The Commissioner of Income Tax vs The Pathinen Grama Arya Vysya Bank Ltd.

Ismail, J.—The income tax Appellate Tribunal, Madras Bench, u/s 256(1) of the Income-fax Act, 1961, has referred to this Court two questions of law for its opinion, namely.

(1) Whether the Appellate Tribunal was right in law in holding that the loss of Rs. 16,096 incurred w the process of the transfer of securities in favour of Karur Vysya Bank Limited, was admissible?

(2) Whether the Appellate Tribunal was right in law in holding that the sum to the extent of Rs. 18,931 which formed part of the total sum transferred by the Assessee to the Karur Vysya Bank Limited, by way of gratuity to the employees for the services rendered to it was admissible as a deduction?

(2) One of the businesses of the Assessee was banking business. The Assessee transferred its banking business to the Karur Vysya Bank Limited, under a series of agreements entered into between the two. Actually the transfer took place on 14th December 1964. One of the agreements entered into between the two parties which is relevant and which is Annexure "E" to the statement of the case is the agreement, dated 11th April 1964. That agreement among others provided for the valuation of the various items of assets and liabilities of the Assessee to be taken over by the Karur Vysya Bank Limited, in the process of taking over the banking business of the Assessee. Clause 2 of this agreement refers to the Assessee bank''s buildings at Main Road, Batlagundu and at North Street, Ramnad Fort, Ramnad, and fixed their value at Rs. 25,000 each. Clause 3 refers to the furniture and fixtures of the Assessee and fixes their aggregate value at Rs. 60,000, based on the current market value. Clause 4 states:

The transferor bank (Assessee) shall transfer and the transferee bank (Karur Vysya Bank Limited), shall take over from the transferor bank the liabilities and assets as described in schedules '' A'' and '' B'' respectively as on 3rd April 1964 subject to the variations on the date of actual transfer.

Schedule ''A'' to the said agreement deals with the liabilities as on 3rd April 1964. Equally schedule '' B '' to the said agreement deals with the assets as on 3rd April 1964. With reference to the first question extracted above, we are concerned with Government securities forming part of the assets in schedule '' B '' to the agreement referred to above. Schedule ''13 '' gives the book value of the Government securities as Rs. 10,43,476.13 and the market value as Rs. 10,33,195.85. At the same time, the agreement also provides that the said securities shall be taken over by the transferee bank at market rate on the date of the transfer. In the present case the market rate as on 14th December 1964, the date of the transfer of the said securities, was Rs. 10,14,337 which was less than the cost of the Government securities and therefore, there was a loss of Rs. 16,096 suffered by the Assessee in respect of the transfer of such securities. The Income Tax Officer in his assessment order look the view that the said loss was of a capital nature and therefore was not allowed as a deduction. On appeal preferred to the Appellate Assistant Commissioner, the Appellate Assistant Commissioner disposed of the appeal summarily by stating:

The securities of the Appellant bank was valued at market value when it was taken over as a going concern by the Karur Vysya Bank. There is no sale of the securities as such or consequent: loss. Notional loss on re-valuation is only a loss in the process of taking over and therefore cannot be allowed as a revenue loss.

In the result the Appellate Assistant Commissioner confirmed the conclusion of the income tax Officer, However, on further appeal preferred by the Assessee, the income tax Appellate Tribunal (sic) the contention of the Assessee. The Tribunal pointed out:

It is common ground, however, that the method of accounting adopted by the Assessee over the years is the mercantile system. It was also accepted by both the sides before us that the Government securities formed part of the stock-in-trade of the Assessee and that the method followed by the Assessee was to enter the valuation of the securities at the end of each accounting year at cost. Further it was accepted by both sides that when the securities were sold, the resultant profits or losses were arrived at with reference to cost of the securities.

It is against the background of this admitted position that the Tribunal held that the securities were sold to Karur Vysya Bank Limited, and that the loss sustained as a result of such sale should be deducted from the profits of the Assessee. The Tribunal also pointed out that the taxing authorities have included in the income from business, profits referable to the provision of Section 41(2) arising from the transfers of immovable properties and furniture and that that could be so only if there was a transaction of sale. It is the correctness of this conclusion of the Tribunal that is challenged before this Court in the form of the first question extracted already.

The learned Standing Counsel for the Department contended that even if the loss is not a capital loss and is a revenue loss, still every revenue toss cannot be allowed as a deduction and only a revenue loss incurred in the carrying on of the business can be allowed as a deduction and that in the present case the revenue loss is not deductible. We are of the opinion that this contention is not well-founded. We have referred to the agreement entered into between the parties for the purpose of showing that each and every one of the items of the assets and liabilities of the Assessee was separately valued and was sold separately, though in the course of transfer of business to the Karur Vysya Bank Limited. To such a situation, the principle that the revenue loss arising in the course of winding up of the business cannot be allowed as a deduction will not apply. The learned Counsel also invited our attention to two decisions of the Supreme Court, namely COMMISSIONER OF Income Tax, KERALA Vs. WEST COAST CHEMICALS AND INDUSTRIES LTD. (IN LIQUIDATION)., . and Commissioner of Income Tax (Central), Calcutta Vs. Mugneeram Bangur and Co. (Land Department), . In the former case, the Assessee company entered into an agreement for the sale of the lands, buildings, plant and machinery of a match factory belonging to it for a total sum of Rs. 5,75,000 with a view to close down the business.

The purchaser made default in payment and subsequently a fresh agreement was entered into between the parties for the sale of the properties mentioned in the first agreement and also chemicals and paper used for manufacture which had not been included in the first agreement. As the memorandum of association of the Assessee company allowed the Assessee to manufacture and sell chemicals, and even after the sale the company carried on manufacture on behalf of the purchaser, the department sought to assess the profit derived from the sale of the chemicals and paper as profits from business. The Assessee contended that it was a realisation sale and that this amount was not liable to tax. The Supreme Court held that the question whether a sale was a realisation sale or a sale in the course of business is not easy to decide and depends upon the facts; that on the facts of that case, the sale of the chemicals and materials used in the manufacture of matches was only a winding up sale to close down the business and to realise all the assets and that the fact that the memorandum gave power to the company to sell chemicals was not of much significance, especially as that power was rarely exercised. It also further held that the fact that the business of the company was sold as a going concern and was in fact worked by the Assessee on behalf of the buyer till the entire consideration was paid made no difference, as the agreement clearly indicated that the Assessee was keeping the factory going, not on his own behalf but entirely on behalf of the buyer. In the second case, a firm which carried on the business of buying land, developing it and then selling it, pursuant to an agreement sold the business as a going concern with its goodwill and all stock-in-trade, etc., to a company promoted by the partners of the firm, the company undertaking to discharge all debts and liabilities, development expenses, and liability, in respect of deposits made by intending purchasers. The consideration of Rs. 34,99,300 was paid by the allotment of share of face value of Rs. 34,99,300 to the partners or their nominees. The schedule to the agreement indicated that the sum of Rs. 34,99,300 was arrived at by valuing the land, goodwill, motor car and lorries and other items of assets at separate figures, the value of all of which totalled Rs. 34,99,300. With reference to those facts, the Supreme Court held that the sale was the sale of a whole concern and no part of the price was attributable to the cost of the land and no part of the price was taxable, that the fact that in the schedule to the agreement the price of the land was stated did not lead to the conclusion that part of the slump price was necessarily attributable to the land sold, that what was given in the schedule was the cost price of the land as it stood in the books of the vendor and that even if the sum of Rs. 2,50,000 attributable to goodwill could be added to the cost of the land, there was nothing to show that (sic) represented the market value of the land. For coming to this conclusion, the Supreme Court relied on its earlier decision in COMMISSIONER OF Income Tax, KERALA Vs. WEST COAST CHEMICALS AND INDUSTRIES LTD. (IN LIQUIDATION)., already referred to and the decision of the Judicial Committee in (sic) v. Commr. of Taxes (1927) A.C. 327.

However, the Supreme Court distinguished the above cases in Associated Clothiers Ltd. Vs. Commissioner of Income Tax Calcutta, . In that case the Appellant company was registered in the name of Phelps and Company Limited, to carry on the business of clothiers and tailors. By an order u/s 11(4) of the Companies Act, 1913, the name of the Appellant-company was altered to Associated Clothiers Limited, on March 21, 1952. On the same day another company was incorporated in the name of Phelps and Company Limited, and by a written agreement of the same date the Appellant-company, viz., Associated Clothiers Limited, agreed to transfer its assets and liabilities to the new company, namely, Phelps and Company Limited, in consideration of the allotment of shares and some cash, the latter taking over the liabilities of the Appellant-company. Under the terms of the agreement, the Appellant-company purported to transfer seven items of property described in the schedules annexed to the deed. No deed of conveyance was executed. On July 1, 1952, the new company took possession of the properties agreed to be sold. In the agreement the properties sold were allotted specific values and no attempt was made to prove that the values so allotted were not true. The consideration for a building transferred was in excess of its original cost and the question was whether the difference between the original cost of the building and its written down value would be deemed profit under the second proviso to Section 10(2)(vii) of the Indian income tax Act, 1922. The Supreme Court held that, as the Appellant-company sold the property for a stated consideration which was not shown to be national and that consideration was in excess of the original cost of the building, the difference between its original cost and its written down value was profit within the meaning of the second proviso to Section 10(2)(vii). While coming to this conclusion, the Supreme Court distinguished its decision in the earlier case, namely, Commissioner of Income Tax (Central), Calcutta Vs. Mugneeram Bangur and Co. (Land Department), and the decision (1) Commissioner of Income Tax (Central), Calcutta Vs. Mugneeram Bangur and Co. (Land Department), . of the Judicial Committee in Doughty v. Commr. of Taxes (1927) A.C. 327 already referred to. The Supreme Court observed:

It was also said that the transfer was a slump sale of the assets and there being no separate sale of the property described in the second schedule, the difference between the written down value and the cost price was not liable to be included as income in the process of assessment. Reliance in this behalf was placed upon the observations of the Judicial Committee of the Privy Council in Doughty v. Commissioner of Taxes (1927) A.C. 327. In that case two partners carrying on business as general merchants and drapers sold the entire assets and goodwill of the partnership business to a limited company in which they became the only shareholders. The nominal value of the shares being more than ''be sum to the credit of the capital account of the partnership in its last balance-sheet, a new balance-sheet was prepared showing a larger value for the stock-in-trade. The Commissioner of Taxes treated the increase in value so shown as a profit on the sale of the stock-in-trade, and assessed the Appellant upon it for income tax. The Judicial Committee held that the assessment was wrongly made since if the transaction was to be treated as a sale there was no separate sale of the stock, and no valuation of it as an item forming part of the aggregate sold. This Court has affirmed the principle in Doughty''s case (1927) A.C. 327 in a recent judgment : Commissioner of Income Tax (Central), Calcutta Vs. Mugneeram Bangur and Co. (Land Department), . That principle has however no application here. In the present case it is true that the entire assets of the Appellant-company were sold to Messrs. Phelps & Co. Ltd.

There was no separate sale of different items, but the consideration of each item of property sold was expressly mentioned in the agreement of sale. The contention that the transaction of sale was a mere attempt to readjust the business position of the transferor was never raised before the Tribunal and does not arise out of the order of the Tribunal. We decide this appeal on the narrow ground that the Appellant-company sold the property in the second schedule for a stated consideration which was not shown to be notional, and since the consideration was in excess of the original cost of the building the difference was profit within the meaning of Section 10(2)(vii), second proviso.

We are of the opinion that the principle of this decision applies to the present case. We have already indicated that there was no slump sale of the assets and that each one of the assets was separately valued and sold. We have also pointed out that with reference to certain items of assets the value was fixed as on 3rd April 1964 and with reference to certain other items including the securities the value was to be the market value as on the date of transfer. These facts clearly and indisputably show that there was no slump sale of the assets and that there was sale of particular items of asset for a stated consideration. Consequently applying the aforesaid decision of the Supreme Court, we answer the first question referred to in the affirmative and in favour of the Assessee.

As far as the second question is concerned, in addition to agreements that were entered into between the Assessee-company and Karur Vysya Bank Ltd., there was also an agreement to which the staff association of the Assessee was also a party. The terms of that agreement provided for the transferee Bank employing all the employees of the transferor Bank who have not completed the age of 60, on the basis of a fresh contract, but on the same terms and conditions as to remuneration and security of tenure as the employees were then enjoying under the transferor bank, as employees of the transferee bank. However, in the transferor bank, there was a provision for payment of gratuity to the employees on (sic) With reference to this provision, the Assessee transferred a sum of Rs. 30,790 to the Karur Vysya Bank as being gratuity payable to the employees who were taken over by the said bank. This amount, the Assessee claimed as deductible u/s 37 of the income tax Act, 1961. The income tax Officer and the Appellate Assistant Commissioner rejected the claim of the Assessee, while the Appellate Tribunal sustained the claim of the Assessee to the extent of Rs. 18,931. For so sustaining, the Tribunal relied upon two circumstances. The first circumstance is that under the agreement entered into between the Assessee and its employees, gratuity was payable only for the period of service upto 30th June 1962. The second is that the Assessee had obtained acquittance from each of its employees for the amount of gratuity only to the extent of Rs. 18,931 and did not do so for the balance. It is on this basis that the Tribunal allowed a sum of Rs. 18,931, as a deduction. It is the correctness of this conclusion of the Tribunal that is challenged in the form of the second question referred to above.

We are of the opinion that the Tribunal was in error in holding that the said sum constituted an allowable deduction. The Supreme Court in Commissioner of Income Tax, Kerala Vs. Gemini Cashew Sales Corporation, Quilon, had occasion to consider the claim of payment of retrenchment compensation in similar circumstances. In that case, upon the dissolution of a firm constituted of two partners, by the death of one of them on August 24, 1957, its business was taken over and continued by the surviving partner on his own account, without any interruption in the services of the employees or alteration in the terms of their employment. In settling the accounts of the firm as on August 24, 1957, a sum of Rs. 1,41,506 was taken into account as retrenchment compensation payable to the employees u/s 25-FF of the Industrial Disputes Act, 1947, which would arise on transfer of ownership. The question was whether the sum of Rs. 1,41,506 constituted an allowable expenditure in computing the income of the firm for the assessment year 1958-59. While holding that the said amount would not constitute in allowable deduction, the Supreme Court observed:

Normally the liability which occurs after the last date, unless its source is in a pre-existing definite obligation, cannot be regarded as a part of the outgoing of the business debitable in the profit and loss account. A deduction which is proper and necessary for ascertaining the balance of profits and gains of the business is undoubtedly properly allowable, but where a liability to make a payment arises not in the course of the business, not for the purpose of carrying on the business, but springs from the transfer of the business, it is not, in our judgment, a properly debitable item in its profit and loss account as a revenue outgoing. The claim of the firm to treat it as an item in the determination of the profits of the firm u/s 10(1) of the income tax Act cannot, therefore, be sustained.

u/s 10(2)(xv) of the Indian income tax Act in the computation of taxable profits (omitting parts of the clause not material) any expenditure laid out or expended wholly and exclusively for the put pose of such business, profession or vocation, i.e., business, profession or vocation carried on by the Assessee, is a permissible allowance. But to be a permissible allowance the expenditure must be for the purpose of carrying on the business. Where accounts are maintained on the mercantile system, if liability to make the payment has arisen during the time the business is carried on, it may appropriately be regarded as expenditure. But where the liability is, during the whole of the period that the business is carried on, wholly contingent and does not raise any definite obligation during the time that the business is carried on, it cannot fall within the expression expenditure laid out or expended wholly and exclusively for the purpose of the business.

We are of the opinion that the above principle laid down by the Supreme Court applies to the case of payment of gratuity to the employees of an Assessee whose business has been transferred to another and where the transferee takes over the employees with the benefit of continuity of service. As a matter of fact, the principle of this decision was applied to a case of payment of gratuity by this Court in Stanes Motors (South India) Ltd. Vs. Commissioner of Income Tax, . In that case, during the assessment year 1963-64 a new company was formed to take over the retreading division of the Assessee-company. The new subsidiary company took over all the employees of the Assessee-company working in the said division. At the time of formation of the new company gratuity payable to the transferred employees was calculated on the basis of the rules of the Assessee-company to be Rs. 56,275. This amount was transferred to the new company from the pension and gratuity reserve of the Assessee-company. The claim of the Assessee that the amount was paid in discharge of its liability for gratuity to the employees transferred to the new company and, hence an allowable deduction u/s 37 of the income tax Act, 1961, was negatived by the officer in the view that no payment having been made to any employee, the amount had merely changed hands from the Assessee-company to the new company and, hence, it amounted only to a transfer and not an expenditure. The Appellate Assistant Commissioner also confirmed the disallowance. The Tribunal, however, allowed the claim in the view that the amount had been paid in discharge of the Assessee''s obligation to its workmen and payment to the new company on behalf of the employees. On a reference to this Court, this Court held that the Tribunal was not right in holding that the amount was deductible. Of course there are a few points of difference between the facts of that case and the facts of the present case. In that case the amount was paid by the transferor company to the transferee company. Here also the amount was paid by the transferor bank to the transferee bank, but with a difference, namely, the transfer bank had obtained acquittance from each one of the employees in respect of the amount payable to him. From that it may be inferred that the transferor bank had paid the amount to the employees and the employees in their turn deposited the money with the new bank, namely, the transferee bank in consideration of the transferee bank taking them over and treating them to be in continuous service with the benefit of their service in the transferor bank. However, one crucial thing to be noticed is that this expenditure was not incurred during the course of carrying on the business or for the purpose of carrying on the business. The obligation of the Assessee-bank to pay gratuity to its employees was at the time of the retirement of the employees concerned. We are assuming for the purpose of the present case that when the Assessee-bank transferred a part of its business and thereby it compelled the employees to retire from its business, the gratuity was payable to them. Still the obligation to pay the gratuity arises only by virtue of transfer of the business and as a matter of fact, the transfer of the business and the obligation to pay the'' gratuity are contemporaneous or simultaneous. Therefore, the payment of gratuity cannot be said to be an item of expenditure incurred in the course of carrying on the business or for the purpose of carrying on the business. In this context, the following observations of this Court in the decision referred to above, namely, Stanes Motors (South India) Ltd. Vs. Commissioner of Income Tax, . Madras are apposite:

As already pointed out the liability to make payment to the employees had not arisen during the accounting period. The liability if at all was wholly contingent. The transfer of gratuity reserve from the Assessee-company to the new company did not also arise in the course of the business or for the purpose of carrying on the business, but springs from the transfer of business. Therefore, it cannot be said that the expenditure was laid out or expended wholly or exclusively for the purpose of business or it was a properly debitable item in its profit and loss account as a revenue outgoing. Consequently, in the light of the decision of the Supreme Court as well as this Court referred to above, it follows that the conclusion of the Tribunal that the sum of Rs. 18,931 being the gratuity transferred by the Assessee-bank to the Karur Vysya Bank was a deductible item of expenditure is erroneous in law. Hence, we answer the second question in the negative and against the Assessee.

Since the parties have succeeded and lost in part, there will be no order as to costs.