Commissioner of Income-Tax, Kerala Vs.
Gemini Cashew Sales Corporation, Quilon [1967] INSC 124 (20 April 1967)
20/04/1967 SHAH, J.C.
SHAH, J.C.
SIKRI, S.M.
RAMASWAMI, V.
CITATION: 1967 AIR 1559 1967 SCR (3) 727
ACT:
Income-Tax Act, 1922, s. 10(1) and 10(2)
(xv)-Partnership dissolved on death of one partner-Whether liability to pay
retrenchment compensation under s. 25FF on transfer of business to surviving
partner a permissible deduction as liability of a revenue nature.
HEADNOTE:
A partnership of two partners was dissolved
on the death of one of them on August 24, 1957 and the business was taken over
by the surviving partner on his own account. The services of the employees were
not interrupted and there was no alteration in their terms of employment. In
proceedings for assessment to income-tax for the assessment year 1958-59 it was
urged on behalf of the firm that an amount of Rs.
1,41,506 taken into account under the head
"gratuity payable to workers of the business" in settling the
accounts of the firm till August 24, 1957 was a permissible outgoing. The
Income-tax Officer rejected the claim and the Appellate Assistant Commissioner
confirmed his order. However, the Tribunal, in appeal, held that on the
dissolution of the firm, the workmen became entitled to retrenchment
compensation under s. 25FF of the Industrial Disputes Act, 1947 and the firm
was therefore entitled to the deduction.
The High Court, upon a reference, confirmed
this view.
On appeal to this Court,
HELD : The amount claimed by the assessee as
a permissible allowance in his profit and loss account could not be regarded as
properly admissible either under s. 10(1) or under s. 10(2)(xv) of the
Income-Tax Act, 1922. [735 B] Under the proviso to s. 25FF 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. It was not therefore a liability of
a revenue nature and could not be treated as a permissible deduction under s.
10(1). [733 H] Alex A. Apcar (Jr.) & Company v. M. V. Gan and Others, A.I.R,
1960 Cal. 14, referred to.
Anakpalia Cooperative Agricultural and
Industrial Society v. Its, Workmen & Others, [1962] 2 LL.J. 621, Calcutta
Company Ltd. v. Commissioner of Income-tax, West Bengal, 37 I.T.R. 1 and Owen
(H. M. Inspector of Taxes) v. Southern Railway of Peru Ltd., 36 T.C. 602,
distinguished.
Where accounts are maintained on the
mercantile system, if liability to make a payment has arisen during the time
the business is carried on. and the expenditure is for the purpose of carrying
on the business, it may be deductible under Section 10(2)(xv) 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 that time
it cannot fall L9Sup.CI/67-3 728 within the expression "expenditure laid
out or expended wholly or exclusively" for the purpose of the business.
[734 D-E) Commissioner of Income-tax, Madras v. Indian Metal and Metallurgical
Corporation, 51 I.T.R. 240 and Standard Mills Company Ltd. v. Commissioner of
Wealth-tax, Bombay, 63 I.T.R. 470, relied on.
CIVIL APPELLATE JURISDICTION: Civil Appeal
No. 702 of 1966.
Appeal by special Leave from the judgment and
order dated July 30, 1964 of the Kerala High Court in Income-tax Referred Case
No. 20 of 1963.
S. T. Desai, S. K. Aiyar and R. N. Sachthey,
for the appellant.
T. V. Viswanath Iyer, S. K. Dholakia, and O.
C. Mathur, for the respondent.
The Judgment of the Court was delivered by
Shah, J. Two persons-Walter and Ramasubramony-carried on business in cashewnuts
as partners in the name and style of Messrs. Gemini Cashew Sales Corporation.
The partnership was dissolved on the death of Ramasubramony on August 24, 1957,
and the business was taken over and continued by Walter on his own account. The
services of the employees were not interrupted and there was no alteration in
the terms of employment of the employees of the establishment.
In proceedings for assessment of tax it was
urged on behalf of the firm that an amount of Rs. 1,41,506 taken into account
under the head "Gratuity payable to workers of the business" in
settling the accounts of the firm till August 24, 1957, was a permissible
outgoing. The Income-tax Officer rejected the claim and the Appellate Assistant
Commissioner confirmed that order. The Income-tax Appellate Tribunal held that
by the transfer of the undertaking to Walter, there was no interruption in the
employment of the workmen of the establishment, that the terms and conditions
of service applicable to the workmen were not altered to their detriment, that
Walter had not expressly agreed to take over the liability for compensation
payable under S. 25FF of the Industrial Disputes Act, 1947, and since there was
dissolution of the partnership on August 24, 1957 and the undertaking was
transferred, the workmen became entitled to retrenchment compensation, which
the firm was liable to pay. The Tribunal accordingly held that the firm was
entitled to deduct the sum of Rs. 1,41,506 in the computation of income in the
assessment year. 1958-59.
In recording their opinion on the following
question submitted by the Tribunal, 729 "Whether the allowance of Rs.
1,41,506 constitutes an allowable expenditure in the assessment of the firm for
the year 1958-59", the High Court of Kerala observed that in the
determination of the taxable profits of the firm till its dissolution,
considerations about the liability to pay retrenchment compensation devolving
upon Walter as the assignee of the business valuable consideration were
irrelevant, and since it was maintaining accounts on mercantile system, the
firm could claim as a Permissible outgoing the amount for which liability was
incurred though no actual payment was made to the workmen. The Commissioner of
Income-tax appeals with special leave, against the order of the High Court
recording an answer in the affirmative.
The, subject-matter of the claim was
retrenchment compensation payable to workmen of the establishment under s. 25FF
of the Industrial Disputes Act, 1947, Section 25F of the Industrial Disputes
Act, 1947, provides :
"No workman employed in any industry who
has been in continuous service for not less than one year under an employer
shall be retrenched by that employer until(a) the workman has been given one
month's notice in writing indicating the reasons for retrenchment and the
period of notice has expired, or the workman has been paid in lieu of such
notice, wages for the period of the notice:
Provided that no such notice shall be necessary
if the retrenchment is under an agreement which specifies a date for the
termination of service;
(b) the workman has been paid, at the time of
retrenchment, compensation which shall be equivalent to fifteen days' average
pay for every completed year of service or any part thereof in excess of six
months; and (c) notice in the prescribed manner is served on the appropriate
Government." Section 25FF, as substituted by Act 18 of 1957 with effect
from November 28, 1956, provides :
"Where the ownership or management of an
undertaking is transferred, whether by agreement or by operation of law, from
the employer in relation to that undertaking to a new employer, every workman
who 73 0 has been in continuous service for not less than one year in that
undertaking immediately before such transfer shall be entitled to notice and
compensation in accordance with the provisions of Section 25F, as if the
workman had been retrenched :
Provided that nothing in this section shall
apply to a workman in any case 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 by the transfer." Under S. 25FF the right of
the workmen to retrenchment compensation arises on transfer of ownerships or
management from the employer in relation to the undertaking to a new employer.
But in the conditions set out in the proviso no such right accrues. It is
common ground that the first and the second conditions in the proviso are
satisfied. Counsel for the Commissioner contended that the third condition of
the proviso was also satisfied, and no right to retrenchment compensation arose
in favour of the workmen under s. 25FF of the Industrial Disputes Act. Counsel
for the Commissioner contended that the liability of the partners in a firm to
pay retrenchment compensation being joint and several, when the undertaking
carried on by a firm is continued by one of the partners after its dissolution,
and the services of the workmen are not terminated and the terms and conditions
of the service are not made less favourable, the partner continuing the
business may appropriately be held liable to pay to the workmen retrenchment
compensation on the footing that the service of the workmen had been
continuous.
Counsel relied upon the view expressed by the
Calcutta High Court in Alex A. Apcar (Jr.) & Company v. M. N. Gan and
Others(1) in which it was observed that a change of partnership by inclusion or
retirement of partner, which legally changes the constitution of the firm, does
not result (1) A.I.R. 1960 Cal. 14 731 in, a "change of business or
employer within the meaning of ss. 25F and 25FF".
Counsel for the assessee relied upon a
judgment of this Court in Anakapalia Co-operative Agricultural and Industrial
Society v. Its Workmen & Others(1) in support of the contention that on a
bona fide transfer of an undertaking the workmen employed in the undertaking
are entitled to retrenchment compensation under s. 25FF against the transferor.
That however was a case in which the transferee had declined to re-employ the
workmen of the transferor and the first condition of the proviso was not
fulfilled. That case can have no application to the present case.
In the view we take, that the allowance
claimed is not a proper outgoing, or allowance in computing the profits of the
assessee, we do not express any opinion on the question whether the workmen of
the undertaking became entitled to retrenchment compensation on the transfer of
the undertaking to Walter.
Liability to pay retrenchment compensation
arises under s. 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.
The judgment of this Court in Calcutta
Company Ltd v. Commissioner of Income-tax, West Bengal (2) on which reliance
was placed by counsel for the assessee has no bearing on the present case, for
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 (1) [962] 2 L.L.J. 621.
(2) 37 I.T.R. 1.
732 deduction in the computation of income.
The Calcutta Company Ltd had sold plots of land for building purposes
undertaking to develop them within six months by laying out roads, providing
drainage and installing lights, etc. In the accounts of the Company maintained
according to the mercantile system, the Company had credited the full sale
price of the. plots agreed to be paid by the purchasers, but not actually
received, and against the price it debited an estimated sum as expenditure for
the development it had undertaken to carry out, even though no part of the
amount was actually spent. By the terms of sale, the Company had undertaken an
unconditional obligation which was enforceable against it : the liability was not
contingent upon the happening of a future event. It was held by this Court that
the outgoing debited was properly admissible.
The decision of the House of Lords in Owen
(H. M. Inspector of Taxes) v. Southern Railway of Peru Ltd.(1) on which counsel
for the assessee relied also does not assist the the assessee. In that case
under the Peruvian law the Southern Railway of Peru Ltd. was bound to pay its
employees in Peru prescribed compensation payments upon termination of their
services, subject to the fulfilment by the employee of certain conditions. The
amount to be paid depended on the length of service and rate of pay at the end
of the period of service. The Company set apart from the gross profits of each
year sums prospectively payable under the Peruvian law as compensation on the
termination of employment. In proceedings for assessment to tax of the Company
made under Case 1 of Sch. D of the Income Tax Act, 1918 (8 & 9 Geo. 5, Ch.
40), it was contended on behalf of the Company that upon proper principles of
commercial accountancy compensation calculated to have accrued due to each
employee from year to year as deferred remuneration was properly allowable as a
deduction. The Special Commissioners upheld the claim of the Company on the
(,round that it was a matter of correct accountancy practice to make provision
in the accounts for the sums in question. The matter reached the House of Lords
in appeal from an order on a reference under s. 64 of the Income-Tax Act, 1952.
The House held that where a number of similar contingent obligations arise from
trading, there is no rule of law which prevents the deduction of a provision
for them in ascertaining annual profits, if a sufficiently accurate estimate
can be made. But a majority of the House held that the "provision claimed
by the Company throughout the proceedings was not permissible by reason of the
absence of discount and other factors". Lord MacDermott observed at p. 635
:
".....as a general proposition it is, I
think, right to say that in computing his taxable profits for a (1) 36 T.C.
602.
733 particular year a trader who is under a
definite obligation to pay his employees for their services in that year an
immediate payment and also a future payment in some subsequent year, may
properly deduct not only the immediate payment but the present value of the
future payment provided such present value can be satisfactorily determined or
fairly estimated. Apart from special circumstances, such a procedure, if
practicable, is justified because it brings the true costs of trading in the
particular year into account for that year and thus promotes the ascertainment
of the "annual profits or gains arising or accruing fro in" the
trade." Lord MacDermott was of the view that the provision made by the
Company led to anomalies, and was not admissible as made, and the case should
be remitted to the Special Commissioners whether it is practicable to arrive at
satisfactory deductions. Lord Radcliffe with whom the Lord Chancellor and Lord
Tucker agreed was of the view that there is no rule of law which forbids the
introduction of a provision for future payments in or payments out, if the
right to receive them or the liability to make them, is in legal terms
contingent at the closing of the relevant year.
The question which arises in the present case
is not about the admissibility of a provision made by a trader by the adoption
of it reasonably satisfactory method estimating the present value of an
obligation which may arise in future to pay a sum of money to his employees. The
question that falls to be determined is whether the liability which arises on
transfer of the, business is to be regarded as a permissible outgoing in the
account of the business which is transferred. Broadly stated, the present value
on commercial valuation of money to become due in future, under a definite
obligation, will be a permissible outgoing or deduction in computing the
taxable profits of a trader, even if in certain conditions the obligation may
cease to exist because of forfeiture of the right. Where, however, the
obligation of the trader is purely contingent, no question of estimating its
present value may arise, for to be a permissible outgoing or allowance, there
must in the year of account be a present obligation capable of commercial valuation.
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 734 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
debit-able in the profit & 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 debatable item in its profit & 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 s. 10(1) of the Income-tax Act
cannot, therefore,. be sustained.
Under s. 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 not or expended
wholly and exclusively" for the purpose of the business.
Two cases illustrative of the principle may
be noticed. It was held by the Madras High Court in Commissioner of Incometax,
Madras v. Indian Metal and Metallurgical Corporation(1) that a provision made
in the annual accounts maintained by an employer setting apart by way of a
reserve to meet the liability, if any, to which the employer may become subject
in the event of retrenching workmen because of the necessity of retrenchment of
the services of the staff, was not a liability in praesenti in the year of
account, but was only a contingent liability which may arise on the happening
of a particular contingency and was not allowable as a ,deduction in assessment
of tax. ThisCourt in dealing with a case under the Wealth Tax Act in Standard
Mills Company Ltd. V.
,Commissioner of Wealth-tax, Bombay(1) held
that a liability under the award of the Industrial Court to pay gratuity to its
,employees at certain rates on death while in service, or on voluntary
retirement or resignation after fifteen years' continuous (1) 51 I.T.R. 240.
(2) 63 I.T.R. 470.
735 service, or on termination of service
after certain specified periods, but not if the employee was dismissed for
dishonesty or misconduct, was a mere contingent liability which arose only when
the employment of the employee was determined by death, incapacity, retirement
or resignation :
the liability did not exist its praesenti.
The amount of Rs. 1,41,506/claimed as a
permissible allowance by the assessee in its profit & loss account cannot,
in our judgment, be regarded as properly admissible either under s. 10 (1) or
s. 10 (2) (xv) of the Income-tax Act.
The answer to the question must, therefore,
be in the negative.
The appeal is allowed and the order passed by
the High Court is set aside. The Commissioner will be entitled to his costs in
this Court.
R.K.P.S. Appeal allowed.
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