1970 (3) TMI 45 - HC - Income Tax

Whether payment of gratuity to employees on death retirement or termination of service on basis of current salary are allowable for deduction when employer is following Mercantile System of accounting

Issues Involved:
1. Deductibility of provisions for gratuity under section 10(2)(xv) or section 10(1) of the Indian Income-tax Act, 1922.
2. Appropriateness of the method used by the assessee to calculate the provision for gratuity.

Detailed Analysis:

1. Deductibility of Provisions for Gratuity:
The primary issue was whether the sums shown as provision for gratuity in the accounts for the relevant previous years (1952-53, 1955-56, and 1956-57) were allowable deductions in computing the business income of the assessee.

The assessee calculated the provision for gratuity based on the salaries payable to employees as if they were eligible for gratuity at the end of each accounting year. These amounts were shown in the books as a provision for gratuity. The amounts calculated for the years were Rs. 48,784, Rs. 43,805, and Rs. 60,958, respectively.

The Income-tax Officer disallowed these provisions, stating that the provision was based on present salaries and that there was no foolproof way to evaluate the present value of a future benefit. The Appellate Assistant Commissioner and the Income-tax Appellate Tribunal upheld this decision, emphasizing that only actual payments made each year could be allowed as a deduction.

The Tribunal observed, "As the terms of the award require calculation of the salary on the date the employee ceases to be in the employment when he is eligible for gratuity, the calculations now made will only be approximations and not accurate figures of the amount of liability."

Mr. Dastur, representing the assessee, argued that the provision for gratuity should be allowed as it represented actual calculations based on the terms of the award. He cited Supreme Court judgments in Metal Box Company of India Ltd. v. Their Workmen and Commissioner of Income-tax v. Swadeshi Cotton and Flour Mills Pvt. Ltd. to support his contention.

Mr. Joshi, representing the revenue, countered that the liability was contingent and not sustainable in law. He cited judgments from the House of Lords in Southern Railway of Peru v. Owen, and the Supreme Court in Indian Molasses Co. v. Commissioner of Income-tax and Standard Mills Co. Ltd. v. Commissioner of Wealth-tax, and the Madras High Court in Commissioner of Income-tax v. Indian Metal and Metallurgical Corporation.

2. Method of Calculating Provision for Gratuity:
The method used by the assessee to calculate the provision for gratuity was scrutinized. The provision was based on the salaries payable during the accounting year, without considering factors such as the possibility of an employee's death, dismissal for dishonesty or misconduct, or the actual salary at the time of retirement.

The court noted, "The basis for this provision by itself suffers from many shortcomings. To illustrate, it does not take into account the possibility of the death of a worker, nor of his being dismissed for dishonesty or misconduct."

The court suggested that a scientific method, similar to actuarial calculations used in insurance, might be possible to determine the provision accurately. However, the assessee did not present any alternative scientific basis for calculation during the appeals.

The court stated, "It might, however, have been possible---and on this point we do not express any opinion---for the assessee to arrive at some scientific basis for calculating in each accounting year the amount which it should provide for during that year against its future liability to pay gratuity to its employees."

Ultimately, the court concluded that the method adopted by the assessee was unsatisfactory and did not allow for a proper evaluation of the liability. The court emphasized that its jurisdiction was to decide whether the method actually followed was correct, not to provide guidance on what the method should be.

Conclusion:
The court answered the question in the negative, stating that the sums shown as provision for gratuity were not allowable deductions. The court highlighted that the assessee did not attempt to present a scientific basis for the calculation of the provision and that the method used was inadequate.

The court remarked, "The necessary conclusion which follows is that the assessee wanted to stand or fall on the amount calculated on the basis which it had adopted and omitted to canvass for any other basis."

The assessee was ordered to pay the costs of the revenue.

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