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Petitioner: W.T. SUREN & CO. LTD. VS Respondent: COMMISSIONER OF INCOME TAX
Court Name: Supreme Court of India Judge(s): D. P. Wadhwa, Mrs. Sujata V. Manohar Title: W.T. SUREN & CO. LTD. vs COMMISSIONER OF INCOME TAX Case No.: Civil Appeal No,479 of 1985 Date of Judgment:1998-02-23 Reported As: 1998 PTD 2650 Result: Appeal allowed
JUDGMENT
JUDGMENT 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 (page 95): "Whether, on to 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 Taddinggton 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 Taddinggton 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
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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. Z. Your actual work and position in the office will remain as it has been here before. 5. As mentioned by W.T. Suren & Co. (Private) Ltd. In their separate letter to you of today's date, we confirm that your past service with W.T. Suren & 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 1959-60 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 be 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 & 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 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 of serviceFor each year of service gratuity equivalent to 5, 6 and 7 Half-a-month's basic salary 8 and 9 1 month's basic salary 10 and above1 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 td Rallis India Ltd. On April 30, 1959. This amount was held by Rallis
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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 to 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 td 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
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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 (Born.). 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 40-A(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
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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 1TR 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 present 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 Venkateswa ra Bank Ltd. (1979) 120 ITR 207 (Mad.) CIT v. Sarada Binding Works (1985) 152 ITR 520 (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 the three judgments of the Madras High Court in Stanes Motor (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.
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Since many judgments of the Madras and Kerala High Courts rendered earlier to the Full Bench of the Kerala High Court and of Sarada Binding 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 25-FF 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 partners 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 25-F and 25-FF of the Industrial Disputes Act and also the proviso to section 25-FF 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 (page 647): "Liability to pay retrenchment compensation arises under section 25-FF 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
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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 (page 649): "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 debatable 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 dubitable 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)…
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