Commissioner of Income-tax Vs. Chackolas Spinning and Weaving Mills Ltd. - Court Judgment

K.S. Paripoornan, J.

1. In these cases, a common question arises for consideration. Both these references are at the instance of the Revenue. Both of them relate to the assessment year 1976-77. The respondents in these cases are different.

2. In ITR No. 351 of 1982, the respondent is Chackolas Spinning and Weaving Mills Ltd. The assessment year is 1976-77. The accounting year ended, on June 30, 1975. In ITR No. 7 of 1984, the respondent is South India Rubber Works. The assessment year is 1976-77. The accounting year ended on August 31, 1975.

3. The sole question that arises for consideration in these cases is whether the respondent-assessees are entitled to deduction of the gratuity provision for the year 1976-77 under Section 40A(7)(b)(i) of the Income-tax Act, 1961 (in short 'the Act'). The questions referred are as follows :

'ITR No. 351 of 1982 :

Whether, on the facts and in the circumstances of the case and on an interpretation of Section 40A(7)(b)(i) of the Income-tax Act, 1961, the assessee is entitled to deduction of the gratuity provision for the assessment year 1976-77 ?

ITR No. 7 of 1984 :

Whether, on the facts and in the circumstances of the case, the provision of gratuity was an allowable deduction under Section 40A(7) of the Income-tax Act, 1961 ?'

3. It is agreed that the decision rendered in ITR No. 351 of 1982 will govern ITR No. 7 of 1984 also. The Appellate Tribunal in rendering the order in ITA No. 392(Coch)81, which is the subject-matter of ITR No. 7 of 1984, followed its earlier decision in ITA No. 681(Coch)77-78 dated November 26, 1979. ITA No. 681(Coch)77-78 is the subject-matter of ITR No. 351 of 1982.

4. We will now consider ITR No. 351 of 1982. The respondent is a company in which the public are not substantially interested. For the assess-merit year 1976-77, corresponding to the previous year ended on June 30, 1975, it claimed deduction of Rs. 2,00,000 being the provision made for gratuity. The Income-tax Officer noticed that the assessee created a gratuity fund on December 22, 1975, after Section 40A(7) was introduced by the Finance Act, 1975. The fund was approved by the Commissioner of Income-tax on March 27, 1976, to be effective from December 22, 1975, the date of creation of the fund. The claim of the assessee for deduction of the above provision of Rs. 2,00,000 in its accounts ending on June 30, 1975, was disallowed by the Income-tax Officer. He held that an approved gratuity fund should exist in the previous year and since in this case the gratuity fund got approval only with effect from December 22, 1975, that is, after the close of the previous year which ended on June 30, 1975, the claim was not allowable. The Appellate Assistant Commissioner allowed the appeal filed by the assessee. The Revenue filed an appeal before the Appellate Tribunal. The Appellate Tribunal held that the assessee was entitled to claim a deduction of Rs. 2,00,000 being the provision made for payment to an approved gratuity fund for the assessment year under consideration. It held that under Section 40A(7)(b)(i) of the Act, the existence of an approved gratuity fund at the time of the creation of a reserve was not necessary and that it was sufficient if the fund was approved by the time the contribution was made to the fund. The order of the Appellate Tribunal is dated November 26, 1979. On motion by the Revenue, the Appellate Tribunal has referred the question as to whether on an interpretation of Section 40A(7)(b)(i) of the Income-tax Act, 1961, the assessee is entitled to deduction of the gratuity provision for the assessment year 1976-77. The question was sought to be referred on the basis that, in the absence of the existence of an approved gratuity fund at the time of making the provision, the assessee will not be entitled to claim a deduction.

5. Sections 40A(7)(a) and 40A(7)(b) of the Act provide as follows :

'40A. Expenses or payments not deductible in certain circumstances. -- ...

(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.'

6. It is common ground that in this case, the provision applicable is Section 40A(7)(b)(i) of the Act. On a plain reading of Section 40A(7)(b)(i) of the Act, it seems to us that what is required is that the provision should be made by the assessee for the purpose of payment of a sum by way of any contribution towards an approved gratuity fund. (The latter limb of Section 40A(7)(b)(i) of the Act, namely, that payment of any gratuity that has become payable during the previous year, does not arise in this case).

7. Counsel for the Revenue argued that the existence of an approved gratuity fund and payment of the sum towards the same are essential for getting deduction under Section 40A(7)(b)(i) of the Act It was submitted that the gratuity fund was constituted only on December 22, 1975, and that it was approved by the Commissioner only on March 27, 1976, long after the accounting period had expired So, the assessee is not entitled to deduction as per Section 40A(7)(b)(i) of the Act. Acceptance of this argument will lead to rewriting the section as 'any payment of a sum by way of any contribution towards an approved gratuity fund'. That is not what is provided by the above sub-section which only contemplates 'any provision' 'for the purpose of payment of a sum' by way of contribution. All that is necessary is that the provision made by the assessee for the purpose of payment of a sum by way of contribution should be towards an approved gratuity fund. It is not sufficient if a 'mere provision or reserve' is made by the assessee. It should be a provision made by the assessee for the purpose of payment of the amount by way of contribution towards an approved gratuity fund. Beyond that, it is not necessary that there should be a payment by the assessee of a sum by way of contribution towards an approved gratuity existing on the day when the provision is made or during the period the provision is made. In the circular issued by the Central Board of Direct Taxes, Circular No. 169 dated June 23, 1975, the scope and effect of Section 40A(7)(b) has been stated thus :

'Some of the High Courts have recently taken a view that a provision made by an assessee in his accounts in respect of estimated service gratuity payable to employees will be deductible in computing the taxable income in cases where the provision has been made on a scientific basis in the form of actuarial valuation. In order to remove uncertainty in the matter, the Finance Act, 1975, has inserted a new Sub-section (7) in Section 40A which provides that no deduction will be allowed in the computation of taxable profits in respect of mere 'provisions' made by employers in their books of account for payment of gratuity to their employees on their retirement or on termination of their employment for any reason. The amendment will not, however, affect provisions made for the purpose of payment of sums by way of contribution towards approved gratuity funds that have become payable during the previous year, or for the purpose of making any payment on account of gratuity to employees where such gratuity has become payable during the previous year and such provisions will continue to be eligible for deduction as hitherto.' (Law of Income-tax by Sampath Iyengar, 7th Edn., Vol. 2, p. 2038).

8. The Supreme Court of India in Shree Sajjan Mills Ltd. v. CIT : 1986ECR276(SC) , has referred to the Notes on Clauses of the amendment, which resulted in Section 40A(7) of the Act as it appears in : [1975]98ITR194(Guj) :

'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, 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 year, or for the purpose of meeting actual liability in respect of payment of gratuity to the employees that has arisen during such year.'

9. The Circular issued by the Central Board of Direct Taxes, as also the Notes on Clauses referred to above, clearly indicate that what is contemplated by Section 40A(7)(b)(i) of the Act, is a definite or clear provision by the assessee for the purpose of payment of a sum, by way of any contribution towards an approved gratuity fund; It is not sufficient if a 'mere reserve' or 'mere provision', without anything more, is made. In this case, there is no dispute that the assessee had made provision, which was clearly one made for payment to an approved gratuity fund. This has been so found by the Appellate Tribunal. In the light of this finding, we have no hesitation in holding that the assessee will be clearly entitled to the deduction of the provision made for the purpose of payment of the sum by way of contribution towards its approved gratuity fund under Section 40A(7)(b)(i) of the Act.

10. In this connection, we should notice that ordinarily the accounting period for the assessment year 1976-77 will be April 1, 1975, to March 31, 1976. In this case, the assessee has chosen a different accounting period ending on June 30, 1975. The Finance Act, 1975, amended Section 40A(7) of the Act with effect from April 1, 1973. The Finance Act was passed on May 12, 1975. For the three prior assessment years 4973-74, 1974-75 and 1975-76, provision has been made under Section 40A(7)(b) of the Act. Certain conditions should be complied with by an assessee to claim deduction. In this case, we are not concerned with those conditions. The immediately preceding assessment year 1975-76, for which the accounting period will normally end on March 31, 1975, will be governed by Section 40A(7)(b) of the Act. For the assessment year 1975-76, for which the accounting period will end on March 31, 1975, the approved gratuity fund, under an irrevocable trust, need be created and the application for the approval of the fund need be made only before January 1, 1976, i.e., on or before December 31, 1975. For the assessment year 1975-76, the assessee will get nine months' time from the close of the accounting period, i.e., till March 31, 1975, but if the argument of counsel for the Revenue is accepted, for the subsequent assessment year 1976-77, even if the approved gratuity fund under the irrevocable trust is constituted long before December 31, 1975, and the application for approval of the fund is made on or before December 31, 1975, as in this case, the assessee will not get the benefit of deduction. We are afraid that such an interpretation cannot be placed on Section 40A(7)(b) of the Act. Section 40A(7)(b)(i) will apply for the assessment years 1976-77 onwards. For the three prior assessment years 1973-74, 1974-75 and 1975-76, Section 40A(7)(b)(ii) will apply. Section 40A(7)(b)(ii) was made as a transitory provision. If the requirement, as enjoined by Section 40A(7)(b)(ii), could be created or initiated on or before December 31, 1975, there is no reason why it could not be so done or applied for the year 1976-77. In this view of the matter, we concur with the decision of the Appellate Tribunal that the respondent-assessee is entitled to the deduction of Rs. 2,00,000, being the provision made for payment to an approved gratuity fund for the assessment year 1976-77.

11. Our answer to the question referred in ITR no. 351 of 1982 is in the affirmative, against the Revenue and in favour of the assessee. So also, our answer to the question referred to us in ITR No. 7 of 1984 is in the affirmative, against the Revenue and in favour of the assessee.

12. A copy of this judgment under the seal of this court and the signature of the Registrar will be forwarded to the Income-tax Appellate Tribunal, Cochin Bench.