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TMI Blog1980 (8) TMI 33X X X X Extracts X X X X X X X X Extracts X X X X ..... mentally incapacitated for further service, (ii) on voluntary retirement or resignation of an employee after fifteen years' continuous service, and (iii) on termination of service by the assessee after ten or fifteen years' continuous service, as the case may be. Broadly speaking, gratuity payable under the award was to be worked out on the basis of one month's or half a month's basic wages for each completed year of service, depending upon the circumstances of the case, subject to a certain maximum. Gratuity would not, however, be payable to an employee dismissed for misconduct. The assessee accepted the award and from time to time it went on paying gratuity to its employees who became entitled thereto under the award from 1957 onwards. The assessee used to make payment on the happening of any of the events mentioned in the award in relation to any of its employees and the payment, when actually made accordingly, used to be debited in its books of account and allowed as a deduction in the computation of the assessee's income for the relevant year in the course of its assessment to income-tax. For the assessment year in question, the assessee filed its return of income on July 10 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ccording to gratuity regulations of the company to employees whose services were terminated otherwise than by normal retirement or death. The certificate in terms recited that the gratuity provision to be made in the accounts of the assessee for the year ending December 31, 1967, arising on account of the services of its employees during the year was Rs. 29,637 and that the valuation basis adopted was 4% per annum rate of interest and modified (1925-35) rates of mortality. It would thus appear that the factor of discount was taken into consideration while making the actuarial valuation. Indeed, it was not even the case of the revenue at any stage that the basis of actuarial valuation was not correct or reliable because any relevant factor was not taken into account. The ITO took into consideration the claim advanced by the assessee but rejected it on the ground that the assessee had neither paid the amount nor made any provision therefor. On appeal, the AAC confirmed the order of the ITO on the ground that although the assessee had adopted the mercantile system of accounting, no provision was actually made in respect of gratuity liability in its accounts for the year in question ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ion ". Under s. 29, the income referred to in s. 28 is required to be computed in accordance with the provisions contained in ss. 30 to 43A. Section 145 provides that income chargeable under the head " Profits and gains of business or profession " or " Income from other sources " shall be computed in accordance with the method of accounting regularly employed by the assessee; provided, however, that in any case, where the accounts are correct and complete to the satisfaction of the ITO but the method employed is such that, in the opinion of the ITO, the income cannot properly be deduced therefrom, then the computation shall be made upon such basis and in such manner as the ITO may determine. Where the ITO is not satisfied about the correctness or the completeness of the accounts of the assessee, or where no method of accounting has been regularly employed by the assessee, the ITO is at liberty to make an assessment in the manner provided in s. 144. The controversy between the parties arising out of the question referred for our opinion is required to be decided against the background of the aforesaid legal provisions. In Southern Railway of Peru Ltd. v. Owen [1957] 32 ITR 737 (HL ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... during that year. As a corollary it will not make any charge to cover the actual payments made in the year in respect of retirement benefits. Only by such a method, it is said, can it bring against the receipts of the year the true cost of the services that it had used to earn those receipts. Generally speaking, this must, think, be true. For, whereas it is possible that any one of its many employees may forfeit his benefit and so never require a payment, the substantial facts of the situation are that when the company has paid every salary and wage that is due for current remuneration of the year it has not by any means wholly discharged itself of the pecuniary burden which falls upon it in respect of the year's employment ... I agree that provision for retirement payments is more likely to give an accurate reflection of the true cost of earning the year's receipts than merely charging against them the year's payments to employees who retire in the year." In Standard Mills Co. Ltd. v. CWT [1967] 63 ITR 470 (SC), which was a case arising out of an assessment under the W.T. Act, 1957, the assessee claimed that in computing its net wealth a certain estimated amount should be deduct ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... relating to deduction of the amount of liability for payment of gratuity to the employees of the company was held to be not maintainable. In Metal Box Company of India Ltd. v. Their Workmen [1969] 73 ITR 53 (SC), both the abovementioned decisions, namely, Southern Railway of Peru Ltd. v. Owen [1957] 32 ITR 737 (HL) and Standard Mills Co. Ltd. v. CWT [1967] 63 ITR 470 (SC) were considered in the context of computation of bonus payable to the employee of the appellant-company in accordance with the Payment of Bonus Ordinance. The company was maintaining its books of account on the mercantile system of accounting. The company computed the amount of bonus payable to its employees but the employees disputed the computation, inter alia, on the ground that the company had wrongly reduced the gross profits and available surplus by deducting from the gross receipts the provision for gratuity made on the basis of the estimated liability under two gratuity schemes framed by the company. The company had worked out on an actuarial valuation its estimated liability and made provision for such liability spread over number of years and deducted the amount so provided from the gross receipts in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... his gross receipts his liability to pay a certain sum for every additional year of service which he receives from his employees. The answer to that question was provided in the following words at page 64 (of 73 ITR) : " This, in our view, he can do if such liability is properly ascertainable and it is possible to arrive at a proper discounted present value. Even if the liability is a contingent liability, provided its discounted present value is ascertainable, it can be taken into account. Contingent liabilities discounted and valued as necessary can be taken into account as trading expenses if they are sufficiently certain to be capable of valuation and if profits cannot be Properly estimated without taking them into account. (Underlining supplied.) Dealing next with the decision in Southern Railway of Peru Ltd. v. Owen [1957] 32 ITR 737 (HL), it was observed at p. 65: " But their Lordships recognised the principle that the company was entitled to charge against each year's receipts the cost of making provision for the retirement payments which would ultimately be payable as the company had had the benefit of the employee's services during that year provided the present valu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... inst its gross receipts for the calendar year 1967, the cost of making provision for the gratuity which would ultimately have to be paid to its workmen by calculating the present value of such liability on an actuarial basis and that it was entitled to work out the net profits chargeable to income-tax under s. 28, accordingly is well founded and that the Tribunal's view to the contrary is not right in law. The submission on behalf of the revenue was that under s. 145, profits of business were required to be computed in accordance with the method of accounting regularly employed by the assessee and that, therefore, the taxing authorities were justified in disallowing the claim of the assessee which was founded on a departure from its established method of accounting. The argument was that up to the account year in question, the method of accounting followed by the assessee was to debit in its accounts the actual payments made during the year to the workmen who became entitled to gratuity under the award and that the claim laid to deduct from the gross receipts the sum in question while preparing the profit and loss account amounted to a departure from its established method of acc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... did not confer a mere discretionary power; in the context, it imposed a statutory duty on the ITO to examine in every case the method of accounting employed by the assessee and to see whether or not it was regularly employed and to determine whether the income, profits and gains of the assessee could properly be deduced therefrom. The following pertinent observations were then made at p. 128 (of 53 ITR): " But the section only deals with the computation of income, profits and gains for the purposes of sections 10 and 12 and does not purport to enlarge or restrict the content of taxable income, profits and gains under the Act. Section 2(15) of the Act defines 'total income' as meaning total amount of income, profits and gains referred to in sub-section (1) of section 4 computed in the manner laid down in the Act ... Section 13 ... merely prescribes that the computation of taxable profits shall be made according to the method of accounting regularly employed ... The section does not compel the Income-tax Officer to accept a balance-sheet of cash receipts and outgoings prepared from the books of account; he has to compute the income in accordance with the method of accounting regul ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... orrectly debited in the books of account maintained on the mercantile system. From the calendar year 1967 onwards, however, the assessee decided to make provision for meeting the gratuity liability not all at once but spread over a number of years on an actuarial valuation by making a provision therefor in the profit and loss account of each year. Having regard to the decision in Metal Box Company of India Ltd. v. Their Workmen [1969] 73 ITR 53 (SC), this could be validly done regard being had to the accepted principles of commercial practice and mercantile system of book-keeping. It is difficult to appreciate under such circumstances the underlying assumption in the submission of the revenue that there was a departure from the method of accounting regularly employed by the assessee. As explained in CIT v. A. Krishnaswami Mudaliar [1964] 53 ITR 122 (SC), the mercantile system permits such actual cash outlays during the year being debited and it also permits provision being made for deduction of liabilities incurred or accrued but not discharged at the end of the year. Thus, there has been no departure from the method of accounting in the instant case. Indeed, it must be stated that ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rom the form of balance-sheet in Sch. VI to the Companies Act, 1956, whereunder provisions for taxation, dividends, provident fund schemes, staff benefit schemes and other items for which a company is contingently liable are to be treated as current liabilities and, therefore, are debitable against the gross receipts. Schedule VI, Pt. 2, lays down the requirements of profit and loss account and clause 3(ix) thereof provides that a profit and loss account shall set out, amongst other things, the aggregate of amounts set aside or provisions made for meeting specific liabilities, contingencies or commitments. Thus, there is no rule against debiting such contingent liability against gross receipts but equally there is no rule which requires that in order that true profits can be deduced for the purposes of income-tax, provision for the present value of the estimated liability must be necessarily made by an actual entry in the accounts and that disclosure in that behalf cannot be made otherwise, e.g., by way of a footnote in the balance-sheet. So far as the present case is concerned, the forty-third annual report and balance-sheet of the assessee-company for the year 1967 were produce ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... books of account, it was debarred from claiming the sum as a deduction either under s. 10(1) or under s. 10(2)(xv) of the Indian I.T. Act, 1922. This contention was repelled in the following words (p. 367): " We are wholly unable to appreciate the suggestion that if an assessee under some misapprehension or mistake fails to make an entry in the books of account and although, under the law, a deduction must be allowed by the Income-tax Officer, the assessee will lose the right of claiming or will be debarred from being allowed that deduction. Whether the assessee is entitled to a particular deduction or not will depend on the provision of law relating thereto and not on the view which the assessee might take of his rights nor can the existence or absence of entries in the books of account be decisive or conclusive in the matter. The assessee who was maintaining accounts on the mercantile system was fully justified in claiming deduction of the sum of Rs. 1,49,776 being the amount of sales tax which it was liable under the law to pay during the relevant accounting year. " This decision is a clear authority for the proposition that the claim for deduction is not dependent upon the ..... X X X X Extracts X X X X X X X X Extracts X X X X
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