PETITIONER:
SHREE SAJJAN MILLS LTD.
Vs.
RESPONDENT:
COMMISSIONER OF INCOME TAX, M.P. BHOPAL AND ANR.
DATE OF JUDGMENT08/10/1985
BENCH:
MUKHARJI, SABYASACHI (J)
BENCH:
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.
JUDGMENT:
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.
615