Madras High Court
Commissioner Of Income-Tax vs Indira Cotton Mills (P) Ltd. on 19 October, 1994
Equivalent citations: [1995]215ITR36(MAD)
JUDGMENT Mishra, J.
1. This reference under s. 256(2) of the IT Act, 1961 (hereinafter referred to as "the Act"), has brought before us a question "Whether, on the facts and in the circumstances of the case and having regard to the provisions of s. 40A(7) of the IT Act, 1961, the Tribunal was right in holding that the assessee is entitled to the deduction of Rs. 1,92,871 representing provision for gratuity relating to the asst. yr. 1972-73 and earlier years from the income of the asst. yr. 1973-74 ?"
In course of the hearing, we have felt persuaded to modify the question and split it in two parts, but before we do so, we may take into consideration the statement of the case.
2. The assessee is a private limited company, its business being manufacture and sale of cotton yarn. For the asst. yr. 1973-74, it claimed that a sum of Rs. 2,23,224 be deducted from the assessable income in the asst. yr. 1973-74. The ITO disallowed the same on finding that a sum of Rs. 1,92,871 representing provision for gratuity related to earlier years ending on 31st March, 1972, and the assessee had not complied with the provisions of s. 40A(7) of the Act in respect of the incremental liability represented by the balance of Rs. 31,353. On appeal, the AAC held that since the assessee had paid Rs. 1,92,871 into a trust in the year 1975, the liability crystallised only in that year and could not be related to the asst. yr. 1973-74. With regard to the balance, the AAC held that the claim could be considered only if the conditions provided under s. 40A(7) were fulfilled. The Tribunal on further appeal by the assessee, however, found that the gratuity scheme of the assessee had been approved by the CIT w.e.f. 1st April, 1975, by his order dt. 17th Dec., 1978. Thus, according to the Tribunal, the provisions of s. 40A(7)(b)(ii) of the Act would apply to the amount of Rs. 1,92,871. About the balance, the Tribunal found that since the assessee had maintained its accounts on the mercantile basis, it rightly claimed deduction in the financial year 1973-74 in which year the liability crystallised. The Revenue sought a reference of the above question which the Tribunal declined at the first instance. It moved this Court in T. C. (R.) No. 599 of 1981. The Court directed and the Tribunal accordingly has made the reference.
3. The statement of the case is not complete unless it is noticed that the legislature felt the need of a law to provide to the employees a terminal lump sum benefit called "gratuity", and Parliament enacted the Payment of Gratuity Act, 1972, providing for a scheme for the payment of gratuity to employees engaged in factories, mines, oil fields, plantations, shops and other establishments, ports, railway companies and for matters connected therewith or incidental thereto. Some States, however, felt the need for such a legislation even earlier and for workers engaged in factories, plantations, shops and other establishments in the States of Kerala and West Bengal, some legislations on gratuity were adopted and enforced, that is, in Kerala in 1971, and in West Bengal first by an Ordinance and later replaced by an Act in the year 1971. Besides legislations in Kerala and West Bengal, there were some employers who had their own schemes of gratuity for their employees and they paid to the employees gratuity under such schemes in lump sum on their retirement or otherwise on termination of service and in some industries in particular to settle industrial disputes, schemes were framed making specific provisions for the payment of gratuity. The Gratuity Act contemplated enforcement of its provisions on a day specified by the State Governments and it is not in dispute that in the State of Tamil Nadu, the Act has come into force w.e.f. 16th Sept., 1972. Gratuity, which until then, except under the two legislations abovementioned, was either a gift or a result of settlement of industrial disputes, changed under the Gratuity Act which has created a right to gratuity on determination of employment on such conditions having been fulfilled as are contemplated in its provisions as a reward for good, efficient and favourable service rendered by an employee for a considerable period. It has thus protected any person (other than an apprentice) employed on wages, not exceeding a specified sum of money per mensem or such higher amount as the Central Government may, having regard to the general level of wages by notification, specify, in any establishment, factory, mine, oilfield, plantation, port, railway company or shop, to do any skilled, semi-skilled or unskilled, manual, supervisory, technical or clerical work, whether the terms of such employment are express or implied, and whether or not such person is employed in a managerial or administrative capacity from exploitation except such persons who hold a post under the Central Government or a State Government and are governed by any other Act or by any rules providing for payment of gratuity [see definition of "employee" in s. 2(e) of the Payment of Gratuity Act, 1972] and made such employee entitled to gratuity on the termination of his employment after he had rendered continuous service for not less than five years on his superannuation, or on his retirement or resignation, or on his death or disablement due to accident or disease, in the last case the period of completion of continuous service of five years was/is not necessary [see s. 4 of the Payment of Gratuity Act, 1972]. The Act has fixed a ceiling and prescribed how the amount of gratuity would be paid, in the case of a dispute determined and in case the employer failed to pay, recovered for the benefit of the employee. The obligation in this behalf is stated in s. 7 of the Gratuity Act, 1972, in these words :
"7. Determination of the amount of gratuity. - (1) A person who is eligible for payment of gratuity under this Act or any person authorised, in writing, to act on his behalf shall send a written application to the employer, within such time and in such form, as may be prescribed, for payment of such gratuity.
(2) As soon as gratuity becomes payable, the employer shall, whether an application referred to in sub-s. (1) has been made or not, determine the amount of gratuity and give notice in writing to the person to whom the gratuity is payable and also to the controlling authority specifying the amount of gratuity so determined.
(3) The employer shall arrange to pay the amount of gratuity, within thirty days from the date it becomes payable to the person to whom the gratuity is payable.
(3A) If the amount of gratuity payable under sub-s. (3) is not paid by the employer within the period specified in sub-s. (3), the employer shall pay, from the date on which the gratuity becomes payable to the date on which it is paid, simple interest at such rate, not exceeding the rate notified by the Central Government from time to time for repayment of long-term deposits, as that Government may, by notification specify :
Provided that no such interest shall be payable if the delay in the payment is due to the fault of the employee and the employer has obtained permission in writing from the controlling authority for the delayed payment on this ground.
(4)(a) If there is any dispute as to the amount of gratuity payable to an employee under this Act or as to the admissibility of any claim of, or in relation to, an employee for payment of gratuity, or as to the person entitled to receive the gratuity, the employer shall deposit with the controlling authority such amount as he admits to be payable by him as gratuity.
(b) Where there is a dispute with regard to any matter or matters specified in cl. (a), the employer or employee or any other person raising the dispute may make an application to the controlling authority for deciding the dispute.
(c) The controlling authority shall, after due inquiry and after giving the parties to the dispute a reasonable opportunity of being heard, determine the matter or matters in dispute and if, as a result of such inquiry any amount is found to be payable to the employee, the controlling authority shall direct the employer to pay such amount, or, as the case may be, such amount as reduced by the amount already deposited by the employer.
(d) The controlling authority shall pay the amount deposited, including the excess amount, if any, deposited by the employer, to the person entitled thereto.
(e) As soon as may be after a deposit is made under cl. (a), the controlling authority shall pay the amount of the deposit -
(i) to the applicant where he is the employee; or
(ii) where the applicant is not the employee, to the nominee or, as the case may be, the guardian of such nominee or heir of the employee if the controlling authority is satisfied that there is no dispute as to the right of the applicant to receive the amount of gratuity.
(5) For the purpose of conducting an inquiry under sub-s. (4), the controlling authority shall have the same powers as are vested in a Court, while trying a suit, under the Code of Civil Procedure, 1908 (5 of 1908), in respect of the following matters, namely :
(a) enforcing the attendance of any person or examining him on oath;
(b) requiring the discovery and production of documents;
(c) receiving evidence on affidavits;
(d) issuing commissions for the examination of witnesses.
(6) Any inquiry under this section shall be a judicial proceeding within the meaning of ss. 193 and 228, and for the purpose of s. 196 of the Indian Penal Code, 1860 (45 of 1860).
(7) Any person aggrieved by an order under sub-s. (4) may, within sixty days from the date of the receipt of the order, prefer an appeal to the appropriate Government or such other authority as may be specified by the appropriate Government in this behalf :
Provided that the appropriate Government or the appellate authority, as the case may be, may, if it is satisfied that the appellant was prevented by sufficient cause from preferring the appeal within the said period of sixty days, extend the said period by a further period of sixty days :
Provided further that no appeal by an employer shall be admitted unless at the time of preferring the appeal, the appellant either produces a certificate of the controlling authority to the effect that the appellant has deposited with him an amount equal to the amount of gratuity required to be deposited under sub-s. (4), or deposits with the appellate authority such amount.
(8) The appropriate Government or the appellate authority, as the case may be, may, after giving the parties to the appeal a reasonable opportunity of being heard, confirm, modify or reverse the decision of the controlling authority."
4. In the Chapter which contained/contains provisions for computation of total income for the purposes of imposition of tax, a provision is specifically introduced by s. 7 of the Finance Act of 1968 specifying the expenses or payments not deductible in certain circumstances. (Sec. 40A of the Act). Sub-s. (7) of this section has made a specific provision in these words :
"(7)(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 cl. (a) 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 assessee for payment of gratuity to his employees on their retirement or on termination of their employment for any reason;
(2) the assessee creates an approved gratuity fund for the exclusive benefit of his employees under an irrevocable trust, the application for the approval of the fund having been made before the 1st day of January, 1976; and (3) a sum equal to at least fifty per cent. of the admissible amount, or where any amount has been utilised out of such provision for the purpose of payment of any gratuity before the creation of the approved gratuity fund, a sum equal to at least fifty per cent. of the admissible amount as reduced by the amount so utilised, is paid by the assessee by way of contribution to the approved gratuity fund before the 1st day of April, 1976, and the balance of the admissible amount or, as the case may be, the balance of the admissible amount as reduced by the amount so utilised, is paid by the assessee by way of such contribution before the 1st day of April, 1977.
Expln. 1. - For the purposes of sub-cl. (ii) of cl. (b) of this sub-section, 'admissible amount' means the amount of the provision made by the assessee for the payment of gratuity to his employees on their retirement or on termination of their employment for any reason, to the extent such amount does not exceed an amount calculated at the rate of eight and one-third per cent. of the salary [as defined in cl. (h) of r. 2 of Part A of the Fourth Schedule] of each employee entitled to the payment of such gratuity for each year of his service in respect of which such provision is made.
Expln. 2. - For the removal of doubts, it is hereby declared that where any provision made by the assessee for the payment of gratuity to his employees on their retirement or on termination of their employment for any reason has been allowed as a deduction in computing the income of the assessee for any assessment year, any sum paid out of such provision by way of contribution towards an approved gratuity fund or by way of gratuity to any employee shall not be allowed as a deduction in computing the income of the assessee of the previous year in which the sum is so paid."
Sub-s. (1) of this s. 40A of the Act contained/contains a provision that the provisions of this section shall have effect notwithstanding anything to the contrary contained in any other provision of this Act relating to the computation of income under the head "Profits and gains of business of profession". Clause (b) of sub-s. (7) of s. 40A, which extended in the relevant year of assessment to the assessee of any deduction in the computation of the total income chargeable under the head "Profits and gains of business or profession", in relation to any provision made by it for the purposes 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 had/has become payable during the previous year relevant to the asst. yr. 193-74, i.e., assessment year commencing on or after the 1st day of April, 1973, but before the 1st day of April, 1976, deduction to the extent of the amount not exceeding the admissible amount on fulfilling conditions :
(1) the provision was/is made in accordance with the actuarial valuation of the ascertainable liability of the assessee for payment of gratuity to his employees on their retirement or on termination of their employment for any reason;
(2) on the assessee creating an approved gratuity fund for the exclusive benefit of his employees under an irrevocable trust, the application for the approval of the fund having been made before the 1st day of January, 1976; and (3) by paying to the said fund a sum equal to at least fifty per cent. of the admissible amount, or where any amount had been utilised out of such provision for the purpose of payment of any gratuity before the creation of the approved gratuity fund, a sum equal to at least fifty per cent. of the admissible amount as reduced by the amount so utilised, before the 1st day of April, 1976, and the balance of the admissible amount or, as the case may be, the balance of the admissible amount as reduced by the amount as utilised by way of such contribution before the 1st day of April, 1977.
5. There is no controversy to the fact before us that the assessee created an irrevocable trust and paid to the said fund the entire amount of gratuity of its employees and that amount on which deduction is claimed for the year 1973-74 by it, i.e., Rs. 1,92,871, is within the limits of the admissible amount. The facts not in controversy thus are :
(1) The assessee has created an irrevocable trust before the 1st day of January, 1976, which fund has been duly approved in the year 1978 by the competent authority and has transferred the contributions to the said funds before the due date;
(2) It has claimed deduction only as respects the payment of gratuity to the employees in the financial year 1972-73. This fact is clearly established by the fact that the liability under the Payment of Gratuity Act, 1972, itself had arisen after September, 1972.
6. On the facts as above, thus, the questions to be answered are :
(1) Having created the irrevocable trust in the year 1975 and having transferred the gratuity payable to its employees before the due date when the liability itself had been created in the financial year 1972-73, whether the assessee fulfilled the conditions as stipulated under s. 40A(7)(b) of the Act ?
(2) Whether the Tribunal is right in holding that the liability for the assessment years, if at all, crystallised during 1972-73 for all such employees who retired on or before 31st March, 1973, in that year and similarly incremental liability for gratuity of such employees also crystallised until the end of the said financial year and was payable to its existing employees on the basis of actuarial valuation thus deductible in the said financial year.
It will only be a repetition of a principle that has been stated so many times by the Courts that the payment of gratuity is a statutory liability created under the Payment of Gratuity Act, 1972, and it can normally be said to have arisen in the carrying on of business and for gratuity to be deductible under the IT Act, 1961, it must fulfil the conditions laid down in s. 40A(7) of the Act. [see Peoples Engineering & Motor Works Ltd. vs. CIT ].
7. The provisions of s. 40A of the Act will have effect notwithstanding anything to the contrary contained in any other provisions of the Act relating to computation of income under the head "Profits and gains of business or profession". They would have effect notwithstanding anything contained in ss. 30 to 39 of the Act and as prescribed under cl. (a) of sub-s. (7) thereof 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. This provision, however, is subject to the prescription contained in cl. (b) thereof. Clause (b)(i) excludes from the operation of cl. (a) contribution to an approved gratuity fund and the amount provided for or set apart for payment of gratuity which would be payable during the year of account. Clause (b)(ii) deals with a situation where the assessee makes provision by the spread over method and provides that such provision would be excluded from the operation of cl. (a) provided the three conditions laid down by the aforementioned sub-clause are satisfied, that is : (1) the provision being made in accordance with an actuarial valuation of the ascertainable liability; (2) the assessee creating an approved gratuity fund for the exclusive benefit of the employees under an irrevocable trust; and (3) at least 50 per cent. of the admissible amount has been paid by the assessee by way of contribution to the gratuity fund before 1st April, 1976, and the balance of the amount paid on or before 1st April, 1977. The last two conditions, it is conceded, are satisfied. The first, however, has to be understood in the light of the first Explanation that the admissible amount of deduction should not exceed eight and one-third per cent. of the salary of each employee entitled to the payment of such gratuity for each year of his service in respect of which such provision is made and the second Explanation, where any provision made by the assessee for the payment of gratuity to his employees on their retirement or on termination of their employment for any reason has been allowed as a deduction in computing the income of the assessee for any assessment year, any sum paid out of such provision by way of contribution towards an approved gratuity fund or by way of gratuity to any employee shall not be allowed as deduction in computing the income of the assessee of the previous year in which the sum is so paid.
8. The relevancy of the second Explanation in the matter before us cannot be denied, but on the facts that are made available to us, it is certain that the assessee has not been allowed any deduction in computing the income for the asst. yr. 1972-73 or any previous year on account of payment of gratuity to the employees. The assessee has made the provision in accordance with an actuarial valuation of the ascertainable liability for payment of gratuity to its employees on their retirement or on termination of their employment for any reason during the said financial year and the statutory liability, that is, the liability where the employee retired previous to the enforcement of the Payment of Gratuity Act or thereafter but before 31st March, 1973, crystallised only in the financial year 1972-73.
9. In Shree Sajjan Mills Ltd. vs. CIT , the Supreme Court has dealt with this aspect of the law and stated :
"Although payment of gratuity is made on retirement or termination of service, it is not for the services rendered during the year in which the payment is made but it is made in consideration of the entire length of service and its ascertainment and computation depend upon several factors. The right to receive the payment accrues to the employees on their retirement or termination of their services and the liability to pay gratuity becomes an accrued liability of the assessee, when the employees retire or their services are terminated. Until then, the right to receive gratuity is a contingent right and the liability to pay gratuity continues to be a contingent liability qua the employer.
Contingent liabilities do not constitute expenditure and cannot be the subject-matter of deduction even under the mercantile system of accounting. Expenditure which is deductible for income-tax purposes is towards a liability actually existing at the time but setting apart money which might become expenditure on the happening of an event is not expenditure."
10. Testing the facts of the case on the touchstone of the law as above, had the assessee claimed deduction in respect of contingent liabilities, i.e., the right to receive the payment is yet to accrue to the employees, it obviously had made a wrong claim. It is not in dispute before us, however, that the claim is made only of such amount of gratuity to which employees on their retirement or termination of their service had become entitled. The claim is in respect of a liability that under the Payment of Gratuity Act, the assessee was obliged to discharge for such employees who had already retired or otherwise been superannuated or whose services had already been terminated before 31st March, 1973. For payment of gratuity to such employees, it made the funds available in the irrevocable trust which had been created in accordance with the requirement of s. 40A(7)(b)(ii) of the Act.
11. On the basis of the above, we have no hesitation in answering the two questions abovementioned against the Revenue and in favour of the assessee. No costs.