1. The assessee is a public limited company. For the assessment year 1963-64 corresponding to the accounting year ending March 31, 1963, it claimed a deduction of a sum of Rs. 56,275 under Section 37 of the Income-tax Act, 1961. During the year under consideration, a new company was formed under the name and style of Stanes Tyre and Rubber Products Ltd., which is a fully owned subsidiary company of the assessee. It may be mentioned that thus subsidiary company was formed in the place of the retreading division of the assessee. This new company took over all the employees belonging to the tyresoles division of the assessee. At the time of the formation of the new company gratuity payable to the transferred employees was calculated on the basis of the rules of the company and the amount thus ascertained was a sum of Rs. 56,275. This amount was transferred to the subsidiary company from the pension and gratuity reserve of the assessee. The assessee claimed that the amount was paid in discharge of their liability for gratuity to the employees transferred to the subsidiary company and as such it was an allowable deduction under Section 37 of the Income-tax Act of 1961. The Income-tax Officer was of the view that the said amount made over to the new company was kept as a reserve by the new company and no payment of any amount to the employees as such was made. Therefore, this amount which has merely changed hands from the assessee-company to the new company, amounted to only a transfer and not an expenditure. In that view he rejected the claim for deduction. The Appellate Assistant Commissioner also took the same view and held that the amount was not paid to the new company on behalf of the employees, that there was only a transfer of funds and that, therefore, the amount is not deductible as an expenditure. The Tribunal considered that, as Section 25FF of the Industrial Disputes Act did not apply to the facts of this case, no compensation was payable to the employees on their transfer from the assessee-company to the subsidiary company, but all the same held that the amount is deductible for the following reasons :
' The assessee has not contributed anything towards an approved gratuity fund. Here what the assessee has done is to pay the amount standing to the credit of the respective employees to the transferee-company. That is, as far as the assessee is concerned, it gets an acquittance from the various employees on such payment. If there is a termination of the services, as far as the assessee is concerned, the assessee would be liable to refund to the various employees the amount standing to their credit on account of gratuity. Therefore, the assessee had paid the amounts payable as gratuity in discharge of its obligations to the workmen to the transfree-company. Therefore, during the year, the assessee has in effect paid the workmen the amounts due to them. It may be that the workmen in turn had authorised the newly formed company to receive these amounts.
Now let us look at it in a different way. Suppose the workmen had been retrenched this year or their services terminated, they would be entitled to the allowance. So what has happened during the year under consideration is that these amounts have been paid to the new company on behalf of the employees. It is not clear, why the Appellate Assistant Commissioner has said, that these amounts have not been paid to the employees. We are of the view that there being no other prohibition, the provisions of Section 37 would apply to the case and the assessee would be entitled to claim this as a deduction against its income for the year under consideration. The contention is accepted.'
2. At the instance of the revenue the following question has been referred :
' Whether, on the facts and the circumstances of the case, the sum of Rs. 56,275 transferred by the assessee to the subsidiary company on account of gratuity fund for the assessment year 1963-64 was an allowable expenditure under Section 37 of the Income-tax Act, 1961 '
3. For the same assessment year the assessee claimed rebate in respect of a sum of Rs. 7,050 paid by the assessee out of the reserve fund for certain charities. The rebate was claimed under Section 88(1) of the Act. The Income-tax Officer held that since the amount was paid out of the reserve fund and not from the income during the year, it did not qualify for the rebate. This view was confirmed by the Appellate Assistant Commissioner and the Tribunal. At the instance of the assessee the following question has been referred :
' Whether, on the facts and in the circumstances of the case, the assessee was entitled to the relief under Section 88 with reference to the sum of Rs. 7,050 '
4. As regards the first question referred to at the instance of the revenue the learned counsel for the revenue contended that the expenditure was not incurred for the purpose of carrying on the business and earning profit and that it was a mere transfer of funds as part of the bargain when the new company was formed. It is the liability which arises on transfer of the business and did not arise during any part of the accounting year. Therefore, the claim for deduction under Section 37 is not tenable.
5. As has been seen from the facts the assessee-company had a gratuity reserve account. It is from the reserve the said amount was made over to the new company to be kept as gratuity reserve by the new company. It is true that the amount was ascertained with reference to the gratuity payable to the transferred employees on the basis of the rules of the company. But it is still only a transfer of fund. No payment as such to any employee was made at the time of transfer. No question of payment of any compensation to the employees under Section 25FF of the Industrial Disputes Act also arises in this case as the proviso to that section is clearly satisfied. The company, therefore, was not under a definite and present obligation to pay any gratuity in respect of the transferred employees. Nor is it correct to say that the amount was paid to the new company on behalf of the employees. The amount is kept as reserve by the new company. Since the new company has agreed to treat the services of workmen as not having been interrupted and under the same terms and conditions applicable to them while they were in the assessee-company and agreed to pay the gratuity as and when it arises on such basis, the amount as such could not be said to have been received by the new company on behalf of the employees. In fact no particular amount stood to the credit of any particular employee. It constituted a consolidated sum under the head 'Gratuity reserve'. Further, the amount was not paid by the assessee in discharging any obligation. No obligation in respect of the employees arose on transfer because the transferee-company took over the employees without break of any service.
6. In the circumstances we are of the view that the said amount could not be said to have been expended wholly and exclusively for purposes of business and, therefore, the claim of deduction under Section 37 is not admissible. In this connection we may also refer to a decision of the Supreme Court in Commissioner of Income-tax v. Gemini Cashew Sales Corporation : 65ITR643(SC) . Though the facts are not very similar, the test propounded in that decision can be applied in order to find whether the claim in question was admissible as a deduction under Section 37. That was a case in which on the dissolution of a firm by the death of one of the partners the sole surviving partner took over the business and continued on his own, account without any interruption in the service of the employees or alteration in the terms of employment. In settling the account of the firm a sum of Rs. 1,41,506 was taken into account as retrenchment compensation payable to the employees under Section 25FF of the Industrial Disputes Act, 1947. On the question whether the sum of Rs. 1,41,506 constituted an allowable expenditure in computing the income of the firm, the Supreme Court held that it was not properly deducted as an item in the profit and loss account or a permissible allowance under Section 10(2)(xv) of the Indian Income-tax Act, 1922. While holding so, the Supreme Court observed as follows :
'Normally the liability which occurs after the last date, unless its source is in a pre-existing definite obligation, cannot be regarded as a part of the outgoing of the business debitable in the profit and loss account. A deduction which is proper and necessary for ascertaining the balance of profits and gains of the business is undoubtedly properly allowable, but where a liability to make a payment arises not in the course of the business, not for the purpose of carrying on the business, but springs from the transfer of the business, it is not, in our judgment, a properly debitable item in: its profit and loss account as a revenue outgoing. The claim of the firm to treate it as an item in the determination of the profits of the firm under Section 10(1) of the Income-tax Act cannot, therefore, be sustained.
Under Section 10(2)(xv) of the Indian Income-tax Act; 1922, in the computation of taxable profits (omitting parts of the clause not material) 'any expenditure laid out or expended wholly and exclusively for the purpose of such business, profession or vocation ', i.e., business, profession or vocation carried on by the assessee, is a permissible allowance. But to be a permissible allowance the expenditure must be for the purpose of carrying on the business. Where accounts are maintained on the mercantile system, if liability to make the payment has arisen during the time the business is carried on, it may appropriately be regarded as expenditure. But where the liability is, during the whole of the period that the business is carried on, wholly contingent and does not raise any definite obligation during the time that the business is carried on, it cannot fall within the expression ' expenditure laid out or expended wholly and exclusively ' for the purpose of the business.'
7. As already pointed out the liability to make payment to the employees had not arisen during the accounting period. The liability if at all was wholly contingent. The transfer of gratuity reserve from the assessee-company to the new company did not also arise in the course of the business or for the purpose of carrying on the business, but springs from the transfer of the business. Therefore, it cannot be said that the expenditure was laid out or expended wholly or exclusively for the purpose of business or it was a properly debitable item in its profit and loss account as a revenue outgoing. For the foregoing reasons we answer the first question in the negative and against the assessee.
8. So far as the second question is concerned the answer to the question depends on the interpretation of Section 88 of the Income-tax Act. That section deals with rebate in respect of donations for charitable purposes. The relevant portion reads as follows :
'88. (1) Subject to the provisions of this section, the assessee shall be entitled to a deduction from the amount of income-tax on his total income with which he is chargeable for any assessment year ...... at the averagerate of ... on any sums paid by the assessee in the previous year--...
(ii) as donations to any other fund or any institution to which this section applies;...'
9. Sub-section (5) of that section provided that this section applies to donations to any institution or fund referred to in Clause (ii) of subsection (1) only if it is established in India for a charitable purpose and if it fulfils the conditions set out therein. There is no dispute that Sub-section (5) to Section 88 is complied with in this case. But this claim was rejected on the ground that the amount paid as contribution for charities did not form part of the income assessable for the year and it was paid out from reserve account. On a plain reading of the section we are of the view that the Tribunal is right in holding that no rebate is permissible in respect of the amount. The rebate or deduction is ' from the amount of income-tax on his total income with which he is chargeable for any assessment year '. Therefore, unless the donations claimed for rebate had formed part of the assessable income of that year it would not be available for rebate under Section 88. In this connection we may also refer to Section 66 of the Act which provides that in computing the total income of an assessee, there shall be included all income on which no income-tax is payable under Chapter VII and any amount in respect of winch the assessor is entitled to a deduction from the amount of income-tax on his total income with which he is chargeable for any assessment year in accordance with and to the extent provided in Sections 87 87A and 88. It is, therefore, clear, that in order to claim a deduction of rebate under Section 88 the amount should have formed part of the total income of that year. We may also state that a similar view was taken in Commissioner of Income-tax v. Samnugger Jute Factory Company Ltd. : 24ITR265(Cal) and in Basant Kumar Aditya Vikram Birla v. Commissioner of Income-tax : 70ITR657(Cal) which were concerned with the interpretation of the corresponding provision in Section 15B(1), Indian Income-tax Act, 1922. In the instant case we find that in the beginning of the accounting year there was a reserve to an extent of Rs. 6,876. From the balance-sheetand the profit and loss account produced before us it appears that no provision was made during the year towards this reserve. Though payment was made towards charity to an extent of Rs. 7,405 as per the profit and loss account only a sum of Rs. 7,050 was claimed for deduction under Section 88. Out of this Rs. 7,050, Rs. 6,876 had come from the reserve. The balance of Rs. 174 alone could have come from the income derived during the year. Therefore, the assessee would be entitled to rebate in respect of only thissum of Rs. 174 and not to the entire sum of Rs. 7,050.
10. We, accordingly, answer the second question to the effect that the assessee is entitled to a relief under Section 88 only to the extent of Rs. 174 and not to the extent of Rs. 7,050.
11. The revenue will be entitled to its costs. Counsel fee is Rs. 250.