1. This is a reference on a case stated under section 256(1) of the Income-tax Act, 1961. The assessment years involved are 1964-65 and 1965-66, for which the respective previous years are the previous years ended October 31, 1963 and October 31, 1964, respectively. The only point for consideration in the appeal before the Income-tax Appellate Tribunal was as to whether the 'Retirement Gratuity Reserves' of Rs. 20,91,490 (assessment year 1964-65) and Rs. 20,83,233 (assessment year 1965-66) respectively appearing in the books of the assessee as on the opening day of the relevant previous year was entitled to be included in the capital computation for the purposes of the assessment under rule 1 of the Second Schedule to the Companies (Profits) Surtax Act, 1964. In the relevant balance-sheets of the assessee, the amounts were shown as provision for service gratuity. The amounts were worked out on a certain basis and were not in the nature of lump sum appropriations. It was not disputed before the Tribunal that the gratuity fund was not a separate and distinct fund for which there was a regular scheme by the assessee. The Income-tax Officer treated these amounts as 'provisions' and not as 'reserves'. The Appellate Assistant Commissioner held that the retirement gratuity provisions were 'reserves' and not 'provisions' and were liable to be included in the computation of the capital for the purposes of the aforesaid Companies (Profits) Surtax Act. This conclusion was upheld by the Tribunal. The question referred to us for determination is as follows :
'Whether, on the facts and in the circumstances of the case, the retirement gratuity amounts of Rs. 20,91,490 (assessment year 1964-65) and Rs. 20,83,233 (assessment year 1965-66) were liable to be treated as 'reserve' in terms of rule 1 of the Second Schedule to the Companies (Profits) Surtax Act, 1964 ?'
2. There is nil dispute as to how the question referred to us has to be determined, in view of the decision of the Supreme Court in Vazir Sultan Tobacco Co. Ltd. v. CIT : 132ITR559(SC)
'Ordinarily, an appropriation to gratuity reserve will have to be regarded as a provision made for a contingent liability, for, under a scheme framed by a company, the liability to pay gratuity to its employees on determination of employment arises only when the employment of the employee is determined by death, incapacity, retirement or resignation - an event (cessation of employment) certain to happen in the service career of every employee; moreover, the amount of gratuity payable is usually dependent on the employee's wages at the time of determination of his employment and the number of years of service put in by him and the liability accrues and enhances with the completion of every year of service; but the company can work out on an actuarial valuation its estimated liability (i.e., discounted present value of the liability under the scheme on a scientific basis) and make a provision for such liability not all at once but spread over a number of years. It is clear that if by adopting such scientific method any appropriation is made, such appropriation will constitute a provision representing fairly accurately a known and existing liability for the year in question; if, however, an ad hoc sum is appropriated without resorting to any scientific basis, such appropriation would also be a provision intended to meet a known liability, though a contingent one, for, the expression 'liability' occurring in clause 7(1)(a) of Part III of the Sixth Schedule to the Companies Act includes any expenditure contracted for and arising under a contingent liability; but if the sum so appropriated is shown to be in excess of the sum required to meet the estimated liability (discounted present value on a scientific basis) it is only the excess that will have to be regarded as a reserve under clause (7)(2) of Part III of Schedule VI to the Companies Act, 1956.'
3. It is an undisputed position that in view of this decision of the Supreme Court, the question as referred to us, will have to be answered in the negative end against the assessee, as the entire amounts set out in the said question cannot be treated as reserves in terms of rule 1 of the Second Schedule to the Companies (Profits) Surtax Act, 1964. It is, however, equally clear that parts of these amounts seem to be in the nature of provisions and the balance of the amounts appear to be in the nature of reserves when the matter goes back to the Tribunal, it will be for the Tribunal to ascertain, in the light of the observations of the Supreme Court which we have set out earlier, as to what portions of these amounts are liable to be treated as reserves and what portions thereof are liable to be treated as provisions and to compute the capital of the assessee-company in accordance with the conclusions which the Tribunal reaches. We further clarify that before deciding these questions, an opportunity must be given to the assessee as well as the Department to place such relevant material, as may be necessary, before the Tribunal.
4. Parties to bear and pay their own costs of the reference.