Provision for payment of gratuity to employees is not allowable as a deduction unless the conditions specified in Clause (b) of Section 40a (7) of the Income-tax Act, 1961, are fulfilled.

( 1 ) AT the instance of the assessee, the following questions have been referred by the Income-tax appellate Tribunal for our opinion. " 1. Whether, on the facts and in the circumstances of the case, the Tribunal was correct in holding that the claim of the assessee is not allowable in the years under consideration by virtue of the provisions of Section 40a (7) of the Income-tax Act, 1961 ?

( 2 ) WHETHER, on the facts and in the circumstances of the case, the Tribunal was justified in holding that the case of the assessee-company is not covered by the provisions of Section 40a (7) (b) (i) of the Act?" 2. The assessee is a company limited by guarantee and had adopted the mercantile system of accounting. For the assessment years 1977-78 and 1978-79, the assessee-company had debited certain amounts under the head " Gratuity " in the income and expenditure account. The auditors in their footnote to their balance-sheet for both the years have stated as under :

" Gratuity.--No provision exists for the payment of gratuity to the employees of the company under the Payment of Gratuity Act, 1972. The accrued liability according to actuarial valuation amounted to Rs. 2,72,436 as on March 31, 1977, for which no provision has been made in the accounts. During the year under report, the management has, however, deposited a sum of Rs. 59,633. 51 in the scheduled bank on account of part payment of gratuity to the employees. The accounts in various banks stand in the joint names of the company and the individual employee. In our opinion, this amount should have been shown in the balance-sheet instead of the profit and loss account because the amount has not been transferred to the trustees of the employees gratuity trust fund which has not been executed so far. "

( 3 ) THE Income-tax Officer called upon the assessee to show cause why the claim for deduction on account of gratuity should not be disallowed. After hearing the assessee and considering the evidence, the Income-tax Officer held that the claim for deduction was hit by Section 40a (7) of the Income-tax Act. It was pointed out by the Income-tax Officer that the assessee had moved the application for recognition of the gratuity fund with effect from May 24, 1978. That being so, the claim for gratuity made in the assessment year 1977-78 could not be allowed as the gratuity fund was not recognized by the Income-tax Officer, Lucknow, for the period under consideration. For the same reasons the claim of gratuity could not be allowed for the assessment year 1978-79 as well.

( 4 ) ON appeal by the assessee, the Commissioner of Income-tax (Appeals) also took the same view and negatived the assessees claim. On a further appeal before the Tribunal, it was urged on behalf of the assessee that the gratuity amount having been deposited by it in the fund of the employee in respective banks the same should have been allowed. For the Department, on the other hand, it was contended that gratuity was not deductible unless the deposit fulfils the conditions laid down in Clause (b) of Section 40a (7 ). Accepting the Departments contention, the Tribunal rejected the claim of the assessee and dismissed the appeal. The Tribunal held that a claim of gratuity could be allowed only if the amount was paid by the assessee by way of contribution to an approved gratuity fund for the exclusive benefit of employees under an irrevocable trust. The Tribunal noted the fact that the gratuity fund was approved by the commissioner of Income-tax only with effect from May 24, 1978.

( 5 ) IN order to appreciate the rival contentions, it will be necessary to have a look at the relevant provisions. We begin with Section 40a (1) of the Income-tax Act which provides :

"40a. (1) The provisions of this section shall have effect notwithstanding anything to the contrary contained in any other provision of this Act relating to the computation of income under the head Profits and gains of business or profession . "

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