Kerala High Court
Commissioner Of Income-Tax vs Chackola Spinning Mills Ltd. on 14 July, 1987
Equivalent citations: [1988]170ITR440(KER)
Author: K.S. Paripoornan
Bench: K.S. Paripoornan
JUDGMENT K. Sreedharan, J.
1. At the instance of the Revenue, the following two questions of law have been referred for the opinion of this court by the Income-tax Appellate Tribunal, Cochin Bench :
"(1) Whether, on the facts and in the circumstances of the case, the manner and method of computation of incremental liability for gratuity by the Tribunal are right in law ?
(2) Whether, on the facts and in the circumstances of the case, the assessee is entitled to the deduction of the incremental liability for the assessment years ? "
2. The assessment years with which we are concerned are 1974-75 and 1975-76. The assessee filed returns for the above assessment years claiming deduction of Rs. 15,76,941 and Rs. 6,81,781, respectively, being the provision made for payment of gratuity in accordance with the provisions of the Payment of Gratuity Act, 1972. For the year 1975-76, a revised return was filed restricting the claim to Rs. 3,65,608 after excluding future increments of the employees from computation of the liability. The Income-tax Officer did not accept the claim for the assessment year 1974-75 holding that the provision included the liability relating to the earlier years and also that the liability was of a contingent nature. On appeal, the Appellate Assistant Commissioner held that the incremental liability which had accrued during the relevant accounting year should be allowed. On appeal by the Department, the Income-tax Appellate Tribunal observed that the liability in question was governed by Section 40A(7) of the Income-tax Act, 1961, and so directed the authorities to consider the effect of the retrospective amendment by its order dated April 21, 1976. Thereupon, the Income-tax Officer, by order dated May 28, 1976, allowed a deduction of Rs. 5,35,363 as provision for payment of gratuity for the assessment year 1974-75. For the year 1975-76, the Income-tax Officer accepted the assessee's claim for deduction of Rs. 3,65,608 as shown in the returns.
3. The Commissioner of Income-tax, acting under Section 263 of the Income-tax Act, held that in view of the Explanation 1 to Section 40A(7) of the Act, only such amount as does not exceed an amount calculated at the rate of 8 1/3% of the salary of each employee entitled to the payment of such gratuity for each year of service could be allowed. He found that 8 1/3% of the salary of all the employees of the assessee entitled to payment of gratuity for the accounting years ending June 30, 1973, and June 30, 1974, worked out to Rs. 1,73,236 and Rs. 2,05,781, respectively. The assessee challenged the order of the Commissioner in appeal before the Appellate Tribunal. The Tribunal held that the view taken by the Commissioner of Income-tax was wrong and that the assessee was entitled to deduction of the incremental liability for the assessment years concerned, since the amount provided was less than 8 1/3% of the amount worked out on the basis of the entire period of service of each employee and the salary last drawn. Thereafter, the Commissioner of Income-tax moved the Appellate Tribunal under Section 256(1) of the Act to refer certain questions of law to this court for decision. The Appellate Tribunal has referred the questions of law stated hereinabove for the decision of this court. Hence these cases.
4. We heard learned counsel appearing for the Revenue, Sri P.K.R. Menon, and learned counsel appearing for the assessee, Sri P. Radhakrishnan.
5. In the course of the assessment proceedings for the assessment year 1974-75, the assessee claimed deduction of Rs. 15,76,941 being the provision for payment of gratuity. The Income-tax Officer did not accept the claim holding that the provision included the liability relating to the earlier years and also that the liability was of a contingent nature. When the matter came up before the Tribunal in second appeal, the Tribunal remanded the matter for considering the effect of the amendment brought about by Section 40A(7). Thereupon, the Income-tax Officer, by order dated May 28, 1976, allowed deduction of Rs. 5,35,363 as provision for payment of gratuity. For the assessment year 1975-76, the Income-tax Officer completed the assessment on June 30, 1976, accepting the assessee's claim for deduction of a sum of Rs. 3,65,608, being the provision for payment of gratuity by way of incremental liability. The Commissioner of Income-tax found that 8 1/3% of the salary for the accounting years ending June 30, 1973, and June 30, 1974, of all the employees of the assessee entitled to the payment of gratuity was only Rs. 1,73,236 and Rs. 2,05,781, respectively. Accordingly, he held that the orders passed by the Income-tax Officer were erroneous and initiated action under Section 263 of the Act. The Commissioner took the view that the admissible amount should not exceed 8 1/3% of the salary of the employees entitled to the payment of gratuity during the particular accounting years. On appeal by the assessee, the Income-tax Appellate Tribunal came to the following conclusion :
" It is, therefore, necessary that the assessee should be directed to produce before the Income-tax Officer an actuarial valuation of its liability for payment of gratuity to all its employees as at the end of the two relevant accounting years without taking into consideration the increase in salary that might be earned by the employees and their future years of service. It is also to be stated that the assessee would be entitled for the deduction of only the incremental liability for the two assessment years under consideration. The Income-tax Officer will pass fresh orders in accordance with our above direction."
6. The liability to pay gratuity is not in praesenti, it would arise in future on the determination of the service, i.e., on the retirement, death or termination of service of the employee. The amount of gratuity is calculated on the basis of the salary drawn by the employee in the year of his retirement or termination of service. Under the provisions of the Payment of Gratuity Act, gratuity is to be computed at the rate of 15 days salary for each year of service on the basis of the last drawn salary. The liability is to be calculated by taking into consideration the entire length of service of the employee. Although the payment of gratuity is made on retirement or termination of service, it was not for the service rendered during the year in which the payment is made, but it is made in consideration of the entire length of service. The right to receive, gratuity is a contingent right and the liability to pay the same continues to be a contingent liability of the employer. Since the amount of gratuity payable in any given year would be a variable amount depending upon the number of employees who would be entitled to receive the payment of gratuity during the year, the employer may set apart for future application a sum every year to meet the contingent liability. The estimated liability under the gratuity scheme, even if it amounted to contingent liability, if properly ascertainable and its present value was fairly determined, is deductible from the gross profits while calculating the profit and loss account. In other words, it is permissible for the assessee if he so chooses to provide in his profit and loss account for the estimated liability under a gratuity scheme by ascertaining its present value on actuarial basis and claim it as an ascertained liability to be deducted in the computation of profits and gains of the previous year. To give legal recognition to the provision made by the employer in his account deducting an estimated service gratuity payable to the employees from the taxable income where the provision has been made on scientific basis in the form of an actuarial valuation, the Legislature enacted Section 40A(7). Clause (a) of the said Sub-section provides that no deduction will be allowed in respect of any provision (whether called as such or by any other name) made by the assesseee for the payment of gratuity to his employees on their retirement or termination of their services for any reason. It means that whatever is provided for future use by the assessee out of the gross profits of the year of account for payment of gratuity to the employee on their retirement or termination of service, would not be allowed as deduction in the computation of profit and loss for the year. This bar in Clause (a) is made subject to the provision contained in Clause (b). Clause (b)(i) excludes from the operation of Clause (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 might provide by the spread over method and provides that such provision would be excluded from the operation of Clause (a), provided the three conditions laid down by the sub-clause are satisfied. The three conditions mentioned therein are :
(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% of the admissible amount has been paid by the assessee by way of contribution to the gratuity fund before April 1, 1976, and the balance of the amount paid on or before April 1, 1977.
7. In order to claim the deduction during the relevant assessment years under Section 40A(7) of the Act towards gratuity, the conditions laid down in that section should be satisfied. The provisions of the section will have effect notwithstanding anything to the contrary contained in any other provision of the Act relating to the computation of income under the head " Profits and gains of business or profession". According to their Lordships of the Supreme Court, Section 40A would have effect notwithstanding anything contained in Sections 30 to 39 of the Income-tax Act, vide the decision in Shree Sajjan Mills Ltd. v. CIT, [1985] 156 ITR 585 (SC). The scope and effect of Section 40A(7) was considered by the Supreme Court in the abovementioned decision. The Tribunal had no occasion to examine the question whether the provisions contained in Section 40A(7) have been complied with by the assessee in the light of the principles laid down by their Lordships in the abovementioned case. In D.V. Bapat, ITO v. Tata Iron & Steel Co. Ltd., [1986] 159 ITR 938 (SC) and CIT v. Vanaz Engineering P. Ltd., [1986] 162 ITR 876 (SC), their Lordships remitted the case to examine whether all the requirements of Section 40A(7) as laid down by the Supreme Court decision have been satisfied by the assessee to claim the benefit of deduction. In the instant case, all the authorities including the Appellate Tribunal had no occasion to adjudicate the matter in the light of the Supreme Court decision aforesaid and to find whether all the requirements of the law for claiming deduction for the relevant assessment years were satisfied. The entire matter requires a fresh or second look.
8. Section 40A(7) has got two Explanations. Explanation 1 deals with " admissible amount " of deduction. It reads as follows :
" For the purposes of Sub-clause (ii) of Clause (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 8 1/3% of the salary (as defined in Clause (h) of Rule 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. "
9. It shows that "admissible amount" should not exceed 8 1/3% 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. This means that in respect of each of the years, provision can be made and deduction can be effected up to 8 1/3% of the salary of each employee entitled to the payment of gratuity. The amount to be paid to an employee towards gratuity for an year can only be 15 days' salary. Fifteen days' salary will be 4 3/6% of the total salary due for the year. Even though while calculating the gratuity, the employee will be getting only 15 days' salary, i.e., 4 1/6%, the statute allows a deduction of up to 8 1/3%. This is because deduction up to 8 1/3% is permissible, if the liability is properly ascertained and it is possible to arrive at a properly determined present value. It appears that the estimated liability under the scheme of gratuity, if properly ascertainable and its present value is discounted, is deductible from the gross profits while preparing the profit and loss account. Nothing appears on record to show that such an assessment (of gratuity) was made by the assessee for claiming deduction. The Tribunal has not examined this question in all its aspects and also whether the exact or proper amount is determined, as the present value of a future liability. This requires further examination and adjudication.
10. As stated earlier, neither the Income-tax Appellate Tribunal nor the Commissioner entered a finding as to whether the assessee is entitled to deduction for the purpose of gratuity under Section 40A(7) of the Income-tax Act, in the light of the principles stated by their Lordships of the Supreme Court in Shree Sajjan Mills Ltd. v. CIT, [1985] 156 ITR 585. The further factual determination contemplated under Section 40A(7) detailed in paragraph 7 hereinabove, requires a more precise and scientific evaluation and adjudication on facts. Details are wanting in the records at present. In this state of affairs, we cannot satisfactorily answer the questions referred to us by the Appellate Tribunal and so we decline to answer the questions referred to us. The Appellate Tribunal is directed to reconsider the right of the assessee to claim deduction for gratuity in the light of the Supreme Court decisions and the other observations contained in this judgment.
11. A copy of this judgment will be sent to the Income-tax Appellate Tribunal, Cochin Bench, by the Registrar under his signature and seal of this court.