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Co-operative Tea Society Ltd. Vs. Commissioner of Income-tax - Court Judgment

LegalCrystal Citation
SubjectDirect Taxation
CourtKerala High Court
Decided On
Case NumberIncome-tax Reference No. 178 of 1979
Judge
Reported in[1985]154ITR405(Ker)
ActsIncome Tax Act, 1961 - Sections 32(1) and 37; ;Kerala Industrial Employees' Payment of Gratuity Act, 1970
AppellantCo-operative Tea Society Ltd.
RespondentCommissioner of Income-tax
Appellant Advocate K.V.R. Shenoi and; P.K. Kurien, Advs.
Respondent Advocate P.K.R. Menon and; N.R.K. Nair, Advs.
Cases ReferredMetal Box Company of India. Ltd. v. Their Workmen
Excerpt:
direct taxation - deduction - sections 32 (1) and 37 of income tax act, 1961 and kerala industrial employee's payment of gratuity act, 1970 - assessee was transferee of some business - assessee retained some amount from sale price of business for payment of gratuity to employee of transferor - whether amount of gratuity deductible - liability of payment of gratuity fell on assessee - assessee discharged liability as per scheme and rules - transfer of business makes no difference in case provision for same not made - assessee entitled to deduction for gratuity. - - this means that with the promulgation of the ordinance with effect from december 10, 1969, which was well before the transfer of the estates, it became the responsibility of the assessee to ensure that the gratuity payable.....kochu thommen, j.1. the following two questions have been, at the instance of the assessee, referred to us by the income-tax appellate tribunal, cochin bench :'1. whether, on the facts and in the circumstances of the case, rs. 13,43,923, being the amount withheld by m/s. gounder & co. p. ltd., for payment of gratuity to the employees from the sale price is to be allowed as a deduction in computing the business loss of the assessee for the assessment year 1971-72? 2. whether, on the facts and in the circumstances of the case, the assessee is entitled to deduction of rs. 2,69,372 in respect of plant and machinery and rs. 3,33,456 in respect of buildings under section 32(1)(iii) of the income-tax act, 1961, for the assessment year 1971-72, though the sale by the assessee to m/s. gounder &.....
Judgment:

Kochu Thommen, J.

1. The following two questions have been, at the instance of the assessee, referred to us by the Income-tax Appellate Tribunal, Cochin Bench :

'1. Whether, on the facts and in the circumstances of the case, Rs. 13,43,923, being the amount withheld by M/s. Gounder & Co. P. Ltd., for payment of gratuity to the employees from the sale price is to be allowed as a deduction in computing the business loss of the assessee for the assessment year 1971-72?

2. Whether, on the facts and in the circumstances of the case, the assessee is entitled to deduction of Rs. 2,69,372 in respect of plant and machinery and Rs. 3,33,456 in respect of buildings under Section 32(1)(iii) of the Income-tax Act, 1961, for the assessment year 1971-72, though the sale by the assessee to M/s. Gounder & Co. P. Ltd. of the four estates, together with the buildings, plant and machinery in question, was made under the deed executed on April 30, 1971 ?'

2. The assessee is a public limited company carrying on the business of manufacture and sale of tea, coffee, pepper, cardamom, etc. It owned five tea estates in the State of Kerala, In the accounting year ending on September 26, 1970, relevant to the assessment year 1971-72, the assessee entered into an agreement dated April 15, 1970, with Gounder & Company P. Ltd. for the sale of four of its estates, pursuant to which, possession was handed over to the latter on May 1, 1970. In the following accounting year, relevant to the assessment year 1972-73, by a deed of sale dated April 30, 1971, the ownership in the property was also transferred to Gounder & Co. P. Ltd. (hereinafter referred to as 'the buyer').

3. In terms of the agreement dated April 15, 1970, the assessee was entitled to receive as sale consideration a sum of Rs. 42,00,000 out of which a sum of Rs. 15,00,000 was agreed to be retained by the buyer as a reserve fund for settlement of the assessee's liability towards gratuity payable to the employees of the four estates in respect of their services under the assessee. On settlement of the accounts, the sum that was finally retained by the buyer for payment of gratuity was only Rs. 13,43,923. The balance amount was received by the assessee after the transfer of the estates.

4. The assessee maintained the mercantile system of accounting. In its return filed on July 7, 1971, as clarified on April 12, 1973, the assessee claimed a business loss of Rs. 9,11,555. In computing this loss, it claimed deduction of Rs. 13,43,923 as gratuity payable to the employees in the four estates for their services under the assessee prior to the date of transfer. This claim for deduction was disallowed by the ITO by his order dated March 14, 1974, on the ground that the liability for payment of gratuity was a contingent liability which did not relate to the assessment year in question. Against that finding, the assessee appealed to the AAC who by his order dated February 20, 1977, dismissed the appeal. A further appeal to the Tribunal was also dismissed. The Tribunal said that theassessee had closed down its business with the transfer of the estates to the buyer. The deduction claimed was purported to be in respect of 'the present discounted value of a luture liability'', But the assessee had no future liability, the Tribunal observed, as the estates had been sold as running business. The Tribunal concluded that the liability of the assessee which had been taken over by the buyer was not in the nature of a revenue expenditure and it could not be taken into account in the assessment of the income of the relevant year.

5. As regards the assessee's claim under Section 32(1)(iii) of the I.T. Act, 1961 (the 'Act'), covered by the second question referred to us, the Tribunal and the authorities below held that it was premature in so far as the actual sale fell outside the accounting year in question. The Tribunal stated :

'The claim could hence arise if at all only in the subsequent year.'

6. We shall now deal with the first question. Appearing for the assessee, Sri K.A. Nayar submits that the liability for payment of gratuity was a debt in praesenti, payable in the future. This debt, he contends, arose for the first time under the Kerala Industrial Employees' Payment of Gratuity Ordinance, 1969, which came into force on December 10, 1969, and later replaced by the Kerala Industrial Employees' Payment of Gratuity Act, 1970, which came into force on February 18, 1970, both within the accounting year relevant to the assessment year in question. This liability covered not only the year of account, but also the earlier years of service. Gratuity is payable to each employee, in respect of the entire period of his service, on the happening of any one of the events specified under Section 4 (see Ordinance No. 7 of 1969 and Act 6 of 1970), namely, (a) superannuation ; (b) retirement, resignation, retrenchment, discharge or dismissal after completion of a minimum period of continuous service ; and (c) death or total disablement due to accident or disease. This means that with the promulgation of the Ordinance with effect from December 10, 1969, which was well before the transfer of the estates, it became the responsibility of the assessee to ensure that the gratuity payable for the years of service of each employee under it was provided for, in order that, on the happening of any one of the specified events, the employee would receive the gratuity. Since it was the buyer who would be called upon to pay the amounts not only in respect of the service under it, but also for the earlier period, the aforesaid sum of Rs. 13,43,923 was, in terms of the agreement, retained by the buyer. Counsel, therefore, contends that, in the light of the decision of the Supreme Court in Metal Box Company of India Ltd. v. Their Workmen : (1969)ILLJ785SC and those of this court in CIT v. High Land Produce Co. Ltd. : [1976]102ITR803(Ker) , CIT v. Kerala Nut Food Co. [1978] 111 ITR 252, CIT v. PratapCashew Co. (P) Ltd. : [1979]116ITR733(Ker) and CIT v. Standard Furniture Co. Ltd. : [1979]116ITR751(Ker) , the Tribunal was in error in holding that the deduction claimed by the assessee was not allowable.

7. Counsel for the Revenue, on the other hand, contends that the principle laid down in these decisions is not applicable to the facts of the instant case as the assessee has sold its business and the amount retained by the buyer towards gratuity is not a sum which the assessee had laid out or expended wholly and exclusively for the purpose of the business so as to entitle it to claim deduction in the computation of the profits and gains of its business. Counsel says that the decision of the Supreme Court in CIT v. Gemini Cashew Sales Corporation : [1967]65ITR643(SC) , is directly in point and, in the light of that decision, the claims of the assessee cannot be allowed. Counsel further contends that in the past, it was not the practice of the assessee, in so far as gratuity was concerned, to maintain its accounts on the basis of the mercantile system.

8. Gratuity is a present liability which has to be discharged at a future date. It is not a contingent liability as the liability has already arisen and is in existence on completion of each year of service or part thereof in excess of six months, although the payment is dependent upon a contingency. It is a debitum in praesenti, solvendttm in futuro. On the other hand, a purely contingent liability is not a present liability, as the liability itself, and not the payment alone, is dependent upon a contingency. What is deductible as a business expenditure under the Act is not a future liability, but a present liability. We shall now examine the basic decisions which explain this distinction.

9. In Calcutta Co. Ltd. v. CIT : [1959]37ITR1(SC) , the Supreme Court had occasion to consider the nature of an accrued liability, deduction for which was claimed on the basis of the estimated expenditure. The court said that an estimated expenditure for development of lands which the assessee had undertaken to carry out was an accrued liability which was a present liability, though it was to be discharged at a future date, and it was, therefore, an allowable deduction under the Act in arriving at the profits and gains of the business in a mercantile system of accounting. The ratio of this decision is that, to give rise to an allowable deduction, it must be a present liability--an accrued liability--although payable only in the future on the happening of an event, not a mere contingent liability which is a future liability.

10. In Indian Molasses Co. v. CIT : [1959]37ITR66(SC) , the Supreme Court disallowed a claim for deduction on the ground that the money put aside to meet a contingency was not an expenditure within the meaning of Section 10(2)(xv) of the Indian I.T. Act, 1922. The court distinguished a liabilityin praesenti from a liability in future, which for the time being was only contingent, and pointed out that the former alone qualified for deduction as business expenditure. Speaking for the court, Hidayatullah J., as he then was, emphasised the true nature of an expenditure and the distinction between a contingent liability and a payment dependent upon a contingency. He said (pp. 78, 79, 80) :

''Expenditure' is thus what is 'paid out or away' and is something which is gone irretrievably............ To be a payment which is madeirrevocably, there should be no possibility of the money forming, once again, a part of the funds of the assessee company. If this condition be not fulfilled and there is a possibility of there being a resulting trust in favour of the company, then the money has not been spent, i.e., paid out or away, but the amount must be treated as set apart to meet a contingency. There is a distinction between a contingent liability and a payment depending upon a contingency.........

In our opinion, the payment was not merely contingent but the liability itself was also contingent. Expenditure which is deductible for income-tax purposes is one which is towards a liability actually existing at the time, but the putting aside of money which may become expenditure on the happening of an event is not expenditure. In the present case, nothing more was done in the account years. The money was placed in the hands of trustees and/or the insurance company to purchase annuities of different kinds, if required, but to be returned if the annuities were not bought and the setting apart of the money was not a paying out or away of these sums irretrievably.'

11. It was thus an uncertain liability which was purely contingent. It had not yet accrued, but might or might not accrue in the future. It was, therefore, not a 'present liability' the payment of which alone remained contingent. In drawing this distinction, the court accepted the principle adopted by the House of Lords in Southern Railway of Peru Ltd. v. Owen (Inspector of Taxes) [1951] AC 334 : 32 ITR 737, where Lord Oaksey observed (p. 344 of [1957] AC & 746 of 32 ITR) :

'There is, in my opinion, a fundamental distinction between a contingent liability and a payment dependent upon a contingency. When a debt is not paid at the time it is incurred, its payment is, of course, contingent upon the solvency of the debtor but the liability is not contingent.'

12. In CWT v. Standard. Vacuum Oil Co. Ltd. : [1966]59ITR569(SC) , the Supreme Court, on the other hand, held that the amounts mentioned in the notices of demand for advance tax were 'debts owed' on the valuation date within the meaning of Section 2(m) of the W.T. Act and had, therefore, to be deducted in computing the net wealth of the assessee. Thisprinciple was followed by the Supreme Court in Kesoram Industries and Cotton Mills Ltd. v. CWT : [1966]59ITR767(SC) , Standard Mills Co. Ltd. v. CIT : [1967]63ITR470(SC) and Bombay Dyeing & Mfg. Co. Ltd. v. CWT : [1974]93ITR603(SC) . In Kesoram Industries and Cotton Mills Ltd.'s case : [1966]59ITR767(SC) , the Supreme Court stated (p. 784) :

'A debt is a present obligation to pay an ascertainable sum of money, whether the amount is payable in praesenti or in futuro : debitum in praesenti, solvendum in futuro. But a sum payable upon a contingency does not become a debt until the said contingency has happened. A liability to pay income-tax is a present liability though it becomes payable after it is quantified in accordance with ascertainable data. There is a perfected debt at any rate on the last day of the accounting year and not a contingent liability.'

13. On the same reasoning, a claim for deduction in respect or dividend was disallowed by the court in that case. The amount had been set apart by the assessee as dividend on the basis of a report of its directors, but it had not been, as on the valuation date, accepted by the company in its general body meeting. The court observed that it was only at the stage of recommendation of the directors which could be withdrawn or modified until the approval of the general body was obtained. It was accordingly held that that was not a 'debt owed' which could be deductible in computing the net wealth of the company.

14. In Standard Mills Co. Ltd. v. CIT : [1967]63ITR470(SC) , the Supreme Court disallowed in respect of gratuity, a claim for deduction under the W.T. Act. The court said that the liability to pay gratuity to the employees arose under the award only when the employment was determined, and it was, therefore, not a 'debt owed' for the purpose of deduction under the W.T. Act. This decision, in the light of the subsequent decision of the Supreme Court in Metal Box Co. of India Ltd. v. Their Workmen : (1969)ILLJ785SC , has, in our view, to be distinguished from the instant case for two reasons. In the first place, the deduction claimed in the instant case is not under the W.T. Act as a 'debt owed' on the valuation date within the meaning of Section 2(m) of the W.T. Act but under the I.T. Act as a business expenditure allowable under Section 37. Secondly, the liability in the instant case did not arise under a contract or an award, but under a statute which came into force in the relevant accounting year imposing for the first time an obligation to pay gratuity not only for that year and the subsequent years of service, but also for the past years of service.

15. In CIT v. Gemini Cashew Sales Corporation : [1967]65ITR643(SC) , the Supreme Court disallowed a claim for deduction in respect of retrenchment compensation payable under Section 25FF of the Industrial Disputes Act, 1947. The court said that the liability arose not for the purpose, or in the course of, the business, but on account of the transfer of the business. The asses-see had no liability to pay retrenchment compensation during the entire period of the business. The liability which arose as a result of the transfer of the business was not of a revenue nature and it could not be deducted under Section 10(1) of the Indian I.T. Act, 1922. The court pointed out that the liability under Section 25FF being wholly contingent and not creating any definite obligation during the operation of the business as a running concern, such liability did not fall within the expression 'expenditure laid out or expended wholly and exclusively for the purpose of the business' in terms of Section 10(2)(xv) of the Indian Income-tax Act, 1922. This is the decision that counsel for the Revenue strongly relies upon. We shall presently revert to it.

16. In Metal Box Company of India Ltd. v. Their Workmen : (1969)ILLJ785SC , the Supreme Court examined the nature of the liability of an assessee, maintaining his accounts on the mercantile system, to pay gratuity in the context of the Bonus Act. The court observed that an estimated liability under a scheme of gratuity, if properly ascertained and its present value fairly discounted, was deductible from the gross receipts while preparing the profit and loss account. The court said (pp. 62, 63, 67) :

'In the case of an assessee maintaining his accounts on the mercantile system, a liability already accrued, though to be discharged at a future date, would be a proper deduction while working out the profits and gains of his business, regard being had to the accepted principles of commercial practice and accountancy. It is not as if such deduction is permissible only in case of amounts actually expended or paid.......

In our view, an estimated liability under gratuity schemes such as the ones before us, even if it amounts to a contingent liability and is not a debt under the Wealth-tax Act, if properly ascertainable and its present value is fairly discounted, is deductible from the gross receipts while preparing the profit and loss account. It is recognised in trading circles and we find no rule or direction in the Bonus Act which prohibits such a practice.'

17. In these decisions, the Supreme Court accepted the principle adopted by the House of Lords in Southern Railway of Peru Ltd. v. Owen (Inspector of Taxes) [1957] AC 334 : 32 ITR 737, as records the nature of an accrued liability and quoted with approval the following observation of Lord MacDermott with whom the other Law Lords had agreed on the point (p. 747 of 32 ITR) :

'...as a general proposition it is, I think, right to say that, in computing his taxable profits for a particular year, a trader, who is under adefinite obligation to pay his employees for their services in that year an immediate payment and also a future payment in some subsequent year, may properly deduct, not only the immediate payment, but the present value of the future payment, provided such present value can be satisfactorily determined or fairly estimated.'

18. What is properly deductible in respect of a liability which accrued in the year of account, but payable only in the future, is the present value of the future payment, provided it can be satisfactorily determined or fairly estimated. It is this principle of actuarial valuation on the basis of a mercantile system of accounting that the Supreme Court had in mind in Indian Molasses Co. (P.) Ltd. v. CIT : [1959]37ITR66(SC) , where Hidayatullah J. referred to the distinction between a mere contingent liability and a payment dependent upon a contingency.

19. Following this principle, the Allahabad High Court in Madho Mahesh Sugar Mills (P.) Ltd. v. CIT [1973] 92 ITR 503, dealt with a claim for deduction based on a Government order providing for payment of gratuity to workers in the sugar industry. The court said that in the relevant year, when the order came into force, it was open to the assessee to make provision for payment of gratuity in terms of the order not only in respect of the year of account but also for the earlier years. The court said (p. 510) :

'The liability for the payment of gratuity was cast upon the assessee for the first time under the notification aforesaid on November 1, 1960. Before that date, there was no such liability upon it. The notification, however, provided that the gratuity would be payable to an employee not only in respect of his future services but also for his past services. Thus, in order to ascertain the quantum of liability as on November 1, 1960, the past services of the employees had also to be taken into account. That does not mean that any part of the gratuity was payable by the assessee in any of the earlier years. The past services of the employees had to be taken into account merely to arrive at the quantum of the liability which became payable after the notification.'

20. The ratio of this decision is that, in the year of account when the liability was imposed for the first time under the notification in respect of the past and future services of the employees, it was open to the assessee to take into consideration not only the liability of that year, but also of the earlier years, for arriving at the right amounts falling due as per the notification. This principle was adopted in the decisions of this court in CIT v. High Land Produce Co. Ltd. : [1976]102ITR803(Ker) , CIT v. Kerala Nut Food Co. [1978] 111 ITR 252 and CIT v. Pratap Cashew Co. (P.) Ltd. : [1979]116ITR733(Ker) , to all of which one of us (Kochu Thommen J.)was a party. In the second of these cases, the claim for deduction for the earlier years was disallowed for the reason that appropriate provision had not been made in the year of account during which the Gratuity Ordinance came into force imposing for the first time a statutory liability. The principle followed in these cases was affirmed by a Full Bench of this court in CIT v. Standard Furniture Co. Ltd. : [1979]116ITR751(Ker) .

21. Counsel for the Revenue, however, contends that, in the light of the decision of the Supreme Court in CIT v. Gemini Cashew Sales Corporation : [1967]65ITR643(SC) , the decision of the Full Bench in Standard Furniture Co. Ltd. : [1979]116ITR751(Ker) , requires reconsideration. The Full Bench dealt with a case where the facts were almost identical to those of this case. Unlike in Pratap Cashew Co. (P.) Ltd. : [1979]116ITR733(Ker) ', where the claim for deduction was made by the transferee, in Standard Furniture Co. Ltd. : [1979]116ITR751(Ker) as well as in the present case, the claim was made by the transferor. Counsel for the Revenue contends that the transferor was no longer interested in the business, for it had already parted with it. It could claim no expenditure to be expended in the course of or for the purpose of the business. No amount could be laid out or expended by it wholly and exclusively for such purpose. The liability for payment of gratuity arose in the present case, counsel submits, exactly as in the case of retrenchment compensation. It arose not in the course of the business, but upon closure of the business consequent upon its transfer. Counsel refers to the following observations of the Supreme Court in CIT v. Gemini Cashew Sales Corporation : [1967]65ITR643(SC) :

'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............During the entire period that thebusiness 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....A deduction which is proper and necessary forascertaining the balance of profits and gains of the business is undoubtedly properly allowable, but where a liability to make a payment arises not inthe 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.'

22. The Supreme Court was dealing with a case of retrenchment compensation payable under Section 25FF of the Industrial Disputes Act, 1947, where the liability did not arise during the continuance of the employment under the transferor. Until the transfer of the business, the liability was purely contingent as distinguished from an accrued liability, such as gratuity, of which payment alone was contingent. Retrenchment compensation, unlike gratuity, is an uncertain liability which is contingent upon the happening of an event, which may or may not happen. Until the event has happened, the liability has not accrued, and it remains purely contingent. A workmen may himself terminate his employment or he may die or he may become superannuated or his service may be terminated on the ground of continued ill-health or by way of disciplinary action. In none of these events, retrenchment compensation is payable. An event postulated under Section 25F or Section 25FF or Section 25FFF of the Industrial Disputes Act may or may not occur and unless it occurs, no retrenchment compensation is due, or liability therefor accrues. Until then, no debt arises in favour of the workman : no debitum in praesenti ; solvendum in futuro. On the other hand, gratuity is an accrued liability--a present liability--due in respect of all the years of service, although not payable until any one of the postulated events under Section 4 of the Gratuity Act happens. One of those events, unlike in the case of retrenchment, is bound to happen giving rise to payment of gratuity. Gratuity is thus a liability which accrues at the end of every completed year of service, or a part thereof in excess of six months, and which becomes due for discharge at a future date upon the happening of an event which is certain. It is a debitum in praesenti solven-dum in futuro. The liability is, therefore, not contingent; only the payment is dependent upon a contingency. Every prudent employer will rightly provide for the same: see Indian Molasses Co.'s case : [1959]37ITR66(SC) ; Southern Railway of Peru Ltd. v. Owen (Inspector of Taxes) [1957] AC 334 : 32 ITR 737. It is this vital distinction between an accrued liability to be discharged in the future, as in the case of Metal Box Co. : (1969)ILLJ785SC , on the one hand and wholly contingent liability, as in the case of Gemini Cashew Sales Corporation [1967] 65 ITR 643 on the other, that is lost sight of by the Revenue in contending for the proposition that the principle adopted by the Full Bench of this court in CIT v. Standard Furniture Co. Ltd. : [1979]116ITR751(Ker) is inconsistent with the decision of the Supreme Court in CIT v. Gemini Cashew Sales Corporation : [1967]65ITR643(SC) . This distinction was very much in the mind of theSupreme Court in that case in distinguishing retrenchment compensation from a liability which was not purely contingent. The court said (p. 649 of 65 ITR) :

''..........the present value on commercial valuation of money tobecome due in future, under a definite obligation, will be a permissible outgoing or deduction in computing the taxable profits of a trader, even if in certain conditions the obligation may cease to exist because of forfeiture of the right. Where, however, the obligation of the trader is purely contingent, no question of estimating its present value may arise, for, to be a permissible outgoing or allowance, there must in the year of account be a present obligation capable of commercial valuation.'

23. Counsel for the Revenue refers to three decisions of the Madras High Court in Stanes Motors (South India] Ltd. v. CIT : [1975]100ITR341(Mad) ; CIT v. Pathinen Grama Arya Vyasa Bank Ltd. : [1977]109ITR788(Mad) and CIT v. Salem Bank Ltd. : [1979]120ITR224(Mad) , where that court held that the liability for payment of gratuity, being a wholly contingent liability springing from the transfer of the business, and not in the course of the business, was not an allowable deduction. In so stating, the court relied upon the decision in CIT v. Gemini Cashew Sale Corporation : [1967]65ITR643(SC) . It would appear that in none of those cases, the decision in Metal Box Company of India. Ltd. v. Their Workmen : (1969)ILLJ785SC was either cited at the bar or considered by the High Court. With the utmost respect, we do not find ourselves able to accept the reasoning of the Madras High Court. In our view, the matter is concluded by the decision of the Full Bench of this court in Standard Furniture Co. Ltd.'s case : [1979]116ITR751(Ker) and, with respect, we do not agree that it requires reconsideration.

24. Counsel for the Revenue refers to the decision of the Supreme Court in E.D. Sassoon & Co. Ltd. v. CIT : [1954]26ITR27(SC) , and submits that, unless the liability of the assessee continued till the end of the accounting year, it was not entitled to provide for deduction and claim it as an allowable item of expenditure under Section 37. The Supreme Court in that case examined the relevant terms of a managing agency agreement and the respective contentions of the parties and came to the conclusion that no part of the managing agency commission accrued prior to the end of the calendar year which was the terminus a quo for the making up of the accounts and determining the net profits of the company. This principle, which was stated with reference to the agreement between the parties, has no application to a case such as the present where, shortly before the transfer of the business, a liability arose for the first timeunder a statute, in respect of the year of account as well as of the earlier years.

25. The Revenue's counsel submits that the assessee did not follow the mercantile system of accounting in so far as payment of gratuity to its former employees was concerned. Why should it change the method of accounting in this respect concerning the employees who remained in its service at the relevant time, counsel asks. We see no merit in this argument. The very order of assessment shows that the method of accounting followed by the assessee was mercantile. There is no case that it followed any other method. It may be true, as stated by the ITO, but not pursued by the higher authorities, that in respect of the employees in the past, the assessee had paid gratuity as per a scheme without making periodical provisions therefor in its accounts for claiming deductions. We have no knowledge of the terms of that scheme, Whatever they were, with the sudden imposition of a liability under the statute, the assessee, as held by this court, became entitled to make provisions therefor in accordance with the mercantile system of accounting, which it had always followed and to claim deduction as business expenditure. Any provision which it chose to make for the earlier years as well as for the year of account had to be made in the year of account when the statute came into force or else, as stated in CIT v. Kerala Nut Food Co. [1978] 111 ITR 252, it would have been too late for deduction. The fact that subsequently the business was transferred made no difference to the liability which arose under the Gratuity Ordinance or the Act and to the concomitant right of deduction in terms of Section 37 of the Act. It must be stated that, in the absence of any exemption having been granted under Section 5 from the operation of the Gratuity Ordinance or the Act, the assessee was bound to make payments in accordance with the statute, and not any scheme.

26. In the circumstances, we see no merit in the contentions of the Revenue in regard to the first question, the extremely well prepared arguments of its counsel notwithstanding.

27. We now come to the second question which refers to a claim for deduction in terms of Section 32(1)(iii). The Tribunal, as we stated earlier, disposed of this question stating that the claim was premature. We agree, for that is what the section says : It reads :

'32. (1) In respect of depreciation of buildings, machinery, plant or furniture owned by the assessee and used for the purposes of the business or profession, the following deductions shall, subject to the provisions of Section 34, be allowed :...

(iii) in the case of any building, machinery, plant or furniture which is sold, decarded, demolished or destroyed in the previous year (other than the previous year in which it is first brought into use), the amount by which the moneys payable in respect of such building, machinery, plant or furniture, together with the amount of scrap value, if any, fall short of the written down value thereof :... '

28. The section shows that the deduction is allowable only in respect of the previous year in which the sale took place and the claim for deduction should be made in the relevant assessment year, which in the present case is 1972-73, the sale having taken place on April 30, 197], in the accounting year 1971-72. Accordingly, the deduction ought to have been claimed by the assessee only in the assessment year 1972-73 and not earlier.

29. In the light of what is stated above, we answer the first question in the affirmative, that is, in favour of the assessee and against the Revenue, and the second question in the negative, that is, in favour of the Revenue and against the assessee. We direct the parties to bear their respective costs in this tax referred case.

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


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