RAJAGOPALAN, OFFG. C.J. - The Associated Publishers Ltd., to which we shall refer hereafter as the predecessor company, carried on the business till January 31, 1950. It was transferred to the assessee company which continued the business from February 1, 1950, without any break. Both were private companies, and a third company, Amalgamations Ltd., was the principal shareholder of both. The year of account of that business ended on January 31 each year. When the business changed hands on February 1, 1950, the claim of the workmen for Deepavali bonus for 1949 was the subject of an industrial dispute pending adjudication before the Industrial Tribunal constituted under the Industrial Disputes Act. The award of the Tribunal, directing the grant of bonus of one and a half months basic wages to each of the workmen, was published on February 9, 1951. The assessee company was a party to that award. Section 18 of the Industrial Disputes Act provided for the enforcement of the award against the successor, where there had been a succession to business. The claim for bonus for Deepavali in 1950 was settled by direct negotiation between the assessee company and its workmen on the same lines, namely, one and a half months wages. That agreement was arrived at on June 30, 1961. The total amount thus payable as bonus for the two years amounted to Rs. 54,140, and that amount was debited in the accounts of the assessee company in its year of account which ended on January 31, 1952. Out of this amount Rs. 51,936 appears to have been disbursed to the workmen in the course of that year. The balance of Rs. 3,204 remained undisbursed even in the next year, and it was shown as a liability of the assessee company in the next years account. The assessee company deducted the amount of Rs. 54,140 as an allowable item of expenditure in computing its losses in the assessment year 1952-53. That claim was disallowed by the Income-tax Officer, who added back the sum of Rs. 54,140 to compute the loss that the assessee could be allowed to carry forward. In the assessment year 1953-54 the undisbursed bonus of Rs. 3,204 was added back by the Income-tax Officer to compute the assessable profits of the year of account 1952-53. The learned counsel for the assessee represented that the assessee company did not claim Rs. 3,204 over again as an allowable item of expenditure in the year of assessment of 1953-54.
The Assistant Commissioner, to whom the assessee company appealed allowed the claim of the assessee for : both the years. On appeal preferred by the department, the Tribunal set aside the orders of the Assistant Commissioner and restored the orders of the Income-tax Officer.
The Tribunal referred the following question to this court under section 66(1) of the Indian Income-tax Act :
'Whether the amounts of Rs. 54,140 and Rs. 3,204 aforesaid are allowable as deductions form the business profits of the assessee for the assessment years 1952-53 and 1953-54 ?'
The real question for determination is, whether the liability to pay Rs. 54,140 as bonus for 1949 and 1950, which was undertaken by the assessee company in its year of account 1951-52, was an allowable item of expenditure in assessing the profits and losses of that year of account in the assessment year 1952-53. It would appear that the department and the Tribunal did not quite realise that the sum of Rs. 3,264 added back in the next year was included in this sum of Rs. 54,140. Whether the claim of the assessee company that Rs. 54,140 was an allowable item of expenditure is allowed or not, if the sum of Rs. 3,204 was included in Rs. 54,140, Rs. 3,204 will have to be excluded in computing the profits of the assessee company in the assessment year 1953-54. The learned counsel represented that an application for rectification was preferred to the Income-tax Officer on July 28, 1956, and that petition has not yet been disposed of.
We may advert even at this stage to one feature which cannot be a matter of controversy. Had there been no disputes at all between the workmen and the management, and had there been no transfer of the business, the Deepavali bonus for 1949 would have been based on the profits of the year of account that ended on January 31, 1949, but would have been paid only in the year of account that ended on January 31, 1950. Similarly, the Deepavali bonus for 1950 would have been paid in the year of account that ended on January 31, 1951. The assessee company succeeded to the business on February 1, 1950. The dispute over the 1949 bonus was settled by an award which became enforceable on February 9, 1951, and the claim for the 1950 bonus was settled by agreement on June 30, 1951. Consistently with the mercantile system of accounting the assessee company adopted, the liability that accrued under the award and under the agreement was shown in the books of account the same year. That the assessee treated it as a liability of its year of account 1951-52 did not admit of any doubt. The genuineness of that liability and that of its discharge were never in issue either.
The grounds on which the Tribunal disallowed the claim of the assessee that the payment of the bonus constituted an allowable item of its trading expenses of its year of account 1951-52 were summarised in paragraph 15 of the statement of the case :
The Tribunal held in the above appeals in the absence of annexure A aforesaid which was not before it at that time :
(i) that the liability of the workers under the awards was primarily the liability of the predecessors;
(ii) by an omission to evaluate the contigent liability for purposes of transfer, the assessee had only voluntarily lost the amount in favour of the predecssor which was, after all, another private limited company with more or less identical shareholders;
(iii) that such loss is referable only to goodwill adjustment and so only capital in nature;
(iv) that the assessee received no direct benefit of such payments as the award related to the period of employment of the labour force by the predecessors; and
(v) that consideration of commercial expediency had to be ruled out as the payments were made only under a legal obligation and necessity which would not be by any means avoided.'
We shall deal first with the question, whose liability it was that the assessee company discharged when it paid the bonus for 1949 and 1950 in the year of account 1951-52. The Tribunal held that the primary liability was that of the predecessor company. It was no doubt for services rendered to the predecessor company that the Deepavali bonus for 1949 was claimed and was eventually paid under the award of the Industrial Tribunal. The bonus payable on the occasion of Deepavali in 1950 could not be viewed as payable wholly for services rendered to the predecessor company. Before that bonus could be claimed, that is, even before the Deepavali in 1950, the assessee company had taken over the business, and after February 1,1950, the services were to the assessee company. That the profits earned in the year of account ended on January 31, 1950, would, in the normal circumstances, have furnished the basis for determining the quantum of bonus payable on the occasion of Deepavali in 1950 did not alter the position, that the bonus was climbable and if there had been no dispute, would have been payable only in the year of account that ended on January 31, 1951. Apart from this aspect of the case, it was a statutory liability that the assessee company discharged when it paid the bonus for 1949. Section 18 of the Industrial Disputes Act made the award enforceable against the successor in business. The assessee company was itself made a party to the industrial dispute, and even as a party it was bound by that award under section 18 of the Industrial Disputes Act. It is true that there was no statutory liability as such when the assessee company undertook to pay bonus for 1950. Had there been no direct settlement with the workmen there would have certainly been an industrial dispute and, section 18 of the Industrial Disputes Act would then have imposed a statutory liability on the assessee company. It was in form a contractual liability under a contract with the workmen, but it was obviously undertaken to avoid an industrial dispute. Thus it was a liability legally enforceable against it that the assessee company discharged by providing for the payment of bonus for the two years 1949 and 1950.
The liability itself accrued only after the date of the transfer. It is not clear when the claim for 1949 was preferred by the workers. Obviously it was not admitted, as that claim was eventually referred as an industrial dispute for adjudication by the Industrial Tribunal. The claim for bonus, to whatever period it relates, is at best a contingent liability even at the stage the claim is preferred. It becomes an accrued liability even at the stage the claim is preferred. It becomes an accrued liability if the claim is admitted by the employer. If the claim is denied and the workmen do not pursue the claim it will never accrue as a liability. If the claim is denied by the employer and it is referred as an industrial dispute, no liability accrues, if the Industrial Tribunal after adjudication, it becomes an accrued liability when the award becomes enforceable. If, as happened in the case of the claim for 1950, the claim for bonus is settled by agreement between the employer and the employees, it becomes an accrued liability on the date of the agreement.
In Muir Mills Co. Ltd. v. Suti Mills Mazdoor Union the Supreme Court pointed out :
'This imports the conception that even though the payment be not strictly due to the recipient nor legally enforceable by him, a claim to the same may be laid by the employee under certain conditions and if such claim is entertained either by an agreement with the employer or by adjudication before a properly constituted Tribunal as on an industrial dispute arising, the same would ripen into a legally enforceable claim.
In Commissioner of Income-tax v. Burmah Oil Co. (Burma Concessions) Ltd. The claim of workmen for wages during the period of occupation of Burma by the enemy forces, which claim was barred by limitation, was allowed in part by the court of industrial arbitration. The amount was ordered to be paid without reference to any particular period of time. The Rangoon High Court held that the liability to pay the amount was incurred by the company only in the year when the industrial court made its award. That was another instance where a claim not legally enforceable becomes an accrued liability when the claim itself becomes legally enforceable.
In the case of the assessee company, when the liability to pay the bonus for 1949 and 1950 became an accrued liability, the law imposed that liability on the assessee. Thus it was its own legal liability that the assessee company discharged when it provided for the bonus payments in the year of account 1951-52.
Annexure 'A' to the statement of the case, which evidenced the terms of the transfer of the business from the predecessor company, made it clear that the liability to pay bonus neither for 1949 nor for 1950 was taken into account in fixing the price paid by the assessee company for the transfer. It was not part of the price payable by the assessee company for the transfer of the business. Whether or not legally the assessee company could recoup itself in full or in part from its predecessor the bonus payments it made in discharge of the liability the law imposed on the assessee company, the assessee company had no contractual right to recover it from its vendor predecessor company. As we pointed out, factually that liability - the Tribunal itself was alive to the feature that it was only a contingent liability at that stage -was not one of the factors taken into account in determining the price the assessee company had to pay for the transfer of the business. Though annexure 'A' was not before the Tribunal when it disposed of the appeal, there fact that the liability to pay bonus payments did not enter the determination of the purchase price was apparently never in dispute, because the Tribunal took the view that 'by the omission to evaluate the contingent liability for purposes of transfer, the assessee only voluntarily lost the amount in favour of the predecessor.' The assessee company was not bound to evaluate that contingent liability before effecting the purchase of the business. Factually it did not. When the legal liability to pay the bonus for 1949 and 1950 accrued, and that legal liability was that of the assessee company, it would be erroneous to view the discharge of that liability as constituting a loss voluntarily undertaken by the assessee company for the benefit of the predecessor company.
We shall next consider the question, whether the expenditure incurred by the assessee company in discharge of its legal liability was of a capital nature. Under normal circumstances the payment of bonus to the employees would be a trading expense, and it would not be an expenditure of a capital nature. If the liability to pay the bonus had been that of the transferor as an accrued liability, and that liability was transferred to the transferee under the terms of the contract of the transfer, that is, if the liability so transferred was one of the factors taken into account to fix the price payable by the transferee, then the amount expanded in discharge of the liability so transferred would have been part of the price paid by the transferee for the acquisition of the business. Whether the accrued liability that was so transferred was a liability to an employee, or any other trade liability, can make no difference in principle.
In Royal Insurance Co. v. Watson on which the learned counsel for the department relied, it was expressly held that what the transferee paid to the manager when dispensing with his services was part of the consideration for the transfer of the business. At page 504 of the report the Lord Chancellor observed :
'it may be said that the bargain between the two companies involved a liability, which was discharged by the payment of this sum, and therefore I, as a matter of fact, come to the conclusion that this was part of the purchase money (and when I use the compendious phrase purchase money, of course I include the arrangement made in respect of shares, because it matters not whether it was paid in money or was paid in moneys worth), but the result is that one of the companies sells to the other, and part of the consideration which was contemplated by both parties, and in respect of which the bargain was made, and without which the bargain could not have been made, was the manager, and all that was incident to the manager in respect of the payments to be made to him, whether made at once, or made in this form of commutation.'
That case is certainly not authority for the proposition which the learned counsel for the department advanced, that where there is succession to business on transfer by sale, payments made by the vendee in discharge of the liability of its predecessor vendor would constitute expenditure of a capital nature in the absence of any express provision in the contract of transfer for the discharge of that liability. We are unable to see anything in principle or authority to support this contention. The payment made in discharge of a contractual liability imposed in express terms by the contract of transfer or sale and equated to payment in part of the purchase price is laid out to complete the purchase and to discharge the purchasers liability. The principle applicable to such payments, that they constitute expenditure of a capital nature, cannot be extended to a case like the present, where the liability devolved on the assessee company by operation of law. That liability itself accrued only after the transfer, that is the liability under the award and the subsequent liability under the agreement between the workmen and the assessee company. As we have pointed out, factually the discharge of that liability was not part of the contract of transfer, and the payment of bonus was not : part of the purchase price. The discharge of the legal obligation was not part of the contract of transfer.
In Cooke v. Quick Shoe Repair Service the sale of the business was on October 2, 1945. The terms of the sale provided that the vendor should discharge the business liabilities he had incurred before September 30, 1945. The vendor was unable to discharge all of them, and in the year after the sale, 1946-47, the vendee discharged some of these liabilities amounting to Pounds 613 18s. 7d. The Commissioners found 'the said liabilities of Mr. Dent (vendor) were discharged by the respondents (vendees) because the respondent found that the creditors of Mr. Dent who had traded in the normal course. The payments were made generally in order to preserve the goodwill of the business and to ensure continuity of supply of material and labour.' Croom-Johnson J. upheld the claim of the vendee that these payments constituted an allowable deduction in the assessment year 1946-47. At page 464 the learned judge observed :
'The purchase having been completed, the vendor found himself unable to pay and did not pay the debts in question, and inasmuch as the purchasers had purchased the goodwill of the business as well as other assets, they found themselves in this position-that if they did not pay, to use a popular expression, their name would be mud (that really is to put this case in its simplest form)-and accordingly they paid voluntarily the debts which the vendor owed and which the vendor ought to have paid. What the Commissioners have found is that those payments were made in order to preserve the value of the capital assets, namely, the purchase of the goodwill, which they had bought. How can I say in those circumstances that there is no evidence to support such a finding ?'
That was a case of an accrued liability, and the legal and contractual liability to discharge it was that of the vendor. Even so, when the vendee paid these debts, they were treated as normal trading expenses. The point to remember is that it was not part of his purchase price. Whether he had a legal remedy to recover this sum from his vendor made no difference. If he recovered them they would obviously be trading receipts.
The claim of the assessee before us is on an even better footing. The liability to pay bonus did not accrue until the transfer on February 1, 1950. Once again, we have to point out that the legal liability to pay the bonus was that of the assessee company. It was a business that continued without a break. Unless the workmen were paid the bonus, apart from the statutory penalties to which the assessee company would be exposed for failing to implement the award for 1949 and the agreement for 1950, continuance of the business itself would have been imperilled. It was an expenditure incurred to continue the business and to secure industrial peace and harmony in which the business could be continued. By no known test could such an expenditure be viewed as a capital expenditure.
In S. R. V. G. Press Co. v. Commissioner of Excess Profits Tax while holding that the payment towards sales tax was an item of expenditure that could be lawfully deducted to ascertain the assessable profits the learned judge observed :
'Sales tax is a compulsory levy under the sanction of the Legislature and there is no discretion left to the assessee as regards the extent of the payment... The expenditure is unremunerative but is not the less a proper deduction, for without such expenditure the business of purchasing and selling could not be carried on... The payment of sales tax has no doubt the effect of diminishing the assessees taxable income but such payment is necessary if the assessee is to carry on business at all and this is not a case where the assessee having a discretion to lay out money for the purpose of earning profits in a business spends an unnecessarily large amount during the chargeable accounting period.'
As we have pointed out, the assessee company was under a legal obligation to pay the bonus for 1949 and 1950. Even apart from that feature of the case that the obligation to pay bonus was legally enforceable against the assessee company, the discharge of that liability after it had accrued was necessary for the continuance of the business. It was an expense incurred not for the acquisition of the business, but for its continuance. It was certainly not an expenditure of a capital nature.
The learned counsel for the department referred us to the decision of the Privy Council in Tata Hydro-Electric Agencies Ltd. v. Commissioner of Income-tax. But the express basis on which the contention of the assessee was negatived in that case was, in the words of their Lordships :
'They must have taken this liability into account when they agreed to take over the business. In short, the obligation to make these payments was undertaken by the appellants in consideration of their acquisition of the right and opportunity to earn profits, that is, of the right to conduct the business, and not for the purpose of producing profits in the conduct of the business. If the purchaser of a business undertakes to the vendor as one of the terms of the purchase that he will pay a sum annually to a third party, irrespective of whether the business yields any profits or not, it would be difficult to say that the annual payments were made solely for the purpose of earning thee profits of the business.'
Commissioner of Income-tax v. Kameshwar Singh does not help the department either. In that case the assessee paid the arrears of rent that had accrued before the transfer. The claim that they constituted allowable deductions was negatived. Their Lordships of the Privy Council Pointed out :
'It is a sum which was payable by him in order to get possession of the colliery, not a sum expended by his in the carrying out of the colliery. It is not rent for any period of his possession, nor is it an expenditure incurred by the assessee for the purpose of earning the profits or gains of the colliery business. If the assessee paid it without any legal liability or necessity on his part to do so, such a voluntary payment is not a permissible deduction from income.'
In the present case we are dealing with a payment made by the assessee company in discharge of a legal liability imposed on it.
The next question is, whether the payment satisfied the other requirement of section 10(2)(xv), that the expenditure was laid out wholly and exclusively for purposes of the business of the assessee. It was common ground that this was not a claim that fell within the scope of section 10(2)(x). What we have already pointed out, that it was an obligation legally enforceable against the assessee, and that even indepentently of that, the assessee had to discharge that obligation to carry on the business to secure the industrial peace and harmony necessary to carry on that business, should suffice to hold that the further requirement of section 10(2)(xv) has also been satisfied in this case. The Tribunal was of the view, that the assessee received no direct benefit by such payments as the award related to the period of employment of the labour force buy the predecessors. Even if the test of direct benefit were to apply, that was satisfied. The assessee company did benefit itself, in that it enabled itself to continue its business with a contented set of employees. The test is not whether the assessee company had the exclusive benefit of the bonus payment. While it would be true to say that the predecessor company had the benefit of the service during the major portion of the period to which the claims for bonus related, the assessee company had obviously the benefit of the payments made after the liability to pay the bonus had accrued. Another of the grounds on which the Tribunal negatived the claim of the assessee company was that the consideration of commercial expendiency had to be ruled out as the payments were made only under a legal obligation and necessity which could not be any any means avoided. If the Tribunal meant that payment made in discharge of a legal obligation would never constitute a deduction under section 10(2)(xv) we must firmly reject such an unwarranted restriction of the scope of section 10(2)(xv).
We differ from the Tribunal and we hold that the sum of Rs. 54,140 constituted an allowable item of expenditure in computing the profits and losses of the assessee company. The requirements of section 10(2)(xv) were satisfied.
The assessees claim, it should be remembered, was to deduct this sum in computing its profits and losses for the year of account that ended on January 31, 1952. The learned counsel for the department urged that, even if the requirements of section 10(2)(xv) were satisfied, the deduction should not be permitted in the assessment year 1952-53, and that the bonus payments for 1949 and 1950 were properly debitable only to the years of account that ended on January 31,1950, and January 31, 1951, respectively. That was not one of the grounds on which the Tribunal negatived the claim of the assessee company. Such a contention was never put forward by the department for adjudication by the Tribunal. Such a contention does not arise for consideration at this stage. As a question of law it does not arise on the order of the Appellate Tribunal.
Were it necessary to decide that question, we should hold that the expenditure was properly debitable in the year of account that ended on January 31, 1952. It was only in that year that the liability accrued. In the earlier years it was at best a claim for bonus, a contingent liability. That a provision for meeting a contingent liability is not an allowable item of deduction was clearly explained by the Supreme Court in Indian Molasses Co. v. Commissioner of Income-tax 1. At page 76 Hidayatullah J. said :
'Expenditure in this sense is equal to disbursement which, to use a homely phrase, means something which comes out of the traders pocket. Thus, in finding out what profits there be, the normal accountancy practice may be to allow as expense any sum in respect of liabilities which have accrued over the accounting period and to deduct such sums from profits. But the income-tax laws do not take every such allowance as legitimate for purposes of tax. A distinction is made between an actual liability in praesenti and a liability de futuro which, for the time being, is only contingent. The former is deductible but not the latter.'
This principle was reaffirmed at page 79 :
'To be a payment which is made irrevocably there should be no possibility of the money forming, once again, a part of the funds of the assessee company. If this condition be not fulfilled and there is a possibility of there being a resulting trust in favour of the company, then the money has not been spent, i.e., paid out or away, but the amount must be treated as set apart to meet a contingency. There is a distinction between a contingent liability and a payment depending upon a contingency. The question is whether in the years of account, one can describe the assessee companys liability as contingent or merely depending upon a contingency.'
In Ford & Co. Ltd. v. Commissioners of Inland Revenue 1 it was laid down that so long as it was only a contingent liability it was not an allowable item of expenditure.
The learned counsel for department referred to Commissioner of Income-tax v. Nagri Mills Co. Ltd. 2 There the assessee company maintained its accounts on the mercantile basis. It did not make any entry towards bonus for the calendar year 1951. The bonus became payable under the award in June, 1952. The company was directed to pay the bonus out of the profits of 1951. The company in making the return claimed to deduct in the year 1951 bonus which it actually disbursed only in December, 1952. The learned judges upheld the claim. But the learned judges proceeded to deal with the question, as if it were really of no importance from which years profits the bonus payments should be deducted. At page 684 the learned judges observed :
'... Whether the deduction in respect of bonus was granted in the assessment year 1952-53 or in the assessment year corresponding to the accounting year 1952, that is, in the assessment year 1953-54, should be a matter of no consequence to the department; and one should have thought that the department would not fritter away its energies in fighting matters of this kind.'
Nor did the learned judges go into the question whether it was only a contingent liability in 1951. We are unable to accept that case as authority for the contention of the learned counsel for the department; that an expenditure incurred for the payment of bonus was not debitable in the year in which the liability accrued.
Since we have held that the department is not entitled at this stage to seek a determination of the further question, whether the expenditure incurred by the assessee in the year of account that ended on January 31, 1952, should be related back to the years for which bonus was claimed, we shall refrain from a detailed examination of all the cases cited during the arguments before us. Without a detailed examination, we shall merely mention that Southern Railway Co., of Peru Ltd. v. Owen, to which the learned counsel for the department referred, was considered by the Supreme Court in Indian Molasses Co. v. Commissioner of Income-tax. The relevant passage is at page 79. The learned counsel for the assessee also referred to the criticism of the decision of the House of Lords in Southern Railway of Peru Ltd. v. Owen 1 in 72 Law Quarterly Review at page 486 ff.
Our answer to the reference is that Rs. 54,140 is an allowable deduction in the assessment year 1952-53. The Tribunal should verify if Rs. 3,204 added back in the assessment year 1953-54 was included in the sum of Rs. 54,140, and if it was, it should be excluded. The assessee will be entitled to the costs of this reference. Counsels fee Rs. 250.