Kerala H.C : Whether, on the facts and in the circumstances of the case, and also in the absence of an approved gratuity fund created by it for the exclusive benefit of employees under an irrevocable trust, the assessee is entitled to claim deduction of the provision for the liability towards gratuity payable to the employees ?

Counsel Appeared

Menon, for the Revenue : Jose Joseph, for the Assessee

KOCHU THOMMEN, J.:

Pursuant to the direction of this Court in O.P. No. 1277 of 1979, the following four questions have been referred to us by the Tribunal, Cochin Bench :

” 1. Whether, on the facts and in the circumstances of the case, and also in the absence of an approved gratuity fund created by it for the exclusive benefit of employees under an irrevocable trust, the assessee is entitled to claim deduction of the provision for the liability towards gratuity payable to the employees ?

Whether, on the facts and in the circumstances of the case, the circular referred to and relied on by the Tribunal is binding on the ITO ?

If the answer to the above question is in the affirmative, whether a circular that is not in force and not acted upon at the time of completing the assessment is binding on the ITO ? Whether, on the facts and in the circumstances of the case, the Tribunal is right in law in deleting the disallowances of Rs. 2,000 towards children allowance and Rs. 1,260 towards house rent under s. 40(a)(v) of the IT Act, 1961 ? “

2. In the light of the decision of a Full Bench of this Court in CIT vs. B. M. Edward, India Sea Foods (1979) 119 ITR 334(Ker), question No. 2 is answered in favour of the assessee and against the Revenue.

3. In the light of the decision of this Court in CIT vs. Malayala Manorama & Co. Ltd. (1983) 143 ITR 29(Ker), question No. 3 is answered in favour of the assessee and against the Revenue.

4. We shall now deal with question No. 4. The assessee claimed the benefit of Circular No. 32 (F.No. 10/93/68-IT (A-11)) dated October 29,1969 (annexure-D), issued by the CBDT, the relevant portion of which reads ((1969) 74 ITR (St.) 34): ” The matter has been examined and it has been decided that salary, dearness allowance, bonus, commission or any other cash allowance payable to the employee in terms of his contract of service, would be regarded as salary under s. 17(3)(ii) and not as ‘ benefit or amenity ‘ for the purposes of s. 40(c)(iii)/40(a)(v) of the IT Act. Further, only those cash payments would be covered by the expression ‘ perquisites, amenities and benefits’ which are paid to the employee voluntarily and gratuitously and not in terms of the specific provisions of his contract of employment. In other words, the employee concerned should not have been in a position to enforce the payment of these amounts in a Court of law.”

5. The Tribunal has not considered the question as to whether the amounts claimed by the assessee towards what is referred to as ” children allowance ” and ” house rent ” fall under s. 17(3)(ii) or s. 40(a)(v) of the IT Act, 1961, as the sections stood at the relevant time. Without adverting to the correct classification of the amounts, the question whether the benefit granted under annexure-D circular is allowable in respect of the amounts in question cannot be answered. Accordingly, we decline to answer question No. 4.

6. We shall now deal with the main question which is question No. 1 That relates to the claim for gratuity. The assessee’s claim for deduction in respect of the years prior to 1971-72 was disallowed by the ITO on the ground that he could not for the first time make a claim in respect of a liability which had accrued in the earlier years. The assessee had followed the mercantile system of accounting. Although the assessee had been making entries in his books of account providing for payment of gratuity, at the time of filing the returns, the assessee claimed only the amount which had actually been paid in the year of account. The system followed was in the words of the officer : ” ……The assessee had been following the practice of making provision for gratuity liability year after year on a certain basis (details of which are not available with me) and such provisions were debited in the P & L a/c. However, for income-tax purposes, in the adjustment statement furnished along with the return of income year after year, these provisions were used to be added back and only the actual payments were claimed as admissible deductions in the earlier years by the assessee. The same procedure was adopted by the assessee at the time of the assessment proceedings for this year. Therefore, there was no error in not allowing any claim which the assessee- company had preferred at the time of assessment proceedings. The new claim now put forward by the assessee is that the provision made in all the past years and debited in the respective P & L a/c which is now available as accumulated provisions in the balancesheet of this year, should be allowed as a deduction in this year as the Kerala Industrial Employees’ Payment of Gratuity Act passed in February, 1970, cast a legal obligation on the assessee to incur this expenditure. It is obvious that in the assessee’s case, the legal obligation has been recognised by the assessee-company even in the past, when it had been making provision for such a payment year after year. However, the assessee-company chose the method of claiming gratuity on actual payment basis since this was the mode of computation of income followed by the ITO and accepted by the assessee. In the circumstances, no fresh claim for provision for gratuity will arise in the assessee’s case ……..”

7. This finding of the officer was reversed by the AAC, and that decision was affirmed by the Tribunal, thereby accepting the assessee’s contention that the gratuity payable in respect of the earlier years was an allowable deduction in the accounting year relevant to 1971-72.

8. The Tribunal referred to the decision of this Court and applied the principle wrongly. This Court in CIT vs. Kerala Nut Food Co. 1976 CTR (Ker) 92:(1978) 111 ITR 252 (Ker), following the decisions in CIT vs. High Land Produce Co. Ltd. 1975 CTR (Ker) 146:(1976) 102 ITR 803 (Ker) and L. J. Patel & Co. vs. CIT (1974) 97 ITR 152 (Ker), held (at pp. 255 and 256): ” Applying this principle, the arrears of the earlier years towards gratuity cannot be taken into account in computing the income of the subsequent accounting period. The assessee having adopted the mercantile system of accounting, it ‘is entitled to deduct from the profits and gains of the business such liability which had accrued during the period for which the profits and gains were being computed’……. The assessee can take into account only such liability as it had incurred during the relevant accounting year ……..”

9. This principle was again followed by this Court in CIT vs. Mittal Steel Re-Rolling & Allied Industries (P) Ltd. 1985 44 CTR (Ker) 71:(1985) 155 ITR 1 (Ker) and CIT vs. G. T. N. Textiles Ltd. (1985) 44 CTR (Ker) 62:(1985) 155 ITR 5 (Ker). In CIT vs. Mittal Steel Re-Rolling & Allied Industries (P) Ltd. (suprar), we had stated (vide headnote) : ” If the liability for gratuity arises for the first time under a statute, deduction could be claimed in respect of that accounting year in which the statute was first enacted as well as for the earlier years provided provision has been made in the accounting year in which the liability first arose.”

10. Referring to this principle, counsel for the assessee submits that provision had been made for each of the earlier years and, therefore, when the liability under the statute arose for the first time in the relevant accounting year, it was open to the assessee to claim deduction in respect of what was provided for the earlier years. That argument is not available here in view of the finding of fact by the officer. Although the assessee made provision and made a debit to his P & L a/c with a corresponding credit to the gratuity account, the entries were reversed each time the returns were filed. The assessee claimed in the returns only the sums paid as gratuity and not the sums payable on the basis of accrual. Accordingly, it was too late in the accounting year for the assessee to claim for the earlier years. In the circumstances, we answer question No.1 in favour of the Revenue and against the assessee.

11. We direct the parties to bear their respective costs in this tax referred case.

[Citation : 169 ITR 134]