1. This reference under Section 256(1) of the I.T. Act, 1961, raises the following question :
' Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in law in allowing the payment of gratuity as an admissible expenditure '
2. The assessee was carrying on business in banking. In accordance with the instructions of the Reserve Bank of India, during 1964, it took over the assets and liabilities of three other banks, namely, the Coimbatore Aryan Bank Ltd., the Coimbatore Varthaka Vridhi Bank Ltd., and the Krupakara Bank Ltd., Coimbatore. As a result of the merger of these banks, the board of directors passed two resolutions, one on 31st January, 1964, and the other, on 21st November, 1964, in the matter of gratuity payments. Under these resolutions, gratuity of one month's pay per year was payable on the retirement of the particular member of the staff. No gratuity was payable if the employee resigned on his own accord or was dismissed from service for misconduct, insubordination, indiscipline or gross neglect of duty.
3. On 31st December, 1966, as directed by the Reserve Bank of India, the assessee-bank was merged with the Indian Overseas Bank. The assessee had fifty-four employees on its staff, out of whom forty-two employees joined the Indian Overseas Bank and the remaining twelve employees were not taken over by that bank. There was an agreement at the time of the merger of the assessee-bank with the Indian Overseas Bank. Clause 13 of the agreement provided that the entire staff must resign from the services of the assessee-bank before any of them was taken over, and that all their dues referable to their service with the assessee must be settled by the assessee-bank. The same clause also provided for weightage being given to the employees taken over by the Indian Overseas Bank in the matter of fixation of their pay, having regard to their qualification and merit. The employees were assured that the total emolument would not be less than what they were getting while they were working with the assessee-bank.
4. The assessee-bank paid the gratuity to the employees as follows:
Payments to employees including managing director (length of service ranging between about 11/2 years and 31 years)--Rs. 65,306.
Payment to staff taken over from other banks whose period of service with the assessee did not exceed 21/2 years--Rs. 4,819.
4. The aggregate amount of Rs. 70,125 was claimed as deduction in the assessment for the assessment year 1967-68, for which the previous year ended on December 31, 1966. The ITO disallowed the claim on the ground that there was no practice in the matter of payment of gratuity and that the payment of gratuity was made on the eve of the winding up of the business. He held that the gratuity could not be described as a payment which would facilitate carrying on the assessee's business, since thebusiness itself was not carried on by it, but taken over by the Indian Overseas Bank with effect from December 31, 1966. In his view, the gratuity payments could not be said to be dictated by commercial expediency, as there was no employee left out for being spurred to activity with an eye on reward in the shape of gratuity, and as the expenditure was incurred at the time of or for the purpose of closing down the business of the assessee, it was not an expenditure coming within the scope of Section 37(1) of the I.T. Act, 1961.
5. The assessee appealed to the AAC, who held that forty-two employees having been taken over by the Indian Overseas Bank, the gratuity paid to them was not an admissible deduction, and with reference to the remaining twelve employees who were not taken over, he was of the view that the gratuity paid to them amounting to Rs. 9,910 should be allowed as a deduction. Accordingly, he reduced the disallowance of Rs. 70,125 by Rs. 9,910.
6. The assessee, thereafter, appealed to the Appellate Tribunal as regards the balance of gratuity remaining disallowed in the assessment. The Tribunal held that the gratuity payment was made on grounds of commercial expediency and in order to carry on its business till liquidation and in that view of the Tribunal, there was a nexus between the gratuity payments made and the conduct of the business of the assessee. The amount was thus allowed as a deduction either under s, 36(1) or under Section 37(1) of the Act.
7. Section 36(1) of the I.T. Act, 1961, provides for deduction of certain amounts specified therein. The Tribunal has not stated the sub-clause under which the present payment is sought to be brought in. There is a provision for the allowance of payment of bonus or commission for services rendered under sub-cl. (ii) of Section 36(1). There is a provision for the allowance of payment of contribution towards a recognised provident fund or an approved superannuation fund under Sub-clause (iv) of Section 36(1). Sub-clause (v) of Section 36(1) provides for the allowance of payment made by the assessee by way of contribution towards an approved gratuity fund created by him for the exclusive benefit of his employees under an irrevocable trust. The present case cannot be brought within the scope of any of these sub-clauses. This is not a payment of bonus or commission, nor is it any contribution towards a recognised provident fund, superannuation fund or gratuity. There is, therefore, nothing in Section 36 which applies here, and the present claim for deduction cannot be brought within the scope of any of the sub-clauses of Section 36. The Tribunal's conclusion based on Section 36 is clearly erroneous.
8. Section 37(1) of the Act provides for any expenditure, which does not fall within Sections 30 to 36 and which is not in the nature of capital expenditureor the personal expenses of the assessee, being allowed as a deduction, provided it is laid out or expended wholly and exclusively for the purpose of the business or profession. The point to be considered is whether the payment in the present case can be brought within the scope of Section 37(1) of the Act.
9. As it is clear from the question itself, the payment is referred to as gratuity. In the narration of facts given above, it would be found that under Clause 13 of the agreement entered into between the assessee and the Indian Overseas Bank, their staff had to resign from the services of the assessee-bank before they were taken over and that all their dues had to be settled by the assessee-bank. Therefore, it is not a case of any voluntary resignation on the part of the staff, so as to disentile it from claiming the benefit which accrued to it under the resolution of the board of directors referred to already. The resignation was actually forced on the members of the staff as a result of the terms of the merger with the Indian Overseas Bank. The liability to pay gratuity thus arose as a result of the obligation undertaken by the assessee in its resolutions dated 31st January, 1964, and 21st day of November, 1964. Thus, it was a pre-existing obligation at the time when the merger took place.
10. The learned standing counsel for the Commissioner contended that the payment actually arose as a result of, or subsequent to, the winding-up of the assessee-company's business. There is one aspect to be noticed in this context. Even in the assessment order, the ITO has stated that the ' steps for liquidation of the assessee-bank are also being taken '. Therefore, it is clear that till the end of 1969, the assessee-company had not gone into liquidation and was continuing in existence.
11. The question of gratuity being allowable as deduction came up for consideration before the Supreme Court in Gordon Woodroffe Leather Manufacturing Co. v. CIT : 44ITR551(SC) . In that case, an employee from 1935, who was also a director from 1940, was paid a gratuity of Rs. 40,000 in appreciation of his long and valuable services to it. The company had no scheme for the payment of gratuities nor did it pay such gratuities in practice. There was also nothing to show that the employee had accepted a low salary in the expectation of a gratuity on retirement. On these facts, the Supreme Court held that the amount of gatuity paid in that case was not an expenditure laid out or expended for the purpose of the assessee's business within the meaning of Section 10(2Xxv) of the Indian I.T. Act, 1922, which corresponded to Section 37(1) of the present Act. The amount was, therefore, held to be not deductible in computing the profits and gains of the company. The proper test to be applied in a case like this was described at p. 555 as follows :
' In our opinion the proper test to apply in this case is, was the payment made as a matter of practice which affected the quantum of salary or was there an expectation by the employee of getting a gratuity or was the sum of money expended on the ground of commercial expediency and in order indirectly to facilitate the carrying on of the business. But this has not been shown and, therefore, the amount claimed is not a deductible item under Section 10(2)(xv). '
12. The learned standing counsel for the Commissioner submitted that there was no practice in the present case and that there was also nothing to show that any employee joined in the expectation of getting the gratuity. As pointed out by the Supreme Court in the recent decision, Sassoon J. David and Co. P. Ltd. v. CIT : 118ITR261(SC) , it is too late in the day now, whatever may have been the position about two decades ago, to treat the expenditure incurred by a management in paying reasonable sums by way of gratuity, bonus, retrenchment compensation or compensation for termination of service as anything other than business expenditure. It was also held that such expenditure would ordinarily fall within the scope of Section 10(2)(xv) of the Act. In the case referred to above, there was a change in the holdings, A group of persons referred to as the Davids had large shareholdings in the company. They transferred their shares to another group called the Tatas. The directors of the company proposed that the services of 22 employees, the managing director and the director be terminated and they be paid a compensation. Subsequently, the shareholders accepted the directors' proposal, and thereafter under an agreement between the Davids and the Tatas, the shares got transferred subject to the amount of compensation payable to the employees being deductible from the consideration payable by the Tatas for the purchase of the shares. After the change in the shareholdings, the company re-employed nine out of the 22 employees, and the services of thirteen persons were terminated. On the payments that were claimed as deductions including the payments to the managing director in lieu of six months' notice and another payment towards compensation for termination of pension allowance and also payment of gratuity, the Supreme Court held that whatever may be the motive behind the payment of compensation, so long as the amount was laid out wholly and exclusively for the purpose of the business, there was no reason for denying the benefit of Section 10(2)(xv). It was pointed out that the company continued to function even after its control passed on to the Tatas. The expenditure in question was, therefore, held to be deductible. The result of this decision is to show that the gratuity paid by the employer is liable to be deducted from the taxable profit, and that is the position here.
13. The learned standing counsel placed great reliance on the decision of the Supreme Court in CIT v. Gemini Cashew Sales Corporation : 65ITR643(SC) . In that case, a firm of two partners was dissolved and the business was taken over by one of the partners. There was no interruption in the services of the employees or alteration in the terms of their employment. In settling the accounts of the firm, a particular sum was taken into account as retrenchment compensation payable to the employees under Section 25FF of the Industrial Disputes Act, 1947, which would apply on a transfer of ownership. The question was whether the sum constituted an allowable expenditure in computing the income of the firm. The Supreme Court held that during the entire period, the business was continued, there was no liability to pay retrenchment compensation ; that the liability arose only on transfer of the business and, that it was not of a revenue nature so as to be deductible under Section 10(1). Similarly, the liability under Section 25FF was also considered to be wholly contingent and did not arise as an obligation during the period of the business of the assessee-company. In the said case, the principle to be applied as pointed out by the Supreme Court at pages 649 and 650 is as follows:
' As already observed, the liability to pay retrenchment compensation arose for the first time after the closure of the business and not before. It arose not in the carrying on of the business but on account of the transfer of the business. During the entire period that the business was continuing, there was no liability to pay retrenchment compensation. The liability which arose on transfer of the business was not of a revenue nature. Profits of a business involve comparison between the state of the business at two specific dates. 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.' (Underlined* by us).
14. The claim in that particular case was held to be rightly disallowed under the provisions of Section 10 of the Act.
15. The above passage clearly lays down that the case of a pre-existing definite obligation would stand out and form a separate category. With reference to such a category the enquiry as to whether it arose on closure (c)f the business or transfer of the business is not relevant. We mayimagine a case, for example, where a dispute against the liability to pay a particular employee is pending, and this dispute is settled either at the time of or subsequent to the closure of the business. In either event, the obligation arose during the continuance of the business and, therefore, in that sense, the expenditure is liable to be deducted. The present case is one where the assessee undertook to pay gratuity under the agreement entered into with the bank in which its business was merged, and so the contingency to pay gratuity as undertaken in its resolutions arose in the present case and, therefore, it comes within the exception to the rule that any payment which is made at the time or after the closure of the business cannot be allowed as deduction. Only where the amount is paid to the employee, it can be called gratuity. Where the amount calculated to be the liability for gratuity is transferred, it is only a transfer of a fund to meet a contingent liability and it cannot be allowed as deduction. The learned counsel drew our attention to the decision in Stanes Motors (South India) Ltd. v. CIT  100 ITR 341 . A new subsidiary company was formed to take over the retreading division of the assessee-company. The subsidiary company took over all the employees who were working in the assessee-company. The gratuity payable to the transferred employees was calculated on the basis of the rules applicable to them, and this amount was transferred to the new company from the pension and gratuity reserve in the hands of the assessee-company. The assessee claimed that the amount so transferred was liable to be allowed as deduction, but this court negatived the claim. The point to be noted with reference to this case is that no payment was made as and by way of gratuity or retrenchment compensation to the employee. Similar is the position in CIT v. Pathinen Grama Arya Vysya Bank Ltd. : 109ITR788(Mad) another decision of a Bench of this court. In that case also, there was a merger of one bank with another. The agreement provided for the transferee-bank employing all the employees of the transferor-bank who had not completed the age of 60. In the transferor-bank, there was a provision for payment of gratuity to the employees on retirement, and with reference to this provision, a particular sum was transferred to the transferee-bank and this amount was claimed as deduction. This court, applying the principle of the decision of the Supreme Court in CIT v. Gemini Cashew Sales Corporation : 65ITR643(SC) held that the said amount cannot be allowed as deduction. In that case also, the amount was not paid as gratuity. The liability alone was transferred to the transferee-bank. The decision in Stanes Motors' case : 100ITR341(Mad) was directly applicable to this case also. In both the cases, there was only a transfer of a liability which was to arise in future, as the employees continued in service without interruption.
16. Another unreported decision dated March 6, 1979, in the case of CIT v. Salem Bank Ltd. in T.C. No. 284 of 1975 [since reported in : 120ITR224(Mad) was brought to our notice. That was also a case where the amount was transferred to the new company and there was also continuity of service of the employees whose services were transferred to the new company. This case will stand in line with the decision in Stanes Motors' case : 100ITR341(Mad) and CIT v. Pathinen Grama Arya Vysya Bank Ltd. : 109ITR788(Mad) .
17. We had also occasion to deal with a similar claim in T.C. No. 183 of 1975 in CIT v. Sri Venkateswara Bank Ltd. in the judgment dated 24th day of January : 120ITR207(Mad) . That was also a case of payment made to the employees as gratuity. In that case, we observed :
' A payment made in the course of carrying on its business as gratuity cannot be equated to a terminal payment on the closure of the business so as to be disallowed '.
18. This principle would apply to the present case.
19. In the three cases, Stanes Motors' case : 100ITR341(Mad) , Pathinen Grama Arya Vysya Bank's case : 109ITR788(Mad) and the unreported decision in T.C. No. 284 of : 120ITR224(Mad) , the question to be considered was not whether the amount when paid to any workman was liable to be deducted. It is that situation which has. arisen in the present case. In the present case, there has been payment directly to the employees' as and by way of gratuity and the principle applicable to this case is different from the one applicable to mere cases of transfer of liability considered in the other three cases mentioned above. The result is that the question referred to us is answered in the affirmative and in favour of the assessee. The assessee is entitled to its costs. Counsel's fee Rs. 500.