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Podar Trading Co. (P.) Ltd. Vs. Income-tax Officer - Court Judgment

LegalCrystal Citation
CourtIncome Tax Appellate Tribunal ITAT Mumbai
Decided On
Judge
Reported in(1984)7ITD666(Mum.)
AppellantPodar Trading Co. (P.) Ltd.
Respondentincome-tax Officer
Excerpt:
.....by the note of the auditors.it claimed deductions on the basis of actual payment which has been allowed year after year since 1973-74. it voluntarily stopped providing for the liabilities and making entries to that effect in its books of account. under the circumstances, we hold that the assessee was, in fact, following the cash system of accounting so far as the liability to pay gratuity is concerned since the assessment year 1973-74 onwards.hence, the question of allowing any deduction for that liability again on accrual basis does not arise at all. having delibsrately changed the system of accounting from mercantile to cash basis, insofar as the liability to pay gratuity was concerned, since several years the assessee was not entitled to suddenly change the basis again and claim.....
Judgment:
1. This appeal has been filed by the assessee against the order dated 21-12-1979 of the Commissioner (Appeals). The assessee is a limited company deriving income from business as a dealer in cotton yarn, silk yarn, soapstone powder, etc. Besides, the assessee also deals in shares and earns income by way of Mukadami Commission. The assessment year involved in this appeal is 1976-77 with the year ended 31-3-1976 as the relevant previous year.

2. The only ground taken in this appeal is that the Commissioner (Appeals) erred in not allowing a sum of Rs. 7,541 being the liability for gratuity which accrued for the previous year under consideration, as computed on actuarial basis. Before the ITO, the assessee claimed to deduct a sum of Rs. 27,330 as gratuity liability computed on actuarial basis while computing the income from its business. No provision for the said amount was made in the acounts but the claim for deduction was made in the course of assessment proceedings. The ITO observed that though the AAC has allowed a similar claim of the assessee in the assessment year 1975-76, yet the said decision of the AAC had not been accepted by the department and appeal has been filed before the Tribunal. Hence, he did not agree to deduct the aforesaid sum of Rs. 27,330 while computing the business income and completed the assessment, accordingly.

3. The assessee appealed to the Commissioner (Appeals) and contended that its claim should have been allowed. However, the assessee reduced its claim from Rs. 27,330 made before the ITO to only Rs. 7,541 representing the incremental liability for gratuity relating to the services rendered by the eligible employees of the assessee during the year under consideration. Reliance was placed on several decisions of the Tribunal including the one passed in the case of Empire Dyeing & Mfg. Co. Ltd. [IT Appeal No. 1875 (Bom.) of 1975]. The case of the assessee was that the conditions laid down in Section 40A(7) of the Income-tax Act, 1961 ('the Act') for getting the deduction for the provision for liability applied only to a case where provision for such liability was made in the books of account and so, those conditions did not apply to a case where the assessee makes no such provision in its books of account. As stated earlier, the assessee did not make any provision for liability to pay gratuity in its books of account and, therefore, argued that its claim could not be denied by invoking the provisions of Section 40A(7). The Commissioner (Appeals) did not agree with the above argument of the assessee because the Special Bench of the Tribunal in their order dated 12-6-1979 in [IT Appeal No. 1599 (Mad.) of 1977-78] have held that the conditions prescribed under Section 40A(7) equally apply to the assessees who have made such provisions in the books of account and also those who make no such provision in their accounts but claim the same as a deduction before the ITO. Relying on the aforesaid decision of the Special Bench of the Tribunal, the Commissioner (Appeals) rejected the claim of the assessee.

4. An alternative ground was raised before the Commissioner (Appeals) by the assessee regarding a sum of Rs. 5,710 being actual payment of gratuity made during the year under consideration. This payment was made out of the provisions created in the assessment year 1973-74. The Commissioner (Appeals) found that though the said provision was originally allowed as a deduction in the assessment, it was withdrawn later by an order under Section 154 of the Act dated 17-3-1978. That order has become final and, as a consequence, no amount stood allowed as a deduction on accrual basis regarding the liability for gratuity in the assessment year 1973-74. Hence, the Commissioner (Appeals) allowed the deduction of Rs. 5,710 actually paid during the year under consideration obviously on the basis of actual payment as distinguished from accrual of the liability.

5. In this further appeal before us, the assessee contends that the aforesaid incremental liability of Rs. 7,541 should have been allowed as a deduction as liability accrued even though they were not paid during the year under consideration. The case of the assessee before us is that the provisions of Section 40A(7) is no bar to its claim because it had made no entries in its books of account relating to the aforesaid provision and in the absence of any such entry in the books of account, the provisions of Section 40A(7) do not come into play.

6. Shri B.L. Kabra, the learned representative for the assessee, urged before us that the claim regarding the deduction of the aforesaid sum of Rs. 7,541 deserved to be accepted. He placed a copy of the order dated 17-4-1978 of the Tribunal in the case of this very assessee for the assessment year 1975-76, wherein a similar claim was allowed as a deduction on the same ground as now pleaded before us. He stated that the decision of the Special Bench of the Tribunal referred to by the Commissioner (Appeals) in his order was erroneous and required reconsideration. According to him, Section 40A(7) applies only when a provision is made in the accounts while the Special Bench has extended the meaning of the word 'provision' to include claims for deductions even though no provision in the books of account was made for the same.

He referred to the Schedule to the Companies Act, 1956, as well as the Dictionary of Accounts, Fifth edition, by Eric Cholar for the proposition that a provision, as understood under the Companies Act and principles of accountancy, can be made only by an entry in the books of account and in no other way. Consequently, he argued that if no entry to that effect is made in the books of account, it cannot be said that a provision has been made. Then he referred to the decision in the case of Swadeshi Cotton Mills Co. Ltd. v. ITO [1978] 112 ITR 1038 (All.) for the proposition that even for the assessment year 1973-74, during which Section 40A(7) was already on the statute book, a claim for deduction of gratuity on accrual basis is allowable where no provision for the same was made in the account books, in view of the earlier decision of the same High Court in the case of Madho Mahesh Sugar Mills (P.) Ltd. v. CIT [1973] 92 ITR 503. Next, he referred to the decision in the case of CIT v. Andhra Prabha (P.) Ltd. [1980] 123 ITR 760 (Mad.) and, in particular, to the observations at page 772. He pointed out that the Court in the case of Andhra Prabha (P.) Ltd. (supra) had only stated that the decision in the case of Madho Mahesh Sugar Mills (P.) Ltd. (supra) appeared to be incorrect because of the provisions of Section 40A(7) which became effective from the assessment year 1973-74. His point was that the observations in the case of Andhra Prabha (P.) Ltd. (supra) did not reduce the weight of the decision in the case of Swadeshi Cotton Mills Co. Ltd. (supra). Finally, he urged that the assessee was maintaining the mercantile system of accounting and so its claim for deduction of gratuity on accrual basis is to be considered in the light of the provisions of Sections 36(1)(v), 40A(7) and the residuary clause of Section 37 of the Act. Section 36(1)(v) did not apply to the facts of this case because the assessee had no approved gratuity fund. Section 40A(7) also did not apply because the assessee made no provision in its books of account. Hence, he argued that the claim of the assessee could be considered only under Section 37 and if so done, it was clearly allowable.

7. To a query put by us as to whether the assessee was maintaining the mercantile system of accounting so far as its liability to pay gratuity was concerned, he stated in the affirmative. However, on further enquiry, he stated that in the year under consideration the Commissioner (Appeals) has already allowed a sum of Rs. 5,710 on the basis of actual payment and not on accrual basis. As stated earlier, in the assessment year 1973-74, the liability for gratuity which was originally allowed on accrual basis was withdrawn under Section 154 with the consent of the assessee. In the assessment year 1974-75, a sum of Rs. 2,480 was actually paid and allowed as a deduction. In the assessment year 1975-76, it appears that no payments have been actually made. However, a claim for deducting a liability of Rs. 14,680 was made which was allowed by the Tribunal on the ground that Section 40A(7) did not apply as the assessee made no entries in its books of account regarding the provision of the liability. In the year under consideration, as stated earlier, the liability for gratuity has been allowed on actual payment basis. In the notes on the balance sheet and the profit and loss account for the year ended 31-3-1976, the following comments of the auditors appear : 6. Provision for taxation for the accounting year ended 31st March, 1973, was made on the basis that the provision for gratuity would be allowed as a deduction in the computation of income and the assessment for that year has been completed on that basis. The Finance Act, 1975, has amended the Income-tax Act retrospectively and under this amendment, deduction in respect of provision for gratuity payable to employees on retirement or termination of their employment is conditional upon the company creating an approved gratuity fund before 1st January, 1976. The company has decided not to create such a fund. Accordingly, there is an additional liability for taxation for the year ended 31st March, 1973, estimated at Rs. 39,000 for which no provision has been made.

The point urged by Shri Kabra was that the assessee did not change over to the cash system of accounting so far as the liability to gratuity was concerned in spite of the above facts as explained by him.

8. Shri A.K. Nagpal, the learned representative for the department on the other hand, supported the order of the Commissioner (Appeals). He stated that the Special Bench of the Tribunal referred to above has considered the whole issue exhaustively and has arrived at the conclusion that the conditions laid down in Section 40A(7) should be satisfied before any deduction for the liability for gratuity can be allowed irrespective of the fact as to whether any entry to that effect was or was not made by the assessee in the books of account. He stated that the decision of Andhra Prabha (P.) Ltd. (supra) relied on by the learned representative for the assessee, does not help its case but it actually helps the stand of the revenue. Finally, he stated that the assessee was following the cash system of accounting so far as the liability to pay gratuity was concerned from the assessment year 1973-74 onwards. Consequently, the question of allowing the said liability again on accrual basis did not arise.

9. We have considered the contentions of both the parties as well as the facts on record. The question raised in this appeal is whether the conditions laid down in Section 40A(7) applies to a case where no entries are made in the books of account towards provision for liability to pay gratuity. It is true that in the case of the assessee, the Tribunal has allowed a similar claim in favour of the assessee in the assessment year 1975-76. However, after the Tribunal gave that decision on 17-4-1978, the Special Bench of the Tribunal in the case already referred to earlier, has considered the whole issue from all angles and has arrived at the conclusion that Section 40A(7) equally applies to cases where entries are made in the books of account as well as to cases where no such entries are made. We have carefully gone through the aforesaid decision of the Special Bench of the Tribunal and we are in respectful agreement with the arguments given and the conclusion arrived at therein. We have also considered the arguments of the learned representative for the assessee by which he tried to persuade us that the aforesaid decision of the Special Bench required reconsideration, but we do not find any force in any of those arguments for the reasons given hereinafter.

10. The judgment of the Special Bench of the Tribunal has to be read as a whole in -its proper perspective. If so done, it is clear that the Special Bench referred to two types of deductions, namely, expenses and losses which arise out of voluntary actions of the assessee and those which arose without the volition of the assessee, like statutory obligations. The Special Bench observed that both the types of expenses can be allowed as deduction even though no entries in the books of the assessees are made in respect of them if and only if the accounts are maintained on mercantile basis. Then, the Special Bench referred to the word 'provision' appearing in Section 40A(7) and considering the content in and the purpose for which it was inserted in the Act, it came to the conclusion that its meaning was not confined only to the entries made in the books of account but extended to all claims for deduction of that expense in the course of assessment proceedings. This claim could be made in the return of income in the computation or other documents accompanying the return or otherwise. The Special Bench considered the fact that 'provision' was not allowed in the computation of income. What was allowed in the computation of income is a deduction of an expense or a liability which has accrued and which has to be allowed if the accounts are maintained on the mercantile system. The Special Bench also took into account the reason for introducing this section into the Act, as stated by the Finance Minister while introducing the amendment in the Parliament. The intention was to prevent a mischief which was prevalent at that time. That mischief was that certain assessees got deductions for provisions made for gratuitees even though they still had control over the funds. In other words, the funds which ultimately belonged to the employees for services already rendered were not kept in an approved gratuity fund as envisaged under Section 36(1)(v) and was continued to be used by the employers, as if it still remained their own money. It is to prevent this mischief that Section 40A(7) was introduced into the Act. Hence, the Special Bench of the Tribunal has stressed the fact that under the mercantile system of accounting, it is the liability which has already accrued that gets deducted and not the provision made in the accounts.

The reason is obvious. The test for allowing a deduction is whether the liability has accrued or not. Whether any entry in the books has been made or not is not at all relevant for deciding the deductibility vide the decision in the case of Kedarnath Jute Mfg. Co. Ltd. v. CIT [1971] 82 ITR 363 (SC). The principles applied by the Special Bench of the Tribunal are well settled. If any authority is required in support thereof, we may refer to the decision of the Supreme Court in the case of CIT v. Sodra Devi [1957] 32 ITR 615. The following quotations have been extracted with approval : ...In the latter event the following observations of Lord Lindley, M.R., in Thomson v. Lord Clanmorris [1900] 1 Ch. 718 would be apposite : 'In construing any...statutory enactment, regard must be had not only to the words used, but to the history of the Act and the reasons which led to its being passed. You must look at the mischief which had to be cured as well as at the cure provided' [See also the observations of Goddard, CJ., in R. v. Paddington and St. Marylebone Rent Tribunal [1949] 65 TLR 200, 203.

The position in law has been thus enunciated in the judgment of Das, Ag. CJ. (as he then was) in Bengal Immunity Co. Ltd. v. State of Bihar 'It is a sound rule of construction of a statute firmly established in England as far back as 1584 when Heydon's case [1584] 3 Co. Rep 7a was decided that ... for the sure and true interpretation of all statutes in general (be they penal or beneficial, restrictive or enlarging of the common law) four things are to be discerned and considered :- 2nd. what was the mischief and defect for which the common law did not provide, 3rd. what remedy the Parliament hath resolved and appointed to cure the disease of the Commonwealth, and 4th. the true reason of the remedy ; and then the office of all judges is always to make such construction as shall suppress the mischief and advance the remedy and to suppress subtle inventions and evasions for continuance of the mischief and proprivato commodo and to add force and life to the cure and remedy, according to the true intent of the makers of the Act, pro bono publico. (pp. 621-22) In the case of CIT v. G.R. Karthikeyan [1980] 124 ITR 85, the Madras High Court has observed as follows : ...The meaning of the word takes its colour from the context in which it is used. If the context shows that a particular expression is used in a manner which is not the same as the meaning given in the dictionary, thethe dictionary meaning may have to be discarded and the contextual meaning adopted. The purpose of interpreting a particular provision is to give effect to the intention of the Legislature to the extent manifested by the words. We have to consider the question in the present case in this background. (p.

91) Hence, we do not find any force in the contention of the learned representative for the assessee before us that the decision of the Special Bench of the Tribunal requires reconsideration.

11. We have considered the decision in the case of Andhra Prabha (P.) Ltd. (supra) referred to by the learned representative for the assessee before us. We find the following observations : ...However, we would only take leave to observe that the said decision does not appear to be correct, because the law, as enacted by Section 40A(7), was inserted with retrospective effect from the assessment year 1973-74 and that case was concerned with 1973-74.

The amendment superseded the general principle as regards the liability for gratuity and, therefore, after the 1st of April, 1973, the question of deductibility of a similar claim would have to be found within the four corners of Section 36 and Section 40A... (p.

772) We find that the above observations do not help the assessee's case at all. The case of Andhra Prabha (P.) Ltd. (supra) was one where a provision for gratuity was actually made in the books of account and also it was a case relating to an assessment year in which Section 40A(7) was not in force. However, while considering the issue before them in that case, they also referred to the provisions of Section 40A(7). In that connection, they referred to the decision in the case of Madho Mahesh Sugar Mills (P.) Ltd. (supra). That was a case where the assessee did not make any entry in its books of account for the gratuity liability because at page 506 of that case of Madho Mahesh Sugar Mills (P.) Ltd. (supra), it is stated that the assessee claimed the deduction in the computation of its net income. That case was one relating to an year when Section 40A(7) has already come into force. It is in the background of these facts that the Madras High Court in Andhra Prabha (P.) Ltd.'s case (supra) made the observations quoted above. Thus, the Madras High Court has clearly stated that after Section 40A(7) came into force, deductions for liability to pay gratuity could be allowed only if it came within the four corners of Section 36(1)(v) or Section 40A(7). After the observations quoted above, the Madras High Court has further commented as below : ...This decision of the Allahabad High Court is also inconsistent with the decision of this Court in CIT v. Carborundum Universal Ltd. [1979] 110 ITR 621, wherein we have pointed out that so long as there is a specific provision which regulates a claim, it is that provision that is to be resorted to and not the general principle of computation of profits. Further, recourse cannot be had to a residuary or general provision if the amount is not deductible as a result of non-compliance with a specific or particular provision.

This aspect has not also been examined there. (p. 772) 12. It is clear from the above decision in the case of Andhra Prabha (P.) Ltd. (supra) that the deduction for liability to pay gratuity in an year to which Section 40A(7) applies, cannot be allowed under the residuary clause of Section 37 or on general principle of law even in a case where no entries have been made for the said liabilities in the books of account maintained by the assessee. The deduction can be allowed only if it comes under Section 36(1)(v) or 40A(7). We find that Section 40A(7) has two clauses. Clause (a) enacts a prohibition to the effect that deductions for liability to pay gratuity will not be allowed even though it is called a provision or by any other name unless it comes under the exceptions laid down in Clause (b). Hence, in order to get the deduction for gratuity liability, one has to satisfy the conditions under Section 36(1)(v) by creating an approved gratuity fund or should bring its case within one of the several exceptions enacted in Clause (b) of Section 40A(7). That is the reason why the Madras High Court, in our opinion, stated that the case should come 'within the four corners of Section 36(1)(v) and Section 40A'.

13. In the case before us, assessee has deliberately decided not to create a gratuity fund as is apparent from the note of the auditors reproduced above. This fact evidently means that the assessee did not want to claim the deduction for gratuity on accrual basis by creating an approved gratuity fund envisaged under Section 36(1)(v). Thus, the assessee voluntarily decided not to part with the control of the funds to the trustees of a gratuity fund without which, it cannot be approved under the provisions of Schedule IV to the Act. Nevertheless, before the enactment of Section 40A(7), it could successfully claim the deduction of such liabilities under the residuary clause of Section 37, because of the decision in the case of Kedar-nath Jute Mfg. Co. Ltd. (supra). That was why Section 40A(7) was enacted after which deduction of any such liability on accrual basis was prohibited, excepting the cases enumerated in Clause (b) of Section 40A(7). Admittedly, the case of the assessee does not come under any of those exceptions. Hence, respectfully following the decision in the case of Andhra Prabha (P.) Ltd. (supra), which is quite in accordance with the law laid down by the Special Bench of the Tribunal referred to above, we hold that the claim of the assessee has been rightly rejected.

14. We have considered the contention raised for the assessee that the system of accounting continued to be mercantile even in respect of the liability to pay gratuity. We do not find any force in the same because the facts, as stated earlier, point to the contrary. To repeat, the assessee agreed to the disallowance of the liability on accrual basis in the assessment year 1973-74. It did not create a gratuity fund envisaged under Section 36(1)(v) as stated by the note of the auditors.

It claimed deductions on the basis of actual payment which has been allowed year after year since 1973-74. It voluntarily stopped providing for the liabilities and making entries to that effect in its books of account. Under the circumstances, we hold that the assessee was, in fact, following the cash system of accounting so far as the liability to pay gratuity is concerned since the assessment year 1973-74 onwards.

Hence, the question of allowing any deduction for that liability again on accrual basis does not arise at all. Having delibsrately changed the system of accounting from mercantile to cash basis, insofar as the liability to pay gratuity was concerned, since several years the assessee was not entitled to suddenly change the basis again and claim the deduction on mercantile basis vide the decision in the case of New Victoria Mills Co. Ltd. v. CIT [1966] 61 ITR 395 (All.).

15. Before concluding, we would like to observe that an argument is generally advanced that gratuity liability is allowed as a deduction not because a provision has been made therefor but because it is a liability accrued during the previous year and, if so, Section 40A(7) which prohibits deduction of a provision in certain cases has no application. In our opinion, this argument is equally fallacious. It is not as if liability for gratuity is allowed as a deduction under Section 37 just because the liability has accrued during the previous year. It is allowed as a deduction only because the assessee follows mercantile system of accountancy as distinguished from cash method of accountancy. In the case of an assessee following mercantile system of accountancy, a provision is always made for the liabilities which have accrued during the previous year but it might not have been discharged for some reason or other. In cases where a provision is not made as such, the law presumes that the provision could have been made but by mistake it has not been made so much so that it can be presumed to have been made and it is only then that a liability For gratuity can be allowed as a deduction. Therefore, there is no material difference in the case of an assessee following mercantile system of accountancy with regard to its gratuity liability whether he makes a provision in the books for that liability or forgets or deliberately omits to make such a provision but claims it as a deduction on the basis of accrual of liability. In the circumstances, we have no difficulty in holding that Section 40A(7) prohibits deduction of gratuity liability in all cases except those which are covered by Section 36(1)(v) or Section 40A(7)(b).

16. We may state that the Tribunal has already taken similar decisions to the effect that the Special Bench of the Tribunal in the case referred to above has laid down the correct law, requiring no reconsideration and, therefore, binding on us, in ITA No. 1627 (Bom.) of 1979 and IT Appeal No. 1907 (Bom.) of 1979 to both of which, one of us (the Accountant Member) was a party.

17. For the above reasons, we uphold the order of the Commissioner (Appeals) and dismiss this appeal.


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