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1982 Supreme(Mad) 364
High Court of Judicature at Madras
THE HONOURABLE MR. JUSTICE BALASUBRAMANYAN & THE HONOURABLE MR. JUSTICE RATNAM
Commissioner of Income Tax, Coimbatore - Appellant
Versus
Coimbatore Cotton Mills Limited - Respondent
Case No : TC No. 1201 of 1977
Decided On : 06 October 1982
Provision for gratuity made by assessee on basis of scientific or actuarial valuation is a proper deduction in computation of assessee's annual business profits. Mahimai collection by assessee from customers on yarn sales is not taxable as part of trading receipts.
Headnote:
INCOME TAX - Provision for gratuity - Whether provision for gratuity made by assessee on basis of scientific or actuarial valuation is a proper deduction in computation of assessee's annual business profits - Whether assessee entitled to deduct an appropriate provision for gratuity as a charge against the profits - Whether mahimai collection by assessee from customers on yarn sales is taxable as part of trading receipts.
Fact of the Case:
The assessee, a textile mill, introduced a system of making provision for gratuity to its employees based on actuarial valuation. The ITO disallowed the provision, but the Tribunal held that the assessee was entitled to deduct an appropriate provision for gratuity as a charge against the profits. The assessee also collected mahimai from its customers on yarn sales, which the ITO added back to the income, but the Tribunal allowed the deduction.
Finding of the Court:
The court held that the provision for gratuity made by the assessee on the basis of scientific or actuarial valuation is a proper deduction in the computation of the assessee's annual business profits. The court also held that the mahimai collection by the assessee from customers on yarn sales is not taxable as part of trading receipts.
Issues: 1. Whether provision for gratuity made by assessee on basis of scientific or actuarial valuation is a proper deduction in computation of assessee's annual business profits? 2. Whether assessee entitled to deduct an appropriate provision for gratuity as a charge against the profits? 3. Whether mahimai collection by assessee from customers on yarn sales is taxable as part of trading receipts?
Ratio Decidendi: 1. The court relied on the decision of the Supreme Court in Vazir Sultan Tobacco Co. Ltd. v. CIT, which held that an actuarial provision for gratuity is a legitimate deduction having regard to a catena of decisions culminating in Vazir Sultan Tobacco Co. Ltd. v. CIT. 2. The court held that the assessee's switch to the system of making provision for gratuity did not create a change in the method of accounting, as the assessee had always been employing the mercantile method of accounting. 3. The court followed the decision of the Supreme Court in CIT v. Bijli Cotton Mills (P.) Ltd., which held that any realisation which cannot be regarded as part of the price or a surcharge on the price but payment for the specific purpose being spent on charitable purposes can by no means be regarded as part of the trading receipts.
Final Decision: The court answered both questions in the affirmative and against the Department, holding that the provision for gratuity and the mahimai collection were not taxable.
BALASUBRAHMANYAN J.
Two questions have been referred by the income-tax Appellate Tribunal for our opinion in this case. They are
"1. Whether, on the facts and in the circumstances of the case, and in view of the provisions contained in section 36(1)(v) of the Income-tax Act, 1961, the Appellate Tribunal was right in holding that the claim of the assessee for allowance of provision for gratuity was liable to be deducted subject to the verification mentioned in its order for the year 1972-73 ?
2. Whether, on the facts and in the circumstances of the case, the mahimai collection of Rs. 17, 610 is not taxable in the assessment year 1972-73 ?"
The assessee in this case runs a textile mill, employing many workmen. In earlier years, the assessee was in the habit of paying gratuity to the workmen who retired from service or got discharged from employment. Whenever gratuity was actually paid, the assessee claimed the payment as a deduction or outgoing of the business in the computation of the assessable profits. In the accounting year relevant to the year 1971-72, the assessee wanted to introduce a scientific system to provide for the payment of gratuity to its workmen. Part of that scheme was to make a provision every year out of the net profits as and towards probable gratuity liability worked out on the basis of actuarial valuation. Any provision of this kind would be a charge against the profits of the year.
In the assessment year 1972-73 relevant to the previous year ended with December 31, 1971, the assessee claimed deduction towards provision made for gratuity in the sum of Rs. 1, 46, 356. In that account year the assessee also happened to make an actual payment out of Rs. 80, 282 towards gratuity payable to certain retired employees who retired during that year. The ITO allowed the actual payment of gratuity in the sum of Rs. 80, 282 as an admissible deduction but refused to deduct Rs. 1, 46, 356 being the provision made by the assessee as regards the existing employees and as and towards their possible gratuity liability as and when it may arise in futureThe assessee objected to the disallowance of the provision for gratuity in the sum Rs. 1, 46, 356 and appealed against the ITO's order. The Appellate Tribunal considered the claim from two aspects, firstly, whether there was any change in the method of accounting when the assessee introduced the system of making provision for gratuity as distinct from the earlier practice of claiming as an expenditure the actual gratuity paid out to the retiring employees. The second aspect, which the Tribunal considered was whether the amount of provision made for possible gratuity liability calculated on scientific basis can at all be regarded as a proper charge against revenue and whether it will come in for deduction in the computation of the assessable business profits. On the latter point, the Tribunal had no difficulty in deciding that the provision for gratuity must be regarded as a charge against revenue. On the former question, however, the Tribunal did not have full materials to show whether any part of the provision for gratuity made during the year in the aggregate sum of Rs. 1, 46, 356 did not also take into account the liability for payment towards the employees who actually retired during the accounting year and got paid Rs. 80, 282 as gratuity. Since the relevant materials were not available, the Tribunal remanded the matter to the ITO for ascertaining the correct position subject to the working out of the details. However, the Tribunal held that the assessee was entitled to deduct an appropriate provision for gratuity as a charge against the profits. They also held that the assessee was entitled to introduce this system of making a provision for gratuity even though it might involve a change in the method of accounting:
The learned standing counsel for the I.T. Dept. could not contest the legal position that a provision for gratuity made by an assessee on the basis of
