TMI Blog1981 (4) TMI 31X X X X Extracts X X X X X X X X Extracts X X X X ..... e employees, who had put in service of 10 years and above, was at the rate of one month's basic salary for each year of service with a maximum of 15 months' salary or Rs. 15,000, whichever was lower. Every year certain ad hoc amounts were transferred to the gratuity reserve by the company. On 22nd April, 1959, a notice was served by the assessee-company on its employees terminating their employment on and from 30th April, 1959, and they were intimated that the transferee-company offered, by separate letter which was enclosed with the notice, employment with the transferee-company on and from 1st May, 1959. Any employee who did not want to accept employment with the transferee-company was free to receive retirement gratuity (on the normal scale), in addition to one month's salary in lieu of notice. The employees were to be given the benefit of continuity of service if they accepted the employment with the transferee-company. The notice of termination was intimated in the following words: " You will see that, in their offer of employment, Rallis India Ltd. undertake that, if you accept service with them from 1st May, 1959, it shall be assumed that there has been no break or interru ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f individual staff members and, he, therefore, declined to allow the claim of the assessee-company for a deduction of gratuity to the extent of Rs. 4,08,622. The AAC, concurring with this finding of the ITO, held that there was no actual termination of the services of the employees in question and that the liability in question was capital in nature. The Appellate Tribunal, however, took a contrary view and held that gratuity would be an allowable deduction as and when it became payable, but, that so far as the assessee-company was concerned, no liability for payment to the employees directly arose as the employees would have to look forward to their claim from M/s. Rallis India Ltd. The Tribunal also held that there was a termination of employment of the employees from the service of the assessee-company and there was, therefore, a legal liability for the assessee-company and the liability had been duly discharged by payment to M/s. Rallis India Ltd. The Tribunal came to the finding that the assessee-company was still functioning and a copy of the profit and loss account found in the printed copy of the directors' report and accounts of Rallis India Ltd. showed that there has been ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 0 ITR 224. The learned counsel appearing on behalf of the assessee has, however, contended that the gratuity scheme having been enforced since, 31st August, 1953, the assessee-company had incurred the liability to pay gratuity and the, time for making the payment of gratuity was the cessation of employment which was an event which was certain to occur and which did occur on 30th April, 1959, when the services of the employees were terminated. There was thus liability, according to the learned counsel, which the assessee was bound to discharge on 30th April, 1959. It was pointed out in respect of some employees who chose to leave the employment and not take up new employment with the transferee-company, gratuity to the tune of Rs. 23,346 had been paid and had been allowed as the deduction. But, so far as the amount of Rs. 4,08,622 was concerned, the contention before us was that the liability of the assessee-company in respect of the gratuity payable to the employees who took up employment with the transferee company, was, by virtue of the arrangement with the transferee-company, extinguished and that the transferee-company had accepted the employment of the employees in whose fav ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ity of service, they would have been entitled to the payment of gratuity. However, admittedly, no amount by way of gratuity was actually paid to the employees. The reason is very clear. Since the employees had been given the benefit of the continuity of employment, in law, there was no retirement from the employment of the assessee-company giving rise to the right in favour of the employees to claim any gratuity from the assessee-company. The liability to pay gratuity to the employees would have arisen only if there was a right which had accrued to the employees to claim gratuity, While that right could have normally accrued in favour of the employees only as a result of the cessation of the business of the assessee-company and employment with the transferee was to be treated as a fresh one. The position in the instant case was different. The facts of the present case will show that, though, technically, so far as the employer-employee relationship is concerned, that was put an end to by the assessee-company, immediately from the next date, i.e., from 1st May, 1959, the employees were taken over by the transferee-company and the benefit of continuity of service was agreed to be giv ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... words the nature of the claim must, in terms, be a claim for gratuity, if any payment is sought to be claimed as a deductible expenditure'. It is clear that unless a payment is made to the employees in accordance with the gratuity scheme such payment cannot properly be described as a payment of gratuity. The payment in the instant case is made not to the employees but is paid to the transferee company in order to enable the transferee-company to meet a future liability for payment of gratuity and it is, therefore, difficult for us to see how the payment to the transferee-company can be said to be a payment on account of gratuity. It is vehemently argued before us that having regard to the documents on record, it is established that the agreement between the assesseecompany, on the one hand, and the employees, and the transferee-company on the other is that the payment has been made to the transferee company for the benefit of the, employees, and the very fact that they have accepted continuity of employment means, that they have chosen not to take the gratuity at the time when their services with the assessee-company stood terminated, but they agreed that the amount due by way of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ctly describe the payment made by the assessee-company to the transferee-company is that it was in the nature of a contribution which is made by it voluntarily to the transferee-company in order to provide funds to it the transferee-company) in respect of the payment of gratuity which could be claimed by the employees from the transferee-company in respect of the period of employment with the assessee-company. So far as the transferee-company is concerned, neither the employees nor the company itself, could make any distinction in respect of the gratuity claimable for the period of employment with the assessee-company and the period of employment with the transferee-company. No such break-up would be permissible either with reference to the claim under the 1957 agreement or under the provisions of the Payment of Gratuity Act. Having chosen to give the advantage of the continuity of employment to the employees of the assessee-company, the liability of the transferee-company would be for the entire period of employment, which would include the period of employment with the assessee-company, irrespective of whether the assessee-company paid or did not any amount to the transferee-comp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... profit as shown in the profit and loss account and the contention was that the amount which can be debited to the profit and loss account was only the amount which was actually paid by way of gratuity and the questions which the Supreme Court was called upon to decide were (p. 62): " (1) whether it is legitimate in such a scheme of gratuity to estimate the liability on an actuarial valuation and deduct such estimated liability in the P. L. account while working out its net profits; and (2) if it is, whether such appropriation amounts to a reserve or a provision." We need not refer to the second question, but so for as the first question is concerned, the Supreme Court held thus (head note): " 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 consideration. " It was held that the 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 and this was recognised i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t, 1961, and the amount representing gratuity liability, if scientifically estimated, was not a provision for a contingent liability but must be properly regarded as provision for a present liability which is allowable in the case of an assessee which keeps its accounts on the mercantile system. The Division Bench followed the view taken in the India United Mills'case [1975] 98 ITR 426 (Bom). In that case, the industrial court had by an award directed the payment of gratuity to workmen of the assessee-company in accordance with the scale provided therein, the amount of gratuity being dependent on the wages at that time and the number of years of service put in by the workmen. In order to implement this the assessee-company set apart during the year 1951, an amount of Rs. 21,77,359 for a gratuity fund made up of Rs. 19,11,658 on account of initial contribution and Rs. 2,65,701 on account of annual contribution for the year 1951. The initial contribution was calculated on the basis of gratuity to which existing employees were entitled up to the beginning of 1951, by reference to the number of years put in by each employee while the annual contribution was calculated by reference to t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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. 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. Contingent rights, if capable of valuation, can similarly be taken into account as trading receipts where it is necessary to do so in order to ascertain the true Profits." We have referred at length this decision because it is vehemently urged before us that a liability in respect of gratuity has always been considered as a liability in praesenti and, therefore, according to the learned counsel, not only was there a liability for payment of gratuity in respect of each year of account but that even in the year of account 1959 there was liability and acco ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing ours). It may, however, be pointed out that in that case though it was held that the company was entitled to charge against each year's receipts the cost of making a provision for the retirement payments which would ultimately be payable as it had had the benefit of the employee's services during that year, provided the present value of the future payments could be fairly estimated, since it was found that in calculating the amount which the company claimed to deduct in each year the company had ignored the factor of discount, the claim for deduction was rejected. Now merely because for the purposes of commercial accounting the discounted value of the liability to pay gratuity is deductible for working out the net profits the payment made by the assessee-company to the transferee-company cannot be said to amount to a payment of gratuity. The question with which we are really concerned is whether as a result of the notice of termination, issued by the assessee, there was any liability which had accrued against the assessee-company to pay any gratuity and if any liability had so accrued, did it stand discharged by payment of any amount to the employees ? The answer to the quest ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... accounts on mercantile system, the firm could claim as a permissible outgoing the amount for which liability was incurred though no actual payment was made to the workmen. The Commissioner appealed against the order of the High Court. While pointing out that under 10(2)(xv) of the Indian I.T. Act, 1922, in the computation of taxable profits " any expenditure laid out or expended wholly and exclusively for the purpose of such business, profession or vocation " was a permissible allowance, it was observed that to be a permissible allowance the expenditure must be for the purpose of carrying on the business and the Supreme Court held that a liability to pay retrenchment compensation arose under 25FF of the Industrial Disputes Act, 1947, when there is a transfer of the ownership or management of an undertaking resulting in retrenchment of the workmen. It was observed that the liability did not, arise before the transfer of the undertaking. It was pointed out that until there was a transfer of the undertaking resulting in determination of employment, the workmen did not become entitled to retrenchment compensation and that so long as the ownership continues with the employer the right ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... during the assessment year 1963-64, a new company was formed to take over the retreading division of the assessee-company. The, new subsidiary company took over all the employees of the assessee-company working in the said division. At the time of formation of the new, company gratuity payable to the transferred employees was calculated on the basis of the rules of the assessee-company to be Rs. 56,275. This amount was transferred to the new company from the pension and gratuity reserves of the assessee-company. The claim of the assessee-company that the amount was paid in discharge of its liability for gratuity to the employees transferred to the new company and, hence, an allowable deduction under s. 37 of the I.T. Act, 1961, was negatived by both the ITO and the AAC. The Tribunal, however, allowed the claim on the view that the amount had been paid in discharge of the assessee's obligation to its workmen and payment to the new company on behalf of the employees. On a reference, the High Court held that the assessee was not under a definite and, present obligation to pay any gratuity in respect of the transferred employees and the payment was not made to the new company on behalf ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... reating them to be in continuous service with the benefit of their service in the transferor-bank, the expenditure was not incurred during the course of carrying on the business or for the purpose of carrying on the business but at the time of transfer of the business. The decisions in Gemini Cashew Saks Corporation [1967] 65 ITR 643 (SC) and Stanes Motors' case [1975] 101 ITR 341 (Mad) were followed and the amount has been held not to be deductible. The learned judges have held that assuming that on transfer of business the assessee compelled the employees to retire from business and gratuity was payable to them, the obligation to pay the gratuity arose only by virtue of transfer of business and, as a matter of fact, the transfer of business and the obligation to pay gratuity were contemporaneous and simultaneous and, therefore, the payment of gratuity cannot be said to be an item of expenditure incurred in the course of carrying on the business or for the purpose of carrying on the business. It is not clear from the decision as to whether the assessee bank had issued notices terminating the employment as was done in the instant case, and it seems to have been assumed that the lia ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... part of the business and the payment made in the course of the business as gratuity cannot be treated its a terminal payment on the closure of the business so as to be disallowed. The payment was also held not liable to be treated as one made at the time of the transfer of the undertaking of the assessee. The distinguishing feature of this case is that the business of the assessee-bank had continued, the payment was not held to be a terminal payment on the closure of the business or the payment made at the time of the transfer of the undertaking. The transferee-bank had not undertaken the liability to pay the employees for the past services of the employees with the assessee-bank, and, therefore, there was actual payment of the gratuity to all the employees for every completed year of service. This decision in Sri Venkateswara Bank's case [1979] 120 ITR 207 (Mad) has been noticed by the same High Court in the decision in the Salem Bank's case [1979] 120 ITR 224 and it has been distinguished on the ground that there was no transfer of the entire business and that there was actual expenditure by way of payment of gratuity amounts to the employees which was a legal obligation which t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s. 10(2)(xv) of the Indian I.T. Act, 1922. The decision of the Full Bench seems to be based on the decisions of the Allahabad High Court in Madho Mahesh Sugar Mills (P.) Ltd. v. CIT [1973] 92 ITR 503, Delhi High Court in Delhi Flour Mills Co. Ltd. v. CIT [1974] 95 ITR 151, and the Bombay High Court in India United Mills Ltd. v. CIT [1975] 98 ITR 425, and it was observed that the Kerala High Court had taken the same view in High Land Produce Company's case [1976] 102 ITR 803 (Ker). We have already referred to the limited scope of the concept of the liability in praesenti spelt out in the three decisions referred to by the Kerala High Court. Even the decision of the Kerala High Court in High Land Produce Company's case [1976] 102 ITR 803, shows that the question dealt with in that decision related to the-valuation of contingent liability after ascertaining the present liability which had arisen during the accounting period on actuarial valuation. As already pointed out earlier, the approach adopted in cases where in a commercial system of accounting the actuarial valuation of the contingent liability was held permissible as a deduction in respect of a particular accounting year woul ..... X X X X Extracts X X X X X X X X Extracts X X X X
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