Income Tax Appellate Tribunal - Mumbai
Wealth-Tax Officer vs H.M. Dalal on 28 January, 1987
Equivalent citations: [1987]21ITD272(MUM)
ORDER
Rajendra, Accountant Member
1. As common points are involved in both, these appeals by the revenue, they are heard together and disposed of by a consolidated order.
2. The assessee is an individual. The relevant valuation dates are 31-10-1978 (Samvat year 2035) for the assessment year 1979-80 and 21-10-1979 (Samvat year 2036) for the assessment year 1980-81.
3. The first common controversy is regarding the inclusion of the assessee's credit balance in CDS account of Rs. 82,762 in the assessment year 1979-80 and of Rs. 1,03,142 in the assessment year 1980-81. The Commissioner (Appeals) had deleted the said amounts following the Tribunal Delhi Bench decision in WTO v. S.D. Nargolwala [1983] 5 ITD 690. The Tribunal, Special Bench, Bombay has since held in Smt. Sushilaben A. Mafatlal v. WTO [1986] 18 ITD 189 that the credit balance in CDS account is includible in the assessee's net wealth. Following the said decision, we vacate the orders of the Commissioner (Appeals) and restore those of the WTO for both the years.
4. The next controversy is regarding the deduction of gratuity liability while valuing under Rule ID of the Wealth-tax Rules, 1957 ('the Rules') unquoted equity shares held by the assessee in both the years. In the assessment year 1979-80 the WTO added Rs. 75,137 and in the assessment year 1980-81 Rs. 49,652 as detailed below :
Assessment year Assessment year
1979-80 1980-81
Rs. Rs.
(i) Cambridge Instruments
(I) Ltd. 13,373 10,194
(ii) J.N. Marshall (P.) Ltd. 48,459 30,341
(iii) Sepulchre Bros. (I) Ltd. 5,544 6,266
(iv) Simmonds Marshall Ltd. 836 429
(v) Spirax Marshall Ltd. 6,925 2,422
75,137 49,652
5. The Commissioner (Appeals) in his consolidated order for both the years vide paragraph 8, held that the gratuity liability as actuarially valued was an allowable deduction. He followed his order for the assessment year 1977-78. In the assessment year 1977-78 the Commissioner (Appeals) followed Tata Iron & Steel Co. Ltd. v. D.V. Bapat, ITO [1975] 101 ITR 292 where the Bombay High Court had referred to the Supreme Court decisions under the Wealth-tax Act, 1957 ('the Act') of Standard Mills Co. Ltd. v. CWT [1967] 63 ITR 470 and Bombay Dyeing & Mfg. Co. Ltd. v. CWT [1974] 93 ITR 603 and under the Payment of Bonus Act, 1965 of Metal Box Co. of India Ltd. v. Their Workmen [1969] 73 ITR 53 and had held that provision for gratuity based on actuarial valuation was allowable as deduction under the Income-tax Act, 1961 ('the 1961 Act'). The said Bombay High Court decision has since been set aside by the Supreme Court in D.V. Bapat, ITO v. Tata Iron & Steel Co. Ltd. [1986] 159 ITR 938 where the Supreme Court has directed the Bombay High Court to decide the matter afresh in the light of the Supreme Court decision in Shree Sajjan Mills Ltd. v. CIT [1985] 156 ITR 585 and to examine whether the said assessee satisfied the conditions of Section 40A(7)(&)(ii) of the 1961 Act. In view of the fact that the aforesaid decision of the Bombay High Court (rendered under the 1961 Act) has since been set aside, we will not further discuss the said judgment.
6. Reverting to the Commissioner (Appeals)'s order, we further note that he relied on Smt. Kusumben D. Mahadevia v. CWT [1980] 124 ITR 799 (Bom.) where it was held that Rule 1D prescribing the break-up method of valuation of unquoted equity shares was directory and not mandatory and that the proper method for valuation of shares was yield method. However, even after noting the said, decision, the Commissioner (Appeals) directed that the only variation the WTO should make in the value of unquoted equity shares as per Rule 1D read with Section 7 of the Act was to allow deduction of gratuity liability. The Commissioner (Appeals)'s directions are self-contradictory because if shares are to be valued by yield method then Rule 1D has to be ignored which follows break-up method for valuation of shares and which method the Supreme Court did not approve in CWT v. Mahadeo Jalan [1972] 86 ITR 621 (which decision was rendered before the introduction of Rule 1D) and which decision of the Bombay High Court was followed in Smt. Kusumben D. Mahadevia's case (supra). However, as the Commissioner (Appeals) has directed that only gratuity liability should be deducted and has not interfered with the other portion of valuation of shares by the WTO under Rule 1D and as only the revenue is in appeal before us objecting to the deduction of gratuity liability, we proceed on the basis that the shares are to be valued under Rule 1D and that the limited question we have to decide is whether deduction for gratuity is to toe allowed under Rule 1D.
7. We note that under Rule 1D, Explanation II, Clause (ii) directs that following items shown as liability in the balance sheet shall not be treated as liabilities :
(f) any amount representing contingent liabilities.
8. Thus, Rule 1D clearly directs that any amount representing contingent liabilities though shown in the balance sheet as liability, will not be treated as liabilities. The language of the said sub-clause, according to us, is quite clear to shut out not only contingent liabilities shown as such in the balance sheet but even the actuarial valuation of the said future contingent liability because the said actuarial valuation would represent the contingent liability for gratuity which is to arise in future. Even if gratuity liability is held to be present liability, still under said sub-clause it would be shut out being a contingent liability. We contrast the language of the aforesaid sub-clause with Clause (c) of Rule 2E of the Rules which directs that 'any provision made for meeting any future or contingent liability' should not be taken into account for the purposes of Rule 2A of the Rules under which the net value of assets of business as a whole is determined having regard to balance sheet of such business under Section 7(2)(a).
9. We may now refer to the Supreme Court decisions holding that gratuity is contingent liability. The Supreme Court in Standard Mills Co. Ltd.'s case (supra) held that liability for gratuity to employees under the Industrial Court Awards was not deductible as debt owed on valuation date because liability to pay gratuity to its employees on determination of employment was a mere contingent liability which arose only when employment of employee was determined by death, incapacity, retirement or resignation" the liability did not exist in praesenti and, therefore, the amount claimed could not be deducted as debt in computing the net wealth of the assessee nor could such contingent liability be taken into account in computing the net value of the assets of the assessee under Section 7(2)(a). The Supreme Court had considered Southern Railway of Peru Ltd. v. Owen (Inspector of Taxes) [1957] 32 ITR 737 and had observed that the House of Lords in that case was concerned to determine the deductibility of present value of a liability which may arise in future in the computation of taxable profits for the relevant year under the 1961 Act but, "same considerations cannot, however, apply to the case under the Wealth-tax Act, where the liability to pay wealth-tax is charged upon the net wealth of an assessee". The Supreme Court disapproved observations of the Gujarat High Court in CWT v. New Rajpur Mills Ltd. [1965] 56 ITR 544 to the effect that since contingent liabilities can be taken into account while computing the net wealth of the assessee under Section 7(2)(a), liability for payment of gratuity under such agreements will have to be estimated and an estimated value of the contingent liability would be a permissible deduction in computing the net wealth of the assessee. In view of the Supreme Court specifically disapproving of the aforesaid observations of the Gujarat High Court, we are unable to accept the assessee's contention that the estimated present value (determined actuarially) of gratuity liability should be allowed as a deduction. The Supreme Court at page 477 (last paragraph) reiterated that the Gujarat High Court in New Rajpur Mills Ltd.'s case (supra) had not appreciated the true function of Section 7(2)(a) because the said section does not deal with the computation of net wealth but with the computation of aggregate value of assets. In view of the said categorical observations of the Supreme Court, we are unable to accept the assessee's contentions for allowing deduction of present value of the contingent liability for gratuity.
10. The assessee's main plank for attacking the aforesaid Supreme Court decision in Standard Mills Co. Ltd.'s case (supra) is the observations of the Supreme Court in Metal Box Co. of India Ltd.'s case (supra) where while dealing with the Payment of Bonus Act, the Supreme Court observed that the company's profits should be determined on commercial principles for the purpose of ascertaining the profits which are available for distribution as bonus to employees. In this context, the Supreme Court observed at pages 64-65 that "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." An estimated liability under a scheme of gratuity, if properly ascertainable and its present value is discounted, is deductible from the gross receipts while preparing the profit and loss account. This is recognised in trade circles and there is nothing in the Payment of Bonus Act which prohibits such a practice and, therefore, such a provision is not a reserve. In this context, the Supreme Court referred to Southern Railway of Peru Ltd.'s case (supra) and observed at page 67 : "In our view, an estimated liability under gratuity schemes such as ones before us, even if it amounts to a contingent liability and is not a debt under the Wealth-tax Act, if properly ascertainable and its present value is fairly discounted is deductible from the gross receipts while preparing the profit and loss account." [Emphasis supplied]
11. The said observations clearly show that the Supreme Court was specifically dealing with the Payment of Bonus Act and did not cast any doubts on the observations made in Standard Mills Co. Ltd.'s case (supra) that liability under gratuity scheme was a contingent liability and was not a debt under the Act. The Supreme Court had earlier discussed Standard Mills Co. Ltd.'s case (supra) at page 64 and had distinguished the case of Metal Box Co. of India Ltd. (supra) from that of Standard Mills Co. Ltd. (supra) by observing that the question before the Court in Metal Box Co. of India Ltd.'s case (supra) was "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. Even if the liability is a contingent liability, provided its discounted present value is ascertainable, it can be taken into account".
12. Thus, it is clear to us that the Supreme Court in Metal Box Co. of India Ltd.'s case (supra) was not casting any doubts on the correctness of the view taken in Standard Mills Co. Ltd.'s case (supra). This was reiterated by the Supreme Court in Bombay Dyeing & Mfg. Co. Ltd.'s case (supra) where it was observed "Metal Box Co.'s case [1969] 73 ITR 53 was a decision rendered under the Bonus Act. In that decision the learned Judges referred to the decision of Standard Mills Co. Ltd. [1967] 63 ITR 470, and distinguished the same. In our opinion there is no conflict between the two decisions." The Supreme Court, therefore, reiterated that the decision in Standard Mills Co. Ltd.'s case (supra) did not need reconsideration and, therefore, there was no justification for referring the Bombay Dyeing & Mfg. Co. Ltd.'s case (supra) to a, larger Bench for reconsideration of the decision in Standard Mills Co. Ltd.'s case (supra). In the said case also, the company's liability in respect of gratuity was in terms of the Industrial Court Awards for the benefit of its employees.
13, We may note that the Bombay High Court in Tata Iron & Steel Co. Ltd.'s case (supra), which has since been set aside by the Supreme Court as noted above, while dealing with deduction under Section 36(1)(v) of the 1961 Act, had held following Metal Box Co. of India Ltd.'s case (supra) that the gratuity liability as actuarially determined is allowable as deduction under the 1961 Act. As the decision has since been set aside, we, therefore, need not discuss this decision in further detail. In this context, we may note that the Supreme Court in Shree Sajjan Mills Ltd.'s case (supra) reiterated that liability to pay gratuity continues to be a contingent liability for the employer because right to receive gratuity accrues to the employees on their retirement or termination of their services and liability to pay gratuity becomes accrued liability of the assessee when the employees retire or their services are terminated and till then the right to receive gratuity was a contingent right and the liability to pay gratuity continued to be a contingent liability for the employer.
14. We are now left with CWT v. S. Ram [1984] 147 ITR 278 on which the assessee relies heavily. The Madras High Court in that case was dealing with, inter alia, valuation of unquoted shares held by the assessee in T.V.S. group of companies who had entered into a scheme for gratuity by agreement dated 3-7-1971 with effect from 31-3-1971 and under which scheme trusts were created for implementation of gratuity scheme. The Madras High Court noted that gratuity liability was a contingent liability but observed that as the said liability becomes a debt due by the employer to the employee on the termination of employee's service, therefore, the employer must provide funds which should be available when such eventuality arises and, therefore, when an actuarial calculation is made of such future liability, then it is proper charge against the profits of the year which is provided in the accounts. They noted the Supreme Court's observations in Vazir Sultan Tobacco Co. Ltd. v. CIT [1981] 132 ITR 559 whether provision for gratuity was a provision of reserve under the Super Profits Tax Act, 1963, and the Companies (Profits) Surtax Act, 1964, that the actuarial valuation of the estimated liability was a provision representing fairly accurately known and existing liability.
15. The Madras High Court at page 282 noted that although gratuity depends on the happening of a contingency for purposes of actual payment, the only elements of uncertainty are-
(i) When exactly the liability becomes payable in the case of each workman, and (ii) how much would be the amount which becomes due for payment.
The Court, however, observed that if notwithstanding these two elements of uncertainty, it is yet possible to arrive on an actuarial basis at the present discounted value of liability to pay gratuity, payable in future, then, according to well-accepted principles of commercial trading and commercial accounting, an employer is entitled to make the provision in the balance sheet equivalent to the discounted value or equivalent to the incremental value after charging the provision to profit and loss account, because it is a current provision for a present discounted value of the future liability. The Madras High Court quoted with approval a Tribunal's decision where it was held that in case of gratuity under an agreement or scheme, collective liability is certain to arise and only the extent of liability would vary as in any particular year. The liability towards particular employee may be contingent but the cumulative or collective liability of the company towards the employees in general is a certain liability and the extent of the liability would depend on contingencies that may take place in each employee in a particular year. The Madras High Court following Vazir Sultan Tobacco Co. Ltd.'s case (supra) held that provision for gratuity is a current provision and is a proper charge against the profits of the year. The Madras High Court followed its earlier decision in CWT v. S. Ramaswami [1983] 140 ITR 606 where the company was under an obligation to make over annual sums equivalent to the incremental value of gratuity to the gratuity trust because under the very terms of the scheme, the amounts ascertained on actuarial valuation became a debt by the company to the gratuity trust. Though in the case of S. Ram (supra) in the relevant year no amounts were transferred to the gratuity trust because the trust had not yet come into existence under agreement dated 3-7-1971, the High Court still held following S. Ramaswami's case (supra) that provision for gratuity was allowable deduction for valuing shares under Rule ID. At page 287 the High Court distinguished 'gratuity' and 'provision for gratuity'. They held that though gratuity may be a contingent liability, but a provision for gratuity made on actuarial basis represented the present discounted value of the employer's commitment as a whole to pay his workmen gratuity as and when it becomes payable. The Madras High Court noted in S. Ram's case (supra) that in Standard Mills Co. Ltd.'s case (supra) it was held that gratuity was not debt due under Section 2(i) of the Act because it was a contingent liability and was not a debt owed in praesenti. They, however, distinguished Standard Mills Co. Ltd.'s case (supra) by observing that the Supreme Court was not concerned with a provision for gratuity. The High Court noted that the Supreme Court in Vasir Sultan Tobacco Co. Ltd.'s case (supra) had distinguished (at pages 575-576) Standard Mills Co. Ltd.'s case (supra) as being a case under the Act, but they still sought to follow Vazir Sultan Tobacco Co. Ltd.'s case (supra) in preference to Standard Mitts Co. Ltd.'s case (supra) while deciding the wealth-tax matter regarding the valuation of shares under Rule ID,
16. The Madras High. Court at page 289 preferred to follow Southern Railway of Peru Ltd.'s case (supra), Metal Box Co. of India Ltd.'s case (supra) and Vasir Sultan Tobacco Co. Ltd.'s case (supra). We have pointed out above that both in Metal Box Co. of India Ltd.'s case (supra) and Vasir Sultan Tobacco Co. Ltd.'s case (supra) the Supreme Court had steered clear of wealth-tax by observing that Standard Mills Co. Ltd.'s case (supra) held the field in wealth-tax. We have also pointed out above that the Supreme Court in Standard Mills Co. Ltd.'s case (supra) had discussed Southern Railway of Peru Ltd.'s case (supra) which was a case under the 1961 Act and had held that the same considerations cannot apply to a case under the 1957 Act.
17. We may, therefore, with respect, point out that the three cases relied upon by the Madras High Court in S. Ram's case (supra) do not support the conclusion arrived at by the Madras High Court in that case. According to our understanding, the Supreme Court throughout has been categorical in holding that under the 1957 Act gratuity being a contingent liability is not an allowable deduction. Explanation II(ii)(f) to Rule 1D clearly directs that any amount representing contingent liabilities is not to be allowed as liability. The words 'any amount representing contingent liabilities' would cover the present value of the future contingent liability and, therefore, the present discounted value on actuarial basis for future contingent liability cannot be allowed by backdoor while accepting that contingent liabilities are not allowable as deduction.
18. We may note that the Payment of Gratuity Act, 1972 clearly lays down under Section 4 as under :
Payment of gratuity.- (1) Gratuity shall be payable to an employee on the termination of his employment after he has rendered continuous service for not less than five years,-
(a) on his superannuation, or
(b) on his retirement or resignation, or
(c) on his death or disablement due to accident or disease :
Provided that the completion of continuous service of five years shall not be necessary where the termination of the employment of any employee is due to death or disablement:
Provided further that in the case of death of the employee, gratuity payable to him. shall be paid to his nominee or, if no nomination has been made, to his heirs.
19. Thus, gratuity is payable only in the contingencies mentioned above and is not a present liability under the said Act.
19.1 Dealing factually with the claim before us, we may point out that only in the case of Simmonds Marshall Ltd. a gratuity fund is claimed to have been set up. Further, only a part of liability had been provided in the accounts of the aferesaid five companies as detailed below :
--------------------------------------------------------------------------------------
Name of company Assessment year Assessment year
1979-80 1980-81
------------------------------------------------
Part of Balance Part of Balance
gratuity gratuity gratuity gratuity
provided liability provided liability
in noted in in noted in
accounts accounts accounts accounts
------------------------------------------------
1. Cambridge Instruments (India) Ltd. 72,790 1,15,217 52,262 89,678
2. J.N. Marshall (P.) Ltd. 1,32,432 5,67,605 1,36,072 3,02,228
3. Sepulchre Bros. (India) Ltd.
4. Simmonds Marshall 30,101 - 34,022 -
Ltd. 29,914 - 15,327 -
5. Spirax-Mar shall Ltd. 86,256 59,231 50,833 65,362
3,51,493 7,42,053 2,88,516 4,57,268
20. Thus, what is not provided in the accounts of the companies as gratuity liability cannot be allowed as a deduction. Further, there is no evidence that the aforesaid liability provided in the accounts or as per notes in the accounts (when not provided) was based on actuarial calculation.
21. We may point out that the Tribunal Bench 'A' in the assessee's case for the assessment year 1976-77 had followed the Bombay High Court decision in Tata Iron & Steel Co. Ltd.'s case (supra) which has since been set aside by the Supreme Court. They had also relied on S. Ram's case (supra). We have discussed in detail the Supreme Court decisions which we are following and that is the reason why we are not falling in line with the decision of the Tribunal, Bench 'A' in the assessee's case for the assessment year 1976-77.
22. In the result, we hold that gratuity liability is not allowable as deduction in view of Explanation II(ii)(f) of Rule 1D while valuing unquoted shares (held by the assessee) under the said rule. We accordingly vacate the Commissioner (Appeals)'a order on this point and restore that of the WTO for the assessment years 1979-80 and 1980-81.
23. The revenue's appeals for the assessment years 1979-80 and 1980-81 are accordingly allowed.