that until there was a transfer of the undertaking resulting in determination of employment, the workmen did not become entitled to retrenchment compensation and that so long as the ownership continues with the employer the right of the workmen to claim compensation remains contingent. Then it was observed as follows (p. 647) :

'The obligation to pay compensation becomes definite only when there is retrenchment by the employer, or when the ownership or management of the undertaking is, except in the cases contemplated by the proviso, transferred to a new employer, and not till then. The right, therefore, arises from determination of employment, or from transfer of the undertaking; it has no existence before these events take place.'

18. Thus, it was held that during the entire period that the business was continued there was no liability to pay retrenchment compensation because it arose on the transfer of the business and was, therefore, not of a revenue nature. While disallowing the claim and reversing the decision of the High Court, the Supreme Court observed as follows (p. 650) :

'A deduction which is proper and necessary for ascertaining the balance of profits and gains of the business is undoubtedly properly allowable, but where a liability to make a payment arises not in the course of the business, not for the purpose of carrying on the business, but springs from the transfer of the business, it is not, in our judgment, a properly debitable item in its profit and loss account as a revenue outgoing. The claim of the firm to treat it as an item in the determination of the profits of the firm under section 10(2) of the Income-tax Act, cannot, therefore, be sustained.'

19. The Supreme Court has thus taken the view that a liability which arises because of the transfer of the business is not a properly debitable item in the profit and loss account as a revenue expenditure. This decision would undoubtedly support the case of the Revenue. We have, however, earlier pointed out that since the employees had been taken over by the transferee-company with the benefit of continuity of employment there was in fact no liability to pay any gratuity amount to the employees on the transfer of business by the assessee-company. Now so far as the Madras High Court decisions are concerned, we my point out that there are three decisions of the Madras High Court, two of which are relied upon on behalf of the Revenue and one on behalf of the assessee.

20. We may refer to the decision of the Madras High Court in Stanes Motors (South India) Ltd. v. CIT : [1975]100ITR341(Mad) . That was a case in which during the assessment year 1963-64, a new company was formed to take over the retreading division of the assessee-company. The new subsidiary company took over all the employees of the assessee-company working in the said division. At the time of formation of the new company gratuity payable to the transferred employees was calculated on the basis of the rules of the assessee-company to be Rs. 56,275. This amount was transferred to the new company from the pension and gratuity reserves of the assessee-company. The claim of the assessee-company that the amount was paid in discharge of its liability for gratuity to the employees transferred to the new company and hence, an allowable deduction under s. 37 of the I.T. Act, 1961, was negatived by both the ITO and the AAC. The Tribunal, however, allowed the claim on the view that the amount had been paid in discharge of the assessee's obligation to its workmen and payment to the new company on behalf of the employees. On a reference, the High Court held that the assessee was not under a definite and present obligation to pay any gratuity in respect of the transferred employees and the payment was not made to the new company on behalf of the employees nor did the new company receive it on their behalf as the employees were taken in the new company on the same terms and conditions. It is also held that no obligation in respect of the employees arose on transfer because the new company took over the employees without any break in service and, hence, the payment by the assessee was not in discharge on any obligation. It is also further held that the liability did not arise in the course of the business or for the purpose of carrying it on but sprang from the transfer of the business; and the amount, therefore, cannot be said to have been expended wholly and exclusively for purposes of business and, hence, the claim for deduction under s. 37 is not admissible. We are inclined to agree with the view taken by the Madras High Court.

21. We may now deal with the other decisions of the Madras High Court to which we may refer, two of them being CIT v. Salem Bank Ltd. reported in : [1979]120ITR224(Mad) and CIT v. Pathinen Grama Arya Vysya Bank Ltd. [1977] 109 ITR 789. In CIT v. Pathinen Grama Arya Vysya Bank Ltd. [1977] 109 ITR 789, the banking business of the assessee-company was transferred to Karur Vysya Bank Ltd. under a series of agreements entered into between them. One of the agreements to which the staff entered association the assessee-bank was also a party, provided for the transferee-bank employing all the employees of the transferor-bank who had not completed the age of 60 years. The employees of the transferor were entitled to gratuity on retirement and in respect of this liability the assessee transferred a sum of Rs. 30,790 to the transferee-bank on account of gratuity payable to the employees who were taken over by the said bank. The claim for deduction of this amount under s. 37 of the I.T. Act was rejected both by the ITO and the AAC. The Tribunal, however, held that inasmuch as the assessee had obtained acquittance from each of its employees for the amount of gratuity to the extent of Rs. 18,931 and did not do so for the balance, the assessee would be entitled to a deduction of this sum of Rs. 18,931 and not of the balance. The High Court, on a reference held that though it may be inferred that the transferor-bank had paid the amounts in question to the employees, who, in turn, had deposited the amounts with the transferee-bank in consideration of the transferee-bank taking them over and treating them to be in continuous service with the benefit of their service in the transferor-bank, the expenditure was not incurred during the course of carrying on the business or for the purpose of carrying on the business but at the time of transfer of the business. The decisions in Gemini Cashew Sales Corporation : [1967]65ITR643(SC) and Stanes Motors' case [1975] 101 ITR 341 were followed and the amount has been held not to be deductible. The learned judges have held that assuming that on transfer of business the assessee compelled the employees to retire from business and gratuity was payable to them, the obligation to pay the gratuity arose only by virtue of transfer of business and as a matter of fact, the transfer of business and the obligation to payment of gratuity were contemporaneous and simultaneous and, therefore, the payment of gratuity cannot be said to be an item of expenditure incurred in the course of carrying on the business or for the purpose of carrying on the business. It is not clear from the decision as to whether the assessee-bank had issued notices terminating the employment as was done in the instant case, and it seems to have been assumed that the liability to pay gratuity had already arisen. In CIT v. Salem Bank Ltd. : [1979]120ITR224(Mad) , the banking business of the assessee-bank was transferred to the Indian Bank Ltd. under an agreement and by virtue of an arrangement between the two banks and the employees' unions, it was agreed that in respect of 27 members of the staff of the assessee-bank who will not be in a position to put in a service of 10 years in the transferee-bank to enable them to be eligible for payment of gratuity, the assessee-bank will pay the gratuity. The gratuity amount payable to these persons was paid by the assessee-bank to the transferee-bank to be kept in deposit so that payment may be made to the employees as and when the occasion to pay gratuity arose. The assessee-bank was ultimately would up by a resolution dated 3rd August 1968. In respect of the claim for deduction of the amount paid by way of gratuity, the Madras High Court took the view that the 27 persons for whose benefit the amount was paid were taken over by the transferee-bank and they continued in service with the transferee-bank and the liability to pay gratuity to them had not arisen in the course of the accounting year and, therefore, the amount in question was not allowable as a deduction under s. 37(1) of the I.T. Act, 1961. However, in the view which we have taken with regard to the nature of payment made by the assessee-company to the transferee-company, we need not go into the question as to whether the liability, if any, can be said to arise in the course of the accounting year.

22. The decision of the Madras High Court relied upon by the learned counsel for the assessee is in CIT v. Sri Venkateswara Bank Ltd. : [1979]120ITR207(Mad) . The facts of the case, however, show that though a substantial part of the business of the assessee-bank was transferred to another bank, the transferee-bank did not undertake any liability arising out of the past services rendered by the employees of the assessee-bank and any such liability had to be discharged by the assessee-bank itself. The assessee-bank, therefore, paid a total amount of Rs. 26,032 to its employees as and by way of gratuity. The claim for deduction of this amount was allowed by the Tribunal and the High Court on a reference took the view that only a part of the assessee's business had been closed down and the assessee continued to carry on the remaining part of the business and the payment made in the course of the business as gratuity cannot be treated as terminal payment on the closure of the business so as to be disallowed. The payment was also held not liable to be treated as one made at the time of the transfer of the undertaking of the assessee. The distinguishing feature of this case is that the business of the assessee-bank had continued, the payment was not held to be a terminal payment on the closure of the business or the payment made at the time of the transfer of the undertaking. The transferee-bank had not undertaken liability to pay the employees for the past services of the employees with the assessee-bank, and, therefore, there was actual payment of the gratuity to all the employees for every completed year of service. This decision in Sri Venkateswara Bank's case : [1979]120ITR207(Mad) has been noticed by the same High Court in the decision in the Salem Bank's case : [1979]120ITR224(Mad) and it has been distinguished on the ground that there was no transfer of the entire business and that there was actual expenditure by way of payment of gratuity amounts to the employees which was a legal obligation which the transferor-bank had to discharge. It is difficult to see how the learned counsel for the assessee can substantially further his case on the basis of the Venkateswara Bank's case : [1979]120ITR207(Mad) . That was a case in which, as it has already been pointed out, the actual payments were made by way of gratuity and the transferee-bank had declined to undertake any liability in respect of the past services and, therefore, the payment was in discharge of the liability.

23. The last decision which now needs to be noticed is of a Full Bench of the Kerala High Court, on which reliance has been placed on behalf of the assessee, in CIT v. Standard Furniture Co. Ltd. : [1979]116ITR751(Ker) . The assessee-company in that case had sold its stock and machinery on 7th March, 1970, to another company prior to its liquidation. The purchaser agreed to take over the services of such of the assessee's employees to whom the provisions of the Industrial Disputes Act, 1947, applied. In view of the provisions of the Kerala Industrial Employees' Payment of Gratuity Act, 1970, the assessee had incurred a liability for payment of gratuity to its workers with effect from 18th February, 1970. The gratuity liability was estimated at Rs. 4,44,988 and was agreed to be paid by the purchaser and the amount was adjusted against the purchase price. Thus, only the balance amount alone was paid so that as far as the assessee was concerned, there was accord and satisfaction of the amount of the gratuity. In respect of the assessment year 1971-72, the assessee claimed this sum of Rs. 4,44,988 as business expenditure. Though the deduction was disallowed by the ITO, the order was set aside by the AAC, whose order was confirmed by the Tribunal. On a reference at the instance of the Revenue, the High Court held that the Tribunal had clearly found that the liability for payment, to which the employer was subject under the Gratuity Act, to the workers was an expenditure wholly and exclusively laid out or expended for the purpose of the business and the amount was, therefore, permissible deduction under s. 37(1). In the judgment in that case the Full Bench observed that expenditure made on the ground of commercial expediency and indirectly to facilitate the carrying on of the business may still be expenditure made wholly and exclusively for the purpose of the business and would fall within the ambit of s. 10(2) (xv) of the Indian I.T. Act, 1922. The decision of the Full Bench seems to be based on the decisions of the Allahabad High Court in Madho Mahesh Sugar Mills (P.) Ltd. v. CIT [1973] 92 ITR 503, Delhi High Court in Delhi Flour Mills Co. Ltd. v. CIT : [1974]95ITR151(Delhi) , and the Bombay High Court in India United Mills Ltd. v. CIT [1975] 98 ITR 425, and it was observed that the Kerala High court had taken the same view in High Land Produce Company's case : [1976]102ITR803(Ker) . We have already referred to the limited scope of the concept of the liability in praesenti spelt out in the three decisions referred to by the Kerala High Court. Even the decisions of the Kerala High Court in High Land Produce Company's case : [1976]102ITR803(Ker) , shows that the question dealt with in that decision related to the valuation of contingent liability after ascertaining the present liability which had arisen during the accounting period on actuarial valuation. As already pointed out earlier, the approach adopted in cases where in a commercial system of accounting the actuarial valuation of the contingent liability was held permissible as a deduction in respect of a particular accounting year would not be attracted to a case like the one before us. Besides, it appears that the decision of the Supreme Court in CIT v. Gemini Cashew Sales Corporation : [1967]65ITR643(SC) , which could have had some bearing on the case before the Full Bench does not seem to have been cited before it. We must, therefore, respectfully dissent from the decision of the Kerala High Court, because we have taken the view that no liability having actually arisen against the assessee-company to pay any gratuity to the employees who had already taken employment with the transferee-company by virtue of the benefit that they were given the advantage of continuity of service, the amount paid to M/s. Rallis India could not be considered as a payment of gratuity to the employees and could not, therefore, be held to be an allowable deduction for the purpose of s. 10(2)(xv) of the Indian I.T. Act, 1922.

24. Consequently, the question referred has to be answered in the negative and against the assessee.

25. The assessee to pay the costs of this reference.


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