Income Tax Appellate Tribunal - Mumbai
Deputy Commissioner Of Income-Tax vs Associated Capsules (P) Ltd. on 5 November, 1998
ORDER
Pradeep Parikh, A.M.
1. The Department is in appeal before us against the order of the learned CIT(A) dt. 13th December, 1990 for asst. yr. 1987-88. The first ground is against the deletion of disallowance of Rs. 48,05,871 being the amount of provision for compensation under the voluntary retirement scheme.
2. The assessee-company is a manufacturer of empty hard gelatine capsules for use in pharmaceutical industries. It returned an income of Rs. 9,05,180 for the year under consideration. During the year, the assessee-company introduced a voluntary retirement scheme by a Notification dt. 6th June, 1986, and updated on 18th June, 1986, for its employees. In all 218 employees opted for voluntary retirement under the scheme. As per the terms of the scheme, assessee computed its liability at Rs. 91,33,219 exclusive of gratuity payable to them and debited the same in its accounts.
3. As per the scheme, the payment was to be made in two parts. Part I payment amounted to Rs. 43,27,348 which was to be paid before the end of the accounting year, i.e. before 31st August, 1986. Part II of the payment, termed as additional compensation, amounted to Rs. 48,05,871 and was to be paid 10 months after the date of retirement. Since the assessee was following mercantile system of accounting, it debited the entire amount of Rs. 91,33,219 in its accounts for the year, which obviously included the Part II amount of Rs. 48,05,871 in the form of provision as liability accrued during the year.
4. The AO did not dispute the revenue nature of the expenditure. However, taking into consideration several clauses of the scheme he came to the conclusion that the liability for Part II payment did not accrue during the year. Also referring to cl. 2(B)(ii) of the scheme, the AO concluded that assessee's liability under Part II was wholly and clearly contingent upon certain specific conditions being fulfilled and hence according to him it was a contingent liability. Hence he disallowed assessee's claim to the extent of Part II payment amounting to Rs. 48,05,871.
5. The CIT(A), besides relying on the decisions cited before him on behalf of the assessee, allowed the claim of the assessee giving following reasons :
(a) There was no devious scheme of tax planning by the assessee;
(b) By agreeing to pay interest on the amount kept aside, the assessee had made its intention clear of not treating the money as its own;
(c) The event that gave rise to the liability had occurred during the relevant previous year, viz., the signing of the agreement by the labour union and its approval by the labour commissioner.
(d) It had no corelation with the income-earning activity following in the subsequent year.
6. The learned Departmental Representative reiterated the views expressed by the AO in his order and drew our specific attention to the following clauses of the voluntary retirement scheme.
Clause 2B
(i) "An additional amount calculated as per table below shall accrue and be paid ten months from the date of retirement to employees who have retired under the scheme. ......."
(ii) "A special payment @ 12.5 per cent on the additional amount of compensation shall accrue and be paid ten months from the date of retirement.
The above additional amount of compensation and the special payment shall accrue and become payable only to those employees who have not accepted employment, full time or part time or involved themselves directly or indirectly in any other unit manufacturing two piece empty hard gelatin capsules in India, for the period of ten months from the date of retirement and further provided that he makes a solemn declaration to this effect before the payment is made to him."
7. In view of the above-mentioned clauses, it was contended by the learned Departmental Representative that Part II liability was clearly contingent and hence was not allowable in the year under appeal. Reliance was placed on the decision of the Supreme Court in Shree Sajan Mills Ltd. vs. CIT (1985) 156 ITR 585 (SC). It was also contended by the learned Departmental Representative that law should take precedence over accounting norms.
8. The contention of the learned counsel was that there were two aspects in respect of a liability, viz; (a) the time of its accrual and (b) its payment which is a procedural aspect. In the instant case, it was submitted, the payment to be made was a procedural aspect which was evident from the fact that the assessee was to pay interest for the ten months period. In other words, it was sought to be emphasised that had not the liability accrued in the year under consideration, it would not have been necessary for the assessee to pay interest. This only showed that liability had already accrued during the year, but its payment was deferred for ten months. Moreover, it was contended that the main event for the accrual of liability was the retirement of the employees. This event had taken place during the year and hence the liability did accrue in this very year. Reliance was placed on the decisions in CIT vs. Swadeshi Cotton Flour Mills (P) Ltd. (1959) 53 ITR 134 (SC), Calcutta Co. Ltd. vs. CIT (1959) 37 ITR 1 (SC), Raja Buland Sugar Co. Ltd. vs. CIT (1980) 122 ITR 817 (All), CIT vs. United Motors (India) Ltd. (1990) 181 ITR 347 (Bom) and Rallis India Ltd. vs. Dy. CIT (1998) 53 ITD 381 (Cal).
9. We have given our anxious consideration to the rival contentions and the material on record. It is undisputed that the assessee follows mercantile system of accounting. Hence, in this context, we agree with the learned counsel that payment is a procedural aspect. What is material is the time of accrual of the liability, which we now proceed to determine.
10. The main thrust of the learned counsel's argument as made before the CIT(A) (p. 1 of paperbook) and also before us is that the liability had arisen (underline, italicised in print, by us) during the relevant accounting year because the assessee had confirmed and guaranteed the total payment of compensation to the employees under VRS. One of the main reasons, as mentioned earlier, which weighed heavily with the CIT(A) to allow the deduction was that the event that gave rise (underline italicised in print, supplied) to the liability had occurred during the relevant previous year, viz. the signing of the agreement by the labour union and its approval by the labour commissioner.
11. The important words in the above paragraph, as underlined (italicised) by us, are "had arisen" and "gave rise". These words denote "had accrued" because in popular as well as in legal sense the words "accrue" and arise" are synonymous. These assessee provided in its books of account the entire amount of compensation payable as, in its opinion, the liability to compensate the retiring workers had arisen in this year when the agreement was signed. This, it was claimed, was in accordance with the Guidance Note on Accrual Basis of Accounting issued by the Institute of Chartered Accountants of India (ICAI).
12. No dispute, probably, can be raised about the accounting treatment given to the liability by the assessee. However, Law Lexicon by P. Ramanath Aiyar (1997 Edn.) gives the meaning of the word 'accrue' as follows;
"Accrue" means to arise (as) cause of action accruing; to grow; or to be added to (as accruing rent, accruing debt, accruing devidend). In the past tense the word 'accrued' is used in the sense of due and payable; vested; and existed (as, rights accrued).
13. In the case before us, the amount payable may have been determined by the agreement executed in the year under consideration. But it cannot be said that, so far as Part II liability is concerned, it has become 'due and payable.' With regard to Part I liability, it can be said that retirement from service was the event which made the employees entitled to the compensation referred to in Part I. However, with regard to Part II liability, retirement was only one of the events to make the employees entitled to compensation. The other event which was to make them finally entitled was to take place 10 months after the date of retirement, that is, only if the employee had not taken up any employment with any other unit manufacturing empty hard gelatine capsules. The point we are trying to stress is that a liability will not accrue until all the events giving rise to the liability have taken place. Till the last event occurs, the liability is a contingent one.
14. Paragraph 3.1 of the Accounting Standard 4(As-4) on Contingencies and Events Occurring After the Balance Sheet Date defines the term 'Contingency' as follows :
"A contingency is a condition or situation, the ultimate outcome of which, gain or loss, will be known or determined only on the occurrence, or non-occurrence, of one or more uncertain future events."
15. In the present case, whether an employee is entitled to Part II compensation or not can be known only 10 months after the date of his retirement. Hence, as per the definition given by ICAI itself, the liability under Part II is a contingent liability.
16. Further, para 5.1 of As-4 reads as follows :
"The accounting treatment of a contingent loss is determined by the expected outcome of the contingency. If it is likely that a contingency will result in a loss to the enterprise, then it is prudent to provide for that loss in the financial statements."
17. Earlier, we have already held Part II liability to be a contingent liability. The ICAI has recommended the provision of such a liability on grounds of prudence. Now prudent accounting is one thing and determination of income for tax purposes is another. One may be almost sure that a certain liability will arise on the happening or non-happening of an event, and from the viewpoint of the management, it may be prudent to set apart a specified amount, but undoubtedly, the liability has not arisen till the happening or non-happening of the event.
18. Now we consider some of the case-laws relied upon by the learned counsel. In the case of Swadeshi Cotton & Flour Mills Ltd. (supra), assessee paid bonus to its employees for the calendar year 1947 in terms of an award made in 1949 under the Industrial Disputes Act. It debited the amount in its P&L a/c for the year 1948 but in fact paid it to the employees in the calendar year 1949. It was held by the Supreme Court that it was only in 1949 that the claim to bonus was settled by an award of the Industrial Tribunal and the only year to which the liability under the award could be properly attributed was 1949 and hence the bonus amount had to be deducted in the calendar year 1949 relevant to asst. yr. 1950-51.
19. In the case before us, no doubt, the agreement was reached in the accounting year ending on 31st August, 1986, relevant to the assessment year under appeal (i.e. asst. yr. 1987-88) and it had also received the approval of the labour commissioner's office in July 1986, but additional compensation, i.e. Part II liability was contingent upon the concerned employee not taking up an employment as specified in the agreement upto 10 months from the date of retirement and further making a solemn declaration to this effect before becoming entitled to the payment. No such condition was there in the case of Swadeshi Cotton & Flour Mills (supra).
20. In the case of Calcutta Co. Ltd. (supra), assessee bought lands and sold them in plots after developing them. When the plots were sold the purchaser paid only a portion of the purchase price and undertook to pay the balance in instalments. The assessee in its turn undertook to carry out the developments within six months but time was not of the essence of the contract. In the relevant accounting year the assessee received in cash only Rs. 29,392 towards sale price of lands, but in accordance with the mercantile system of accounting adopted by it, it credited in its accounts the sum of Rs. 43,692 representing the full sale price of lands. At the same time, it also debited an estimated sum of Rs. 24,809 as expenditure for the developments it had undertaken to carry out even though no part of that amount was actually spent. The Department disallowed the expenditure. The Supreme Court allowed the deduction by holding that it was an accrued liability. The Court held it to be an accrued liability on the ground that the undertaking to carry out the developments within a reasonable time was unconditional. The Supreme Court as a matter of fact, found that the undertaking imported a liability on the assessee which accrued on the dates of the deeds of sale, though that liability was to be discharged at a future date.
21. In the case before us, the liability for additional compensation was conditional. The liability was to accrue, as per cl. 2B(i) of the agreement, only 10 months from the date of retirement of the employee. Hence, the decision in 37 ITR 1 (supra) also does not help the assessee.
22. In Raza Buland Sugar Co. Ltd. (supra), the assessee was allowed deduction of Rs. 2,04,273 on the ground that the said liability was fixed by statutory orders in respect of the full amount. The subsequent decision determining the liability was only quantification of the liability, which undoubtedly accrued at the time of the purchase of sugarcane in the year 1957-58. In the case before us, our categorical finding is that the liability will accrue only at the end of the 10th months from the date of retirement of each employees. Hence, this case also does not help the assessee.
23. In the case of United Motors India Ltd. (supra), the assessee was allowed deduction of the provision of Rs. 1,00,000 made by it as soon as the awards which governed the terms and conditions were terminated by the trade union, though the same was precisely quantified and paid in the subsequent years. The Bombay High Court took the date of noting by the management about the termination of agreements as the date of accrual of the liability. This was so because the management was sure of the impending liability. The exact quantification was to be arrived at merely by negotiation. On the other hand, in the instant case, though negotiations are over and the impending liability is quantified, it is not unconditional as was the case in United Motors. In the instant case, liability was to accrue only if the employee did not take up employment in a similar unit till 10 months. We repeat, in the case of United Motors (supra), on such condition was attached, only quantification was pending and hence the liability was held to have been accrued. The assessee in the case of United Motors (supra) had made up its mind to improve the service conditions of the employees and hence, there was no question of refuting the liability. In the instant case, if an employee involved himself directly or indirectly within 10 months of retirement with a similar unit, the assessee had a right to deny the payment of additional compensation. Thus, the case of United Motors (supra) is quite distinguishable from the present case.
24. Similarly, the case of Rallis India (supra) decided by the Calcutta Bench of the Tribunal is also quite distinguishable. In the said case, under the voluntary retirement scheme (VRS) formulated by the assessee-company, the concerned employees were to be paid monthly pension. The assessee's liability was actuarially determined at Rs. 3,68 crores. The entire liability was claimed as deduction but was disallowed by the Department, inter alia, on the ground that under the scheme, the assessee could stop or withhold payment if an employee who had taken retirement under VRS had acted in a manner prejudicial to the interest of the company. The Tribunal held that the liability to pay pension in future years was not a contingent liability but was a real, definite and ascertained liability. The Tribunal further observed that the clause empowering the assessee to stop or withhold the payment did not make the liability contingent upon any particular event. Here lies the difference. In the present case, the liability is contingent upon a particular event of not accepting employment in a similar unit within 10 months. In Rallis' case (supra) the Tribunal also observed that it was only the payment which was contingent upon the good behaviour of the employee. The same is not the case in the present appeal. The agreement itself states that "the above additional amount of compensation and the special payment shall accrue and become payable only to those employees who have not accepted employment ......... for the period of ten months ........". "Good behaviour" in Rallis' case (supra) is too general and quite subjective as against the objective and specific condition of not taking employment in a competitor's unit within a period of 10 months. Thus the case of Rallis India (supra), in our opinion, is not applicable to the present case.
25. One of the contentions made was that the assessee had agreed to pay interest on the additional compensation for the ten months period and this proved that the liability was not contingent. We are not impressed by this contention for the reason that this payment as mentioned in cl. 2B(ii) of the agreement has been described as "a special payment". We fail to understand that, though the said special payment is determinable as a percentage of additional compensation, and is to be computed from the date of retirement, yet it has not been described as interest. This is not to suggest that it is the nomenclature which has swayed us holding it otherwise . But by describing it as a special payment one may be tempted to take it as one of the several types of payments under the VRS and not necessarily interest to compensate the purported deferment of additional compensation.
26. Earlier, we had summarised the four reasons advanced by the CIT(A) for allowing the deduction. Firstly, as regards devious scheme of tax planning, there was no such allegation by the AO. Secondly, even if the special payment is treated as interest, the money set apart to meet the liability of additional compensation remains assessee's own money till the expiry of 10 months from the date of retirement of each employee, because liability accrues only thereafter. Thirdly, we have already held that signing of agreement is only one of the events giving rise to the liability. The last event which actually fastens the assessee with the liability is the fulfilment of the condition mentioned in cl. 2B(ii) of the agreement. Fourthly, though matching cost concept is one of the principles of accountancy, there are certain costs which have no corelation with the income-earning activity of a particular year. In that sense, the liability for additional compensation has no corelation with the income-earning activity of the present year as well. In any event, the deduction is not allowed solely on the ground that the liability though determined, has not actually accrued in the present year. In view of the foregoing discussion we hold that the CIT(A) was not justified, on facts and in law, to allow the deduction of additional compensation amounting to Rs. 48,05,871. Accordingly, we restore the disallowance thereof made by the AO.
27. Second ground relates to the deletion of interest amount of Rs. 14,19,296 charged under s. 215 of the Act. While framing the assessment, the AO levied interest under s. 215. The CIT(A) observed that main difference between estimated income and assessed income arose on account of disallowance of additional compensation of Rs. 48,05,871 which the assessee could not have foreseen and hence cancelled the interest charged under s. 215.
28. The assessee estimated its income at Rs. 10.00 lacs and paid advance tax of Rs. 1,66,668 thereon. It returned an income of Rs. 9,04,181 which was assessed to Rs. 74,21,920. We are unable to subscribe to the view of the CIT(A). The Supreme Court in the case of Central Provinces Manganese Ore Co. Ltd. vs. CIT (1986) 160 ITR 961 (SC), held that where the jurisdictional fact attracting the levy cannot be disputed, it will be a question merely of satisfying the relevant authority that there are circumstances calling for a reduction or waiver of the interest. In the instant case, the advance tax paid is less than the assessed tax as provided in s. 215(1) and hence the jurisdictional fact attracting the levy cannot be disputed. The CIT(A) was, therefore, not justified in cancelling the interest on grounds of unforeseen additions or disallowances. Accordingly, we restore the levy of interest. The assessee, may, however, if so advised, approach the AO for reduction or waiver of interest under s. 215(4). If the assessee so chooses, the AO may decide the issue in accordance with law.
29. In the result, the appeal of the Department is allowed.