The judgment of the court was delivered by
D. P. WADHWA J.---This is the assessee's appeal against
judgment dated April 29, 30, 1981, of the Division Bench of the Bombay High
Court (see [1982] 138 ITR 91) on a reference under section 66(1) of the Indian
Income-tax Act, 1922 (1922 Act, for short), on the following question :
"Whether, on the facts and in the circumstances of
the case, the payment of gratuity in the sum of Rs. 4,08,622 which the
assessee-company made to Rallis India Ltd., was an allowable deduction?"
The High Court answered the question in favour of the
Revenue and against the assessee.
As to how the reference arose, we may notice a few facts.
The assessee, a private limited company, was a wholly owned subsidiary of Rallis
India Ltd. One of its activities was the distribution of the products of
Taddington Chemical Factory Private Ltd. which was also another wholly owned
subsidiary of Rallis India Ltd. With effect from May 1, 1959, the assessee
closed its unit for distribution of the products of Taddington Chemical Factory
Private Ltd. which business was taken over by Rallis India Ltd. On April 22,
1959, the assessee wrote letters to employees working in the unit dealing with
the distribution stating that arrangements had been made for the business
conducted by the assessee to be taken over by Rallis India Ltd. and that the
transfer would take effect from May 1, 1959. By this letter, the employees were
further informed that arrangements had also been made whereby all the employees
of the assessee of the distribution unit would be offered similar employment
with Rallis India Ltd. on and from May 1, 1959. The employees were, therefore,
informed that their employment was to cease on and from April 30, 1959. The
employees were further told as under :
"(A) If, for any reason, any member of the staff does
not wish to accept employment with Rallis India Ltd., retiring gratuity on the
normal scale will be paid to him on the close of his service with us as also one
month's salary in lieu of notice . . .
(D) 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 interruption in your
employment and they undertake to assume liability to pay on that basis any
retrenchment compensation that may become payable in the event of any subsequent
retrenchment."
By a separate letter of the same date Rallis India Private
Ltd. also informed the employees of the assessee offering employment with that
company from May 1, 1959, on the following terms and conditions :
"1. The general terms and conditions, grades and
rates of pay are set out in the terms of service of which a copy is attached.
2. Your actual work and position in the office will remain
as it has been herebefore . . .
5. As mentioned by W. T. Suren and Co. Private Ltd. in
their separate letter to you of today's date, we confirm that your past service
with W. T. Suren and Co. Private Ltd. shall count as continuous with future
service with Rallis India Limited and that the change of employment on May 1,
1959, shall not constitute a break in or interruption of employment and we
hereby assume liability to pay on that basis any retrenchment compensation that
may become payable in the event of any subsequent retrenchment.
If you accept this offer of employment, will you please
sign and return to us immediately the letter of acceptance which is
attached." .
Some of the employees of the assessee did accept the offer
given by Rallis India Ltd. and some did not. On May 1, 1959, Rallis India Ltd.
issued Circular No. 1 of 59-60 to all the members of the staff. A part of the
circular concerned payment of gratuity to the employees who had come from the
assessee and this was to the following effect :
"Re : Gratuity :
In order to dispel any doubt which might have arisen from
our letter of appointment dated April 22, 1959, we wish to make it clear that
continuity of service will operate in all respects, including the computation of
gratuity. In this respect, as there may be certain cases in which there will be
difference between the gratuity accrued in the service of W. T. Suren and Co.
Private Ltd. and the gratuity as calculated under our gratuity scheme, it is
understood that any members of the staff so affected will, on leaving the
company be paid the gratuity accrued to them in the service of W. T. Suren and
Co. Pvt. Ltd. as at April 30, 1959, if it is higher than the gratuity as
calculated under our scheme."
The assessee had announced a gratuity scheme for its
employees on August 31, 1953. It is as under :
"The management have pleasure in announcing a
gratuity scheme for the members of the staff as under :---
No. of completed years For each year of service
of service gratuity equivalent to
5, 6 and 7 Half-a-month's basic salary.
8 and 9 3/4 month's basic salary
10 and above 1 month's basic salary with a
maximum of 15 months or Rs. 15,000
which is lower.
Gratuity will not be payable to those staff members who
have been dismissed for misconduct, etc. The above scheme is being introduced as
from September 1, 1953."
In respect of the employees whose services had been
terminated and who had accepted the offer to join Rallis India Ltd. with
continuity of service as offered, their gratuity amounting to Rs. 4,10,177.75
was paid over by the assessee to Rallis India Ltd. on April 30, 1959. This
amount was held by Rallis India Ltd. on trust for the benefit of the staff of
the assessee and a declaration was made to the effect that Rallis India Ltd. had
no beneficial interest in the said sum of Rs. 4,10,177.75 or any part thereof.
Though a part of the business of the assessee was closed and taken over by
Rallis India Ltd. the other business of the assessee continued. In its return of
income for the assessment year 1960-61, the assessee claimed the amount of Rs.
4,08,622 as deduction. The Income-tax Officer was, however, of the view that the
correct procedure was that Rallis India Ltd. alone would be entitled to claim
the amount when paid by them to the employees of the assessee at the time of
their respective retirement. He, therefore, declined to allow the claim of
deduction of gratuity to the assessee. Being aggrieved the assessee appealed to
the Appellate Assistant Commissioner contending that payment of gratuity to
Rallis India Ltd. should be held to be an allowable deduction on the ground that
the assessee had a liability to pay such amount on the date when the employees
of the assessee were transferred to Rallis India Ltd. It was also the contention
of the assessee that the amount of gratuity was actually paid to the trustees of
Rallis India Ltd. and that, therefore, the payment of the gratuity to the
trustees should be treated as the discharge of the liability of the assessee.
The Appellate Assistant Commissioner concurring with the Income-tax Officer held
that there was no actual termination of the services of the employees and the
discharge of the liability in question was capital in nature and he also
rejected the claim of the assessee. The appeal was then taken by the assessee to
the Income-tax Appellate Tribunal where again the assessee asserted that the
payment of the amount to Rallis India Ltd. had been necessitated by business
considerations, viz., to keep the employees contented and satisfied and,
therefore, the amount should be allowed as a deduction. It was submitted that
the assessee had addressed a letter dated April 23, 1959, to its employees about
ceasing of their employment on and from April 30, 1959. According to assessee,
this letter terminated the services of the employees and the assessee was bound
to pay gratuity till that point of time. It, therefore, could not be said that
there existed no liability to pay any gratuity. It was also submitted that if
the assessee had not paid the gratuity amount to Rallis India Ltd. the employees
were well within their legal right to claim it from the assessee. The Revenue,
on the other hand, asserted that the employees had waived their claim with the
assessee in regard to their gratuity and, therefore, no liability survived in
the hands of the assessee. The Revenue also submitted that the payment made to
Rallis India Ltd. was in pursuance of an arrangement with the assessee which was
ceasing to carry on its main business activities which formed the structure of
the assessee and thus this was nothing but in the nature of transfer of business
by the assessee to Rallis India Ltd. According to the Revenue, therefore, the
payment was rightly treated as not deductible from the business income of the
assessee-company. After considering the rival contentions of the parties, the
Tribunal allowed the appeal in favour of the assessee. The Tribunal held that
there was a termination of employment of the employees from the service of the
assessee and also that there was a valid discharge of the payment of gratuity;
that the assessee was still functioning and payment of the gratuity amount was
rightly claimed as deduction. At the instance of the Revenue, the Tribunal
referred the aforesaid question to the High Court for its opinion. No question
whether there was termination of the services of the employees of assessee was
sought to be referred or whether the assessee was still functioning. The High
Court in the impugned judgment answered the question in favour of the Revenue
and against the assessee holding that the amount paid by the assessee to Rallis
India Ltd. could not be considered as a payment of gratuity to the employees of
the assessee and could not, therefore, be held to be an allowable deduction for
the purpose of section 10(2)(xv) of the Indian Income-tax Act, 1922. The High
Court said that since the employees had been given the benefit of continuity of
employment, in law, there was no retirement from employment of the assessee
giving rise to the right in favour of the employees to claim gratuity from the
assessee. In this circumstance, it was of the view that the amount paid to
Rallis India Ltd. by the assessee could not be considered as a payment of
gratuity to the employees and could not, therefore, be held to be an allowable
deduction for the purpose of section 10(2)(xv) of the 1922 Act. The High Court
referred to a number of judgments of other courts but it was the judgment of
this court which formed the base for the impugned decision and that was CIT v.
Gemini Cashew Sales Corporation [1967] 65 ITR 643. This judgment considered the
question if retrenchment compensation payable under section 25-FF of the
Industrial Disputes Act, 1947, constituted an allowable deduction, which was
answered in the negative, in favour of the Revenue. The High Court, however,
granted a certificate of fitness to appeal to this court under section 261 of
the Income-tax Act, 1961 (for short, "1961 Act"), as in its opinion
the question involved in the present case was a substantial question of law of
general importance which needed to be decided by this court. The impugned
judgment is reported in [1982] 138 ITR 91 (Bom).
Before we consider the rival contentions, we may note down
the relevant provisions of law both in the 1922 Act and the 1961 Act.
Indian Income-tax Act, 1922 :
"10. Business.---(1) The tax shall be payable by an
assessee under the head 'Profits and gains of business, profession or vocation'
in respect of the profits and gains of any business, profession or vocation
carried on by him.
(2) Such profits or gains shall be computed after making
the following allowances, namely :---. . .
(x) any sum paid to an employee as bonus or commission for
services rendered, where such sum would not have been payable to him as profits
or dividend if it had not been paid as bonus or commission :
Provided that the amount of the bonus or commission is of
a reasonable amount with reference to---
(a) the pay of the employee and the conditions of his
service :
(b) the profits of the business, profession or vocation
for the year in question; and
(c) the general practice in similar businesses,
professions or vocations; . . .
(xv) any expenditure (not being an allowance of the nature
described in any of the clauses (i) to (xiv) inclusive, and not being in the
nature of capital expenditure or personal expenses of the assessee) laid out or
expended wholly and exclusively for the purpose of such business, profession or
vocation."
Income-tax Act, 1961 :
"36. (1) The deductions provided for in the following
clauses shall be allowed in respect of the matters dealt with therein, in
computing the income referred to in section 28---
(ii) any sum paid to an employee as bonus or commission
for services rendered, where such sum would not have been payable to him as
profits or dividend if it had not been paid as bonus or commission :
37. (1) Any expenditure (not being expenditure of the
nature described in sections 30 to 36 and not being in the nature of capital
expenditure or personal expenses of the assessee), laid out or expended wholly
and exclusively for the purposes of the business or profession shall be allowed
in computing the income chargeable under the head 'Profits and gains of business
or profession'."
It may be noticed that provision where no deduction shall
be allowed in respect of any provision made by the assessee for the payment of
gratuity to his employees on their retirement or on termination of their
employment for any reason was made in the Income-tax Act, 1961, by section
40A(7) introduced by the Finance Act with effect from April 1, 1973.
It was submitted by Mr. Vellapally that the High Court
went wrong in holding that there was no termination of the services of the
employees of the assessee. He said the High Court wrongly addressed itself to
this question of termination of services of the employees of the assessee which
had never been referred to it and the consequent error committed by the High
Court when the High Court did not in effect refer to the question referred to
it. Commenting on the decision of the Supreme Court in Gemini Cashew Sales
Corporation [1967] 65 ITR 643, Mr. Vellapally said it was distinguishable and
submitted that retrenchment compensation payable to an employee was not the same
thing as gratuity. While the right to gratuity accrues year after year and is
payable at the termination of employment voluntarily or otherwise except when it
is on account of misconduct, the right to retrenchment is not always by reason
of closure of the unit or otherwise termination of employment. If the employees
did not suffer any disadvantage on being taken over by Rallis India Ltd. It was
the affair of the transferee company but it could not be said that there was no
termination of the services of the employees of the assessee. Mr. Iyer, learned
counsel for the Revenue, did not dispute the fact that there was valid
termination of services of the employees of the assessee. It was submitted by
the assessee that the amount in question was certainly business expense and it
was the liability of the assessee in praesenti and was discharged by making over
the payment to Rallis India Ltd. on behalf of the employees. If we consider the
balance-sheet of Rallis India Ltd. the amount in question did not form part of
its profit and loss account. It was not a revenue receipt. It was entered in the
balance-sheet as trust amount. Mr. Vellapally said as to how the amount is
received and utilised by Rallis India Ltd., the transferee, is also a relevant
consideration. If the service of the employee is terminated, he would become
entitled to the payment of gratuity as per the scheme of the assessee and
instead of getting the amount directly, it was paid to Rallis India Ltd. which
created a trust for that amount for the employees so transferred from the
assessee to it. This amount could not be forfeited by the transferee company
even if an employee transferred from the assessee is ultimately dismissed on the
ground of alleged misconduct. He may in that case forfeit his right to get
gratuity from Rallis India Ltd. accruing to him after May 1, 1959, while in the
service of Rallis India Ltd. Mr. Vellapally, in support of his submissions,
relied upon a Full Bench decision of the Kerala High Court (sic) in CIT v. Sri
Venkateswara Bank Ltd. [1979] 120 ITR 207 (Mad), CIT v. Sarada Binding Works
[1985] 0152 ITR 52 (Mad) and CIT v. Salem Magnesite pvt. Ltd. [1991] 189 ITR 154
(Bom).
Mr. Iyer in response said the amount was not paid for
carrying on the business of the assessee and rather it was for closing its
business and, therefore, could not be a business expense deductible under
section 10(2)(xv) of the old Act. It was submitted that the arrangement of
payment of amount to Rallis India Ltd. by the assessee was between these two
parties and the employees of the assessee were not to fall back upon it for
payment of gratuity. There was, therefore, no liability existing for the
assessee to pay the gratuity to the employees. In support of his submissions he
relied on three judgments of the Madras High Court in Stanes Motors (South
India) Ltd. v. CIT [1975] 100 ITR 341; CIT v. Pathinen Grama Arya Vysya Bank
Ltd. [1977] 109 ITR 788; and CIT v. Salem Bank Ltd. [1979] 120 ITR 224. These
three judgments were considered by the Madras High Court itself in its later
judgment in CIT v. Sarada Binding Works [1985] 152 ITR 520. Mr. Vellapally
pointed out that the impugned judgment was considered by the Bombay High Court
in CIT v. Salem Magnesite Pvt. Ltd. [1991] 189 ITR 154 where it was
distinguished. Mr. Iyer's stress was that the ratio of the judgments cited by
him was, here the expense was not laid out for the business of the assessee and
so was not deductible and that it was not for conducting or carrying on the
business of the assessee but for closing the same. But then what we find is that
before the Tribunal and in the High Court, the whole edifice of the Department
was built on the stand that there was no termination of employment of the
employees by the assessee and as such no liability had arisen and that the
assessee was not liable to pay any gratuity. It was, however, admitted that
there was no dispute as to the fact that gratuity would be allowable deduction
as and when it becomes payable. The contention of the Revenue was that so far as
the assessee was concerned, there was no liability for payment of gratuity to
the employees directly arising as the employees would have to look forward to
their claim of gratuity from Rallis India Ltd.
Since many judgments of the Madras and Kerala High Courts
rendered earlier to the Full Bench of the Kerala High Court and of Sarada
Building Works' case [1985] 152 ITR 520 of the Madras High Court, extensively
relied upon the decision of this court in Gemini Cashew Sales Corporation's case
[1967] 65 ITR 643, we may consider that judgment somewhat in detail.
In CIT v. Gemini Cashew Sales Corporation [1967] 65 ITR
643 the question before this court was whether the allowance of Rs. 1,41,506
constituted an allowable expenditure in the assessment of the firm for the year
1958-59 being retrenchment compensation payable under section 25FF of the
Industrial Disputes Act. The facts giving rise to the question were that there
were two partners constituting the firm. One partner died on August 24, 1957,
and the partnership stood dissolved. The business was taken over and continued
by the surviving partner on his own account. The services of the employees of
the firm were not interrupted and there was no alteration in the terms of their
employment. It was urged that since the firm stood dissolved on August 24, 1957,
and the undertaking was transferred, the employees became entitled to
retrenchment compensation which the firm was liable to pay. Though the assessee
failed in its claim before the Income-tax Officer and the Appellate Assistant
Commissioner, the Appellate Tribunal held that the firm was entitled to deduct
the sum of Rs. 1,41,506 in the computation of its income in the assessment year
1958-59. The Kerala High Court on a reference made to it at the instance of the
Revenue agreed with the view of the Appellate Tribunal and said that the firm
could claim as a permissible outgoing an amount for which liability was incurred
though no actual payment was made to workmen, since the firm was maintaining its
accounts on mercantile system. This court noticed the provisions of sections 25F
and 25FF of the Industrial Disputes Act and also the proviso to section 25FF
which provided that no retrenchment compensation would be payable where there
has been a change of employers by reason of the transfer if---
"(a) the service of the workman has not been
interrupted by such transfer;
(b) the terms and conditions of service applicable to the
workman after such transfer are not in any way less favourable to the workman
than those applicable to him immediately before the transfer; and
(c) the new employer is, under the terms of such transfer
or otherwise, legally liable to pay to the workman, in the event of his
retrenchment, compensation on the basis that his service has been continuous and
has not been interrupted. . ."
This court said :
"Liability to pay retrenchment compensation arises
under section 25FF when there is a transfer of the ownership or management of an
undertaking: it arises on the transfer of the undertaking and not before.
Transfer of ownership or management of an undertaking in law operates, except in
the conditions set out in the proviso, as retrenchment of the workmen. But until
there is a transfer of the undertaking resulting in determination of employment,
the workmen do not become entitled to retrenchment compensation. So long as the
ownership of the business continues with the employer, the right of the workmen
to claim compensation remains contingent. A workman may, before the transfer of
ownership of the business, himself terminate the employment : he may die or he
may become superannuated : in none of these cases the owner of the business is
under any obligation to pay retrenchment compensation to the workman. The
obligation to pay compensation becomes definite only when there is retrenchment
by the employer, or when the ownership or management of the undertaking is,
except in the cases contemplated by the proviso, transferred to a new employer,
and not till then. The right therefore arises from determination of employment,
or from transfer of the undertaking : it has no existence before these events
take place."
This court also referred to its earlier judgment in
Calcutta Co. Ltd. v. CIT [1959] 37 ITR 1. It said that in that case, expenditure
which it was estimated had to be incurred to discharge an existing and definite
obligation enforceable against the assessee in praesenti, was held a permissible
deduction in the computation of income.
This court held that the amount claimed as a permissible
allowance by the assessee in its profit and loss account cannot, in its
judgment, be regarded as properly admissible either under section 10(1) or
section 10(2)(v) of the 1922 Act. This is how the court said :
"As already observed, the liability to pay
retrenchment compensation arose for the first time after the closure of the
business and not before. It arose not in the carrying on of the business, but on
account of the transfer of the business. During the entire period that the
business was continuing, there was no liability to pay retrenchment
compensation. The liability which arose on transfer of the business was not of a
revenue nature. Profits of a business involve comparison between the state of
the business at two specific dates. Normally, the liability which occurs after
the last date, unless its source is in a pre-existing definite obligation,
cannot be regarded as a part of the outgoing of the business debitable in the
profit and loss account. A deduction which is proper and necessary for
ascertaining the balance of profits and gains of the business is undoubtedly
properly allowable, but where a liability to make a payment arises not in the
course of the business, not for the purpose of carrying on the business, but
springs from the transfer of the business, it is not, in our judgment, a
properly debitable item in its profit and loss account as a revenue outgoing.
The claim of the firm to treat it as an item in the determination of the profits
of the firm under section 10(1) of the Income-tax Act cannot, therefore, be
sustained.
Under section 10(2)(xv) of the Indian Income-tax Act in
the computation of taxable profits (omitting parts of the clause not material)
'any expenditure laid out or expended wholly and exclusively for the purpose of
such business, profession or vocation', i.e., business, profession or vocation
carried on by the assessee, is a permissible allowance. But to be a permissible
allowance the expenditure must be for the purpose of carrying on the business.
Where accounts are maintained on the mercantile system, if liability to make the
payment has arisen during the time the business is carried on, it may
appropriately be regarded as expenditure. But where the liability is, during the
whole of the period that the business is carried on, wholly contingent and does
not raise any definite obligation during the time that the business is carried
on, it cannot fall within the expression 'expenditure laid out or expended
wholly and exclusively' for the purpose of the business."
When the Tribunal decided the matter in favour of the
appellant in the present case it referred to the aforesaid statement of law by
this court in the case of the same Gemini Cashew Sales Corporation [1967] 65 ITR
643 and observed that the facts in the case before it were not the same as
before the Supreme Court in that case. In our view, the Tribunal was just right.
In Stanes Motors (South India) Ltd. v. CIT [1975] 100 ITR
341 (Mad), the assessee claimed deduction of Rs. 56,275 under section 37 of the
1961 Act which amount represented gratuity payment to its employees transferred
to the new company. The amount was calculated on the basis of the scheme of the
assessee and was from the pension and gratuity reserve of the assessee. The
claim of the assessee that the amount was paid in the discharge of the liability
of gratuity to the employees transferred to the new company and hence allowable
as deduction was negatived. The High Court relied on the decision of this court
in Gemini Cashew Sales Corporation's case [1967] 65 ITR 643. It observed as
under :
"As already pointed out the liability to make payment
to the employees had not arisen during the accounting period. The liability if
at all was wholly contingent. The transfer of gratuity reserve from the
assessee-company to the new company did not also arise in the course of the
business or for the purpose of carrying on the business, but springs from the
transfer of the business. Therefore, it cannot be said that the expenditure was
laid out or expended wholly or exclusively for the purpose of business or it was
a properly debitable item in its profit and loss account as a revenue outgoing,
For the foregoing reasons, we answer the first question in the negative and
against the assessee."
In CIT v. Pathinen Grama Arya Vysya Bank Ltd. [1977] 109
ITR 788 (Mad) the question before the High Court was whether a sum of Rs. 18,931
which formed part of the total sum transferred by the assessee to the Karur
Vysya Bank Ltd., by way of gratuity to the employees for the services rendered
to it, was admissible as a deduction. Again relying on the aforesaid decision in
Gemini Cashew Sales Corporation's case [1967] 65 ITR 643, the High Court said
that the principle of the decision of the Supreme Court relating to retrenchment
compensation to the employees equally applied to the payment of gratuity to the
employees of an assessee whose business had been transferred to another and
where the transferee took over the employees with the benefit of continuity of
service.
In CIT v. Sri Venkateswara Bank Ltd. [1979] 120 ITR 207
(Mad), the assessee transferred a substantial part of its business to the Indian
Overseas Bank Ltd. At the time of the transfer, the assessee paid a sum of Rs.
26,032 as "gratuity" to its employees and claimed the same as
deduction in the computation of its income. The question before the High Court
was whether, on the facts and in circumstances of the case, the Appellate
Tribunal was right in allowing the said sum as admissible deduction under
section 36(1)(ii) or under section 37(1) of the 1961 Act. The Income-tax Officer
referred to the amount as "retrenchment compensation" while the
assessee claimed it as gratuity. The High Court said that in either case, the
amount cannot be allowed as deduction under section 36(1)(ii). It was found that
the assessee was continuing to carry on its business. The High Court observed as
under :
"The point now to be considered is whether the
payment of gratuity with reference to its employees who were found to be surplus
at the time of the transfer of a part of the business is an allowable deduction
under section 37(1). A payment made in the course of carrying on its business as
gratuity cannot be equated to a terminal payment on the closure of the business
so as to be disallowed. There was no closure on the facts. Therefore, such a
claim cannot also be equated to a payment made at the time of the transfer of
the undertaking of the assessee as in the cases cited. It is not necessary,
therefore, to go into the decisions in CIT v. Gemini Cashew Sales Corporation
[1967] 65 ITR 643 (SC) and CIT v. Pathinen Grama Arya Vysya Bank Ltd. [1977] 109
ITR 788 (Mad). Those are cases where there had been a cessation of the business
or a transfer of the undertaking as such. On the facts found, the assessee will
be eligible for the allowance under section 37(1). The several clauses under
section 36 do not apply here. The question is, therefore, answered in the
affirmative as far as allowability under section 37 is concerned and in favour
of the assessee."
In CIT v. Salem Bank Ltd. [1979] 120 ITR 224 (Mad), the
assessee transferred its banking business to the Indian Bank Ltd. and deposited
a sum of Rs. 37,560 with the transferee bank for the purpose of ultimate
disbursement to its 27 employees (who were transferred to the Indian Bank Ltd.)
for the purpose of ultimate disbursement to them at the time of their retirement
or earlier as per the provisions of the gratuity scheme of the assessee. The
amount was claimed as expenditure under section 36(1)(ii) or section 37(1) of
the 1961 Act. The plea of the assessee of its case falling under section
36(1)(ii) was not considered. The court distinguished its earlier judgment in
the case of Sri Venkateswara Bank Ltd. [1979] 120 ITR 207 (Mad) and said that
section 37(1) was not attracted in the case and the question referred to it was
answered in negative, in favour of the Revenue and against the assessee. The
court observed that liability to pay gratuity could not be said to have arisen
at the time of the transfer as a result of the assessee carrying on its
business. It said that firstly there was no present liability to pay gratuity
and the amount had been deposited with the transferee-bank only in pursuance of
an understanding or agreement between the two and not on the basis of the
liability which had accrued on the date of transfer and that if the transfer had
not taken place, the assessee's liability would arise as and when a particular
employee got a right to receive the gratuity as per the scheme applicable to the
assessee. The court, therefore, said that a liability which could not have been
there if the business was continued in the year of account and which arose as a
result of the transaction under which the business of the assessee had been
transferred, could not be said to be an expenditure incurred for the purpose of
carrying on the business in the accounting year in question.
In CIT v. Standard Furniture Co. Ltd. [1979] 116 ITR 751
(Ker) [FB], the question before the court was whether the expenditure of Rs.
4,44,988 was an expenditure incurred wholly and exclusively for the purpose of
the business within the meaning of section 37(1) of the Income-tax Act, 1961, as
applied to the assessment year 1971-72. In this case the assessee went into
voluntary liquidation. It sold its stock and machinery to one Sudarsan Trading
Company for a consideration of Rs. 20,09,962. The purchaser agreed to take over
the services of such of the assessee's employees to whom the provisions of the
Industrial Disputes Act applied. Under a provision of law relating to payment of
gratuity as in force in the State of Kerala, the assessee had incurred a
liability for the payment of gratuity to its workers which was estimated at Rs.
4,44,988. The liability of the assessee for payment of this amount was agreed to
be paid by the purchaser at a future date. The purchaser paid the purchase price
of the stock and machinery of the assessee minus the amount of gratuity payable
to the employees which arrangement was made with the consent of the concerned
employees. The High Court considered various judgments of the High Courts and
also that of this court in Gemini Cashew Sales Corporation [1967] 65 ITR 643 and
held that the amount in question was an expenditure incurred wholly and
exclusively for the purpose of the business of the assessee within the meaning
of section 37(1) of the 1961 Act. It upheld the view of the Appellate Tribunal
that liability for payment to which the employer was subject under the local
Gratuity Act, to the workers was an expenditure wholly and exclusively laid out
or expended for the purpose of the business of the assessee. The court disagreed
with the view of the Revenue that the incurring of expenditure for payment of
gratuity much ahead of the actual time for payment of gratuity could not amount
to an expenditure incurred "wholly and exclusively for the purpose of the
business".
In CIT v. Sarada Binding Works [1985] 152 ITR 520 (Mad),
the High Court struck a different note. It had the advantage of the Full Bench
decision of the Kerala High Court in Standard Furniture Company Ltd. [1979] 116
ITR 751 (Ker). In this case the assessee, a registered firm, was doing business
in the name of Sarada Binding Works, as also in the name of Chandamama
Publications. Under an agreement, the assessee gave up possession of all the
assets and liabilities in Chandamama Publications. On a settlement of the assets
and liabilities as described in the schedule to the agreement, the excess of
liabilities over assets came to Rs. 67,687 and the assessee paid the said sum to
the transferee who succeeded to the business of Chandamama Publications. One of
the clauses of the agreement was that all the employees in that business would
become employees of the transferee on terms no less favourable to them with
continuity of service. The liabilities as worked out in the schedule included an
amount of Rs. 80,309 which was a provision for gratuity due to the employees of
the business taken over by the transferee. The assessee claimed this amount as
deduction. The question before the High Court was whether the Appellate Tribunal
was right, on the facts and in the circumstances of the case, in allowing
deduction of gratuity liability of Rs. 80,309. The court answered the question
in favour of the assessee and against the Revenue holding that in respect of the
business that was transferred though the payment under the agreement was not
made directly to the employees as such, the amount was paid for discharging the
assessee's liability to pay gratuity to its employees for the period ending with
the date of transfer and, hence, the payment should be taken to be a payment
made to discharge the assessee's liability for gratuity and, hence, had to be
allowed as a deduction.
In CIT v. Salem Magnesite Pvt. Ltd. [1991] 189 ITR 154
(Bom), the services of the employees in one of the departments of the assessee
were discontinued which department was taken over by the State of Tamil Nadu.
The liability of the assessee in respect of payment of gratuity to those
employees had become due which the assessee was prepared to pay to the employees
directly. However, the concerned employees desired that the payment be made to
the State Government as they wanted to have advantage of continuity of service.
The State Government agreed to accept the proposal and payment was made by the
assessee to the State Government on behalf of the employees. The court, in which
one of us was a party (Sujata V. Manohar J.) was of the view that the Tribunal
was right in holding that the said amount was allowable as deduction in
computing the taxable profits of the assessee. Another question which was
referred in that case for decision of the court was :
"Whether, on the facts and in the circumstances of
the case, the Tribunal should not have upheld the disallowance of the said
amount in view of the decision of the Bombay High Court in CIT v. W. T. Suren
and Co. Ltd. [1982] 138 ITR 91? "
In answer to this question, the High Court distinguished
the impugned judgment by saying that no right to gratuity had accrued in favour
of the employees whose services were alleged to have been terminated. This is
how the court considered its earlier case in W. T. Suren and Co. Ltd. [1982] 138
ITR 91 :
"We have been taken through our decision in CIT v. W.
T. Suren and Co. Ltd. [1982] 138 ITR 91. In this case, no right to gratuity had
accrued in favour of the employees whose services were alleged to have been
terminated. This was so in view of the assessee's agreement with the
transferee-company to take them up in employment with continuity of employment.
There was thus no liability to pay gratuity to the employees as such. The
assessee-company had merely made the payment in connection therewith to the
transferee-company under an agreement.
In the present case, the assessee-company had not only
computed the amount payable to the employees but was also willing to make
payment to them. It was the workers who did not want to receive the payment
direct as they wanted continuity of service. There were negotiations between the
workers and the Government of Tamil Nadu. After the agreement between them, the
assessee-company paid the said amount of Rs. 44 lakhs to the Tamil Nadu
Government. Thus, even though the workers had the benefit of continuity of
service, it was not on account of the assessee-company but as a result of a
separate arrangement/agreement between the workers and the Government of Tamil
Nadu. This court's decision in CIT v. W. T. Suren and Co. Ltd. [1982] 138 ITR 91
was, therefore, rightly distinguished."
In our view, the Kerala High Court in Standard Furniture
Co. Ltd.'s case [1979] 116 ITR 751 [FB], the Madras High Court in Sarada Binding
Works' case [1985] 152 ITR 520 and the Bombay High Court in Salem Magnesite Pvt.
Ltd.'s case [1991] 189 ITR 154 have rightly distinguished the judgment of this
court in Gemini Cashew Sales Corporation's case [1967] 65 ITR 643. Retrenchment
compensation is not the same thing as gratuity. In Gemini Cashew Sales
Corporation's case [1967] 65 ITR 643, this court considered the question of
payment of retrenchment compensation under the provisions of the Industrial
Disputes Act. That Act contains the provisions under what circumstances a
workman is entitled to retrenchment compensation. While section 25F of that Act
prescribed conditions precedent to the retrenchment of workmen, section 25FF
provides for compensation to workmen in the case of transfer of undertakings.
The right to claim retrenchment compensation remains contingent and there may be
varying circumstances under which employment may cease. Yet there may not be any
right to such compensation, like death, retirement, resignation, etc. Under the
law the right to retrenchment compensation arises when the employer terminates
the employment or the undertaking of the employer is transferred and in the
latter case that too if the case does not fall under the proviso to section
25-FF of the Industrial Disputes Act. Those provisions cannot certainly be
applied in the case of payment of gratuity. The scheme of gratuity as applicable
to the members of the staff of the assessee provided as to how much gratuity
would become due and payable to an employee for each year of service except to
one who is dismissed for misconduct, etc. Gratuity is, thus, payable on the
termination of employment of the employee on any account except dismissal and
calculated on the basis of the number of years of service and at the rate
prescribed in the scheme. In the present case, the amount of gratuity which was
paid to Rallis India Ltd. on behalf of the employees was not on account of
transfer of the distribution unit of the assessee but on account of stopping of
that business and the employees working in that unit becoming surplus resulting
in termination of their services. Other business of the assessee, as held by the
Tribunal, continued. Payment of the gratuity amount to Rallis India Ltd. was not
made by the assessee of its own but at the instance and on behalf of the
employees whose services though terminated in the assessee-company were taken
over by Rallis India Ltd. with the promise of continuity of service in Rallis
India Ltd. As far as the assessee is concerned, it was bound to make payment of
gratuity to the employees whose services were terminated and, in fact, as
noticed above, the employees who did not join Rallis India Ltd. were directly
paid gratuity. The assessee was obliged to pay gratuity to those employees who
had joined Rallis India Ltd. Instead of those employees getting the gratuity
amount directly, they got that amount paid to Rallis India Ltd. who put that
amount in trust in a separate account for the exclusive use of the transferred
employees and payable to them after their services in Rallis India Ltd.
terminated including the gratuity due on account of service rendered in Rallis
India Ltd. as per the scheme relating to gratuity of that company. Payment of
the amount of gratuity to Rallis India Ltd. was made as per the scheme of the
assessee and it was not an ex gratia or some isolated payment. It was never
disputed and, in fact, no question was raised, if the services of the employees
of the assessee were not terminated and that being the position, the obligation
of the assessee to make payment of gratuity to its employees was an obligation
in praesenti. Payment of the gratuity amount to Rallis India Ltd. was with the
consent of the employees transferred there. We are, thus, of the view that
payment of gratuity awarded by the assessee to Rallis India Ltd. in the
circumstances of the case was an expenditure wholly laid out or expended for the
purpose of the business of the assessee and was allowable deduction. It cannot
certainly be said that it was an expenditure incurred much ahead of time as the
services of the employees with the assessee were terminated. The Tribunal also
found that the assessee was a going concern and only one of its departments was
closed. The assessee had not wound up all of its affairs. Only a part of its
business was closed and transferred to Rallis India Ltd. In these circumstances,
in our view, the Tribunal was right in holding that the payment of gratuity
amount was not on account of closing the business of the assessee but for the
purpose of the business of the assessee and, thus, entitled to deduction under
clause (xv) of sub-section (2) of section 10 of the 1922 Act corresponding to
section 37(1) of the 1961 Act. We, therefore, hold that the assessee, the
appellant herein, is entitled to the payment of gratuity amount of Rs. 4,08,622
made to Rallis India Ltd. as an allowable deduction.
We allow the appeal, set aside the judgment of the High
Court and answer the question in affirmative, in favour of the assessee and
against the Revenue.
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