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TMI Blog1985 (12) TMI 100X X X X Extracts X X X X X X X X Extracts X X X X ..... any actuarial valuation, but an ad hoc sum is appropriated without resorting to any scientific basis. In such an event, following the Bombay High Court decision in CIT v. Blundell Eomite Paints Ltd. [1983] 140 ITR 51 and the Kerala High Court decision in CIT v. Periakaramalai Tea Produce Co. Ltd. [1973] 92 ITR 65, the whole provision should be treated as part of the capital under the Second Schedule, for purpose of determining the standard deduction. The provision for gratuity as on 1-1-1974 was stated to be Rs. 2,92,512; whereas it stood at Rs. 7,91,487 as on 1-1-1975. The learned counsel for the assessee submitted before us that the assessee adopted a rough and ready method of considering half-a-month's salary for each completed month's service of an employee, in each accounting year, for computing the provision for gratuity. He submitted that this principle itself is defective. By this method it is assumed that all employees are to retire at the end of the year. It is obvious that this method would be ignoring estimation of the liability on actuarial basis. He submitted that an ad hoc provision for gratuity not with reference to actuarial method, is not a provision for any kno ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... omputing the capital of the company for the purposes of the Act. In Vazir Sultan Tobacco Co. Ltd. v. CIT [1974] 96 ITR 248 (AP) it was held that the amount set apart for gratuity was set apart in respect of a liability known on the date of the balance sheet and, therefore, it is only a provision and not a reserve. However, in the said case, the Kerala High Court decision in Periakaramalai Tea Produce Co. Ltd.'s case was not considered. In Hyderabad Asbestos Cement Products Ltd.'s case, it is held that a 'provision' does not acquire the character of a 'reserve' merely because the assessee has been carrying forward the balance in the provision account from year to year after meeting the liability, unless some person possessing requisite authority designated it as such or indicated the manner of the disposal or the distinction of the balance amount concerned. Admittedly, as no such designation had been made in the case which had arisen before the Andhra Pradesh High Court, the Full Bench held that the provision cannot be treated as a reserve for purpose of computation of chargeable profits under the Super Profits Tax Act, 1963. It is no doubt true that the Full Bench specifically di ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... irst time in its appeal before this Court...." The above principle they have extended even to the item of appropriation to gratuity reserve also, when they have specifically stated as follows : "Originally an appropriation to gratuity reserve will have to be regarded as a provision made for a contingent liability, for, under a scheme framed by a company the liability to pay gratuity to its employees on determination of employment arises only when the employment of the employee is determined by death in capacity, retirement or resignation---an event (cessation of employment) certain to happen in the service career of every employee; moreover, the amount of gratuity payable is usually dependent on the employee's wages at the time of determination of his employment and the number of years of service put in by him and the liability accrues and enhances with the completion of every year of service; but the company can work out on an actuarial valuation its estimated liability (i.e., discounted present value of the liability under the scheme on a scientific basis) and make a provision for such liability not all at once but spread over a number of years. It is clear that if by adoptin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Ordinance. However, in that decision also recognising the provision for payment of gratuity is a contingent liability, the Kerala High Court held : "The correct principle of valuation of this contingent liability is to ascertain the present value of the contingent liability which had arisen during the accounting period on actuarial valuation." Therefore, the learned counsel for the assessee agreed that a direction may be given to the ITO to call upon the assessee-bank to file an actuarial valuation regarding the gratuity liability of its employees and the said liability can be spread over years, as held in Vazir Sultan Tobacco Co. Ltd.'s case by the Supreme Court and whatever excess reserve is found over and above the actuarial valuation, such excess only can be treated as a reserve. 5. After considering all the arguments, we feel that this request is quite just and is in consonance with the ratio laid down by the Supreme Court in Vazir Sultan Tobacco Co. Ltd.'s case. Therefore, we send back the matter to the ITO and direct him to give the assessee a notice to file before him an actuarial valuation of the estimated liability, i.e., the discounted present value of the liabilit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . [1971] 80 ITR 566 the amount transferred to the reserve fund cannot be treated as an outgoing by way of transfer as on 31-12-1974 or 31-12-1975, since they are effective only from 1-1-1975 and 1-1-1976, respectively, and, therefore, the request for deducting the amount transferred to a statutory 'reserve fund' from the chargeable profits, has been rightly turned down by the ITO, firstly, on the ground that there is no actual transfer and secondly, that the transfer is not effective as on the last day of the relevant previous year. It is submitted by the learned counsel for the assessee that, out of the profits for the year ended on 31-12-1974 (which is the last day of the previous year relevant to the assessment year 1975-76) the assessee-bank transferred an amount of Rs. 7 lakhs to the statutory reserve fund. The proposal for appropriation by the directors was made on 26-4-1975. The said proposal was approved at the general body meeting on 17-6-1975. So also the assessee-bank transferred an amount of Rs. 9,84,967 to the statutory reserve fund out of the profits for the year ended on 31-12-1975 (which is the last day of the previous year relevant to the assessment year 1976-77). ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... efore, it is popularly called as 'statutory reserve'. Whether the actual transfer of 20 per cent of the profits is made to the reserve fund in the accounts of the banking companies or not, it is the legal obligation of every banking company who earned profit to do so. Therefore, the moment a banking company earns profit a corresponding statutory liability is incurred by the said banking company to transfer 20 per cent of its profits which would be determined as per its profit and loss account every year and, therefore, there is a statutory liability to transfer a sum equivalent to 20 per cent of profits earned to a reserve fund. In our considered opinion, the ratio of Kedarnath Jute Mfg. Co. Ltd. v. CIT [1971] 82 ITR 363 (SC) would apply to the facts of the case and on the strength of the said decision the assessee can argue that whether actual transfer was made or not to the reserve fund, as it had incurred a legal liability to do so, the transfer should be deemed to have been made. The moment the assessee-banking company is found to have earned profits as per its profit and loss account prepared for the accounting years relevant to the assessment years 1975-76 and 1976-77, it is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ribunal had the occasion to consider a similar question in the case of Catholic Syrian Bank Ltd. [ST Appeal Nos. 2 and 3 (Coch.) of 1983 dated 16-4-1985] is furnished to us. At paragraph 3 this point was discussed and a decision also was given in favour of the assessee which is as follows : "It is pointed out by the assessee that it is physically impossible to effect an actual transfer during the previous year. The amount to be transferred under section 17 of the Banking Companies Act is a sum which should not be less than 20 per cent of the profits. It will not be possible for a banking company to close the accounts completely and work out the profits on the last working day of the previous year and to transfer the amount. The accounts have to be collected from the various branches, the profit and loss account and the balance sheet have to be prepared and the various appropriations have to be approved by the board of directors and the general body. Obviously this cannot be done before the close of the previous year. It is explained by the learned representative for the assessee that the actual practice is to make the necessary entries in the account books as on the last day of t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 7 in the pervious year relevant to the assessment year 1976-77 and in the view we have taken these amounts are liable to be adjusted from the total income while arriving at the chargeable profits under the First Schedule for the assessment years 1975-76 and 1976-77, respectively. 9. One of the grounds raised in the assessment year 1975-76 is that a sum of Rs. 25,000 appropriated from out of the profits of the year relating to the calendar year 1973 by the directors on 16-6-1974 and approved by the general body meeting on 16-6-1974 can constitute a part of capital at the beginning of the year on 1-1-1974 in view of the Supreme Court decision in Mysore Electrical Industries Ltd.'s case. The following is what is held by the Hon'ble Supreme Court : "It is well known that the accounts of the company have to be made up for a year up to a particular day. In this case that day was the 31st March, 1963. If it was reasonably practicable to make up the accounts up to the 31st March, 1963, and present the same to the directors of the respondent on April 1, 1963, they could have made up their minds on that day and declared their intention of appropriating the said and other sums to reserves ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as well as the decision of the Income-tax Appellate Tribunal, Cochin Bench for some of those years in the appellant's own case. It has been held in appeal for earlier years that interest from sticky advances is not includible in the gross receipts for computing the business income. I would accordingly exclude the interest from sticky advances for the two years under consideration also." This order of the Commissioner (Appeals) was implemented by the IAC (Assessment), by passing a rectificatory order dated 7-10-1985, a photostat copy of which is also filed before us. As can be seen from the said order, an amount of Rs. 14,625 was deducted from out of the total income determined as per the order dated 15-5-1982, towards interest on sticky advances. Thus, it can be seen that an amendment to the ITO's orders in pursuance of the Commissioner (Appeals)'s order dated 21-8-1985 was already made. Section 14 of the Companies (Profits) Surtax Act, clearly states that where as a result of any order made under section 154 of the Income-tax Act, it is necessary to recompute the chargeable profits determined in any assessment under this Act, the ITO may proceed to recompute the chargeable prof ..... X X X X Extracts X X X X X X X X Extracts X X X X
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