Shree Sajjan Mills Ltd. Vs.
Commissioner of Income Tax, M.P. Bhopal & ANR [1985] INSC 224 (8 October
1985)
MUKHARJI, SABYASACHI (J) MUKHARJI, SABYASACHI
(J) TULZAPURKAR, V.D.
MISRA RANGNATH
CITATION: 1986 AIR 484 1985 SCR Supl. (3) 593
1985 SCC (4) 590 1985 SCALE (2)737
CITATOR INFO:
RF 1987 SC1143 (8) R 1987 SC1770 (3)
ACT:
Income Tax Act 1961, ss. 40A (7), 36 (1) (v)
and 37 (1) Deduction - Payment of Gratuity - Whether deduction can be claimed
under any other provision under the head "business or profession"
without complying with the requirements of s.
40A (7) (b) - Distinction between an actual
liability in praesenti and a liability de futuro explained.
Interpretation of statutes - Taxing statutes
- Principle of reasonable construction - Applicability of - Words and Phrases -
"Provision" - Meaning of.
HEADNOTE:
The appellant-assessee is a public limited
company. The relevant assessment year in C.A. No. 4222 of 1984 is 1973-
74. With the coming into force of the Payment
of Gratuity Act, 1972 with effect from 16th September 1972 a statutory
liability was created on the assessee to pay gratuity to its employees and the
appellant arranged for actuarial determination of its liability. Pending
determination of such an actuarial valuation, the assessee made a provision of
Rs. 20 lacs against the total accruing liability till the date of the
preparation of the balance sheet. At the time of filing of the return of income
for the assessment 1973-74, the assessee added back this provision for gratuity
amounting to Rs. 20 lacs and claimed deduction of the total liability of Rs.
48,59,431 which was the actuarial determination of liability on the ground that
the provisions of s.40A (7) of the Income Tax Act 1961 were not applicable.
The Income-Tax Officer disallowed the claim
on the ground that there was non-compliance with the requirements of section
40A (7) of the Act, and allowed deduction only to the extent of actual payment
which came to Rs. 24,366 towards payment of gratuity to the employees during
the relevant accounting year.
594 Against the aforesaid order of the
Income-tax Officer, an appeal was preferred before the Appellate Assistant
Commissioner who held that provisions of section 40A (7) did not constitute any
bar to the assessees claim for deduction u/s 37 of the Act as the assessee had
not made any provision in its books in respect of the amount of gratuity
determined actuarially and the provision of Rs. 20 lacs had also been added
back in the statement of income. The Appellate Assistant Commissioner, however,
allowed deduction of Rs. 30,25,662 on this head which according to him
constituted the assessees liability for the relevant accounting year.
The Revenue appealed to the Tribunal which
held that the sum of Rs. 20 lacs could not be allowed as deduction, but, the
balance of Rs. 28,59,431 for which no provision was made in the books was
allowable under section 37(1) of the Act.
In the reference to the High Court under
section 256(1) of the Act at the instance of the Revenue, it was held that the
tribunal was not justified in allowing the deduction of Rs. 28,59,431 under
section 37 of the Act out of the total Rs. 48,59,431 made by the assessee
towards liability for gratuity on the ground that in view of the non-obstante
clause in section 40A of the Act, no deduction was permissible under section 37
for the assessee's liability for payment of gratuity to its employees without
complying with the provisions of sub-section (7)(a) of Section 40A of the Act.
A similar question of law arose in the other appeal where the appellant -
assessee is the same.
Dismissing the appeals to this Court, ^
HELD: l(i) Payment of gratuity as commonly
understood is the payment made to the employee by the employer on his
retirement or termination of his service for any reason. It is made voluntarily
by the employer as a regular practice or pressure of trade or business either
under an agreement with the employees or on the understanding of the trade and
after the enactment of the Payment of Gratuity Act, 1972 which came into force
on 16th September, 1972 as a Statutory liability under the said Act. Although
payment of gratuity is made on retirement or termination of service, it was not
for the service rendered during the year in which the payment is made but it is
made in consideration of the entire length of service and its ascertainment and
computation depend upon several factors. [608 H; 609 A-B] 1(ii) The right to
receive the payment accrued to the employees on their retirement or termination
of their services 595 and the liability to pay gratuity became the accrued
liability of the assessee when the employees retire or their services were
terminated. Until then the right to receive gratuity is a contingent right and
the liability to pay gratuity continues to be a contingent liability qua the
employer. Since the amount of gratuity payable in any given year would be a
variable amount depending upon the number of employees who would be entitled to
receive the payment during the year, the amount being a large one in one year
and a small one in another year, the employer often finds it desirable and/or
convenient to set apart for future use a sum every year to meet the contingent
liability as a provision for gratuity or a fund for gratuity. He might create
an approved gratuity fund for the exclusive benefit of his employees under an
irrevocable trust and make contributions to such fund every year. Contingent
liabilities do not constitute expenditure and cannot be the subject matter of
deduction even under the mercantile system of accounting. Expenditure which was
deductible for income tax purposes is towards a liability actually existing at
the time but setting apart money which might become expenditure on the
happening of an event is not expenditure. [609 C-G] 1(iii) The position till
the provisions of section 40A(7) were inserted in the Act in 1973 was as
follows :-
1. Payments of gratuity actually made to the
employee on his retirement or termination of his service were expenditure
incurred for the purpose of business in the year in which the payments were
made and allowed under section 37 of the Act.
2. Provision made for payment of gratuity
which would become due and payable in the previous year was allowed as an
expenditure of the previous year on accrued basis when mercantile system was
followed by the assessee.
3. Provision made by setting aside an advance
sum every year to meet the contingent liability and gratuity as and when it
accrued by way of provision for gratuity or by way of reserve or fund for
gratuity was not allowed as an expenditure of the year in which such sum was
set apart.
4. Contribution made to an approved gratuity
fund in the previous year was allowed as deduction under section 36(1)(v).
5. Provision made in the Profit and Loss
Account for the estimated present value of the contingent liability properly
596 ascertained and discounted on an accrued basis as falling on the assessee
in the year of account could be deductible either under Section 28 or section
37 of the Act. [610 E-H;
611 A] 1(iv) As there were several methods
which the assesseeight choose to adopt in meeting his liability to pay
gratuity, the treatment which he would receive under the Income-tax Act would
depend upon the method adopted by him.
The assessee is only under an obligation to
pay gratuity when it became due ant payable. The other methods adopted by the
assessee for meeting the liability for gratuity as and when it arose are
provisions or arrangements mate by him at his option. It is not obligatory on
him to make any such provision and if no such arrangement or provision was
made, no question arose to consider its deductibility or allowance under the
Act. [611 B-C] 2(i) On a plain construction of clause (a) of sub- section (7)
of section 40A of the Act, it means that whatever is provided for future use by
the assessee out of the gross profits of the year of account for payment of
gratuity to employees on their retirement or on the termination of their
services would not be allowed as deduction in the computation of profits and
gains of the year of account. The provision of clause (a) was made subject to
clause (b). The embargo is on deductions of amounts provided for future use in
the year of account for meeting the ultimate liability to payment of gratuity.
Clause (b)(i) excludes from the operation of
clause (a) contribution to an approved gratuity fund any amount provided for or
set apart for payment of gratuity which would be payable, during the year of
account. Clause (b) (ii) deals with a situation that the assessee might provide
by the spread over method and provides that such provision would be excluded
from the operation of clause (a) provided the three conditions laid down by the
sub-clauses are satisfied. [612 E-H] 2(ii) The expression 'provision' in clause
(a) of the said sub-section has not been defined in the Act and is not used in
any artificial sense but in its ordinary meaning.
This is clear from the words (whether called
as such or by any other name) occurring in sub-section. 'Provision' in its
ordinary sense means 'something provided for future use'.
[612 D] 2(iii) Section 40A is in Chapter IV
which deals with computation of total income. It is with the marginal note
under the heading "expenses or payments not deductible in certain
circumstances". The heading of this section is a clear indication 597 that
certain payment and expenses which would be otherwise deductible would not be
deductible except in certain circumstances indicated in the section. This is
abundantly made clear by the non-obstante expression used in sub- section (1)
of section 40A. The provision of section 40A shall have effect
notwithstandinganything to the contrary contained in any other provision of the
Act. Payments or provisions for deduction could have been eligible for
deduction or could have been deducted either under section 28 or under section
37 of the Act. But the use of the non- obstante expression makes it clear that
if there is any legislative base dealing with the provisions for gratuity then
the same would be applicable in spite of and notwithstanding any other
provision of the Act. [608 B-E] 2(iv) Read with the marginal notes of section
40A the non-obstante clause of sub-section (1) of section 40A has an overriding
effect over the provisions of any other section.
Expenditures or allowances which are
deductible under any other provision relating to the head 'Business or
profession' will be disallowed in cases to which these provisions of the
section apply. The submission of the appellant-assessee that if provision is
made by the assessee for gratuity, still the same will be deductible and
8. 40A(7) will have no application, would
defeat the very purpose and object of s. 40A(7) and render it nugatory. [608
E-G]
3. The principle that fiscal statutes should
be strictly construed does not rule out the application of the principles of
reasonable construction to give effect to the purpose or intention of any
particular provisions as apparent from the scheme of the Act with the
assistance of such external aids as are permissible under the law. [614 G]
Webster's English Dictionary referred to.
Vazir Sultan Tobacco Co Ltd. Etc. Etc. v.
Commissioner of Income Tax, Andhra Pradesh, Hyderabad, [1982] 1 S.C.R.
789 at 800 & 804 = 132 I.T.R. 559 at 568,
Metal Box Company of India Ltd. v. Their workmen, 73 I.T.R. 53 at 67-68. and
Indian Molasses Co. (P) Ltd. v. Commissioner of Income Tax, West Bengal, 37
I.T.R. 66 at pages 76 & 80. relied upon.
Peoples Engineering & Motor Works Ltd. v.
Commissioner of Income Tax, West Bengal-II, 130 I.T.R. 174 and Commissioner of
Income-tax Central-V, Calcutta v. New Swadeshi Mills of Ahmedabad Ltd" 147
I.T.R. 163 approved.
598 Tata Iron & Steel Co. Ltd. v. D.V.
Bapat, Income Tax Officer, Companies Circle I (2) Bombay and Anr., 101 I.T.R.
292 and C.I.T. Kerala v. High Land Produce
Co. Ltd., 102 I.T.R. 803 distinguished.
Kedarnath Jute Mfg. Co. Ltd. v. Commissioner
of Income- tax (Central), Calcutta , 82 I.T.R. 363 and Commissioner of Income
Tax, Madras (Central) v. Andhra Prabha P. Ltd. 123 I.T.R. 760 at 772 and
Swadeshi Cotton Mills Co. Ltd. v. I.T.O., 1978 112 I.T.R. 1038 (All) referred
to.
CIVIL APPELLATE JURISDICTION: Civil Appeal
Nos. 4221- 22 (NT) of 1984.
From the Judgment and Order dated 29.11.1982
of the Madhya Pradesh High Court in Misc. Civil Case No. 240, 263 of 1980.
Soli J. Sorabjee, P.H. Parekh, P.K. Manohar
and S. Ganesh for the Appellant.
V.S. Desai, Gauri Shankar ant Miss A
Subhashini for the Respondents.
The Judgment of the Court was delivered by
SABYASACHI MUKHARJI, J. These appeals by special leave arise from the Judgment
and order of the High Court of Madhya Pradesh dated 29th November, 1982, in
reference under Section 256(1) of the Income-tax Act, 1961 (hereinafter
referred to as the 'Act'). The assessee is a public limited company. The
related assessment year in Appeal No 4221 of 1984 is 1974-75. In Appeal No 4222
of 1984, the assessment year is 1973-74. The relevant accounting years ended on
31st March, 1974 and 31st March, 1973 respectively.
For the assessment year 1974-75, the assessee
company sought to deduct a sum of Rs.18,37,727 towards the amount of gratuity
payable to its employees and worked out actuarially. The break up of this
liability was as follows:
- for periods ending on 31st March, 1972,
31st March, 1973 and 31st March, 1974, assessee's liability was worked out at
Rs. 64,31,286. Out of this amount, provision had been made during these years
to the tune of Rs. 45,93,559. No provision had been made for the balance amount
of Rs.
18,37,727. The claim for deduction was set up
on the ground that this liability was ascertained by actuarial 599 valuation
and was deductible under section 37(1) of the Act.
The Income-tax Officer allowed the deduction
of a sum of Rs.
2,65,872 only which was actually paid by the
assessee and the rest was disallowed on the ground of non-compliance with the
provisions of section 40A(7) of the Act. The assessee preferred an appeal but
the same was dismissed by the Commissioner of Income-tax (Appeals). The
assessee thereafter preferred a second appeal to the Tribunal. The Tribunal,
for the reasons mentioned, held that for the assessment year relating to
1973-74, actuarially ascertained liability for gratuity especially arising
under the Payment of Gratuity Act, 1972 was an allowable detection. The
Tribunal had consistently taken the view that the assessee would not be
eligible for deduction under section 37 in respect of such liability to the
extent of the provision made by the assessee in its account without
simultaneously conforming to the requirements of section 40A(7). Where however,
the actuarially determined liability was not provided for or was in excess of
the provision made by the assessee in the books of account, the relevant amount
could be allowed as liability under Section 37 as the provisions of section
40A(7) would not reach it.
In the assessment of 1974-75, the Tribunal
referred to the facts and observed that increased liability of Rs.
15,71,855 had been claimed by the assessee
without any provision made in respect thereof in the books of account.
In the circumstances, they upheld the claim
of the assessee for Rs. 15,71,855 and directed the Income-tax Officer to allow
this sum as a liability.
At the instance of the revenue, the following
questions were referred to the High Court, namely:
"(1) Whether, on the facts and in the
circumstance of the case, the tribunal was right in law in allowing the
deduction of Rs. 15,71,855 under Section 37 of the I.T. Act, 1961 out of the
sum of Rs. 28,59,431 for which provision was made towards liability for
gratuity? (2) Whether, on the facts and in the circumstances of the case, the
Tribunal was right in law in holding that Section 40A(7) is attracted only in
respect of the provision made in the books of account and that the balance
liability claimed i.e. Rs.15,71,855 towards gratuity is admissible under sec.
37 of the Income Tax Act, 1961. " 600 and for the reasons mentioned, for
the assessment year 1973- 74 which is the subject matter of the next appeal and
following the said decision, the High Court held that the assessee was not
entitled to deduction on account of its liability for gratuity under the Payment
of Gratuity Act, 1972 without complying with the provisions of section 40A(7)
of the Act and accordingly answered both the questions in the negative and
against the assessee. This decision is the subject matter of Appeal No. 4221
(NT) of 1984.
Civil Appeal NO. 4222 (NT) of 1984 arises out
of the assessment year 1973-74. The High Court observed that the assessee
company had entered into agreements with the Workers Union for payment of
gratuity by the 31st March, 1972. Company's practice was to account for
gratuity on cash basis as and when paid. The company had made a provision in
its books of account for payment of gratuity to its employees to the extent of
Rs. 20,00,000 during the relevant accounting year. With the coming into force
of the Payment of Gratuity Act, 1972 with effect from 16th September, 1972, a
statutory liability was created of the company to pay gratuity to its employees
as per the provisions of the said Act. The assessee company, therefore,
arranged for actuarial quantification of its liability for gratuity to its
employees. Pending the determination of such an actuarial valuation, the
assessee had made a provision of Rs.
20,00,000 Against the total accruing
liability till the date of the preparation of the balance-sheet. At the time of
the filing of the return of income for the assessment year 1973- 74, the
assessee added back this provision for gratuity amounting to Rs. 20,00,000 and
claimed the total liability of Rs. 48,59,431 which was the actuarial
determination of liability arising under the Payment of Gratuity Act, 1972 in
the relevant accounting year.
Before the Income-tax Officer, the assessee
claimed deduction of the entire liability of Rs. 49,59,431 as determined
actuarially. It was contended that the provisions of section 40A(7) of the Act
were not applicable. The Income-tax Officer had disallowed the claim on the
ground that there was non-compliance with the requirements of section 40(A)(7)
of the Act. The Income-tax Officer allowed deduction only to the extent of
actual payment made towards gratuity to the employees during the relevant
accounting year. This amount came to Rs. 24,366. The assessee preferred an
appeal against the Income-tax Officer, order before the Appellate Assistant
Commissioner. The Appellate 601 Assistant commissioner was of the view that
provisions of section 40(A)(7) did not constitute any bar to the assessee's
claim for deduction as the assessee had not made any provision in its books in
respect of the amount of gratuity determined actuarially and the provision of
Rs.
20,00,000 had also been added back in the
statement of income. However, the Appellate Assistant Commissioner allowed
deduction of Rs. 30,25,662 on this head which according to him constituted
assessee's liability for the relevant accounting year.
The revenue appealed against this decision.
It was contended that the assessee was not entitled to any deduction for
gratuity except the amount actually paid because there was non-compliance with the
statutory provisions of section 40A(7) of the Act. The Tribunal held that the
total liability for gratuity actuarially determined for the accounting year was
Rs. 48,59,431. However, the assessee had made a provision of Rs. 20,00,000
without complying with the requirements of section 40A(7) of the Act and,
therefore, this sum of Rs. 20 lakhs could not be allowed as deduction. But the
balance of Rs. 28,59,431 for which no provision was made in the books was
allowable under section 37(1) of the Act.
At the instance of the revenue, the following
question for this year was referred to the High Court :
"Whether, on the facts and in the
circumstances of the case, the Tribunal was justified in allowing the deduction
of Rs. 28,59,431 under section 37 of the Income Tax Act, 1961 out of the total
Rs, 48,59,431 made by the assessee towards liability for gratuity?"
Section 40A was inserted by the Finance Act, 1968 with effect from 1st April,
1968. It is necessary to set out the relevant provisions of section 40A:
"40A. Expenses or payments not
deductible in certain circumstances - (1) The provisions of this section shall
have effect notwithstanding anything to the contrary contained in any other
provision of this Act relating to the computation of income under the head to
the computation of income under the head "Profits and gains of business or
profession".
....
.................................................
602 (7)(a) Subject to the provisions of
clause (b), no deduction shall be allowed in respect of any provision (whether
called as such or by any other name made by the assessee for the payment of
gratuity to his employees on their retirement or on termination of their
employment for any reason (b) Nothing in clause (a) shall apply in relation to
- (1) any provision made by the assessee for the purpose of payment of a sum by
way of any contribution towards an approved gratuity fund, or for the purpose
of payment of any gratuity, that has become payable during the previous year;
(ii) any provision made by the assessee for
the previous year relevant to any assessment year commencing on or after the
1st day of April, 1973, but before the 1st day of April, 1976, to the extent
the amount of such provision does not exceed the admissible amount, if the
following conditions are fulfilled, namely - (1) the provision is made in
accordance with an actuarial valuation of the ascertainable liability of the
assessee for payment of gratuity to his employees on their retirement or on
termination of their employment for any reason;
(2) the assessee creates an approved gratuity
fund for the exclusive b n fit of his employees under an irrevocable trust, the
application for the approval of the fund having been made before the 1st day of
January 1976; and (3) a sum equal to at least fifty percent of the admissible
amount, or where any amount has been utilised out of such provision for the
purpose of payment of any gratuity before the creation of the approved gratuity
fund, a sum equal to at least fifty percent of the admissible amount as reduced
by the amount so utilised, is paid by the assessee by way of contribution to
the approved gratuity fund before the 1st Day of April, 1976, and the balance
of the admissible amount or, as the case may be, the balance 603 of the
admissible amount as reduced by the amount so utilised, is paid by the assessee
by way of such contribution before the 1st day of April, 1977." According
to the High Court, section 40A had an overriding effect on the other provisions
relating to the computation of income under the head "profit" ant
gains of business or profession". This meant that while computing income
under the head "profits and gains of business or profession" and
allowing various deductions provided for under the Act, requirements of 40A
would be mandatory In respect of the matters covered thereunder. The High Court
was of the view that sub-section (7) of section 40A referred to deductions on
account of payment of gratuity to the employees of an assessee and section 37
which was the residuary section for allowance of expenditure would not be
applicable. The High Court agreed with the view expressed by the Calcutta High
Court In the case of Peoples Engineering & Motor Works Ltd. v. Commissioner
of Income Tax, West Bengal - II, 130 I.T.R. 174.
The High Court was also of the view that if,
therefore, an assessee claimed deduction on account of accrual of liability for
gratuity, the same will be hit by the bar under sub-section (7)(a) of section
40A of the Act irrespective of the fact whether the account books of the
assessee referred to the liability or not.
The High Court was further of the opinion
that In view of the non obstante clause in section 40A of the Act, no deduction
was permissible under section 37 of the Act for the assessee's liability for
payment of gratuity to its employees without complying with the provisions of
sub section (7)(a) of section 40A of the Act. The question was therefore,
answered in the negative and against the assessee.
On behalf of the assessee in these appeals it
was submitted with reference to section 40A(7) of the Act that the said section
was a provision of disallowance and but for the said section, provisions made
by an assessee for payment of gratuity could be claimed as deduction under
section 37 of the Act as expenditure incurred wholly and exclusively for the
purpose of the assessee's business. Alternatively, It was urged that such a
provision would have been claimed as deduction generally in determining the
true profits ant gains of business which could be subjected to tax under
section 28 of the Act. It was emphasised on behalf of the 604 assessee that
deduction in respect of gratuity could be claimed de hors section 40A(7) which
in effect provided for the disallowance of the deduction in respect of gratuity
in certain circumstances. therefore, it was urged on behalf of the assessee
that this provision should be very strictly construed. And so construed,
section 40A(7) could only apply if the assessee had made provision for payment
of gratuity and only to the extent of the amount of such provision.
It was emphasised that the expression
'Provision made by the assessee' is a term of accounting and signified that the
assessee hat set apart the amount in his books of account for meeting the
liability known to exist on the date of the balance-sheet. Consequently if no
amount had been specifically set apart in the books of account of the assessee
for meeting the liability of gratuity, it could not be said that there was any
provision made by the assessee for the payment of gratuity. Reliance in this
connection was placed on the observations of this Court in Vazir Sultan
Tobacco. Ltd. etc. etc. v. Commissioner of Income Tax, Andhra Pradesh,
Hydrabad, [1982] 1 S.C.R. 789 at 800 & 804 132 I.T.R. 559 at 568. at 800
& 804. It was submitted that a provision could be made only after an amount
was specifically set apart in the books of account by debiting the profit and
loss account for meeting a certain liability.
It was then urged that the language and the
scheme of the Act supported the aforesaid submission namely;
(a)that section 40A(7)(b) (ii) drew a clear
distinction between 'provision made by the assessee....for payment of gratuity'
and 'amount admissible as deduction on account of gratuity'. This showed
clearly that the making of a claim by the assessee for deduction on account of
gratuity could not be equated with the making of a provision.
(b)The words 'made by the assessee' following
the word 'provision' were also very significant and clearly indicated that an
amount must be set apart specifically by the assessee for meeting the liability
for gratuity.
(c)If the legislature at all wanted to equate
a deduction in respect of gratuity with a provision made for payment of
gratuity section 40A(7) would have been worded differently, namely;
"No deduction shall be allowed in
respect of any liability for the payment of gratuity...." 605 (d) The
expression 'provision made by the assessee' occurs in section 40A(7) no less
than seven times. These words must therefore be given their due meaning and
effect and could not be treated as redundant.
(e) Explanation II to section 40A(7) referred
to amount being paid to an employee in a subsequent year out of the provision
of gratuity. This provision was intelligible and meaningful only if 'provision'
was understood to mean the setting apart of an amount in the books of account.
So as to make funds available for disbursement.
(f) Section 36(1)(vii a) of the Act provided
for deduction in respect of the provision for doubtful debts made by certain
financial institutions. There was no doubt that 'provision' in section
36(1)(vii a) of the Act meant an amount specifically set apart in the books of
account of the assessee to meet the loss on doubtful debts. The word
'provision' in section 40A(7) must also receive the same meaning, according to
the assessee.
(g) Section 34(3)(a) spoke of the creation of
a development rebate reserve by debiting the Profit and Loss Account and
crediting the Reserve Account. Thus, the Income- tax Act itself contemplated,
according to the assessee, a Reserve as an appropriation or earmarking of
profits by making entries for this purpose in the books of account.
(h) The other clauses of section 40A spoke of
'expenditure' and 'allowance'. But section 40A struck a different note and used
the word 'provision. Consequently 'provision' could not be equated with
'expenditure' or 'allowance' or 'deduction.
In interpreting a taxing statute, it was
submitted on behalf of the assessee, equitable considerations were entirely out
of place, nor could taxing statute be interpreted on any presumptions or
assumptions. The Court must look squarely at the words of the statute and
interpret these. It should interpret a taxing statute in the light of what was
clearly expressed and it could not imply anything which was not expressed; it
could not import provisions into the statute so as to supply any assumed
deficiency, nor could It refuse to give effect to the plain and clear meaning
of the words on the ground that strange and anomalous consequences might arise.
It was, therefore, urged on behalf of the
assessee that the judgment under appeal of the High Court was erroneous for the
following reasons:
606 (a) that it regarded a claim for
deduction of gratuity in the income-tax assessment as tantamounting to the
making of a provision by the assessee in his books of account, and (b) it
proceeded on the unwarranted assumption that the Companies Act mandatorily
required a company to make a provision for gratuity, and failure to make such a
provision constituted a violation of the Companies Act, and such a company
should not be permitted to take advantage of its own wrong.
It was submitted that there was no provision
in the Companies Act or in the accounting practice making it mandatory for a
company to get an actuarial valuation of its gratuity liability or to make a
provision for the same in its books of account. The Company Law Board had put
this matter beyond doubt under circulars on several occasions specially by
Circular No. 13/77 dated 21st November, 1977, which provided that a company
might either make a provision for gratuity or might merely indicate the fact of
the liability for gratuity by appending a note at the foot of the accounts.
Further, the Institute of Chartered Accountant had also issued a publication
titled 'statement on treatment of Retirement Gratuity' which also clarified
that a company need not make any provision for gratuity. These submissions were
elaborated with reference to certain books on accountancy.
Our attention was drawn to the observations
of this Court in the case of Metal Box Company of India Ltd. v.
Their Workmen, 73 I.T.R. 53 at 67-68, which
were reiterated and referred to in the decision of this Court in Vazir Sultan
Tobacco Co. Ltd. v. Commissioner of Income Tax (supra). In these appeals we are
not concerned with the distinction between 'provision' and 'reserves'. We are
concerned with the true meaning and purport of the expression provision made by
the assessee . This Court in Vazir Sultan's case observed at page 569 referring
to the observations in the case of Metal Box:
"The distinction between a provision and
a reserve is in commercial accountancy fairly well known.
Provisions made against anticipated losses
and contingencies are charges against profits and, therefore, to be taken into
account against gross receipts in the P. & L. account and the balance-
sheet. On the other hand, reserves are appropriations of profits, the assets by
which they are represented being retained to form part 607 of the capital employed
in the business.
Provisions are usually shown in the
balance-sheet by way of deductions from the assets in respect of which they are
made whereas general reserves and reserve funds are shown as part of the
proprietor's interest. (See Spicer and Pegler's Book keeping and Accounts, 15th
Edn. p. 42)." It was emphasised that the concept of provision applied not
only in respect of companies but also to individual assessees.
Reliance was also placed on the observations
of this Court in Kedarnath Jute Mfg. Co. Ltd. v. Commissioner of Income-tax
(Central), Calcutta, 82 I.T.R. 363, where it was emphasised that whether an
assessee was entitled to a particular deduction or not depended on the
provision of law relating thereto and not on the view that the assessee might
take of his rights; nor could the existence or absence of entires in the books
of account be decisive or conclusive in the matter. The assessee who was
maintaining accounts on the mercantile system was fully justified in claiming
deduction of the amount of sales tax which it was, under the law, liable to pay
during the relevant accounting year.
Counsel was emphatic that there was no
obligation cast on any assessee either by any law or even by the canons of
accounting practice to make any provision in the books of account in respect of
the liability to pay gratuity.
Consequently, an assessee might claim as
deduction in his income-tax assessment the liability in respect of gratuity
even though he might not have made any provision or other entry in his books of
account in respect of gratuity.
It was the assessee's case that section
40A(7) was not a complete code in respect of gratuity. Section 40A contained
only a series of specific and limited disallowances. If an item of expenditure
was not covered by section 40A, it was not as if it could not be claimed as
deduction at all. On the contrary, if section 40A did not apply, there was no
bar at all to claiming the expenditure as deduction either under section 28 or
under section 37 provided it was incurred wholly and exclusively for the
purpose of business. It was further submitted that section 40A(7) could not
possibly be considered to be a complete code with regard to the allowance of
deduction for gratuity, inter alia, because section 40A(7) merely provided for
disallowance if provision of gratuity was made by the assessee. It does not say
608 that no deduction will be allowed in respect of gratuity unless and until
certain conditions were fulfilled.
Section 40A is in Chapter IV which deals with
computation of total income. It is under the sub-heading of a group of sections
dealing with the computation of profits and gains of business or profession.
The said group of section begin with section 28 and go upto section 40D.
Section 40A is with the marginal note under
the heading "Expenses or payments not deductible in certain
circumstances". If the marginal note or heading is any indication, and it
certainly is a relevant factor to be taken into consideration in construing the
ambit of the section, then these payments mentioned therein are not deductible
according to the statute in certain circumstances. therefore, the heading of
this section is a clear indication that certain payments and expenses which
would be otherwise deductible would not be deductible except in certain
circumstances indicated in the section. This is abundantly made clear by the
non-obstante expression used in sub-section (1) of section 40A. As noted
before, the provisions of section 40A shall have effect notwithstanding
anything to the contrary contained in any other provision of the Act. Payments
of deductions or provision for deduction could have been eligible for deduction
or could have been deducted either under section 28 or under section 37 of the
Act. But the use of the non-obstante expression makes it clear that if there is
any legislative base dealing with the provisions for gratuity then the same
would be applicable in spite of and notwithstanding any other provision of the
Act.
Read with the marginal notes of section 40A,
the non- obstante clause of sub-section (l) of section 40A has an overriding
effect over the provisions of any other section by providing that the
provisions of the section will have effect notwithstanding anything to the
contrary contained in any other provision relating to the computation of income
under the head Profits and gains of business or profession .
Expenditures or allowances which are
deductible under any other provision relating to the head 'Business or
profession' will be disallowed in cases to which these provisions of the
section apply. This sub-clause was inserted by Finance Act, 1975 with
retrospective effect from 1.4.1973. It is necessary to appreciate the purpose
and object intended to be achieved by this sub-section in order to arrive at
the true meaning of the provision.
Payment of gratuity as commonly understood is
the payment made to the employee by the employer on his retirement or
termination of his service for any reason. It is made voluntarily 609 by the
employer as a regular practice or pressure of trade or business either under an
agreement with the employees or on the understanding of the trade and after the
enactment of the Payment of Gratuity Act, 1972 which came into force on 16th
September, 1972, as a statutory liability under the said Act Although payment
of gratuity is made on retirement or termination of service, It was not for the
service rendered during the year In which the payment is made but it is made in
consideration of the entire length of service and its ascertainment and
computation depend upon several factors.
The right to receive the payment accrued to
the employees on their retirement or termination of their services and the
liability to pay gratuity became the accrued liability of the assessee when the
employees retired or their services, were terminated. Until then the right to
receive gratuity is a contingent right and the liability to pay gratuity
continues to be a contingent ability qua the employer. An employer might pay
gratuity when the employee retires or his service is terminated and claim the
payment made as an expenditure incurred for the purpose of business under
section 37. He might, if he followed the mercantile system, provide for the
payment of gratuity which became payable during the previous year and claim it
as an expenditure on the accrued basis under section 37 of the said Act. Since
the amount of gratuity payable in any given year would be a variable amount
depending upon the number of employees who would be entitled to receive the
payment during the year, the amount being a large one in one year and a small
one in another year, the employer often finds it desirable and/or convenient to
set apart for future use a sum every year to meet the contingent liability as a
provision for gratuity or a fund for gratuity. He might create an approved
gratuity fund for the exclusive benefit of his employees under an irrevocable
trust and make contributions to such fund every year. Contingent liabilities do
not constitute expenditure and can not be the subject matter of deduction even
under the mercantile system of accounting. Expenditure which was deductible for
income tax purposes is towards a liability actually existing at the time but
setting apart money which might become expenditure on the happening of an event
is not expenditure.
(See in this connection the observations of
this Court in Indian molasses Co. (P) Ltd., v. Commissioner of Income-tax, West
Bengal), 37 I.T.R. 66 at pages 76 & 80. A distinction is often made between
an actual liability in praesenti and a liability de futuro, which for the time
being is only contingent. The former is deductible but not the latter.
610 Amounts set apart by way of provision or
by way of a reserve or fund to meet the liability of gratuity as and when it
becomes payable will not be deductible allowance or expenditure. Where,
however, an approved gratuity fund is created for the exclusive benefit of the
employees under an irrevocable trust, contribution made to the fund during the
year of account will be allowed to be deducted under section 36(1)(v), In Metal
Box Company of India v. Their Workmen (supra), this 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 properly ascertainable and its present value was fairly
discounted was deductible from the gross profits while preparing the profit and
loss account. In view of this decision and other decisions that followed it, lt
became permissible for an assessee if he so chose to provide in his profits and
loss account for the estimated liability under a gratuity scheme by
ascertaining its present value on accrued basis and claiming it as an
ascertained liability to be deducted in the computation of the profits and
gains of the previous year.
It would thus be apparent from the analysis
aforesaid that the position till the provisions of section 40A(7) were inserted
in the Act in 1973 was as follows :- (1) Payments of gratuity actually made to
the employee on his retirement or termination of his services were expenditure
incurred for the purpose of business in the year in which the payments were
made and allowed under section 37 of the Act.
(2) Provisions made for payment of gratuity
which would become due and payable in the previous year was allowed as an
expenditure of the previous year on accrued basis when mercantile system was
followed by the assessee.
(3) Provisions made by setting aside an
advance sum every year to meet the contingent liability and gratuity as and
when it accrued by way of provision for gratuity or by way of reserve or fund
for gratuity was not allowed as an expenditure of the year in which such sum
was set apart.
(4) Contribution made to an approved gratuity
fund in the previous year was allowed as deduction under section 36(1)(v).
611 (5) Provision made in the Profit and Loss
Account for the estimated present value of the contingent liability properly
ascertained and discounted on an accrued basis as falling on the assessee in
the year of account could be deductible either under section 28 of section 37
of the Act.
As there were several methods which the
assessee might choose to adopt in meeting his liability to pay gratuity, the
treatment which he would receive under the Income-tax Act would depend upon the
method adopted by him. The assessee is only under an obligation to pay gratuity
when it became due and payable. The other methods adopted by the assessee for
meeting the liability for gratuity as and when it arose are provisions or
arrangements made by him at his option. It is not obligatory on him to make any
such provision and if no such arrangement or provision was made, no question
arose to consider its deductibility or allowance under the Act.
The intention of the legislature in enacting
the provision of section 40(A)(7) would be apparent from the notes on clauses
of the amendment where in paragraph 46, after referring to the provisions of
section 37(1) and section 36(1)(v) of the Act, it was observed (98 I.T.R.
Statutes p. 194), inter alia, as follows :-
"A reading of these two provisions clearly shows that the intention has
always been that deduction in respect of gratuities should be allowed either in
the year in which the gratuity is actually paid or in the year in which
contributions are made to an approved gratuity fund. A doubt has been expressed
that the relevant provisions, as presently worded, do not secure the underlying
objective and that a provision made by a taxpayer in his accounts in respect of
estimated service gratuity payable to employees will be deductible in computing
the taxable income in a case where the provision has been made on a scientific
basis in the form of an actuarial valuation. In order to remove uncertainty in
the matter, it is proposed to specifically provide in the law that no deduction
will be allowed, in the computation of profits and gains of a business or
profession, in respect of any reserve created or provision made for the payment
of gratuity to the employees on retirement or on termination of employment for
any reason. This restriction will, 612 however, not apply in relation to a
provision made for the purpose of payment of a sum by way of contribution
towards an approved gratuity fund that has become payable during the relevant
account year, on for the purpose of meeting actual liability in respect of payment
of gratuity to the employees that has arisen during such year." This
intention and the purpose of the legislature was carried into effect by
inserting sub-section (7) in section 40A by ensuring the overriding effect over
the other provisions of the Act. Therefore, in interpreting or in trying to
find out the meaning of that provision, one should, if possible and in this
case lt is not at all straining, give effect to that intention and not to make
a nonsense of that intention. Clause (a) of the said sub- section provides that
no deduction will be allowed in respect of any provision (whether called as
such or by any other name) made by the assessee for the payment of gratuity to
his employees on their retirement or termination of their services for any
reason. The expression 'provision' has not been defined in the Act ant lt is
not used in any artificial sense but in its ordinary meaning. This 18 clear
from the words (whether called as such or by any other name) occurring in
sub-section. According to Webster, 'provision' in its ordinary sense means
'something provided for future use' On a plain construction of clause (a) of
sub-section (7) of section 40A of the Act, what it means is that whatever is
provided for future use by the assessee out of the gross profits of the year of
account for payment of gratuity to employees on their retirement or on the
termination of their services would not be allowed as deduction in the
computation of profits and gains of the year of account. The provision of
clause (a) was made subject to clause (b). The embargo is on deductions of
amounts provided for future use in the year of account for meeting the ultimate
liability to payment of gratuity.
Clause (b) (i) excludes from the operation of
clause (a) contribution to an approved gratuity fund and amount provided for or
set apart for payment of gratuity which would be payable during the year of
account. Clause (b)(ii) deals with a situation that the assessee might provide
by the spread-over method and provides that such provision would be excluded
from the operation of clause (a) provided the three conditions laid down by the
sub-clauses are satisfied.
The submission of the assessee is that if no
provision is made by the assessee for gratuity, still the same will be 613 deductible
and section 40A(7) will have no application, would defeat the very purpose and
object of section 40A(7) and render it nugatory. The interpretation as
suggested by the assessee would entitle the assessee who made no provision to
claim deduction whereas an assessee who made a provision would not get
deduction unless the requirements laid down in the sub-section are fulfilled.
This interpretation, if accepted, will lead to a curious result, and if one may
venture to say an absurd result, and even where the assessee has not chosen to
adopt the spread-over method and has not provided for the present value of the
contingent liability attributable to the year of account by charging it on the
profits of the year, the assessee would still be entitled to claim as deduction
from the gross profits of the year the said estimated liability which he could
have provided for but he has not chosen to do so.
Where the intention of the legislature in
enacting the provision in question was to put an embargo on the deduction, the
interpretation suggested by the assessee defeats that purpose.
Kedarnath Jute Mfg. CD. Ltd. v. C.I.T.
referred to hereinbefore dealt with a different situation. The accrual of
sales-tax liability in that case did not depend on the option of the assessee
to make or not to make it for the year. The case of Bombay High Court in Tata
Iron & Steel Co.
Ltd. v. D.V. Bapat, Income-tax Officer,
Companies Circle I (2), Bombay and Anr., 101 I.T.R. 292, was a case on which
reliance was placed on behalf of the assessee where provision was made but was
a case before the enactment of section 40A(7) arising out of the assessment
year 1972-73.
Similarly C.I.T. Kerala v. High Land Produce
Co. Ltd., 102 I.T.R. 803, another decision relied on by the assessee was, where
a provision was made. It arose out of the assessment year 1970-71 before the
enactment of section 40A(7). These are the cases upon which the assessee had
relied. Another case upon which the assessee relied was Swadeshi Cotton Mills
Co. Ltd. v. Income-Tax Officer, Special Circle 'A' Ward, Kanpur (supra). This
case arose out of assessment year 1973-74 to which the provision of section
40A(7) was applicable. The Allahabad High Court how- ever took the view that
bar created by the said provision did not apply since the conditions laid down
had to be fulfilled in future. It did not take into consideration the provision
of section 155(13) of the Act. Madras High Court in Commissioner of Income-Tax,
Madras (Central) v. Andhra Prabha P. Ltd., 123 I.T.R. 760 at 772, has doubted
the decision of the Allahabad High Court in 112 I.T.R. 1038 and further
observed that the question of deductibility of a claim for gratuity liability
could not be allowed on general principles under any provisions of the Act.
614 The aforesaid difficulties in accepting
the contentions urged on behalf of the assessee were highlighted by the
Calcutta High Court in the case of Peoples Engineering & Motor Works Ltd. v
Commissioner of Income-Tax West Bengal- II, (supra). It was pointed out that
payment of gratuity was a statutory liability created under the Payment of
Gratuity Act, 1972. It could normally be said to have arisen for the carrying
on of business. However, for gratuity to be deductible under the Act, must
fulfil the conditions laid down in section 40A(7). The deduction could not be
allowed on general principles under any other section of the Act because
sub-section (1) of section 40A makes it clear that the provisions of the
section shall have effect notwith standing anything to the contrary contained
in any other provision of the Act relating to the computation of income under
the head "Profits and gains of business or profession" or in other
words it means that section 40A would have effect notwith standing anything
contained in sections 30 to 39 of the Act.
This position was again reiterated by the
Calcutta High Court in the case of Commissioner of Income Tax, Central-V,
Calcutta v. New Swadeshi Mills of Ahmedabad Ltd., 147 I.T.R, 163, where it was
explained at page 172 of the report that prohibition in section 40A(7) was on
deduction in respect of any provision (whether called as such or by any other
name) made by the assessee for the payment of gratuity. The amplitude of the
section was indicated by the use of the expression "whether called as such
or by any other name." It was further reiterated that the interpretation
suggested on behalf of the assessee would lead to a conclusion which would be
extra-ordinary and repugnant to commonsense. It will also cause grave injustice
to the assessees who have been prudent enough to set apart a sum for payment of
gratuity.
The principle that fiscal statutes should be
strictly construed does not rule out the application of the principles of
reasonable construction to give effect to the purpose or intention of any
particular provision as apparent from the scheme of the Act, with the
assistance of such external aids as are permissible under the law.
For the aforesaid reasons, it is not possible
to accept the assessee's contentions. The questions referred to the High Court
were therefore rightly answered in negative by the High Court, The appeals,
accordingly, fail and are dismissed with costs.
M.L.A. Appeals dismissed.
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