Karvalves Ltd. vs Commissioner of Income Tax

K.S. Paripoornan, J.—These two references are connected cases. The parties in both the cases are the same. I.T. Reference No. 72 of 1987 is a reference made by the Tribunal at the instance of an assessee, who was appellant before it in IT Appeal No. 318 (Coch.) of 1983. IT Reference No. 117 of 1987 is a reference made by the Tribunal at the instance of the revenue, which was the appellant before it in I.T. Appeal No. 360 (Coch.) of 1983. IT Appeal No. 318(Coch.) of 1983 and IT Appeal No. 380 (Coch.) of 1983, both related to the assessment year 1971-72 of the same assessee and were heard together and disposed of by a common judgment by the Tribunal on31-l-1986. The assessee as well as the revenue filed R.A. No. 125 (Coch.) of 1986 and R.A. No. 131 (Coch.) of 1986, respectively, praying that the Tribunal may be pleased to refer certain questions of law, specified in the respective reference applications for the decision of this Court. Accordingly, the Tribunal has referred four questions of law in IT Reference No. 72 of 1987 at the instance of the assessee. At the instance of the revenue, the Tribunal has referred two questions of law in IT Reference No. 117 of 1987. Since the parties involved in both the references are the same, and they relate to the same assessment year 1971-72, we heard the above references together and a common judgment is delivered in the said referred cases. The four questions of law referred at the instance of the assessee to this Court for decision in IT Reference No. 72 of 1987 are as follows:

Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that the Ernakulam Electrical Undertaking which constitutes the profit-making apparatus and the business of the electrical undertaking falls within the definition of ''capital asset'' as defined in section 2(14) of the income tax Act, 1961, the transfer of which will attract capital gains?

Whether, on the facts and in the circumstances of the case, and on the evidence on record the Tribunal was right in law in holding that the assessee-company was not entitled to claim gratuity during the assessment year 1971-72 either as a business expenditure or as a deduction in computing capital gains?

Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that solatium is part of the sale consideration the value of which is to be taken into consideration?

Whether, solatium is a ''capital asset'' within the meaning of section 2(74) of the income tax Act, the value of which is to be taken into account for the purpose of determining capital gains?

The two questions referred at the instance of the revenue for the decision of this Court in IT Reference No. 117 of 1987 are as follows:

Whether, on the facts and in the circumstances of the case, the Tribunal is justified in holding that the liability accrued to the assessee under the proviso to section 25FF and not u/s 25FF of the Industrial Disputes Act?

Whether, on the facts and in the circumstances of the case, the Tribunal is justified in holding that the retrenchment compensation is a permissible deduction in computing the capital gains?

Briefly the facts necessary to adjudicate the questions referred for the decision of this Court are as follows:

The applicant in IT Reference No. 72 of 1987 (respondent in I.T. Reference No. 117 of 1987) is an assessee to incompetence. It is a public limited company. Formerly, it was known as ''Cochin State Power & Light Corpn. Ltd.''. It had a licence granted to it by the erstwhile Princely State of Cochin to distribute electricity in the Ernakulam area. On 7-3-1969 the Kerala State Electricity Board exercised the option vested in it by sending a notice to the assessee to purchase the said electrical undertaking at Ernakulam. The assessee was required to sell the undertaking to the Board at the expiry of the period of the licence. The assessee, in turn, gave notice soon thereafter to its employees that their services would not be required after the undertaking vests in the Kerala State Electricity Board. Accordingly, the undertaking vested in the Kerala State Electricity Board on 3-12-1978. The purchase price of the electrical undertaking, fixed by the Board, was not accepted by the assessee. The Board fixed it at Rs. 71,22,600 plus solatium at 20 per cent thereon. The assessee claimed Rs. 1,30,69,200 including solatiun as compensation. The matter was finally referred to arbitrators. On 22-8-1978, the arbitrators passed the award and determined the purchase price due to the assessee (licensees in respect of the Ernakulam Electrical Undertaking) at Rs. 88,97,000 excluding solatium. The award was filed in Court for acceptance in O.P. No. 67 of 1978. By judgment dated 28-10-1976, the Court directed the Kerala State Electricity Board to pay to the assessee a sum of Rs. 88,97,000 excluding solatium. There was no break-up of the compensation amount in respect of plant, machinery, lands and buildings, etc. The ITO happened to pass the order of assessment for the year 1971-72 on 27-3-1974, long before the arbitrators passed their award or the Court determined the compensation. By order dated 27-3-1974 the ITO determined the total income of the assessee for the year at Rs. 97,78,410. He levied tax on capital gains at Rs. 1,36,69,200 including solatium, based on the assessee''s own claim. This order was set aside in appeal by the AAC by order dated 9-8-1974, and the assessing authority was directed to redo the assessment. Accordingly, the ITO passed an order of assessment dated 31-8-1977 and determined the total income of the assessee at Rs. 97,37,160. This order was also set aside in appeal by the A AC by order dated 31 -3-1978 and the ITO was directed to redo the assessment after looking into the fresh details produced before the arbitration authorities and after giving a reasonable opportunity to the assessee of being heard. Thereafter, the ITO made a fresh assessment on the assessee by order dated 26-9-1981. He determined the total income of the assessee at Rs. 56,61,650. The assessee filed an appeal before the Commissioner (Appeals), who, by his order dated 19-2-1983 allowed the appeal filed by the assessee in part. The main relief afforded by the Commissioner (Appeals) to the assessee, was regarding the retrenchment compensation. It was totally disallowed by the ITO. In appeal, the Commissioner (Appeals) held that the disallowance of the claim as a business deduction is valid but it should be deducted from the full value of consideration for the purpose of capital gains. In other words, only the net amount after such deduction will be assessable to capital gains. The assessee and the revenue filed appeals from the aforesaid order of the Commissioner (Appeals) dated 19-2-1983, which were numbered and disposed of as IT Appeal No. 318 (Coch.) of 1983 and IT Appeal No. 360 (Coch.) of 1983 by a common order dated 31-1-1986. In the appeal filed by the revenue, the sole question that arose for consideration was whether the Commissioner (Appeals) was justified in holding that the retrenchment compensation should be deducted from the full value of consideration for the purpose of capital gains. The Tribunal dismissed the appeal filed by the revenue, objecting to the above deduction, as in its view, the amount paid as retrenchment compensation will be covered by section 37 of the income tax Act, 1961 (''the Act'') and so a permissible revenue expenditure. It was also opined that the said amount is deductible from the capital gains as a charge on the amount of compensation as rightly held by the Commissioner (Appeals). It is thereafter, at the instance of the assessee, as well as the revenue, the Tribunal has referred the questions of law, formulated hereinabove, which are said to arise out of the appellate order for the decision of this Court. The questions referred at the instance of the assessee turn on the exigibility of amounts received on acquisition, to capital gains and whether gratuity paid is a permissible deduction for the year in question. In the questions referred at the instance of the revenue, the sole question that arises for consideration is whether retrenchment compensation is a permissible deduction.

We heard the counsel for the assessee, Mr. CM. Devan, as also the counsel for the revenue Mr. P.K.R. Menon. The broad facts of this case are as follows:

The Kerala State Electricity Board, by their letter dated 7-3-1969, exercised the option to purchase the Ernakulam Electrical Undertaking and required the assessee-company to sell the undertaking to the Board at the expiry of the period of the running licence. The assessee immediately thereafter served notices to its employees, intimating that their services would not be required after the undertaking vests in the Kerala State Electricity Board. It was so done before the undertaking was taken over by the Board. The undertaking vested in the Kerala State Electricity Board on 3-12-1970. The determination of the purchase price by the Board in the sum of Rs. 71,22,600 plus solatium at 20 per cent was not accepted by the assessee-company. There was dispute regarding the compensation amount payable. The assessee-company claimed Rs. 1,30,69,200 including solatium as compensation. In view of the dispute, the matter was referred to arbitration. The joint arbitrators passed an award on 22-8-1978 and determined the purchase price due to the licensees (assessee) at Rs. 88,97,000 excluding solatium. The award was filed in the Sub-Court, Ernakulam and the Court in O.P. No. 67 of 1978 by judgment and decree dated 28-10-1978 directed the Board to pay the assessee a sum of Rs. 88,97,000 excluding solatium, with interest at 6 percent on the balance due. Neither the award, nor the decree passed by the Court, contained any break-up of the compensation amount in respect of plant, machinery, land, buildings, etc. The initial order passed by the ITO dated 27-3-1974 was long before the award passed by the arbitrators and it did not reckon the realities of the situation. There were further proceedings by way of appeals and finally a fresh assessment order was passed by the ITO dated 26-9-1981, whereby the total income of the assessee was determined at Rs. 56,61,650. It was this fresh order of assessment, which was taken in appeal by the assessee, wherein the Commissioner (Appeals), by order dated 19-2-1983 allowed the appeal filed by the assessee in part. So far as these references are concerned, we are only concerned with the relief afforded by the Commissioner, to the extent he held that the retrenchment compensation of Rs. 3,31,534 should be deducted from the full value of the consideration for the purpose of capital gains.

On the other questions, relevant for these references - (1) exigibility of the amount received to capital gains, (2) whether solatium is part of the sale consideration and no part of the capital asset, and (3) whether the assessee- company is entitled to claim gratuity during the assessment year 1971-72 - the Commissioner (Appeals) held against the assessee. Disposing of IT Appeal No. 318 (Coch.) of 1983 and IT Appeal No. 360(Coch.) of 1983 (the appeals filed by the assessee-company and the revenue), by a common order dated 31-1-1986, the Tribunal affirmed the decision of the Commissioner (Appeals) on the above questions. It should be stated that further relief was given to the assessee in the appeal filed by it, affording relief regarding profits u/s 41(2) of the Act, with which we are not concerned in these references.

We shall first take up the points that arise for consideration in IT Reference No. 72 of 1987 - the reference at the instance of the assessee. There are four questions as stated in paragraph 2 supra. But they involve three distinct points:

(1) When the undertaking as a whole, as a going concern is transferred and the compensation is received therefor, is the compensation, so received, exigible to capital gains?

(2) Is solatium paid for the transfer of the undertaking part of the sale consideration and forms part of the capital asset? and

(3) Is the assessee-company entitled to deduction of the gratuity amount paid in the sum of Rs. 3,08,614?

6A. In considering the above aspects it is useful to quote section 45(1) and section 2(14) of the Act:

Capital gains. - (1) Any profits or gains arising from the transfer of a capital asset effected in the previous year shall, save as otherwise provided in sections 53, 54, 54B, 54D and 54E, 54F and 54G be chargeable to income tax under the head ''Capital gains'', and shall be deemed to be the income of the previous year in which the transfer took place."

Definitions.-In this Act, unless the context otherwise requires, -

(1) to (13) ******

(14) ''capital asset'' means property of any kind held by an assessee, whether or not connected with his business or profession,...

Section 45 of the Act specifies when capital gains chargeable to income tax arise and section 2(14) defines what the capital asset is. Following the decision of the Gujarat High Court in Vadilal Soda Ice Factory Vs. Commissioner of Income Tax, Gujarat II, , the Tribunal held that solatium represents consideration for the property acquired and should be taken into account in computing the capital gains (paragraph 21 of the order). The Tribunal also held that the plea of the assessee that the compensation fixed is in respect of the undertaking as a whole is a going concern, that is to say, that the compensation is for the profit-making apparatus and so cannot be said to be towards land, machinery or plant as such and so not exigible to capital gains, is without substance. Adverting to the plea of the assessee in this regard in paragraphs 2,12 and 11 of the order and relying on the decisions of the Gujarat High Court in Sarabhai M. Chemicals Private Ltd. Vs. P.N. Mittal Competent Authority, Inspecting Assistant Commissioner of Income Tax, Acquisition Range-II, Ahmedabad and another, and Artex Manufacturing Co. Vs. Commissioner of Income Tax, Gujarat-II, , the Tribunal held in paragraph 12 of the order that in the transfer of the undertaking, though various assets like land, building, plant, machinery, etc., are involved, it cannot be denied that the undertaking itself, so a capital asset is transferred and so exigible to capital gains. The Tribunal concluded that the assessee was rightly taxed for capital gains. It was in the light of the above reasoning the Tribunal concluded that solatium is part of the sale consideration and so part of the capital asset and, therefore, it should be taken into account for the purpose of determining capital gains and even if it is considered that the undertaking as a whole was transferred as a going concern, there was a transfer of the capital asset and so the assessee was rightly taxed for capital gains. We are of the view that the aforesaid conclusions of the Tribunal covering question Nos. 1,3 and 4 in IT Reference No. 72 of 1987 are valid and justified in law. A Bench of this Court in Commissioner of Income Tax Vs. Smt. M. Subaida Beevi, and 563 considered the question as to whether the solatium received by the assessee, on a result of transfer of capital asset and forming part of the profits or gains arising therefrom is exigible to tax u/s 45. Following the decisions of the Gujarat High Court in Vadilal Soda Ice Factory''s case (supra) and the later decision in Hamidkhan Samsherkhan and etc. Vs. Special Land Acquisition Officer, Broach and etc., a Bench of this Court held that solatium forms part of the consideration for the land (capital asset) transferred by way of acquisition and so exigible to tax. In West Coast Electric Supply Corporation Ltd. and Another Vs. Commissioner of Income Tax, a Bench of the Madras High Court, construing section 12B of the Indian income tax Act, 1922 (corresponding to section 45 of the income tax Act, 1961) held that the word ''property'' in the definition of ''capital asset'' in section 2(4A) [similar to section 2(14)] would include an undertaking acquired as a whole. Similarly, a Bench of the Gujarat High Court in Artex Mfg. Co.''s case (supra) following its earlier decision in Sarabhai M. Chemicals (P.) Ltd. v. P.M. Mittal, Competent Authority''s case (supra) held that when the whole business of the undertaking, together with its assets and liabilities are transferred for a consolidated price, and not sold by any itemized value or item-by-item price fixed for the different assets of the firm, any surplus, in the sense of excess of the consideration for the transfer of the business of the undertaking over the cost of the acquisition of the business of undertaking, will be capital gain and the excess is assessable to capital gains tax. In the light of the above Bench decision of this Court and as well as of the Gujarat High Court, we are of the view, that solatium is part of the sale consideration, the value of which should be taken into consideration, and that is a capital asset for the purpose of determining the capital gains and on transfer of the business of the Emakulam Electrical Undertaking, levy of capital gains tax is attracted.

We answer question Nos. 1, 3 and 4 in IT Reference No. 72 of 1987 in the affirmative, against the assessee and in favour of the revenue.

The only further question that survives for consideration in the reference made to this Court at the instance of the assessee - IT Reference No. 72 of 1987 - In question No. 2 - whether the assessee-company was entitled to get deduction of the gratuity amount paid in the sum of Rs. 3,08,614 in the assessment for the year 1971-72 as a business expenditure or as a deduction in computing capital gains. It is not in dispute that the Kerala Industrial Employees Payment of Gratuity Ordinance came into force on 10-12-1969. The Ordinance was replaced by the Act which came into force on 17-2-1970. The Act was deemed to have come into force on 10-12-1969 the date of the Ordinance. The plea of the revenue is that the liability for gratuity had accrued in the assessment year 1970-71 and what was claimed was deduction for gratuity in respect of the entire liability of the employees for all the years up to the time of transfer of the asset and not confined to the liability for gratuity to the current accounting year. It is argued, that gratuity liability accrued even on the date of the Ordinance, 10-12-1969. It did not accrue during the accounting period 1-4-1970 to 31-3-1971 - assessment year 1971-72. It accrued even earlier. The plea of the assessee was that it had applied to the Government for exemption from the provisions of the gratuity on 15-4-1969 and the application was disposed of only on 14-7-1970. The assessee had also filed a Writ Petition in the Kerala High Court questioning the validity of the Act. Though no provision was made by the assessee in the accounting period, relevant to the assessment year 1970-71, nor was it claimed in that year, in the accounts for the year ended on 31-3-1970, it was indicated that there was possible liability under the above head. When the undertaking was about to be transferred to the Board, the Board insisted that the issue relating to gratuity and retrenchment compensation should be settled as a condition precedent for the payment of compensation money. A memorandum of settlement under a tripartite agreement dated 22-7-1972 came into existence, by which the original statutory liability, which arose under the Kerala State Industrial Employees Payment of Gratuity Act, 1970 was substituted by a fresh liability, which arose under the aforesaid memorandum of settlement. In other words, the statutory liability was substituted by contractual liability and so the claim made for deduction in the assessment year 1971-72 (accounting period ending 31-3-1971) should be allowed. Adverting to the above aspects, in paragraphs 14 to 16 of the appellate order dated 31-1-1986, the Tribunal held that admittedly the assessee maintains its accounts on mercantile basis, and the statutory liability towards gratuity accrued on 10-12-1969 and, therefore, should have been claimed in the assessment year 1970-71 and not in this assessment year 1971-72. Reliance was placed on the decision of this Court in L.J. Patel and Company Vs. Commissioner of Income Tax, and Commissioner of Income Tax Vs. K.A. Karim and Sons and Others, . The Tribunal held that even conceding that the statutory liability was replaced by a contractual liability by the settlement effected on 27-12-1972, it should be stated that the date of the settlement did not fall in the accounting year relevant to the assessment year under consideration and on that basis also the claim cannot be allowed in the assessment year 1971-72. The Tribunal held that in the light of the decisions of the Kerala High Court in LJ. Patel & Co.''s case (supra) and ATA Karim & Sons'' case (supra) the assessee is not entitled to the claim of gratuity during the assessment year in question. The assessee''s counsel argued, that though the accounts are kept on mercantile basis, and the claim for deduction can be claimed in the year in which the liability accrued, there is no bar to the assessee deferring the claim to a later date when the precise quantification or the occasion for payment of the liability arises. In other words, it is permissible to claim the liability in a later year when actually payment is made or the quantification is made. Reliance was also placed on certain passages occurring in Kanga and Palkhivala''s Law & Practice of income tax, Vol.1, p. 870, to substantiate the above proposition. We are of the view that the reasoning and conclusion of the Tribunal to hold that the assessee is not entitled to the claim of gratuity during the assessment year in question, is sound. The plea that the statutory liability got itself transformed into a contractual liability, even if it is acceptable, is relevant only for the assessment year 1973-74 and not for this assessment year 1971-72. The earlier decisions of this Court brought to our notice - L.J. Patel & Co.''s case {supra) and K.A. Karim & Sons'' case (supra) - are binding on us. A Bench of this Court in an unreported decision in IT Reference No. 121 of 1986, judgment dated 25-6-1990, had followed the said earlier decisions. In the light of the above decisions of this Court, we are satisfied that the Tribunal was justified in holding that the assessee is not entitled to the claim of gratuity during the assessment year in question. The assessee, which is maintaining its accounts on mercantile basis, should have claimed the liability for gratuity in the assessment year 1970-71 when the liability accrued. The liability cannot be claimed in the subsequent year. The Bench decisions of this Court in CIT v. Kerala Nut Food Co. [1978] 111 ITR 252 and Commissioner of Income Tax Vs. Travancore Timbers and Products, also make this position clear. We, therefore, answer question No. 2 in IT Reference No. 72 of 1987 in the affirmative, against the assessee and in favour of the revenue.

All the four questions referred to this Court, in IT Reference No. 72 of 1987 are answered against the assessee and in favour of the revenue.

We shall now take up the two questions referred to this Court in IT Reference No. 117 of 1987-the reference made to this Court at the instance of the revenue. That is regarding the tenability of the assessee''s claim for deduction of the retrenchment compensation in the sum of Rs. 3,31,534 as business expenditure. The Tribunal considered the claim for gratuity and also the claim for retrenchment compensation together in paragraphs 13 to 16 of its appellate order. While dealing with the retrenchment compensation, the Tribunal referred to the tripartite memorandum of settlement dated 27-12-1972 and extracted paragraph 5(1) of the settlement in paragraph 15 of its order. In paragraph 16 of the appellate order, the Tribunal found that the liability for retrenchment compensation stands on a different footing from that relating to gratuity. It was held that on the facts of this case, the proviso to section 25FF of the Industrial Disputes Act will apply and the assessee will not be liable to pay retrenchment compensation to its employees. It was further found that nonetheless, the assessee agreed to pay the compensation under the provisions of section 25FF, which means, that the liability is fastened upon the assessee by the memorandum of settlement and this liability so fastened related back to the accounting year 1970-71, when the undertaking was taken over. In this view, the Tribunal held that in respect of the retrenchment compensation, when the amount was quantified in the assessment dated 27-12-1972 and was paid over to the Kerala State Electricity Board, there was a definite ascertained obligation which dates back to the date of taking over and is a permissible deduction. Reliance was placed on the decision of the Punjab and Haryana High Court in Ambala Cantt. Electric Supply Corporation Ltd. Vs. Commissioner of Income Tax, . The Tribunal held that the Kerala State Electricity Board exercised its option to purchase the assessee''s undertaking on 7-3-1979. The assessee-company gave notice soon thereafter to its employees that their services would not be required after the undertaking vested in the Board and the undertaking ultimately vested in the Board on 3-12-1970 and from those facts it is clear that during the continuation of the business, but before the transfer, the assessee issued notices of termination to the workmen and by issuing such notices, the assessee created a liability, which is a legitimate liability, which had accrued during the accounting period relevant to the assessment year in question. The amount so expended by the assessee by way of retrenchment compensation will be covered by section 37, and so a permissible deduction. The Tribunal also concurred with the view of the Commissioner (Appeals) that the retrenchment compensation is deductible from the capital gains as a charge on the amount of compensation. Emphasis was laid on the fact that the assessee did not get the benefit of the amount that was required to be paid over to the Board towards the retrenchment compensation, that the notice of retrenchment was given by the assessee in the relevant year of account soon after the notice exercising the option was given by the Board on 7-3-1969 and the liability accrued in the course of the business and the termination of the services of the workmen was well before the undertaking was taken over by the Board. The Tribunal distinguished the decision of the Supreme Court in Commissioner of Income Tax, Kerala Vs. Gemini Cashew Sales Corporation, Quilon, in the light of the above distinguishing factors. The counsel for the revenue contended that there is no liability for the assessee u/s 25FF and so the amount cannot be claimed at all as a payment made for retrenchment compensation. The counsel for the revenue further contended that the deduction can be claimed only for the purpose of a business, which was being carried on. Having bestowed our anxious consideration to the rival pleas put forward before us, we are satisfied that the Tribunal was justified in placing emphasis on the fact that the termination of the services of the workmen in this case was well before the undertaking was taken over by the Kerala State Electricity Board and so the liability for gratuity cannot be said to have sprung up from the cessation of its business. In this view, the decision of the Supreme Court in CIT v. Gemini Cashew Sales Corpn.''s case (supra) is distinguishable. Moreover, it is evident from the memorandum of settlement referred to in paragraph 15 of the appellate order that the assessee was required to pay over to the Board the amount towards retrenchment compensation and it should be borne in mind that the liability to pay the said compensation had accrued or arose immediately after the notice of retrenchment was given by the assessee in the relevant year of account, soon after the notice, exercising the option, was given by the Board on 7-3-1969. The expenditure was incurred in the course of the business. The liability was fastened on the assessee as a result of the notice of retrenchment given by it, soon after the Board exercised its option on 7-3-1969. The amount was quantified in the tripartite settlement dated 27-12-1972 and paid over to the Board. On these premises, and in view of the fact that the liability to pay the compensation arose when the business was a going concern, the conclusion of the Appellate Tribunal based on the decision of the Punjab and Haryana High Court in Ambala Cantt. Electric Supply Corporation Ltd.''s case (supra) that the amount of retrenchment compensation will be covered by section 37 of the income tax Act, is justified in law. It cannot be said that the Tribunal was wrong when it held that alternatively the retrenchment compensation is deductible from the capital gains as a charge on the amount of compensation. That is only an alternative finding concurring with the conclusion of the Commissioner (Appeals). We are, therefore, of the view, that the Tribunal was justified in law in holding that the relief by way of deduction for retrenchment compensation, claimed by the assessee, is permissible u/s 37. Alternatively, and in any view of the matter, the concurrent finding arrived at by the Commissioner (Appeals) and the Tribunal, that the retrenchment compensation is deductible from the capital gains as a charge on the amount of compensation, cannot be said to be erroneous on the facts of this case and in the light of the decisions adverted to by the Tribunal. We, therefore, answer question Nos. 1 and 2 referred to this Court in. IT Reference No. 117 of 1987 in the affirmative, against the revenue and in favour of the assessee. Both the references are answered as above.