RAJAGOPALAN, J. - Under section 66 (1) of the Income-tax Act, the Appellate Tribunal referred the following question to this Court;
'Whether the sum of Rs. 40,000 paid to Mr. J. H. Phillips on his retirement from the service of the company was not an admissible deduction under section 10 (2) (XV) of the Income-tax Act, 1922 ?'
The facts were never in dispute. The assessee, which was a private limited company, was incorporated in 1928 to carry on business in the manufacture of leather. Gordon Woodroffe & Co., Ltd., was the parent company, and after the incorporation of the assessee-company Gordon Woodroffe & Co., Ltd., were the managing agents. Mr. Phillips was employed in the parent company from 1922 to 1935, and thereafter he was employed in the assessee-company. He was manager of the assessee-company and also one of its directors from 1940. Mr. Philips decided to retire from service with effect from 4th April, 1949. He resigned his directorship. At the meeting of the board of directors dated 24th March, 1949, it was resolved, 'to accept Mr. Phillips resignation with regret and to place on record the keen appreciation of the board of his long and valuable services to the company'. It was further resolved to convey to Mr. Phillips the best wishes of the directors and the staff in his retirement from India. It was also resolved to recommend at the forthcoming extraordinary general meeting that Mr. J. H. Phillips be paid a gratuity of Rs. 50,000, and to recommend further that the parent company should be asked to contribute a portion of this sum. These recommendations were accepted. Rs. 50,000 was paid as a gratuity to Mr. Phillips, of which, however, the assessee-company paid only Rs. 40,000. The balance was paid by the parent company. This payment of Rs. 40,000 was claimed by the assessee as an allowable deduction in the assessment year 1950-1951. The claim was disallowed by the Department and the Tribunal agreed with them.
The Tribunal held as recorded in paragraph 6 of the statement of the case, that the amount was not expended wholly and exclusively for the purpose of the business and that it was also capital in nature.
It is easier to dispose of the question, whether the payment of Rs. 40,000 constituted an expenditure of a capital nature. Every lump payment is not necessarily a payment incurred by way of capital expenditure. The test most frequently applied is that laid down by Lord Cave in British Insulated and Helsby Cables Ltd. v. Atherton :
'But when an expenditure is made not only once and for all, but with a view to bring into existence an asset or advantage for the enduring benefit of trade, I think that there is very good reason (in the absence of special circumstances leading to an opposite conclusion) for treating such an expenditure as properly attributable not to revenue but to capital.'
Judged by that test, it should be obvious that the expenditure in question was not of a capital nature. The payment of Rs. 40,000 did not bring into existence any asset for the enduring benefit of the business the assessee carried on. Nor did it secure to it an advantage for the enduring benefit of its business. It was a payment to an employee who retired from the service of the assessee-company in grateful recognition of his past services, which the assessee-company justly assessed as valuable services. It should be noted that the good faith attendant on the transaction was never in doubt.
That it was not an expenditure of a capital nature does not solve the question we have to answer; the claim has still to satisfy the other requirements of section 10 (2) (XV) of the Act : Was it laid out or expended wholly or exclusively for the assessees business still remains to be answered.
The two cases on which text book writers both in England and in India have based their comments, with reference it such lump sum payments of gratuity to retiring servants, are Smith v. The Incorporated Council of Law Reporting and Hancock v. General Reversionary and Investment Co. Ltd.
In Smith v. The Incorporated Council of Law Reporting, the Incorporated Council paid a sum of pounds 1,500 as gratuity on the retirement of one of its reporters. The question was, whether this pounds 1,500 should be included in the profits of the assessee (the Incorporated Council) assessable to income-tax. The Commissioners decided that it was not. That decision was confirmed by Scrutton, J., when the Crown appealed. The learned Judge pointed out that the Commissioners had found as a fact that pounds 1,500 was money wholly and exclusively laid out or expended for the purpose of the trading and proceeded to determine the question, was there evidence upon which they could find that. The learned Judge observed. 'What they find is that though the reporters have no legal right to payment on retirement, it has been the habit of the respondents to give a gratuitous pension or to make a gratuity of a lump sum on retirement to a reporter after long service. One cannot help using ones ordinary knowledge of human nature to know that in some cases the expectation of gratuities may materially affect the amount of salary... When I find that the commissioners have found that it is the habit of these employees to give their reporters gratuitous pensions or gratuities of lump sums, I cannot help seeing that there is evidence upon which the Commissioners, judging from facts, may find that those payments were made in the way of their trade, because they at any rate may affect the amount of ordinary salary which they pay to their reporters.'
In Hancock v. General Reversonary and Investment Company Ltd., the assessee-company sought to charge as a trading expenditure a lump sum which it had paid for the purchase, for the benefit of a former actuary and secretary of the company, of an annuity equal in amount to the pension, which had been awarded to him by a resolution of the company. Lush, J., held that the lump sum paid to purchase the annuity was an expenditure incurred in the business not in the nature of capital expenditure, and was an admissible expense in computing the companys profits assessable to income-tax. Lush, J., observed at page 371, '....... I think that it necessarily follows...... that pounds 4,994 should be treated, as the pension was treated. as an ordinary business expenditure and that the deduction should be allowed. It is the pension in another from; it is actuarially equivalent in value and it is identical in character. It was paid to meet a continuing demand which was itself an ordinary business expense. It seems to be as impossible to hold that, if any employer were under a voluntary arrangement with his servant to pay the servant years salary in advance instead of paying each years salary as it fell due, he would be making a capital outlay.'
There is no scope for extending to the claim of the assessee in this case the principle laid down in Hancock v. General Reversionary and Investment Company Ltd. It was not as if Mr. Phillips was paid a lump sum gratuity in lieu of any annual pension, to which he would otherwise have been entitled.
In our opinion, the principle laid down in Smith v. The Incorporated Council of Law Reporting either cannot be extended to the assessees claim. The Tribunal recorded, '..... there is nothing to indicate that Mr. J. H. Phillips had accepted a lower salary in the hope of getting a gratuity. He could not have had any such hope as there was no such practice in the assessee-company....' It should be remembered it was found in Smith v. The Incorporated Council of Law Reporting, that it was the habit of the Incorporated Council of Law Reporting to give a gratuitous pension or to make a gratuity of a lump sum on retirement to a reporter after long service. No precedent for the payment of such a gratuity was proved by the assessee-company before the Tribunal. During the course of arguments before us, we offered an opportunity to learned counsel for the assessee to produce evidence, if any, of similar payments having been made in the past either by the assessee-company or by its parent company. Had any such evidence been forthcoming, we would have considered the desirability of allowing the assessee to place that material before the Tribunal and to call for a further statement of the case. But no real evidence of similar payments in the past was forthcoming. Of course, a precedent for such a payment would only be one of the relevant factors to be taken into consideration with its proper probative value. We should not be understood to lay down that in the absence of precedents a claim under section 10 (2) (XV) of the Act must necessarily be disallowed. Every company has to make a beginning, and a first payment of its kind does not cease to be deductible if it satisfies the requirements of section 10 (2) (XV).
What was the nature of the payment made to Mr. Phillips is the question for consideration. It was obviously paid to him in grateful; and possibly just recognition of the valuable services he had rendered to the company. But those services had already been rendered. The payment was certainly not to secure the services of Mr. Phillips in the future. The assessee did not establish that the payment was designed in the interests of the future business of the company, either to act as an incentive to the employees still in service, or to act as an incentive to the employee to be recruited in future. As the Tribunal has in effect found, expectancy of a gratuity on retirement did not play any part either when Mr. Phillips joined the service of the company, or when any other employee entered its services. Apparently the company has now a scheme of a contributory provident fund which, of course, is quite distinct from the expectancy of any gratuity on retirement. Thus the position is the normal service conditions of the assessee company did not provide for any expectancy of any gratuity on retirement either in the past or probably in the future. It is with reference to these facts that we have to decide the question, whether the payment of Rs. 40,000 to Mr. Phillips satisfies the test, whether it was wholly or exclusively expended for the business of the company. Gratitude for past services expressed in a monetary from by itself, and with nothing more, may not satisfy that test.
In The Principles of Income Taxation by Hannan and Farnsworth at page 478 the learned authors stated :
'Arrangements for the retirement of employees are a necessary part of the operations of a business. Consequently financial provision by the employer for such a happening is more or less directly associated with the earning of the profits. As employee is likely to give better service when he can reasonably expect to receive a gratuity or pension upon the termination of a long period of employment. The expectation, though it may rest only upon the fact that similar provision has been made for former employees, is calculated to promote better relations between employer and employee, with beneficial results to the business concerned.
For these reasons it is now generally recognised that payments made by an employer top his retired employees are a proper charge in arriving at the taxable profits of his business. Such payments are in an entirely different category from a lump sum set aside to establish a pension fund similar to that in Athertons case. But even payments of the former class may be made in circumstances so exceptional that their admissibility as deductions is liable to be challenged by revenue authorities.
Learned counsel for the Department invited out attention to a passage from, Gunns Commonwealth Income Tax Law & Practice, Fourth Edition. Section 51 of the Astralian Act provided 'losses and outgoings to the extent to which they are incurred in gaining or producing the assessable income or are necessarily incurred in carrying on a business for the purpose of gaining or producing such income shall be allowable deductions except to the extent to which they are losses or outgoings of capital....' Though not in pari materia with section 10 (2) (XV) of the Income-tax Act one of the tests imposed by section 51 is that the expenditure should be necessarily incurred in carrying on a business for the purpose of gaining or producing assessabler income.
In paragraph 1195 at page 421 the learned authors stated :
'A payment to an employee on his retrenchment or retirement is deductible under section 51 only where it can be established that the payment was in the future interests of the taxpayers business. The position is otherwise under the specific provisions of section 78 (1) (C) where an allowance is granted for payments in consideration of the past services of employees.'
Section 78 (1) (C) provided for a deduction of 'persons, gratuities, or retiring allowance to persons who are or have been employees or dependents of the employees to the extent to which were carried by the taxpayer.' There is no analogous provision in the Inidan Income-tax Act. With reference to a claim under section 51 of the Australian Act, somewhat analogous to section 10 (2) (XV) of the Indian Act, the learned authors extracted a passage in an Australian decision :
'It has never been held that a pension or other allowance paid by a taxpayer in business to a retiring of deceased director or his dependents solely in respect of past services of the director or employee is an allowable deduction under income-tax provisions dealing with the allowance of business outgoings generally. Whenever such a payment has been held to be deductible the decision has been based on the fact that it was made in the future interests of the business............. There must be a connexion between the purpose of the payment and the further pursuit of gain. There must be some facts which justify the inference that the outgoing was incurred to conduce to that end.'
These principles, in our opinion, could well be invoked in applying the provisions of section 10 (2) (XV) of the Income-tax Act.
Two other cases were referred to, though they did not themselves deal with payments of gratuities to a retiring servant.
In B. W. Noble Ltd. v. Mitchell, the directors were appointed for life, subject to dismissed; forthwith for neglect or misconduct towards the company. A director so dismissed was only entitled to receive his salary then due. He could also be required to sell his shares to the other directors at par. He would also have to surrender for cancellation certain notes issued by the company entitling him to participate in above its face value, because the shares paid a dividend of 677%. Circumstances arose in 1920 and 1921, in which the company might have been justified in dismissing one of the directors. But to avoid publicity injurious to the companys reputation it entered into a negotiated settlement with the director, under which he retired from the company and the company and the company paid him pounds 19,200. The companys claim to deduct this payment was allowed. Rowlatt, J., held, '...... Although the largeness of the figures and the peculiar nature of the circumstances perplex one..... this is not more than a payment to get rid of a servant in the course of the business and in the year in which the trouble comes. I do not think it is a capital expense; and I have held that it is an expense incurred in the conduct of the business.'
Lord Hanworth, M. R., agreed that the payment should be treated as a revenue its, and not as a capital item. He observed at page 420 :
'It seems to attain more closely to Hancocks case and The Law Reporting case than to other cases...... It is a payment made in the course of business, dealing with a particular difficulty which arose in the course of the year, and was, made in order not to secure an actual asset to the company but to enable them to continue, as they had in the past, to carry on the same type and high quality of business unfettered and unimperilled by the presence of one who, if the public had known about it, might have caused difficulty to their business and whom it was necessary to deal with and settle with at once.'
The principle laid down in B. W. Noble Ltd. v. Mitchell was followed by the High Court of Australia in W. Nevill & Co. Ltd. v. Federal Commissioner of Taxation. There again it was an unwanted director that the company got rid of, and it secured the cancellation of the agreement in his favour by a payment of pounds 2,500. The High Court held that this sum of pounds 2,500 was a 'loss or outgoing incurred in gaining or producing assessable income,' to satisfy the requirements of the statutory provisions in Australia.
Latham, C.J., observed at page 301, 'No expenditure, strictly and narrowly considered, in itself actually gains or produces income. It is an outgoing, not an incoming. Its character can be determined only in relation to the object is the conduct of the business on a profitable basis with that due regard to economy which is essential in any well conduced business, then the expenditure (if not a capital expenditure) is an expenditure incurred in gaining or producing the assessable income. It it is not a capital expenditure it should be deducted in ascertaining the taxable income of the taxpayer.'
Though, as we said, Nevills case did not deal with the payment of a gratuity voluntarily made by the employer to a retiring employee, the general observations of Latham, C.J., which we have extracted above, explain the view point from which to judge whether an expenditure was laid out by the assessee wholly or exclusively for the purpose of his business.
Before we revert to the requirements of section 10 (2) (XV) of the Act, we have to refer to two features of the order of the Tribunal. The Tribunal pointed out that Mr. Phillips was in receipt of a salary and a 2 1/2 per cent. commissioner in addition to his salary and recorded, 'In these circumstances, it is idle to contend that the payment made on resignation of the employee was in return for long and faithful services rendered.' We are really unable to appreciate the scope of these observation or discover what the basis for them was. As we said, that the company acted in goof faith was never really in dispute. The genuineness of the payment was not in dispute. That Mr. Phillips rendered valuable services to the assessee company and that the company was conscious of that and was justly grateful to him for that were not matters in dispute either. As the learned counsel for the assessee pointed out, the Tribunal failed to understand the scope of the payment : it failed to view it from the view point of commercial expenditure was not debited to the profit and loss account, but was debited to the appropriation account, thereby strongly indicating that it was an extraordinary payment or a made in the nature of capital expenditure. Every extraordinary payment is not necessarily an expenditure of a capital nature. Entry in the accounts by itself may not conclude the question, what was the nature of the payment. Neither of the two features to which we have referred above, which were taken into consideration by the Tribunal in disallowing the assessees claim, was really relevant. But that does not in any way affect our decision in this case on the question, whether the claim of the assessee falls within the scope of section 10 (2) (XV) of the Act.
We have already pointed out that to bring a claim within the scope of section 10 (2) (XV) it is not enough to show that it was not in the nature of a capital expenditure. The further test of section 10 (2) (XV) has to be satisfied : was the amount laid out or expended wholly and exclusively for the purpose of the business of the assessee-company. In this case the sum of Rs. 40,000 was paid as gratuity on retirement for the valuable services rendered by the employee, Mr. Phillips. There was no evidence to show that at any time before the payment was resolved Mr. Phillips expected to receive it or even that the company contemplated its payment. No doubt the payment was for past services rendered. But it was not remuneration that the company was bound to pay for those services. The payment of gratuity was voluntary. Even a voluntary payment could satisfy the requirements of section 10 (2) In this case there was no evidence to show that it was in the future innterests of the business of the assessee that the expenditure was incurred. In the case of a payment of a graduity for a retiring employee in recognition of his past services with nothing more, cannot in our opinion satisfy the requirements of section 10 (2)(xv) even if those requirements are judged from the view point of commercial expendiency as it always should be when a claim arises under section 10(2)(xv). Was the expenditure incurred in the future interests of the business of the assessee Was there any connection between the purpose of the payment and the further conduct of the business of the assessee These are the tests to be satisfied before it could be said that in paying the gratuity money was laid out or expended wholly and exclusively for the purpose of the business of the company. These tests the assessee did not satisfy in this case.
Mr. Subbaraya Ayyar, learned counsel for the assessee, pointed out that the company accepted it as a legitimate payment. But obviously that is not enough to sustain a claim under section 10 (2) (xv). As we said, the good faith attendant on the transaction was never in dispute. The action of the company in rewarding a trusted employee after long years of faithful service by making him a substantial payment may be laudable, but the question is, is it a claim that could be allowed under section 10 (2) (xv) of the Act. That question, in the circumstances of this case, has to be answered in the negative.
We answer the question in the negative and against the assessee. The assessee will pay the costs of this reference. Councils fee Rs. 250.
Questions answered in the negative.