Janarthanam, J.
1. The assessee--The South Madras Electric Supply Corporation Limited, Tiruchirappalli, in the assessment year 1972-73 made provision of Rs. 1,80,255 towards payment of gratuity to employees. Subsequently, on December 1, 1973, the entire undertaking of the assessee was acquired by the Government of Tamil Nadu under the Tamil Nadu Private Electricity Supply Undertakings (Acquisition) Act, 1973.
2. The Inspecting Assistant Commissioner of Income-tax (Assessment), Trichy, has disallowed the provision so made on the ground of non-complying with the provisions adumbrated under Section 40A(7) of the Income-tax Act, 1961 (Act No. 43 of 1961)-for short 'LT. Act').
3. The Commissioner of Income-tax (Appeals)-VI, Madras, also agreed with the Inspecting Assistant Commissioner of Income-tax.
Before the Income-tax Appellate Tribunal, Madras Bench 'D', Madras (for short 'the Tribunal'), the assessee argued that Section 40A(7) was introduced by the Finance Act, 1975, with retrospective effect from April 1, 1973. The conditions to be satisfied by the assessee in respect of the assessment years 1973-74 to 1976-77 are laid down under Section 40A(7)(b)(ii). Those conditions could not be satisfied in the case of the assessee, since the entire undertaking had been acquired by the Government on December 1, 1973. On acquisition, the entire staff gratuity reserve had to be handed over to the Government, inclusive of the provision of Rs. 1,80,255 for the assessment year 1973-74. It was, therefore, impossible for the assessee to comply with the conditions laid down in Section 40A(7). Since the provision has been made on a scientific basis on an actuarial valuation and the reserve had also been handed over to the Government, the assessee contended that the provision should be allowed as a deduction from its total income.
4. The Tribunal rejected the contention of the assessee on the basis that the conditions laid down in Section 40A(7) have not been complied with.
5. It is on these facts, the Tribunal, at the instance of the assessee, referred the question of law, as below, for the opinion of this court :
'Whether, on the facts and circumstances of the case, the Income-tax Appellate Tribunal was right in holding that the provision of Rs. 1,80,255 for payment of gratuity is not deductible in arriving at the taxable profits even though the entire undertaking had been acquired by the Government on December 1, 1973 ?'
6. The arguments of Mr. K. Vaitheeswaran, of Subbaraya Aiyar, Padmana-bhan and Ramamani, learned counsel appearing for the assessee, and Mr. R. Sivaraman, learned counsel representing Mr. C. V. Rajan, learned junior standing counsel for the Revenue, were heard.
7. Section 40A(7)(a) and (b)(i) and (ii) of the Income-tax Act--relevant for our present purpose--reads as under :
'40A. (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.
Explanation J.--For the purpose of Sub-clause (ii) of Clause (b) of this sub-section, 'admissible amount' means the amount of the provision made by the assessee for the payment of gratuity to his employees on their retirement or on termination of their employment for any reason, to the extent such amount does not exceed an amount calculated at the rate of eight and one-third per cent, of the salary (as defined in Clause (h) of rule 2 of Part A of the Fourth Schedule) of each employee entitled to the payment of such gratuity for each year of his service in respect of which such provision is made.
Explanation 2.--For the removal of doubts, it is hereby declared that where any provision made by the assessee for the payment of gratuity to his employees on their retirement or on termination of their employment for any reason has been allowed as a deduction in computing the income of the assessee for any assessment year, any sum paid out of such provision by way of contribution towards an approved gratuity fund or by way of gratuity to any employee shall not be allowed as a deduction in computing the income of the assessee of the previous year in which the sum is so paid.'
8. The provision, as stated above, came up for consideration and interpretation in the case of Shree Sajjan Mills Ltd. v. CIT : 1986ECR276(SC) , wherein their Lordships of the Supreme Court said that on a plain construction of Clause (a) of Section 40A(7) of the Income-tax Act, 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.
9. 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.
10. The apex court further said that although payment of gratuity is made on retirement or termination of service, it is not for the services 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 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 be a contingent liability qua the employer.
11. Contingent liabilities do not constitute expenditure and cannot be the subject-matter of deduction even under the mercantile system of accounting. Expenditure, which is 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 an expenditure.
12. The Supreme Court also summed up the position till the provisions of Section 40A(7) were inserted in the Income-tax Act in 1975.
13. It is also to be noticed that Sub-section (1) of Section 40A of the Income-tax Act prescribes that the provisions of the said section shall have effect, notwithstanding anything to the contrary contained in any other provision of the said Act relating to the computation of income under the head 'Profits and gains of business or profession'. This means the provisions of the said section and that section alone will be applicable, notwithstanding the contrary provisions in any of the sections of the said Income-tax Act.
14. There is no dispute that the provision of Rs. 1,80,255 is not representing the sum or contribution towards the approved gratuity fund. Further, that sum is not for the purpose of payment of gratuity that has become payable during the previous year. It is after all a provision made for payment of gratuity on a future occasion when employees retire on superannuation. Therefore, such a provision made is after all a contingent liability and such liability is taken over by the Government.
15. In this view of the matter, the assessee is not entitled to deduction of a sum of Rs. 1,80,255 in arriving at the taxable profits. We, therefore, hold that the Tribunal was right in holding that the provision of Rs. 1,80,255 for payment of gratuity is not deductible in arriving at the taxable profits, even though the entire undertaking had been acquired by the Government on December 1, 1973. This question is answered accordingly.
16. This tax case (reference) is, thus, disposed of. There shall, however, be no order as to costs, on the facts and in the circumstances of the case.