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TMI Blog1982 (3) TMI 80X X X X Extracts X X X X X X X X Extracts X X X X ..... . IAC u/s 144B. The ld. Inspecting Asstt. Commr. (hereinafter referred to as 'IAC') noted that the assessee had not made any provision for payment of gratuity but claimed the deduction on basis of the certificate of the actuary. The contention of the assessee before the IAC was that since no actual provision was made s. 40A (7) had no application. The ld. IAC however disagreed with this contention and stated that in the instant case the assessee had not fulfilled the requisite conditions as laid down in s. 40A (7) of the Act. Therefore, even if a provision was made, for non-fulfilment of conditions laid down in s. 40A (7), the said provision would have been disallowed. In the instant case, there was not even a provision. Therefore, in accordance with the decision of the Allahabad High Court in case of Swadeshi Cotton Mills Ltd. vs. ITO (1978) 112 ITR 1038 (All) was not applicable inasmuch as the said decision governed a case of provisional assessment and secondly the conditions laid down in sub-cl. (ii) of cl. (b) of s. 40A (7) had to be fulfilled in future. In this view of the matter, he did not allow the claim for deduction as made by the assessee. 4. The matter was carried in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rary view seem to have been expressed, the ld. A.M. considered the meaning of expression 'provision'. He examined the meaning of the said expression with reference to principles of accountancy and observed that the 'provision' would mean a known liability, the amount of which cannot be determined with substantial accuracy. Hence, when a known liability can be ascertained with substantial accuracy, it may cease to be a provision whether it is entered into books or not. In light of this observation and relying on the decision of the Madras High Court, the ld. Accountant Member held that the assessee cannot be denied the benefit of deduction as claimed by it. He accordingly held that the assessee's claim for deduction of gratuity liability as aforesaid was allowable. 7. The ld. J.M. on the other hand, observed that the claim for liability for payment of gratuity was a statutory liability under the Payment of Gratuity Act, 1972. Secondly, the assessee had not made any provisions in its accounts in regard to the said liability. The assessee's claim was based on actuarial report dt. 18th March, 1975. According to the ld. J.M., the main stay of the assessee's case was that provisions o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... prevent the assessee for making a claim for deduction on actual payment basis even after the claim made, as aforesaid, was allowed to the assessee. The ld. J.M. then referred to the Circular No. 146 dt. 26th Sep.,1974 under which earlier Circular No. 47 dt. 24 Sept.,1970 was withdrawn. The instruction of the CBDT according to the ld. Judicial Member was binding on the ITO. In light of these facts, the ld. J.M. took the view that the claim for deduction as made by the assessee, was not allowable. 8. At the time of hearing of this appeal before me, Shri Kaji, the ld. counsel for the assessee contended that admittedly no provision was made the accounts in regard to the liability for gratiuity amounting to Rs. 20,03,560. The assessee had made the claim for deduction of the said amount u/s 28 of the Act. The said claim was not made either u/s 36 or 37 of the Act. Referring to the provisions contained in s. 40A (7) of the Act, Shri Kaji contended that the said section made a prohibition against the allowance as deduction of provision for gratuity. The prohibition laid down in the said section had certain exceptions. In other words, if the conditions laid down in s. 40A (7) (b) were f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ts and gains on which the charge is levied have been computed in accordance with general or normal commercial practice. Thus, in the computation of profits and gains, as is understood in commercial parlance, a deduction in respect of accrued liability comes into play. The charge is levied on what is called real profits. Thus, if a trader were to incur an expenditure or to provide for liability which is incidental to carrying on of the business such expenditure or liability has to be deducted before real profits could be determined. Such deduction is permissible on the principle of commercial expediency. Thereafter dealing with the point as to whether there was expressed or implied prohibition against the allowance of claim for accrued liability for gratuity, Shri Kaji submitted that s. 36(1) (v) deals with contributions to approved gratuity fund that is to say actual outlay or expenditure. Now if any claim is covered by s. 36(1) (v), the courts have held that such a claim would not fall for consideration u/s 37 or u/s 28. Now, the prohibition u/s 40A (7) may hit allowance for deduction u/s 37 of the Act. But such prohibition does not extend to deduction u/s 28 of the Act. In this c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sary to consider whether the conditions laid down in s. 40A(7)(b) are satisfied or not. Now a provision, which is made in the books, cannot be equated to a claim made. A claim for deduction is larger in scope than deduction claimed on basis of provision. Therefore, a claim made on basis of accrued liability, which is allowable in computing commercial profits, is not hit by s. 40A(7) of the Act. There is no implied prohibition against the allowance of such a claim. 9. Shri Kaji then referred to the decision of the special Bench in case of Soft Beverages Pvt. Ltd. and submitted that very premises on which the said decision was based was not quite correct. It as much as, an expenditure never results in a liability. Shri Kaji, then referred to the decision in case of Nagri Mills Ltd. vs. CIT 131 ITR 251 and submitted that in accordance with the above binding decision the claim for deduction based on actuarial valuation in respect of an accrued liability is allowable u/s 28 of the Act. Therefore, in accordance with the said decision, the assessee's claim would be tenable as provisions of s. 40A(7) do not apply to a case of accrued liability. Refering to the decision of Calcutta High ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Act. In other words, according to Shri Mittal, a claim for deduction in regard to provision for gratuity whether actually debited in the books or otherwise has to be found within the four corners of s. 40A(7) of the Act This section has put a statutory bar for allowance of deduction in regard to any provision for grautity by whatever name called. Now accrued liability cannot be considered de hors the provision. In other words, an accrued liability can be equated to provision less the actual payment. It was also not possible to accept the contention raised on behalf of the assessee, based on the ground that provisions of s. 40A(7) would not affect a deduction of commercial principles which would be otherwise allowable u/s 28 of the Act. In this connection, Shri Mittal pointed out that s. 40A(3) of the Act lays down that if any expenditure is incurred in excess of Rs. 2,500 the said expenditure would not be allowable unless the payment was made by cross cheque or cross draft, subject, of course, to the provisions contained in r. 6DD of the IT Rules. Now, whether the payment was made towards purchases, i.e., in the nature of direct expenditure or whether any indirect expenditure was i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... system of accounting it had decided to switch over the cash system of accounting in regard to gratuity liability. Shri Mittal then referred to the decision of Nagri Mills and pointed out that if the principle laid down in the said decision was considered along with the provisions of s. 40A(7), then the assessee's claim to certainly stand disallowed. In particular, he referred to the observation at page 273 of the report which states that if in a given case, the ITO finds that provision for such accrued liability has not been made in the books of account for an oblique purpose or that income cannot be properly deduced for want of entries or for some such or similar reason, such a case might stand on a different footing and the claim for deduction may be validly rejected in such a case. No such claim can be just rejected solely on the ground of want of entry or provision in the books of account, unless there is something more. Now, this observation, if viewed in proper light, would certainly stand in the way of the assessee for allowance of its claim. It was submitted that assuming for the sake of argument that the above contention based on the ground that the assessee has switched ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... h a claim, therefore, would be outside the scope of s. 40A(7). 13. On consideration of the rival submissions as set out in detail in the foregoing paragraphs I find that the first point which calls for decision is in regard to the method of accounting employed by the assessee in regard to the claim for deduction of the gratuity liability. I must state here that both the ld. brothers have proceeded on the footing that the assessee has been following mercantile system of accounting. The point regarding the change in method of accounting, as was placed before me, was not considered by them presumably because the same was not placed before them. Be that as it may, since the point of difference, as placed before me, is wide enough to consider the question of deduction of the amount in question claimed as a gratuity liability. I first proceed to deal with the question relating to the method of accounting qua deduction of gratuity following mercantile system of accounting. It is, however, pertinent to note that the director's report dt. 7th May,1975 relating to the year ending 31st Dec., 1974 mentions the following noting in regard to the gratuity liability: 'Gratuity' The compan ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r years no provision for gratuity in respect of the employees in service has been made and the gratuity amount actually paid during the year has been duly debited. This fact also supports the noting made by the directors to the effect that they have changed over the method of accounting from mercantile to cash in respect of the gratuity liability. Now Shri Kaji has placed before me a certificate dt. 5th Feb., 1982 stating that the assessee proposed to switch over to the cash basis of accounting but did not choose to do so on advice from their accountants. This certificate now placed before me reveals the position which is quite contrary to what the directors had in effect decided and acted upon. The notes appended to the accounts as also the director's report, as also entire in the books, clearly show that the as has switched over to the cash system of accounting. It is new too late for assessee company to resile from the position. It is also not possible to hold otherwise because the directors were fully aware of the implications of the proposed change in the Finance Bill, 1975 under which s. 40A(7) was proposed to be introduced retrospectively, which would have covered the assess ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... may be, before the claim for deduction of gratuity could be allowed. The s. 40A(7), as set out in para 9 of the order of the ld. J.M. as is relevant for my purpose reads as follows: "(a) Subject to the provisions of cl. (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 (e) 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 approved 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 previous year relevant to any assessment year commencing on or after the 1st day of April, 1973, but before the 1st day of April, 1976, to the extent the amount of such provision does not exceed the admissible amount, if the following conditions are fulfilled, namely: (1) the provision is made in accordance with an actuarial valuation of the ascertainable liability of the asses ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ovision if the said valuation, is based in the manner indicated above. The provision it may be stated need not be made in the accounts. Now so far as this aspect of the matter is concerned, I may refer to the decision of the Gujarat High court in case of Nagri Mills Ltd. Their Lordships after examining various authorities on the subject were pleased to observe of the report as follows : "The decision in Metal Box Company of India Ltd. vs. Their Workmen (1969) 73 ITR 53 (SC) leaves no room for doubt that the deduction by way of expenditure of a sum paid by the assessee as contribution towards an approved gratuity fund set up under s. 36 (1)(v) is not the only permissible deduction. The statutory provision in that behalf does not negative the alternative of deduction from the gross receipts of an estimated liability for gratuity, even if it amounts to a contingent liability, while preparing the profit and loss account, if such liability is properly ascertainable and its present value is fairly discounted. In our opinion, therefore, the assessee's claim in the instant case that it was entitled to charged against its gross receipts for the calendar year 1967, the cost of making prov ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is made in the statute on the ground of ordinary commercial principles. However, there is a built-in limit for allowance of such a claim for deduction, i.e., that there is no prohibition against the allowance of such claim either express or implied in the Act. Therefore, the claim for deduction on commercial principles has to be subjected to a statutory prohibition, if any. Now looking to the scheme of the Act and the purpose and purport of introduction of s. 40A(7), it is clear to my mind that a deduction in respect of gratuity liability could be allowed if the requisite conditions laid down in the section were fulfilled. In other words, s. 40A(7) acts as a statutory prohibition against the allowance of claim for deduction of gratuity liability even if the same is claimed of general commercial principles. 14. There is yet one more reason which has inclined me to take the above view. In Nagri Mills' case, it is observed as follows: "If in a given case, the ITO finds that provision for such accrued liability has not been made in the books of account for an oblique purpose or that that income cannot be properly deduced for want of entries or for some such or similar reason suc ..... X X X X Extracts X X X X X X X X Extracts X X X X
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