TMI Blog1974 (2) TMI 2X X X X Extracts X X X X X X X X Extracts X X X X ..... set off against the company's profits of the business under proviso (a) to Explanation 2 of section 24(1) of the said Act ? (2) Whether, on the facts and in the circumstances of the case, Rs. 52,633 claimed as business expenditure for the assessment year 1957-58 and Rs. 11,578 claimed as such for the assessment year 1958-59, under section 10(2)(xv) of the Indian Income-tax Act, 1922, have rightly been disallowed?" The facts relevant to the first question may now be stated. M/s. Delhi Flour Mills Co. Ltd., New Delhi (hereinafter referred to as "the assessee") carried on the following businesses: 1. Grinding of wheat for manufacturing atta and wheat products. 2. Manufacturing of ice and maintaining a cold storage. 3. Washing, calendering and dyeing business which is a part of the hosiery department. During the accounting year relevant to the assessment year 1957-58, the assessee entered into forward transactions in matra (a substitute of gram). These transactions comprised purchases amounting to Rs. 6,82,141 and sales amounting to Rs. 6,16,124. There was a loss amounting to Rs. 66,417 resulting from these forward transactions. These transactions were concluded not by the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... relates, to income from business consisting of speculative transactions, and places the limitation that losses sustained in speculative transactions are not to be taken into account in computing the profits and gains chargeable under the head 'profits and gains of business, profession or vocation', except to the extent that they will be set off against profits and gains in any other business which itself consists of speculative transactions. The effect of the proviso is that if there are profits in speculative business, those profits are added to income under the other heads mentioned in section 6 for purposes of computing the total income of the assessee in order to determine the tax under section 23 of the Act. On the other hand, losses in speculative business are not to be taken into account when computing the total income, except to the extent to which they can be set off against profits from other speculative business. The first proviso, thus, clearly limits the applicability of the principal clause of section 24(1) ; and, when applied, it governs the manner in which the total income of the assessee is to be computed." The above rule was reaffirmed by the Supreme Court in a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tion 2 is quite clear and we need not, therefore, seek any guidance in the interpretation of this proviso from the speech of the Finance Minister. Even if we do refer to the relevant portions of the speech of the Finance Minister, we do not find anything in them to support the contention of the learned counsel. This is what the Finance Minister stated in the speech: "In the Bill, as it is drafted, we have excluded hedging transactions, the common hedging transactions, that is, a mill buys cotton and sells cloth. There are various other varieties of hedging transactions and after discussions with the representatives of trade and business, I have come to the conclusion that they are also legitimate. One category of transactions is the on I referred to just now: a man wants to protect himself against any loss in certain scrips he holds, but he sells some other scrips which he expects will have a reverse movement. The object is to save that kind of transactions. The other is where there are jobbers and brokers and others-it is their regular business and their ordinary transactions are not transactions such as we want to avoid, namely, selling and buying of losses." The examples whi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... so it is quite clear that the raw materials or merchandise in respect of which the forward transactions have been made by a person must have a direct connection with the goods manufactured or merchandise sold by him. Otherwise, the use of the words "raw materials" would have have no special significance. It must be presumed that the legislature deliberately used these words so as to give them a special significance in relation to the goods manufactured by the assessee. In the present case, matra may be considered to be raw material for manufacturing basin or some other articles made out of matra. Matra cannot certainly be considered as raw material for the manufacture of atta and other wheat products. Therefore, the forward transactions made by the assessee in respect of matra cannot be treated as hedging transactions within the meaning of proviso (a) to Explanation 2 and the loss sustained by the assessee in such transactions cannot be set off against his profits in the business of manufacturing atta and other wheat products. We find support for this view from two reported decisions, one of the Andhra Pradesh High Court and the other of the Gujarat High Court. In Omkarmal Agarwa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... culative transactions in question are not saved by clause (a) of the proviso to Explanation 2 of section 24(1)." In Chimanlal Chhotalal v. Commissioner of Income-tax, the assessee carried on business as a dealer in cotton and cotton seeds. The assessee entered into certain forward contracts of sale of kapas (unginned cotton in pods) and cotton bales. The assessee sustained a loss in these forward contracts and claimed a set-off of this loss against his business income on the ground that these forward transactions were in the nature of hedging transactions. The High Court rejected the assessee's claim. The proviso to Explanation 2 was interpreted by the High Court in the following manner: "The proviso takes out of the ambit and operation of the second Explanation 'a contract in respect of raw materials or merchandise entered into by a person in the course of his manufacturing or merchanting business' and, prima facie, these words would include not only a contract for purchase of raw materials or merchandise but also a contract for sale of raw materials or merchandise. But such contract, under the proviso, has to be a hedging contract entered into by the person concerned for the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e assessee or merchandise sold by him and the other, a contract in respect of raw materials or merchandise entered into in the course of the assessee's manufacturing or merchanting business to guard against loss through future price fluctuations in order to bring the forward transactions within the scope of proviso (a) to Explanation 2 or with the view of the Gujarat High Court that a contract in respect of raw materials or merchandise entered into by a person in the course of his manufacturing or merchanting business should only be a contract for the purchase of the raw materials or merchandise and that such a contract does not include a contract for sale of the raw materials or merchandise. We are, however, in respectful agreement with the views expressed by these High Courts to the extent that the raw material in respect of which the assessee has entered into the forward transactions must be the same raw material which is used by him in his manufacturing business. The forward transactions in matra made by the assessee, thus, do not fall within the scope of proviso (a) to Explanation 2 and the assessee cannot claim a set-off of the loss sustained by it in such forward transaction ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ,633. Similarly, the Income-tax Officer allowed the assessee's claim in respect of the second year only to the extent of Rs. 425 which was the amount actually disbursed during that year and disallowed the balance of the assessee's claim amounting to Rs. 11,576. The disallowance made by the Income-tax Officer was confirmed by the Appellate Assistant Commissioner as well as by the Tribunal. The crucial question to be considered is whether the amount which was disallowed by the Income-tax Officer represented the liability of the assessee which had accrued in the respective years under reference. If the answer to this question is in the affirmative, then the fact that the assessee did not actually pay these amounts during these years but merely transferred these amounts to the Employees' Gratuity Fund would not justify the rejection of the assessee's claim in view of the fact that the assessee was following the mercantile system of accounting. According to the mercantile system of accounting, as explained by the Supreme Court in Keshav Mills Ltd. v. Commissioner of Income-tax: "That system brings into credit what is due, immediately it becomes legally due and before it is actually ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... payable being dependent on his wages at that time and the number of years of service put in by him. The company had worked out on an actuarial valuation its estimated liability and made provision for such liability not all at once but spread over a number of years. Thus, in 1959-60, 1960-61 and 1961-62 the company allocated towards this liability Rs. 5 lakhs, Rs. 10 lakhs and Rs. 5 lakhs respectively from out of the profits, debiting these amounts in the profit and loss account. In all Rs. 40 lakhs had so far been provided in the aforesaid manner, against the said liability. The practice followed by the company was that every year the company worked out the additional liability incurred by it on the employees putting in every additional, year of service. Whenever an employee retired, the amount of gratuity payable to him was debited against the amount provided for as aforesaid. The amount so paid was not debited in the profit and loss account as an outgoing or expenditure but against the estimated liability provided as aforesaid. In 1964-65, the company introduced a similar gratuity scheme for its officers. According to the company, the estimated liability under this scheme was wo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ingent liability and, therefore, not a 'debt' under section 2(m) of the Wealth-tax Act, it would be deductible under the Income-tax Act while computing the taxable profits. In the instant case, the question is not whether such estimated liability arising under the gratuity schemes amounts to a debt or not. The question that concerns us is whether, while working out the net profits, a trader can provide from his gross 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." The Supreme Court, also quoted with approval the following observations of Lord Radcliffe in Southern Railway of Peru Ltd. v. Owen: " Now ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ompany has paid every salary and wage that is due for current remuneration of the year it has not by way means wholly discharged itself of the pecuniary burden which falls upon it in respect of the year's employment." The Supreme Court concluded the answer to the first question by observing that: "In our view, an estimated liability under gratuity schemes such as the ones before us, even if it amounts to a contingent liability and is not a debt under the Wealth-tax Act, if properly ascertainable its present value is fairly discounted is deductible from the gross receipts while preparing the profit and loss account." The Supreme Court then answered the second question in the following manner: "An amount set aside out of profits and other surpluses, not designed to meet a liability, contingency, commitment or diminution in value of assets known to exist at the date of the balance-sheet is a reserve but an amount set aside out of profits and other surpluses to provide for any known liability of which the amount cannot be determined with substantial accuracy is a provision." The Supreme Court held that it was only a reserve that could be added back while computing the gross p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... oses of assessment to income-tax. It can also not be disputed that the payment of gratuity to workmen of a business concern would be an expenditure of that nature but the expenditure which is allowable in a particular year must be certain and capable of ascertainment. If the liability is uncertain and contingent, it cannot be allowed as a deduction. Under the notification aforesaid, a liability was cast upon the assessee to pay gratuity to its workmen in accordance with the scale provided in that notification. The gratuity is payable when a workman dies, retires, resigns or is removed from service. These events no doubt take place in the future but they cannot be said to be uncertain. The services of every workman are bound to come to an end on account of one or the other causes mentioned above. Under the scheme every employer is bound to pay gratuity to a workman for his past and future services. In the circumstances every businessman would make provision every year for his liability under the notification. Under the mercantile system of accounting an expenditure is admissible not only when it is actually paid but when the liability for the expenditure is incurred. The only questi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the happening of two contingencies, namely, death or voluntary retirement of an employee after 10 years' service and that the gratuity is not payable under other contingencies, such as retirement of the employee on attaining the age of superannuation, retrenchment or dismissal from service. We cannot construe the agreement as denying gratuity to an employee when he retires from service on attaining superannuation. It would be unreasonable to say that in order to become entitled to the gratuity, an employee must leave the service one day before he attains the age of superannuation. We, however, agree with the construction placed by the learned counsel for the revenue on the agreement to this extent, namely, that gratuity will not be payable to an employee if he is dismissed from service or even in cases of retrenchment. But, at the same time, we cannot accept his contention that, for this reason, the liability of the assessee for payment of gratuity to its employees under the agreement dated February 14, 1956, did not accrue during the years under reference. The learned counsel seeks support for his contention from the decision of the Supreme Court in the case of Indian Molasses Co ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... al provision and clause III of the second schedule to the policy, and there was a possibility of there being a resulting trust in favour of the company, the sums paid should be treated as set apart to meet a contingency, the payment of those sums was not a paying out or away of those sums irretrievably and did not amount to "expenditure" and a deduction could not be made in respect thereof under section 10(2)(xv). The above observations of the Supreme Court were made in the context of the special facts of that case and why the Supreme Court considered the assessee's claim to be based upon an uncertain event is clear from the following observations of the Supreme Court: " In the years of account the assessee-company did hand out to the trustees, the sums of money for which deduction is claimed. But was the money spent in so far as the assessee-company was concerned ? Harvey was then alive and it was not known if any pension to him would be payable at all. Harvey might not have lived to be 55 years. He might even have abandoned his service or might have been dismissed. Till September 20, 1955, the assessee-company had dominion through the grantees over the premia paid, at least in ..... X X X X Extracts X X X X X X X X Extracts X X X X
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