B.C Misra, J.:— In this reference made under section 66 of the Indian Income-tax Act, 1922, the following question of law has been referred to this court for decision:
“Whether, on the facts and circumstances of the case, the assessee was entitled to deduct a sum of Rs. 41,313 from its income for the assessment year 1956-57?”
2. The facts giving rise to this reference, as stated in the statement of the case, are that the assessee-company is a private limited company registered under the Companies Act, 1956, and it maintains its accounts according to the calendar year. During the assessment year 1956-57, that is to say, the calendar year 1955, there arose a dispute between the assessee-company and its employees with regard to the amount of gratuity payable to the latter. On 15th July, 1955, an agreement was reached whereby it was agreed between the parties that the employees would be entitled to receive gratuity on the following terms:
“It is agreed that the employees will receive gratuity on the following terms:
(a) On the death of an employee while in service of the company.
Half a month's wages for each year of service to be paid to his/her heirs or assignee.
(b) On retirement or termination of service.
Half a month's wages for each year of service.
(c) On resignation by the employees after 5 years.
Half a month's wages for each year of service.
All employees of sister concerns whose services were transferred an??? or placed at the disposal of M/s. Escorts (Agents) Ltd. will also be en???tled to gratuity at the above scales, and their services will be calcula???ed from the date of their first appointment. The wages for purpos???s o??? calculating gratuity shall be the average wages during the 3 months next previous to death, retirement or termination of service or resignation, as the case may be. Gratuity will not be paid to an employee who is dismissed for mis conduct involving financial loss to the company.”
3. Pursuant to the aforesaid agreement, the assessee???pened a separate account for each of its employees some time in 1956, and credited the amount of gratuity payable for the years 1955 and 1956 to the individual accounts of the employees. According to the scheme of the agreement an employee could withdraw the money only on his reti???ement, though the money was also payable to him in case of dismissal except where he was dismissed for misconduct involving financial loss to the company. For the calendar year 1955, i.e, the previous year for the asses???sment year 1956-57, the amount payable under the aforesaid gratuity scheme totalled Rs. 41,313. It is common ground that this amount was not debited in the profit and Loss account for the aforesaid year but was only debited in the books of the year ending December 31, 1956, relevant to the assessment year 1957-58. The assessee-company debited income-tax deducted at source from the gratuity credited to the account of each employee wherever due according to the total income of the employee concerned and deposited the tax so deducted in the treasury. In the certificates regarding the payment of salary to the employees for the purposes of their own income-tax return, the amount credited to their account on account of gratuity was included in the total salary paid for that year. The aforesaid sum of Rs. 41,313 was claimed as a deduction in Part IV of one of the revised returns for the assessment year 1956-57. The Income-tax Officer disallowed the claim on the ground that under the agreement an employee was not entitled to withdraw the money before he retired or died and the company had not executed an irrevocable trust for the administration of the gra???uity fund.
4. The assessee took up the matter in appeal and objected to the disallowance. The Assistant Commissioner upheld the objection and allowed the assessee's claim. He relied upon the case of Smyth v. Stretton [1904] 5 T.C 36 K.B. and held that the company had deducted the income-tax at source from the gratuity and credited the same to the account of each employee wherever due according to the total income of the employee concerned and deposited???he tax in the treasury and he found that the amount credited to each???mployee belonged to him and the company was merely a custodian of the fund as trustee. He further held that the question of executing a trust???ed did not arise as the company did not credit any reserve or fund out of wh???ch the gratuity was to be paid, and the employer as well as the employee??????re treating the gratuity as an additional remuneration earned by and paid to, the employees. He, therefore, held that the gratuity credited to the account of the employees was an additional remuneration paid by the assessee to its employees for the year under appeal and that the assessee had???educted tax at source from the payments so made and so he allowed Rs. 41,313 as a deduction.
5. The department appealed against the said decision to the Tribunal and the Tribunal acce???ted the department's appeal. The relevant portion of the order of the Tribunal is quoted as under:
“We have carefully perused the Assistant Commissioner's order and it seems that his reasoning is that the amount though credited in a later year relates to the year???nder appeal and as such the assessee is entitled to claim deduction in this year. He has presumed that the amount has been set apart and earmarked for the specific purpose and that the company was merely in the position of trustee with regard to this amount. In our opinion, the Assistant Commissioner is clearly in error in thinking so. From the facts stated above it is clear that, so far as the year under appeal is concerned, there was no earmarking of any funds for this specific purpose. Admittedly, the debit in the profit and loss account was made in the next year for both the amounts of gratuity payable for this year as well as for the next year. On the short ground that there was no such debit, so far as this year is concerned, the assessee's contention must fail.”
6. Mr. B.N Kirpal, appearing for the assessee, has contended that the liability to pay the amount of gratuity had been created by the agreement between the company and the employees on 15th July, 1955, and it was immaterial when and how the same was paid and whether the same bad been debited in the books of accounts or not, and the same ought to have been allowed during the year 1955 to which it related. The learned counsel cited Calcutta Co. Ltd. v. Commissioner of Income-tax and Keshav Mills Ltd., v. Commissioner Of Income Tax, Bombay [1953] 23 I.T.R 230 to explain what the mercantile system of accounting was and he urged that in the said system it was not necessary that the expenditure must actually be incurred or paid and he claimed deduction under clauses (x) and (xv) of sub-section (2) of section 10 of the Income-tax Act. The learned counsel strongly relied upon the authority of the Supreme Court in Commissioner of Income-tax v. Swadeshi Cotton and Flour Mills Ltd. [1964] 53 I.T.R 134 to support the proposition that the amount was deductible as soon as the liability had been created irrespective of the fact in what year the entry had been made. He also relied upon the judgment of the High Court of Bombay in Commissioner of Income-tax v. Nagri Mills Co. Ltd. [1958] 33 I.T.R 681 Bom.. and a judgment of the Supreme Court in Commissioner of Income-tax v. Chamanlal Mangaldas & Co. [1960] 39 I.T.R 8 in support of his submission that the manner of making the entry or the absence of entry was not at all a material consideration for the purpose of allowing the deduction claimed. He also relied on J.K Chemicals Ltd. v. Commissioner of Income-tax [1966] 62 I.T.R 34 Bom.. decided by the High Court of Bombay.
7. Mr. D.K Kapur appearing for the department contended that the deduction was not legally claimable and at all events the same had not been quantified or paid or incurred or debited in the books of account in the relevant previous year and so they could not be claimed in the year under assessment. He relied upon Allahabad Bank Ltd. v. Commissioner of Income-tax, Commissioner of Income-tax v. Nedungadi Bank Ltd., and Burma Corporation Ltd. v. Commissioner of Income-tax,. and he cited Commissioner of Income-tax v. Singari Bai and a decision of the House of Lords, Southern Railway of Peru Ltd. v. Owen.
8. The learned counsel for the assessee has invited our attention to section 7 and the last clause under the heading “Deductions” in Part IV of the particulars of income-tax returns required under sub-section (5) of section 22 of the Income-tax Act. He has claimed the deduction in question under clause (x) as well as clause (xv) of sub-section (2) of section 10 of the Income-tax Act which read as follows:
Clause (x) of sub-section (2) of section 10:
“any sum paid to an employee as bonus or commission for services rendered, where such sum would not have been payable to him as profits or dividend if it had not been paid as bonus or commission:
Provided that the amount of the bonus or commission is of a reasonable amount with reference to—
(a) the pay of the employee and the conditions of his service;
(b) the profits of the business, profession or vocation for the year in question; and
(c) the general practice in similar businesses, professions or vocations.”
9. Clause (xv) of sub-section (2) of section 10:
“(xv) any expenditure (not being an allowance of the nature described in any of the clauses (i) to (xiv) inclusive, and not being in the nature of capital expenditure or personal expenses of the assessee) laid out or expended wholly and exclusively for the purpose of such business, profession or vocation….”
10. In our opinion, before the deduction could be allowed by the income-tax department, the same must be either paid or shown as a debit in the books of accounts maintained on the mercantile system of accounting and the said expenditure should be justified under the law. Both the conditions are necessary to be fulfilled and it is not enough if the liability to pay has merely been created but has been deferred and not enforced in present or satisfied by payment or debit, nor will it suffice if the payment has been made or the amount debited, but is not justified in law. Clause (x) of subsection (2) refers to any sum paid to an employee as bonus or commission for services rendered and sub-section (2) of section 10 of the Act provides that under sub-section (2) “paid” means actually paid or incurred according to the method of accounting upon the basis of which the profits or gains are computed under the section. Therefore, it follows that unless the amount has been actually paid to the employee or incurred by debit in the books of account, the same ca???not be claimed as a deduction under clause (x). Section 13 of the Act further lays down that income, profits and gains shall be computed for the purpose of sections 10 and 12 in accordance with the method of accounting regularly employed by the assessee. There is, therefore, no escape from the conclusion that the amount of gratuity must have been shown as a debit in the books of accounts of the assessee for the relevant year before it could be legitimately claimed as a deduction.
11. Under clause (xv) of sub-section (2) of section 10 of the Income-tax Act as it stood on the relevant date what was permissible to be deducted was an expenditure laid out or expended wholly and exclusively for the purpose of business, profession or vocation excluding the amounts which were in the nature of capital expenditure or personal expenses of the assessee or which had been specified in the clauses (???) to (xiv) of the said sub-section. Again it is obvious that in order to claim the benefit under clause (xv) the amounts sought to be deducted must constitute an expenditure. The word “expenditure”. is defined in the Shorter Oxford English Dictionary as “the action or practice of expending, disbursement, consumption, or the amount expended from time to time” and the word “expend” is defined as to pay away, lay out and spend. The Supreme Court in the judgment in Indian Molasses Co. P. Ltd. v. Commissioner of Income-tax laid down, at page 78, that:
“Expenditure is equal to ‘expense’ and ‘expense’ is money laid out by calculation and intention though in many uses of the word this element may not be present……. But the idea of ‘spending’ in the sense of ‘paying out or away’ money is the primary meaning and it is with that meaning that we are concerned. ‘Expenditure’ is thus what is ‘paid out or away’ and is something which is gone irretrievably… But whatever the character of the expenditure, it must be a paying out or away….”
12. Consequently, in order to constitute “expenditure” within the meaning of clause (xv), the amount claimed must have been paid away or laid out and if the same had not been done in the relevant year, it could not be said to constitute a deductible expenditure.
13. The learned counsel for the assessee laid great stress on the submission that as soon as the company had incurred the liability under the settlement mentioned above, the amount should be deemed to be an expense of the business. We are not inclined to accept the said submission. After the legal liability regarding gratuity had been created, it was not payable at once but was deferred for payment under specified circumstances and it had still to be enforced either by its own force or by voluntary act on the part of the assessee and it was incumbent upon it to either pay it out or enter it in the books of accounts as a debit of the amount accrued as paid. Unless and until the same had been done, it was not possible to determine what was the amount payable under the settlement, nor could the department know or allow it as a deduction. In this reference we are not concerned with the question as to whether or not the item claimed by the assessee was a permissible deduction, had the proper entry in respect of it been made in the relevant year as that is not the question that has been referred to us nor had it been decided by the Tribunal and the arguments at the bar before us were confined to the question as to what was the effect of the absence of entry and whether the claim could be allowed as a deduction in the relevant assessment year.
14. The learned counsel for the assessee strongly relied upon the judgment of the Supreme Court in Commissioner of Income-tax v. Swadeshi Cotton and Flour Mills Pvt. Ltd. The facts of the said case were that the assessee paid as bonus to its employees a certain amount for services rendered during the calendar year 1947 in terms of an award made on 13th January, 1949, under the Industrial Disputes Act. The amount was debited by the assessee in its profit and loss account for the year 1948, and corresponding credit was given to the bonus payable amount as the books of accounts for 1948 had not been closed till the date of the order of the Tribunal and this amount of bonus was, in fact, paid to the employees in the calendar year 1949. The question raised before the Supreme Court on behalf of the department was that the amount could not be claimed for the calendar year 1949 as the liability related to the year 1947. The said question was answered by their Lordships of the Supreme Court in the negative and their Lordships held as follows:
“In our opinion it is only when the claim to profit bonus, if made, is settled amicably or by industrial adjudication that a liability is incurred by the employer, who follows the mercantile system of accounting, within section 10(2)(x), read with section 10(5) of the Act. On the facts of this case, it is clear that it was only in 1949 that the claim to profit bonus was settled by an award of the Industrial Tribunal. Therefore, the only year the liability can be properly attributed to is 1949, and hence we are of the opinion that the High Court was right in answering the question in favour of the assessee.”
15. The said authority does not support the proposition contended for by Mr. Kirpal that the amount became due as soon as the liability had been declared by the industrial adjudication or amicable settlement irrespective of its deferred payment or debit in the books of accounts. Their Lordships have themselves referred to section 10(5) of the Act and the authority indicates that a mere entry without liability to pay would not constitute a deductible expenditure, but the question whether in spite of the liability if the amount had been deferred and not paid or debited in the books, it could be a permissible deduction, did not arise for consideration before their Lordships of the Supreme Court and the judgment does not afford any guidance on the question raised before us.
16. The next case relied upon by Mr. Kirpal is the judgment of the High Court of Bombay in Commissioner of Income-tax v. Nagri Mills Co. Ltd., Mr. Kirpal himself conceded that the said judgment was not good law in view of the Supreme Court judgment in Commissioner of Income-tax v. Swadeshi Cotton and Flour Mills Ltd. mentioned above. With great respect we are, however, unable to agree with the observations of the learned judges in the said case why the income-tax authorities raised disputes as to the year in which the deduction should be allowed when the deduction was obviously a permissible deduction and that it was a matter of little significance that in point of fact no entry had been made in the accounts of the year making the provision for the bonus and that the absence of an entry did not affect the question whether the assessee was entitled to a deduction or not. We are of the view that the department is fully justified in raising a question which it is entitled to raise under the law and the existence or absence of entry is a very material circumstance in determining permissible expenditure in the relevant accounting year. The said case of the High Court of Bombay was noticed by the High Court of Madras in Associated Printers (Madras) P. Ltd. v. Commissioner of Income-tax and their Lordships were not persuaded to follow the reasoning of the Bombay authority.
17. The learned counsel for the assessee further relied upon the judgment of the Supreme Court in Commissioner of Income-tax v. Chamanlal Mangaldas & Co. The question raised before their Lordships was whether there was a voluntary relinquishment on the part of the managing agents of a part of the commission which was the difference under the original and the modified agreement. The contention advanced was that the right to receive the commission arose at the end of the accounting year when all the sales had been added and the accounts made up. What was claimed was the amount actually received at the end of the year under modified agreement and not what was credited during the year under the original agreement. The department relied upon the entry in the books of accounts to show that the entry had been made six-monthly and the total was larger than the amount received by the managing agents. In this context their Lordships observed that, no doubt, in this case the amount of commission was credited every six months which only meant that, as an interim arrangement, the accounts of all sales were also made up at the end of six months but this would not affect the construction of the clause containing the terms for payment of commission which was an integrated and indivisible agreement nor the reduction made there as a result of the modified arrangement. The amount which accrued or which the agents would have a right to receive could not be affected by the manner in which the entry was made. The aforesaid authority deals with the construction of a document creating legal liability as unaffected by the manner in which the entry had been made. The same is; not an authority for the proposition contended for by the assessee that without there being an entry of any kind or in any manner, the amount can be claimed as a permissible deduction.
18. The learned counsel for the assessee relied upon another case of the High Court of Bombay, J.K Chemicals Ltd. v. Commissioner of Income-tax, where their Lordships relied upon their earlier decision in Kohinoor Mills Co. Ltd. v. Commissioner of Income-tax and held that mere expiry of period of limitation did not constitute cessation of liability and that a unilateral act on the part of the debtor by transferring entries in the books of accounts could not bring about cessation of liability as transfer of an entry was neither an agreement between the parties nor payment of a liability. There is no dispute with the aforesaid proposition of law that a mere entry in a book of account cannot affect the legal liability but the same does not???upport the contention of the learned counsel for the assessee that a mere deferred liability without a corresponding entry in the books of accounts can constitute a permissible deduction under the Income-tax Act.
19. Mr. D.K Kapur, learned counsel for the revenue, urged that in the case decided by the Supreme Court in Commissioner of Income-tax v. Swadeshi Cotton and Flour Mills Pvt. Ltd. the amount of bonus had been quantified and was immediately payable while in the case before us there was no quantification and nobody knew what the extent of the liability would be and whether the same would actually arise or not. He relied upon the judgment of the Supreme Court in Allahabad Bank Ltd. v. Commissioner of Income-tax, but the said judgment is absolutely of no assistance in the question raised before us, as there is no question of creation of any trust involved before us and we are not deciding the question whether the deduction claimed was or was not permissible had the entry been made in the relevant year.
20. In Commissioner of Income-tax v. Nedungadi Bank Ltd. it is laid down that in respect of allowing expenditure incurred for purposes of the business the contribution to the employees' provident fund can be deducted only if the employee withdraws the amount standing to his credit in the provident fund and until then it did not constitute expenditure for the purposes of business but was only a liability which the bank had made for itself by paying certain proportions of the same which were invested for itself for the benefit of its employees. It may be observed that in the Income-tax Act of 1922, Chapter No. IX-B has been added specifically in respect of payment of bonus and that the authority is not of great assistance in deciding the question of law arising before us.
21. Mr. D.K Kapur invited our attention to Burma Corporation Ltd. v. Commissioner of Income-tax and Commissioner of Income-tax v. Singari Bai, but the said authorities are of no assistance in determining the controversy raised before us. Mr. Kapur, however, strongly relied upon a judgment of the House of Lords in Southern Railway of Peru Ltd. v. Owen in which Lord MacDermott observed as follows:
“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. (Further), such a procedure…. 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.”
22. The said judgment as delivered under the Income Tax Act, 1918 (8 and 9 Geo. 5, c. 40), the provisions of which are not in pari materia with the Income-tax Act with which we are dealing, but the said observations lend support to the view we are taking on the question before us. Therefore, in our opinion, before a deduction claimed could be allowed as an expenditure, it must have been valued or quantified at least provisionally, and actually paid or entered as a debit according to the system of accounts maintained by the assessee during the year in which it is claimed. In view of the above discussion, we answer the question referred to us in the negative. We do not make???ny order as to costs of this reference.
23. Question answered in the negative.