Judgment:
S.D. Shah, J.
1. The Income-tax Appellate Tribunal has referred the following questions of law for our opinion :
'(1) Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that the assessee was not entitled to a deduction of Rs. 20,03,560 in the assessment year 1975-76 on account of liability for gratuity
(2) Whether the Tribunal was right in law in permitting the Department to raise the contention for the first time before the Tribunal that the assessee had adopted the cash system of accounting in respect of liability for gratuity, when the matter had proceeded before the lower authorities on the admitted footing that the system of accounting adopted was mercantile
(3) Whether, on the facts and in the circumstances of the case, the Tribunal was justified in law in coming to the conclusion that the assessee adopted cash system of accounting for the purpose of liability for gratuity for the assessment year 1975-76 ?'
2. In order to answer the aforesaid questions, relevant facts shall have to be stated :
(i) The assessee is a public limited company, and the relevant assessment year is 1975-76. For the previous year ending on December 31, 1974, corresponding to the assessment year 1975-76, the assessee did not make any provision in its accounts in respect of its liability for gratuity but put a note in the accounts in that behalf. The assessee, in the course of assessment proceedings, claimed that its liability for gratuity calculated on actuarial basis amounting to Rs. 20,03,560 be allowed as deduction under section 37 of the Income-tax Act, 1961. Admittedly, the assessee had not followed the procedure laid down in section 40A(7) of the Act, but made the claim on the ground that the claim was allowable under section 37 of the Act. The Income-tax Officer disallowed the claim and the Commissioner of Income-tax also confirmed the order passed by the Income-tax Officer. On second appeal preferred to the Tribunal, there was divergence of opinion between the Judicial Member and the Accountant Member. The matter was referred to a Third Member who agreed with the opinion of the Judicial Member disallowing the claim of the assessee.
(ii) In the aforesaid fact situation, we shall have to examine whether the claim of the assessee that its liability for the amount calculated on actuarial basis amounting to Rs. 20,03,560 be allowed as deduction under section 37 of the Act without following the procedure prescribed under section 40A(7) of the Act, and we shall also have to see as to whether following different systems of account, i.e., whether cash system or mercantile system of account, followed by the assessee would make any difference.
3. At the hearing of this reference, our attention was invited to the decision of the Supreme Court in the case of Shree Sajjan Mills Ltd. v. CIT : 1986ECR276(SC) . In the case before the Supreme Court, the company had entered into an agreement with the workers' union for payment of gratuity. Its practice was to account for gratuity on cash basis as and when paid. On the coming into force of the Payment of Gratuity Act, 1972, with effect from September 16, 1972, a statutory liability was created on the company to pay gratuity to its employees as per the provisions of the said Act. The company, by actuarial valuation of its liability under the Act, made a provision of Rs. 20,00,000 against the total accruing liability till the date of preparation of the balance-sheet. At the time of filing of the return of income for the assessment year 1973-74, the actuarial valuation had been determined at Rs. 48,59,341 and the company added back this provision for gratuity amounting to Rs. 20 lakhs and claimed the total liability of Rs. 48,59,341/- determined actuarially as a deduction. The Tribunal allowed Rs. 28,59,341 and did not allow deduction of Rs. 20 lakhs since the provision for the Rs. 20 lakhs had been made without complying with the requirements of section 40A(7). For the assessment year 1974-75, the liability towards gratuity had been worked out at Rs. 69,31,286 and the company had made a provision for Rs. 45,93,559. Out of the balance for which no provision had been made, the Tribunal allowed deduction of Rs. 15,71,855 and did not allow deduction of provision made for Rs. 45,93,559, since the requirements under section 40(7) had not been complied with. On a reference to the High Court, the High Court held that no deduction towards gratuity was allowable unless the provisions of section 40A(7) of the Act were complied with. On appeal to the Supreme Court, the Supreme Court confirmed the decision of the High Court and held that, for gratuity to be deductible, the conditions laid down in section 40A(7) had to be fulfilled. The deduction could not be allowed on general principles under any other section of the Act, because sub-section (1) of section 40A made it clear that the provisions of the section had effect notwithstanding 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'. In other words, section 40A had effect notwithstanding anything contained in sections 30 to 39 of the Act. In view of this decision, it is clear that the assessee was not entitled to claim its liability for gratuity calculated on actuarial valuation at Rs. 20,03,569 be allowed under section 37 of the Act, 1961. As observed by the Supreme Court unless the provisions of section 40A(7) are satisfied, there would not be any entitlement to the assessee to claim deduction of liability arising from the payment of gratuity and that sections 30 to 39 of the Act will not come to the rescue of the assessee.
4. The Supreme Court also held that although the payment of gratuity is made on retirement or termination of service, it is not for the services rendered during the period in which payment is made, but it is made in considered of the entire length of service and its ascertainment and computation depend upon several factors. The right to receive the payment accrues to the employees on their retirement or termination of their services and the liability to pay gratuity becomes an accrued liability of the assessee when the employees retire or their services are terminated. Until then, the right to receive gratuity is a contingent right and the liability to pay gratuity continues to the contingent liability qua the employer. A contingent liability does not constitute expenditure, and cannot be the subject-matter of deduction even under the mercantile system of accounting. Expenditure which is deductible for the 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.
5. In view of the aforesaid decision of the Supreme Court, it would not be necessary for us to decide questions Nos. 2 an 3 which are referred for our opinion.
6. In the result, question No. 1 is answered to the affirmative, i.e., against the assessee, and in favour of the Revenue. So far as questions Nos. 2 and 3 are concerned, they do not survive in view of the decision of the Supreme Court in the case of Shree Sajjan Mills Ltd. : 1986ECR276(SC) . No costs.