1. The assessee-individual holds shares in certain private limited companies, one of which is Jagdish Oil Industries (P.) Ltd. In working out the value of these shares, the assessee deducted liability in respect of the gratuity payable to employees amounting to Rs. 5,64,528.
This amount was not provided for in the balance sheet. Before the WTO the assessee claimed that even though the gratuity liability was not provided for, it did exist and should be taken into account while computing the break-up value of the shares. On the ground that this amount had not been provided in the balance sheet, the WTO did not accept the assessee's case. On appeal, the AAC confirmed the order of the WTO. Thus, the appeal before the Tribunal. The AAC rejected the assessee's claim partly because the claim was not based on any proper scientific basis or actuarial valuation which was properly proved before him.
2. The learned Counsel for the assessee has pointed out that the amount payable by way of gratuity has been properly computed. The people who were on the list of the employees of the company were known. They were entitled to be paid gratuity on retirement, etc. The amount of Rs. 5,64,528 was calculated on the basis that all the persons on the list of the company on the valuation date, if retired, etc., would have to be paid this amount by way of gratuity. According to the learned counsel, this was a real liability and the fact that it did not find a place in the balance sheet did not alter the position with regard to the value of the shares.
3. After hearing the learned Counsel for the department who laid stress on the orders of the authorities below, we see no reason to reject the assessee's claim. Whether a liability appears in the balance sheet or not, if it were shown to exist, it has to be taken into account. A prospective purchaser of shares is not likely to be blind to the existing liability to the extent of more than Rs. 5 lakhs which the assessee has to discharge at any time, the conditions for payment are satisfied. The mere fact that the employees do not retire immediately, but their retirement, discharge, etc. will take place over a period does not make the liability any the less real as far as a purchase of shares is concerned. The purchaser has to take note of the fact that the overall assets of the company stand depleted to the extent of this liability. The learned Counsel for the department has pointed out that at best this liability could be called a contingent liability and so does not deserve deduction. We feel that this approach is erroneous.
The AAC has referred to the Gujarat High Court's decision in the case of Nagri Mills Co. Ltd. v. CIT  131 ITR 257 and distinguished it on the ground that in the Income-tax matter of that company deduction was claimed on the basis of actuarial valuation of the liability. In our opinion, the correct view in the present matter would be not as to whether the payment of gratuity would be a contingent liability--which it could be if we understand it as contingent on the happening of an event like the retirement of an employee--but the alternative question: whether the company can under any circumstances get rid of the statutory liability to pay the gratuity to its retiring employees, etc.
In law if gratuity is payable, it cannot be avoided. If that be so, it definitely becomes the charge on the company going to reduce its assets. A purchaser would certainly not ignore this position. We have, therefore, no hesitation in coming to the conclusion that in finding the market value of the shares the existence of this liability whether recorded in the balance sheet or not cannot be ignored. We find also merit in the computation of the liability on the basis of the actual amount payable if the contingency happened in respect of all the employees on the rolls on the valuation date of the company since after all the valuation is a nominal process to be done on the valuation date.
2. The assessee, who is appellant before us, is an individual, who held shares in certain private limited companies, including Jagdish Oil Industries (P.) Ltd. The valuation of the shares of the company held by the assessee was done by the WTO in accordance with Rule 1D of the Wealth-tax Rules, 1957 ('the Rules').
3. The contention of the assessee before the WTO was that liability of the company to pay gratuity to its employees should be taken into account in the process of determination of the value of the shares of the company and this liability, according to him, was Rs. 5,64,528.
4. The WTO rejected the prayer on the ground that this liability had not been mentioned in the balance sheet of the company, whereas Rule 1D required that only those liabilities should be taken into account which have been mentioned in the relevant balance sheet.
5. In the appeal filed by the assessee, the AAC confirmed the decision of the WTO not only on the ground that the said liability had not been mentioned in the balance sheet, but also on additional ground to the effect that the amount claimed did not represent actuarial valuation of the liability to pay gratuity and that the scientific method had not been employed to arrive at the said figure.
6. In this appeal, it was stated before us that the amount of Rs. 5,64,528 was the amount which the company would have been required to pay to all employees who were in employment of the company on the valuation date, if all those employees had retired on that date. This amount, according to the learned Counsel for the assessee, represented real liability of the company on valuation date and, as such, the said amount was liable to be deducted under Rule 1D.7. The learned departmental representative, on the other hand, supported the order of the AAC on both the grounds mentioned in the impugned order and submitted that the amount mentioned by the assessee represented contingent liability to pay gratuity and not the liability existing on the date of valuation. As such, the said amount could not be deducted.
8. It may be mentioned here that it is not the contention of the assessee that method under Rule 1D should not be applied. Consequently, what we have to see is whether the said amount is liable to be deducted if the method under that rule is employed.
9. I shall assume, for the purpose of the present appeal, that mere non-mention of the liability to pay gratuity in the balance sheet of the company would not, ipso facto, render that liability ineligible for deduction under Rule 1D, although the words used in the said rule make pointed reference to only those liabilities which find mention in the balance sheet. However it cannot be gainsaid that before any amount is deducted as a liability under Rule 1D, that amount should represent the value of liability in pracsenti as on valuation date. The liability to pay gratuity to employees, arising under Payment of Gratuity Act, 1972, is such, as cannot be avoided by the company, as and when it arises.
Generally speaking, the gratuity would be payable to those employees who retire after completing the qualifying period of service. It would not be payable to those who are dismissed or removed or who leave service under other circumstances. The liability is, thus, dependent upon a large number of contingencies and is spread over a number of years. We are concerned with the value of this liability on the valuation date. In the circumstances, when the business of the company is a running business' and has not come to an end, the contingencies on which this liability is dependent are to be taken into account and then its value, as on the valuation date, is to be determined. The actuarial method of calculation takes into account all this and, as such, unless the actuarial valuation is done, or the present value of the said liability as on the valuation date is otherwise scientifically determined, no deduction on that account can be claimed. In fact, without such ascertainment, the said liability would remain a contingent liability as far as the valuation date is concerned.
10. It is true that the break-up value method is, normally, appropriate when the company is ripe for winding up. However, the break-up method (or asset-backing method, as it is sometimes called) has been prescribed as a method for valuation under Rule 1D and, as such, when this method is applied in cases of the companies, which are not ripe for winding up, what we have to take into account is the present value of the future liability ascertained on actuarial valuation or on scientific basis and not the amount payable to all the employees who are in employment on the valuation date on the hypothesis that they all retired on that date.
11. Reliance was placed before us on the decision of the Tribunal in the case of ITO v. Charandas Vallabhdas [WT Appeal Nos. 218 to 220 (Bom.) of 1976-77] pertaining to the assessment years 1973-74 and 1974-75. In that case, provision for gratuity had been made in the balance sheet itself and it was not the revenue's case that the said provision was on scientific basis. In the present case, it is the revenue's case that the amount claimed has not been calculated on scientific basis. It was observed in that case that an intending purchaser would look into the balance sheet to find out the liability and would assume that liability, which finds place therein, has been properly evaluated and, as such, the said liability should be taken into account. In the present case, as already stated, the liability does not find mention in the balance sheet. Moreover, it has not been calculated on actuarial or scientific basis. In that case, the amount claimed as deduction did not represent the amount which the company would have been required to pay if all the employees had happened to retire on the valuation date, as is the case now before us. In that case, it was assumed that the amount represented value in praesenti, as on the valuation date, of the liability to pay gratuity arising in future. In the present case, no such assumption can be made, in view of the method disclosed by the assessee. The ratio of that decision, consequently, does not support the present case of the assessee.
REFERENCE UNDER SECTION 25(11) OF THE WEALTH-TAX ACT, 1957 - On 7-6-1983 we heard the aforesaid appeal [WT Appeal No. 1405 (Bom.) of 1981 decided on 21-7-1983]. As we have differed in our conclusion about the disposal of the aforesaid appeal, we hereby refer the following question to the President for being referred to Third Member under Section 25(11) of the Wealth-tax Act, 1957: Whether, on the facts and in the circumstances of the case, the sum of Rs. 5,64,528 representing the gratuity liability would be a proper liability deductible in working out the value of shares 1. This is a case allotted to me as Third Member by the President under Section 24(11) of the Wealth-tax Act, 1957 ('the Act') to resolve, rather to express my opinion on the following point of difference of opinion that arose between my learned brothers: Whether, on the facts and in the circumstances of the case, the sum of Rs. 5,64,528 representing the gratuity liability would be a proper liability deductible in working out the value of shares 2. The assessee is a shareholder in a company called Shree Jagdish Oil Industries (P.) Ltd. In working out the value of the shares for the purpose of the wealth-tax assessment, the assessee deducted the liability in respect of the gratuity payable to the employees which was worked out at Rs. 5,64,528. It has to be noted that this amount was not provided for in the balance sheet, i.e., in the accounts. However, this was pointed out by way of a note in Schedule 'B' attached to the balance sheet. The auditors also qualified their report by referring to the non-provision for gratuity, among others and subject to the non-provision, they certified that the balance sheet as giving a true and fair view of the state of affairs of the company as on 30-9-1978.
In other words, the auditors of the company considered the non-provision for gratuity as a point worthy of being brought to the notice of the shareholders, meaning thereby that if a provision had been made for gratuity in the accounts the position of the state of affairs as then disclosed would be more truer and fairer.
3. In the course of the assessment proceedings, the assessee contended that even though the liability for gratuity was not provided for in the accounts, nonetheless the liability did exist and should be taken into account while computing the break-up value of the shares. The WTO rejected this claim mainly on the ground that this amount was not provided for in the balance sheet and that the assessee would not be entitled to claim this liability as a deduction. On appeal, the AAC confirmed the order of the WTO. Thus, the matter came up on appeal before the Tribunal. One of the reasons which weighed with the AAC was that even though the liability was not provided for in the accounts and exhibited as such in the balance sheet, the liability itself was not arrived at on any proper scientific basis or actuarial valuation, conveying thereby that the liability was not an ascertained liability but only a vague liability, a contingent liability. On hearing the matter, the learned Vice President, who is a party to the order, opined that on the facts of the case it could not be said that the liability was not properly ascertained on scientific basis, that the liability of Rs. 5,64,528 was calculated on the basis of the employees then existing in accordance with the rules provided for in the Payment of Gratuity Act, as well as the rules governing the scheme of the payment of gratuity. The learned Vice President held that whether the liability appeared in the balance sheet or not if it were shown to exist on the valuation date, it has to be taken into account in arriving at the true and fair value of the shares because what was to be ascertained under the Act was the market value of the shares as on the valuation date and a prospective buyer of shares was not likely to be ignorant of the existing liability to the extent of more than Rs. 5 lakhs on account of gratuity which has to be discharged at any given point of time.
Therefore, the question that the employees do not retire immediately or the assumption that the employees would retire on the valuation date is not material. Retirement of employees is bound to take place one day or the other. Thus, a company could never get rid of its obligation to pay the gratuity and since the amount was payable, the question was only about the ascertainment of the liability. If the liability was properly ascertained then it has to be taken into account and it is not necessary that the liability should be ascertained always on actuarial valuation. But, the learned Judicial Member was of a different opinion.
Dealing with the argument whether for the purpose of Rule 1D, the liability to pay gratuity should be provided for in the accounts or not, it was also one of the reasons why the department did not allow the assessee's claim, he assumed that the mere non-mention of the liability to pay gratuity in the balance sheet of the company would not ipso facto render that liability ineligible for deduction under Rule 1D although the words used in the said rule make a reference only to those liabilities which find a mention in the balance sheet. Thus, the Judicial Member proceeded on the assumption that it was not necessary for the mention of the liability to pay gratuity in the accounts of the company provided it is a liability. He, therefore, concentrated on the issue whether on the facts of this case that amount could be termed as a liability. For an amount to represent a liability in praesenti as on a particular valuation date, the amount must be such that it is an ascertained liability either by actuarial valuation or some other scientifically determined method. He was of the opinion that in the case of a running business which has not come to an end the liability to pay gratuity does not arise all by itself unless certain contingency happens, like retirement of employees satisfying the requirements of law. Since there is a provision in the law that dismissed or removed employees or employees who left the service under certain circumstances, would not be eligible for gratuity, the liability to pay gratuity cannot be said to be certain, ascertained and, therefore, the contingency, i.e., the possibility of expecting non-payment of gratuity under certain circumstances, in his opinion, made the liability to pay gratuity a contingent liability and for it to become an ascertained liability, there should be actuarial valuation or any other scientifically determined valuation. Since Rule 1D provided for valuation of shares on what is generally recognised as break-up value method, this method takes into its sweep the present value of the future liabilities ascertained on actuarial valuation and since the gratuity in this case that was being sought for deduction as a liability, is the present value of the future liability, it should have been ascertained on actuarial or on scientific basis. A case decided by the Tribunal, Bombay Bench, in the case of another shareholder who happens to be the assessee's brother was brought to the notice of the Bench [WT Appeal No. 315 (Bom.) of 1983 dated 27-9-1983]. While the learned Vice President did not make a reference to this decision, the learned Judicial Member, however, discussed the decision in his order and distinguished it, by pointing out that in that case provision for gratuity was made in the balance sheet and that it was not the case of the revenue that that was not on scientific lines.
4. Thus, the difference of opinion mentioned above arose which was referred to me for my opinion. I have heard the parties before me at great length. I am of opinion that the view expressed by the learned Vice President should prevail. It has to be borne in mind that what we are concerned here is the market value of the shares to find out the proper wealth-tax liability. How do we ascertain the market value of the shares? There are several methods of ascertaining the market value of the shares. In the case of quoted shares, there is no difficulty in ascertaining the value because the stock exchange quotations are available. The difficulty will arise only in the case of unquoted shares. Even here, there are several accepted methods to arrive at the market value of the shares of which two have assumed a sort of universal acceptance and judicial recognition; one is yield method and the other is break-up value method or intrinsic value method. The income method is the method which is generally accepted and adopted by almost all the dealings where shares are concerned. The intrinsic value method or the break-up value method is general and so accepted in commercial world all because even if the intrinsic value of the shares is more, if the yield from shares is less than expected, the low potentiality of the yield would bring down the market value of the shares even if the intrinsic value happens to be more. There are several difficulties in arriving at the intrinsic value of the shares because that would depend upon the realisable value of the various assets in the balance sheet which is often very difficult to ascertain which, again, will depend upon the market value of the assets.
Similarly, the liability also. Though it is well settled that the most rational method of valuing the shares is the yield method, of the Rules, by Rule 1D, gives preference to valuation of shares by break-up value method by providing in specific terms the way in which that value has to be worked out, the kinds of assets that should be taken into account and the kinds of liabilities that should be excluded. Though Rule 1D speaks of liabilities referred to in the balance sheet for the purpose of consideration it does not, in terms, specifically prohibit inclusion of liabilities not provided for in the accounts from being taken into consideration once they are shown to exist as liabilities.
It is, perhaps, for this reason that my learned brother, Judicial Member, had assumed that even though the liability was not provided for in the accounts still it required to be considered even as per Rule 1D.Proceeding from this premises on which there is no disagreement between my learned brothers, I am now to address myself as to whether the sum in question is a liability ascertained on scientific method because since it is not a liability ascertained on actuarial valuation which is not a point in dispute while the learned Vice President had expressed that since the rules governing the payment of gratuity as well as the requirement of law of Payment of Gratuity Act are complied with, this amount can be said to be the amount ascertained on scientific lines the Judicial Member was not prepared to accept this view. In the opinion of the learned Judicial Member as I recapitulate, the sum in question is a contingent liability only because this was not ascertained on scientific lines and the payment of gratuity was not immediate and depended upon happening of the event which may or may not take place.
What the happening of this event would result in is cash payment. Since the liability was not to be paid immediately and the payment is to depend upon happening of an event, this situation is considered by the learned Judicial Member as creating at worst a contingent liability.
This, in my opinion, may not be proper and fair. The liability may exist; the payability may be postponed. Merely on the ground that the payability is postponed, the liability that has accrued does not cease to be a liability. Thus, the payment of gratuity is a certainty because each member of the staff is entitled to gratuity if he had fulfilled the conditions entitling him to the gratuity. Ascertainment of the amount payable by way of gratuity is thus a liability which comes upon the assessee-company as a certainty. What remains to be seen is whether the liability was properly ascertained or not. The liability for the payment of gratuity is to be ascertained as per the provisions of the Payment of Gratuity Act and the rules made by the assessee-company governing the payment of gratuity. If as per these provisions and the rules the amount now claimed as a liability was arrived at, that amount has to be allowed as a deduction. In allowing the said amount' as a liability the issue that the payment is postponed cannot enter into calculation. As already observed earlier, liability can accrue but the payment may be postponed and yet the liability subsists. The contingent liability is a liability the payment of which has to depend upon the happening of a particular event. In this case the retirement of the employees is an event which will certainly take place. If under the Payment of Gratuity Act and the rules made by the assessee-company for the payment of gratuity, it is to be assumed that the employees would retire on the balance sheet day and if a provision for payment of gratuity is required to be made on those lines, then the amount provided for to meet that eventuality is nontheless a liability although the employees do not retire on that day. The question that dismissed employees or the employees who left the services will not be entitled to payment of gratuity will not then be a point for reckoning the amount of liability that had accrued to the company for the discharge of the liability towards gratuity. Thus, the matter is one of calculation and the mere fact there is difficulty in quantification should not detract it from being a liability or should make it a contingent liability. On a proper verification and scrutiny the amount now claimed as a liability may vary. But that does not mean that no liability at all accrued. Therefore, it is incorrect, in my view, to say that because of the possibility of incorrectness of the amount now claimed as a liability, the amount claimed ceased to be a liability. A buyer of shares in a company now after the passing of the legislation providing for the welfare of the employees for several amenities including payment of gratuity and payment of bonus more or less on a compulsory and a permanent basis, the liability for which is not inconsiderable, will not ignore the effect of the social welfare legislation on the quantum of profitability and the consequent depression in the value of the shares. This would mean ignoring the effect of the liabilities in toto, which cannot be considered as proper particularly in the matter of arriving at the market value of a share of a company. The fact that the auditors of the assessee-company found it necessary to mention in their report that provision for gratuity was not made shows how important and significant the making of a provision for gratuity assumed in the matter of presenting a true and fair view by the balance sheet. The auditors felt and rightly too that non-provision for gratuity did not reflect the true and fair view of the state of affairs of the company which would also suggest that inclusion of this liability into the calculation of the value of shares is a necessity and is not capable of being ignored.
5. For the aforesaid reasons and for the reasons advanced by the learned Vice President, I am inclined to agree with the view that the sum in question cannot be said to be a contingent liability and, therefore, not entitled to be taken into consideration in the valuation of the shares. It is, therefore, a proper liability deductible in working out the value of the shares.
6. Before I part with the order, I would also like to mention that the view expressed by another Bench, Bombay Bench, in the case of Charandas Vallabhdas (supra), another shareholder of the same company that gratuity should be allowed as a deduction and that it was in the nature of a liability in praesenti is correct and I would agree with it. The distinction the learned Judicial Member brought about between that case and the present case does not, in my opinion, really matter for the simple reason that having proceeded on the assumption that even if the liability is not provided for in the accounts, still it can be considered as a liability provided it is a liability, the fact that that liability was provided for in the books for that year in that case would not really make a difference. The position would have been different if the assumption of the Judicial Member had been that it was necessary to provide for the liability in the accounts. If it is considered that the provision in the books is not necessary for the amount to be claimed as a liability, the fact that no provision was made in the accounts could not be a distinguishing feature.
7. Now the matter will go before the regular Bench for deciding it in accordance with the majority opinion.