S.C : Whether, on the facts and in the circumstances of the case, the Tribunal is right in law in holding that for the asst. yr. 1971-72 the assessee is entitled under s. 37 of the IT Act, 1961, to a deduction of Rs. 56,485 as gratuity to his employees under the Kerala Industrial Employees (Payment of Gratuity) Act, 1970, when the assets and liabilities of the assessee’s proprietary business including the employees and the liability to pay gratuity to them were taken over as a running concern on 15th Oct., 1970, by a firm consisting of himself and another as partners ?

Supreme Court Of India

K.J. Francis vs. CIT

Section 37(1)

Asst. Year 1971-72

S.P. Bharucha & B.N. Kirpal, JJ.

Civil Appeal No. 1777 of 1979

6th February, 1996

Counsel Appeared

S. Balakrishnan, for the Appellant : J. Ramamurthy with S. Rajappa & S.N. Terdol, for the Respondent

JUDGMENT

BY THE COURT :

This is an appeal by certificate granted by the High Court of Kerala, which answered the question referred to it in favour of the Revenue.

The appellant is an individual. He was carrying on business as its sole proprietor. The accounting year of the appellant was the financial year. On 14th Oct., 1970, the books of account of the appellant were closed and the sole proprietary concern was taken over by a partnership with effect from 15th Oct., 1970, the appellant being one of the partners. During the accounting year 196970, relevant to the asst. yr. 1970-71, an Ordinance had been issued, known as The Kerala Industrial Employees’ (Payment of Gratuity) Ordinance, which made it obligatory for employers to set aside particular amounts for payment as gratuity to their employees. It is not in dispute that the liability in respect of the accounting year 1969-70, and for the earlier years, did arise in that accounting year, but the appellant chose not to make any entry in his books of account towards the discharge of that liability. In the following accounting period, i.e., 1st April, 1970 to 14th Oct., 1970, when his proprietorship came to an end, the assessee debited the amount in his books of account and claimed deduction of the gratuity which was payable to his employees.

The ITO rejected the claim of the appellant on the ground that the amount included liabilities of earlier accounting years. According to him, the liability for that year alone, i.e., asst. yr. 1971-72, could be allowed. The appellant filed an appeal before the AAC, who held that a provision in respect of the liability should have been made when the Ordinance was promulgated on 9th Dec., 1969, and the statutory liability should have been claimed as a deduction by the appellant in the first year in which it arose because he followed the mercantile system of accounting. The claim of the appellant was, accordingly, rejected.

The appellant filed a further appeal to the Tribunal. The Tribunal agreed with the AAC that the liability arose for the first time in the accounting year relevant to the asst. yr. 1970-71 and that the appellant should have claimed the deduction in that year as he followed the mercantile system of accounting. The Tribunal, however, came to the conclusion that this amount should be treated as expenditure of the year 1971-72 because, in computing the income for the period ending 14th Oct., 1970, provision for gratuity had already been debited to the P&L a/c. The Tribunal held that the firm had taken over the entire business as a running concern and, if the appellant had not debited his business with this amount, then the credit he would have got in the books of the firm would have increased by the said amount, i.e., his capital account would have gone up to that extent. The firm had not given him this credit and, therefore, according to the Tribunal, the entries made in the books of the appellant towards the gratuity had been taken over by the firm as its liability and, as far as the appellant was concerned, the amount had been paid off by him.

On an application under s. 256(1) of the IT Act, 1961, the Tribunal referred the following question to the High Court : “Whether, on the facts and in the circumstances of the case, the Tribunal is right in law in holding that for the asst. yr. 1971-72 the assessee is entitled under s. 37 of the IT Act, 1961, to a deduction of Rs. 56,485 as gratuity to his employees under the Kerala Industrial Employees (Payment of Gratuity) Act, 1970, when the assets and liabilities of the assessee’s proprietary business including the employees and the liability to pay gratuity to them were taken over as a running concern on 15th Oct., 1970, by a firm consisting of himself and another as partners ?”

The High Court answered the question in favour of the Revenue, holding that it was unable to sustain the contention of the appellant that, so far as he was concerned, there was a discharge of the liability as evidenced by the entries in the P&L a/c. It held that the liability had arisen and it could have been claimed as a deduction only in the asst. yr. 1970-71.

It has been contended by learned counsel for the appellant that the decision of the Tribunal in allowing the deduction was correct for the reason that, as far as the appellant was concerned, he had discharged his liability when he debited his P&L a/c with Rs. 56,485 towards payment of gratuity to his employees. It is clear that the liability to pay this amount arose by reason of the promulgation of the Ordinance on 9th Dec., 1969. The liability towards payment of gratuity was not only with respect to that accounting year but also in respect of the earlier years in which the employees of the appellant had served; the liability had to be computed by the amount of 15 days’ wages for every year. Both the AAC as well as the Tribunal came to the conclusion that the liability had accrued in the accounting year 1969-70 and not in the following accounting year, with which we are here concerned. The High Court was right in holding that no claim for a deduction could have been allowed for the asst. yr. 1971-72 merely because the appellant chose to debit his P&L a/c with the aforesaid amount of Rs. 56,485 during its course. In fact, no payment was made by the appellant to any of the employees; this was merely an accounting entry. This entry could not and did not represent any disbursement of money by the appellant and, therefore, neither on the principles of the mercantile system of accounting nor on the basis of the cash system of accounting could the appellant validly claim this amount as a deduction.

The High Court rightly answered the question of law referred to it in favour of the Revenue. This appeal is accordingly dismissed. There shall be no order as to costs.

[Citation: 236 ITR 308]

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