Provision for estimated service gratuity payable to its employees -Deduction under section 37(1) and section 40A(7) after its insertion by the Finance Act, 1975, with effect from 1-4-1973 - Income Tax - 146/1974

Circular No. 146 Dated 26/9/1974 Provision for estimated service gratuity payable to its employees -Deduction under section 37(1) and section 40A(7) after its insertion by the Finance Act, 1975, with effect from 1-4-1973 clarification 1 In the Board's Circular No. 47, dated 21-9-1970 [ Clarification 2 ]. It was stated that provisions made by an assessee in his accounts on a scientific basis in respect of estimated service gratuity payable to employees would be admissible as deduction under section 37(1). The matter was re-examined by the Board in 1974 and the earlier instructions were withdrawn by the Board's Circular No. 146, dated 26-9-1974 [Clarification 2]. Some of the High Courts have recently taken a view that a provision made by an assessee in his accounts in respect of estimated service gratuity payable to employees will be deductible in computing the taxable income in cases where the provision has been made on a scientific basis in the form of actuarial valuation. In order to remove uncertainty, in the matter, the Finance Act, 1975 has inserted a new sub-section (7) in section 40A which provides that no deduction will be allowed in the computation of taxable profits in respect of mere "provisions" made by employers in their books of account for payment of gratuity to their employees on their retirement or on termination of their employment for any reason. The amendment will not, however, affect provisions made for the purpose of payment of sums by way of contribution towards approved gratuity funds that have become payable during the previous year, or for the purpose of making any payment on account of gratuity to employees where such gratuity has become payable during the previous year and such provisions will continue to be eligible for deduction as hitherto. Circular : No. 169 (para 27), dated 23-6-1975 . clarification 2 1. Attention is invited to the Board's Circular No. 47 [F. No. 9/100/69-IT(A-II), dated September 21, 1970] [Clarification 3] on the above subject. In this circular, the Board had considered the question as to whether provision made by an assessee in its accounts for estimated service gratuity payable to its employees could be allowed as a deduction even though no approved gratuity fund under the provisions of the Income-tax Act had been set up. At the relevant time when this circular was issued, the Supreme Court's decision in the case of Metal Box Co. of India Ltd v. Their Workmen [1969] 73 ITR 53 was available and taking note of certain observations in this particular decision of the Supreme Court, it was felt that provision of gratuity on a scientific basis (in the form of actuarial valuation carried out every year) could be considered to represent a real liability of the employer to the employees. Accordingly, the Board decided that such provision would not be a contingent liability and may be treated as admissible deduction under section 37(1). 2. The decision of the Board has been re-examined in the light of the unreported judgment of the Supreme Court in the case of Bombay Dyeing Manufacturing Co. Ltd. v. CWT [since reported in [1974] 93 ITR 603]. In this judgment, their Lordships have confirmed their own views in Standard Mills Co. Ltd. v. CWT [1967] 63 ITR 470 and have observed that the decision in Metal Box Co.'s case (supra) was rendered under a different Act and in a different context. 3. In view of the later pronouncement of the Supreme Court in the case of Bombay Dyeing and Manufacturing Co. Ltd. (supra) and on the clear provisions of law contained in section 36(1)( v ) under which any sum paid by an employer by way of contribution towards an approved gratuity fund created by him for the exclusive benefit of its employees under an irrevocable trust alone was admissible, any allowance of such liability towards an unapproved gratuity fund under section 37(1) does not arise. In view of this, the earlier instructions of the Board referred to above, stand withdrawn with immediate effect. 4. All pending assessments may be completed in the light of the present instruc-tions. Circular : No. 146 [F. No. 228/2/73-IT(A-II)], dated 26-9-1974 . clarification 3 A question has arisen whether the provision made by an assessee in its accounts on account of the estimated service gratuity payable to the employees can be allowed as a deduction when no gratuity fund has been set up under Part C of the Fourth Schedule to the Income-tax Act. The Board have decided that following the decision of the Supreme Court in the case of Metal Box Co. of India Ltd. v. Their Workmen [1969] 73 ITR 53, the provision of gratuity on a scientific basis (in the form of an actuarial valuation carried out every year) can be considered to represent a real liability of the employer to the employees. The Supreme Court, in the case of Garment Cleaning Works v. Workmen AIR 1962 SC 673, decided that the employer would be required to pay gratuity even to an employee who has been dismissed on account of misconduct. The Board have, therefore, come to the conclusion that the liability so ascertained cannot be considered as a contingent liability. Such provision of gratuity may be treated as an admissible deduction under section 37(1). Circular : No. 47 [F. No. 9/100/69-IT(A-II)], dated 21-9-1970 clarification 4 I am directed to refer to your letter dated 25-1-1971, on the above subject and to say if an assessee decided to start making a provision on gratuity from the current year, then the provision made in respect of the current year only will be allowable as deduction under section 37. The liability for paying gratuity in respect of earlier years will not be allowed as deduction in computing the income for the current year. In the year when the gratuity is actually paid to the employee, the portion of gratuity which is not covered by the annual provisions made in respect of those employees on the basis of actuarial valuation and allowed as deduction in the computation of income, the employer will be allowed as deduction in the year in which the gratuity is paid to the employee. This will, of course, necessitate maintenance of two sets of accounts for the employee— i. gratuity payable to him for the period during which the provision for gratuity was not allowed as deduction in computing the income of the employer; and ii. gratuity payable to the employee on the basis of actuarial valuation made from year to year, debited to the profit and loss account and allowed as deduction in the computation of income of the employer. In the year in which the employee is paid the gratuity, only the first amount will be allowed as deduction, the second having been allowed in the earlier years when provisions were made. Letter : F. No. 204/10/71-IT(A-II), dated 17-4-1971 . clarification 5 I am directed to refer to your letter dated 31-5-1971 [Annex] on the above subject and to say that the provision has to be made in respect of gratuity payable to each employee and it has to be decided by taking into account several factors such as length of service, salary progressions and the like which would be lost sight of in making an overall provision for the company as a whole and that would not reflect the correct provision for gratuity. Letter : F. No. 204/10/71-IT(A-II), dated 17-8-1971 . ANNEX - LETTER, DATED 31-5-1971 REFERRED TO IN CLARIFICATION With reference to your Circular No. 47, dated 21-9-1970 on the above subject, our clients are raising a doubt as to actuarial valuation of gratuity liability. It appears that actuarial valuation can be made only in respect of general gratuity liability of the company, covering all the employees entitled to gratuity and not in respect of a particular employee of the company. It appears from your circular that the actuarial valuation for the gratuity liability should be obtained in respect of each and every employee and record is to be maintained by the company, in respect of this particular valuation for each year. Under the circumstances, we request you to kindly clarify the point and confirm that actuarial valuation of general gratuity liability of the company covering all the employees will suffice.