1. In this reference at the instance of the Commissioner of Income-tax, Bombay-City-II, Bombay, the following two question have been referred to us for our opinion :
'(1) Whether, on the facts and in the circumstances of the case, the Tribunal was justified in holding that the sums of Rs. 98,730 for the assessment year 1964-65, Rs. 1,10,000 for the assessment year 1965-66 and Rs. 81,000 for the assessment year 1966-67, representing provision for gratuity were includible in computing the capital of the assessee-company under rule 1 of Schedule II of the Companies (Profits) Surtax Act, 1964, for the purpose of surtax
(2) Whether, on the facts and in the circumstances of the case, the Tribunal was justified in holding that the sums of Rs. 3,20,000 for the assessment year 1964-65, Rs. 3,48,943 for the assessment year 1965-66, and Rs. 4,62,609 for the assessment year 1966-67, representing dividend reserves were includible in the computation of the capital of the assessee-company under rule 1 of Schedule II of the Companies (Profits) Surtax Act, 1964, for the purpose of surtax ?'
2. The first question relates to the assessment years 1964-65, 1965-66 and 1966-67, the previous accounting years in respect whereof were calendar years ended December 31, 1963, December 31, 1964, and December 31, 1965, respectively; consequently the material date being the first day of the previous accounting period for the purpose of capital computation under the Companies (Profits) Surtax Act, 1964, would be January 1, 1963, January 1, 1964, and January 1, 1965, respectively. For the relevant assessment years 1964-65, 1965-66 and 1966-67 there were three amounts standing to the credit of gratuity reserve in the company's books, the amounts being Rs. 98,730, Rs. 1,10,000 and Rs. 81,000, respectively. In surtax assessment the assessee-company included in the computation of its capita for these three assessment years the said three amounts. Admittedly, these amounts had not been allowed as a deduction under the Income-tax Act, 1961. The Income-tax Officer while computing the capital of the assessee-company under the Companies (Profits) Surtax Act, 1964, did not include these amounts in the capital computation as, according to him, these amounts were meant for specific purposes. In appeals before the Appellate Assistant Commissioner the assessee-company pressed its claim for including these amounts in the capital computation, but the Appellate Assistant Commissioner confirmed the orders of the Income-tax Officer. When the matter was carried by the assessee-company in second appeals to the Appellate Tribunal, the Tribunal followed its own decision in the case of M/s. Voltas Ltd., in which, after referring to the Supreme Court decision in Metal Box Co.'s case : (1969)ILLJ785SC , it had allowed inclusion of amounts set apart for gratuity reserve in the capital commutation. It, accordingly, held that these three amounts which had been set apart and appropriated towards gratuity reserve were includible in the capital computation. At the instance of the Commissioner of Income-tax, therefore, the first question mentioned above has been referred to us for our opinion.
3. For the purpose of computing the capital base of the assessee-company in the instant case the same will have to be done in accordance with the rules which have been framed under the Second Schedule to the Companies (Profits) Surtax Act, 1964, and under rule 1 it has been provided that the capital of a company shall be the aggregate of the amounts, as the first day of the previous year relevant to the assessment year, of (i) its paid-up share capital; (ii) its reserves, if any, created under the proviso (b) to clause (vib) of sub-section (2) of section 10 of the Indian Income-tax Act, 1922, or under sub-section (3) of section 34 of the Income-tax Act, 1961; (iii) its other reserves as reduced by the amounts credited to such reserves as have been allowed as a deduction in computing the income of the company for the purpose of the Indian Income-tax Act, 1922, or the Income-tax Act, 1961, Two condition are required to the fulfilled before any item could be included in the aggregate amount which go to make up the capital base of the assessee-company : (i) the item must be a reserve falling within the expression 'its other reserves' occurring in rule 1(iii); and (ii) if any amounts credited to such reserves have been allowed as a deduction in computing the income of the company for the purposes of the Indian Income-tax Act, 1922, or the Income-tax Act, 1961, the same would have to be capital computation. Admittedly, in the instant case, none of the three amounts for the relevant years have been allowed as a deduction while computing the assessee-company's income of that purpose of the Income-tax Act, 1961. The only question which requires our consideration is whether these amounts which stand to the credit of gratuity reserve could be regarded as reserves falling within the concept of 'reserve' under rule 1(iii) of the Second Schedule to the Companies (Profits) Surtax Act, 1964. Certain undisputed facts with regard to these amounts standing to the credit of gratuity reserve may be stated. In the first place, it was not disputed before us that there was no approved gratuity scheme framed as such be the assessee-company until such appropriation to gratuity reserve had been made; secondly, it was not disputed before us that while appropriating the amounts to gratuity reserve ad hoc amounts were appropriated or transferred to that reserve without undertaking any actuarial valuation. In other words, no attempt was made to estimate the person liability that would arise as a result of either retirement, death or superannuation or anything which may require the company to undertake a recourse to gratuity reserve. In view of these facts, were not disputed, it seems to us quite clear that these appropriations which were made to the gratuity reserve will have to be regarded as reserve and not provision, for these appropriations were not intended to meet a known or existing liability.
4. In Metal Box Co.'s case : (1969)ILLJ785SC the Supreme Court was concerned with the nature of liability under the scheme of gratuity in connection with the payment of Bonus Act, 1965. The relevant portion in the head-note in that case runs thu :
'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. An estimated liability under a scheme of gratuity, if properly ascertainable and its present value is discounted, is deduction from the gross receipts while purporting the profit and loss account. This is recognised in treat circles and there is nothing in the Bonus Act which prohibits and such a practice. Such a provision provides for a known liability of which the amount can be determined with substantial accuracy. It cannot, therefore, be termed a 'reserve'. Therefore, the estimated liability for the year on account of a scheme of gratuity should be allowed to be deducted from the gross profits. The allowance is not restricted to the actual payment of gratuity during the year.'
'Two question, therefore, arise : (1) whether is it 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) i its is, whether such appropriation amounts to a reserve or a provision. If it is a reserve, obviously the amount has to be added back while computing the gross profits. But, it that event, the company would be entitled to interest thereon at 6 per cent. per annum under item 1(iii) of the Third Schedule to the Act. In the case of an assessee maintaining his accounts on mercantile system, a liability already occurred, though to be discharged at a future date, would be a proper deduction while working out the profits an gains of his business, regard being had to the accepted principles of commercial practice and accountancy. It is not as if such deduction is permissible only in case of amounts actually expended or paid. Just as receipts, though not actual receipts but accrued due would be taken into account while working our the profits and gains of the business.'
5. Again, at page 64 of the report, this is what Supreme Court has observe :
'The question that concerns us is whether, while working out the net profits, a trader an 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 i 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.'
6. From the aforesaid observations the principal which is deducible is, though ordinarily appropriations to gratuity reserve are to be regarded as contingent liabilities, if on actuarial basis the estimated present liability could be ascertained properly, then, such ascertained estimated present liability could be allowed as a deduction while computing the profits of a business. On the hand, if appropriations have been made to gratuity reserve without undertaking any actuarial liability or discounting the present value, then, obviously the appropriations cannot be regarded as a provision made by way of providing for any knows or existing liability. In the instant case, as we have observed earlier, there is no dispute before us that there was neither the scheme of gratuity framed and got approved by the assessee-company under which the amounts were set apart towards gratuity reserve nor was scientific or actuarial valuation undertaken by the assessee-company. The three amounts which stood credited to the gratuity reverse, therefore, as on the material date, being the first day of the previous year relevant to the assessment years will have to be regarded as amounts having been set apart not designed to meet any known or existing liability and as such will have to be regarded as reserve.
7. We may point out that in a later decision in the case of Workmen of William Jacks and Co. Ltd. v. Management of William Jacks and Co. Ltd. : (1971)ILLJ503SC , the Supreme Court has, after referring to the distinction pointed out in Metal Box Co.'s case : (1969)ILLJ785SC , between the two concepts 'provision' and 'reserve', observed at page 1825 of the report as follow :
'The provision for gratuity, furlough, salary, passage, service and commission in the present case was all made in respect of existing and known liabilities, though, in some cases, the amount could not be ascertained with accuracy. It was not a case where it was and anticipated loss or anticipated expenditure which would arise in future. Such provision is, therefore, not a reserve at all and cannot be added back under item 2(c) of the Second Schedule.'
8. In that case also the court was concerned with the question as to whether particular provision made for gratuity, furlough, salary, etc., was a reserve on a provision for the purpose of Schedule II to the Payment of Bonus Act, 1965. In para. 8 of its judgment the Supreme Court has categorically observed that all those items, viz., gratuity, furlough, salary, passage, service, commission, etc., were clearly in respect of liabilities which had already accrued in the years in which the provision was made and where not in respect of anticipated liabilities which might arise in future and, therefore, the court held that the said provisions was not a reserve but a provision.
9. Our attention was invited by Mr. Joshi for the revenue to a decision of the Andhra Pradesh High Court in the case of Vazir Sultan Tobacco Co. Ltd. v. Commissioner of Income-tax : 96ITR248(AP) , where the question that was considered by the court was whether appropriation made for gratuity on retirement on retirement was a 'provision' or 'reserve' and the court had, at page 259 of the report, come to the conclusion that the amount set apart for gratuity was certainly liability known on the date of the balance-sheet, that it was a contractual liability of the company and, therefore, the amount retained for gratuity was a provision and not a reserve.
10. In our view, in view of the principles enunciated by the Supreme Court in the case of Metal Box Co. : (1969)ILLJ785SC and in the case of Workmen of William Jacks and Co. : (1971)ILLJ503SC ; it will not be possible to accept the view taken by the Andhra Pradesh High Court and come to the conclusion that notwithstanding the admitted position in the instant case that the three amounts had been ad hoc set a part and carried to the gratuity reserve without undertaking any actuarial valuation, should be regarded as a provision. In the absence of any actuarial valuation having been undertaken and also in the absence of setting apart the amounts without there being any gratuity scheme having been framed and got approved by the company, the amounts so set apart will have to be regarded as making a provision for contingent liability, the present discounted value where of had not been ascertained. In the circumstances, we are of the will have to be regarded as amounts retained not intended to provide for any known or existing liability and as such these will have to be regarded as reserves.
11. Having regard to the above discussion, our answer to the first question would be in the affirmative and in favour of the assessee.
12. So far as the second question is concerned, the same in covered by our decisions rendered in I. T. References Nos. 49 of 1972 Commissioner of Income-tax v. Bharat Bijlee Ltd. : 107ITR30(Bom) and 316 of 1975 Commissioner of Income-tax v. Marrior (India) Ltd. : 107ITR35(Bom) on 28/29-7-1976 and 29-7-1976, respectively, and that question will have to be answered in the negative and in favour of the department.
13. There will be no order as to costs.