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Nagri Mills Co. Ltd. Vs. Commissioner of Income-tax, Gujarat - Court Judgment

LegalCrystal Citation
SubjectDirect Taxation
CourtGujarat High Court
Decided On
Case NumberIncome-tax Reference No. 149 of 1975
Judge
Reported in[1981]131ITR257(Guj)
ActsIncome Tax Act, 1961 - Sections 2(15), 4, 10, 12, 13, 28, 29, 30, 31, 32, 33, 34, 35, 36, 36(v), 36(1), 37, 37(1), 38, 39, 40, 41, 42, 43A, 143, 144 and 145; Wealth Tax Act, 1957 - Sections 2 and 7(2)
AppellantNagri Mills Co. Ltd.
RespondentCommissioner of Income-tax, Gujarat
Appellant Advocate K.C. Patel, Adv.
Respondent Advocate G.N. Desai, Govt. Pleader
Cases ReferredMetal Box Company of India Ltd. v. Their Workmen
Excerpt:
direct taxation - deduction - sections 28 and 37 of income tax act, 1961 - assessee claimed deduction in computation of income regarding some amount being expenditure of nature described in section 37 - whether tribunal justified in confirming disallowance on account of gratuity liability - claim of deduction not dependant upon fact whether relevant entries are made in books of account or not - entitlement of assessee to particular deduction depends upon provisions of law - assessee maintaining accounts on merchantile system justified in claiming deduction in respect of its estimated gratuity liability which was worked out on actuarial valuation while computing income under section 28. - - indeed, it was not even the case of the revenue at any stage that the basis of actuarial.....p.d. desai, j.1. the assessee is a public limited company carrying on business of textile manufacture. it maintains its books of account on the mercantile system of accounting. the assessment year is 1968-69, the previous year being the calendar year 1967. 2. it appears that the assessee, along with certain other textile mills, was a party to an industrial dispute raised by the textile labour association, ahmedabad, under the provisions of the bombay industrial relations act, 1946, and that the said dispute resulted in an award made by the industrial court, bombay, on september 16, 1957. the award came into force on and with effect from the said date. under the award, gratuity was payable to the employees of the assessee according to the scale and subject to the conditions therein laid.....
Judgment:

P.D. Desai, J.

1. The assessee is a public limited company carrying on business of textile manufacture. It maintains its books of account on the mercantile system of accounting. The assessment year is 1968-69, the previous year being the calendar year 1967.

2. It appears that the assessee, along with certain other textile mills, was a party to an industrial dispute raised by the Textile Labour Association, Ahmedabad, under the provisions of the Bombay Industrial Relations Act, 1946, and that the said dispute resulted in an award made by the Industrial Court, Bombay, on September 16, 1957. The award came into force on and with effect from the said date. Under the award, gratuity was payable to the employees of the assessee according to the scale and subject to the conditions therein laid down, (i) on the death of an employee while in the service of the assessee or on his becoming physically or mentally incapacitated for further service, (ii) on voluntary retirement or resignation of an employee after fifteen years' continuous service, and (iii) on termination of service by the assessee after ten or fifteen years' continuous service, as the case may be. Broadly speaking, gratuity payable under the award was to be worked on the basis of one month's or half a month's basic wages for each completed year of service, depending upon the circumstances of the case, subject to a certain maximum. Gratuity would not, however, be payable to an employee dismissed for misconduct. The assessee accepted the award and from time to time it went on paying gratuity to its employees who became entitled thereto under the award from 1957 onwards. The assessee used to make payment on the happening of any of the event mentioned in the award in relation to any of its employees and the payment, when actually made accordingly, used to be debited in its books of account and allowed as a deduction in the computation of the assessee's income for the relevant year in the course of its assessment to income-tax.

3. For the assessment year in question, the assessee filed its return of income on July 10, 1968. After the return was filed but before the assessment was completed, the assessee decided to obtained an actuarial valuation of its estimated gratuity liability and to make provision for meeting such liability not all at once in the year in which the gratuity became payable to any employee but to spread it over a number of years by making a provision therefor in the profit and loss account of each year on the basis of the present value of such estimated liability. The assessee, accordingly, obtained an actuarial valuation of its gratuity liability for the calendar year 1967, and decided to charge against that year's income the cost of making provision for such liability.

4. On December 10, 1971, the assessee addressed a letter to the ITO, who was seized of its assessment proceeding for the relevant assessment year, stating that the 'gratuity payable by the assessee to its employees for the year ending December 31, 1967' was estimated at Rs. 29,637 on the basis of an actuarial report and that in view of the decision in Metal Box Company of India Ltd. v. Their Workmen : (1969)ILLJ785SC , the company was entitled to deduction under s. 37(1) of the I.T. Act, 1961, (hereinafter referred to as 'the Act'), in respect of such gratuity liability. The assessee requested the ITO to consider its claim in that behalf while finalising its assessment.

5. Along with the said letter, the assessee annexed what was described as 'Annual Gratuity Provision Report in respect of the year 1967' and a certificate, both dated November 16, 1971, of M/s. B. G. Dave & Co. Under the said report, on the basis of the date supplied by the assessee, the annual gratuity provision of the calendar year 1967 was worked out on an actuarial valuation basis at Rs. 29,637. Be it stated that the annual gratuity provisions was calculated so as : (i) to include the commuted value of the increases (during the year) in accrued nominal gratuity amounts for employees in the service of the company at the end of the year, (ii) to take into account the difference between the actual gratuity payment and the accrued nominal gratuity amount arising on account of service during the year in case of employees whose services were terminated for one or the other reason during the course of the year, and (iii) to take account of or incorporate the exact particular effect of gratuity payments according to gratuity regulations of the company to employees whose services were terminated otherwise than by normal retirement or death. The certificate in terms recited that the gratuity provision to be made in the accounts of the assessee for the year ending December 31, 1967, arising on account of the services of its employees during the year was Rs. 29,637 and that the valuation basis adopted was 4% per annum rate of interest and modified (1925-35) rates of mortality.

6. It would thus appear that the factor of discount was taken into consideration while making the actuarial valuation. Indeed, it was not even the case of the revenue at any stage that the basis of actuarial valuation was not correct or reliable because any relevant factor was not taken into account.

7. The ITO took into consideration the claim advanced by the assessee but rejected it on the ground that the assessee had neither paid the amount nor made any provision therefor. On appeal, the AAC confirmed the order of the ITO on the ground that although the assessee had adopted the mercantile system of accounting, no provision was actually made in respect of gratuity liability in its accounts for the year in question and that, in any case, the award of the Industrial Court merely provided for gratuity being paid on the happening of certain events and that, therefore, the assessee could not be said to have incurred any present liability for the payment of gratuity. On further appeal, the Income-tax Appellate Tribunal took note of the fact that in the past the amounts paid by way of gratuity to employees were claimed and allowed as a deduction whenever the actual payment was made upon the happening of any of the contingencies provided in the award. Besides, though in the year of assessment the assessee claimed a deduction on the basis of an actuarial valuation of the estimated liability, no provision therefor was made in the accounts, although the assessee's books of account were maintained on the mercantile system of accounting. There was also no well-regulated scheme in existence whereunder contributions could be made to a gratuity fund. Moreover, the approval of the Commissioner of Income-tax was not obtained under the relevant rules as required by section 36. According to the Tribunal, the assessee was, therefore, not entitled to claim any deduction in respect of such estimated liability.

8. At the instance of the assessee, the Tribunal has referred the following question of law for the opinion of this court :

'Whether, on the facts and in the circumstances of the case, and having regard to the principles laid down by the various High Courts and the Supreme Court, the Tribunal was justified in law in confirming the disallowance of Rs. 29,637 on account of gratuity liability ?'

9. At the hearing of the reference, the assessee claimed that the amount of Rs. 29,637 was an expenditure of the nature described in s. 37 and allowable as a deduction in the computation of its income and, alternatively, that it was entitled to deduct the present value of the estimated gratuity liability worked out on actuarial basis in the profit and loss account while working out the net profits chargeable to income-tax under s. 28. We are of the view that the assessee is entitled to succeed on its alternative argument based on s. 28. We do not, therefore, propose to express any opinion on the question whether the deduction is allowable under s. 37.

10. Section 28 provides that the income therein described shall be chargeable to income-tax under the head 'Profits and gains of business or profession'. Under s. 29, the income referred to in s. 28 is required to be computed in accordance with the provisions contained in ss. 30 to 43A. Section 145 provides that income chargeable under the head 'Profits and gains of business or profession' or 'Income from other sources' shall be computed in accordance with the method of accounting regularly employed by the assessee; provided, however, that in any case, where the accounts are correct and complete to the satisfaction of the ITO but the method employed is such that, in the opinion of the ITO, the income cannot properly be deduced therefrom, then the computation shall be made upon such basis and in such manner as the ITO may determine. Where the ITO is not satisfied about the correctness or the completeness of the accounts of the assessee, or where no method of accounting has been regularly employed by the assessee, the ITO is at liberty to make an assessment in the manner provided in s. 144. The controversy between the parties arising out of the question referred for our opinion is required to be decided against the background of the aforesaid legal provisions.

11. In Southern Railway of Peru Ltd. v. Owen [1957] 32 ITR 737 , an English company operating a railway in Peru was, under the laws operating in that country, liable to pay its employees compensation on certain basis on the termination of their services either by dismissal or by notice or by death or efflux of contractual time. The company claimed, in the computation of taxable income under the I.T. Act, 1918, to be entitled to charge against each year's receipts the cost of making provision for the retirement payments which would ultimately be thrown on it, calculating the sum required to be paid to each employee if he retired without forfeiture at the close of the year and setting aside the aggregate of what was required in so far as the year had contributed to the aggregate. The House of Lords rejected the deduction on the ground that in calculating the deductions the company had ignored the factor of discount. The principle was, however, recognised that the company was entitled to charge against each year's receipts the cost of making provision for the retirement payments which would ultimately be payable as the company had had the benefit of the employee's services during that year, provided the present value of the future payments could be fairly estimated. The argument that the company was not in any year under a definite obligation to pay its employees lump sums on the termination of their employment as in each case the right to a lump sum was contingent on certain conditions being fulfilled and so the prospective liability remained contingent until the service was actually ended was not upheld. Lord MacDermott observed at 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 a definite 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.'

12. Lord Radcliffe made similar observations at pp. 754, 755 :

'What the appellant claims the right to do is to charge against each year's receipts the cost of making provision for the retirement payments that will ultimately be thrown upon it by virtue of the fact that it has had the benefit of its employees' service during that year. As a corollary it will not make any charge to cover the actual payments made in the year in respect of retirement benefits. Only by such a method, it is said, can it bring against the receipts of the year the true cost of the services that it had used to earn those receipts. Generally speaking, this must, I think, be true. For, whereas it is possible that any one of its many employees may forfeit his benefit and so never require a payment, the substantial facts of the situation are that when the company has paid every salary and wage that is due for current remuneration of the year it has not by any means wholly discharged itself of the pecuniary burden which falls upon it in respect of the year's employment... I agree that provision for retirement payments is more likely to give an accurate reflection of the true cost of earning the year's receipts than merely charging against them the year's payments to employees who retire in the year.'

13. In Standard Mills Co. Ltd. v. CWT : [1967]63ITR470(SC) , which was a case arising out of an assessment under the W.T. Act, 1957, the assessee claimed that in computing its net wealth a certain estimated amount should be deducted on account of liability for gratuity to its workmen and staff in accordance with certain awards of the Industrial Court and the Labour Appellate Tribunal made before the relevant valuation date. Under the awards, gratuity was payable to an employee at certain prescribed but varying rate on the happening of certain specified events. The contention of the assessee was that the present value of the liability for payment of gratuity was a permissible deduction in valuing the assets of the business of the assessee under s. 7(2)(a) of the Act. Reliance was placed on behalf of the assessee, inter alia, upon the decision of the House of Lords in Southern Railway of Peru Ltd. v. Owen [1957] 32 ITR 737 . The Supreme Court held that the charge under the W.T. Act, 1957, was on the net wealth, on the corresponding valuation date, of every individual. Broadly speaking, net wealth is the difference on the valuation date between the aggregate value computed in accordance with the provisions of the Act of the assets belonging to the assessee and the aggregate value of all the debts owned by the assessee. If there is no debt owned on the valuation date, it can obviously not be deducted in determining the next wealth which is liable to tax. The following pertinent observations then appears at p. 474 (of 63 ITR) :

'.... there is little doubt on the plain terms of the awards that the liability to pay gratuity to the employees of the appellant-company on determination of employment is a mere contingent liability which arises only when the employment of the employee is determined by death, incapacity, retirement or resignation.....

The right to obtain gratuity under the awards arises only when there is determination of employment and not before. The liability does not exist in preaesenti; it is contingent upon the determination of employment.'

14. The decision in Southern Railway of Peru [1957] 32 ITR 737 was distinguished on the ground that the House of Lords in that case was concerned with the determination of the deductibility of the present value of a liability which may arise in future in the computation of taxable profits for the relevant year under the I.T. Act and that the same considerations could not apply to a case under the W.T. Act where the liability was to pay wealth-tax charged upon the net wealth of an assessee. In this view of the matter, the claim relating to deduction of the amount of liability for payment of gratuity to the employees of the company was held to be not maintainable.

15. In Metal Box Company of India Ltd. v. Their Workmen : (1969)ILLJ785SC , both the abovementioned decisions, namely, Southern Railway of Peru Ltd. v. Owen [1957] 32 ITR 737 and Standard Mills Co. Ltd. v. CWT : [1967]63ITR470(SC) were considered in the context of computation of bonus payable to the employee of the appellant-company in accordance with the Payment of Bonus Ordinance. The company was maintaining its books of account on the mercantile system of accounting. The company computed the amount of bonus payable to its employees but the employees disputed the computation, inter alia, on the ground that the company had wrongly reduced the gross profits and available surplus by deducting from the gross receipts the provision for gratuity made on the basis of the estimated liability under two gratuity schemes framed by the company. The company had worked out on an actuarial valuation its estimated liability and made provision for such liability spread over a number of years and deducted the amount so provided from the gross receipts in the profit and loss account while working out net profits. The contention on behalf of the workmen was that the amount which could be debited was that which was actually paid during the year and that the company was not entitled to debit in the profit and loss account any amount worked out by it is estimated liability. The company, on the other had, maintained that what it had done was legitimate and warranted by the principles of accountancy. While dealing with these rival contentions, the following general observations were made at the outset at pp. 62-63 (of 73 ITR) :

'In the case of an assessee maintaining his accounts on 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. Just as receipts, though not actual receipts but accrued due are brought in for income-tax assessment, so also liabilities accrued due would be taken into account while working out the profits and gains of the business.'

16. Amongst others, the decisions in Standards Mills Co. Ltd. v. CWT : [1967]63ITR470(SC) and Southern Railway of Peru Ltd. v. Owen [1957] 32 ITR 737 were referred to and while dealing with the decision in Standard Mills Co. Ltd., the following observations were made at p. 64 :

'The court held, in view of the terms of section 2(m) of the Wealth-tax Act, that as the liability to pay gratuity was not in preaesenti but would arise in future on the termination of service, i.e., on retirement, death or termination, the estimated liability under the scheme would not be a debt and, therefore, could not be deducted while computing the net wealth. These observations show that the court was of the view that though such a liability is a contingent liability and, therefore, not a 'debt' under section 2(m) of the Wealth-tax Act, it would be deductible under the Income-tax Act while computing the taxable profits....

It was then pointed out that the question in the case in hand was not whether such estimated liability arising under the gratuity schemes amounted to a debt or not but whether while working out the net profits, a trader can provide from his gross receipts his liability to pay a certain sum for every additional year of service which he receives from his employees. The answer to that question was provided in the following words at page 64 (of 73 ITR) : 'This, in our view, he can do if such liability is properly ascertainable and it is possible to arrived at a proper discounted present value. Even if the liability is a contingent liability, provided its discounted present value is ascertainable, it can be taken into account. Contingent liabilities discounted and valued as necessary can be taken into account as trading expenses if they are sufficiently certain to be capable of valuation and if profits cannot be properly estimated without taking them into account.'

17. Dealing next with the decision in Southern Railway of Peru Ltd. v. Owen [1957] 32 ITR 737, it was observed at p.65 :

'But their Lordships recognised the principle that the company was entitled to charge against each year's receipts the cost of making provision for the retirement payments which would ultimately be payable as the company had had the benefit of the employee's services during that year provided the present value of the future payments could be fairly estimated.'

18. Reference was then made to the form of balance-sheet in Sch. VI to the Companies Act, 1956, which allows certain items such a provident fund scheme, etc., for which a company is contingently liable to be treated as current liability and to Sch. VI, Pt. 2, which lays down the requirements of profits and loss account and requires that such account shall set out amongst other things, the aggregate amounts set aside or provisions made for meeting specific liabilities, contingencies or commitments. The contention that though Sch. VI to the Companies Act might permit a provision for contingent liabilities, the I.T. Act, 1961, does not, because, under s. 36(v), the only deduction from profits and gains permissible is of a sum paid by an assessee as an employer by way of his contribution towards an approved gratuity fund created by him for the exclusive benefit of his employees under an irrevocable trust, was rejected in the following words at p. 67 :

'This argument is plainly incorrect because section 36 deals with expenditure deductible from out of the taxable income already assessed and not with deductions which are to be made while making the P. & L. account. In our view, an estimated liability under gratuity scheme such as the one before us, even 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 P. & L. account. It is recognised in trading circles and we find no rule or direction in the Bonus Act which prohibits such a practice.'

19. The deduction in Metal Box Company of India Ltd. v. Their Workmen : (1969)ILLJ785SC leaves no room for doubt that the deduction by way of expenditure of a sum paid by the assessee as contribution towards an approved gratuity fund set up under s. 36(1) (v) is not the only permissible deduction. The statutory provision in that behalf does not negative the alternative of deduction from the gross receipts of an estimated liability for gratuity, even if it amounts to a contingent liability, while preparing the profit and loss account, if such liability is properly ascertainable and its present value is fairly discounted. In our opinion, therefore, the assessee's claim in the instant case that it was entitled to charge against its gross receipts for the calendar year 1967, the cost of making provision for the gratuity which would ultimately have to be paid to its workmen by calculating the present value of such liability on an actuarial basis and that it was entitled to work out the net profits chargeable to income-tax under s. 28, accordingly to work out the net profits chargeable to income-tax under s. 28, accordingly is well founded and that the Tribunal's view to the contrary is not right in law.

20. The submission on behalf of the revenue was that under s. 145, profits of business were required to be computed in accordance with the method of accounting regularly employed by the assessee and that, therefore, the taxing authorities were justified in disallowing the claim of the assessee which was founded on a departure from its established method of accounting. The argument was that up to the account year in question, the method of accounting followed by the assessee was to debit in its accounts the actual payments made during the year to the workmen who became entitled to gratuity under the award and that the claim laid to deduct from the gross receipts the sum in question while preparing the profit and loss account amounted to a departure from its established method of accounting which was not permissible having regard to the provisions of s. 143. For the reasons which follow, we are unable to accept this submission.

21. Section 145 in substance enacts that for the purposes of s. 28, income, profits and gains must be computed in accordance with the method of accounting regularly employed by the assessee. The choice of the method of accounting undoubtedly lies with the assessee but it must be shown by him that such method has been followed regularly. The section is couched in mandatory terms and the department is bound by the assessee's choice of method regularly employed unless by that method, in the opinion of the ITO, the true income cannot properly be arrived at.

22. In CIT v. A Krishnaswami Mudaliar : [1964]53ITR122(SC) , the question was with regard to the applicability of the proviso to s. 13 of the Indian T. Act,. 1922. Section 13, broadly speaking, corresponds to s. 145. Both the provisions require that the income shall be computed in accordance with the method of accounting regularly employed by the assessee, but they also enable the ITO to compute the income, profits and gains upon such basis and in such manner as he may determine it, in his opinion, the method employed by the assessee is such that the income cannot be properly deduced therefrom. While considering the scope and ambit of s. 13 in A. Krishnaswami's case : [1964]53ITR122(SC) , the following observations from the decision of the Privy Council in CIT v. Sarangpur Cotton . [1938] 6 ITR 36 were extracted at p. 128 :

''... the section relates to a method of accounting regularly employed by the assessee for his own purposes.... and does not relate to a method of the section clearly makes such a method of accounting a compulsory basis of computation, unless, in the opinion of the Income-tax Officer, the income, profits and gains cannot properly be deduced therefrom. It may well be that, though the profit brought out in the accounts is not the true figure for income-tax purposes, the true figures can be accurately deduced therefrom.''

23. The decision in CIT v. McMillan & Co. : [1958]33ITR182(SC) was next referred to and it was pointed out that according to the said decision, the word 'in the opinion of the Income-tax Officer', occurring in the proviso to s. 13, did not confer a mere discretionary power; in the context, it imposed a statutory duty on the ITO to examine in every case the method of accounting employed by the assessee and to see whether or not it was regularly employed and to determine whether the income, profits and gains of the assessee could properly be deduced therefrom. The following pertinent observations were then made at p. 128 (of 53 ITR) :

'But the section only deals with the computation of income, profits and gains for the purposes of sections 10 and 12 and does not purport to the Act. Section 2(15) of the Act defines 'total income' as meaning total amount of income, profits and gains referred to in sub-section (1) of section 4 computed in the manner laid down in the Act.... Section 13... merely prescribes that the computation of taxable profits shall be made according to the method of accounting regularly employed.... The section does not compel the Income-tax officer to accept a balance-sheet of cash receipts and outgoings prepared from the books of account; he has to compute the income in accordance with the method of accounting regularly employed by the assessee... If, therefore, there is a system of accounting regularly employed and by appropriate adjustments from the accounts maintained taxable profit may properly be deduced, the Income-tax Officer is bound to compute the profits in accordance with the method of accounting. But where in the opinion of the Income-tax Officer the profits cannot properly be deduced from the system of accounting adopted by the assessee it is open to him to adopt a more suitable basis for computation of the true profits.'

24. This decision given in the context of s. 13 which, as earlier pointed out, broadly corresponded to s. 145, throws light on the context and meaning of s. 145. Under s. 145, it is open to the assessee to adopt any one of the recognised systems of accounting, whether it be cash system or mercantile system or hybrid or heterogeneous system. It is obligatory on the ITO to compute income for the purpose of s. 28 in accordance with such method of accounting provided it is regularly employed and if profits can properly be deduced therefrom. However, the section only deals with the computation of income for the purpose of s. 28. It does not purport to enlarge or restrict the content of income chargeable to tax under the head 'Profits and gains of business or profession'. If, therefore, there is system of accounting regularly employed and by appropriate adjustments from the accounts maintained taxable profit may be properly deduced, the ITO is bound to compute the profits in accordance with such method of accounting.

25. Now, in the instant case, it is not in dispute that the assessee is maintaining its books of account on the mercantile system of accounting. According to the mercantile method, actual cash receipts during the year and the actual cash outlays during the year are treated in the same way as under the cash system, but to the balance thus arising, there is added the amount of the outstanding not collected at the end of the year and from this is deducted the liabilities incurred or accrued but not discharged at the end of the year. (See CIT v. A. Krishnaswami Mudaliar : [1964]53ITR122(SC) ]. Up to the calendar year 1967, the assessee debited only the sum actually disbursed during the year on account of gratuity to such of its workmen to whom payment became due under the award. Such sum being the actual cash outlay on gratuity was correctly debited in the books of account maintained on the mercantile system. From the calendar year 1967 onwards, however, the assessee decided to make provision for meeting the gratuity liability not all at once but spread over a number of years on an actuarial valuation by making a provision therefor in the profit and loss account of each year. Having regard to the decision in Metal Box Company of India Ltd. v. Their Workmen : (1969)ILLJ785SC , this could be validly done regard being had to the accepted principles of commercial practice and mercantile system of book-keeping. It is difficult to appreciate under such circumstances the underlying assumption in the submission of the revenue that there was a departure from the method of accounting regularly employed by the assessee. As explained in CIT v. A. Krishnaswami Mudaliar : [1964]53ITR122(SC) , the mercantile system permits such actual cash outlays during the year being debited and it also permits provision being made for deduction of liabilities incurred or accrued but no discharged at the end of the year. Thus, there has been no departure from the method of accounting in the instant case. Indeed, it must be stated that that was not even the case of the revenue at any previous stage.

26. It was then urged on behalf of the revenue-that was also the view of the Tribunal-that since the profit and loss account of the assessee for the accounting year in question does not show that the present value of the estimated liability in respect of gratuity worked out on actuarial valuation was actually debited, it was not open to the assessee to claim deduction on the basis that it was entitled to work out its real profits after discounting such liability. Such an exercise, in the submission of the revenue, would amount to reopening the profit and loss account which, according to the accountancy practice recognised in our country, is not permissible.

27. This submission again is without any substance. As earlier observed, in the case of an assessee maintaining his books of account on mercantile system, while working out net profits, he can make provision to set off against the gross receipts his liability to pay a certain sum for every additional year of service which he receives from his employees, provided such liability is ascertainable and is arrived at one a proper discounted present value. Now, since the provision is to be made in respect of a contingent liability, it is not usual to make relevant provision in the accounts but such provision is made by way of a footnote in the balance-sheet. (See Accountancy by William Pickles, 3rd edn., p. 188). Contingent liabilities are not usually provided for by actual entry in the accounts, but a note is made at the foot of the balance-sheet. (See Accounting by Rowland & Magee, 7th edn., p. 243). Although contingent liabilities are not entered in books of account, standard practice requires their disclosure in balance-sheets. They sometimes appear between liabilities and net worth, but more often in appended footnotes. (See A Dictionary for Accountants, 5th edn., Eric L. Kohler, p. 120). It is true that when on the basis of actuarial valuation, the estimated liability is quantified by scientific principles and is apportioned to each year of service and deducted in the profits and loss account of each year, a specific provision, therefore, can be made in the books of account. Some companies do make provision or such expected costs in their own financial accounting and reporting. As earlier pointed out, such a provision is permissible as can be seen from the form of balance-sheet in Sch. VI to the Companies Act, 1956, whereunder 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, are debitable against the gross receipts. Schedule VI, Pt. 2, lays down the requirements of profit and loss account and clause 3(ix) thereof 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. Thus, there is no rule against debiting such contingent liability against gross receipts but equally there is no rule which requires that in order that true profits can be deduced for the purposes of income-tax, provision for the present value of the estimated liability must be necessarily made by an actual entry in the accounts and that disclosure in that behalf cannot be made otherwise, e.g., by way of a footnote in the balance-sheet.

28. So far as the present case is concerned, the forty-third annual report and balance-sheet of the assessee-company for the year 1967 were produced at the hearing of the reference and, though they do not form part of the statement of the case, they have been taken on record with the consent of the revenue (Ex. I). At the foot of the balance-sheet there are certain notes and note (1) mentions that there was present liability in the sum of Rs. 9,66,844 in respect of gratuity payable in future to the members of the staff and to the workmen of the company for which no provision was made. The note also mentions that in the previous year the present liability under the said head was in the sum of Rs. 9,27,844. The different between the sum of Rs. 9,27,844 and the sum of Rs. 9,66,844 works out to Rs. 39,000 and that would appear to the estimated additional liability incurred in the year of account in respect of the gratuity payable in future. It is not right to contend, therefore, that the accounts of the assessee are altogether silent about the accrued liability incurred under this head. It cannot be overlooked also that this is not a case where the revenue is disputing the computation of accrued liability incurred under this head. It cannot be overlooked also that this is not a case where the revenue is disputing the computation of accrued liability on merits; it is also not disputing the correctness of the accounts. The omission to precisely provide or the liability is also understandable having regard to the act that the legal position in that behalf was not crystallised until the decision in Metal Box Company of India Ltd. v. Their Workmen : (1969)ILLJ785SC was delivered. This, therefore, is not a case where there is a purposeful omission to make a specific provision in order to evade tax.

29. There is also another answer to this contention. In Kedarnath Jute Mfg. Co. Ltd. v. CIT : [1971]82ITR363(SC) , the assessee-company, which followed the mercantile system of accounting, incurred a liability on account of sales tax determined to be payable by the sales tax authorities on the sales made by it during the relevant previous year. The sales tax assessee's claim for deduction of that amount was rejected by the ITO, inter alia, on the ground that no provision therefor was made in the books of account of the assessee. The appeals to higher authorities failed and in the reference before the High Court the assessee could not succeed. In the assessee's appeal before the Supreme Court, the contention of the revenue was that as the assessee had failed to debit the liability in its books of account, it was debarred from claiming the sum as a deduction either under s. 10(1) or under s. 10(2)(xv) of the Indian I.T. Act, 1922. This contention was repelled in the following words (p. 367) :

'We are wholly unable to appreciate the suggestion that if an assessee under some misapprehension or mistake fails to make an entry in the books of account and although, under the law, a deduction must be allowed by the Income-tax Officer, the assessee will lose the right of claiming or will be debarred from being allowed that deduction. Whether the assessee is entitled to a particular deduction or not will depend on the provision of law relating thereto and not on the view which the assessee might take of his rights nor can the existence or absence of entries in the books of accounts be decisive or conclusive in the matter. The assessee who was maintaining accounts on the mercantile system was fully justified in claiming deduction of the sum o Rs. 1,49,776 being the amount of sales tax which it was liable under the law to pay during the relevant accounting year.'

30. This deduction is a clear authority for the proposition that the claim for deduction is not dependent upon the fact whether relevant entries are made in the books of account or not. That factor is not decisive. What determines the claim for deduction is the right accruing to the assessee under the law in regard to such deduction. It is true, as contended on behalf of the revenue, that in Kedarnath Jute Mfg. Co. Ltd. v. CIT : [1971]82ITR363(SC) , there was a present liability in regard to the payment of sales tax. That factor, however, would not detract from the applicability of the principle laid down in that decision because, in view of the pronouncement in Metal Box Company of India Ltd. v. Their Workmen : (1969)ILLJ785SC , a contingent liability such as the liability for payment of gratuity, if the present value of such liability is ascertainable, can be validly taken into account for estimation of real profits. In other words, for the applicability of the principle laid down in Kedarnath Jute Mfg. Co. Ltd. v. CIT : [1971]82ITR363(SC) , both the cases stand on an equal footing, whether it is the present liability or accrued liability such as the one with which we are concerned herein. If, in a given case, the ITO finds that provision for such accrued liability has not been made iu the books of account for an onlique purpose or that that income cannot be properly deduced for want of entries or for some such or similar reason, such a case might stand on a different footing and the claim for deduction may be validly rejected in such a case. No such claim can be justly rejected solely on the ground of want of entry or provision in the books of account, unless there is something more.

31. In view of the foregoing discussion, we are of the view that the assessee was entitled to the deduction of the amount of Rs. 29,637 in respect of its estimated gratuity liability which was worked out on actuarial valuation while computing income under s. 28. The Tribunal, in our opinion, was not justified in law in confirming the disallowance of the said amount. Our answer to the question referred to us for our opinion is, therefore, in the negative, that is to say, in favour of the assessee and against the revenue. The Commissioner will pay the costs of this reference to the assessee.


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