1. This is a reference under Section 66 (1) of the Indian Income-tax Act, 1922, at the instance of the assessee, the Chhaganlal Textile Mills Private Ltd. Bhopal. The question, which the Income-tax Appellate Tribunal has referred to us for decision, is :
' Whether on the facts and in the circumstances of the case, the disallowance of the claims in the sum of Rs. 75,000 and Rs. 1,75,000 for earned leave wages and retrenchment compensation respectively by the Tribunal is justified in law '
2. The material facts are that the assessee is a private limited company engaged in the business of manufacture of textiles at Bhopal. It was incorporated in January 1956. In the assessment year 1957-58 on which the accounting period ended on 28-2-1957, the assessee claimed that in the computation of its profits and gains for the accounting period it was entitled to a deduction of Rs. 75,000 being the amount set apart as a reserve fund in its balance-sheet as on 28th February 1957 for the payments it may have to make to its workers in the next year on account of holiday wages under Section 79 of the Factories Act, 1948. Similarly, it claimed a deduction of Rs. 1,75,000 on account of the compensation it may be required to pay under Section 25F of the Industrial Disputes Act, 1947, to those of its workmen who may he retrenched in the following year.
The Income-tax Officer rejected the claim of the assessee on account Of both the deductions taking the view that the assessee's liability for holiday-wages under the Factories Act, 1948, and for payment of retrenchment compen. sation under the Industrial Disputes Act, 1947, was only a contingent liability and not an actual liability in praesenti and, therefore, the amounts of Rs. 75,000 and Rs. 1,75,000 which the assessee set apart for meeting these contingent liabilities could not be regarded as ' expenditure deductible for income-tax purposes '; and that the 'expenditure deductible for income-tax purposes' was one for meeting a liability actually existing at the time, but (he setting aside of an amount which would become expenditure on the happening of an event was not such a one. This decision of the Income-tax Officer was upheld in appeal by the Appellate Assistant Commissioner, as well as in second appeal by the Tribunal.
3. In our opinion, the Tribunal was right in upholding the decision of the taxing authorities in disallowing the deduction claimed by the assessee. The assessee obviously made the claim under Clause (xv) of Section 10 (2) of the Indian Income-tax Act, 1922. But it is now well settled that under this clause a deduction is not permissible for a contingent liability. Theyreason is that this clause allows deduction only in respect of 'expenditure' and a contingent liability is not 'expenditure' and, therefore, cannot be the subject of deduction even under the mercantile system of accounting; under the mercantile system a debit can bs equated with actual expenditure provided a liability has been incurred (see Indian Molasses Co. (Private) Ltd. v. Commr. of Income-tax West Bengal : 37ITR66(SC) and Senthikumara Nadar and Sons v. Commr. of Income-tax : 32ITR138(Mad) , In the case of Indian Molasses Co. : 37ITR66(SC) , the Supreme Court, after explaining the meaning of the word ' expenditure' as that which is paid out or away and is something which is gone irretrievably, has held that expenditure, which is deductible for income-tax purposes, is one which is towards a liability actually arising at the time, but that the putting aside of money which may become expenditure on the happening of an event is not ' expenditure '.
It has further been held in that case that the income-tax law makes a distinction between an actual liability in praesenti and a liability de futuro which for the time being is only contingent; and that the former is deductible but not the latter. The distinction between a legal liability which is deductible and a liability which is future or contingent and for which no deduction can be made has been pointed out also in Calcutta Co. Ltd. v. Commr. of Income-tax West Bengal : 37ITR1(SC) . In that case, the Supreme Court has quoted with approval the statement contained in paragraph 230, at page 203, of Simon's ' Income-tax ' which is as follows :
' In computing the profits of a trade it is the normal accountancy practice to allow as an expense any sum in respect of liabilities which have accrued over the accounting period, and to make a deduction of such sums from the profits. Following the decision in Peter Merchant Ltd. v. Stadeford (1948) 30 Tax Cas 496 however, it appears that the nature of liabilities which may be deducted on business and accountancy principles does not accord with the nature of liabilities deductible for income-tax purposes. For income-tax purposes it was held that a distinction must be drawn between an actual, i.e., legal, liability, which is deductible, and a liability which is future or contingent and for which no deduction can be made.'
The above passage makes it very clear that if an assessee out of prudence sets aside a part of the profits in one year to meet a contingency then he cannot claim any deduction on account of the money so set apart for the simple reason that the sum set apart does not amount to ' expenditure '.
4. Now, it is clear from an examination of Section 79 of the Factories Act, 1948, that the liability of the assessee for holiday-wages under that provision is a contingent liability. Under Section 79, every worker who has worked for a period of 240 days or more in a factory during a calendar year is allowed during the subsequent calendar year leave with wages for a number of days calculated at the rate specified in Sub-section (1) thereof. If a worker fails to avail himself of the whole of the holidays allowed to him during any period of twelve months, the leave not taken by him is added to the leave to be allowed to him in the succeeding calendar year subject, however, to the limit that the total number of days of leave that can be carried forward to a succeeding year does not exceed thirty in the case of an adult or forty in the case of a child. A worker is paid for the leave period to which be may be entitled only if (i) he takes the leave, or (ii) if he is discharged, or (iii) if being refused leave he quits his employment before the holidays are allowed to him.
Now, it is clear that it is impossible for an employer to know in advance in any one year as to how many of his employees will go on leave next year and at what rate wages would have to be paid to them for the period of leave. The question of payment of wages for leave to a worker would arise only if the worker goes on leave, or if he is discharged, or on being refused leave he quits his employment. Till these circumstances arise, the liability that rests on the employer to pay to a worker wages in accordance with Section 79 for leave period remains a contingent liability which the employer may or may not be called upon to discharge. That being so, any sum set apart by an employer in any year for meeting the contingency of some of his workers going on leave the next year cannot be regarded as a permissible expenditure under Section 10 (2) (xv) of the Indian Income-tax Act, 1922.
5. The view that the liability of the assessee under Section 79 of the Factories Act, 1948, is a contingent liability is fully supported by the decision of the Calcutta High Court in Bengal Enamel Works Ltd. v. Commr. of Income-tax, West Bengal ILR (1955) 2 Cal 13. In that case also, the assessee, which was a company, asked for a deduction of Rs. 6,800 which it had debited to its expenses account; the assessee claimed that this amount was allowable to it because it had incurred a liability for a corresponding amount to the employees on account of holiday-wages which would have to be paid to them sometime in the following year in accordance with Section 49B of the Factories Act, 1934. The Calcutta High Court agreed with the Tribunal that the assessee was not entitled to the deduction claimed both for the reason that no expenditure had been actually incurred and also for the reason that the amount could not be claimed even as an account representing a certain liability. After examining the provisions of Section 49-B of the Factories Act, 1934, the learned Chief Justice of the Calcutta High Court said :
' It should be clear from what I have stated above that such statutory liability for holiday wages as the Factories Act creates is only a contingent liability which may or may not have to be discharged and, secondly the measure of that liability can never be known in advance. It cannot be so known, because it cannot be known in advance how many employees will avail themselves or how many holidays and when and, necessarily, at what rate, holdiay wages would be payable. In these circumstances it is perfectly clear that not only is the amount claimed not allowable as an item of expenditure, because in fact, no expenditure had been incurred and not a pice had gone out of the funds of the company, but also that the amount does not even represent a certain liability which will have to be discharged in any event. It may be that although a particular amount is not actually expended during the currency of a particular accounting year, the assessee will still be entitled to a deduction if a certain liability for its payment has arisen so that it may be said that the expenditure is as good as made. The amount claimed in the present case is certainly not even of that character and, as I have already pointed out, it is not an amount which was actually spent.'
Thus it was held by the Calcutta High Court that the liability under Section 49-B of the Factories Act, 1934, to pay holiday-wages depended on the arising of the circumstances specified therein, and since they might or might not arise, the liability was only a contingent and uncertain liability which might or might not have to be discharged. As there is no material difference between Section 49-B of the Factories Act, 1934 and Section 79 of the Factories Act, 1948, the decision of the Calcutta High Court must be taken as supporting the view that the liability of an employer under Section 79 of the Factories Act, 1948, to pay to his workers holiday-wages is a contingent liability.
6. The deduction of Rs. 1,75,000 claimed by the assessee on account of 'retrechment compensation' is not different in character. It is also a deduction for a contingent liability. The assessee's liability to pay retrenchment compensation to a worker who has been retrenched rests on Section 25F of the Industrial Disputes Act, 1947. That section provides that no workman employed in any industry who has been in continuous service for not less than one year under an employer shall be retrenched until he has been given one month's notice in writing indicating the reasons for retrenchment and the period of notice has expired, or the workman has been paid, in lieu of such notice wages for the period of the notice, and further until the workman has been paid at the time of retrenchment, compensation equivalent to fifteen days' average pay for every completed year of service or any part thereof in excess of six months. Section 25F thus laid down the conditions precedent for the retrenchment of workmen, and if these conditions are not complied with, then the retrenchment becomes illegal and improper.
But Section 25F does not cast on the employer a statutory obligation to retrench a particular number of employees in any particular year. It is for the employer to decide whether at any given moment because of business exigencies or vicissitudes of business it is necessary to retrench any of the workmen employed in the industry. It is plainly impossible for an employer to say in advance the number of employees he will be required to retrench at a subsequent point of lime having regard to the state of business then existing. Much less is it possible for him to evaluate his liability for payment of retrenchment compensation in the event of his being required to retrench some workmen. When, therefore, in any year of account the assessee claims a deduction of a sum which he may be required to pay as retrenchment compensation the next year or sometime later, then the deduction that is claimed is not on account of a liability in praesenti but on account of a liability which may arise in future on the happening of a particular contingency. As pointed out earlier, such a deduction is clearly not permissible under Section 10 (2) (xv) of the Indian Income-tax Act, 1922.
7. Shri Chitale, learned counsel for the assessee, relied on a decision of the House of Lords in Southern Railway of Peru v. Oven, 1957 AC 334: (1957) 32 ITR 737, to support his contention that the possibility of retrenchment being effected in any running business was something which was usual and ordinarily incidental to the carrying on the business, that it was not a remote possibility; and that, therefore, if under Section 25F of the Industrial Disputes Act, 1947, a particular compensation on a particular basis had to be paid to the retrenched staff, then a provision made for payment of the anticipated retrenchment compensation would only amount to making a provision for meeting a liability in praesenti and not a contingent liability. In our opinion, the decision in the case of Southern Railway of Peru 1957 AC 334: (1957) 32 ILR 737 is not in point here. In that case, there was a statutory obligation on an English Company operating in Peru to pay compensation on the termination of services of its employees depending on the length of service subject, however, to certain contingencies where the employee would forfeit the benefits.
The company claimed to deduct an estimated liability for this retirement compensation based on a proportion of the period of service of the employees at the end of the period of account though the employees had not retired and were in service. It was contended by the Crown that no deduction could be made there since there was no liability till the employees retired and that the whole of the compensation was deductible in the year of payment. The House of Lords held that the company was eft-titled to charge each year in respect of its prospective lump-sum liabilities provided such deduction could be fairly estimated or otherwise satisfactorily assessed. The deduction claimed by the assessee was, however, disallowed on the ground that in calculating the amount which it claimed to deduct in each year the assessee had ignored the factor of discount and the estimation made by it was not reasonable.
The decision in the case of Southern Railway of Peru 1957 AC 334 : 1957 32 ITR 737 is distinguishable by the fact that here the assessee is not under any definite obligation in any relevant year to pay to its employees any retrenchment compensation; the liability to pay retrenchment compensation depends on the existence and fulfilment of certain conditions, and that makes the assessee's prospective liability, contingent until the services of any employees arc terminated by way of retrenchment. The principle laid down by the House of Lords in the case of Southern Railway of Peru 1957 AC 334 : 1957 32 ITR 737 is, therefore, not applicable to the present case. The decision that is relevant here, and which fully supports the view we have taken, is the decision of the Madras High Court in Commr. of Income-tax v. Indian Metal and Metallurgical Corporation, Madras : 51ITR240(Mad) . In that case, it has been ruled that the liability of an employer assessee in respect of retrenchment compensation under Section 25F of the Industrial Disputes Act, 1947, is not a liability in praesenti but is only a contingent liability which cannot be taken into account as an accrued liability, even though the assessee has been maintaining his account books on the mercantile system.
8. For the foregoing reasons, our answer to the question referred to us for decision is in the affirmative. The assessee shall pay costs of this reference. Counsel's fee is fixed at Rs. 200.