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TMI Blog1980 (6) TMI 25X X X X Extracts X X X X X X X X Extracts X X X X ..... AAC that the entire provision of Rs. 8,57,863 was made on actuarial basis and was in consonance with the statutory provisions of the West Bengal Employees Payment of Compulsory Gratuity Act, 1971 (hereinafter referred to as "the said Act "). It was submitted that in view of the decision of the Allahabad High Court, which we shall presently note, the disputed amount has been wrongly disallowed. The AAC accepted the assessee's contention. He, therefore, deleted the addition made by the ITO on this score. Being aggrieved by the decision of the AAC, there was a further appeal to the Tribunal and reliance was placed on several decisions to which we shall presently refer and after discussing the contentions of the parties the Tribunal was of the opinion that the AAC was right in allowing this appeal of the assessee. Accordingly, the appeal by the revenue was dismissed, by the Income-tax Appellate Tribunal. In these circumstances, the question as indicated before has been referred to this court. The fundamental question involved in this reference is how to compute the profit for the purpose of income-tax for the relevant accounting year. In the facts and circumstances of the case, it ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ward or agreement or contract with the employer." The assessee claims that as it maintains its accounts on the mercantile basis, in order to arrive at its proper income assessable to tax, the liability accrued should be deducted in computing its profits for the purpose of tax. The question, therefore, is whether this sum of Rs. 8,57,863 could be said to be a liability which had accrued to the assessee on account of payment of gratuity to the employees which the assessee was entitled to deduct for arriving at its net profits ? Section 36 of the I.T. Act, 1961, provides for deduction in computing the income referred to, under s. 28 of the said Act and sub-cl. (v) of sub-s. (1) of s. 36 covers " any sum paid by the assessee as an employer by way of contribution towards an approved gratuity fund created by him for the exclusive benefit of his employees under an irrevocable trust ". Section 37 of the Act under which this deduction is claimed provides that any expenditure (not being expenditure of the nature described in ss. 30 to 36 and s. 80VV and not being in the nature of capital expenditure or personal expenses of the assessee), laid out or expended wholly and exclusively for the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ervices during that year, provided the present value of the future payments could be fairly estimated. Earl Jowitt, Lord MacDermott, Lord Radcliffe and Lord Tucker held that since in calculating the amount which it claimed to deduct in each year the company had ignored the factor of discount, the claim should be rejected. In the circumstances it was not proper, their Lordships found, to remit the case to the Special Commissioners whether a satisfactory method of provision could be extracted from the evidence. Lord MacDermott further dissented and held despite this defect, it was not to be assumed that a set of acceptable deductions could not be produced, and the case, according to his Lordship, should be remitted to the Special Commissioner S. Lord MacDermott observed at page 747 of the Income Tax Reports ([1957] 32 ITR) that there is a fundamental distinction between a contingent liability and a payment dependent upon a contingency. This distinction is significant in discussing the contingent liability or accrued liability. The liability might arise. But the liability might make discharge of that liability dependent upon a contingency. His Lordship further observed that in compu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... it in respect of the year's employment. In considering the aforesaid observations, we have to bear in mind that in this case for the first time in the year in question, by virtue of the statutory provision, which we referred to hereinbefore, the said liability was imposed upon the petitioner. The principle behind this decision has been followed universally in all the subsequent decisions, though the application of this principle has created different results. It has to be emphasised that in a case of this nature where a statutory liability is being accrued for the first time and an assessee deducts or seeks to deduct its estimated value of that liability for computing the profit and the contingent part is so insignificant or so irrelevant that it could not be considered contingent in the real sense of the term. Therefore, in earning the income for that year that liability had been incurred by the assessee-company by virtue of the Act in question. In the case of Calcutta Co. Ltd. v. CIT [1959] 37 ITR 1 (SC), the assessee bought lands and sold them in plots fit for building purposes undertaking to develop them by laying out roads, providing a drainage system and installing ligh ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssessee, under s. 10(1) of the Act, there being no prohibition against it, express or implied, in the Act. It was further held by the Supreme Court that the expression " profits or gains " in s. 10(1) of the Indian I.T. Act, 1922, had to be understood in its commercial sense and there could be no computation of such profits and gains until the expenditure which was necessary for the purpose of earning the receipt was deducted therefrom whether the expenditure was actually incurred or the liability in respect thereof had accrued even though it might have to be discharged at some future date. In the case of Indian Molasses Co. P. Ltd. v. CIT [1959] 37 ITR 66, the Supreme Court was concerned with s. 10(2)(xv) of the Indian I.T. Act, 1922, and held that the " spending " in the sense of " paying out or away " of money was the, primary meaning of " expenditure ". " Expenditure " was what was paid out or away and was something which was gone irretrievably. Expenditure, which was deductible for income-tax purposes, was one which was towards a liability actually existing at the time, but the putting aside of money which might become expenditure on the happening of an event was not an expe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Supreme Court held that as until September 20, 1955, the assessee-company had dominion through the trustees over the sums paid at least in two circumstances, viz., under the special provision and cl. III of the second schedule to the policy, and there was a possibility of there being a resulting trust in favour of the company, the sums paid should be treated as set apart to meet a contingency, the payment of those sums was not a paying out or away of those sums irretrievably and did not amount to " expenditure and a deduction could not be made in respect thereof under s. 10(2)(xv) of the Indian I.T. Act, 1922. It was further held by the Supreme Court that s. 10(2)(xv) of the Indian I.T. Act, 1922 , which is similar to s. 37 of the present Act, enacted affirmatively what was stated in the negative form in the English statute and was substantially in pari materia with the English enactment and the courts might consider the English authorities as aids to the intepretation thereof. Reliance was placed on behalf of the revenue on this decision. It was emphasized by the learned advocate for revenue that like Indian Molasses' case [1959] 37 1TR 66 (SC), in the instant case, until the cont ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... recurring liability of a pension which was compressed into a lump payment should itself be a legal obligation, and that, if contingent, the present value of the future payments should be fairly estimable. In this case, we have further to bear in mind that the liability was in respect of a large number of employees in a piece of social legislation created by statute. Therefore, a prudent businessman in the present context was bound to make a fair estimate of that liability from year to year, but as in the year in question with which we are concerned the liability had come for the first time the assessee was entitled to make a prudent estimate of this liability which would be accrued for the payment of gratuity in the form of a deferred payment of wages for the employees concerned, which was necessary for earning its profit. In a case where the liability itself was contingent, there was no accrued liability. But in a case of the present type, where a large number of employees are concerned and the circumstances under which it could be defeated are remotely contingent and so insignificant in reality in view of the number of employees concerned, it could not be said to be contingent i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 1957. Their Lordships of the Supreme Court quoted there the observations of Lord MacDermott which we have set out hereinbefore. But referring to the said observations, their Lordships of the Supreme Court observed at page 476 of the report ([1967] 63 ITR) and held thus: "The same considerations cannot, however, apply to a case under the W.T. Act, where the liability to pay wealth-tax is charged upon the net wealth of an assessee". Therefore, the principle that the House of Lords had enunciated in the case of Southern Railway of Peru Ltd. v. Owen [1957] 32 ITR 737 (HL) was not, in any way, doubted or dissented from. It was, in this light, that the Supreme Court understood the said decision in the subsequent decisions which we shall presently notice. In the case of Metal Box Company of India Ltd. v. Their Workmen [1969] 73 ITR 53; 39 Comp Cas 410 (SC) this question was considered. There the Supreme Court held that where the liability under a scheme of gratuity in respect of the accounting year was stated in the profit and loss account, in the absence of any challenge by the workmen to the correctness of the method of valuation and in the absence of a challenge that such liabil ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d, therefore, not a 'debt' under section 2(m) of the Wealth-tax Act, it would be deductible under the Income-tax Act while computing the taxable profits. In the instant case, the question is not whether such estimated liability arising under the gratuity schemes amounts to a debt or not. The question that concerns us is whether, while working out the net profits, a trader can provide from his gross receipts his liability to pay a certain sum for every additional year of service which he receives from his employees. 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." There, the Supreme Court further observed that contingent rights, if capable of valuation, could similarly be taken into account as trading receipts where it was necessary to do so in order to ascertain the true profits. At page 67 of the report ([1969] 73 ITR), the Supreme Court observed as follows : " That there is no rule against providing for any such contingent liability but on the contrary such a provision is permissible can be seen from the form of balance-sheet in Schedule VI to the Companies Act, 1956, where provisions ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nt because the case dealt with the provisions of the West Bengal Employees' Payment of Compulsory Gratuity Act, 1971, the Act with which we are concerned. There, the taxpayer company, which was resident in the United Kingdom, carried on business in West Bengal and was subject to the laws of that State. In August, 1971, the Act came into force with effect from 14th June, 1971. Under it, the taxpayer company became liable to pay gratuities to all its employees in West Bengal earning less than 750 rupees per month on their leaving its employment for any reason other than gross misconduct. The amount to which each such employee would be entitled had to be calculated by reference to, inter alia, his salary at the end of his employment and his length of service. Service prior to the coming into force of the Act had to be taken into account. The taxpayer company had not hitherto operated any scheme or agreement by which its employees in West Bengal were entitled to receive any retirement gratuity. It decided to make an annual provision to meet its accruing liability to pay the gratuities under the Act rather than charge the actual liability in its accounts for the respective years in whic ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e true amount by which its liabilities in respect of the employment of its work-force were increased in 1971. It could not have made any provision earlier for the payments required by the Act for the years preceding 1971, as it was under no liability to pay any gratuities until the Act came into force. The appeal was dismissed. The Lord President Lord Emslie, at page 174 of the report ([1978] Simon's Tax Cases), had observed that there was much common ground. It was accepted that as a result of the 1971 Act the taxpayer company came under the obligation to pay gratuities to its work-people at the end of their service, the amount of the gratuity payable to each employee being calculated in the manner prescribed by the Act itself. This obligation or liability arose for the first time in the course of the accounting year which ended on 31st December, 1971. With most of the observations of the Lord President we are in respectful agreement. The Lord President, thereafter, went on to observe that payment of gratuity to which an employee had acquired a vested sight was, however, deferred until the end of his service to which learned advocate for the revenue before us took strong objection ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ough payable in future. There, in 1961, the U.P. Government issued a notification with regard to the sugar industry imposing liability on persons running sugar mills to provide gratuity to their work-men in accordance with the scale provided in that notification. In pursuance of this notification the assessee set apart the sum of Rs. 1,37,811 representing the sum that the assessee would be required to pay to its workmen as gratuity and made an appropriate entry in its books of account, crediting the gratuity account and debiting the profit and loss account for the assessment year 1962-63. This sum was claimed by the assessee as business expenditure bat the claim was disallowed by the ITO, the AAC and the Appellate Tribunal. On a reference to the High Court it was contended for the revenue that at best the assessee could claim only the gratuity relevant to the previous year. The discounted value of the assessee's liability to pay gratuity based on actuarial valuation was determined at the instance of the High Court at Rs. 1,05,200. It was held that the Government order provided that the gratuity would be payable to an employee not only in respect of his future services but also for ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... encies were taken into considerations, was a liability in praesenti and was capable of ascertainment and, therefore, the amount set apart was a permissible expenditure in the assessment year concerned. The gratuity was payable when a workman dies, retires, resigns or is removed from service. These events no doubt would take place in the future but they could be said to be uncertain. The services of every workman were bound to come to an end on account of one or the other of the causes stated above. Under the award, every employer was bound to pay gratuity to his workman for his past and future services. In the circumstances, every businessman would make provision every year for his liability under the award. Under the mercantile system of accounting, an expenditure was admissible not when it was actually paid but when the liability for the expenditure is incurred. It was legitimate in such a scheme of gratuity to estimate the liability by actuarial valuation. Their Lordships referred to the other decisions which we have discussed before they upheld the assessee's contention. It would be material to refer to the observation of the court at page 435 of the report ([1975] 98 ITR). The ..... X X X X Extracts X X X X X X X X Extracts X X X X
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