Commissioner Of Income-Tax, Madras (Central) v. Andhra Prabha P. Ltd.

The Judgment of the Court was delivered by

Sethuraman, J.:— The Income-tax Appellate Tribunal has referred the following two questions under s. 256(1) of the I.T Act, 1961:

“(1) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that the extra printing charges paid by the assessee to M/s. Indian Express Private Ltd. of Rs. 1,27,245 is an admissible deduction under section 37 of the Income-tax Act, 1961, for the assessment year 1969-70?

(2) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that the assessee was entitled to the deduction of the estimated gratuity payable to non-working journalists if it is established that the provision for payment of gratuity is based on legal and scientific basis?”

2. We shall consider the first question first, and take up the second question later, The assessee was printing the Vijayawada edition of the daily newspaper “Indian Express” and its Sunday Edition, for Indian Express (Madurai) Private Ltd. The Madurai company, in its turn, printed for the assessee the “Andhra Prabha Illustrated Weekly” for circulation in Bangalore area. The printing charges for the illustrated weekly came to Rs. 425 for ten pages of Indian Express size. The assessee, was printing the daily Indian Express and its Sunday Edition by the ordinary letter press process, whereas the Madurai company was printing the Andhra Prabha Illustrated Weekly by the offset process. Printing by offset process was costlier than by ordinary letter press process. So, the Madurai company increased the printing charges from Rs. 4.25 to Rs. 5.50 for ten pages of Indian Express size. The increase in this charge resulted in the assessee-company having to pay a sum of Rs. 1,27,245 to the Madurai company. This claim for increase in printing expenses made by the assessee was disallowed by the ITO holding that it was not a bona fide expenditure. According to him, there was no agreement between the two parties governing the substantial increase; and the resolutions approving the printing charges recovered during the year were passed long after the expiry of the accounting year. His further point was that the enhanced claim for printing charges was foisted on the assessee with a view to siphon off the profit after it had accrued and been ascertained. The assessee contested this disallowance before the AAC who confirmed the order of the ITO more or less for the same reasons. The assessee appealed to the Tribunal. The Tribunal went into each one of the contentions taken on behalf of the department and came to the conclusion that all the conditions necessary for allowing the expenditure as a “deduction” under s. 37(2) of the Act were fulfilled. In the absence of any material to suggest that the claim for extra expenditure was made for an oblique purpose or with an ulterior motive, in the view of the Tribunal, there was no reason why the claim should be disallowed. It is this conclusion of the Tribunal that has resulted in the first question being referred. The question as to whether the sum of Rs. 1,27,245 is liable to be allowed as deduction is essentially a factual question. There is no doubt about the fact that the assessee had paid the said sum to the Madurai company. The accounting entries had also been made contemporaneously. The fact that the process employed by the Madurai company in printing the illustrated weekly by the offset process, which is costlier than ordinary letter press process, was not also in dispute. In these circumstances, the only question is whether the said amount was wholly and exclusively laid out for the purposes of the assessee's business. Merely because the payment had been made to a sister concern, so to say, would not negative its allowance, so long as the payment had been made bona fide out of commercial considerations and so long as the allowance is not prohibited by any of the provisions of the Act.

3. The way in which the allowance was contested by the department was that the assessee's profit was siphoned off to gain a tax advantage for the Madurai company. The Tribunal has gone into this aspect in its order and has found that the Madurai company was being taxed at a higher rate than the assessee and that, therefore, there was no question of any tax advantage. The next reason for disallowance was that there was no agreement in support of the claim for the increase in printing expenses. It was pointed out by the Tribunal that a written agreement is not a condition precedent for the allowance. It was also contended that this device had been adopted for getting funds for the construction of a building by another sister concern in Bombay. The Tribunal pointed out that there was no material to show that the higher recovery of printing charges found its way to the holding company in Bombay and utilised in the construction of a skyscraper in Bombay. The last contention was that there was no corresponding increase in the charges for printing Indian Express for the Madurai company by the assessee. It has been pointed out that the process employed by the Madurai company in printing the illustrated weekly being a costlier one, the charges came to be increased, while there was no need for any increase in the charges with reference to the printing by the ordinal letterpress process. Thus, every one of the contentions taken by the revenue has been examined by the Tribunal and negatived. We do not find that there is any error committed by the Tribunal in arriving at the conclusion that the amount was liable to be deducted under s. 37(2) of the Act. The first question is, accordingly, answered in the affirmative and in favour of the assessee.

4. We shall now take up for consideration the second question. This question related to the claim of the assessee for the deduction of Rs. 1,32,653 being the gratuity amount payable to the employees of the assessee and debited in the profit and loss account of the relevant accounting year. The ITO has disallowed this amount, on the basis of the disallowance made by the assessee in the adjusted statement of income. After receipt of the assessment order when the assessee preferred the appeal to AAC, it took up this point, on the ground that the initial disallowance in the statement was due to a mistake. The AAC held that the assessee had been claiming the gratuity payment as a deduction in the year in which it was disbursed and that since the claim for deduction was made in the year to which the gratuity related, there was a change in the method of accounting and that the claim for deduction could hot, therefore, be allowed. He further held that the gratuity claimed had not become an ascertained or accrued liability and that the provision made for payment of gratuity was not based on any legal or scientific basis. The assessee appealed to the Tribunal on this point also, and the Tribunal found that the gratuity liability was payable to two classes of employees, viz, (i) non-journalists, and (ii) working journalists. As far as non-journalists were concerned, there was a scheme and agreement dated 13th of March, 1968, under which gratuity liability arose. As regards working journalists, the amount had to be paid under the statutory provision. According to the assessee, the amount, viz., Rs. 1,32,653 had accrued as a liability on the basis of a scientific calculation of the present liability which had to be discharged at a future date. But, according to the revenue, there were no liabilities, which had accrued, and, therefore, the amount could not be allowed as deduction. The Tribunal referred to s. 5 of the Working Journalists (Conditions of Service and Miscellaneous Provisions) Act, 1955, and also to the agreement with the non-journalists. The Tribunal accepted the claim of the assessee in principle but directed the ITO to go into the question and allow the gratuity provision as a deduction if he was satisfied that the provision for payment of gratuity was based on legal or scientific ground. It is this part of the order of the Tribnnal that has given rise to the second question set out already.

5. At the relevant time, the only provision that related to the allowance of gratuity was contained in s. 36(1)(v) of the Act. The provision, in so far as it is relevant, ran as follows:

“36. (1) The deductions provided for in the following clauses shall be allowed in respect of the matters dealt with therein, in computing the income referred to in section 28—…

(v) any sum paid by the assessee as an employer by way of contribution towards an approved gratuity fund created by him for the exclusive benefit of his employees under an irrevocable trust.”

6. Subsequently, a new provision, s. 40A(7), came to be introduced by the Finance Act, 1975, with effect from 1st of April, 1973. The new provision stated:

“(a) Subject to the provisions of clause (b), no deduction shall be allowed in respect of any provision (whether called as such or by any other name) made by the assessee for the payment of gratuity to his employees on their retirement or on termination of their employment for any reason.

(b) Nothing in clause (a) shall apply in relation to—

(i) any provision made by the assessee for the purpose of payment of a sum by way of any contribution towards an approved gratuity fund, or for the purpose of payment of any gratuity, that has become payable during the previous year;

(ii) any provision made by the assessee for the previous year relevant to any assessment year commencing on or after the 1st day of April, 1973, but before the 1st day of April, 1976, to the extent the amount of such provision does not exceed the admissible amount, if the following conditions are fulfilled, namely:—

(1) the provision is made in accordance with an actuarial valuation of the ascertainable liability of the assessee for payment of gratuity to his employees on their retirement or on termination of their employment for any reason;

(2) the assessee creates an approved gratuity fund for the exclusive benefit of his employees under an irrevocable trust, the application for the approval of the fund having been made before the 1st day of January, 1976; and

(3) a sum equal to at least fifty per cent. of the admissible amount, or where any amount has been utilised out of such provision for the purpose of payment of any gratuity before the creation of the approved gratuity fund, a sum equal to at least fifty per cent. of the admissible amount as reduced by the amount so utilised, is paid by the assessee by way of contribution to the approved gratuity fund before the 1st day of April, 1976, and the balance of the admissible amount or, as the case may be, the balance of the admissible amount as reduced by the amount so utilised, is paid by the assessee by way of such contribution before the 1st day of April, 1977…”

7. There are two Explanations, but those Explanations have no relevance to the point now in issue.

8. The effect of the statutory provisions may be described as follows: Section 36(1)(v) provides for deduction of any amount paid by way of contribution towards an approved gratuity fund created by the employer. Sub-section (7) of s. 40A prohibits the deduction of a provision for gratuity. But the prohibition does not extend to the following cases:

(a) provision for contribution to approved gratuity fund, or

(b) provision for payment of gratuity for which a liability has arisen during the year.

9. There is a transitory provision enacted in cl. (b)(ii) of s. 40A(7) to soften the hardship that would arise by the retrospective operation given to s. 40A(7) from 1st April, 1973, while it was actually enacted in 1975. We need not go into the provision as it is not germane to the assessment under consideration for 1969-70. Thus, the two provisions, even taking into account s. 40A(7), take care of:

(a) the claim for deduction based on payment to an approved gratuity fund, and

(b) provision for payment to an approved fund and provision for payment for which a liability has arisen.

10. We are here concerned with a third category where provision is made for a future payment, on a “scientific” method of calculation, for which no statutory provision exists. The provision made is in principle a present liability though it could be discharged later.

11. In the present case, the sum of Rs. 1,32,653 represents an estimate of an accrued liability calculated on a “scientific” basis, which had to be discharged in future. Therefore, s. 36(1)(v), which applied to actual payments, would not stand in the way of the matter being considered in the light of the other provisions of the Act.

12. The Supreme Court pointed out in Badridas Daga v. Commissioner Of Income Tax, [1958] 34 ITR 10, 15, after observing that the word “profits” had to be understood in its natural and proper sense—in a sense in which no commercial man would misunderstand:

“The result is that when a claim is made for a deduction for which there is no specific provision in section 10(2), whether it is admissible or not will depend on whether, having regard to accepted commercial practice and trading principles, it can be said to arise out of the carrying on of the business and to be incidental to it. If that is established, then the deduction must be allowed, provided of course there is no prohibition against it express or implied, in the Act.”

13. There is no express or implied prohibition against deduction of such an existing liability which had not matured into a payment, falling within s. 36(1)(v). We have, therefore, to examine the claim in the light of accepted commercial practice or principles which regulate the determination of profits.

14. It is on this aspect that there is light thrown by the decision of the Supreme Court in Metal Box Company Of India Ltd. v. Workmen, [1969] 73 ITR 53. That was a case which arose out of a reference made by the Govt. of West Bengal to the Sixth Industrial Tribunal of the following question (p. 56):

“Whether computation of bonus in respect of the accounting year ending 31st March, 1965, payable to the employees is in accordance with the payment of Bonus Ordinance? If not, what should be the quantum of bonus for the employees?”

15. The company, in that case, had a dispute with its employees. The company computed the amount of bonus payable to the employees under the Payment of Bonus Ordinance by taking the available and allocable surplus at Rs. 49.96 lakhs and Rs. 29.98 lakhs, respectively. On this basis, the company declared the bonus at 13.28 per cent. In making its calculation the company deducted the depreciation admissible under the I.T Act development rebate, amount due as and by way of direct taxes, etc. The employees disputed the computation contending that the company had wrongly reduced the gross profits and the available surplus and that the amounts should be added back. In dealing with this question, the matter was examined in the light of the decisions rendered under the I.T Act and other direct tax Acts. At pages 62-63, the following passage occurs in that judgment:

“In the case of an assessee maintaining his accounts on mercantile system, a liability already accrued, though to be discharged at a future date, would be a proper deduction while working out the profits and gains of his business, regard being had to the accepted principles of commercial pract???ce and accountancy. It is not as if such deduction is permissible only in case of amounts actually expended or paid. Just as receipts, though not actual receipts but accrued due, are brought in for income-tax assessment, so also liabilities accrued due would be taken into account while working out the profits and gains of the business.”

16. At page 64, it was stated:

“In the instant case, the question is not whether such estimated liability arising under the gratuity schemes amounts to a debt or not. The question that concerns us is whether, while working out the net profits, a trader can provide from his gross receipts his liability to pay a certain sum for every additional year of service which he receives from his employees. This, in our view, he can do, if such liability is properly ascertainable and it is possible to arrive at a proper discounted present value. Even if the liability is a contingent liability, provided its discounted present value is ascertainable, it can be taken into account. Contingent liabilities discounted and valued as necessary can be taken into account as trading expenses if they are sufficiently certain to be capable of valuation and if profits cannot be properly estimated without taking them into account.”

17. A similar question as to the deductibility of a provision for retirement gratuity arose for consideration in Southern Railway of Peru Ltd. v. Owen, [1957] 32 ITR 737 (HL). Under the legislation of Peru, an English company operating a railway line there, was bound to pay its employees compensation on the termination of their services, the legislative provisions being deemed to be incorporated into all contracts of service. The right to gratuity or compensation arose on dismissal of the employee or on termination of the employment by the employee by proper notice, or on such termination by the death of the employee or on the expiry of the term of the employment. Certain exceptions were there when such benefits were not payable. The company claimed as against each year's profits certain amounts as and by way of provision for retirement payments which would ultimately be thrown on it, calculating the same on the basis of what each employee would have got if he had retired without forfeiture of the right at the close of the year. In examining this claim, Lord Radcliffe, with whom two other law Lords agreed, pointed out at page 754 of the report:

“What the appellant claims the right to do is to charge against each year's receipts the cost of making provision of the retirement payments that will ultimately be thrown upon it by virtue of the fact that it has had the benefit of its employees' services during that year. As a corollary it will not make any charge to cover the actual payments made in the year in respect of retirement benefits. Only by such a method, it is said, can it bring against the receipts of the year the true cost of the services that it has used to earn those receipts. Generally speaking, this must, I think, be true. For, whereas it is possible that any one of its many employees may forfeit his benefit and so never require a payment, the substantial facts of the situation are that when the company has paid every salary and wage that is due for current remuneration of the year it has not by any means wholly discharged itself of the pecuniary burden which falls upon it in respect of the year's employment.”

18. Dealing with the contention that such liability was contingent, Lord Radcliffe observed at page 758:

“…where you are dealing with a number of similar obligations that arise from trading, although it may be true to say of each separate one that it may never mature, it is the sum of the obligations that matters to the trader, and experience may show that, while each remains uncertain, the aggregate can be fixed with some precision.”

19. In the same page, it was further observed:

“But, whatever the legal analysis, I think that for liabilities as for debts their proper treatment in annual statements of profit depends not upon the legal form but upon the trader's answers to two separate questions. The first is: Have I adequately stated my profits for the year if I do not include some figure in respect of these obligations? The second is do the circumstances of the case, which include the techniques of established accounting practice, make it possible to supply a figure reliable enough for the purpose?”

20. Viewing in this line, the House of Lords allowed in principle the claim of the assessee for a deduction. In the same case, Lord Mac Dermott, at page 747 of the report, has observed:

“My Lords, as a general proposition it is, I think, right to say that, in computing his taxable profits for a particular year, a trader, who is under a definite obligation to pay his employees for their services in that year an immediate payment and also a future payment in some subsequent year, may properly deduct, not only the immediate payment, but the present value of the future payment, provided such present value can be satisfactorily determined or fairly estimated. Apart from special circumstances s???ch a procedure, if practicable, is justified because it brings the true costs of trading in the particular year into account for that year and thus promotes the ascertainment of the ‘annual profits or gains arising or accruing from’ the trade.”

21. Lord Mac Dermott has observed again at page 748 of the report:

“The question, as I see it, on this branch of the case, was not whether, in a given year, the appellant's liability to pay this employee or that was contingent; it was whether the appellant's liability to make some payment in respect of the lump sums accruing for the benefit of all its employees in that year was in any relevant sense contingent. If that is the right view, I think the Crown's contention on this point must fail. It is clear from the accounts that the appellant's employees during the material years were numerous and the chances of all, or even a substantial proportion of them, acting so as to forfeit their lump sum rights seem to me to be much too distant and improbable to merit significance.”

22. So, the very concept of profit would require adjustment being made for the claims of the employees for gratuity in so far as it is possible to relate it to the current year. The estimate is a present one for a future liability. This will have to be properly worked out on legal or scientific basis. Any arbitrary claim in this behalf cannot be countenanced.

23. Learned counsel for the revenue, however, contended that the decision of the Supreme Court in Metal Box Company's case, [1969] 73 ITR 53 had not been applied in Bombay Dyeing & Mfg. Co. Ltd. v. Cwt, [1974] 93 ITR 603 (SC), and would thus have to be confined to industrial disputes. The latter was a case in which the net wealth of the company as defined in s. 2(m) of the W.T Act, 1957, had to be computed. The question was whether, in assessing the net value of the assets, the estimated liability of the company in respect of gratuity was deductible. It was held, following an earlier decision of the Supreme Court in Standard Mills Co. Ltd. v. CWT, [1967] 63 ITR 470, that such a deduction was not permissible. In the course of the judgment, it was observed that the decision in Metal Box Company's case, [1969] 73 ITR 53 (SC) was one rendered under the Bonus Act.

24. The attempt of the learned counsel for the revenue to confine the principle decided in Metal Box Company's case, [1969] 73 ITR 53 to cases under the Bonus Act cannot be accepted. The Supreme Court in Metal Box Company's case, [1969] 73 ITR 53 elaborately went into the question of the computation of “profits” under the I.T Act, and then considered the question of allocable surplus. In order to arrive at the commercial profits, it was necessary for the Supreme Court to go into the question of computation of “profits” under the I.T Act, as several items of expenditure deductible under the I.T Act arise for consideration only in the context of computation of commercial profits. In fact, the consideration of decisions on the computation of profits under the I.T Act was a necessary and essential step in examining the question of a similar computation under the Bonus Act. Under the Bonus Act as well as under the I.T Act, it is the real profits that form the base. The decision in Metal Box Company's case, [1969] 73 ITR 53, would thus be a binding authority on the question of the computation of profits in a commercial sense. As the Supreme Court in Bombay Dyeing's case, [1974] 93 ITR 603 was dealing with an assessm???nt under the W.T Act, there was no need for going into the provisions of the I.T Act. It was in that sense that the Supreme Court distinguished the earlier decision in Metal Box Company's case, [1969] 73 ITR 53 (SC). The Metal Box Co.'s case, [1969] 73 ITR 53 cannot be confined to Bonus Act problems.

25. The learned counsel for the revenue contended that in Commissioner Of Income-Tax, Madras-I. v. Carborundum Universal Ltd., [1977] 110 ITR 621 (Mad), it has been held by this court that a similar claim was not admissible. It is, therefore, necessary to examine whether the earlier decision of this court affects the assessee's claim in the present case. In that decision, the question before this court was whether a sum of Rs. 17,575 contributed by the assessee, an Indian company, to the superannuation fund maintained by a U.K company was deductible while computing profits or gains of the assessee under s. 28 of the I.T Act, 1961. Section 36(1)(iv) provided for deduction of any sum paid by an employer-assessee by way of contribution towards recognised provident fund or an approved superannuation fund subject to certain prescribed limits and subject to such conditions as the Central Board of Direct Taxes may think fit to specify. In order to qualify for deduction under that provision, it was necessary to maintain a fund in India and to secure an approval for such a fund from the prescribed authority. As the assessee had paid the amount to a fund outside India, a fund which had not secured the approval of the prescribed authority, the question arose whether it could be allowed as a deduction under the general concept for determination of profits. It was in this context that this court observed that the nature of the payment being one described in s. 36(1)(iv), it could not be held to be deductible under s. 28 on general principles in arriving at the true profits and gains of the business in a commercial sense. In effect, the decision is that where there is a specific provision governing the deductibility of a particular amount and where the claim is not consistent with the particular provision, then, one cannot seek to claim the amount as a deduction under the general concept of ascertaining the true profits and gains. That is not the position here. There is no provision for deduction of the amount of claim that is now before us. Section 36(1)(v), as already seen, does not apply to the matter before us nor does s. 40A(7). This is not a case where the assessee after failing to satisfy a specific provision falls back on the general concept of profits. In these circumstances, the assessee would be eligible for the allowance of the claim so long as there is no provision which stood in the way of the acceptance of the assessee's claim. In fact, this aspect has been pointed out in CIT v. High Land Produce Co. Ltd., [1976] 102 ITR 803 (Ker). In dealing with a similar claim for deduction in respect of the amount set apart for the payment of gratuity in future, Govindan Nair C.J, observed that the mere fact that a claim would not fall within s. 36 would not automatically make it unsustainable under the other provisions of the Act. That decision supports the assessee's claim here.

26. During the course of the arguments, our attention was invited to a decision of the Allahabad High Court in Swadeshi Cotton Mills Co. Ltd. v. ITO, [1978] 112 ITR 1038. The assessee in that case maintained his accounts on mercantile basis. Gratuity based on actuarial valuation was claimed as deduction, as a result of which the assessee would have sustained a loss. On the basis of the return showing loss, the assessee claimed a refund of the advance tax paid. The claim for gratuity and consequently for refund was rejected by the ITO. On a writ petition filed to quash the order of the ITO, the Allahabad High Court held that the claim for gratuity was admissible if based on actuarial valuation, even though the assessee had made no provision in his account books, and in doing so followed an earlier decision of the same High Court in Madho Mahesh Sugar Mills (P.) Ltd. v. Commissioner Of Income-Tax., [1973] 92 ITR 503 and also of the Supreme Court in Metal Box Company Of India Ltd. v. Workmen, [1969] 72 ITR 53. This case also supports the assessee's claim in the present case. However, we would only take leave to observe that the said decision does not appear to be correct, because the law, as,;enacted by s. 40A(7), was inserted with retrospective effect from the assessment year 1973-74 and that case was concerned with 1973-74. The amendment superseded the general principle as regards the liability for gratuity and, therefore, after the 1st of April, 1973, the question of deductibility of a similar claim would have to be found within the four corners of s. 36 and s. 40A. This decision of the Allahabad High Court is also inconsistent with the decision of this court in Commissioner Of Income-Tax, Madras-I. v. Carborundum Universal Ltd., [1977] 110 ITR 621, wherein we have pointed out that so long as there is a specific provision which regulates a claim, it is that provision that is to be resorted to and not the general principle of computation of profits. Further, recourse cannot be had to a residuary or general provision if the amount is not deductible as a result of non-compliance with a specific or particular provision. This aspect has not also been examined there.

27. The learned counsel for the revenue brought to our notice the decision in CIT v. Indian Steel Rolling Mills Ltd., [1973] 92 ITR 78 (Mad) and submitted that this was only in the nature of a “reserve”. As far as the present claim is concerned, whether it is a provision or reserve is not strictly relevant. The question as to whether it is a provision or a reserve would be material only in the context of the provisions of the Super Profits Tax Act, 1963, with which we are not now concerned. The result is that the second question also is answered in the affirmative and in favour of the assessee.

28. The assessee will have its costs. Counsel's fee Rs. 500.