JUDGMENT
G.G. Sohani, J.
1. By this reference under Section 256(1) of the Income-tax Act, 1961 (hereinafter referred to as “the Act”), the Income-tax Appellate Tribunal, Indore Bench, has referred the following questions of law to this court:
“(1) Whether, on the facts and in the circumstances of the case, the Income-tax Appellate Tribunal was correct in law in holding that the gratuity payable at Rs. 33,059 to employees of the assessee in the electricity undertaking of Mount Abu Electric Supply Co, being compulsorily taken over by the Rajasthan Government under the Compulsory Acquisition Act (Vesting Act) was not an allowable deduction and was hit by Section 40A(7) of the Income-tax Act, 1961 ?
(2) Whether, on the facts and in the circumstances of the case, the Income-tax Appellate Tribunal was correct in law in holding that even if Section 40A(7) was applicable, the case is not covered by Section 40A(7)(b)(i) of the Income-tax Act, 1961 ?”
2. The material facts giving rise to this reference, briefly, are as follows :
3. The assessee is a registered firm. During the assessment year 1975-76, the assessee derived income from carrying on business in supply of electrical energy. The assessee had a scheme for payment of gratuity to its employees. According to that scheme, the assessee was debiting each year in the books of account the amount of liability to pay gratuity on account of the services of the employees for that year. In respect of the assessment year 1975-76, the assessee contended that the accrued liability towards payment of gratuity was Rs. 33,059, which was provided for in the account books and the assessee, therefore, claimed that amount as a deduction out of the profits for the year in question. The Income-tax Officer disallowed the claim of the assessee on the ground that in view of the provisions of Section 40A(7) of the Act, the claim of the assessee could not be allowed as the conditions specified in that section were not fulfilled. On appeal, the Commissioner of Income-tax (Appeals) held that the provisions of Section 40A(7) of the Act were not attracted as the assessee was not claiming any deduction for any provision and, consequently, the appeal preferred by the assessee in that behalf was allowed. The Revenue, therefore, preferred an appeal before the Tribunal. The Tribunal held that after the provisions of Section 40A(7) of the Act had been brought into force, the liability for payment of gratuity could not be allowed unless the conditions referred to in that section were satisfied. The Tribunal further held that even if the provisions of Section 40A(7) of the Act were applicable, the case of the assessee was not covered by the provisions of Sub-clause (i) of Sub-section (7)(b) of Section 40A of the Act. Aggrieved by the order passed by the Tribunal, the assessee sought a reference and it is at the instance of the assessee that the aforesaid questions have been referred to this court for its opinion.
4. This court had occasion to consider the scope of the provisions of Section 40A(7) of the Act in CIT v. Shree Sajjan Mills Ltd. [1984] 147 ITR 185. The view taken by this court that since Sub-section (7) of Section 40A of the Act refers to deductions on account of payment of gratuity to employees of an assessee, Section 37 of the Act which is a residuary section would not be applicable, has been approved by the Supreme Court in Shree Sajjan Mills Ltd. v. CIT [1985] 156 ITR 585 (Civil Appeals Nos. 4221-22 (NT) of 1984). The Supreme Court has observed as follows (at p. 601):
“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 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 where 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,”
5. The Supreme Court has held that 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 would not be deductible allowance or expenditure. In view of this decision of the Supreme Court, our answer to the first question has to be in the affirmative and against the assessee.
6. As regards the second question, the Tribunal, in our opinion, has rightly held that as the take-over of the undertaking of the assessee by the Rajasthan Electricity Board was in the subsequent accounting year, the debits made towards meeting the liability for payment of gratuity could not be held to be actual payments within the meaning of Section 40A(7)(b)(i) of the Act.
7. For all these reasons, our answer to the two questions referred to this court by the Tribunal is in the affirmative and against the assessee. In the circumstances of the case, parties shall bear their own costs of this reference.