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TMI Blog1982 (12) TMI 7X X X X Extracts X X X X X X X X Extracts X X X X ..... a stroke of luck, as it were, we had in our dockets a number of tax references, all of them on the same point about provision for taxation and gratuity, although they arose under different taxing enactments. When it was proposed to hear them all together, no objections were heard from any quarter. Apparently, the Bar was happy at the prospect of viewing the problem Whole and in all its aspects, and not having to argue according to the forensic exigencies of each case. It might have been felt also as the only way to get out of the morass of confusion on fundamentals which characterised the earlier case law on the subject. The confusion lay chiefly in the inability to distinguish between gratuity, on the one hand, and a provision for gratuity, on the other. And during all the discussion, the expression " contingent liability " was being bandied about without a precise appreciation of what it meant. Gratuity long ago ceased to be gratuitous. Under the pressure of trade unions or left-wing state statutes, the payment of gratuity has become a " must " in every establishment employing workmen and staff. Gratuity becomes payable under certain contingencies like retirement, resignation, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to his workmen by taking note of several factors which may or may not vary, such for instance as the number of workmen employed, their age group, their life expectancy, the occupational hazards in the business, the size of the employees' emoluments, the likelyhood of expansion of the labour force in the establishment, and the like. From those factors, an actuary can scientifically estimate the present discounted value of how much the employer may have to shell out to the workmen by way of gratuity as and when the time comes therefor. Where an industrial or business concern is already established, the employees therein would have already put in a number of years of service. If in such a situation, a gratuity scheme is introduced and the employer wishes to make a provision for gratuity, then he has got to obtain a scientific report about the discounted value of his liability in that regard up to that date. On the basis of the figure provided by the actuary, the employer would be justified, as a prudent businessman, to charge the entire discounted value in the profit and loss account as on that date, of the future liability for gratuity. Once the initial provision is made in this m ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... incorporated company, a provision for gratuity, being a, current provision, cannot be dealt with as a reserve, although both provisions and reserves figure, as they ought to, on the liabilities side of the balancesheet. It is in this context, that the controversy as to whether the provision for gratuity is a provision or a reserve was examined in cases which arose under the Super profits Tax Act and Companies (Profits) Surtax Act., Under the scheme of these two statutes, tax is levied on the excess of company's income over a minimum standard. The standard, which is called a " standard deduction " or a " statutory deduction " is arrived at by applying a certain statutory percentage to the capital of the company. A company's capital, as normally understood, represents its paid-up capital plus reserves. That is also broadly the basis of calculation of capital for purposes of the Super Profits Tax Act and the Surtax Act. Schedule I of these Acts broadly follows the method of adding a company's reserves to its paid-up capital in order to arrive at its overall capital. In this statutory milieu, the temptation for surtax and super profits tax assessees was always to increase the capita ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... for evaluation of an unquoted share for purposes of the E.D. Act, of the W.T. Act and of the G.T. Act, the assessees were interested in urging the contrary position that a provision for gratuity is a charge on the profits and a provision in the balance-sheet in that regard cannot be discarded as a mere appropriation out of profits or as reserve, leaving the Department to toe the other line and go on urging that a provision for gratuity cannot be regarded as charge against profits, but only as an appropriation out of it and must be regarded as a reserve and not as a provision. Since tax courts discharging their advisory jurisdiction had to dispose of cases within the exigencies of the particular question of law in the particular reference case before them, the result was that a provision for gratuity happened to be examined by courts according to the exigencies of the argument and not so much according to fundamental principles. The result has been an utter confusion. It was, in such a state, that the Supreme court rendered their ruling in the Vazir Sultan's case [1981] 132 ITR 559 (SC). It is enough that the following passage is quoted to bring out the essence of the distinction be ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... certain to arise and only the extent of the liability would vary in any particular year. The liability towards a particular employee may be contingent, but the cumulative or collective liability of the company towards the employees in general is a liability which is certain and the extent of the liability will depend upon contingencies that will take place in each employee in a particular year ...... We, therefore, hold that the liability is not to be excluded in making a computation under rule 1-D ". In all the present references, provision for gratuity figures in the context of the valuation of unquoted shares held by each and every one of the assessees in these cases. The valuation question has arisen in the context of the assessment of a shareholder under the W.T. Act, 1957, under the G.T. Act, 1958, and of a deceased shareholder's estate under the E.D. Act, 1953. Valuation of unquoted shares for the purpose of wealth-tax is now governed by express rules framed under the W.T. Rules, 1957. Rule I-D of the W.T. Rules incorporates the 'break-up value' method for determining the market value of unquoted shares. Under this method, the net wealth of the company is first determine ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... gratuity scheme must be left in the hands of trust for each of these companies. The trust actually came into being on September 5, 1975. But even before the trust came into being, these companies had been in a position to obtain the discounted present value of their commitment in regard to gratuity liability of all their workmen from an actuarial calculation and had made suitable entries in their accounts in regard to initial provision for gratuity as well as for subsequent incremental values year by year. The charge towards provision for gratuity was also being made in the profit and loss account every year; and the amount was being shown as a provision for gratuity in the balance-sheet under the head " Current liabilities and provisions ". After the trust was created, the amount representing the provision for gratuity was turned over by the companies concerned to the trust. To the extent of the incremental value also for every year thereafter, the amounts were turned over to the trust year by year. Cases arose before this court in respect of periods subsequent to the creation of the trust and the obligation of the employer concerned who makes over the yearly incremental value to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... some of the cases, urged that on the authority of the Supreme Court's decision in Standard Mills Co. Ltd., v. CWT [1967] 63 ITR 470, even a provision for gratuity must be regarded as a contingent liability so long as there is no inter-position of a gratuity trust to whom the company concerned is under an obligation to pay yearly contributions towards gratuity liability. This contention is untenable. In the Standard Mills' case [1967] 63 ITR 470, the Supreme Court was concerned with examining whether the liability for gratuity, as such, can be regarded as a debt owed by the employer within the meaning of s. 2(m) of the W.T. Act, 1957. With respect, they were right in holding that gratuity is merely a contingent liability and it cannot be, in that sense, a debt owed in praesenti. The Standard Mill's case [1967] 63 ITR 470 (SC), was not, however, concerned with the case of a provision for gratuity. It is also necessary to remember that the Supreme Court's decision was rendered on the W.T. Act as it stood then, when even companies were liable to pay wealth-tax on their net wealth. Incidentally, from 1960-61 onwards, the wealth-tax on companies has been abolished. Thereafter, the only ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ommitment to pay gratuity to all its workmen as and when the time comes is a current, direct, and present liability. With general principles laid down in all these three cases, namely, Southern Railway of Peru Ltd. v. Owen (Inspector of Taxes) [1957] 32 ITR 737 (HL), Metal Box Company's case [1969] 73 ITR 53 (SC) and Vazir Sultan's case [1981] 132 ITR 559 (SC), it would be a mistake to dismiss the authority of these cases by saying that this is a wealth-tax case, that is a bonus case, and the other one is surtax case, and so on. With respect, we hold that a coherent discussion about the nature of a provision for gratuity had been made on the basis of fundamental principles only in these three decisions. The fact that the decisions were rendered, in the one case, in respect of an industrial dispute, or, in the other case, on surtax or super profits tax, cannot derogate from the fact that the decisions were rendered on basic principles. Applying the governing concept that a provision for gratuity really is a discounted present value of the employer's commitment to pay gratuity, it can never be regarded as a contingent liability and Explanation II (ii) (f ) to rule ID of the W.T. Rule ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of the company's assets. There are two other questions of minor importance which figure in the gift-tax references. One of them, again, relates to the computation of the market value of unquoted shares. The question is, whether a " provision for proposed dividends " found in the balance-sheet of a company can be taken into account in arriving at the net value of the company's assets. This question also finds a ready answer in the Vazir Sultan's case [1981] 132 ITR 559 (SC). The Supreme Court held that irrespective of when the dividend happens to be actually distributed, the provision made in the balance-sheet for proposed dividend must be regarded as a current liability and has got to be deducted in ascertaining the net worth of the company. The Department contended before the Tribunal that the provision for proposed dividend must not be deducted in computing the net assets of the company. On the basis of the decision of the Supreme Court, however, we must hold that the Tribunal was right and the Department's contention is wrong. This question which has figured in some of the gifttax references before us is accordingly answered against the Department. One other question which ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is and an ideal solution. But since the valuation question arises only in a shareholder's assessment, neither the shareholder nor the Department can expect the staff and accountants of the company to oblige them by meticulously drawing up a balance-sheet as on the date of the gift even assuming that the drawing up of a balance-sheet on that date would be feasible or is capable of being done in a correct manner, after a passage of time. In the absence of the facility of drawing up a balance-sheet precisely on the date of the gift, the next best thing, both for the assessee who is the holder of the unquoted shares and the. Department, which is charged with the duty of evaluating the market value of the shares, not to speak of the company itself, is to take the balance sheets falling both before and after the date of the gift and arrive, as near as may be, at the break-up value of the assets and liabilities of the company as on the date of the gift on a time basis, or on some other basis. The Tribunal in this case had held that only the earlier published balancesheet must be taken note of. This is not a correct direction in law of how to proceed. We cannot be dogmatic about taking, as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rtained, when, after realization, at market value, of all the assets of the firm and the payment of all the debts and liabilities due by the firm, the surplus remaining, if any, is ascertained, and then allocated as between the different partners according to their respective aliquot shares in the firm. It is this principle which is imbedded in rule 2 of the W.T. Rules, 1958. We do not find any reason why this principle cannot be adopted for the purpose of valuation of deceased partner's share for purpose of estate duty. The question which has arisen in this case is whether a provision for gratuity found in the balance-sheet of the partnership firm can or cannot be deducted in ascertaining the net wealth of the partner's assets as a whole. The problem, according to us, is similar to the problem which was resolved by the Supreme Court in Vazir Sultan's case [1981] 132 ITR 559. We heard Mr. A. N. Rangaswami argue in the course of his arguments that Vazir Sultan's case must be regarded as laying down special rules only in cases where the balance-sheet of a company is concerned. We, however, hold that these principles are general in nature and the question whether provision for gratuit ..... X X X X Extracts X X X X X X X X Extracts X X X X
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