1. This judgment will dispose of all these tax cases since they raise an identical question of law on identical facts.
2. Shri Ramalinga Mills Private Ltd. and Aruppukkottai Shri Jayavilas Private Ltd. are two private limited companies in which all the assessees who figure in these references are holding equity shares. Some of the assessees are partners in 'Shri Jayajothi and Company', which is a partnership firm. Each of these concern in carrying on business with the aid of employees who have had a number of years of service to their credit. The management in each of these concerns took a decision to create a gratuity fund in terms of the scheme in Pt. C of Sch. IV to the I.T. Act, 1961. In each of these concerns a gratuity fund was established with effect from January 1, 1973. They also applied to the Commissioner for the approval of the gratuity funds so created. The approval by the Commissioner was granted on March 9, 1976, but with effect from January 1, 1973.
3. The common question in all these references related to the valuation of shares in the two companies and the valuation of the partnership interest in the firm held by the assessees on all valuation dates which fall subsequent to January 1, 1973. It is needless to say that the shares held by the assessees in Shri Ramalinga Mills Private Ltd. and Aruppukkottai Shri Jayavilas Private Ltd. are not shares quoted in the share market. The W.T. Rules, 1957, make provision for ascertaining the value of unquoted equity shares. The relevant rule is r. 1D. The rule merely incorporates what goes by the name of 'break-up method of valuation' of shares. Under this system, the surplus of the assets of a company over the liabilities, which leaves us with the new worths of the company, is regarded as the first step in the valuation of the shares in the company. The individual market value of share, under this method, is to be regarded as a fraction of the new worth of the company, arrived at by dividing the company's net worths by the number of shares in the company. Rule 1D, however, lays down that for the purposes of reckoning, in the first instance, the assets and liability of the company, certain liabilities should not be taken into account and musts be excluded. One such exclusion relates to any amount representing contingent liabilities.
4. A similar provision is found in the W.T. Rules as respects the valuation of a partner's share. The relevant provisions are to be found in rr. 2, 2A, 2C, 2D and 2E. Under r. 2, for ascertaining the market value of the partner's share, the net wealth of the firm as a whole as on the valuation date must first be reckoned. The share of the partner must, thereafter, be derived from the net wealth of the partnership. Rule 2A provides for the method by which the net wealth of the firm should be ascertained Rule 2A provides that net Wealth of the firm's business as a whole has to be ascertained by taking the balance-sheet of the business, but subject to the adjustments specified in rr. 2D and 2E. Rule 2E names certain liabilities of the firm which should not be taken into account in ascertaining the firm's new worth. One such excluison related to any provision made in the balance-sheet for meeting any future or contingent liability.
5. We had earlier observed that, in the case of the two companies, Shri Ramalinga Mills Private Ltd., and Aruppukkottai Shri Jayavilas Private Ltd., as well as in the case of the partnership firm, Shri Jayajothi and Company, approved gratuity funds had been created for the benefit of the respective employees of the three concerns in accordance with the provisions of Pt. C of Sch. IV to the I.T. Act, 1961. The Commissioner had granted his approval to the gratuity funds so created. Under r. 104 of the I.T. Rules, 1962, the employer who has created an approved gratuity fund will have to make an initial contribution to the fund in respect of the past services of the employees admitted to the benefits of the fund, and also successive contributions to the fund for every year following.
6. In the present group of cases, the finding of the AAC is that the three concerns had transferred to the trustees of the gratuity fund sufficient sums of money by way of initial contribution in respect of the past services of their employees in accordance with the schemes of the respective gratuity funds. Although it is not very clear from the record whether the initial contribution had been made by these concerns to the gratuity funds before the Commissioner granted the approval or afterwards, it seems to us, however, quite clear that this initial contribution was the first contribution which the concerns ought to be making, having decided to create the gratuity funds.
7. The question which had arisen in these cases was whether the initial contribution by the three concerns to the respective gratuity funds as well as the subsequent years' annual contributions can be regarded as contingent liabilities and hence to be disregarded in the compultaion of the net worth of these concerns or whether they should be held to be 'other liabilities' which have got to be deducted from the assets without question, for the purpose of computing the net worth of these concerns as on the relevant valuation dates. The WTO did not regard the liabilities towards gratuity as a present liability, but as a contingent liability, and in that view disallowed the amounts in the computation of the net worth of these concerns.
8. On appeal, the AAC was not consistent in his decision. In some cases, relating to some assessment years, he held that the contribution made by the companies and the partnership firm to their respective gratuity funds, was not a contingent liability. In other cases, he held it was a contingent liability.
9. On further appeal to the Tribunal, they took a uniform view of the nature of the liability represented by the contributions to the gratuity funds. They held that when once the Commissioner had granted his approval to the gratuity funds, the contributions made by the respective employers to the gratuity funds must be regarded as certain liabilities and not as contingent liabilities. In this view, they held that those liabilities will have to be deducted in arriving at the net worth of the concerns for the purpose of working out the valuation of the companies' shares or partnership interest, as the case may be, held by each of these wealth-tax assessees.
10. In the course of their order, the Tribunal referred to the provisions for gratuity made in the balance-sheets of the two companies and of the partnership firm as having been made on the basis of actuarial valuation of the gratuity liability. Relying on the balance-sheet provisions and their actuarial base the Tribunal proceeded to hold that the provision so made for gratuity liability was an ascertained liability, although the actual liability for payment of the gratuity would not arise till the death or retirement of the employees concerned. The Tribunal in their order did refer to the provisions of r. 1D read with Expln. II(ii)(f) and r. 2E(c) read with r. 2 of the W.T. Rules. But even apart from what the Rules laid down, the Tribunal came to the conclusion that the provision of gratuity on the basis of actuarial valuation cannot be considered as a mere contingent liability.
11. Against this order of the Tribunal, which is a common order in all the assessee's cases, the question of law referred to us for our consideration is as follows:
'Whether, on the facts and in the circumstances of the case, it has been rightly held that provision for gratuity should be deducted in determining the value of the shares either in a partnership firm or in a private limited company ?'
12. The learned standing counsel for the Department submitted that the Tribunal was in error in regarding the provision made in the balance-sheets of the two companies and the partnership firm as a certain liability. According to him, the liability would become certain only in the event of an employee retiring or dying and the amount becomes due to be paid either to the employee or to his next of kin. Till so long as these eventualities do not happen, learned counsel said, the provision made in the balance-sheet, although on the basis of scientific or actuarial valuation, can only be regarded as a contingent liability, and as contingent liability it cannot be deducted from the assets of these companies or of the firm for the purpose of arriving at their net worth.
13. We do not wish to enter into a general discussion as to whether a provision made in a balance-sheet for liability towards gratuity on the basis of an actuarial valuation can be treated as a mere contingent liability or as a known and existing liability. We think it is unnecessary to enter into this discussion, because the question in this case can be decided on the basis of the application of the relevant W.T. Rules to which we have made reference earlier and in the light of the provisions in the I.T. Act, 1961, relating to the approved gratuity funds. Both r. 1D read with Expln. II(ii)(f) and r. 2 read with r. 2E (c) of the W.T. Rules expressly exclude from the compultaion of the net wealth of the companies or of partnership, all contingent liabilities. In terms of this rule, the question in the present case, is not whether a mere provision in the balance-sheet on the basis of an actuarial valuation for gratuity liability can be regarded as a contingent liability. The question, rather, is whether after an approved gratuity fund has been created as in this case, and the employer this incurred the obligation for the payment of initial and subsequent contributions to that approved gratuity fund, the liability of the employer in that regard can at all be regarded as a contingent liability. We have referred to r. 104 of the I.T. Rules, 1962, which relates to approved gratuity funds. Under that rule, the employer must make an initial contribution to the approved gratuity fund in respect of the past services of every employee admitted to the benefits of the fund. Rule 103 likewise provides that an employer must make ordinary annual contributions to the fund on such reasonability basis as may be approved by the Commissioner having regard to the length of service of each employee admitted to the benefits of the fund. 'These obligations have been fastened on the employer by the statutory rules by the mere fact of the employer having created an approved gratuity fund and having obtained the approval of the Commissioner for that fund. The moment the fund is created and the approval of the Commissioner is obtained, the employer renders himself, subject to the obligation of making the initial contribution as well as the subsequent annual contributions in accordance with the scheme as approved by the Commissioner. It may be that actual contributions are not made promptly. It may also be that even credits in favour of the fund may not be raised at the appropriate time. Nevertheless, the moment the Commissioner grants the approval of the gratuity fund, the fund becomes a reality, not from the date of the Commissioner's approval, but as from the date when it has been created, so that the employer's liability to make contributions would arise in accordance with the terms of the gratuity fund.
14. In the present case, it is stated on behalf of the assessees, that the gratuity funds in the case of the two companies, Shri Ramalinga Mills Private Ltd., and Aruppukkottai Shri Jayavilas Private Ltd., as well as in the case of Shri Jayajothi and Company were all created on January 1, 1973. At any rate, the Commissioner's order of approval dated March 9, 1976, shows that the fund was created not alter than January 1, 1973. If so mush is granted, then in terms of the requirements of rr. 103 and 104 of the I.T. Rules, 1962, relating to approved gratuity funds, the three concerns were under a statutory obligation to make over their initial and annual contributions to the trustees of the gratuity funds. If the contributions are actually made, to that extent, the concerns would not be having equivalent assets, because that is the effect of payments out. But to the extent that the initial contributions have not been made, the concerns will necessarily have to be debtors to the trustees of the fund, the liability being a present liability, having already accrued by the vary creation of the gratuity funds.
15. The error we find in the Tribunal's order if it can be so called, is in mistaking the obligation to make contributions to the fund as a mere self-made provision for gratuity figuring only in the balance-sheets and proceedings to discuss whether such provision is to be deducted in the computation of the new worth of the concerns.
16. The learned standing counsel referred to the ceiling fixed in rr. 103 and 104 of the I.T. Rules for putting forward an argument that, in any case, the provision made in the balance-sheets of the companies and the partnership concern cannot be deducted in toto, but must be limited to 8 1/3 per cent. of the salary of each employee in respect of his past services and in respect of the current year. We do not think that the ceiling fixed under these two rules has anything to do with the nature of the liability, much less conclude the question whether it is current indefinite of whether it is merely contingent. Rules 103 and 104 of the I.T. Rules only provided that in the assessment of the employer the deduction as respects contribution to the gratuity fund, as an item of allowance in the computation of business profits, shall not exceed 8 1/3 per cent. of the salary of each employee. Far from these provisions meaning that there is a ceiling fixed on the size of the contribution which the employer could make to the fund, it implies that the contribution can exceed 8 1/3 percent of the employee's salary. The I.T. Rules, concerned with the quantum of permissible deductions, have laid down that the employer will be entitled to the deduction from the business profits of an amount which will not exceed 8 1/3 per cent. of the employee's salary. What should not exceed this ceiling is not the contribution, but the deduction in respect of the contribution.
17. We are to a certain extent incommoded in the hearing of these references by the absence of the Rules and Regulations of the gratuity funds of these three concerns, we could not also get at the information about the precise date when the funds were established and when credits were given for past contributions as well as contributions towards the gratuity funds.
18. But, we did not think it would be absolutely necessary, for the purpose of deciding the question of law before us, to obtain a supplemental statement of the case, by sending the case back to the Tribunal for ascertainment of these facts, since we are in a position to decide the points at issue on our reading of the provisions of rr. 103 and 104 of the I.T. Rules and the nature of the liability undertaken by an employer under the terms of the three approved gratuity funds, as approved by the Commissioner.
19. In the course of the arguments in these references, a case decided by a Bench of this court in CWT v. Ranganayaki Gopalan : 92ITR529(Mad) , was cited before us. In that case, a company had a scheme of gratuity. Under that scheme the company agreed to transfer to a proposed trust a sum of Rs. 19,50,000 being the liability towards gratuity which arose to its employee up to a particular date to start with, on the basis of an actuarial valuation. Under the gratuity trust deed, the company had the option to pay the fund either the entire sum in one lumpsum or in installments. The company paid certain sums by way of annual installments. These payments, however, left a balance of Rs. 19,11,620. The question arose whether, in ascertaining the net worth of the company, this outstanding liability of Rs. 19,11,620 owed by the company to the trustees of the gratuity fund can be regarded as a liability to be deducted or whether it represented a mere contingent liability. The question arose in the context of the wealth-tax assessment of the shareholders of the company, and the question was what would be the correct method of valuing the shares of the shareholders in that company. The Department took the view that, in ascertaining the net worth of the company, the liability to the fund of Rs. 19,11,620 should not be deducted since it was a contingent liability. This court held that the liability to pay the entire sum of Rs. 19,50,000 under the terms of the trust deed was not a contingent liability but was a definite, ascertained and present liability. The Bench pointed out that whatever might be the position in regard to a mere provision made in the balance-sheet as to gratuity liability, the interposition of a trust and the vesting of the gratuity fund in the trustees, all of which took place in that case as in the case before us, made quite a difference to the legal position. The Department, in that case, sought to make a point out of the fact that the sum of Rs. 19,50,000 which was undertaken to be paid by the company to he trustees of the gratuity fund did not even figure as a liability in the company's balance-sheet, but only figured as a note at the foot of the balance-sheet. On the question of balance-sheet norms, the court was inclined to take the view that the liability of Rs. 19,11,620 which remained unpaid by the company to the gratuity trustees as on the balance-sheet date, ought properly to have been openly exhibited in the body of the balance-sheet itself and not shown by way of a mere foot-note. This shortcoming in depicting this item in the balance-sheet, however, was not thought to affect the real position, namely, that the company had subjected itself to an obligation for payment of Rs. 19,50,000 of which Rs. 19,11,620 still remained unpaid, which was a definite liability and not a mere contingent liability.
20. It will be observed that in the above case, the matter was considered by this court on the basis of the application of ordinary accountancy principles, apparently because the case related to a point of time when the W.T. Rules did not made a specific provision for the valuation of unquoted company shares and for valuation of interests in partnership firms. It seems to us that even after the promulgation of the relevant rules, to which we have earlier alluded, the principle does not stand altered from the one which has been adumbrated in the above decision. The position, if anything, is a furrier as respects contributions to approved gratuity funds governed by the I.T. Act and Rules.
21. Having regard to the considerations we have stated above, any answer to the question of law is in the affirmative and against the Department. The Department will pay the costs. Counsel's fee is fixed at Rs. 500 (one set).