1. This is an appeal filed by Sundaram Spinning Mills of Kumarapalayam against the order of the Commissioner (Appeals) for the assessment year 1975-76.
2. The assessee is a public limited company engaged in the manufacture of textiles. The only point in dispute relates to the disallowance of the assessee's claim of Rs. 80,621 representing the assessee's liability for gratuity. The assessee created a gratuity fund for the benefit of its employees by a document dated 25-1-1974 and applied for recognition to the Commissioner on 7-2-1974. The approval was also given on 18-4-1977 with effect from 7-2-1974. For the year ended 31-3-1974, the assessee had ascertained the initial and incremental liability so far at Rs. 5,34,841 and had also made over Rs. 5 lakhs (which was allowed as a deduction) on 31-3-1974 to the trustees of the gratuity fund. The difference of Rs. 3,48,418 is the opening balance as on 1-4-1974. We are concerned with the provision for the year ending 31-3-1975. The relevant account for the year ending 31-3-1975 is as under:Account year ended: 31-3-1975 Assessment year: 1975-76 Rs. Np.
Rs. Np.1-4-1974 By opening balance 34,841.0031-3-1975 To transferred from gratuity expensesaccount page No. 71 18,836.411974-75) 34,841.00 18,836.41account page No. 71 18,558.68By provision charged during the year 1974-75 80,621.00To payment to Sundaram Spg. Mills, gratuitytrust account, for the period 1974-75 50,000.00 The assessee, it may be noticed, made a payment of Rs. 37,395.09 and had made the additional provision towards incremental liability as at the end of the year at Rs. 80,621. Since, the payment of Rs. 37,395 was debited to profit and loss account, it is allowed apparently on payment basis. The dispute relates only to the provision of Rs. 80,621. The assessee made a payment of Rs. 50,000 towards the provision made during the year on 31-3-1975. The ITO, however, did not allow even this amount of Rs. 50,000 on payment basis. He disallowed the entire amount of Rs. 80,621 on the ground that the assessee did not satisfy the conditions under Section 40A(7)(b)(ii)(3) of the Income-tax Act, 1961 ('the Act') requiring 50 per cent of the payment before 1-4-1976 and the balance before 1-4-1977. It is common ground that there was no further payment either on or before 31-3-1976 or on or before 31-3-1977. It was for this reason, the disallowance was made. The first appellate authority confirmed the disallowance. The assessee is, therefore, in second appeal before us.
3. The learned counsel for the assessee claimed that there has been a misunderstanding regarding the provisions of the Act on the part of the authorities. The provision has been made on actuarial basis. There is no dispute on this point. The assessee had also filed a certificate from a qualified actuary in this regard. Though, Section 40A(7)(a) bars the deduction of provision because of the insertion of Section 40A(7) by the Finance Act, 1975, with retrospective effect from 1-4-1973, there are two exceptions. The first exception is available in Sub-clause (i) of Clause (b) of Sub-section (7) of Section 40A which stipulates that any provision made by the assessee for the purpose of payment of a sum by way of any contribution towards an approved gratuity fund will be allowable. According to the learned counsel, Sub-clause (ii) would apply only to such of those cases where a gratuity fund is set up after the enactment of the provision by the Finance Act, 1975, and the payment of 50 per cent is made before 31-3-1976 and the balance on or before 31-3-1977. The belief that all assessees must satisfy the conditions in Sub-clause (ii) in respect of the assessment years 1973-74 to 1976-77 overlooks the fact that Sub-clause (ii) was meant to cover cases of persons who would be hit by the retrospective amendment and help them out if they create a gratuity fund even after the enactment. Sub-clause (i) is the standing provision which is available for all assessments from the assessment year 1973-74 where there is a pre-existing gratuity fund. In the assessee's case the gratuity fund was created on 25-1-1974 and even recognised with effect from 7-2-1974. The assessee's accounting year ended on 31-3-1975. The assessee did not wait for the retrospective amendment for creation of the gratuity fund. The law is satisfied if a provision is made towards an approved gratuity fund, i.e., where an approved gratuity fund is in existence as at the end of the accounting year. It also stands to reason because the authorities can withdraw recognition if a provision made towards gratuity fund is not made good by payment within reasonable time. In fact the assessee has made 50 per cent in the same year and the balance later though not before 31-3-1977, the date which the department considers as the dead-line. He claimed that there is no such dead-line for those assessees who had already a pre-existing gratuity fund on the date of provision. This, in short, was the gist of the arguments advanced by the learned counsel for the assessee. It was alternatively argued that at least the payment of Rs. 50,000 should have been allowed by the authorities under Section 36(1)(v) of the Act on the payment basis.
4. The learned departmental representative, on the other hand, relied upon the orders of the authorities below. He claimed that Sub-clause (ii) of Clause (b) of Sub-section (7) of Section 40A applied to all cases of all the assessees for the assessment years 1973-74 to 1976-77.
A plain reading of the Act, he contended, would point out only to this inference. Sub-clause (i), according to the learned departmental representative, can have no application. Once it is conceded that Sub-clause (ii) can alone apply, he contended that there could be no objection to the disallowance as it is common ground that the second instalment payable before 31-3-1977 had not been paid. Since it is not paid, the question of allowance of even Rs. 50,000, according to him, would not arise. Though he admitted that his stand regarding the alternative claims was a technical one, he claimed that the disallowance is a technical one and that the assessee has to satisfy the requirements of law in this regard.
5. We have carefully considered the records as well as the arguments.
The assessee had paid an amount of Rs. 50,000 towards an approved gratuity fund on 31-3-1975. The assessee was entitled to the claim under Section 36(1)(v). There was absolutely no reason for disallowing this amount, whatever might have been the misgivings of the revenue in respect of Rs. 80,621 provided in the accounts towards gratuity.
However, we are also of the view that there was no case for allowance of Rs. 80,621 itself. It must be remembered that the law prior to the retrospective amendment by the Finance Act, 1975, with effect from 1-4-1973 was that a provision made on an actuarial or scientific basis towards gratuity by an assessee who keeps accounts on mercantile basis was allowable as a deduction following the rationale of the decision of the House of Lords in Southern Railway of Peru Ltd. v. Owen (Inspector of Taxes)  32 ITR 737, approved by the Supreme Court in Metal Box Co. of India Ltd. v. Their Workmen  73 ITR 53. In fact it was the departmental practice also. However, a provision made without setting apart the funds for the purpose, it was decided, cannot be allowed.
Only provision in cases where there is already a pre-existing approved gratuity fund was considered allowable. This is the principle embodied in Sub-clause (i) of Clause (b) of Sub-section (7) of Section 40A.Since, however, this provision was brought into effect retrospectively by the Finance Act, 1975, with effect from 1-4-1973, it was decided that an opportunity should be given to those employers who had already made provisions to create a gratuity fund before 1-4-1976 and make payments to the extent of 50 per cent before 1-4-1976 and the balance before 1-4-1977. This is embodied in Sub-clause (ii) of Clause (b) of Sub-section (7) of Section 40A. The authorities are not right in using the second provision meant for employers who had not hitherto created a gratuity fund for denying a rightful exemption to employers like the assessee who already had pre-existing fund. As observed by the Madras High Court in the case of CIT v. Andhra Prabha (P.) Ltd.  123 ITR 760, Sub-clause (ii) is a transitory provision to soften the hardship that would arise by the retrospective operation given to Section 40A(7) from 1-4-1973. It summarised the effect of Section 40A(7) in the following words: The effect of the statutory provisions may be described as follows: Section 36(1)(v) provides for deduction of any amount paid by way of contribution towards an approved gratuity fund created by the employer. Sub-section (7) of Section 40A prohibits the deduction of a provision for gratuity. But the prohibition does not extend to the following cases: (b) provision for payment of gratuity for which a liability has arisen during the year.
There is a transitory provision enacted in Clause (b)(ii) of Section 40A(7) to soften the hardship that would arise by the retrospective operation given to Section 40A(7) from 1st April, 1973, while it was actually enacted in 1975 It must be pointed out that there are no qualifying words in Clause (b) which would justify the inference that Sub-clause (i) of Clause (b) would apply to all the assessees for the assessment year 1973-74 to the assessment year 1976-77. Where an assessee satisfies either Section 40A(7)(b)(i) or Section 36(1)(v), one has no need to look into Section 40A(7)(b)(ii). Hence, in this case the assessee will be entitled to the full allowance of Rs. 80,621 on the basis of the provision made towards gratuity in view of the preexisting fund, though it had paid only Rs. 50,000 thereof before 31-3-1975 and the balance was paid on 8-12-1977 as against the imaginary dead-line of 31-3-1977 set by the revenue. Our decision also accords with the view of the Special Bench, Madras Bench 'C, in the case of ITO v. Sri Krishna Tiles & Potteries (Madras) (P.) Ltd.  1 SOT 305 though the issue in that case related to the question of incremental vis-a-vis initial liability. In the said decision it was pointed out that Rule 2 of part C of Schedule IV of the Act enables the Commissioner to withdraw the approval already granted to a fund when such withdrawal is warranted by circumstances and it stands to reason that the non-payment of the amount provided in the accounts within a reasonable time should be such a circumstance. We are pointing this out as it gives a clue for the intention behind the provision which allows a mere provision towards a pre-existing gratuity fund. In any view of the matter, the assessee is entitled to the deduction. Under the circumstances the appeal is allowed. Relief due Rs. 80,621.