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Commissioner of Wealth-tax and ors. Vs. S. Ram and ors. - Court Judgment

LegalCrystal Citation
SubjectDirect Taxation
CourtChennai High Court
Decided On
Case NumberTax Case No. 14, 21, 26 to 29, 150, 189 to 194, 238 to 243, 246 to 252, 281 to 283, 289, 358, 401, 4
Judge
Reported in(1983)37CTR(Mad)158; [1984]147ITR278(Mad)
ActsIncome Tax Act, 1961 - Sections 36(1) and 40A(7); Wealth Tax Act, 1957 - Sections 2; Gift-tax Act, 1958; Estate Duty Act, 1953
AppellantCommissioner of Wealth-tax and ors.
RespondentS. Ram and ors.
Appellant AdvocateJ. Jayaraman, ;A.N. Rangaswami and ;Nalini Chidambaram, Advs.
Respondent AdvocateS. Swaminathan, ;S.A. Balasubramanian, ;V. Balachandran, ;S.V. Subramaniam, ;K.J. Rebello and ;V. Rajagopalan, Advs.
Cases ReferredAddanki Narayanappa v. Bhaskara Krishnappa
Excerpt:
direct taxation - gratuity - sections 36 (1) and 40a (7) of income tax act, 1961, section 2 of wealth tax act, 1957 and gift tax act, 1958 - in case under reference stand of department has been that provision for gratuity is contingent liability which cannot qualify for deduction from value of assets in order to arrive at value of net assets - tribunal concluded that provision for gratuity cannot be regarded as contingent liability - reference to precedents - department failed to distinguish between gratuity which is contingent liability and provision for gratuity which is current liability - provision for gratuity is proper charge against net profits of year - order of tribunal upheld. - - apparently, the bar was happy at the prospect of viewing the problem whole and in all its.....balasubrahmanyan, j.1. this judgment disposes of as many as 146 tax cases. they are from different taxing statutes. but all of them raise an identical question about 'provision for gratuity'. and they were all heard together. 2. in ordinary times, a comprehensive hearing of this kind would have been unthinkable. the court would have had to mull over each case, as it arose, within the confines set by the question in each reference. but, then, the supreme court had recently come out with a ruling on the 'provision gratuity' in vazir sultan tobacco co. ltd. v. cit : [1981]132itr559(sc) . the supreme court were there engaged in disposing of references which arose under the super profits tax act, 1963, and the companies (profits) surtax act, 1964. but then utilised the occasion to go into the.....
Judgment:

Balasubrahmanyan, J.

1. This judgment disposes of as many as 146 tax cases. They are from different taxing statutes. But all of them raise an identical question about 'provision for gratuity'. And they were all heard together.

2. In ordinary times, a comprehensive hearing of this kind would have been unthinkable. The court would have had to mull over each case, as it arose, within the confines set by the question in each reference. But, then, the Supreme Court had recently come out with a ruling on the 'provision gratuity' in Vazir Sultan Tobacco Co. Ltd. v. CIT : [1981]132ITR559(SC) . The Supreme Court were there engaged in disposing of references which arose under the Super Profits Tax Act, 1963, and the Companies (Profits) Surtax Act, 1964. But then utilised the occasion to go into the fundamental concept of 'provision for gratuity'. Just about that time, by a stroke of luck, as it were, we had in our dockets a number of tax reference, all of them on the same point about provision for taxation and gratuity, although they arose under different taxing enactments. When it was proposed to hear them all together, no objections were heard from any quarter. Apparently, the Bar was happy at the prospect of viewing the problem whole and in all its aspects, and not having been felt also as the only way to get out of the morass of confusion on fundamentals which characterised the earlier case law on the subject.

3. The confusion lay chiefly in the inability to distinguish between gratuity, on the one hand, and a provision for gratuity, on the other. And during all the discussion, the expression 'contingent liability' was being bandied about without a precise appreciation of what it meant. Gratuity long ago ceased to be gratuitous. Under the pressure of trade unions or left-wing state statutes, the payment of gratuity has become a 'must' in every establishment employing workmen and staff. Gratuity becomes payable under certain contingencies like retirement, resignation, death and the like of the employee concerned. Hence it is regarded as a contingent liability. If the contingency does not arise, gratuity does not become payable either. Because gratuity is payable only on the happening of a contingency under which the employer-employee relationship must cease, the employee cannot be said to be entitled to gratuity so long as he is in service. Gratuity is usually calculated at fifteen days pay for every year of service. But this does not mean that gratuity 'accrues' to the employee in that sum year by year. For, he cannot, while in service, bank on the gratuity, or charge it for any debt of his. For, who knows that something might happen which might defeat his claim at the time when his employment terminates Since gratuity does not accrue year by year, in this sense, the employer also cannot claim a deduction for this liability as an accrued liability. He cannot charge fifteen days wages every year to the profit and loss account as a liability which accrues for that year. But when the service of the employee terminates, the liability becomes a debt due by the employer to the employee, and it will get discharged only on payment. But at all earlier points of time, gratuity is only a contingent liability, it is not either a certain liability or a current liability.

4. A provision for gratuity, however, is a different cup of tea altogether. It is based on a wider conception and on a different approach. If there is an award or scheme, or settlement, relating to gratuity, the employer has to pay his employees their legitimate gratuity, one day or other, and it is quite likely that at the time when gratuity becomes payable, he must have the requisite funds at his disposal to discharge the liability. All prudent businessmen, therefore, make a provision here and now for the due discharge of their obligation to their workers in the matter of payment of gratuity. This provision is not made merely on a calculation based on fifteen days wages every year. For making a present provision for gratuity liability as a whole, it would be necessary that the employer should know the present discounted value of his overall commitment to his workers in this regard.

5. This calculation is, in essence, an actuarial calculation. the actuaries would be in a position to calculate the present discounted value of the employer's commitment for gratuity to his workmen by taking note of several factors which may or may not vary, such for instance as the number of workmen employed, their age group, their life expectancy, the occupational hazards in the business, the size of the employee's emoluments, the likelihood of expansion of the labour force in the establishment, and the like. From those factors, an actuary can scientifically estimate the present discounted value of how much the employer may have to shell out to the workmen by way of gratuity as and when the time comes therefor.

6. Where an industrial or business concern is already established, the employees therein would have already put in a number of years of service. If in such situation, a gratuity scheme is introduced and the employer wishes to make a provision for gratuity, then he has got to obtain a scientific report about the discounted value of his liability in that regard up to that date. On the basis of the figure provided by the actuary the employer would be justified, as a prudent businessman, to charge the entire discounted value in the profit and loss account as on that date, of the future liability for gratuity. Once the initial provision is made in this manner, as and towards provision for gratuity, then in every succeeding year the actuary will have to revise the figure of the discounted value of the liability. Other things remaining equal, the employer's overall commitment to gratuity will become greater and greater as the years roll by. Thus, the discounted value of the employer's commitment to gratuity as between one year and the next would register an increase. This is sometime called an incremental value. Where an initial provision towards gratuity has been made by the employer in a given year, then in every subsequent year, he would find that the actuarial valuation registers an incremental value. To the extent of the annual incremental value, the employee would be entitled to charge his P & L account with the provision of gratuity for that year. This stands to reason because every year the employer's commitment increases and an increased provision must be made.

7. The whole rationable behind making a present provision for gratuity is that, although gratuity, depends on the happening of a contingency for the purpose of actual payment, the only elements of uncertainty, if they can be so called, in the matter are (1) when exactly the liability becomes payable in the case of each workmen and (ii) how much would be the amount which becomes due for payment. If, notwithstanding these two elements of uncertainty, it is yet possible to arrive on an actuarial basis at the present discounted value of the liability to pay gratuity, payable in the future, then, according to well-accepted principles of commercial trading and commercial accounting, an employer is entitled to make a provision in the balance-sheet equivalent to the discounted value or as the case may be equivalent to the incremental value, after charging the provision to P & L account. The employer would be entitled to charge the amount against the net profits in the P & L account, because it is a current provision for a present discounted value, and, by the same token, the provision for gratuity would figure amongst the current liabilities and provisions on the liabilities side of the balance-sheet. Showing a particular account as a 'current provision' would mean that the amount in question in the balance-sheet is not available for appropriation to the private or personal needs of the proprietor of the business. If the proprietor of the business is an incorporated company, a provision for gratuity, being a current provision, cannot be dealt with as a reserve, although both provisions and reserves figure, as they ought to, on the liabilities side of the balance-sheet.

8. It is in this context, that the controversy as to whether the provision for gratuity is a provision or a reserve was examined in cases which arose under the Super profits Tax Act and Companies (Profits) Surtax Act Under the scheme of these two statutes, tax is levied on the excess of a company's income over a minimum standard. The standard, which is called a 'standard deduction' or a 'statutory deduction' is arrived at by applying a certain statutory percentage to the capital of the company. A company's capital, as normally understood, represents its paid-up capital plus reserves. That is also broadly the basis of calculation of capital for purposes of the Super Profits Tax Act and the Surtax Act. Schedule I of these Acts broadly follows the method of adding a company's reserves to its paid-up capital in order to arrive at its overall capital. In this statutory milieu, the temptation for surtax and super profits tax assessees was always to increase the capital base and show it at as high an amount as possible, so that it might thereby obtain a very high standard deduction and, in consequence, a pro tanto lower surtax profit. The opposite tendency can be discerned in the approach of taxing department. For, the Department would always be interested in asking for as low a capital base as possible. It is in this context that both the Department and the taxpayers have been engaged in a sterile controversy as to whether a provision for gratuity can really be regarded as a provision or merely as a reserve. To a certain extent this controversy could not be avoided because professional accountants have a habit of forgetting themselves and calling a provision a reserve and vice versa. Further confusion was introduced into the discussion by an inability to mark the distinction between gratuity, as such, and a provision for gratuity. Disputants often forgot the point of the discussion and, therefore, they were apt to regard a provision for gratuity as a contingent liability thereby committing the mistake of treating a provision for gratuity which is a present and certain liability chargeable to the profits of the year of trading as a mere contingent liability. The discussion in some of the reported cases also reflect this confusion about fundamental concepts. As if these difficulties were not enough, the approach of the Department on the one side and the general body of the taxpayers on the other side was neither consistent nor uniform. In cases arising under the Super Profits Tax Act or the Surtax Act, as we have already observed, a provision for gratuity has to be considered in the context of computation of capital, as a first step in ascertaining how much of the current profits will have to be excluded as a standard deduction at a certain percentage of the capital of the company. As we had earlier mentioned, the tendency of taxpayers was top attempt to argue that a provision for gratuity was only a reserve, because it was only that way they could increase the size of the company's capital. Whereas in the context of that discussion, the Department equally was insistent that a provision for gratuity is not a reserve, but a mere provision. When, however, it came to a question of deductibility of the amount under the I.T. Act, or for a global valuation of the business for the purpose of assessment under the W.T. Act, or for evaluation of an unquoted share for purposes of the E.D. Act, of the W.T. Act and of the G. T. Act, the assessees were interested in urging the contrary position that a provision for gratuity is a charge on the profits and a provision in the balance-sheet in that regard cannot be discarded as a mere appropriation out of profits or as a reserve, leaving the Department to toe the other line and go on urging that a provision for gratuity cannot be regarded as charge against profits, but only as an appropriation out of it and must be regarded as a reserve and not as an provision. Since tax courts discharging their advisory jurisdiction hard to dispose of cases within the exigencies of the particular question of law in the particular reference case before them the result was what a provision for gratuity happened to be examined by courts according to the exigencies of the argument and not so much according to fundamental principles. The result has been an utter confusion. It was, in such a state, that the Supreme court rendered their ruling in the Vazir Sultan's case : [1981]132ITR559(SC) . It is enough that the following passage is quoted to bring out the essence of the distinction between gratuity on the one hand, and a provision for gratuity on the other (p. 574) :

'Ordinarily, an appropriation to gratuity reserve will have to be regarded as a provision made for a contingent liability for under a scheme framed by a company, the liability to pay gratuity to its employees on determination of employment arises only when the employment of the employee is determined by death, incapacity, retirement or resignation an event (cessation of employment) certain to happen in the service carrier of every employee; moreover, the amount of gratuity payable is usually dependent on the employee's wages at the time of determination of his employment and the number of years of service put in by him and the liability accrues and enhances with the completion of every year of service; but the company can work out on an actuarial valuation its estimated liability, i.e., discounted present value of the liability under the scheme on a scientific basis, and make a provision for such liability not all at once but spread over a number of years. It is clear that if by adopting such scientific method, any appropriation is made, such appropriation will constitute a provision representing fairly accurately a known and existing liability for the year in question'.

9. We find in a recent decision of the Tribunal a very clear enunciation of the distinction between gratuity, as a contingent liability, and a provision for gratuity, as a certain current liability, which is a charge against profits. This decision of the Tribunal has served as a model for all the orders under reference in these case. We think that the following passage from the Tribunal's decision is worth quoting for its comprehension of the basic concepts and the lucidity with which they are expounded.

'The Wealth-tax Rules provide that contingent liabilities should be excluded. We consider that the term 'Contingent liabilities' here has to be interpreted to mean those liabilities considered to be contingent liabilities from an accountancy point of view i.e., where there is an uncertainty as to whether there would be a legal obligation to pay the money or not. Any other interpretation would make the rules, which are intended for arriving at the break-up value of shares by a rough and ready method, unrealistic. In the case of gratuity, under an agreement of scheme, the collective liability is certain to arise and only the extent of the liability would vary in any particular year. The liability towards a particular employee may be contingent, but the cumulative or collective liability of the company towards the employees in general is a liability which is certain and the extent of the liability will depend upon contingencies that will take place in each employee in a particular year..... We, therefore, hold that the liability is not to be excluded in making computation under rule 1-D'.

10. In all the present references, provision for gratuity figures in the context of the valuation of unquoted shares held by each and every one of the assessees in these cases. The valuation question has arisen in the context of the assessment of a shareholder under the W.T. Act, 1957, under the G.T. Act, 1958, and of a deceased shareholder's estate under the E.D. Act, 1953.

11. Valuation of unquoted shares for the purpose of wealth-tax is now governed by express rules framed under the W.T. Rules, 1957. Rule 1-D of the W.T. Rules incorporates the 'break-up value' method for determining the market value of unquoted shares. Under this method, the net wealth of the Company is first determined the market value of the shares held by the assessee in that company is ascertained as a fraction of the net wealth of the assessee. In arriving at the net wealth or the net assets of the company, as the first step in the computation of the value of the unquoted shares, rule 1-D lays down that the value of 'all the liabilities as shown in the balance-sheet shall be deducted from the value of all assets shown in the balance-sheet'. In one of the Explanations to this rule, certain liabilities are to be excluded from deduction, Explanation-II (ii)(f) lays down that any amount representing contingent liabilities (other than arrears of dividends payable in respect of cumulative preference shares) shall not be treated as liabilities.

12. In the wealth-tax cases now under reference, the Department stand has been that a provision for gratuity is a contingent liability and, therefore, the amount representing such provision cannot be deduction from the value of the assets in order to arrive at the value of the net assets of the company. The Tribunal, however, disagreed with the view of the Department and held that a provision for gratuity cannot be regarded as a contingent liability.

13. On the basis of the decision of the Supreme Court we must agree with the Tribunal's conclusion. The Department's stand is the outcome of a mental confusion and an inability to distinguish between gratuity, as a thing in itself, which is a contingent liability, and a provision for gratuity made on an actuarial basis which is a balance-sheet item and a current liability. This is because, as we had earlier observed, the provision for gratuity is not merely a current provision in the balance-sheet but it is a proper charge against the net profits of the year.

14. In the wealth-tax references before us, the companies in which the assessees hold shares belong to the T. V. S. Group of companies. The shares of these companies are not quoted in the market. There was an overall agreement between the management of these companies, on the one hand, and the employees employed therein, on the other.

15. The agreement related to the introduction of a scheme for gratuity in all these companies. The agreement was signed on July 3, 1971. But, under the terms of the agreement, the gratuity scheme was to come into effect on March 31, 1971. It was contemplated in the agreement that the implementation of the gratuity scheme must be left in the hands of a trust for each of these companies. The trust actually came into being on September 5, 1975. But even before the trust come into being these companies had been in a position to obtain the discounted present value of their commitment in regard to gratuity liability of all their workmen from an actuarial calculation and had made suitable entries in their accounts in regard to initial provision for gratuity as well as for subsequent incremental values year by year. The charge towards provision for gratuity was also being made in the profit and loss account every year; and the amount was being shown as a provision for gratuity in the balance-sheet under the head 'Current liabilities and provisions'. After the trust was created, the amount representing the provision for gratuity was turned over by the companies concerned to the trust. To the extent of the incremental value also for every year thereafter, the amounts were turned over to the trust year by year. Cases arose before this court in respect of periods subsequent to the creation of the trust and the obligation of the employer concerned who makes over the yearly incremental value to the trust. In such cases, the question was whether the amount which was due to be paid by the company in question to the gratuity trust can be regarded as a liability or whether it should be left out of account as a contingent liability under the provisions of Explanation II (ii)(f) to rule 1-D of the W.T. Rules. It was held by this court that in cases where, under the terms of the gratuity scheme, the company employing the workmen is under an obligation to make over annual sums equivalent to the incremental value to the gratuity trusts established under the scheme, then the question of regarding the said amounts as contingent liability does not arise, because under the very terms of the scheme, the amounts, once ascertained on actuarial valuation, becomes a debt due by the company to the trust. Vide judgment in T.C. Nos. 446 to 449 of 1978, dated December 8, 1981. (CWT v. Ramaswami : [1983]140ITR606(Mad) ).

16. In the present group of wealth-tax references before us, the companies whose unquoted shares are the subject matter of valuation had only made a provision for gratuity according to the actuarial basis and they did not have to transfer an amount equivalent to the provision in favour of any gratuity trust, for the simple reason that the gratuity trust had not yet come into existence. The query raised by the Department's learned counsel before us was, whether a mere provision for gratuity can be regarded as a liability which is deductible under the rule 1-D of the W.T. Rules or whether a mere provisions of such a kind must be disallowed as a contingent liability under Explanation II (ii)(f) to rule 1-D of the W.T. Rules

17. On the basis of the earlier discussion, the answer seems to us to be too plain to need further elaboration. Explanation II (ii)(f) to rule 1-D of the W.T. Rules only speaks of 'contingent liabilities'. We have earlier observed that gratuity as a conception from the point of view of the liability to workmen may be a contingent liability, but when, on a scientific or actuarial basis, an employer makes a provision for gratuity, such a provision must be regarded as a present, direct, and immediate, liability of the company, for the reason that it represents the present discounted value of the employer's commitment, as a whole to pay his workmen gratuity as and when it becomes payable.

18. Mr. A. N. Rangaswamy, representing the Department in some of the cases, urged that on the authority of the Supreme Courts decision in Standard Mills Co. Ltd. v. CWT : [1967]63ITR470(SC) , even a provision for gratuity must be regarded as a contingent liability so long as there is no inter-position of a gratuity trust to whom the company concerned is under an obligation to pay yearly contributions towards gratuity liability. this contention is untenable. In the Standard Mills case : [1967]63ITR470(SC) , the Supreme Court was concerned with examining whether the liability for gratuity, as such, can be regarded as a debt owed by the employer within the meaning of s. 2(m) of the W.T. Act, 1957. With respect, they were right in holding that gratuity is merely contingent liability and it cannot be, in that sense, a debt owned in praesenti. The Standard Mills case : [1967]63ITR470(SC) was not however, concerned with the case of a provision for gratuity. It is also necessary to remember that the supreme court decision was rendered on the W.T. Act as it stood then, when even companies were liable to pay wealth-tax on their net wealth. Incidentally, from 1960-61 onwards, the wealth-tax on companies has been abolished. Thereafter, the only purpose for which the company's balance-sheet are to be looked into by the taxing Department is in connection with the ascertainment of the market value of unquoted shares, either on general principles or in terms of rule 1-D of the W.T. Rules. Standard Mills case : [1967]63ITR470(SC) , therefore, is doubly distinguishable from the present case.

19. Mr. Rangaswamy then pointed out that in Vazir Sultan's case : [1981]132ITR559(SC) , the Supreme Court had referred to standard Mills decision : [1967]63ITR470(SC) and distinguished that case as a wealth-tax case. Apparently what the Supreme Court meant was what we have earlier elaborated, namely, that in Standard Mills case : [1967]63ITR470(SC) the Supreme Court was concerned with having to decide whether a liability for gratuity which was not arrived at as a provision for gratuity can be regarded as a debt in connection with the assessment of a company to wealth-tax where the net wealth of the company itself fell to be ascertained as being in excess of the value of all assets over the value of debts of the company. It was because of the different contexts in which the Standard Mills case : [1967]63ITR470(SC) , was decided that the Supreme Court in Vazir Sultan case : [1981]132ITR559(SC) , had briefly distinguished the decision in Standard Mills case as a wealth-tax case. It was not the intention of the Supreme Court that a provision for gratuity will have a certain kind of legal quality or character under the W.T. Act but quite a different legal character under the Surtax Act or any other Act. On the contrary, the Supreme Court expressly declared in Vazir Sultan's case : [1981]132ITR559(SC) , that they were discussing the real nature of a provision for gratuity in a company's balance-sheet on general principles of accountancy as well as of corporate law. These principles were derived by the Supreme Court from the Privy Council decision in Southern Railway of Peru Ltd. v. Owen (Inspector of Taxes) [1975] 32 ITR 737 and also Metal Box Company of India Ltd. v. Their Workmen : (1969)ILLJ785SC , which was rendered by the Supreme Court in a case arising under the Industrial Disputes Act. In both these cases is has been very clearly stated that although gratuity may be a contingent liability, considered in itself, a provision for gratuity based on actuarial valuation representing the present discounted value of the employer's commitment to pay gratuity to all its workmen and when the time comes is a current, direct and present liability. With general principles laid down in all these three cases, namely, Southern Railway of Peru Ltd. v. Owen (Inspector of Taxes) [1957] 32 ITR 737 Metal Box Companys case : (1969)ILLJ785SC and Vazir Sultan's case : [1981]132ITR559(SC) , it would be a mistake to dismiss the authority of these cases by saying that this is a wealth-tax case, that is a bonus case, m and the other one is surtax case, and so on. With respect, we hold that a coherent discussion about the nature of the provision for gratuity had been made on the basis of fundamental principles only in these three decisions. The fact that the decisions were rendered, in the one case, in respect of an industrial dispute or in the other case on surtax or super profits tax, cannot derogate from the fact that the decisions were rendered on basic principles. Applying the governing concept that a provision for gratuity really is a discounted present value of the employers commitment to pay gratuity, it can never be regarded as a contingent liability and Explanation II (ii) (f) to rule 1D of the W.T. Rules will not apply.

20. As we had earlier mentioned the value of unquoted shares figures in connection with the gift tax references also. The tax under this Act is chargeable on the value of the gifts, which value has got to be ascertained on the basis of market value. Unlike as in the W.T. Act and the rules made thereunder there is no detailed provision in the G.T. Act or the G.T. Rules as to how the market value of unquoted shares has to be ascertained. Mention, however, should be made of rule 10(2) of the G. T. Rules, 1958. According to this rule, the value of unquoted shares must be ascertained on the break-up value method. But where the break-up value method cannot be applied then the rule lays down that the market value of the unquoted shares may be ascertained on the footing that a purchaser of the unquoted shares may be ascertained on the footing that a purchaser of the unquoted shares would be entitled to get registered as a transferee in the company's registry. This rule, therefore, shows that the preferred method of market valuation of unquoted shares is the break-up value method. But unlike as in the W.T. Rules, the G.T. Rules do not contain any conditions or restrictions in the matter of decution of contingent liabilities. The absence of such a provision has not been taken to mean that unquoted shares cannot have any market value and cannot be subject to gift-tax. In all the gift-tax references before us, the unquoted shares have been valued for the purpose of gift-tax and the only problem in valuations relates to the Department's contention that, in ascertaining the break-up value of the company's assets, provision for gratuity cannot be deducted from the value of the assets, the argument being that a provision for gratuity is only a contingent liability. Even while we were faced with as express statutory rule under the W.T. Act which disallowed a contingent liability in the computation of the break-up value of the company's assets, we had decided, on general principles and on the authority of the Supreme court decisions, that a provision for gratuity cannot be classed among contingent liabilities. On a question of valuation arising under the G.T. Act, the position if any is a fortiori. We, therefore, hold that in all these cases where unquoted shares have figured as the break-up value method after deducting the provision of gratuity from the value of the company assets.

21. There are two other questions of minor importances which figure in the gift-tax reference. One of them again relates to the computation of the market value of unquoted shares. The question is whether a provision for proposed dividends found in the balance-sheet of a company can be taken into account in arriving at the net value of the company's assets. This question also finds a ready answer in the Vazir Sultans case : [1981]132ITR559(SC) . The Supreme Court held that irrespective of when the dividend happens to be actually distributed the provision made in the balance-sheet for proposed dividend must be regarded as a current liability and has got to be deducted in ascertaining the net worth of the company. The Department contended before the Tribunal that the provision for proposed dividend must not be deducted in computing the net assets of the company. On the basis of the decision of the Supreme Court however, we must hold that the Tribunal was right and the Department contention is wrong. This question which has figured in some of the gift-tax references before us is accordingly answered against the Department.

22. One other question which arises in a few of the gift-tax references is this group relates to the choice of the balance-sheet which has got to be taken as the basis for purpose of computation of the company's net wealth as a first step in arriving at the value of the unquoted shares. We may visualise the gift of unquoted shares as having occurred on the date of the company's balance-sheet. In such a case, no problem is presented, because the balance-sheet figures of assets and liabilities can be taken as they are, for the purpose of computing the break-up value of the company's assets as on the date of the gift. Where, however, a gift of unquoted shares takes place in between the dates of two balance-sheet the question is which is the balance-sheet which has got to be adopted, as the basis The taxpayer's view has been that only the last published balance-sheet which precedes the date of the gift must be taken note of. This is a dogmatic assertion for which we find no support in principle. On the contrary, there are decisions of this court which say that the true rule would be to take into consideration not only the balance-sheet immediately after the gift and find out, on some principle which would be appropriate, the value of the assets and the value of the liabilities of the company as on the date of the gift. A similar problem had arisen before this court on several occasions. In one of the judgment on the subjects in T.C. No.863 of 1977, dated December 9, 1981, CGT v. K. Ramesh : [1983]141ITR462(Mad) , this court preferred to adopt the figures in a balance-sheet which were drawn up two or three days subsequent to the date of the gift. It may be explained that this decision was rendered by this court, not as a matter of principle but by way of avoiding as remittal order or two separated the date of the gift from the date of the balance-sheet, it would be an unnecessary exercise of one's labour not to take note of the nearest balance-sheet but to go upon some other laboured valuation of the company's assets involving effort and time. In all these cases of valuation of unquoted shares, however, the true principle is that if it were possible to draw up a precise balance-sheet as on the date of the gift, that would afford quite an accurate basis and an ideal solution. But since the valuation question arises only in a shareholder's assessment, neither the shareholder nor the Department can expect the staff and accountants of the company to oblige them by meticulously drawing up a balance-sheet as on the date of the gift even assuming that the drawing up of a balance-sheet on that date would be feasible or is capable of being done in a correct manner after a passage of time. In the absence of the facility of drawing up a balance-sheet precisely on the date of the gift, the next best thing, both for the assessee who is the holder of the unquoted shares and the Department which is charged with the duty of evaluating the market value of the shares not to speak of the company itself, is to take to the balance-sheet falling both before and after the date of the gift and arrive as near as may be at the break-up value of the assets and liabilities of the company as on the date of the gift on a time basis, or on some other basis. The Tribunal in this case and held that only the earlier published balance-sheet must be taken note of. This is not a correct direction in law of how to proceed. We cannot be dogmatic about taking as the basis, either the balance-sheet which falls before or the balance-sheet which falls after the date of the gift. We have to take into account both. Our answers to the questions on this point raised in some of the gift-tax cases are rendered accordingly.

23. The estate duty reference which was heard in this group of cases does not deal with the question of valuation of an unquoted share in a private company which remains as part of estate of the deceased. The share of the deceased was different; it was his share or interest as a partner in a firm. On his death, his interest in the partnership had to be evaluated as one of the properties passing on his death. That interest had to be included in the principle value of the estate on the basis of its market value. There are not guidelines for valuation of the interest of a partner in a partnership either in the E.D. Act or in the Rules made thereunder. Rule 7(1)(c) of the E.D. Rules, 1953, speaks of a share of a partner in a partnership as an 'indivisible assets', for the purpose of determination of its nature and locality. The rule further says that the share of a partner in a partnership is movable property, notwithstanding that the firm own immovable property. The latter part of the rule merely restates the proposition reiterated more recently by the supreme court in Addanki Narayanappa v. Bhaskara Krishnappa, : [1966]3SCR400 . Beyond these general propositions rule 7(1)(c) of the E.D. Rules does not lay down any guidelines in the matter of valuation of a partners interest in the firm. A similar problem has been tackled by rule (2) of the W.T. Rules, 1958. In that rule, the value of the interest of a person in a firm of which he is a partner has got to be determined under a step by step method. The net wealth of the firm itself has first to be determined. The portion of the net wealth of the firm which is equal to the share of capital of the partner wealth of the firm. As we mentioned, a similar express rule is found absent in the E.D. Rules. However, the W.T. Rules merely reflect an acknowledged principle of valuation of a partner's interest. A partners interest under the break-up value method is ascertained more or less on the basis of a notional dissolution and winding up of the firm wherein the real net surplus of every partner gets ascertained when, after realization, at market value, of all the assets of the firm the surplus remaining if any in ascertained and then allocated as between the different partners which is embedded in rule 2 of the W.T. rules, 1958. We do not find any reasons why this principle cannot be adopted for the purpose of valuation of a deceased partners share for purpose of estate duty. The question which has arisen in this case is whether a provision for gratuity found in the balance-sheet of the partnership firm can or cannot be deducted in ascertaining the net wealth of the partner's assets as a whole. The problem according to us is similar to the problem which was resolved by the Supreme Court in Vazir Sultan's case : [1981]132ITR559(SC) . We heard Mr. A. N. Rangaswami argue in the course of his arguments that Vazir Sultans case must be regarded as laying down special rules only in cases where the balance-sheet of a company is concerned. We, however, hold that these principles are general in nature and the question whether a provision for gratuity is or is not be allowed has got to be decided on the same principles, whether it occurs in the balance-sheet of a company or it occurs in the balance-sheet of a partnership firm or for that matter, whether it occurs in the balance-sheet of a sole proprietary of business. In all these cases the principle is that where a gratuity provisions is based on a scientific or actuarial valuation and it truly reflects the discounted present value of the assessee's future liability as a whole towards his employees then such a provision must be regarded as a here and now liability and not as a contingent one. Our determination is that such a provision must also be deducted in arriving at the net capital of the firm from which the value of the deceased partners interest in the partnership must be ascertained. The question in this estate duty reference must accordingly be answered in favour of the accountable person.

24. Before concluding, we may observe that the tax treatment of a provision for gratuity in the I.T. Act 1961, has now been settled by s. 40A(7) of the I.T. Act, 1961, with effect from April 1, 1973. Before April 1, 1973, the position under the I.T. Act was the one which we have stated in this judgment namely that where the assessee is under a legal obligation to pay gratuity to his workmen under an award, decree settlement or statutory provision, and has made a provision for gratuity liability on its present discounted value on the basis of an actuarial report, then the provision and has made a provision for gratuity liability on its present discounted value on the basis of an actuarial report then the provision is a proper charge against the profits and is deductible while computing the taxable profits under the head Business Section 36(1)(iv) read with Part C of Schedule IV of the I.T. Act, 1961, grants a deduction to the assessee in respect of his annual contribution to a gratuity fund approval by the Commissioner of Income-tax. In CIT v. Andhra Prabha P. Ltd., : [1980]123ITR760(Mad) , a Bench of this court however, held that a provision for gratuity scientifically calculated providing for the assessee's legal obligation by making a present discounted value of its obligation is an admissible deduction in the computation of business profits even after the introduction of s. 36(1)(iv) of the Act. The said decision however, did not deal with the position after the enactment of s. 40A(7) of the Act. Under this section an assessees cannot after April 1, 1973, subject to certain exceptions, deduct a provision for gratuity even if based on actuarial valuation; the only way to claim deduction in regard to gratuity is to create a gratuity fund, get the Commissioner's approval, make annual contributions to that fund and get a deduction for the amount of that contribution.

25. The income-tax aspects of provision for gratuity do not arise in these references, but we have briefly touched upon them to show to what extent the taxing statute can make inroads into the fundamental accountancy principles governing a provision for gratuity.

26. For the reasons which we have earlier set out at the appropriate places in the foregoing paragraphs, the questions of law in all these tax reference are answered against the Department. There will, however, be no order as to costs.


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