Commissioner of Income Tax vs Haileyburia Tea Estates Co. Ltd.

V.V. Kamat, J.—By the judgment dated February 6, 1985, this court in Original Petition No. 4563 of 1983 directed the Income Tax Appellate Tribunal, Cochin Bench, to draw up a statement of case and refer the following question of law to this court. The question is as follows :

"Whether, on the facts and in the circumstances of the case, the provision for gratuity is ''reserve'' under the Second Schedule to the Surtax Act, 1964, and the same should be taken into account in the computation of capital for the purpose of the Surtax Act ?"

The matter relates to the surtax assessment of the assessee. The assessment year is 1975-76, ending on December 31, 1974. The balance-sheet of the assessee showed a reserve for the purpose of gratuity.

The Income Tax Officer did not take this item placed in the category of "reserve" in computing the capital for the purpose of the Second Schedule to the Surtax Act, holding that this was not a "reserve". The officer relied on the decision of this court, without mentioning it in the order.

The assessee preferred an appeal to the Appellate Assistant Commissioner. He contended that the opening balance as regards provision for gratuity amounting to Rs. 3,03,798 ought to have been considered for the purpose of computing the standard deduction. The appellate authority accepted this contention, relying on the decision in the case of Commissioner of Income Tax Vs. Indian Steel Rolling Mills Ltd., as well as the decision of this court in CIT v. Periakaramalai Tea and Produce Co. Ltd. [1975] 92 ITR 65. The two decisions specify the meaning of "statutory deduction" to an amount equal to ten per cent. of the capital of the company as computed in accordance with the provisions of the Second Schedule, or an amount of two hundred thousand rupees, whichever is greater. The court has observed that the amount standing to the credit under the heading "Retirement gratuity reserve" is to be treated as "reserve" and normally has to be taken into account for the purpose of calculating the capital. The court took up for consideration as to what exactly is "reserve" and What exactly is "reserve for gratuity" shown in the balance-sheet produced before the authority. In the context, it is further observed that the term "reserve" is not defined under the Act and would have to be taken into consideration in relation to the factual background as regards the use to which the amount in question is applied. The court has understood the "provision" in relation to balance-sheet for the year in question as one for meeting the liabilities of the year and then in that case, it would not be in the nature of "provision".

The Department preferred an appeal to the Income Tax Appellate Tribunal contending that the liability towards gratuity would have to be treated as an ascertained liability and, therefore, could not be allowable as a deduction as claimed by the assessee. It would be necessary to consider and examine the reasoning of the Tribunal in the context to provide an answer to the question under reference.

The Tribunal took up for consideration as to what is the exact nature of the liability towards gratuity. The Tribunal considered the question as to whether the liability in question would be considered as an ascertained liability or whether it is a contingent liability. The Tribunal placed reliance on two decisions in Commissioner of Income Tax Vs. High Land Produce Co. Ltd., and Commissioner of Wealth-tax Vs. K. Gopinathan Nair, to come to the conclusion that the liability to pay gratuity is a contingent liability and, therefore, proceeded to consider the contention as to whether it could be allowable as a deduction. The Tribunal has considered the question from the point of view of deduction for Income Tax purposes and held that the said amount of gratuity becomes deductible in case it constitutes a liability, but because it is required to be taken into account for the purpose of ascertaining the proper income for the year. It is in this context, the Tribunal placed reliance on the decision of this court in Commissioner of Income Tax Vs. Periakaramalai Tea and Produce Co. Ltd., .

The question was argued before us from both sides. On the basis of the factual matrix in regard to which there could be little or no dispute. In other words, in regard to the year in question in the opening balance, there is a provision for gratuity account of Rs. 3,03,798, shown for the purpose of computing the standard deduction. At the same time, the amount is shown in the balance-sheet as a "reserve" for the purpose of gratuity.

The amount which is shown as a "reserve" or sometimes even shown as a "gratuity reserve", no doubt, according to the methods of accountancy would go towards the capital and, therefore, would not be available for deduction as is sought to be claimed. It was urged on behalf of the assessee that what is required to be considered is the nature of the amount, as to whether it has been set apart for being spent towards the payment of gratuity which would, then, amount to an item of expenditure liable for deduction.

On the other hand, it was sought to be contended on behalf of the Department by learned counsel that it would be clear from the principles of accountancy that any amount shown as "reserve" would get added to capital and in that event, it could not be considered as an item of expenditure and, therefore, consequently, it will have to be stated that such an amount would not be available for a claim of deduction in any event. Thus, on the basis of the submissions, the question that would be required to be considered would be as to what is the nature of the amount or in other words, as to what use the amount could be considered, in spite of the fact that it is shown as "reserve" in the balance-sheet. While recording the submissions, it must be stated that learned standing counsel for the Department, placing reliance on two decisions of the Gujarat High Court in Commissioner of Surtax Vs. Suhrid Geigy Ltd., and Commissioner of Income Tax Vs. Megaw Ravindra Laboratories (I) P. Ltd., sought for a remand of the proceedings to ascertain the factual nature of the reserve, as according to him, following the Gujarat High Court, the proper course would be to settle the controversy.

The question as to whether a particular item of the amount would be "reserve", or "provision" has ultimately come up for consideration before the Supreme Court in Vazir Sultan Tobacco Co. Ltd., Hyderabad and Others Vs. Commissioner of Income Tax, Andhra Pradesh, Hyderabad, , proceeding with the factual position that the expression "reserve" has not been defined, yet it occurs in various taxing statutes applicable to companies only and to no other assessable entities or attempted to be understood in its popular sense. The attempt was to understand the meaning attributed to it by men of business, trade and commerce and by persons interested in or dealing with companies, it was understood that the broad distinction between the two terms--"provision" and "reserve" would have to be understood. A "provision" could be understood as a charge against the profit to be taken into account against gross receipts in the profit and loss account whereas a "reserve" would be an appropriation of profits the asset or assets by which it is represented being retained to form part of the capital employed in the business. The Supreme Court in the process of reasoning also considered its earlier decision in Metal Box Company of India Ltd. Vs. Their Workmen, , where the same question came up for consideration. It is observed that the effect of reading the two definitions, together would show that "provision" would never be a reserve. If any retention or appropriation of a sum is not a provision, it is not designed to meet depreciation, renewal or diminution in the value of assets or any known liability, the same would not necessarily be a reserve. In the process of reasoning, it is recorded that as to whether the amount constitutes reserve or not will have to be decided by having regard to the true nature and character of the sums so appropriated depending on the surrounding circumstances particularly the intention with which and the purpose for which such appropriations had been made. In the process of reasoning the Supreme Court gave importance to the substance of the matter observing that one must have regard to the intention with which and the purpose for which the appropriation has been made, such intention and purpose being gathered from the surrounding circumstances. In fact by way of guidelines, it is observed as follows (headnote of Vazir Sultan Tobacco Co. Ltd., Hyderabad and Others Vs. Commissioner of Income Tax, Andhra Pradesh, Hyderabad, ) :

"The following aspects provide some guidelines : (a) a mass of undistributed profits cannot automatically become a reserve and somebody possessing the requisite authority must clearly indicate that a portion thereof has been earmarked or separated from the general mass of profits with a view to constituting it either a general reserve or a specific reserve ; (b) the surrounding circumstances should make it apparent that the amount so earmarked or set apart is in fact a reserve to be utilised in future for a specific purpose and on a specific occasion ; and (c) a clear conduct on the part of the directors in setting apart a sum from out of the mass of undistributed profits avowedly for the purpose of distribution as dividend in the same year would run counter to any intention of making that amount a reserve."

The Supreme Court in Vazir Sultan Tobacco Co. Ltd., Hyderabad and Others Vs. Commissioner of Income Tax, Andhra Pradesh, Hyderabad, considered the common question as to whether the amounts retained or appropriated or set apart by the concerned assessee-company by way of making provision, (a) for taxation, (b) for retirement gratuity, and (c) for proposed dividends from out of profits and other surpluses, could be considered as "other reserves" and the consequences of their inclusion in the capital computation or otherwise. In the process of reasoning, the distinction was attempted to be considered with reference to the fairly well-known principles of commercial accountancy. In the context, referring to Metal Box Company of India Ltd. Vs. Their Workmen, , it is observed that provisions made against anticipated losses and contingencies are charged against profits and, therefore, are required to be taken into account against gross receipts in the profit and loss account and the balance-sheet. The Supreme Court also considered the characteristics of "reserves" or "provisions" retained to form part of the capital employed in the business, it is in the process of reasoning, it is observed that appropriation of gratuity reserve will have to be regarded as a provision. In the process certain features of gratuity are taken into consideration. Under a scheme framed by a company to pay gratuity to its employees on determination of employment the liability arises only when the employment of the employee is determined by death, incapacity, retirement or resignation, events that are certain to happen in the service career of every employee. In other words payment of gratuity would be a certain event. However, the amount is variable depending on various other factors. In the process of discussion, the liability as regards payment of gratuity is described as a contingent liability with reference to the exactness of the payment in regard thereto. The reasoning leads to the conclusion that the decision clearly lays down that the true nature and character of the appropriation must be determined with reference to the substance of the matter ; obviously, this means that one must have regard to the intention with which and the purpose for which appropriation has been made, such intention and purpose being gathered from the surrounding circumstances.

It is in the context of these aspects that the decision of this court in Commissioner of Income Tax Vs. Periakaramalai Tea and Produce Co. Ltd., and Commissioner of Income Tax Vs. Indian Steel Rolling Mills Ltd., would require consideration.

In Commissioner of Income Tax Vs. Periakaramalai Tea and Produce Co. Ltd., , in the matter of the Companies (Profits) Surtax Act, 1964, this court was dealing with an undisputed factual matrix. The assessment years were 1964-65, 1965-66 and 1966-67 and the question was as to whether as held by the Tribunal it would be correct in law to hold that the amount standing to the credit of the "retirement gratuity reserve" is to be treated as a reserve and has to be taken into account for the purposes of calculating the capital, this court considered whether the sums created by the assessee as "reserve for retirement gratuity" were really to be treated as "reserves" in computing the statutory deduction permissible under the Act. The dispute necessitated the consideration of two questions. The first as to what exact is meant by "reserve", and the other whether reserve for gratuity shown in the balance-sheet would be any item under the heading "Current liabilities and provisions". This court held that any amount so reserved towards gratuity would not have the character of an amount reserved by way of provision to meet a liability. In this process of reasoning, on the facts it is held that by its very nature a reserve such as one for retirement gratuity is not a reserve for meeting any liability which has already arisen. It is on the basis of these aspects the court held that the amount should be taken for the purpose of statutory deduction.

Subsequently also, the Madras High Court in Commissioner of Income Tax Vs. Indian Steel Rolling Mills Ltd., , again on the factual position held that the amount set apart for payment of gratuity, admittedly a future liability, though pointed as a reserve would have to be treated and taken into account in determining the standard deduction. Commissioner of Income Tax Vs. Indian Steel Rolling Mills Ltd., is a decision of the Madras High Court and the amount related to payment of gratuity and in regard to the character of the amount there was no dispute. It is held that the expression "other reserves" should be read as ejusdem generis because the test is that the amount set apart for gratuity will have to be understood in terms of its purpose.

Learned counsel for the Department submitted that the course adopted by the Gujarat High Court of remanding the matter is necessary in the interest of justice. Having gone through the two decisions of the Gujarat High Court, the matters were remanded to ascertain the exact nature of the amount. It is clearly observed that the reserve of the amount is for doubtful debts. This obviously not the position in the matter before us. Learned counsel for the Department placing reliance on the Full Bench decision of the Andhra Pradesh High Court in Hyderabad Asbestos Cement Products Ltd. Vs. Commissioner of Income Tax, to the effect that the decision of this court in Commissioner of Income Tax Vs. Periakaramalai Tea and Produce Co. Ltd., does not represent the correct position in law urges us to consider the above observations of the Full Bench.

For this purpose, we have carefully gone through the judgment of the Supreme Court in Vazir Sultan Tobacco Co. Ltd., Hyderabad and Others Vs. Commissioner of Income Tax, Andhra Pradesh, Hyderabad, wherein also it is clearly observed that the situation depends on the factual particulars. We have considered Commissioner of Income Tax Vs. Periakaramalai Tea and Produce Co. Ltd., independently and we do not find that this court does not represent the correct position in law in the said decision. While considering the common question of law certain general principles are specified in Vazir Sultan Tobacco Co. Ltd., Hyderabad and Others Vs. Commissioner of Income Tax, Andhra Pradesh, Hyderabad, which are to be applied to the factual matrix. Before the Gujarat High Court the amounts in question were found to be doubtful debts which necessitated the order of remand. However, this is not the position before us. As we have already specified, the opening balance in the provision for gratuity account of Rs. 3,03,798 is seen for the purpose of computing standard deduction. The Appellate Assistant Commissioner would have to be stated as having correctly relied upon the decision in Commissioner of Income Tax Vs. Indian Steel Rolling Mills Ltd., . The said decision is the decision of the Madras High Court. The decision of this court in Commissioner of Income Tax Vs. Periakaramalai Tea and Produce Co. Ltd., leads to the same conclusion on the basis of the clear factual matrix. It is not necessary to consider the question of remand because on the facts there is no doubt of any kind.

For all the above reasons, taking into consideration the peculiar facts of the case, we hold that the decision of the Appellate Assistant Commissioner considering the amount in question for the purpose of computing the standard deduction is correct.

For the above reasons, the question referred is answered in favour of the assessee and against the Department by agreeing with the view of the Appellate Assistant Commissioner to consider the amount for the purpose of computing standard deduction.

Copy of this judgment under the signature of the Registrar and seal of the High Court will be sent to the Income Tax Appellate Tribunal, Cochin Bench, as required u/s 260(1) of the Income Tax Act, 1961.