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TMI Blog1998 (2) TMI 4X X X X Extracts X X X X X X X X Extracts X X X X ..... assessee. As to how the reference arose, we may notice a few facts. The assessee, a private limited company, was a wholly owned subsidiary of Rallis India Ltd. One of its activities was the distribution of the products of Taddington Chemical Factory Private Ltd. which was also another wholly owned subsidiary of Rallis India Ltd. With effect from May 1, 1959, the assessee closed its unit for distribution of the products of Taddington Chemical Factory Private Ltd. which business was taken over by Rallis India Ltd. On April 22, 1959, the assessee wrote letters to employees working in the unit dealing with the distribution stating that arrangements had been made for the business conducted by the assessee to be taken over by Rallis India Ltd. and that the transfer would take effect from May 1, 1959. By this letter, the employees were further informed that arrangements had also been made whereby all the employees of the assessee of the distribution unit would be offered similar employment with Rallis India Ltd. on and from May 1, 1959. The employees were, therefore, informed that their employment was to cease on and from April 30, 1959. The employees were further told as under : "(A ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... atuity accrued in the service of W. T. Suren and Co. Private Ltd. and the gratuity as calculated under our gratuity scheme, it is understood that any members of the staff so affected will, on leaving the company be paid the gratuity accrued to them in the service of W. T. Suren and Co. Pvt. Ltd. as at April 30, 1959, if it is higher than the gratuity as calculated under our scheme." The assessee had announced a gratuity scheme for its employees on August 31, 1953. It is as under : "The management have pleasure in announcing a gratuity scheme for the members of the staff as under :--- No. of completed years For each year of service of service gratuity equivalent to 5, 6 and 7 Half-a-month's basic salary. 8 and 9 3/4 month's basic salary 10 and above 1 month's basic salary with a maximum of 15 months or Rs. 15,000 which is lower. Gratuity will not be payable to those staff members who have been dismissed for misconduct, etc. The above scheme is being introduced as from September 1, 1953." In respect of the employees whose services had been terminated and who had accepted the offer to join Rallis India Ltd. with continuity of service as offered, their gratuity amounting to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ime. It, therefore, could not be said that there existed no liability to pay any gratuity. It was also submitted that if the assessee had not paid the gratuity amount to Rallis India Ltd. the employees were well within their legal right to claim it from the assessee. The Revenue, on the other hand, asserted that the employees had waived their claim with the assessee in regard to their gratuity and, therefore, no liability survived in the hands of the assessee. The Revenue also submitted that the payment made to Rallis India Ltd. was in pursuance of an arrangement with the assessee which was ceasing to carry on its main business activities which formed the structure of the assessee and thus this was nothing but in the nature of transfer of business by the assessee to Rallis India Ltd. According to the Revenue, therefore, the payment was rightly treated as not deductible from the business income of the assessee-company. After considering the rival contentions of the parties, the Tribunal allowed the appeal in favour of the assessee. The Tribunal held that there was a termination of employment of the employees from the service of the assessee and also that there was a valid discharge ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the head 'Profits and gains of business, profession or vocation' in respect of the profits and gains of any business, profession or vocation carried on by him. (2) Such profits or gains shall be computed after making the following allowances, namely :---. . . (x) any sum paid to an employee as bonus or commission for services rendered, where such sum would not have been payable to him as profits or dividend if it had not been paid as bonus or commission : Provided that the amount of the bonus or commission is of a reasonable amount with reference to--- (a) the pay of the employee and the conditions of his service : (b) the profits of the business, profession or vocation for the year in question; and (c) the general practice in similar businesses, professions or vocations; . . . (xv) any expenditure (not being an allowance of the nature described in any of the clauses (i) to (xiv) inclusive, and not being in the nature of capital expenditure or personal expenses of the assessee) laid out or expended wholly and exclusively for the purpose of such business, profession or vocation." Income-tax Act, 1961 : "36. (1) The deductions provided for in the following claus ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of the employees of the assessee. It was submitted by the assessee that the amount in question was certainly business expense and it was the liability of the assessee in praesenti and was discharged by making over the payment to Rallis India Ltd. on behalf of the employees. If we consider the balance-sheet of Rallis India Ltd. the amount in question did not form part of its profit and loss account. It was not a revenue receipt. It was entered in the balance-sheet as trust amount. Mr. Vellapally said as to how the amount is received and utilised by Rallis India Ltd., the transferee, is also a relevant consideration. If the service of the employee is terminated, he would become entitled to the payment of gratuity as per the scheme of the assessee and instead of getting the amount directly, it was paid to Rallis India Ltd. which created a trust for that amount for the employees so transferred from the assessee to it. This amount could not be forfeited by the transferee company even if an employee transferred from the assessee is ultimately dismissed on the ground of alleged misconduct. He may in that case forfeit his right to get gratuity from Rallis India Ltd. accruing to him after M ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... claim of gratuity from Rallis India Ltd. Since many judgments of the Madras and Kerala High Courts rendered earlier to the Full Bench of the Kerala High Court and of Sarada Building Works' case [1985] 152 ITR 520 of the Madras High Court, extensively relied upon the decision of this court in Gemini Cashew Sales Corporation's case [1967] 65 ITR 643, we may consider that judgment somewhat in detail. In CIT v. Gemini Cashew Sales Corporation [1967] 65 ITR 643 the question before this court was whether the allowance of Rs. 1,41,506 constituted an allowable expenditure in the assessment of the firm for the year 1958-59 being retrenchment compensation payable under section 25FF of the Industrial Disputes Act. The facts giving rise to the question were that there were two partners constituting the firm. One partner died on August 24, 1957, and the partnership stood dissolved. The business was taken over and continued by the surviving partner on his own account. The services of the employees of the firm were not interrupted and there was no alteration in the terms of their employment. It was urged that since the firm stood dissolved on August 24, 1957, and the undertaking was transfer ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... enchment compensation to the workman. The obligation to pay compensation becomes definite only when there is retrenchment by the employer, or when the ownership or management of the undertaking is, except in the cases contemplated by the proviso, transferred to a new employer, and not till then. The right therefore arises from determination of employment, or from transfer of the undertaking : it has no existence before these events take place." This court also referred to its earlier judgment in Calcutta Co. Ltd. v. CIT [1959] 37 ITR 1. It said that in that case, expenditure which it was estimated had to be incurred to discharge an existing and definite obligation enforceable against the assessee in praesenti, was held a permissible deduction in the computation of income. This court held that the amount claimed as a permissible allowance by the assessee in its profit and loss account cannot, in its judgment, be regarded as properly admissible either under section 10(1) or section 10(2)(v) of the 1922 Act. This is how the court said : "As already observed, the liability to pay retrenchment compensation arose for the first time after the closure of the business and not before. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 65 ITR 643 and observed that the facts in the case before it were not the same as before the Supreme Court in that case. In our view, the Tribunal was just right. In Stanes Motors (South India) Ltd. v. CIT [1975] 100 ITR 341 (Mad), the assessee claimed deduction of Rs. 56,275 under section 37 of the 1961 Act which amount represented gratuity payment to its employees transferred to the new company. The amount was calculated on the basis of the scheme of the assessee and was from the pension and gratuity reserve of the assessee. The claim of the assessee that the amount was paid in the discharge of the liability of gratuity to the employees transferred to the new company and hence allowable as deduction was negatived. The High Court relied on the decision of this court in Gemini Cashew Sales Corporation's case [1967] 65 ITR 643. It observed as under : "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 busine ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f the business so as to be disallowed. There was no closure on the facts. Therefore, such a claim cannot also be equated to a payment made at the time of the transfer of the undertaking of the assessee as in the cases cited. It is not necessary, therefore, to go into the decisions in CIT v. Gemini Cashew Sales Corporation [1967] 65 ITR 643 (SC) and CIT v. Pathinen Grama Arya Vysya Bank Ltd. [1977] 109 ITR 788 (Mad). Those are cases where there had been a cessation of the business or a transfer of the undertaking as such. On the facts found, the assessee will be eligible for the allowance under section 37(1). The several clauses under section 36 do not apply here. The question is, therefore, answered in the affirmative as far as allowability under section 37 is concerned and in favour of the assessee." In CIT v. Salem Bank Ltd. [1979] 120 ITR 224 (Mad), the assessee transferred its banking business to the Indian Bank Ltd. and deposited a sum of Rs. 37,560 with the transferee bank for the purpose of ultimate disbursement to its 27 employees (who were transferred to the Indian Bank Ltd.) for the purpose of ultimate disbursement to them at the time of their retirement or earlier as p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e assessee for payment of this amount was agreed to be paid by the purchaser at a future date. The purchaser paid the purchase price of the stock and machinery of the assessee minus the amount of gratuity payable to the employees which arrangement was made with the consent of the concerned employees. The High Court considered various judgments of the High Courts and also that of this court in Gemini Cashew Sales Corporation [1967] 65 ITR 643 and held that the amount in question was an expenditure incurred wholly and exclusively for the purpose of the business of the assessee within the meaning of section 37(1) of the 1961 Act. It upheld the view of the Appellate Tribunal that liability for payment to which the employer was subject under the local Gratuity Act, to the workers was an expenditure wholly and exclusively laid out or expended for the purpose of the business of the assessee. The court disagreed with the view of the Revenue that the incurring of expenditure for payment of gratuity much ahead of the actual time for payment of gratuity could not amount to an expenditure incurred "wholly and exclusively for the purpose of the business". In CIT v. Sarada Binding Works [1985] ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... agreed to accept the proposal and payment was made by the assessee to the State Government on behalf of the employees. The court, in which one of us was a party (Sujata V. Manohar J.) was of the view that the Tribunal was right in holding that the said amount was allowable as deduction in computing the taxable profits of the assessee. Another question which was referred in that case for decision of the court was : "Whether, on the facts and in the circumstances of the case, the Tribunal should not have upheld the disallowance of the said amount in view of the decision of the Bombay High Court in CIT v. W. T. Suren and Co. Ltd. [1982] 138 ITR 91? " In answer to this question, the High Court distinguished the impugned judgment by saying that no right to gratuity had accrued in favour of the employees whose services were alleged to have been terminated. This is how the court considered its earlier case in W. T. Suren and Co. Ltd. [1982] 138 ITR 91 : "We have been taken through our decision in CIT v. W. T. Suren and Co. Ltd. [1982] 138 ITR 91. In this case, no right to gratuity had accrued in favour of the employees whose services were alleged to have been terminated. This was s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rred and in the latter case that too if the case does not fall under the proviso to section 25-FF of the Industrial Disputes Act. Those provisions cannot certainly be applied in the case of payment of gratuity. The scheme of gratuity as applicable to the members of the staff of the assessee provided as to how much gratuity would become due and payable to an employee for each year of service except to one who is dismissed for misconduct, etc. Gratuity is, thus, payable on the termination of employment of the employee on any account except dismissal and calculated on the basis of the number of years of service and at the rate prescribed in the scheme. In the present case, the amount of gratuity which was paid to Rallis India Ltd. on behalf of the employees was not on account of transfer of the distribution unit of the assessee but on account of stopping of that business and the employees working in that unit becoming surplus resulting in termination of their services. Other business of the assessee, as held by the Tribunal, continued. Payment of the gratuity amount to Rallis India Ltd. was not made by the assessee of its own but at the instance and on behalf of the employees whose se ..... 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