TMI Blog1984 (5) TMI 33X X X X Extracts X X X X X X X X Extracts X X X X ..... d that the liability which was ascertained on May 24, 1972, could not be provided for in the accounting year ending on December 31, 1970, on the reasoning that the liability did not accrue in the previous year, and hence, the deduction could not be allowed. The liability was discounted when the actuary made the actuarial valuation. It was also held that the amount was not set apart and handed over to any trustees and the dominion and the control over the funds continued to be vested in the management. The liability was: therefore, of a contingent nature. For various reasons, the deduction was disallowed. As a result of this conclusion, the assessee has sought a reference of the following question referred to us for assessment year 1971-72, the accounting year being the calendar year 1970 " Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was justified in holding that the assessee's liability to payment of gratuity to its employees was not deductible in the computation of its business income for the assessment year 1971-72 ? " The learned counsel for the assessee referred to the Supreme Court's decision in Calcutta Co. Ltd. v. CIT [1959] 37 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... other case referred to, which was also decided by the Madras High Court, was CIT v. Sitalakshmi Mills Ltd. [1983] 141 ITR 415, which was case of gratuity. It was there observed that where an employer had gratuity scheme, the employer should obtain a scientific actuarial calculation under which the present discounted value of the gratuity liability is ascertained and then the employer can charge his profit and loss account with the incremental value of the year and make a provision for that amount. It was also observed that a provision for gratuity although charged against current profits, is not an item of expenditure strictly so called, but the deduction is warranted by sound principles of commercial accountancy and such deduction is not prohibited by any of the express provisions relating to business deduction which can be allowed. The principle on which the claim for gratuity could be allowed to be deducted was explained. In the above decision of the Madras High Court, reference was made to the case of Vazir Sultan Tobacco Co. Ltd. v. CIT [1981] 132 ITR 559 (SC), where there are valuable observations regarding gratuity. Although that was a surtax case, the question does not ap ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... settlement between the assessee and its employees on February 14, 1956, providing for gratuity to be paid in certain circumstances. A sum of Rs. 55,712 and Rs. 12,001 was transferred to the Employees' Gratuity Fund as payable for the assessment years 1957-58, and 1958-59. Oat of this sum, the ITO allowed Rs. 3,078 in the first year and Rs. 425 in the second year and disallowed the balance. The disallowance was confirmed by the AAC as well as the Tribunal. Referring to number, of decided cases, the court came to the conclusion that the amount actually transferred to the gratuity fund by the assessee had to be allowed as a deduction. The contention before the court urged on behalf of the Revenue was that the gratuity was not payable unless there was death or voluntary retirement of an employee and hence liability had not accrued. The court came to the conclusion that the amount was an expenditure which could properly be appropriated at an earlier stage. The court appears to have adopted the point that though the gratuity was payable much later, it accrued during each year of service and, therefore, on the mercantile system of accounting, a prudent businessman would appropriate the e ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . 1,71,496 and the accrued liability as on December 31, 1969, was determined as Rs. 1,55,997 and, therefore, the liability was worked out, by the ITO, as Rs. 15,499 for the year in question. The earlier amount was disallowed and it is with this earlier amount that we are concerned. The reason for disallowing the amount was that the liability as on December 31, 1969, was Rs. 1,55,997 which did not relate to this particular accounting year. The problem is whether the amount relating to the earlier year can also be claimed in this particular year ? The cases cited earlier show the principle on which the valuation of the liability has to be done. Undoubtedly, the gratuity amount is accumulated in the account of each member of the scheme from year to year, but is payable only on the date of retirement or death, as the case may be. The gratuity scheme is in reality salary which is not paid to the employee but is retained to be paid in a lump sum on his retirement date. In the event of his death, the accumulated gratuity is to be paid to his heirs. Hence the liability arises from year to year, but is payable much later. There is no difficulty about finding out how much gratuity has accu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rule states: "Rule 14.-The company shall not have any lien or charge on the gratuity fund and no moneys belonging to on/or credited to the gratuity fund shall be receivable by the company under any circumstances except as provided in this scheme." It thus appears that as soon as the amount is credited to the gratuity fund, it is no longer capable of being used by the company for its own purposes. At another place in the scheme, the definition of " gratuity fund is given. It is as follows: "Gratuity Fund.-The fund consisting of any sum or sums specifically provided and set apart by the company for the purpose of payment of gratuity to the members under the scheme." The other terms of the scheme show that the company has to make an annual contribution in respect of every member and credit the amount to the gratuity fund at the end of the accounting year. Paragraph 10 shows that the initial contribution, etc., will be computed by a competent expert or actuary and the amount shall be debited to the profit and loss account of the relevant accounting year. No doubt, a scheme can be operated by having trustees separately, but it can as well be operated by having board of direct ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 970, or afterwards. The company could then calculate the liability as it existed. According to the scheme, it could work out the liability for each completed year of service as defined by the scheme, and hence, the liability as on December 31, 1969, could be determined. Similarly, the liability as on December 31, 1970, could be worked out. This had to be verified under the scheme by an actuary. The valuation thus made would determine the liability on these two dates, December 31, 1969 and December 31, 1970. As the fund under the scheme had to remain with the company and was to be treated separately, it could immediately be put down as a debit in the accounts on the mercantile system of accounting. It was a known liability and thus could be debited in the accounts. What could be debited in the accounts for the period January 1, 1970, to December 31, 1970, was, (a) the liability under the scheme arising during the accounting period as well as, (b) the liability which related to the previous period ending on December 31, 1969. Though calculated in relation to the previous period as Rs. 1, 55,997, it became a liability only during the accounting year in question. The feature of the mer ..... X X X X Extracts X X X X X X X X Extracts X X X X
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