ORDER
G. Santhanam, Accountant Member
1. This is an appeal by the department against the order of the Commissioner (Appeals) in having allowed the claim of the assessee to deduct the gratuity payments as business expenditure. The assessee is a registered firm. Its previous year ended on 31-3-1978. The assessee has business in cultivation and sale of coffee and tea and also deals in pepper and cardamom. In the course of the previous year a portion of the business relating to cultivation and sale of tea carried on under the name and style ‘Mount Stuart Tea Estate’ was sold to a firm of R.M.T. Natesa Pillai Co. by a sale deed dated 15-6-1977. There was an agreement on 21-3-1977 preceding the sale and in page 3 of the agreement the property sold is defined as “together with all tea, coffee, cardamom and other plants and trees, nurseries and all cultivation on the said premises and generally known as ‘Mount Stuart Estate’ with the rented depot at Pollachi excluding however the property at Candura known as ‘Amar Coffee Plantation’ and establishment at Bombay, and the new Ambassador car just purchased by the vendors” [Emphasis supplied]. Clause 10 of the agreement runs as follows :
The purchaser will take over all the staff except the assistant manager employed on the estate and will take over all the labour employed on the estate and employ them on the same terms and conditions as were applicable to them before the date of completion of sale. The purchaser will have no liability whatsoever as regards the assistant manager. The vendors will be liable for all dues of the said staff and labourers in respect of wages, salaries, provident fund, maternity leave and other allowances and benefits, bonus and plucking incentives in respect of their services under the vendors up to the date of delivery of possession except gratuity and shall keep the purchasers indemnified against all claims that may be made against the purchasers in respect thereof. The purchaser will be liable for all gratuity due to the staff and labourers for their services including services under the vendors, and also for any payments which may become payable after the date of taking over in respect of their prior services except bonus and plucking incentives.
As per clause 11 of the agreement the total consideration of Rs. 35 lakhs included a sum of Rs. 5,40,000 being an estimated gratuity liability up to date. In the sale deed dated 15-6-1977 the following appears :
Whereas under the agreement aforesaid the vendors have to bear the liability to gratuity payable to the employees of the estate for the period up to the 31st day of May, 1977 which liability of the vendors has been ascertained at Rs. 5,40,000.
Whereas it has been agreed that the vendors pay the said amount of Rs. 5,40,000 to the purchaser and the purchaser receives the same on behalf of the employees and for being disbursed by them to the employees and the said payment is to be made by authorising and allowing the purchaser to adjust and keep with themselves for disbursement to the employees the said amount of Rs. 5,40,000 out of the agreed price of Rs. 35 lakhs payable by the purchaser to the vendors and by receipt of the said payment in the manner aforesaid which the purchaser hereby acknowledges, the vendors are relieved from liability for gratuity to employees in the estate.
The assessee sought to claim the sum of Rs. 5,40,000 as business expenditure under Section 37(1) of the Income-tax Act, 1961 (‘the Act’). The ITO negatived the claim on three grounds : (i) that the gratuity was not paid to the employees, (ii) that the apparent claim that it was paid to the purchaser of the tea estate on behalf of the employees will not entitle it for allowance of the said sum, and (Hi) there was no evidence on record to show that the employees were ever made a party to such an agreement between the seller and the buyer of the estate.
2. The matter was carried in appeal to the Commissioner (Appeals). The Commissioner (Appeals) applied the ratio of the decision of the Madras High Court in the case of CIT v. Sarada Binding Works [1985] 152 ITR 520 and allowed the claim of the assessee. In the process of reasoning the Commissioner (Appeals) did not find it necessary to follow the decisions of the Madras High Court in Stanes Motors {South India) Ltd. v. CIT [1975] 100 ITR 341 and CIT v. Salem Bank Ltd. [1979] 120 ITR 224. The department is aggrieved over this.
3. Shri V.S. Kandasamy, the learned departmental representative, submitted that the Commissioner (Appeals) erred in not applying the ratio laid down in the following decisions to the facts of the case on hand : CIT v. Gemini Cashew Sales Corporation [1967J 65 ITR 643 (SC), Stanes Motors {South India), Ltd.’s case {supra) and Salem Bank Ltd.’s case {supra). He submitted that there is a special provision enacted in Sub-section (7) of Section 40A of the Act concerning gratuity and any provision made in respect of gratuity by whatever name called unless it is by way of contribution towards an approved gratuity fund or based on actuarial valuation of ascertainable liability and an approved gratuity fund in connection therewith was created. The assessee had done nothing except to make a provision for gratuity and, therefore, the same was rightly disallowed by the ITO. In view of the special provision concerning gratuity the case will not fall under Section 37.
4. Shri Padmanabhan, the learned counsel for the assessee submitted that the assessee sold a part of its estate while remaining in the same trade in respect of its other units and in view of the sale of the estate known as ‘Mount Stuart Tea Estate’ the assessee had bargained for the transfer of its employees to the vendee and had agreed for a cut in the sale consideration to the extent of Rs. 5,40,000 being the ascertained gratuity liability of its employees and, therefore, the decision of the Madras High Court in Sarada Binding Works’ case {supra) would squarely apply to the facts of the case. As regards the argument of the learned departmental representative that a provision pure and simple without an approved gratuity fund being created would not entitle the assessee to deduct gratuity, Shri Padmanabhan submitted that though no provision as understood in the accounting jargon was made by the assessee actual payment was made to the transferee of the business to cover the gratuity liability of the employees of the transferor as on the date of transfer. As regards the relevance of the cases relied on by the departmental representative Shri Padmanabhan submitted that those cases were decided when the Payment of Gratuity Act 1972, was not enacted at all and moreover those were cases involving total closure of business. On the other hand in the case before us the assessee continued to have another coffee estate by name Amar Coffee Plantation and other establishments and continued to remain very much in the business. Regarding the argument of the learned departmental representative that Section 40A(7) would govern the payment of gratuity Shri Padmanabhan submitted that the concerned section would apply to the cases of the assessees who continued to employ the same personnel for whom gratuity is payable in future depending upon contingencies such as superannuation, retirement, resignation or death. In this situation alone when the assessee makes a provision such provision should fulfil the conditions enumerated in Section 40A(7).
5. We have heard rival submissions and perused the materials on record. Only a part of the business of the assessee was sold. Except the assistant manager in the employment of the assessee, ail other workers have been taken over by the vendee for employment. According to Section 4 of the Payment of Gratuity Act, gratuity is payable to an employee on the termination of his employment after he has rendered continuous service for not less than five years either on superannuation or retirement or resignation or death or disablement. Section 2(q) of the Payment of Gratuity Act, defines retirement as meaning termination of the services of an employee otherwise than on superannuation Thus, we find that the employees are entitled to gratuity upon termination even otherwise than on superannuation which is described as retirement. The dispute is not about compensation payable under Section 25FF of the Industrial Disputes Act, 1947 but it is with regard to the gratuity under the Payment of Gratuity Act. Though gratuity is payable only upon the happening of specified event, viz., superannuation, retirement, resignation or death or disablement, the employee acquired a right to gratuity if he had rendered continuous service for not less than five years and in view of the fact that the employee has acquired the right upon completion of continuous service for five years, there is growing liability on the part of the employer to pay gratuity to the workers. Of course the actual payment will take place upon the happening of the contingencies envisaged in the Payment of Gratuity Act. Cases involving provision of gratuity fell before the Courts because of the crude and rudimentary manner in which such liability was estimated from year to year. However, when gratuity liability was estimated on actuarial or other scientific basis the Courts have allowed the claim under Section 37. With the introduction of Section 40A(7) the interest of the employees are secured because that section envisages deduction of gratuity only, when certain conditions are fulfilled. It is the department’s case that Section 40A(7), rather than Section 37, would apply to the facts of the case and in terms of Section 40A(7) the assessee is not entitled to deduction.
On the other hand it is the assessee’s plea that Section 37 would apply and the ‘provision’ envisaged in Section 40A(7) is the ‘provision’ which is normally understood in the accounting jargon.
6. The width and the ambit of Section 40A(7) is explained by the Supreme Court in its latest decision in Shree Sajjan Mills Ltd. v. CIT [1985] 156 ITR 585 as follows :
On a plain construction of Clause (a) of Section 40A(7) of the Income-tax Act, 1961 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 a deduction in the computation of profits and gains of the year of account, unless the respective conditions specified in Clause (b) were fulfilled. The expression ‘provision made by the assessee’ is not used in any artificial sense, e.g., of setting apart specifically by the assessee for meeting the liability for gratuity in his account books, but in its ordinary sense. The embargo under Clause (a) is on deduction 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 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.
The marginal note or heading to Section 40A 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. Actual payments or provisions for payment 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 in Section 40A(1) makes it clear that if there is any legislative base dealing with the provision for gratuity, then the same would be applicable in spite of and notwithstanding any other provision of the Act. Read with the marginal note to Section 40A, the non obstante clause of Sub-section (1) 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 the provisions of Section 40A apply. (p. 585)
Therefore, we reject the contention of the assessee that Section 37, rather than Section 40A(7) would apply to the facts of the case. We also reject the contention of the assessee that the word ‘provision’ used in Section 40A(7) should be understood in accounting parlance, as the Supreme Court held that the expression ‘provision made by the assessee’ must be understood only in the ordinary sense and not in any artificial sense.
7. Having decided that the provisions of Section 40A(7) would be applicable to the facts of the case, it is to be seen whether the assessee is entitled to deduct the gratuity in the facts and circumstances of this case. Section 40A(7) reads as follows :
(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-
(i) 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 benefit 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 per cent 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 per cent 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 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.
Sub-clause (ii) is not applicable to the facts of the case as the assessment year in question is 1978-79. Sub-clause (i) which is material, is in two parts, viz., (i) where any ‘provision … by way of any contribution towards an approved gratuity fund’ is made or (ii) where the ‘provision’ is ‘for the purpose of payment of any gratuity, that has become payable during the previous year’. The first limb of this sub-clause would apply to subsisting concerns. When the assessee has sold one of its concerns which is a part of its business it is bound to pay gratuity to its employees upon termination of employment in terms of Section 4 read with Section 2(q), notwithstanding the fact that the employees were absorbed by the purchaser. So the gratuity had become presently payable on account of the transfer of business and any ‘provision’, as understood in the ordinary sense of the term, made by the assessee for the purpose of payment of gratuity is exigible for deduction in such circumstances in terms of the second limb of Section 40A(7)(b)(i). In the case before us the assessee has agreed to provide by accepting a cut of Rs. 5,40,000 from out of the sale consideration towards gratuity that may become payable to the employees of the assessee and the purchaser had agreed to discharge the gratuity liability to the employees of the transferor. Thus, an actual payment had been made and the gratuity that has become presently payable was provided for in the ordinary sense of the term ‘provision’ occurring in the second limb of Clause (b)(i) of Section 40A(7). In such a situation there is no need for the creation of an approved gratuity fund and make contribution to it as will be evident from the second limb of Sub-clause (i) of Clause (b) of Sub-section (7) of Section 40A. We have already indicated that Sub-clause (ii) of Section 40A(7)(&) will not apply to the facts of the case.
8. The cases relied upon by the revenue are all cases resulting in total closure of business which is not the case before us. The Commissioner (Appeals) has applied the ratio of the decision of the Madras High Court in Sarada Binding Works’ case {supra) and allowed the appeal under Section 37. In that case the assessee gave up possession of its assets and liabilities in respect of one of its businesses in favour of another concern. As per agreement all the employees of the transferor became employees of the transferee. One of the items of liability that was considered in the settlement was a sum of Rs. 80,309 which was the provision for gratuity due to the employees of the business taken over by the assessee. It was held in that case that though the payment under the agreement was not made directly to the employees as such, the amount was paid for discharging the assessee’s liability to pay gratuity to its employees for the period ending with the date of transfer and hence the payment should be taken to be a payment made to discharge the assessee’s liability for gratuity and hence it had to be allowed as a deduction. It was held in that case at page 526 that ‘admittedly, the payment made to the purchaser was for the discharge of an obligation incurred already while the business was carried on by the assessee and it was not a payment. . . ‘arising after the transfer [of business] or on the closure of business, as was the case in CIT v. Gemini Cashew Sales Corporation [1967] 65 ITR 643 (SC) and other allied cases, relied on by the revenue. In that case the High Court had no occasion to consider the provisions of Section 40A(7), as that section came into force only with effect from 1-4-1973 and the assessment year in that case was 1972-73. Therefore, the High Court allowed the claim under Section 37 and the Commissioner (Appeals) applying the ratio in the case cited supra allowed the appeal of the assessee under Section 37. We have already indicated that with effect from 1-4-1973, Section 40A(7) is the only provision of law that would apply in relation to gratuity provision. We have also held that the expression ‘provision’ should be understood in the ordinary sense, as laid down by the Supreme Court in Shree Sajjan Mills Ltd. ‘s case (supra). In our view the liability for gratuity accrues in respect of each employee upon his completing a continuous period of service for five years, and thereafter goes on accruing with the completion of each year of service, though the payment is postponed till the happening of events like retirement, superannuation, death or disablement. The word ‘retirement’ as denned in Section 2(q) would mean termination, when part of the business of the assessee was sold, there is technically termination of employment with the erstwhile employer giving rise to payment of gratuity. The assessee had certainly provided for payment of gratuity by accepting a cut of Rs. 5,40,000 from out of the sale consideration (towards the gratuity liability of his employees) with the condition that the purchaser will discharge the gratuity liability when the occasion for payment arises. This mode of settlement of gratuity is recognised by the High Court in Sarada Binding Works’ case (supra) where it is observed as follows :
It must be noted, in this connection, that the transferor of a business as in this case has normally got three options :
(1) to allow the employees to continue in service in his other business, if any ;
(2) to discharge the employees on payment of retrenchment compensation, gratuity and notice pay, etc., or ;
(3) to transfer their service along with the gratuity liability to the purchaser on his undertaking to discharge the entire gratuity liability as and when the occasion for its payment arises.(p. 524)
9. In the light of the above discussion, we uphold the order of the Commissioner (Appeals) not under Section 37 but under the second limb of Section 40A(7)(b)(i). The Commissioner (Appeals)’s order is modified to this extent.
10. In the result, the departmental appeal is dismissed.