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TMI Blog1980 (2) TMI 45X X X X Extracts X X X X X X X X Extracts X X X X ..... this case, the sum of Rs. 37,359, being the gratuity payable to certain employees of the assessee-company in terms of a scheme dated April 8, 1955, was a permissible deduction while computing profits and gains of the business carried on by the assessee-company? 4. Whether, on the facts and in the circumstances of the case, the amount of Rs. 21,110 could be deducted while determining the income of the company?" It will be convenient to take up the second and third questions for disposal at the outset as there is not much controversy about them. The assessee paid a sum of Rs. 67,067 by way of interest on its income-tax arrears. In order to obtain a stay of recovery of the tax demand raised against it, the company had to offer security to the Government. For this purpose, it persuaded M/s. Bhriguraj Charity Trust to pledge certain shares belonging to them by way of security and for this service the said Trust was paid a sum of Rs. 7,680 as commission. The question raised was whether the amount of interest paid on income-tax arrears and the commission paid on shares borrowed for the purpose of pledging them as security against the income-tax demand raised against the assessee are p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as gratuity to certain employees who retired during the year. Deducting this amount the balance of Rs. 37,359 (sic) was credited to a provision account. The assessee claimed the whole sum of Rs. 52,882 as a deduction in its assessment for the assessment year in question. The ITO, however, allowed only the sum of Rs. 15,526 actually paid and disallowed the balance of the amount as representing a contingent liability which had not crystallized into an expenditure or into an accrued liability. Before the Tribunal it was contended on behalf of the assessee that the allowance should have been made at least to the extent that the provisions covered amounts relating to employees who had already completed fifteen years of service. But according to the Tribunal even in respect of such persons there were contingencies in which the gratuity was not payable. The Tribunal held that the amount which was not actually paid during the period of account was not an allowable deduction. The assessee has, therefore, sought a reference to this court for a decision of the question whether the assessee is entitled to a deduction of a sum of Rs. 37,359 provided for towards retirement gratuity. This quest ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... claimed as a deduction. The court found that the contingencies of an employee not being entitled to a gratuity were remote and that, having regard to the terms of the settlement, the method of accounting employed by the assessee properly reflected the liability incurred by the assessee in the year of account towards the payment of gratuity and that the assessee was entitled to claim the deduction in question. The above decisions clearly show that even though the liability of the company to pay gratuity is a future and contingent liability, an assessee is entitled to claim deduction for income-tax purposes where he ascertains the present value of such liability in some satisfactory manner. This can be done either by arriving at an actuarial valuation as has been done in some of the cases referred to above or by actually crediting the amount of each employee with gratuity attributable to a particular year on the assumption that the gratuity would be so payable to him. We, therefore, hold that in the present case also the department was not justified in disallowing the claim made by the assessee. We are not able to ascertain from the statement of facts and the orders of the authori ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... conditions subject to which this permission was granted were set out in the letter of the Ministry of Commerce and Industry dated December 17, 1960, addressed to the assessee. This letter also makes it clear that packing charges payable to cement producers for cement packed in new and second-hand bags for the period from January 1, 1961, to June 30,1971, would be Rs. 13 per ton. On receiving the above permission from the Government, the company came to the conclusion that the new gunny bags which it had contracted to buy were not necessary. The company's decision was arrived at partly because it was permitted to use second-hand bags and partly because the anticipated production, on the basis of which the contracts had been made, did not materialise. The company implemented this decision in the following manner. The contracts for the gunny bags were not cancelled. Only the new gunny bags contracted for were not taken delivery of but were disposed of by the suppliers on the company's behalf. In the meantime, the prices of gunny bags had risen and the result of the above arrangement was that the suppliers paid to the assessee an amount of Rs. 4,45,618, being obviously the differenc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... le of gunny bags was made by Becker Gray Co. (P.) Ltd. on the instructions of the appellant and in fact they had even charged their commission @ 3/4% on the re-sale value. The purchase of gunny bags was, therefore, directly related to the operations of business of the appellant. The transactions of advance contracts were entered into in the ordinary course of and for the purposes of the appellant's business, and were, therefore, a part of the trading operations of the appellant. As the appellant was allowed to pack cement in second-hand gunny bags which were cheaper it decided to buy less costly items of stores and to realise the profit on the more costly items of stores already contracted for. The profit made by the appellant on the re-sale of gunny bags, which were like any other stores, was a profit made in the operation of the appellant's business. The agreements by virtue of which the profit arose were not by themselves casual but were being regularly entered into. In all these circumstances there was no question of treating these contracts as a separate venture and in treating the profit arising on the re-sale of the gunny bags as a profit not liable to tax as a part of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... been an intention to sell the gunny bags in order to invest their subsequent sales with the character of a business transaction. Similarly, the fact that the assessee realised the surplus by settling the contract instead of taking delivery and disposing of them itself did not change the essential nature of the transaction. The important fact was that the transaction originated as a routine transaction of the assessee's day-to-day business and its settlement in the light of business exigencies was equally a routine operation of the business. The contract which yielded a surplus, it must be Stated at the risk of repetition, was a routine contract of the assessee's business. It was as routine as the purchase of raw material like limestone and sand. It had nothing whatsoever to do with the company's permanent apparatus for running the business. On the other hand, it had everything to do with the process of profit earning which required adequate supplies of packing material and their effective disposal when their stocks had piled up. It was also not possible to carry the surplus as casual or accidental. Fluctuations in the prices of raw material and stores including packing material is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... suggested that packing materials like gunny bags should be treated as capital assets but this suggestion is untenable. As rightly observed by the Tribunal, packing material, in accountancy and commercial practice, are put on a par with trading stock and they are outside the pale of fixed or capital assets. It is well settled that the losses incurred by an assessee would be treated as eating into the profits of a business where they are revenue in nature and arise out of or are incidental to the business. It should correspondingly follow that profits, though not strictly arising from the main operation of the business, really go to augment those profits when they arise out of the normal trading operations. An example of this is seen, for example, where surpluses arise in the course of trading operations due to fortuitous factors such as devaluation of currency which, it is now settled law, would constitute trading receipts: [vide CIT v. Canara Bank [1967] 63 ITR 328 (SC) and Sutlej Cotton Mills Ltd. v. CIT [1979] 116 ITR 1 (SC)]. The argument of counsel that these profits cannot be taken as part of the business profits cannot, therefore, be accepted. Shri Sharma also contended th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... w : -------------------------------------------------------------------------------------------------------------------- Date No. of Purchase Face debentures price value -------------------------------------------------------------------------------------------------------------------- Rs. Rs. 30-4-61 310 3,14,960 3,10,000 27-6-61 290 3,00,150 2,90,000 23-10-61 300 3,06,000 3,00,000 ------------ ----------------- ------------------- 900 9,21,110 9,00,000 ------------ ---------------- ------------------ ----------------------------------------------------------------------------------------------------------------- It was claimed before the ITO that, since the debentures had been purchased with interest and since the face value of the debentures was only Rs. 9,00,000, the additional sum of Rs. 21,110 paid for these debentures was deductible as interest on borrowed capital in the form of debentures. The question whether this claim could be accepted was answered by the ITO and the Tribunal in the negative though the AAC was inclined to answer it affirmatively. Before dealing with this question, it is necessary to make a reference to the confusion ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t Rs. 23,4,18 to tax. The AAC observed that the overall result of the transaction had to, be taken into account. It could not be that, where interest receivable on the debentures was taken into account, the interest surrendered by the appellant proportionate to time could be disallowed. In other words, the loss which had been suffered was equivalent to the interest already earned by the other party and in all fairness such loss should have been set off against the income receivable by the appellant. He, therefore, deleted the addition of Rs. 21,110 Throughout there was no controversy regarding the assessment of Rs. 23.418 as interest on debentures receivable by the assessee and we need not express any opinion on that issue. The only issue considered by the Tribunal, and also referred to us is whether Rs.21,110 can be said to be interest paid to the debenture-holders while purchasing the debentures, and hence allowable as an outgoing against the sum of Rs. 23,418 assessed in the assessee's hands. The Tribunal has answered this issue in the negative. The answer given by the Tribunal would be-clearly correct in the case of an assessee who is not a dealer in debentures. Thus, if ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... such a transaction can only mean that the company has redeemed the debentures and the transaction thus resulted in wiping off the company's liability to the debenture-holder. This is quite clear from the decisions in Hummel v. George Routledge Sons Ltd. [1904] 2 Ch 474 (Ch D) and Hoare v. W. Tasker Sons Ltd. [1905] 2 Ch 283 (Ch D). This being the legal position, since the company owes the debenture-holder only the amount of the principal of the debentures and the interest payable thereon, the transaction means that this has been paid and so the excess payment over and above the principal can be attributed only to interest. Pausing here, it is necessary to observe that the decisions in Routledge [1904] 2 Ch 474 (Ch D) and Tasker [1905] 2 Ch 283 (Ch D) had been rendered despite the fact that in company law the debentures of a company were generally considered as having an entity or existence independent of the company. Though a debenture means only a debt borrowed by the company and the document evidencing the same, debentures have always been treated as assets, capable of being transferred from person to person by mere delivery (when issued to bearer) or by endorsement and de ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e debentures shall have, and shall be deemed always to have had, the same rights and priorities as if the debentures had never been redeemed. (3) Where with the object of keeping debentures alive for the purpose of re-issue, they have, either before or after the commencement of this Act, been transferred to a nominee of the company, a transfer from that nominee shall be deemed to be a re-issue for the purposes of this section. (4) Where a company has, either before or after the commencement of this Act, deposited any of its debentures to secure advances from time to time on current account or otherwise, the debentures shall not be deemed to have been redeemed by reason only of the account of the company having ceased to be in debit whilst the debentures remained so deposited. (5) The re-issue of a debenture or the issue of another debenture in its place under the power by this section given to, or deemed to have been possessed by, a company, whether the re-issue or issue was made before or after the commencement of this Act, shall be treated as the issue of "new debenture for the purposes of stamp duty, but it shall not be so treated for the purposes of any provision limit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the company in the present case had reissued the 300 debentures purchased by it on October 23, 1961, to some third party (say X) in the next few weeks, the interest on the debentures for the period July 1, 1961 to December 31, 1961, would have been payable to and receivable by X. In such an eventuality, it will be clear that no portion of the payment made by the company while purchasing the debentures on October 23, 1961, could be attributed to the interest between July 1, 1961, and October 23, 1961, as contended for by the assessee have given the illustration only to clarify the position. It is not necessary, for deciding the issue here, to examine on facts whether any such issue was, made by the company or not. The above discussion would show that except in the eventuality of the debentures having to be treated as cancelled, for the reasons given in s. 121 (1), the debentures, despite their purchase by the company, retain their separate existence. The company is, again, except in the above eventuality, in the same position vis-a-vis the debentures as any outside purchaser thereof. The records of the case do not indicate any facts to show cancellation and so we think the Tribunal ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to the above entries. However, the above authors point out, debentures may not be purchased on the due date for payment of interest. These may be purchased in between the two dates of payment. In such cases, the purchase may be cum-interest in which case the seller will receive only the sale price and nothing more. Or the purchase may be ex-interest in which case the purchaser will have to pay interest in addition to the purchase price. In the former situation, in a case where 100 six-per cent. debentures of the face value of Rs. 100 each are purchased for Rs. 98 each on 1st October (the due dates for payment of interest being 30th June and 31St December) the entries will be as follows, say the authors (at p. 663) : Rs. "6% Debentures Dr. 10,000 Rs. Interest on Debentures Dr. 150 (between 1st July 30th September) To Bank Account 9,800 To Profit on Redemption of Debentures Account 350." It is explained that though the price being cum-interest, nothing is payable for interest : "...nevertheless, for making entry in books the purchaser has to calculate the, interest to the date of purchase and debit the amount to the interest account, only the remai ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Also market it, as and when found necessary and, as pointed out above, this is also legally permissible now. Relying upon the passages quoted above from pp. 661 to 663 it is contended for the assessee that the sum of Rs. 21,110 is properly allowable as interest paid on the debentures. We are, however, unable to accept the contention for two reasons. In the first place, there is nothing on record to indicate that the purchase was ex or cum interest. All that is known is that the assessee purchased the debentures of Rs. 9 lakhs for Rs. 9,21,110. This being so, the first set of entries made by the company were the correct entries to make. In this context, it will be noticed that the amount of accrued interest was Rs. 23,481 whereas the assessee had paid only Rs. 21,110. There is nothing to show that it was intended to be a purchase of the securities-cum-interest (by paying the face value as price and Rs. 21,110 towards interest as against Rs. 23,481 accrued till then). But, even otherwise, whatever may be the justification from the point of view of accountancy principles, in making notional entries towards interest calculated as having accrued up to the point of sale, in order to ..... X X X X Extracts X X X X X X X X Extracts X X X X
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