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TMI Blog1985 (10) TMI 2X X X X Extracts X X X X X X X X Extracts X X X X ..... No. 4221 of 1984 is 1974-75. In Appeal No. 4222 of 1984, the assessment year is 1973-74. The relevant accounting years ended on March 31, 1974, and March 31, 1973, respectively. For the assessment year 1974-75, the assessee company sought to deduct a sum of Rs. 18,37,727 towards the amount of gratuity payable to its employees and worked out actuarially. The break up of this liability was as follows : for periods ending on March 31, 1972, March 31, 1973, and March 31, 1974, the assessee's liability was worked out at Rs. 64,31,286. Out of this amount, provision had been made during these years to the tune of Rs. 45,93,559. No provision had been made for the balance amount of Rs. 18,37,727. The claim for deduction was set up on the ground that this liability was ascertained by actuarial valuation and was deductible under section 37(1) of the Act. The Income-tax Officer allowed the deduction of a sum of Rs. 2,65,872 only which was actually paid by the assessee and the rest was disallowed on the ground of non-compliance with the provisions of section 40A(7) of the Act. The assessee preferred an appeal but the same was dismissed by the Commissioner of Income-tax (Appeals). The assessee ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ubject-matter of Appeal No. 4221(NT) of 1984. Civil Appeal No. 4222(NT) of 1984 arises out of the assessment year 1973-74. The High Court observed that the assessee company had entered into agreements with the workers' union for payment of gratuity by March 31, 1972. The company's practice was to account for gratuity on cash basis as and when paid. The company had made a provision in its books of account for payment of gratuity to its employees to the extent of Rs. 20,00,000 during the relevant accounting year. With the coming into force of the Payment of Gratuity Act, 1972, with effect from September 16, 1972, a statutory liability was created on the company to pay gratuity to its employees as per the provisions of the said Act. The assessee company, therefore, arranged for actuarial quantification of its liability for gratuity to its employees. Pending the determination of such an actuarial valuation, the assessee had made a provision of Rs. 20,00,000 against the total accruing liability till the date of the preparation of the balance-sheet. At the time of the filing of the return of income for the assessment year 1973-74, the assessee added back this provision for gratuity amo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... , 1961, out of the total Rs. 48,59,431 made by the assessee towards liability for gratuity ? " Section 40A was inserted by the Finance Act, 1968, with effect from April 1, 1968. It is necessary to set out the relevant provisions of section 40A: "40A. Expenses or Payments not deductible in Certain circumstances. -(1) The provisions of this section shall have effect notwithstanding anything to the contrary contained in any other provision of this Act relating to the computation of income under the held 'Profits and gains of business or profession'.... (7)(a) Subject to the provisions of clause (b), no deduction shall be allowed in respect of any provision (whether called as such or by any other name) made by the assessee for the payment of gratuity to his employees on their retirement or on termination of their employment for any reason. (b) Nothing in clause (a) shall apply in relation to- (i) any provision made by the assessee for the purpose of payment of a sum by way of any contribution towards an approve gratuity fund, or for the purpose of payment of any gratuity, that has become payable during the previous year; (ii) any provision made by the assessee for the previou ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... be hit by the bar under sub-section (7)(a) of section 40A of the Act irrespective of the fact whether the account books of the assessee referred to this liability or not. The High Court was further of the opinion that in view of the non obstante clause in section 40A of the Act, no deduction was permissible under section 37 of the Act for the assessee's liability for payment of gratuity to its employees without complying with the provisions of subsection (7)(a) of section 40A of the Act. The question was, therefore, answered in the negative and against the assessee. On behalf of the assessee in these appeals, it was submitted with reference to section 40A(7) of the Act, that the said section was a provision for disallowance and but for the said section, provision made by an assessee for payment of gratuity could be claimed as deduction under section 37 of the Act as expenditure incurred wholly and exclusively for the purpose of the assessee's business. Alternatively, it was urged that such a provision would have been claimed as deduction generally in determining the true profits and gains of business which could be subjected to tax under section 28 of the Act. It was emphasised ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... se words must, therefore, be given their due meaning and effect and could not be treated as redundant. (e) Explanation II to section 40A(7) referred to amount being paid to an employee in a subsequent year out of the provision for gratuity. This provision was intelligible and meaningful only if " provision " was understood to mean the setting apart of an amount in the books of account so as to make funds available for disbursement. (f) Section 36(1)(viia) of the Act provided for deduction in respect of provision for doubtful debts made by certain financial institutions. There was no doubt that " provision " in section 36(1)(viia) of the Act meant an amount specifically set apart in the books of account of the assessee to meet the loss on doubtful debts. The word " provision " in section 40A(7) must also receive the same meaning, according to the assessee. (g) Section 34(3)(a) spoke of the creation of a development rebate reserve by debiting the profit and loss account and crediting the reserve account. Thus, the Income-tax Act itself contemplated, according to the assessee, a reserve as an appropriation or earmarking of profits by making entries for this purpose in the books ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... accountancy. Our attention was drawn to the observations of this court in the case of Metal Box Company of India Ltd. v. Their Workmen [1969] 73 ITR 53, which were reiterated and referred to in the decision of this court in Vazir Sultan Tobacco Co. Ltd. v. CIT [1981] 132 ITR 559 (SC). In these appeals, we are not concerned with the distinction between " provision " and " reserves ". We are concerned with the true meaning and purport of the expression " provision made by the assessee ". This court in Vazir Sultan's case observed at page 569 referring to the observations in the case of Metal Box: " ` The distinction between a provision and a reserve is in commercial accountancy fairly well known. Provisions made against anticipated losses and contingencies are charges against profits and, therefore, to be taken into account against gross receipts in the P. L. account and the balancesheet. On the other hand, reserves are appropriations of profits, the assets by which they are represented being retained to form part of the capital employed in the business. Provisions are usually shown in the balancesheet by way of deductions from the assets in respect of which they are made where ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... It is under the sub-heading of a group of sections dealing with the computation of profits and gains of business or profession. The said group of sections begin with section 28 and go up to section 40D. Section 40A is with the marginal note under the heading " Expenses or payments not deductible in certain circumstances ". If the marginal note or heading is any indication, and it certainly is a relevant factor to be taken into consideration in construing the ambit of the section, then these payments mentioned therein are not deductible, according to the statute, in certain circumstances. Therefore, the heading of this section is a clear indication that certain payments and expenses which would be otherwise deductible would not be deductible except in certain circumstances indicated in the section. This is abundantly made clear by the non obstante expression used in sub-section (1) of section 40A. As noted before, the provisions of section 40A shall have effect notwithstanding anything to the contrary contained in any other provision of the Act. Payments of deductions or provision for deduction could have been eligible for deduction or could have been deducted either under section 2 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ated and claim the payment made as an expenditure incurred for the purpose of business under section 37. He might, if he followed the mercantile system, provide for the payment of gratuity Which became payable during the previous year and claim it as an expenditure on accrued basis under section 37 of the said Act. Since the amount of gratuity payable in any given year would be a variable amount depending upon the number of employees who would be entitled to receive the payment during the year, the amount being a large one in one year and a small one in another year, the employer often finds it desirable and/or convenient to set apart for future use, a sum every year to meet the contingent liability as a provision for gratuity or a fund for gratuity. He might create an approved gratuity fund for the exclusive benefit of his employees under an irrevocable trust and make contributions to such fund every year. Contingent liabilities do not constitute expenditure and cannot be the subject-matter of deduction even under the mercantile system of accounting. Expenditure which was deductible for income-tax purposes is towards a liability actually existing at the time but setting apart mone ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... meet the contingent liability and gratuity as and when it accrued by way of provision for gratuity or by way of reserve or fund for gratuity was not allowed as an expenditure of the year in which such sum was set apart. (4) Contribution made to an approved gratuity fund in the previous year was allowed as deduction under section 36(1)(v). (5) Provision made in the profit and loss account for the estimated present value of the contingent liability properly ascertained and discounted on an accrued basis as falling on the assessee in the year of account could be deductible either under section 28 or section 37 of the Act. As there were several methods which the assessee might choose to adopt in meeting his liability to pay gratuity, the treatment which he would receive under the Income-tax Act would depend upon the method adopted by him. The assessee is only under an obligation to pay gratuity when it became due and payable. The other methods adopted by the assessee for meeting the liability for gratuity as and when it arose are provisions or arrangements made by him at his option. It is not obligatory on him to make any such provision and if no such arrangement or provision was ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r retirement or termination of their services for any reason. The expression " provision " has not been defined in the Act and is not used in any artificial sense but in its ordinary meaning. This is clear from the words (whether called as such or by any other name) occurring in the sub-section. According to Webster, " provision ", in its ordinary sense, means " something provided for future use ". On a plain construction of clause (a) of sub-section (7) of section 40A of the Act, what it means is that whatever is provided for future use by the assessee out of the gross profits of the year of account for payment of gratuity to employees on their retirement or on the termination of their services would not be allowed as deduction in the computation of profits and gains of the year of account. The provision of clause (a) was made subject to clause (b). The embargo is on deductions of amounts provided for future use in the year of account for meeting the ultimate liability to payment of gratuity. Clause (b)(i) excludes, from the operation of clause (a) contribution to an approved gratuity fund and amount provided for or set apart for payment of gratuity which would be payable during ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... v. ITO [1978] 112 ITR 1038 (All). This case arose out of the assessment year 1973-74, to which the provision of section 40A(7) was applicable. The Allahabad High Court, however, took the view that the bar created by the said provision did not apply since the conditions laid down had to be fulfilled in future. It did not take into consideration, the provision of section 155(13) of the Act. The Madras High Court in CIT v. Andhra Prabha P. Ltd. [1980] 123 ITR 760, has doubted the decision of the Allahabad High Court in Swadeshi Cotton Mills Co. Ltd. v. ITO [1978] 112 ITR 1038 and further observed that the question of deductibility of a claim for gratuity liability could not be allowed on general principles under any provisions of the Act. The aforesaid difficulties in accepting the contentions urged on behalf of the assessee were highlighted by the Calcutta High Court in the case of Peoples Engineering Motor Works Ltd. v. CIT [1981] 130 ITR 174. It was pointed out that payment of gratuity was a statutory liability created under the Payment of Gratuity Act, 1972. It could normally be said to have arisen for the carrying on of the business. However, for gratuity to be deductible un ..... X X X X Extracts X X X X X X X X Extracts X X X X
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