1. The dispute in this appeal is with regard to the deduction of gratuity of Rs. 99,249 and notice pay of Rs. 21,018.
2. Smt. Jyothi Chellaram, proprietrix of Jaypee Electronics, died on 24-5-1980. After her death, her husband, Shri P.R. Chellaram, took over the business. It was contended before the ITO that the services of the employees were terminated by issuing notice on 30-5-1980 and gratuity of Rs. 99,249 and notice pay of Rs. 21,018 were paid. Thereafter, those employees were reappointed by Shri P.R. Chellaram, the husband of the assessee. Thus, it was urged that the above amounts paid were deducted in this year as it was a liability of this year. The ITO did not accept these submissions. He held that there was no termination of services of employees at all and there was no question of payment of gratuity and notice pay. He held that 24-5-1980 was a Sunday and there was no discontinuance of business also even for a day. The business was continued as a going concern by Shri P.R. Chellaram, the husband of the assessee Under Section 40A(7) of the Income-tax Act, 1961 ('the Act') no provision for gratuity can be allowed unless the conditions prescribed therein are fulfilled. None of the conditions were fulfilled. Thus, he rejected the assessee's claim.
3. The assessee appealed to the Commissioner (Appeals). He held that this is a case where there has been no transfer at all from one employer to another employer. There was, at best, a succession by one employer in place of another. There has been continuity of the business with change in person which does not amount to transfer. He applied the ratio laid down by the Supreme Court in CIT v. Gemini Cashew Sales Corpn.  65 ITR 643. Thus, he upheld the disallowance made by the ITO. Against the said order, the assessee has preferred this appeal.
4. The learned Counsel for the assessee strongly urged that the liability for payment of gratuity and notice pay had arisen under the Andhra Pradesh Shops and Establishment Act, 1966 as well as under the Payment of Gratuity Act, 1972. The services of the employees were terminated from 24-5-1980, though notices were issued on 30-5-1980. The business has been transferred and, hence, the liability for payment of gratuity and notice pay arises. As the said liability was payable, provision has been made in the books of account. Thus, the same is an allowable deduction even under Section 40A(7). When gratuity becomes payable, it is an allowable deduction. He placed reliance on various decisions.
5. The learned departmental representative submitted that no amount of gratuity or notice pay has become payable. Unless the liability was payable by the assessee or on his behalf, the amount claimed as deduction cannot be allowed. Liability, in this case, did not arise during the period when the business was carried on by the assessee.
Hence, it is not payable. Thus, the disallowance made was justified.
6. We have considered the rival submissions. Smt. Jyothi Chellaram died on 24-5-1980. 25th was a Sunday, which was a general holiday. The business was continuously carried on without any break by Shri P.R.Chellaram, her husband. As legal heirs, he carried on business and as such, there was no transfer of the business from one person to someone else. Hence, the question of payment of any gratuity or notice pay did not arise during the accounting year. There is no provision either in the Andhra Pradesh Shops and Establishment Act or in the payment of Gratuity Act that on the death of the employer, services of the employees would automatically get terminated. Since there is no transfer of the business, the question of termination of the services of the employees did not arise. The so-called notices issued on 30-5-1980, terminating the services of the employees, are only to give a colour that the employees' services were terminated. The very fact that those employees continued in the business carried on by Shri P.R.Chellaram, husband of the assessee, would itself indicate that the services of the employees under the assessee have not been terminated.
The liability for payment of gratuity and notice pay should arise during the lifetime of the assessee in the business so carried on up to 24-5-1980 for allowing the same as deduction but such liability did not arise during the accounting year ending 24-5-1980. If at all, any liability has arisen, it might be only after the accounting year which ended on 24-5-1980. Hence, the liability did not arise in this year.
Further, no liability has been incurred for the purpose of business carried on during this year.
7. In Gemini Cashew Sales Corpn.'s case (supra), the Supreme Court considered the question whether the gratuity and retrenchment compensation payable on transfer of business under the Industrial Disputes Act, 1947, is an allowable deduction. In that case, two persons, Walter and Ramasubramony, carried on business as partners in the name and style of Gemini Cashew Sales Corporation. The partnership was dissolved on the death of Ramasubramony on 24-8-1957 and the business was taken over and continued by Walter on his own account. The services of the employees were not interrupted and there was no alteration in the terms of employment of the employees of the establishment. It was urged that an amount of Rs. 1,41,506 taken into account under the head 'Gratuity payable to workers of the business' in settling the accounts of the firm till 24-8-1957 was a permissible outgoing. This contention was rejected by the revenue authorities, but the Tribunal allowed the claim for deduction and the High Court, on reference, upheld the findings of the Tribunal. The matter was carried to the Supreme Court. Especially, it was observed by the Supreme Court as under: In the view we take, that the allowance claimed is not a proper outgoing, or allowance in computing the profits of the assessee, we do not express any opinion on the question whether the workmen of the undertaking became entitled to retrenchment compensation on the transfer of the undertaking to Walter.
Liability to pay retrenchment compensation arises under Section 25FF when there is a transfer of the ownership or management of an undertaking: it arises on the transfer of the undertaking and not before. Transfer of ownership or management of an undertaking in law operates, except in the conditions set out in the proviso, as retrenchment of the workmen. But until there is a transfer of the undertaking resulting in determination of employment, the workmen do not become entitled to retrenchment compensation. So long as the ownership of the business continues with the employer, the right of the workmen to claim compensation remains contingent. A workman may, before the transfer of ownership of the business, himself terminate the employment: he may die or he may become superannuated: in none of these cases the owner of the business is under any obligation to pay retrenchment compensation to the workman. The obligation to pay compensation becomes definite only when there is retrenchment by the employer, or when the ownership or management of the undertaking is, except in the cases contemplated by the proviso, transferred to a new employer, and not till then. The right therefore arises from determination of employment, or from transfer of the undertaking: it has no existence before these events take place.
As already observed, the liability to pay retrenchment compensation arose for the first time after the closure of the business and not before. It arose not in the carrying on of the business, but on account of the transfer of the business. During the entire period that the business was continuing, there was no liability to pay retrenchment compensation. The liability which arose on transfer of the business was not of a revenue nature. Profits of a business involve comparison between the state of the business at two specific dates. Normally the liability which occurs after the last date, unless its source is in a pre-existing definite obligation, cannot be regarded as a part of the outgoing of the business debitable in the profit and loss account. A deduction which is proper and necessary for ascertaining the balance of profits and gains of the business is undoubtedly properly allowable, but where a liability to make a payment arises not in the course of the business, not for the purpose of carrying on the business, but springs from the transfer of the business, it is not, in our judgment, a properly debitable item in its profit and loss account as a revenue outgoing. The claim of the firm to treat it as an item in the determination of the profits of the firm under Section 10(1) of the Income-tax Act cannot, therefore, be sustained.
Under Section 10(2)(xv) of the Indian Income-tax Act in the computation of taxable profits (omitting parts of the clause not material) 'any expenditure laid out or expended wholly and exclusively for the purpose of such business, profession or vocation', i.e., business, profession or vocation carried on by the assessee, is a permissible allowance. But to be a permissible allowance the expenditure must be for the purpose of carrying on the business. Where accounts are maintained on the mercantile system, if liability to make the payment has arisen during the time the business is carried on, it may appropriately be regarded as expenditure. But where the liability is, during the whole of the period that the business is carried on, wholly contingent and does not raise any definite obligation during the time that the business is carried on, it cannot fall within the expression 'expenditure laid out or expended wholly and exclusively' for the purpose of the business.
Thus, it was held that the amount of Rs. 1,41,506 cannot be regarded as properly admissible deduction either under Section 10(1) or Section 10(2)(xv) of the Indian Income-tax Act, 1922. The above ratio squarely applies to the instant case. In the instant case also, the gratuity liability did not arise during this year of accounting. It did not arise in the carrying on of the business of the assessee. There is no transfer of the business at all in this case. Even if it is considered for argument's sake that it arose on account of the transfer of the business, it is not an allowable deduction as it did not arise in the carrying on of the business. There is no agreement between the assessee-employer and the employees that gratuity will be payable on the death of the employer even if the business is carried on by the legal heirs. There is no termination of the services of the employees as they continued without any break in the business carried on by Shri P.R. Chellaram, husband of the assessee. As held by the Hon'ble Supreme Court in Gemini Cashew Sales Corpn.'s case (supra) the liability which arose on transfer of the business was not of revenue nature. Even under the provisions of the Andhra Pradesh Shops and Establishment Act, there is no liability for the payment of gratuity or notice pay on the death of the employer. Even if it is considered as transfer, the assessee's case comes under Clause (c) to proviso to Section 42 of the Andhra Pradesh Shops and Establishment Act. Once the assessee comes under Clause (c) to the proviso, the main Section 42 shall not apply. Under Clause (c) to proviso to Section 42, the new employer will be liable to pay to the employee gratuity in the event of termination of services.
Hence, the assessee has no liability to pay any gratuity or notice pay during the accounting year ending 24-5-1980. Thus, there is no liability on the part of the assessee for payment of gratuity under the Andhra Pradesh Shops and Establishment Act, so far as the assessee is concerned. Similarly, there is no liability by the assessee for payment of gratuity or notice pay under the Payment of Gratuity Act. Under Section 40A(7)(6)(i), only gratuity that has become payable during the previous year will be allowed. But in the instant case, no gratuity became payable during the previous year. Thus, the provisions of Section 40A(7) will not help the assessee. Thus, in our view, no liability for payment of gratuity and notice pay has arisen during the previous year.
8. The learned Counsel for the assessee relied on the decisions in Dalmia Dadri Cement Ltd. v. CIT  126 ITR 851 (Delhi), CIT v. High Land Produce Co. Ltd.  102 ITR 803 (Ker.), CIT v. Sitalakshmi Mills Ltd.  141 ITR 415 (Mad.), CIT v. Sri Ranilakshmi Ginning, Spg. & Wvg. Mills (P.) Ltd.  132 ITR 360 (Mad.), Delhi Flour Mills Co. Ltd. v. CIT  95 ITR 151 (Delhi), and Escorts (Agents) (P.) Ltd. v. CIT  80 ITR 61 (Delhi). In our view, those decisions have no application to the facts of the instant case. The decision of Dalmia Dadri Cement Ltd.'s case (supra) is a case of settlement of gratuity with the employees which has no application to the instant case. The decision in High Land Produce Co. Ltd.'s case (supra) is a case of gratuity liability arising under the Kerala Industrial Employees' Payment of Gratuity Ordinance, 1969. Hence, that case has no application to this case. The decision in Sri Ranilakshmi Ginning, Spg.
& Wvg. Mills (P.) Ltd.'s case (supra) is also a case of settlement of gratuity with the labour union for the payment of gratuity. Similarly, the decision in Delhi Flour Mills Co. Ltd.'s case (supra) is a case of payment of gratuity under an agreement. The decision in the case of Escorts (Agents) (P.) Ltd.'s case (supra) is also a case of agreement reached between the assessee-company and its employees for payment of gratuity. In all those cases, there was clear liability for payment of gratuity which is not the position in the instant case. Hence, they are not applicable to the instant case. The decision in Sitalakshmi Mills Ltd.'s case (supra) has also no application to the facts of the instant case. That was a case where there was a gratuity scheme and liability had arisen. Thus, none of the cases relied on by the learned Counsel for the assessee have any application to the facts of the instant case.
Thus, in our view, the claim for deduction of gratuity amount of Rs. 99,249 and notice pay of Rs. 22,018 has rightly been disallowed.