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Commissioner of Income-tax Vs. High Land Produce Co. Ltd. - Court Judgment

LegalCrystal Citation
SubjectDirect Taxation
CourtKerala High Court
Decided On
Case NumberIncome-tax Referred Case Nos. 43, 59 and 68 of 1974
Judge
Reported in[1976]102ITR803(Ker)
ActsIncome Tax Act, 1961 - Sections 30 to 36, 36(1) and 37(1); Kerala Industrial Employees' Payment of Gratuity Ordinance, 1969; Kerala Industrial Employees' Payment of Gratuity Act, 1970
AppellantCommissioner of Income-tax
RespondentHigh Land Produce Co. Ltd.
Appellant Advocate P.A. Francis and; P.K. Raveendranatha Menon, Advs.
Respondent Advocate P.K. Kurien and; K.A. Nayar, Advs.
Cases ReferredMadho Mahesh Sugar Mills (P.) Ltd. v. Commissioner of Income
Excerpt:
.....liability - assessee entitled to get deduction for such liability. - - deduction towards gratuity liability can be made only under section 36(1)(v) and since, admittedly, in these cases the terms of section 36(1)(v) not having been satisfied, such liability cannot be reckoned for purposes of determining the true profits and gains. in other words, the mere fact that a claim will not fall under any of the sections 30 -36 will not automatically make the claim unsustainable under section 37(1) of the act as well. we cannot give a meaning to the words 'in the nature of' so as to stultify a legitimate claim in accordance with the principles of accountancy and according to well-established commercial practice and which must be taken into account in ascertaining the true profits and..........the liability imposed by the act, therefore, can generally be said to be a liability incurred from year to year and for every year an employee continues in service he gains the right to claim a certain amount towards gratuity from the employer. recognising this fact often employers created a fund, at times, a trust fund, or more often a reserve for meeting the liability. they also resorted to making a provision towards gratuity in their accounts from year to year by estimating the accrued liability during the particular year of account. the question that pointedly arises in this batch of cases is whether the claim that because of the gratuity act there is a liability in a certain sum which has arisen during the accounting period and that the sum representing that liability should be.....
Judgment:

Govindan Nair, C.J.

1. The questions referred in these three tax referred cases raise a point of law in regard to the interpretation of Sections 36and 37 of the Income-tax Act, 1961, for short, 'the Act'. We shall extract the questions referred in the three cases :

(1) I. T.R. C. No. 43 of 1974 :

'Whether, on the facts and in the circumstances of the case, the Income-tax Appellate Tribunal is right in law in allowing the assessee's claim for deduction of Rs. 3,48,671 towards liability for gratuity under the Kerala Industrial Employees' Payment of Gratuity Act, 1970, for the assessment year 1970-71 ?' (2) I. T.R.C. No. 59 of 1974 :

'Whether, on the facts and in the circumstances of the case, the Income-tax Appellate Tribunal is right in law in holding that the assessee is entitled to a deduction of Rs. 11,415 being provision for gratuity payable under the Kerala Industrial Employees' Payment of Gratuity Act, 1970?' (3) I. T. R. C. No. 68 of 1974 : 'Whether, on the facts and in the circumstances of the case, the Income-tax Appellate Tribunal is right in law in allowing the assessee's claim for deduction of Rs. 6,42,917 towards liability for gratuity under the Kerala Industrial Employees' Payment of Gratuity Act, 1970, for the assessment year 1970-71 ?'

2. The year of assessment in I. T. R. C. No. 43 of 1974 is 1970-71 and the relevant accounting period is that which ended on December 31, 1969. The year of assessment with which we are concerned in I. T. R. C. No. 68 of 1974 is also 1970-71 though the relevant accounting period therein is that which ended on March 31, 1970. The assessment year relating to I. T. R. C. No. 59 of 1974 is also 1970-71, the accounting period being that which ended on March 31, 1970. The Kerala Industrial Employees' Payment of Gratuity Ordinance, 1969, was passed with effect from December 10, 1969, providing for a gratuity scheme and a liability to pay gratuity at a certain number of days' wages for every year of service on death, superannuation, resignation or dismissal. The Ordinance was replaced by the Kerala Industrial Employees' Payment of Gratuity Act, 1970, for short, the 'Gratuity Act', which came into force on February 18, 1970. Section 4 of the Gratuity Act provided that gratuity shall be payable to an employee on his superannuation, on his retirement, resignation, retrenchment, discharge or dismissal from service after completion of a minimum period of five years of continuous service and on his death or total disablement due to accident or disease. The gratuity payable is at the rate of fifteen days' wages based on the last drawn wages for every completed year of service or part thereof in excess of six months subject to the maximum amount of fifteen months' wages. It is unnecessary to refer to the other detailed provisions in the Gratuity Act. It is clearthat there is a statutory obligation imposed on the employer to pay gratuity to the employees in accordance with the terms of the Gratuity Act. Though the right of an employee to claim gratuity in a case falling under Section 4(1)(b) will arise only after five years' of service, it is reasonable to expect that most of them will continue in service for five years and on that basis make provision for gratuity which will have to be paid at the time of their retirement, resignation, retrenchment, discharge or dismissal. The liability imposed by the Act, therefore, can generally be said to be a liability incurred from year to year and for every year an employee continues in service he gains the right to claim a certain amount towards gratuity from the employer. Recognising this fact often employers created a fund, at times, a trust fund, or more often a reserve for meeting the liability. They also resorted to making a provision towards gratuity in their accounts from year to year by estimating the accrued liability during the particular year of account. The question that pointedly arises in this batch of cases is whether the claim that because of the Gratuity Act there is a liability in a certain sum which has arisen during the accounting period and that the sum representing that liability should be allowed as a deduction in computing the profits and gains for the assessment for the corresponding assessment year. Counsel on behalf of the assessees strenuously contended before us that such deductions are permissible even though the liability in question may be only a contingent liability provided a real and true estimate can be made of the present value of that contingent liability. Counsel on behalf of the revenue, on the other hand, contended that such deductions are not permissible. He urged that there is specific provision made in Section 36(1)(v) of the Act for deducting payments towards a fund for meeting the liability towards gratuity. Deduction towards gratuity liability can be made only under Section 36(1)(v) and since, admittedly, in these cases the terms of Section 36(1)(v) not having been satisfied, such liability cannot be reckoned for purposes of determining the true profits and gains. We must at this stage read Section 36(1)(v) and Section 37(1) of the Act:

'36. (1) The deductions provided for in the following clauses shall be allowed in respect of matters dealt with therein, in computing the income referred to in Section 28 ;......

(v) any sum paid by the assessee as an employer by way of contribution towards an approved gratuity fund created by him for the exclusive benefit of his employees under an irrevocable trust.'

'37. (1) Any expenditure (not being expenditure of the nature described in Sections 30 - 36 and not being in the nature of capital expenditure or personal expenses of the assessee), laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowedin computing the income chargeable under the head ' Profits and gains of business or profession'.'

3. Counsel also submitted that the words within brackets 'not being expenditure of the nature described in Sections 30 - 36' will further preclude the assessee from claiming the benefit of Section 37(1), for, what is claimed by the assessees, according to counsel for the department, a liability of the nature described in Sections 30 - 36, for, the liability is one that falls within Section 36(1)(v).

4. To understand the scope of Sections 36 and 37, it is necessary to go back to the Indian Income-tax Act, 1922, and find out the origin of the words within the brackets which have been relied on by counsel for the department. Those words were introduced into the Indian Income-tax Act, 1922, by Act 25 of 1953, The reason for introducing these words has been stated in the note to Sub-clause (a)(iii) of Section 8 of Act 25 of 1953 in these terms:

'This is a clarificatory amendment to make it clear that the revenue expenditure admissible under this residuary clause is that which is not specifically covered by the preceding clauses. If it is covered by those clauses, it should be admissible only under those clauses, and not under this residuary clause.'

5. The object of Section 37(1) of the Act which is very similar to Section 10(2)(xv) of the Indian Income-tax Act, 1922, is not to preclude consideration of a claim which would not fall under Sections 30 - 36 of the Act. In other words, the mere fact that a claim will not fall under any of the Sections 30 - 36 will not automatically make the claim unsustainable under Section 37(1) of the Act as well. To say so would be to detract from the residuary nature of the provision in Section 37(1). We are supported by authority for this proposition and we shall quote a passage from the judgment in Liberty Cinema v. Commissioner of Income-tax, : [1964]52ITR153(Cal) wherein the scope of Section 10(2)(xv) of the Indian Income-tax Act, 1922, similar to Section 37(1) of the Act was considered. The Calcutta High Court observed therein as follows :

'It will be, therefore, stultifying Sub-clause (xv) of Section 10(2) and its residuary nature if a construction is put on it to mean that, whenever an allowance falls under these Clauses (i) to (xiv), that fact by itself would exclude entertainment of the claim under Clause (xv) of Section 10(2) of the Act.'

6. We are in respectful agreement with the observation. The residuary nature of the provision in Section 37(1) will, therefore, have to be given its full play. Bearing in mind the reason for the introduction of the words within the brackets 'not being expenditure of the nature described inSections 30 - 36' we have to remember that those words do not preclude certain species of liabilities but only exclude consideration of liabilities which would fall under any of those sections. We shall explain. Taking for instance, the liability for gratuity, the nature of the liability is a liability towards gratuity. It is towards that liability provision has been made under Section 36(1)(v) of the Act. If the submission of counsel for the revenue is accepted, only payments made to a fund such as contemplated by Section 36(1)(v) of the Act will be permissible as deductions towards gratuity liability for computing profits and gains. We cannot accept this contention. We cannot give a meaning to the words 'in the nature of' so as to stultify a legitimate claim in accordance with the principles of accountancy and according to well-established commercial practice and which must be taken into account in ascertaining the true profits and gains of business. Unless there be some statutory provisions which in clear terms or by necessary implication negatives against the adoption of such principles and practice, those principles and practice must be given their full play. So, in Badridas Daga v. Commissioner of Income-tax, : [1958]34ITR10(SC) the Supreme Court ruled that:

'When a claim is made for a deduction for which there is no specific provision under Section 10(2), whether it is admissible or not will depend on whether, having regard to accepted commercial practice and trading principles, it can be said to arise out of the carrying on of the business and be incidental to it. The loss for which a deduction is claimed must be one that springs directly from the carrying on of the business and is incidental to it, and not any loss sustained by the assessee even if it has some connection with his business. If that is established, then the deduction must be allowed, provided that there is no provision against it, express or implied, in the Act.'

7. This view was expressed in a case where the loss arose as a result of defalcation committed by one of the employees of the bank and which was claimed to be deducted from the profits and gains for ascertaining the taxable profits and gains. The claim was allowed. The principle of this decision was applied by the Supreme Court in Calcutta Co. Ltd. v. Commissioner of Income-tax, : [1959]37ITR1(SC) wherein the question was whether the sum to be expended for the development of the land which had been parcelled and sold out and which had actually not been spent during the accounting period but which the assessee had undertaken to spend could be deducted from the profits and gains. It was ruled that the deduction is permissible. The Supreme Court in Commissioner of Wealth-tax v. Standard Vacuum Oil Co. Ltd., : [1966]59ITR569(SC) held that the claim arising out of a notice under Section 18A of theIndian Income-tax Act, 1922, would amount to a debt under Section 2(m) of the Wealth-tax Act, 1957, and would have to be taken into account for determining the wealth of an assessee for assessment under the Wealth-tax Act, 1957. Similarly, the provision for tax liability would be a debt for the purpose of the Wealth-tax Act as has been ruled in Kesoram Industries and Cotton Mills Ltd. v. Commissioner of Wealth-tax, (1) : [1966]59ITR767(SC) . But in Standard Mills Co. Ltd. v. Commissioner of Wealth-tax, : [1967]63ITR470(SC) it was held that an estimate towards gratuity liability was not a debt for the purpose of the Wealth-tax Act. Much reliance has been placed on this decision as well as the decision in Indian Molasses Co. (Private) Ltd. v. Commissioner of Income-tax, : [1959]37ITR66(SC) by counsel on behalf of the revenue against the contention put forward by the assessee that the gratuity liability must be taken into account for determining the profits and gains. These two decisions, we do not think, have any application in deciding the question before us. The true principle is that stated by Lord Radcliffe in the decision in Southern Railway of Peru Ltd. v. Owen, [1957] 32 ITR 737 which is in these terms:

'Now, the question is, how ought the effects of this statutory scheme to be reflected in the appellant's accounts of the annual profits arising from its trade One way, which is certainly the simplest one, is to let the payments made fall entirely as expenses of the year of payment and ignore any question of making provision for the maturing obligation during the years of service that precede it ...... It has one considerableadvantage; no element of estimate or valuation appears in the profit assessment and nothing is charged to profits except the actual cash outgoing. But, when this has been conceded, I think that there is the very serious disadvantage to be set against the cash basis that it affords a comparatively inefficient method of arriving at the true profits of any one year. The retirement benefit is not, obviously, paid to obtain the services given in the year of retirement. The incidents of retirement payments must be variable from year to year, and they may inordinately depress the profits of one year just as they may inordinately innate the profits of another. It is true that the company carries on business from one year to another, but it is not charged on the average of its annual profits. Tax rates and allowances themselves vary and, apart from that, to charge tax on a profit unduly accelerated or unduly deferred is, in my opinion, no more respectable an achievement than to admit that the annual accounts of business do in some cases require the introduction of estimates or valuations if a true statement of profit is to be secured.'

8. The Supreme Court quoted the above passage with approval and observed in Metal Box Company of India Ltd. v. Their Workmen, : (1969)ILLJ785SC :

'There is no rule against providing for any such contingent liability but on the contrary such a provision is permissible can be seen from the form of balance-sheet in Schedule VI to the Companies Act, 1956, where provisions for taxation, dividends, provident fund schemes, staff benefit schemes and other items for which a company is contingently liable are to be treated as current liabilities and, therefore, debitable against the gross receipts. Schedule VI, Part 2, lays down the requirements of profit and loss account and Clause 3(ix) of it provides that a profit and loss account shall set out amongst other things the aggregate of amounts set aside or provisions made for meeting specific liabilities, contingencies or commitments.'

9. Their Lordships were dealing with the question whether the gratuity liability can be taken into account for the purpose of the Bonus Act, 1965. After discussing the question, their Lordships concluded thus:

'If under the Income-tax Act an estimated liability ascertainable with substantial accuracy can be taken into account for arriving at the true profits and gains, there is no reason why the same cannot be done under the Bonus Act unless there is any provision therein forbidding such a practice recognised by commercial accountancy.'

10. Having said so, their Lordships further observed:

'No such provision was shown to exist in the Bonus Act.'

11. And we are able to discern no such provision in the Income-tax Act either. So the principle laid down by the House of Lords in the decision in Southern Railway of Peru Ltd. v. Owen and accepted by the Supreme Court must govern this case as well.

12. The actual obligation to pay the gratuity will of course arise only on superannuation, retirement, resignation, retrenchment, discharge or dismissal or death as is provided in Section 4 of the Gratuity Act. But no prudent employer would wait for the day of death or for the occurrence of the event mentioned in Section 4 of the Gratuity Act for the purpose of payment of liability which has accrued through the period of service of an employee which may be for 20 or 30 years. A prudent employer would either create a fund or determine his profits for the year by taking into account the liability towards gratuity relatable to the year of account. The question is whether such determination of profits and gains is permissible. We hold that it is permissible in the light of the discussion.

13. The Allahabad High Court in two decisions wherein the specific question arose has allowed such claims. Those decisions are in Madho Mahesh Sugar Mills (P.) Ltd. v. Commissioner of Income-tax, [1973] 92 ITR 503 and in Commissioner of Income-tax v. Laxmi Ratan Cotton Mills Ltd., : [1975]98ITR341(All) . With great respect, we agree with the view taken in those decisions.

14. The question of course would arise how this contingent liability should be valued for the purpose of a particular accounting period. We think the correct principle is to ascertain the present value of the contingent liability which had arisen during the accounting period on actuarial principles.

15. The questions referred in all these cases, which we have read, have mentioned certain figures as if those figures represented the liabilities that arose during the relevant accounting periods. The Tribunal has, however, not accepted those figures as depicting the actual liability for the particular year in question. In the Tribunal's order in I.T.R.C. No. 43 of 1974 it is specifically stated in the last paragraph:

'The Income-tax Officer is, however, directed to verify the basis of computation of the liability and exclude therefrom what had not accrued as a liability to the assessee under the Gratuity Act this year.'

16. There is a similar finding in the Tribunal's order in I.T.R.C. No. 68 of 1974:

'The Income-tax Officer is, however, directed to verify the basis of computation of the liability to and exclude therefrom what had not accrued as a liability to the assessee under the Gratuity Act this year.'

17. In I.T.R.C. No. 59 of 1974, the Tribunal has accepted the figure mentioned in the question as actually representing the liability in the year in question.

18. In the light of the above, we answer the questions referred in I.T.R.Cs. Nos. 43 and 68 of 1974, by stating that the Tribunal was right in allowing the liability towards gratuity though only a contingent liability. We thus answer the questions referred to us in the affirmative, that is, in favour of the assessee and against the department. We, however, hasten to add that this does not mean that the Tribunal has allowed the sum of Rs. 3,48,671 and Rs. 6,42,917 mentioned in the two questions as liabilities that had accrued in the years of account for the relevant assessment years in those two cases. What the Tribunal has stated, we have extracted in our judgment and it is for the Income-tax Officer to determine the exact quantum of liability in the light of the principles stated in this judgment and in accordance with the directions in the orders of the Tribunal.

19. We answer the question referred to us in I.T.R.C. No. 59 of 1974 in the affirmative, that is, in favour of the assessee and against the department.

20. We direct the parties to bear their respective costs in all these tax referred cases.

21. A copy of this judgment, under the seal of the High Court and the signature of the Registrar will be forwarded to the Income-tax Appellate Tribunal, Cochin Bench.


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