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Judgment
N.V. Balasubramanian, J.—These appeals arise out of the order of the Income Tax Appellate Tribunal (hereinafter referred to as the
''Tribunal'') in I.T.A. Nos. 1092/Mds/1991 and 2402/Mds/1991 dated 14.8.2001 in respect of two assessment years, 1988-89 and 1989-90 of
the assessee.
The point that arises in both the appeals is common regarding the claim of the assessee for deduction of certain amounts of payments of gratuity
to the workers whose services were taken over by the assessee for the period of service rendered by them to the transferor company in a take
over bid. The appellant (hereinafter referred to as the ""assessee"") is Sree Akilandeswari Mills Private Limited and it is a wholly owned subsidiary
company of Sree Rajendra Mills Limited. On 25.3.1983, an agreement was entered into between Sree Rajendra Mills Limited and the assessee,
which is a subsidiary of Sree Rajendra Mills Limited, by which the textile unit at Salem called ""A"" unit belonging to Sree Rajendra Mills was
trasnferred to the assessee. The agreement provided, inter alia, for continuity of service of workmen who were employed in the textile unit of Sree
Rajendra Mills at Salem taken over by the assessee company and the agreement also protected the conditions of service of workmen taken over
by the assessee. Sree Rajendra Mills Limited delivered possession of the scheduled properties to the assessee company on 22.11.1982 and the
employees of Sree Rajendra Mills working in ""A"" unit were transferred to the assessee company with the benefit of continuity of service. In the
assessment proceedings for the assessment year 1988-89, the assessee company claimed a deduction of a sum of Rs. 7,96,121/- as gratuity
payment to workers who had retired during the previous year. The Assessing Officer held that the gratuity payments made to the employees who
were employed in the service of the assessee company for less than five years from the date of take over of the ""A"" unit of Sree Rajendra Mills
Limited were not eligible for deduction, and so also, the assessee company was not entitled to claim deduction of the proportionate payment of
gratuity paid to the employees with reference to their period of service rendered to the transferor company. The Assessing Officer, in other words,
held that the liability towards the payment of gratuity relating to the years of service rendered by the employees in Sree Rajendra Mills Limited
prior to take over by the assessee was not allowable as business expenditure in the hands of the assessee and he held that the assessee would be
entitled to claim only a deduction of a sum of Rs. 1,22,226/- and disallowed the balance sum of Rs. 6,73,895/- and completed the assessment for
the assessment year 1988-89. The assessee carried the matter on appeal before the Appellate Authority and the Commissioner of Income Tax
(Appeals) held that the liability of the assessee towards gratuity paid to the employees for their services rendered to their previous employer
namely, Sree Rajendra Mills Limited would be capital expenditure and not allowable in computing the income of the assessee. He upheld the
disallowance made by the Assessing Officer for the assessment year 1988-89.
As regards the assessment year 1989-90, the assessee claimed deduction of a total sum of Rs. 4,08,378 as gratuity paid to 17 employees , who
retired during the previous year. The Assessing Officer, following his earlier order, held that the liability of the assessee to the workmen for the
gratuity subsequent to the period after take over of the unit of Sree Rajendra Mills Limited would be allowable as business expenditure, but the
payment of gratuity relating to the period of service prior to the transfer of the unit was not allowable. He held that the assessee was entilted to
claim deduction of a sum of Rs. 71, 848/- and allowed the same and disallowed the balance sum of Rs. 3,36,530/- and completed the assessment.
The Commissioner of Income Tax (Appeals), on appeal, by the assessee held that the assessee was entitled to claim full deduction following an
earlier order of the Commissioner of Income Tax (Appeals) for the assessment year 1988-89. Hence, the Revenue preferred an appeal before the
Income Tax Appellate Tribunal. The appeal preferred by the Revenue and the appeal preferred by the assessee were heard together and the
Appellate Tribunal held that the Commissioner of Income Tax (Appeals) was justified in holding that the liability of the assessee towards gratuity
payment for the employees for the services rendered by them for the period prior to the take over of the unit would be capital expenditure and was
not an allowable expenditure in the hands of the assessee. The Tribunal dismissed the appeal preferred by the assessee for the assessment year
1988-89 ad allowed the appeal preferred by the Revenue for the assessment year 1989-90. It is against the common order by the Tribunal, the
assessee has preferred the two appeals.
The appeals were admitted and the following question of law was framed for consideration:
Whether on the facts and circumstances of the case, the Tribunal was right in confirming the disallowance of gratuity paid to the retiring
employees?
Heard Mr.P.P.S. Janardhana Raja, learned counsel for the appellant and Mr.K. Subramaniam, learned senior Standing counsel for the
Revenue.
Mr. Janardhana Raja, learned counsel for the assessee submitted that services of the workmen employed in the textile unit of the predecessor
company were continued with the assessee with no break in service and the existing service conditions of the workmen were also protected. The
assessee, when the liability to pay gratuity to the workmen arose at the time of superannuation or death, has discharged the liability to its employees
and no distinction can be made between service rendered prior to the take over and the services rendered by the employees after the take over of
the unit by the assessee. The learned counsel also submitted that the holding company, Sree Rajendra Mills Limited has not claimed any deduction
towars its gratuity liability in its assessment. Learned counsel further submitted that the Tribunal had proceeded on an erroneous assumption that
the amount paid towards gratuity was part of the sale consideration paid by the assessee to Sree Rajendra Mills Limited. He also referred to the
schedules to the agreement and submitted that there is nothing in the agreement, either expressly or impliedly, to indicate that the amounts paid to
the employees formed part of the sale consideration paid to Sree Rajendra Mills Limited and hence, the Tribunal was not correct in holding that it
is not allowable as a business deduction. Learned counsel strongly relied on the decision of this Court in Commissioner of Income Tax Vs. Fenner
(India) Ltd., (one of us was a party) and submitted that when the amalgamated company took over the employees of amalgamating company, the
gratuity paid to the employees, who were taken over, was held to be deductible expenditure and he submitted that the ratio of the decision of this
Court in Fenner (India) Limited would squarely apply to the facts of the case. Learned counsel also relied on a decision of this Court in
Commissioner of Income Tax Vs. Pandian Roadways Corporation Ltd., wherein the claim of gratuity paid to the employees, who were taken over
by the Transport Corporation, was held to be an allowable expenditure. Learned counsel, therefore, submitted that on the basis of the decisions of
this Court, the Tribunal was not correct in holding the amount paid to the employees towards gratuity is not an allowable expenditure. Learned
counsel also submitted that the Commissioner of Income Tax (Appeals) allowed the claim of the assessee for the assessment year 1987-88 which
was confirmed by the Tribunal, and the order of Appellate Tribunal for the earlier year has been accepted by the Revenue and therefore, the
amounts claimed for both the assessment years in question are not capital expenditure, but allowable as business expenditure.
Mr. K. Subramaniam, learned senior Standing counsel appearing for the Revenue, on the other hand, submitted that the amount paid by the
assessee to the employees for the service rendered prior to the take over of the textile unit by the assessee is a capital expenditure and he referred
to the terms of the agreement and submitted that the amounts paid to the employees for the period prior to the take over formed part of the sale
consideration and hence, it is capital in nature. Learned counsel relied on the following decisions in support of his submissions:
(i) Associated Printers (Madras) Private Ltd. Vs. Commissioner of Income Tax, Madras,
(ii) Dashmesh Transport Co. (P.) Ltd. Vs. Commissioner of Income Tax,
(iii)Commissioner of Income Tax v. Dutta Tin Works P. Ltd. 172 ITR 667
(iv) Puspa Perfumery Products Pvt. Ltd. Vs. Commissioner of Income Tax,
(v) Hotel Broadway Complex, Bangalore Vs. Commissioner of Income Tax,
(vi) Commissioner of Income Tax Vs. Plasmac Machine Mfg. Co. Ltd.,
(vii) Commissioner of Income Tax Vs. Hyderabad Race Club,
(viii) Commissioner of Income Tax Vs. Hooghly Mills Co. Ltd.,
We carefully considered the submissions of the learned counsel for the assessee and the learned counsel for the Revenue. As far as the gratuity
liability is concerned, the obligation to pay gratuity on the part of the assessee to all its employees for the service rendered in a particular year is a
definite and ascertainable liability on the basis of acturial valuation. In Metal Box Company of India Ltd. Vs. Their Workmen, , the Supreme Court
considered the question whether, while working out the net profit by a trader, can he provide from his gross receipts, his liability to pay certain sum
for every additional year of service towards gratuity, which he received from his employees and the Supreme Court held as hereunder:
...In our view, an estimated liability under gratuity schemes such as the ones before us, even if it amounts to a contingent liability and it not a debt
under the Wealth-tax Act, if properly ascertainable and its present value is fairly discounted is deductible from the gross receipts while preparing
the P. & L. Account. It is recognised in trading circles and we find no rule or direction in the Bonus Act which prohibits such a practice.
We hold that the liability to pay gratuity to the workmen of the transferor company on the date of transfer of the unit is a known and an
ascertained liability on the date of transfer and is ascertainable on the basis of acturial valuation.
The next question that arises is whether the expenditure is an allowable business expenditure or capital expenditure. It is fairly settled that if an
ascertained liability of the predecessor on the date of transfer was taken over by the successor in business, and later it was discharged, the
expenditure incurred would be capital in nature. This Court, in Associated Printers (Madras) Private Ltd. Vs. Commissioner of Income Tax,
Madras, has dealt with a case where a running business was taken over by the transferee and the transferee discharged its liability to pay bonus
under the award and it was held, on the facts of the case, that the payment of bonus was an expenditure incurred for business purpose as the
liability accrued after the date of transfer of the business. This Court, while so holding, held that if the transferor''s liability was an ascertained one
on the date of transfer and it was an accrued liability on the date of transfer which was taken into account in reckoning the payment of
consideration, the liability discharged later by the transferee would be capital in nature. In the aforesaid decision, this Court held as hereunder:-
...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 expended 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...
The Punjab and Haryana High Court in Dashmesh Transport Co. (P.) Ltd. Vs. Commissioner of Income Tax, , while considering the case of
discharge of liability of the transferor company taken over by the transferee, held as follows:
...Although the terms and conditions of the transfer had not been proved on the record but it is evidence from Article 18 of the articles of
association of the assessee-company that it had taken over all the assets and liabilities of the transferor-company. The conclusion is, therefore,
irresistible that the liabilities of the said company form part of the consideration for the acquisition of group ''A'' transport of the transferor-
company. The Tribunal, therefore, rightly came to the conclusion that the expenditure of Rs. 2,77,630/- representing the liability of Khalsa Nirbhai
Transport Company (P.) Ltd. And discharged by the assessee, was in the nature of capital expenditure...
The Kerala High Court in Commissioner of Income Tax v. Dutta Tin Works P. Ltd.172 ITR 667 and the Calcutta High Court in Puspa
Perfumery Products Pvt. Ltd. Vs. Commissioner of Income Tax, and the Karnataka High Court in Hotel Broadway Complex, Bangalore Vs.
Commissioner of Income Tax, and the Bombay High Court in Commissioner of Income Tax Vs. Plasmac Machine Mfg. Co. Ltd., and the Andhra
Pradesh High Court in Commissioner of Income Tax Vs. Hyderabad Race Club, have all taken the view that if the liability of the predecessor was
taken over by the successor, then it would form part of the purchase consideration and the expenditure incurred subsequently by the transferee to
discharge that liability would be capital in nature and the assessee is not entitled to claim deduction.
The Calcutta High Court in Commissioner of Income Tax Vs. Hooghly Mills Co. Ltd., , while considering the case of liability of gratuity taken
over by the assessee from the transferor when the business was taken over as a going concern, held that the gratuity liability till the date of transfer
taken over by the assessee would be capital in nature and it would form part of the sale consideration and it has to be added to the cost of
acquisition of the assets transferred. The Calcutta High Court held as under:
In terms of Section 4(1) of Payment of Gratuity Act, the liability of the employer to pay gratuity to its employees accrues as soon as the
concerned employee completes five years'' continuous service, from the date the service is reckoned to be continuous, though payable on
superannuation or retirement or resignation or death of disablement due to accident or disease. Sub-section (2) prescribes fifteen days'' wages
based on the rate of wages last drawn by the employee for every completed year of service or part thereof in excess of six months. Thus, with the
continuation of employment, the gratuity continues to accrue on account of the respective employee. The right to receive gratuity is right vested in
the employee on completion of five years continuous service receivable from the date from which continuous service is reckoned. The employees,
whose service was continuing after the transfer of the undertaking, were entitled to claim gratuity from the transferor on account of cessation of
employment under him. But for their continuation under the assessee, it was not payable till the occurrence of any of the conditions mentioned in
Sections 4(1)(a), (b) and (c) of the Payment of Gratuity Act. The payment of gratuity to these employees till the date of transfer was deferred by
reason of the terms of the agreement and the liability accrued till that date and payable by the transferor was taken over by the assessee. Thus, this
liability became part of the consideration paid for the assets transferred and is liable to be added to the consideration mentioned in the agreement.
It cannot be construed otherwise. This is to be treated as capital expenditure.
The next question that arises is whether the Tribunal was correct in holding that the liability to pay gratuity was part of the consideration. We
have perused the memorandum of transfer dated 25.3.1983. It is seen from the agreement that on the date of transfer, the holding company Sree
Rajendra Mills Limited transferred the ""A"" unit with all the assets and liabilities for a consideration of Rs. 10 lakhs. Mr. K. Subramaniam, learned
senior Standing counsel for the Revenue pointed out the total value of the assets and the total liability taken over and submitted that the gratuity
liability of the tranferor company, Sree Rajendra Mills Limited on the date of transfer was also part of the sale consideration. We find force in the
submission of Mr. K. Subramaniam, learned senior Standing counsel for the Revenue as it cannot be said that the gratuity liability of the transferor
company towards its employees till the date of the transfer was not a known liability. It is not possible to accept the submission that the assessee
was not aware or oblivious of the gratuity liability of the transferor company towards all its employees taken over by the assessee, and the liability
was not one of the factors reckoned in fixing the price payable by the assessee. The liability to pay gratuity to the employees of the transferor till
the date of transfer is a known liability and it is an ascertained liability. Since the assessee had the requisite knowledge of the gratuity liability of the
transferor company to its employees of the unit transferred on the date of transfer , that liability would not have been ignored by the assessee as a
prudent businessman in the computation of the amount payable by it to the transferor company for the transfer of the unit by the transferor
company. The Karnataka High Court in Hotel Broadway Complex, Bangalore Vs. Commissioner of Income Tax, was considering a similar
question and held as follows:
The existence of arrears of property tax should be presumed to be known to the assess when it was constituted, because any prudent person who
transacts any dealing in relation to an immovable property is expected to verify the tax liability in relation to the said property; arrears of property
tax attach themselves as a burden on the property by operation of law. The nature of property tax is quite different from other taxes like sales tax
or income tax; property tax due to a municipal body is reflected in the municipal property registers. It is not possible to hold that the partners who
joined Ananthasivan should be assumed to be ignorant about property tax arrears. If knowledge of the tax arrears is attributed to them, then,
necessarily the said liability would go into the computation of the firm''s capital. The assessee cannot take advantage of the fact that these were not
reflected in the books of the previous firm, since a prudent businessman is expected to probe into the tax liabilities attached to a business premises.
In these circumstances, the payments made towards property tax arrears cannot be held to be in the nature of non-capital expenditure at all.
We hold that the Tribunal was correct in holding that only after adjusting the liability towards gratuity, the sale consideration of Rs. 10 lakhs was
arrived at. We therefore hold that the assessee by virtue of the deed of transfer had taken over the liability of the transferor company towards its
gratuity liability of the employees of the transferor company on the date of transfer and it was an ascertained liability on the basis of acturial
valuation and the liability which formed part of the sale consideration was discharged later by actual payment by the assessee to the employees in
subsequent years and it is a capital expenditure.
Mr. P.P.S. Janardhana Raja, learned counsel for the assessee heavily relied upon the decision of this Court in Commissioner of Income Tax
Vs. Fenner (India) Ltd., . It was case of amalgamation of companies and there was a stipulation that the amalgamated company would continue the
employees of the amalgamating company and the gratuity paid to the employees of the amalgamated company by the amalgamating company was
held to be revenue expenditure. We are of the view that this decision does not help the assessee as in that case, the question whether the amount
expended was a capital expenditure or not was not the subject matter of consideration and the only argument that was advanced was that if the
amount is allowed in the hands of the amalgamated company, then it would amount to double deduction as the amalgamating company would have
had the benefit of deduction of the same liability. This Court rejected the said contention, but it had no occasion to go into the question whether it
was a capital expenditure or not as that issue was not posed before this Court and the Court was also not called upon to consider that question.
The other decision relied upon by the learned counsel for the assessee is the decision in Commissioner of Income Tax v. Pandian Roadways
Corporation Limited (cited supra). In that case also, the question whether it was a capital expenditure was not the subject matter of consideration
and hence, that decision also does not aid the assessee in any manner. The reliance placed by the learned counsel for the assessee on the decision
in Commissioner of Income Tax Vs. National Textile Corporation, also does not assist the assessee as the Madhya Pradesh High Court
considered Section 40A(7) of the Income Tax Act and the question whether it was a capital expenditure or not was not the subject matter of
consideration.
Learned counsel for the assessee submitted that the claim of the assessee was upheld by the Appellate Tribunal for the earlier assessent year
1987-88 and hence, the Appellate Tribunal should not have taken a different view for the subsequent assessment years 1988-89 and 1989-90.
We are of the view that there is no question of res judicata, and further the Appellate Tribuanl itself has found that when the order was passed for
the assessment year 1987-88, it had no occasion to go through the agreement under which the transfer took place. On the other hand, the
agreement was placed before the Appellate Tribunal during the course of hearing of the appeals before the Tribunal and the Appellate Tribunal,
after going through the terms of the agreement, held that the amount paid was capital expenditure. Hence, we do not find any infirmity on the part
of the Appellate Tribunal in taking a different view from its earlier view taken for the assessment year 1987-88 and on that account, the order of
the Appellate Tribunal which is subject matter of appeal is not liable to be set aside.
We, therefore, hold that the Tribunal was correct in law in holding that the gratuity paid to the retiring employees for the period of service
rendered to the transferor company is a capital expenditure and was right in upholding the disallowance. The question of law framed by this Court
is answered against the assessee and in favour of the Revenue.
Consequently, the appeals stand dismissed. The Revenue is entitled to costs of Rs. 500/- in respect of each of the appeals.