S.K Desai, J.:— This is a reference made to us by the Income-tax Appellate Tribunal, Bombay Bench “C”, under section 256(1) of the Income-tax Act, 1961. The reference is at the instance of the Commissioner.

2. The assessee in this reference is a company carrying on business in cotton and cotton waste. We are dealing with the assessment year 1962-63, the relevant previous year being the year ending on 31st August, 1961. The assessee-company had been carrying on this business for a number of years on a large and substantial scale. There was another firm carrying on similar business known as Volkart Brothers. In 1961 negotiations were carried on by the assessee-company for taking over business in cotton and cotton waste of Volkart Brothers, and such negotiations had reached an advanced stage in the first half of 1961. A preliminary agreement was arrived at between the assessee and the said firm on 31st May, 1961. This was followed by a formal agreement which was entered into on 23rd October, 1961. The business in cotton of Volkart Brothers was taken over from 1st September, 1961. Under the agreement dated 23rd October, 1961, 1,300 shares of Rs. 500 each were to be allotted to Volkart Brothers or their associates at a premium of Rs. 300 each. A new company called Messrs. Volkart (Bombay) Private Ltd. was registered at or about that time to take over the other business carried on by Volkart Brothers. The assessee-company took over the plant, machinery and buildings and lands owned by Volkart Brothers in relation to its cotton and cotton waste business at various places. The staff of Volkart Brothers in the cotton department also came over to the assessee.

3. Volkart Brothers had a scheme in force of retiring its employees at the age of 571/2 and paying them gratuity at the time of retirement. The assessee had a scheme of paying gratuity to its employees when their services came to an end, but there was no fixed age of retirement for the employees of the assessee-company. It had thus employees who had exceeded the age of 57½ years. Under clause 35 of the agreement dated 23rd October, 1961, the assessee was to retire all its employees who had exceeded the age of 57½ years on or before 31st August, 1961, and to pay to these employees the gratuity, provident fund, etc., due to them. It may be mentioned that in the preliminary agreement dated 31st May, 1961, there was no provision for or reference to the termination of the services of any employee on this basis.

4. By 31st August, 1961, the assessee's employees who had already reached the age of 571/2 years were given notices and they were paid gratuity amounting in the aggregate to the sum of Rs. 1,45,844. In their assessment for the year 1962-63, the assessee claimed deduction of the sum of Rs. 1,45,844 paid as such gratuity to its employees, but the claim was rejected by the Income-tax Officer on the ground that the compulsory retirement or retrenchment of the staff was occasioned by or was directly relatable to the acquisition by the assessee of the new business, that it was done as part of the terms for purchase of the new business, and that it was nothing but a part of the purchase consideration. According to the Income-tax Officer, the expenditure was capital in nature and not allowable as deduction. It was further held that it was not incurred in the interest of the existing business but only of a new business to be acquired by the assessee. The assessee, thereafter, appealed to the Appellate Assistant Commissioner, who took the view that the payment was essentially in the nature of gratuity paid to the employees of the assessee and directed its allowance. The department, thereafter, came in appeal to the Tribunal. According to the department, the retirement of the employees was connected with the acquisition of a new business, and it was submitted, therefore, that the payment of retirement gratuity was a payment of capital nature only. On behalf of the assessee it was urged that the liability to pay retirement benefit was not undertaken as an obligation under the scheme of acquisition and that it was already a part of the terms of employment under the assessee. It was further submitted that this was expediency as the employees who were retired were comparatively advanced in age. The Tribunal upheld the order of the Appellate Assistant Commissioner directing allowance of the amount as the expenditure. It is from this order of the Tribunal that the following question has been referred to us at the instance of the Commissioner:

“Whether, on the facts and in the circumstances of the case, the Tribunal was justified in allowing the sum of Rs. 1,45,844 paid as gratuity to the assessee's employees as expenditure commercially expedient and allowable as a revenue deduction?”

5. Before dealing with some authorities to which our attention was drawn, I may mention certain findings arrived at by the Tribunal, which are reproduced in paragraph 7 of the statement of the case:

(1) The assessee was carrying on an identical business and there was nothing to show that the business taken over was run as a separate and an independent business. The contention of the department that there was an acquisition of a wholly new business is not correct to the fullest extent. The said business merged in that of the assessee and there was no separate business carried on by the assessee so as to distinguish the said business taken over from Volkart Brothers from the existing business of the assessee.

(2) By the year end (i.e, 31st August, 1961), the business of Volkart Brothers had not been taken over. The taking over was only subsequent. The assessee had paid gratuity only to its own employees. Under the preliminary agreement dated 31st May, 1961, there was no provision for termination of services of any one already working in the assessee-company and the incorporation of such a clause in the formal agreement dated 23rd October, 1961, would not have the effect of making it a condition of the taking over, because the date on which the termination is envisaged had already passed by.

(3) There was no suggestion that the assessee-company did not independently consider the value of the services of persons who had attained the age beyond 571/2. The assessee had itself a scheme of paying gratuity and this was clear from several extracts from the minutes of the earlier years, Thus, according to the Tribunal, it was established on the facts that there was a system of payments of gratuity to the employees at the time of the termination of their services. The termination of the services of persons beyond the age of 571/2 was considered to be commercially expedient by the assessee.

(4) According to the Tribunal, it may be that the prospect of getting the employees of the cotton department of the Volkart Brothers provided an occasion for the assessee to look into its establishment list and retire persons beyond a particular age. By itself, however, this would not justify the disallowance of the gratuity paid. The payment of gratuity, according to the Tribunal, would under such circumstances also ensure retention of the staff working already and contentment amongst them.

6. It is on these findings that the Tribunal held that the allowance of Rs. 1,45,844 given by the Appellate Assistant Commissioner was fully justified.

7. It is clear to me that in view of these findings of the Tribunal the question referred to us is required to be answered in favour of the assessee. A reference may, however, be made to certain authorities to which our attention was drawn by the counsel.

8. The Supreme Court had an occasion to consider the question whether the amount paid as gratuity to an employee or director on retirement is allowable as expenditure under section 10(2)(xv) of the Indian Income-tax Act, 1922, in Gordon Woodroffee Leather Manufacturing Company v. Cit, Madras [1962] 44 ITR 551 (SC). It was found on the facts of that case that the payment in dispute did not fall within the provisions of section 10(2)(xv), as the amount was not paid in pursuance of any scheme of payment of gratuities nor was it an amount which the recipient expected to be paid for long and faithful service, but it was a voluntary payment not with the object of facilitating the carrying on of the business of the appellant-company or as a matter of commercial expediency but in recognition of long and faithful service of Mr. J.H Philips. According to the Supreme Court, the relevant factor was that there was no practice in the appellant-company to pay such amounts and it did not affect the quantum of salary of the recipient. The proper test has been indicated by the Supreme Court in the penultimate paragraph of its decision (at page 555 of the report). In the instant case arising before us there is an express finding of the Tribunal that there was a scheme in force for the assessee-company and further, according to the Tribunal, the payment of gratuity under the circumstances was one which would ensure retention of the staff working already and contentment amongst them, which would also suggest that the payment must be regarded as one made as a matter of commercial expediency.

9. The aforesaid Supreme Court decision was considered by the Division Bench of this High Court in Sassoon J. David and Company Pvt. Ltd. v. Commissioner of Income-tax [1972] 85 ITR 83 (Bom), where the amount paid as gratuity was not allowed as expenditure under section 10(2)(xv) of the Indian Income-tax Act, 1922, one of the pertinent factors being, in the view of the court, that there was no practice of payment of gratuity and no legally enforceable claim for such payment against the company. Both decisions were considered and the decision in Gordon Woodroffe Leather Manufacturing Co.'s case [1962] 44 ITR 551 (SC) was applied by the Madras High Court in Balarama Varma Textiles Ltd. v. Commissioner of Income-tax [1973] 92 ITR 485 (Mad). In the Madras case the payment was not allowed, inter alia, on the footing that there was no material to show that the decision to pay the amount as gratuity to the employees in question had been taken even during the currency of their employment. It was found that the amount had been given as ex gratia payment without reference to any anterior obligation of the assessee to pay the said amount (See page 491 of the report).

10. All these three cases were considered in an unreported judgment of a Division Bench of this court consisting of the learned Chief Justice and Tulzapurkar, J. in Income-tax Reference No. 40 of 1970, decided on 15th July, 1975) [Since reported as Commissioner Of Income-Tax, Bombay City-Iii v. Oxford University Press. Press [1977] 108 ITR 166 (Bom)]. According to Tulzapurkar J., who delivered the judgment of the court, the Supreme Court in Gordon Woodroffe Leather Manufacturing Co.'s case [1962] 44 ITR 551 (SC) had laid down three tests for determination of the question:

(a) was the payment made as a matter of practice which affected the quantum of salary?

(b) was there an expectation by the employee of getting a gratuity? and

(c) was the sum of money expended on the ground of commercial expediency and in order indirectly to facilitate the carrying on of the business?

11. If the answer to any of the tests is in the affirmative, the payment would be allowed as a revenue expenditure. It has been found by the Tribunal that there was an existing scheme for the employees of the assessee-company who were paid this amount by way of gratuity. It has been found further that the payment was made under the circumstances as would ensure retention of the remaining staff and contentment amongst them. Both the second and third tests, as mentioned in Oxford University's case [1977] 108 ITR 166 (Bom) are satisfied and the decision of the Tribunal would be required to be upheld.

Vimadalal, J.:— I agree. I have nothing to add.

13. By the Court.—In the affirmative and in favour of the assessee.

14. Mr. Kaka does not seriously press for costs. Accordingly, each party will bear its own costs.