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Issues Involved:
1. Justification of the Tribunal's decision to allow the claim of gratuity under section 37 or section 28(i) of the Income-tax Act, 1961. 2. Applicability of section 40A(7)(a) of the Income-tax Act, 1961, to the assessee's claim of gratuity. Issue-wise Detailed Analysis: 1. Justification of the Tribunal's Decision to Allow the Claim of Gratuity under Section 37 or Section 28(i) of the Income-tax Act, 1961: The Tribunal allowed the assessee's claim for gratuity on the basis that the assessee maintained its accounts on a mercantile basis, and the statutory liability for gratuity accrued in the relevant previous year under the Payment of Gratuity Act, 1972. The Tribunal held that the liability for gratuity was deductible as business expenditure in the computation of income from business, either under section 37 or section 28(i). It reasoned that the real profits from the business could not be determined without accounting for this liability. The Tribunal also concluded that the deduction was admissible on ordinary commercial principles. However, the court analyzed sections 28, 36(1)(v), 37, and 40A(7) of the Income-tax Act, 1961, and concluded that the Tribunal's decision was incorrect. Section 40A(1) has an overriding effect over other provisions of the Act, and section 40A(7) specifically disallows any deduction in respect of any provision made by the assessee for the payment of gratuity to employees on their retirement or termination, except under certain conditions. The court cited the apex court's decision in Shree Sajjan Mills Ltd. v. CIT [1985] 156 ITR 585, which clarified that contingent liabilities do not constitute expenditure and cannot be deducted even under the mercantile system of accounting. The court held that the Tribunal's interpretation would lead to an absurd result and was not sustainable. 2. Applicability of Section 40A(7)(a) of the Income-tax Act, 1961, to the Assessee's Claim of Gratuity: The Tribunal held that the assessee's claim for gratuity was not hit by section 40A(7)(a) because no provision was made in the books for this liability. However, the court disagreed, emphasizing that section 40A(7) was inserted by the Finance Act of 1975 with retrospective effect from April 1, 1973, and has an overriding effect over other provisions of the Act. Section 40A(7)(a) disallows any deduction for provisions made for the payment of gratuity, except under the conditions specified in clause (b). The court noted that the assessee did not fulfill these conditions, such as creating an approved gratuity fund or making contributions towards it. The court also referenced decisions from other High Courts, such as the Madhya Pradesh High Court in Jiwajirao Sugar Co. Ltd. v. CIT [1985] 144 ITR 729, the Kerala High Court in CIT v. N. Radha Bai [1989] 180 ITR 429, and the Calcutta High Court in CIT v. New Swadeshi Mills of Ahmedabad Ltd. [1984] 147 ITR 163, which supported the view that the conditions laid down in section 40A must be met to claim a deduction for gratuity payments. Therefore, the court concluded that the Tribunal was not justified in holding that the assessee's claim for gratuity was allowable under section 37 or section 28(i) of the Income-tax Act, 1961, and that the claim was not hit by section 40A(7)(a). Conclusion: The court answered the reference in favor of the Revenue and against the assessee, holding that the Tribunal was not justified in allowing the claim of gratuity under section 37 or section 28(i) and that the claim was indeed hit by section 40A(7)(a) of the Income-tax Act, 1961. No order as to costs was made.
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