Commissioner of Income Tax vs S.A.E. (I)(P.) Ltd.

G. Ramanujam, J.—The following question of law has been referred to this Court for its opinion, at the instance of the revenue :

Whether, on the facts and in the circumstances of the case, the sum representing ''Incremental liability'' towards gratuity of the current year was

deductible from the profit of the year?

The assessee in this case is a private limited company manufacturing and erecting transmission towers. For the accounting year ending 30-6-1965

corresponding to the assessment year 1966-67, it claimed deduction of a sum of Rs. 1,09,575 as provision for gratuity for two of its full time

directors, Shri C. Valdettarao and Shri G. Abbagnane. The ITO did not allow the same on the ground that gratuity fund has not been recognised

by the Commissioner and that it was only a provision and not an actual payment. He also took note of the fact that the provision has been made on

the basis of 12 years'' salary for one director and 91/4 years'' salary for the other director and that the provision thus, in fact, related to the earlier

years and not to the year of accounting. The disallowance of the claim of the assessee was questioned before the AAC by filing an appeal. The

AAC, however, allowed the claim, relying on Circular No. 47 [F. No. 9/100/69-IT(A-II) ], dated 21-9-1970 [ See Taxmann''s Direct Taxes

Circulars, Vol. 1, 1980 edn., p. 239] issued by the CBDT. The revenue took the matter in appeal to the Tribunal and the Tribunal upheld the claim

of the assessee, holding that the business requirements of the company had compelled the assessee to provide for payment of gratuity to its

directors and what was necessarily to be debited in the year of accounting for the purpose of arriving at a proper profit was necessarily to be

allowed. The Tribunal, however, found that the computation made by the assessee of the current year''s liability on actuarial basis at Rs. 1,09,575

was wrong and that computation had to be made on incremental basis. In this view, the Tribunal allowed in part the appeal and remitted the matter

to the ITO for computing the incremental liability towards the gratuity in receipt of the two directors in the assessment year and allowed the same.

Aggrieved against the order of the Tribunal, the revenue sought and obtained a reference on the question set out above.

The question as to whether, a provision made in relation to the gratuity payable on a future date can be allowed in the year during which the

provision has been made, came up before this Court and the Supreme Court under varied circumstances. The latest pronouncement of the

Supreme Court on this question is Vazir Sultan Tobacco Co. Ltd., Hyderabad and Others Vs. Commissioner of Income Tax, Andhra Pradesh,

Hyderabad, Though that case related to the provisions of the Companies (Profits) Surtax Act, 1964, the general discussion as to the nature of the

liability for payment of gratuity to the employees and its allowability in respect of a provision made towards that liability was considered. The

decision in that case appears to apply squarely to the facts of this case. Before dealing with the said decision, it will be useful to refer to some of

the decisions of this Court on the point at issue.

In Commissioner of Income Tax Vs. Andhra Prabha P. Ltd., the question arose whether a provision which had been made for payment of

gratuity calculated on a scientific and legal basis could be debited to profit and loss account and whether it is allowable as a deduction u/s 37(2) of

the income tax Act, 1961 (''the Act''). After referring to section 36(1)(v) of the Act, which provides for deduction of any amount actually paid by

way of contribution to an approved gratuity fund created by the employer, and section 40A(7) of the Act, introduced by the Finance Act, 1975,

prohibiting deduction of a provision for gratuity under certain circumstances, this Court held that the said two provisions did not cover the case

where a provision was made for a future payment on a scientific method of calculation and even in the absence of any specific provisions of the

statute in that regard, the revision made for a future payment calculated on a scientific basis could be allowed in the computation of the profits u/s

28 of the Act itself. The Court also held that so long as the provision had been made bona fide and out of commercial consideration and the

allowance was not prohibited by any of the provisions of the Act, the payment could not be disallowed merely because the payment had not been

actually made during the assessment year, for the very concept of profit would require adjustment, being made for the claims of the employees for

gratuity insofar as it is possible to relate it to the current year. In taking that view, the learned Judges relied on the decision of the Supreme Court in

Metal Box Company of India Ltd. Vs. Their Workmen, and the decision of the House of Lords in Southern Railway of Peru Ltd. v. Owen [1957]

32 ITR 737.

In Metal Box Co. of India Ltd.''s case (supra) the question that arose before the Supreme Court was, whether in computing the amount of

bonus payable to workmen, a provision made for payment of gratuity to the workmen on a future date could be deducted from the profits. The

Supreme Court held that such a provision for discharge of a liability on a future date would be a proper deduction in the calculation of the

commercial profits. The relevant observation of the Supreme Court is as follows :

... 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. It is not as if such deduction is permissible only in case of amounts actually expended or paid. Just as receipts, though

not actual receipts but accrued due, are brought in for income tax assessment, so also liabilities accrued due would be taken into account while

working out the profits and gains of the business....

Thus, on the question, whether in computing the amount of bonus payable to the employees, the estimated liability arising under the gratuity

schemes should be taken into account or not, the Supreme Court held that a provision for payment of gratuity to be discharged at a later date

could be taken into account on the basis of commercial practice and accountancy. The Supreme Court further observed :

... In the instant case, the question is not whether such estimated liability arising under the gratuity schemes amounts to a debt or not. The question

that concerns us is whether, while working out the net profits, a trader can provide from his gross receipts his liability to pay a certain sum for every

additional year of service which he receives from his employees. This, in our view, he can do, if such liability is properly ascertainable and it is

possible to arrive at a proper discounted present value. Even if the liability is a contingent liability, provided its discounted present value is

ascertainable, it can be taken into account. Contingent liabilities discounted and valued as necessary can be taken into account as trading expenses

if they are sufficiently certain to be capable of valuation and if profits cannot be properly estimated without taking them into account....

In Southern Railway of Peru Ltd.''s case (supra) an English company operating a railway line in Peru, which was found to pay its employees

compensation on the termination of their services, claimed as against each year''s profits, certain amounts as and by way of provision for gratuity

and other payments which would ultimately be payable. In examining that claim Lord Radcliffe, with whom other two Law Lords agreed, observed

:

What the appellant claims the right to do is to charge against each year''s receipts the cost of making provision for the retirement payments that

will ultimately be thrown upon it by virtue of the facts that it has had the benefit of its employees'' services during that year... Only by such a

method, it is said, can it bring against the receipts of the year the true cost of the services that it has used to earn those receipts. Generally

speaking, this must, I think, be true. For, whereas it is possible that any one of its many employees may forfeit his benefit and so never require a

payment, the substantial facts of the situation are that when the company has paid every salary and wage that is due for current remuneration of the

year, it has not, by any means, wholly discharged itself of the pecuniary burden which falls upon it in respect of the year''s employment...

Lord Mac Dermott, in the same case, has observed :

... as a general proposition it is, I think, right to say that, in computing his taxable profits for a particular year, a trader, who is under a definite

obligation to pay his employees for their services in that year an immediate payment and also a future payment in some subsequent year, may

properly deduct, not only the immediate payment, but the present value of the future payment, provided such present value can be satisfactorily

determined or fairly estimated....

Following the above observations of the House of Lords in Southern Railway of Peru Ltd.''s case (supra) and of the Supreme Court in Metal Box

Co. of India Ltd.''s case (supra), this Court has held that the gratuity based on actuarial valuation could be claimed as a deduction, even though the

actual discharge of that liability by payment arises later.

In COMMISSIONER OF Income Tax, TAMIL NADU-V Vs. SRI RANILAKSHMI GINNING, SPINNING and WEAVING MILLS (P.)

LTD., this Court was concerned with a question as to whether a provision for gratuity liability arrived at by adopting a scientific method of

valuation could be claimed as deduction. The Court expressed the view that it had to be regarded as a business expenditure incurred by the

assessee wholly and exclusively for the purposes of the business and, hence, it was properly allowable as a deduction, even though there is no

specific provision for such a deduction in the Act.

In Vazir Sultan Tobacco Co. Ltd.''s case (supra) a question arose as to whether a provision for payment of gratuity determined on the basis of

scientific and actuarial valuation could be debited against the profit and loss account and claimed as a deduction. The Supreme Court held that

normally, a liability to pay gratuity to employees arises on determination of their employment either by death, incapacity, retirement or resignation,

an event which is certain to happen in the service career of every employee, that the amount of gratuity payable is usually dependent on the

employees'' wages at the time of the determination of their employment and the number of years of service put in by them, that the liability accrues

and enhances with the completion of every year of service that, therefore, the company can work out on an actuarial valuation its estimated liability,

that is, the discounted present value, a future liability on a scientific basis and make a provision for such liability, but not at all once but spread over

a number of years, and that such a provision has to be allowed as deduction as the liability with reference to that year, though discharged at a later

stage, taking it as an expenditure in relation to that year of assessment. The Supreme Court also referred to one of its earlier decisions in Standard

Mills Co. Ltd. Vs. Commissioner of Wealth-tax, Bombay City, , where the question for decision was whether an estimated liability under the

gratuity scheme framed under industrial awards amounted to debts and could be deducted while computing the net wealth of the assessee and the

Supreme Court has taken the view that the liability is a contingent one and, therefore, it is not a debt u/s 2(m) of the Wealth-tax Act, 1957, though

it would be deductible under the income tax Act while computing the taxable profits and that different considerations would have to apply to cases

arising under the Wealth-tax Act and the income tax Act. In the case of Metal Box Co. of India Ltd.'' (supra), the Supreme Court was directly

concerned with the nature of a liability under a scheme of gratuity in the context of the Payment of Bonus Act, 1965, and the question was whether

the estimated liability under the gratuity schemes framed by the company could be deducted from the gross receipts in the profit and loss account,

it being contended on behalf of the workmen that such a deduction was not justified while determining the ''available surplus'' and the ''allocable

surplus'' for the payment of bonus under the Payment of Bonus Act. The Supreme Court rejected the contention and held that an estimated liability

under the gratuity schemes, even if it amounted to a contingent liability and was not a debt under the Wealth-tax Act, was deductible from the

gross receipts while preparing the profit and loss account, if its present value was fairly ascertainable and could be discounted. Having regard to

the consistent view taken by the Supreme Court in Standard Mills Co. Ltd.''s case (supra), Metal Box Co. of India Ltd.''s case (supra) and Vazir

Sultan Tobacco Co. Ltd.''s case (supra), the decision of the Tribunal, in this case, is to be upheld. The question referred to us has, therefore, to be

answered in the affirmative and against the revenue. No costs.