TMI Blog1994 (12) TMI 22X X X X Extracts X X X X X X X X Extracts X X X X ..... gratuity liability on the basis that the amount represented the assessee's liability for gratuity for that year on accrual basis. Section 40A(7) was introduced in the Income-tax Act, 1961 ("the Act"), with effect from the assessment year 1973-74. As the assessee did not comply with the requirements of the provisions of the newly inserted sub-section (7) of section 40A, no claim was made by the assessee for deduction on account of gratuity liability on accrual basis in computation of its income for the assessment year 1973-74 and onwards. In the previous year relevant to the assessment year 1977-78, the assessee wrote back the aforesaid amount of Rs. 1,19,564 being the provision for gratuity liability claimed and allowed as a deduction in the computation of its income for the assessment year 1972-73 and credited it to the profit and loss appropriation account. This was done as the assessee had decided to follow the cash system of accounting with regard to its gratuity liability. The Income-tax Officer being of the view that writing back the liability of Rs. 1,19,564 and crediting the amount thereof to the profit and loss appropriation account by changing its method of accounting in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ility made by it, there was no cessation of liability within the meaning of section 41(1) of the Act. According to him, the liability for gratuity accrued from year to year and continued despite the provision being written back and the amount credited to the profit and loss appropriation account. Reliance was placed in support of this contention on the decision of the Supreme Court in the case of Shree Sajjan Mills Ltd. v. CIT [1985] 156 ITR 585. In support of his contention that there was no cessation of liability, counsel relied on the decisions of this court in the case of J. K. Chemicals Ltd. v. CIT [1966] 62 ITR 34, in CIT v. Sadabhakti Prakashan Printing Press (P.) Ltd. [1980] 125 ITR 326 and in CIT v. Bennett Coleman and Co. Ltd. [1993] 201 ITR 1021. We have carefully considered the above submissions. We, however, find it difficult to agree with learned counsel for the assessee that there was no cessation of liability for payment of gratuity for which provision had been made by the assessee in the assessment year 1972-73 following the mercantile system of accounting, even after writing off the provision created by it for that purpose, for which deduction had also been allo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... vision can be made therefor and it is for that reason that deduction was allowed on account of the same as business expenditure. According to the assessee, as it was following the mercantile system of accounting in relation to its gratuity liability in the year 1972-73, provision was made for the accrued liability. Later, when it switched over to the cash system of accounting in relation to gratuity liability, it decided to write back the amount of provision for gratuity standing in its accounts and to credit the same to its profit and loss appropriation account. This action of the assessee, according to learned counsel for the assessee, cannot amount to cessation of liability because the liability for gratuity accrues from year to year and continues till the actual payment of gratuity is made on retirement or termination of the services of the employees. This contention, in our view, is not tenable in law. Payment of gratuity is by the employer to the employee on his retirement or termination of his service. The right to receive it accrues to the employees only on the retirement or termination of their services and the liability to pay gratuity became the accrued liability of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e, no question would arise to consider its deductibility or allowance under the Act. (See the observations of the Supreme Court in Shree Sajjan Mills Ltd.'s case [1985] 156 ITR 585 (at page 600)). It is thus clear that only assessees following the mercantile system of accounting can set apart for future use a sum every year to meet the contingent liability as a provision for gratuity or fund for gratuity. In Metal Box Co. of Ltd. v. Their Workmen [1969] 73 ITR 53, the Supreme Court held that contingent liabilities discounted and valued as necessary could be taken into account as trading expenses if these were sufficiently certain to be capable of being valued. An estimated liability under a gratuity scheme even if it amounted to a contingent liability, if it was properly ascertainable and its present value was fairly discounted was, therefore, held to be deductible from the gross profits while preparing the profit and loss account. In view of this decision and other decisions that followed it, it became permissible for an assessee if he so chose to provide in his profit and loss account for the estimated liability under a gratuity scheme by ascertaining its present value on actua ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the amount is credited back to the profit and loss account, evidently it would cease to be a liability on account of gratuity. In the present case, the provision for liability was made voluntarily by the assessee during the previous year relevant to the assessment year 1972-73 for its own convenience though there was no enforceable liability on that account. In that view of the matter, the effect of writing off the provision for gratuity and appropriating the same to the profit and loss account is a clear cessation of trading liability of the assessee. The liability had been created voluntarily and unilaterally by the assessee. It was not a result of any bilateral act between the assessee and its employees. No law required the assessee to make a provision for gratuity from year to year. The liability of the assessee under the Payment of Gratuity Act arises on termination of the services and/or retirement of the employees. The provision made by the assessee having been written back, even the liability for gratuity created by the assessee ceased to exist. In that view of the matter, in our opinion, section 41(1) is clearly attracted. We have perused the decisions of this court in ..... X X X X Extracts X X X X X X X X Extracts X X X X
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