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Judgment
S. P. Sinha, J. - At the instance of the CIT. Bihar Patna, the Patna Bench of the Income Tax Appellate Tribunal has referred the undermentioned question for opinion of this Court.
"Whether on the facts and in the circumstances of the case, the Tribunal was correct in law in allowing the provision of Rs. 81,978/- as an additional liability for gratuity in accordance with the provisions of Gratuity Act ?"
On the statement of the case, as made by the Tribunal the question requires to be reframed, but before doing so, the facts may be stated.
The assessee is a company, engaged in the business of recovery of iron contents from slags deposit of the steel plants at Jamshedpur, Rourkela and Burnpur, with its head office at Jamshedpur. Its method of accounting is mercantile. For the assessment year 1973-74, for which the accounting period is the calendar year ending on the 31st December, 1972 the assessee made a provision of Rs. 81,978/- towards payment of retirement grauity. This provision admittedly had been made in accordance with the provisions of Payment of Gratuity (Act No. 39 of 1972) which came into force, during the relevant accounting year, from the 16th September, 1972 (hereinafter referred to as the Gratuity Act). The assessee claimed it as a deduction in computing its profits from business. The total amount claimed towards gratuity was a sum of Rs. 2,92,160/- which included the aforesaid sum of Rs. 81,978/-. The ITO allowed the claim to the extent of Rs. 81,978/- on the ground that it was a mere provision under the Gratuity Act. According to the ITO, only such contribution to the gratuity fund was allowable as deduction which had been made towards an approved gratuity fund.
On appeal to the AAC the submission made by the assessee was that the said sum of Rs. 81,978/- being an ascertained liability under the Gratuity Act, was deductible against the profits of the year. The AAC accepted the assessees claim. Holding that the disputed amount was an additional liability to the assessee.
The Department then appealed to the Tribunal. The Tribunal dismissed the Departments appeal observing-
".... It is clear that the assessee had already been contributing towards payment of gratuity for its employees. Therefore, the provision for Rs. 81,978/- being the amount of difference between the existing contribution and the contribution as per provision of the payment of Gratuity Act, 1972, which came into effect during this year, became an additional liability of the assessee. In view of that fact, it could not be said to be a contingent liability ....."
On the above facts, the proper question which arises is :
"Whether on the facts and in the circumstances of the case, the Tribunal was correct in law in upholding the deduction of Rs. 81,978/- which amount had been set apart as an additional liability in accordance with the provisions of the payment of Gratuity Act, 1972 ?"
Learned Standing Counsel for the Department submitted that the admissibility of an amount set apart towards gratuity is dependent upon the fulfilment of the conditions laid under s. 40A(7) of the I.T. Act, 1961. The claim for deduction of an amount set apart towards gratuity has, therefore, to be examined in the light of the provisions contained in the aforesaid provisions of the I.T. Act.
In the instant case, it is submitted that although the said amount of Rs. 81,978/- had been set apart towards gratuity account, it was merely a contingent liability and not a pressing obligation. Further, the setting apart of the said sum did not conform to the requirements of s. 40A(7)(b)(ii) of the I.T. Act, inasmuch as it was over and above the admissible limit.
According to learned Counsel for the assessee, the argument raised on behalf of the Department was irrelevant, inasmuch as it did not arise of the Tribunals order. The facts, as found by the Tribunal, were that the contribution towards the gratuity, of which the deduction was claimed, was not a contingent liability but an additional liability of the assessee. The additional amount of the gratuity has been calculated in accordance with the provisions contained in s. 4 of the Payment of Gratuity Act. Moreover, the deduction of such amount in computing the asses sees profits and gains from business was not prohibited under the provisions of s. 40A(7) of the I.T. Act According to learned counsel for the assessee, therefore, the case squarely fell within the principles laid by the Supreme Court in the case of Metal Box Company of India Ltd., v. Their Worksmen The question, therefore, be answered in the affirmative.
I think the contention made on behalf of the assessee is sound and is fit to be accepted.
In the case of Ushers Wiltshire Brewery Ltd. v. Bruce, Lord Parker has observed that -
"Where a deduction is proper and necessary to be made in order to ascertain the balance of profits and gains, it ought to be allowed .... provided there is no prohibition against such an allowance ......."
This principle has since been accepted by the Supreme Court in one of the cases, in which that principle has been reiterated. In the case of Badridas Daga v. CIT it has been observed that subject to the special requirement of the Act, the profits to be assessed are the real profits and they must be ascertained on ordinary principle of commercial trade and commercial accounting.
There can be no dispute that the deductibility or otherwise of an amount in computing the assessees profits and gains of business has first to be tested in the light of the provisions contained in that regard in the Act. Only when it is found that there is no prohibition for the deductibility of the claim, it can be taken into consideration in computing the assessees real profits which should be chargeable to Income Tax.
Now in the instant case, the departmental appeal to the Tribunal was not on the ground that the provisions made by the assessee for the payment of gratuity has been allowed in contravention of one or the other conditions laid in sub-s. (ii) of s. 40A(7)(b) of the I.T. Act, but on the ground that it was not admissible on general commercial principles. It was this aspect of the matter which was considered by the AAC and also by the Tribunal Necessarily, therefore, it follows that the contention which is now being raised on behalf of the Department, does not arise out of the Tribunals order and consequently it cannot be permitted to be raised.
The question, however, still remains as to whether the Tribunal was correct in law in allowing the deductions as an additional liability. That by virtue of the Gratuity Act, the liability arose in the accounting year is not disputed and in fact it has been held that the liability did exist during the accounting year. It has been further held by the Tribunal, as a fact, that the liability was not contingent, These two facts being there, the question arises, whether the Tribunal was correct in law in upholding the deduction of Rs. 81,978/- in computing the assessees income from business. In the case of Metal Box Company of India Ltd. (Supra), the Supreme Court while deciding the real profits of the company which should form the basis for distribution of bonus to the workmen, made the following observations, relating to the contribution towards gratuity fund as an additional deduction in working out the profits and gains, of the business;
"Two questions, therefore, arise : (1) whether it is legitimate in such a scheme of gratuity to estimate the liability on an actuarial valuation and deduct such estimated liability in the P. & L. account while working out its net profits; and (2) if it is, whether such appropriation amounts to a reserve or a provision. If it is a reserve, obviously the amount has to be added back while computing the gross profits ... In the case of an assessee maintaining his accounts on mercantile system, a liability already accrued, though to be discharged at a future date, would be a proper deduction while working out the profits and gains of his business, regard being had to the accepted principles of commercial practice and accountancy ....."
Their Lordships drew a clear distinction between "reserve" and "a provision" observing in the following terms :
"..... An amount set aside out of profits and other surplues, not designed to meet a liability, contingency commitment or diminution in value of assets known to exist at the date of the balance sheet is a reserve but an amount set aside out of profits and other surpluses to provide for any known liability of which the amount cannot be determined with substantial accuracy is a provision :"
This decision clearly describes the manner in which the profits and gains of a business is to be computed on the basis of general commercial principles. It further clarifies the position that where an amount is set aside out of profits for any known liability, such setting aside is not a contingent liability but a provision towards a known liability. Such known liability is to be deducted in computing the assessees profits and gains from business : determining it on the basis of general commercial principles.
Now in the instant case, s. 4 of the Gratuity Act casts a legal obligation on the employer to pay gratuity to its employees in accordance with the terms thereof. It is not disputed that in the instant case the said sum Rs. 81,978/- had been calculated in accordance with the said provisions of the Gratuity Act. The said amount, therefore, was a known liability which the assessee had to set apart out of its profit of the year. May be that it was an additional liability, but all the same, the amount was not set apart merely as a reserve, but had been set apart for a known liability. I think, then it has rightly been held to be deductible in assessing the assessees real profits from business.
The question, as reframed is accordingly answered in the affirmative and against the Department. The assessee will be entitled to costs. Hearing fee Rs. 250/-.