JUDGMENT
Jeevan Reddy, J.
1. The following question has been referred by the Income-tax Tribunal, Hyderabad, under section 256(1) of the Income-tax Act, 1961, at the instance of the Revenue. :
“Whether, on the facts and in the circumstances of the case, the Income-tax Appellate Tribunal is justified in holding that the leave/retirement gratuity appearing in the balance-sheet should be taken into account for computation of capital for surtax purposes ?”
The question arises under the Companies (Profits) Surtax Act, 1964. The assessment years concerned are 1966-67 and 1967-68.
2. The assessee is a public limited company engaged in the manufacture of cigarettes and other tobacco products. Under the Companies (Profits) Surtax Act, the relevant date with reference to which the capital of a company has to be determined is the first day of the previous year relevant to the assessment year – which means that, for the assessment year 1966-67, it is October 1, 1964, and, for the assessment year 1967-68, it is October 1, 1965. On October 1, 1964, an amount of Rs. 15,75,000 was shown as “reserve” under the heading “Reserve for leave/retirement gratuities”. On October 1, 1965, it became Rs. 16,75,000. The assessee claimed that these two amounts should be taken into account and included in the capital base of the company for the purpose of the Surtax Act. The Income-tax Officer agreed with the assessee and passed an order which was revised by the Commissioner in exercise of his power under section 263 of the Income-tax Act. The Commissioner directed the exclusion of the said amounts from the capital base of the company on the ground that they constituted a provision for a known liability. On appeal, the Tribunal, purporting to follow an unreported decision of the Bombay High Court in Abbott Laboratories (I) (Pvt.) Ltd., which is said to have been affirmed by the Supreme Court (CIT v. Abbott Laboratories (I.) Ltd. [1983] 143 ITR (St.) 39, 40) (by rejecting an application for grant of special leave to appeal), in preference to the decision of this court pertaining to this very assessee, allowed the appeals. The Tribunal was of the opinion that the Commissioner erred in following the decision of this court pertaining to this very assessee reported in Vazir Sultan Tobacco Co. Ltd. v. CIT [1974] 96 ITR 248, inasmuch as the said decision was contrary to the aforesaid unreported decision of the Bombay High Court which was affirmed by the Supreme Court. On this basis, the Tribunal directed that these two amounts should be included in the capital base of the company for the respective assessment years. Thereupon, the Department obtained this reference.
3. Before proceeding further, we may state that when the Tribunal disposed of the appeals, the decision of the Supreme Court in the case of this very assessee relating to the assessment year 1963-64 reported in Vazir Sultan Tobacco Co. Ltd. v. CIT , was not available. The decision of the Tribunal in this case was in June, 1980, whereas the decision of the Supreme Court was rendered in September, 1981. It is brought to our notice by Sri M. Suryanarayana Murthy, learned standing counsel for the Revenue, that an identical question was urged before and considered by the Supreme Court and a certain direction was given therein. He says that the same direction should follow in respect of the two assessment years concerned herein.
4. The capital base of a company for the purpose of the Surtax Act has to be determined in accordance with the rules contained in the Second Schedule to the Act. In so far as it is relevant, rule 1 reads as follows :
“1. Subject to the other provisions contained in this Schedule, the capital of a company shall be the aggregate of the amounts, as on the first day of the previous year relevant to the assessment year, of –
(i) its paid-up share capital;
(ii) its reserves, if any, created under the proviso (b) to clause (vib) of sub-section (2) of section 10 of the Indian Income-tax Act, 1922 (11 of 1922), or under sub-section (3) of section 34 of the Income-tax Act, 1961
(43 of 1961);
(iii) its other reserves as reduced by the amounts credited to such reserves as have been allowed as a deduction in computing the income of the company for the purposes of the Indian Income-tax Act, 1922 (11 of 1922), or the Income-tax Act, 1961 (43 of 1961)”.
(Other clauses omitted as unnecessary.)
The relevant clause in the present case is clause (iii) of rule 1. A reading of the said rule with the relevant clause shows that the capital of a company shall be the aggregate of the amounts mentioned in the said rule as on the first day of the previous year relevant to the assessment year. One of such items is mentioned in clause (iii), viz., the other reserves of the company as reduced by the amounts credited to such reserves as have been allowed as a deduction in computing the income of the company for the purpose of the Income-tax Act.
5. Now, coming back to the facts of the case before us, it would be evident from a perusal of the decision of the Supreme Court in Vazir Sultan Tobacco Co. Ltd. v. CIT , that the Supreme Court remanded the matter through the Tribunal to the taxing authority to decide the issue whether the amount concerned for the said assessment year, viz., a sum of Rs. 9,08,106, set apart and transferred to gratuity reserve by the assessee-company was either a provision or a reserve and, if it is latter, to what extent ? The taxing authority was directed to decide the issue in the light of the principles enunciated by the Supreme Court in the said decision. The principle enunciated by the Supreme Court is that gratuity is a known liability; therefore, a provision therefor will have to be regarded as a provision made for a known liability, no doubt a contingent one. The court held that, if the amount credited to the said account is determined by adopting the actuarial valuation of its estimated liability, it would be a provision; but if an ad hoc sum is appropriated without resorting to any scientific basis, such appropriation would also be a provision; but any sum so appropriated in excess of the sum required to meet the estimated liability will have to be regarded as a reserve. This is what the Supreme Court said at pages 574 and 575 of the report :
“Ordinarily an appropriation to gratuity reserve will have to be regarded as a provision made for a contingent liability, for, under a scheme framed by a company the liability to pay gratuity to its employees on determination of employment arises only when the employment of the employee is determined by death, incapacity, retirement or resignation – an event (cessation of employment) certain to happen in the service career of every employee; moreover, the amount of gratuity payable is usually dependent on the employee’s wages at the time of determination of his employment and the number of years of service put in by him and the liability accrues and enhances with the completion of every year of service but the company can work out on an actuarial valuation its estimated liability (i.e., discounted present value of the liability under the scheme on a scientific basis) and make a provision for such liability not all at once but spread over a number of years. It is clear that if by adopting such scientific method any appropriation is made, such appropriation will constitute a provision representing fairly accurately a known and existing liability for the year in question; if, however, an ad hoc sum is appropriated without resorting to any scientific basis, such appropriation would also be a provision intended to meet a Known liability, though a contingent one, for, the expression ‘liability’ occurring in clause 7 (1) (a) of Part III of the Sixth Schedule to the Companies Act includes any expenditure contracted for and arising under a contingent liability; but if the sum so appropriated is shown to be in excess of the sum required to meet the estimated liability (discounted present value on a scientific basis) it is only the excess that will have to be regarded as a reserve under clause 7 (2) of Part Ill to the Sixth Schedule.”
6. In view of the said decision of the Supreme Court, we have no other course left open to us except to make a similar direction with respect to the two assessment years concerned herein. Accordingly, we remand the matter relating to the two assessment years concerned herein to the taxing authority through the Tribunal for determination of the question whether the amount credited to the said account during each of the said assessment years was arrived at on the basis of an actuarial valuation of its estimated liability or was an ad hoc amount not determined on any scientific basis. In short, the remand is for the very same purpose as the Supreme Court has indicated in its judgment with respect to the assessment year 1963-64. The principles enunciated by the Supreme Court in the said decision should be applied and it should be determined whether the amount credited to this account during the accounting year relevant to the assessment year was arrived at on a scientific basis, i.e., by an actuarial valuation or was an ad hoc amount and then it should be determined whether any part of it was to be treated as reserve.
7. Mr. Ratnakar, learned counsel for the assessee-company, raised a further contention before us to the following effect : A sum of Rs. 1,00,000, which was credited to the said account during the accounting year relevant to the assessment year 1967-68 was claimed as a deduction in the income-tax proceedings relating to that assessment year, but was disallowed. If so, the said amount cannot be treated at the same time as a provision. He says that it is not open to the Income-tax Department to take two inconsistent stands under the Income-tax Act and the Surtax Act. We find that a similar argument was addressed before the Supreme Court in the aforesaid decision relating to the assessment year 1963-64; but the Supreme Court preferred to express no opinion on the said contention. It would suffice on our part to observe that the relevancy of the said question should be examined in the light of the rules contained in the Second Schedule to the Act.
8. For the above reasons, we decline to answer the question referred to us and remand the matter to the taxing authority through the Tribunal to determine, applying the principles enunciated by the Supreme Court in Vazir Sultan Tobacco Co. Ltd. v. CIT , whether the amounts credited to this account during the accounting year relevant to the assessment year was arrived at on a scientific basis, i.e., by actuarial valuation or was it an ad hoc amount and, if so, what part of these amounts credited to the said account during the relevant assessment years should be included in the capital base of the company for the purpose of surtax. It is evident that, while carrying out this direction, the taxing authority shall also have regard to the direction of the Supreme Court with respect to the assessment year 1963-64 and shall take into account the amounts, if any, which are found entitled to be credited as reserves for the said assessment year 1963-64 and for the subsequent years, if any.
9. No order as to costs.
