1. The assessee, a banking company, transferred its banking business with its assets and liabilities to the Indian Bank Ltd. in pursuance of an agreement entered into between them on December 12, 1966. The assessee-bank had its own retiring gratuity benefit rules and these rules provided for the benefit of gratuity to its employees on retirement after attaining the age of 55 or service of 30 years, or death or abolition of the post or on account of retrenchment or on proof of permanent incapacity to work. The said rules also provided for the quantum of gratuity to be paid to the employees in the various contingencies set out therein. Even before the actual transfer of the banking business by the assessee-company to the Indian Bank on December 12, 1966, there was a negotiation between the assessee-company and the Indian Bank as regards the payment of gratuity to the employees who are to be taken over by the transferee-company. There was also tripartite discussion between the assessee-company, its employees' union and the transferee-company. As a result of the discussion, it was agreed with the consent of the employees' union that in respect of 27 members of the staff who will not be in a position to put in a service of 10 years in the transferee-bank, the assessee-company will pay gratuity and in respect of the rest of the staff, the transferee-company had to pay gratuity. This arrangement is contained in the letter dated January 31, 1966, sent by the assessee-bank to the Indian Bank in which it is stated that the amount of gratuity to those 27 persons might be kept as a deposit in the Indian Bank so that it may be paid to them at the time of their retirement or early. Subsequent to this letter, the board of directors of the assessee-bank, by a resolution dated June 7, 1967, resolved to take over the liability for payment of gratuity to the 27 persons. In pursuance of this resolution, a sum of Rs. 37,560 came to be deposited with the Indian Bank on June 16, 1967, for the purpose of ultimate disbursement to the 27 employees at the time of their retirement or earlier as per the provisions of the said gratuity scheme. The said sum of Rs. 37.560 had been calculated on the basis of the gratuity scheme which was applicable to the employees of the assessee-bank. Subsequently, by a resolution dated August 3, 1968, the assessee-bank resolved to wind up.
2. In the assessment proceedings for the assessment year 1968-69, the assessee claimed the said sum of Rs. 37,560 as allowable expenditure under Section 36(1)(ii) or under Section 37(1) of the I.T. Act, 1961. The ITO, however, disallowed the claim on the ground that the said sum of Rs. 37,560 represented the compensation paid to the staff for loss of employment as contemplated in Section 25FF of the Industrial Disputes Act in the course of winding up of the company and, therefore, the said amount cannot be allowed as business expenditure in view of the decision of the Supreme Court in the case of Gemini Cashew Sales Corporation : 65ITR643(SC) .
3. Against the disallowance of this claim, the assessee-company took the matter in appeal to the AAC who took the view that the expenditure of Rs. 37,560 had been incurred in connection with the closing operations of a part of the business and, therefore, it cannot be treated as a revenue expenditure relating to the year of account and, the disallowance of the claim by the ITO was justified. The matter was taken in appeal before the Tribunal. The Tribunal, however, held that the amount of Rs. 37,560 claimed as deduction by the assessee is allowable under Section 37(1) of the I.T. Act, 1961. At the instance of the revenue, the following question has been referred to this court for its opinion :
' Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in allowing the sum of Rs. 37,560 as an admissible deduction under Section 36(1)(ii) or under Section 37(1) of the Income-tax Act, 1961?'
4. The facts are not much in controversy. The assessee-company has transferred its banking business along with its assets and liabilities to the Indian Bank by an arrangement entered into between them on December 12, 1966. In the course of the negotiation for the transfer of the said business, an arrangement was arrived at as regards the gratuity amounts payable to the employees of the assessee-bank who are to be taken over by the transferee-bank. As per this arrangement, while the assessee-company had undertaken to bear the liability to pay gratuity amount to 27 workmen who will not be in a position to put in 10 years of service in the transferee-company, the transferee-company had agreed to bear the liability to pay gratuity amounts to the other employees. In pursuance of this arrangement, the assessee-company had deposited the said sum of Rs. 37,560 to the transferee-bank so that it may be paid to the said 27 employees at the time of their retirement or early in pursuance of the provisions of the gratuity scheme which governed them while they were in service with the assessee-company. The question is whether the said sum of Rs. 37,560 which has been deposited by the assessee-bank with the transferee-company for future payment to the said 27 employees when the occasion for payment of gratuity arises, can be taken to be an expenditure laid out or expended wholly and exclusively for the purposes of the business of the assessee-company so as to attract the provisions of Section 37(1) of the Act.
5. Though the question referred seems to suggest that the said sum of Rs. 37,560 has been allowed as a deduction under Section 36(1)(ii) or under Section 37(1) of the Act, having regard to the fact that the Tribunal has upheld the assessee's claim for allowance only under Section 37(1) of the Act, we have to consider the question of allowability of the claim only under Section 37(1) and not under Section 36(1)(ii) of the Act.
6. For an allowance to be claimed under Section 37(1) of the Act, two things must be established by the assessee, namely, that the expenditure has been incurred in the year of assessment and that such an expenditure was incurred exclusively for the purposes of the business. There is some controversy between the parties as to whether the assessee-company had continued its business even after the transfer of its business to the Indian Bank. The assessee's case was that even after the transfer of the assets and liabilities relating to its banking business to the transferee-company, it had large investments in fixed deposits, securities and house properties as also certain shareholdings in various companies, that the company was not wound up as a result of the transfer of the business to the Indian Bank, that, therefore, the assessee should be taken to have carried a part of its business even after the transfer of its banking business to the Indian Bank. The assessee contends that as it was carrying on a part of its business during the course of the assessment year, the sum of Rs. 37,560 should be taken to be an expenditure incurred for its business. It is also pointed out by the learned counsel for the assessee that the assessee-company was actually wound up after August 3, 1968, when a resolution was passed by the assessee-company for its winding up arid that till such winding up is completed, the assessee-company should be taken to have carried on its business. As regards the question as to whether the amount was actually expended towards the assessee's gratuity liability for the 27 employees referred to above, the assessee contends that that amount having been deposited with the transferee-bank for purpose of payment to the employees as and when the liability arises for payment of gratuity amounts to them, the assessee should be taken to have discharged its liability for payment of the gratuity amounts to the 27 employees, and, therefore, it should be taken to be an expenditure incurred by the company to discharge a liability which arose while the banking business was carried on.
7. In this case, the assessee-company has been incorporated for the purpose of carrying on a banking business and it was carrying on that business till the business was transferred to the Indian Bank. It is true that after the transfer of its business, it had certain assets such as house property, securities, fixed deposits in banks, and shares in certain companies and these assets have brought in income by way of rents from house properties, interest from fixed deposits and securities, and dividends from the shareholdings. As a matter of fact, in the assessment year in question, the assessee had received a sum of Rs. 599 as income from house property, Rs. 8,187 as interest income, and a sum of Rs. 1,500 as dividend income. The question is whether the receipt of income from certain assets retained by the assessee-company can lead to an inference that the assessee-company is carrying on its usual business which is a banking business.
8. It is no doubt true that the ITO has assessed the interest income as business income in the assessment years. But so long as the nature of the income has been shown as the income from interest, the treatment of the said interest income as business income by the ITO will not change its nature. From the mere receipt of income in the year of account from house property and from investments and from shareholdings, it is not possible to say that the assessee-company carried on its banking business which is the only business for which the company was incorporated in the year of account. It is only on the basis that the assessee has received interest from investments, dividends from shareholdings, and the income from house property, the Tribunal has assumed that the assessee is carrying on the banking business. The Tribunal's assumption that the assessee carried on a business during the year of account cannot be sustained on facts. Once the assessee is found to have not carried on business of banking subsequent to the transfer of its business to the Indian Bank, it is not entitled to claim the said sum of Rs. 37,560 as allowance under Section 37(1) of the Act.
9. In similar circumstances, a Division Bench of this court, to which one of us was a party, in Stanes Motors (South India) Ltd. v. CIT : 100ITR341(Mad) , held that an expenditure incurred in connection with the transfer of a business cannot come within the scope of Section 37(1) of the Act. In that case, the assessee, a public limited company, carried on various activities one of which was tyre retreading. As a result of the forming of a new company for taking over the business of retreading by name 'Stanes Tyres and Rubber Products Ltd.', which was a subsidiary of the main company, the retreading business was transferred to the new company. At the time of transfer of the retreading business to the new company, the assessee-company transferred a sum of Rs. 56,275 to the new company towards the assessee's liability for payment of gratuity to the employees taken over from the assessee-company by the new company. The assessee claimed that the amount transferred to the new company being in discharge of its liability towards gratuity payable to the employees transferred to the new company, it is an allowable deduction under Section 37(1) of the I.T. Act. This court took the view that though the amount has been transferred by the assessee to the new company from its gratuity reserve account, no payment had actually been made to the employees towards gratuity at the time of transfer, and that it is a transfer of a fund from the assessee-company to the new company, for payment to the employees in future. The question of payment of gratuity did not arise to the transferred employees on the date of transfer of the retreading business and, therefore, there being no present obligation to pay any gratuity at the time of transfer, the mere transfer of the fund from the assessee-company to the new company cannot be taken to be an expenditure incurred wholly and exclusively for the purposes of the assessee's business. As in that case, here also all the employees of the assessee-bank had been taken over by the transferee-company and, therefore, there is no present obligation to pay gratuity on the date of transfer. The assessee had transferred an amount of Rs. 37,560 to the transferee-company so as to enable the transferee-company to pay the gratuity amount to the 27 employees as and when occasion arises. This cannot be taken to be an actual payment to the employees concerned and as a discharge of the obligation of the assessee-company of its liability to pay gratuity to its employees. The deposit of the amount by the assessee-company with the transferee-company may, if at all, amount to a creation of a reserve for meeting a liability which the assesseee-company has undertaken as a result of an agreement entered into with the transferee-bank in future. It is not in dispute that the 27 employees, for whom gratuity liability was taken over by the assessee-company have in fact been taken over by the transferee-bank and they continue in service with the transferee-bank and it has not been shown that the liability to pay gratuity to the 27 persons had arisen in the course of the accounting year. In those circumstances, the principle of the decision in Stones Motors (South India) Ltd, v. CIT : 100ITR341(Mad) is squarely applicable, which in its turn, follows the decision of the Supreme Court in CIT v. Gemini Cashew Sales Corporation : 65ITR643(SC) . In the case before the Supreme Court, a business which was originally carried on by a firm of two partners was subsequently taken over and continued by a surviving partner after the death of one partner. In settling the accounts 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, which would arise on a transfer of owner-ship. When the firm claimed the said sum of Rs. 1,41,506 as allowable expenditure in computing the income of the firm, the Supreme Court held that the said sum was not properly admissible under Section 10(1) or under Section 10(2)(xv) of the Indian I.T. Act, 1922, for the reason that their liability to pay retrenchment compensation under Section 25FF of the Industrial Disputes Act arose for the first time after the closure of the business and not before and that the liability did not arise in the carrying on of the business, but on account of the transfer of the business. Therefore, neither Section 10(1) nor Section 10(2)(xv) will stand attracted. In this case also, the liability to pay gratuity cannot be said to have arisen at the time of the transfer as a result of the petitioner's company carrying on its business. Firstly, there is no present liability to pay gratuity and the amount has been deposited with the transferee-bank only in pursuance of an understanding or agreement between the assessee-company and the transferee-company and not on the basis of a liability which had accrued on the date of transfer. If the transfer had not taken place, the assessee-company's liability will arise as and when a particular employee gets a right to receive the gratuity as per the provisions of the gratuity scheme applicable to the assessee company. Therefore, a liability, which could net have been there if the business was continued in the year of account and which arose as a result of the transaction under which the business of the assessee had been transferred cannot be said to be an expenditure incurred for the purpose of carrying on the business in the accounting year.
10. Learned counsel for the assessee relies on a decision of the Division Bench of this court in T. C. No. 183 of 1975 CIT v. Sri Venkateswara Bank Ltd. (since reported in : 120ITR207(Mad) and submits that the facts in that case were on all fours with the present case before us and, therefore, the principle of that decision will squarely apply. In that case, a sum of Rs. 26,032 was claimed as deduction under Section 36(1)(ii) or under Section 37(1) of the I.T. Act, 1961. In that case also, the assessee-company was taken over by the Indian Overseas Bank. At the time of the transfer, the assessee paid a sum of Rs. 26,032 as gratuity to its employees and this was claimed as deduction in the computation of income of the transferor-company. When the matter came to this court, this court took the view that the entire business of the transferor-company has not been transferred and that part of the business had been retained. It was also found in that case that the said sum of Rs. 26,032 has actually been paid to the employees with respect to their past services. The transferee-company did not undertake any liability on behalf of the transferor-bank to pay gratuity amounts payable to the employees for their past services with the transferor-bank. Therefore, there was an actual payment of gratuity amount to all its employees calculated at 15 days' salary for every completed year of service under the transferor-company. Thus, in that case, there was actual payment of gratuity amounts to the employees concerned. Therefore, the facts in that case are entirely different. The court in that case specifically found that there is no transfer of the entire business and that there was actual expenditure by way of payment of gratuity amounts to the employees which is a legal obligation which the transferor-bank had to discharge. Once the expenditure has been shown to have been incurred in connection with the business, Section 37(1) of the Act has necessarily to apply. Therefore, the decision in that case cannot be Jaken advantage of by the assessee.
11. On the facts of the case, we are of the view that Section 37(1) will not stand attracted. In this view, we have to answer the question in the negative and in favour of the revenue. The revenue will have its costs from the assessee. Counsel's fee Rs. 300.