Citation Codes

Equivalent Citations

citation codes

Case Number

Income-Tax Reference No. 116 of 1976

Judges

Hon'ble Mr. Justice Bipinchandra Jivanlal Divan
Hon'ble Mr. Justice Shailesh Bhadrayulal Majmudar

Acts

provision of s. 37 of the I.T. Act, 1961. Question
provisions of s. 37 of the I.T. Act, 1961,
s. 10(2)(xv) of the Indian I.T. Act, 1922,
Employees' Provident Funds Act, 1952,
provisions of s. 37 of the I.T. Act.
s. 36(1)(iv) of the I.T. Act, 1961.
s. 37 of the I.T. Act of 1961
s. 256(1) of the I.T. Act

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Smart Summary

Structured Summary of the Provided Opinion

Factual and Procedural Background

The reference arises out of appeals concerning assessment years 1966-67 to 1969-70. The assessee is a limited company carrying on distributorship business (sole distributor of products of M/s. Chhotabhai Jethabhai Patel & Co.) which began on July 1, 1962. The matters referred involve two questions at the instance of the revenue and one question at the instance of the assessee:

Question (1) concerns whether a contribution of Rs. 32,245 made by the assessee to a provident fund for the previous year (Samvat 2021: 5 Nov 1964 to 24 Oct 1965) — i.e., contributions referable to the period prior to the fund's recognition from 1 July 1965 — was deductible under s. 37 of the Income-tax Act, 1961.
Question (2) concerns whether gratuity payments made by the assessee should be allowed on the basis of twelve months' salary last drawn under s. 37.
Question (3), referred at the instance of the assessee, asks whether the Tribunal was right in law in not allowing the entire payment of gratuity under s. 28 and/or s. 37.

Procedural history (as stated): The ITO disallowed the provident fund claim for contributions made before the fund was recognised (holding they did not fall under s. 36(1)(iv)). The assessee appealed to the AAC, which confirmed the ITO regarding the provident fund. The Income-tax Appellate Tribunal (the Tribunal) allowed the provident fund deduction under s. 37 and allowed a part of the gratuity claim (holding 12 months' salary last drawn to be a reasonable deduction under s. 37). Questions were then referred to the High Court: Questions (1) and (2) at the instance of the revenue; Question (3) at the instance of the assessee.

Legal Issues Presented

Whether the Tribunal was right in law in holding that the expenditure of Rs. 32,245 incurred by the assessee by way of contribution to the provident fund, before the date of recognition, is an allowable deduction under s. 37 of the Income-tax Act, 1961?
Whether the Tribunal was right in allowing the claim of the assessee in respect of payment of gratuity on the basis of 12 months' salary last drawn under s. 37 of the Income-tax Act, 1961?
Whether the Tribunal was right in law in not allowing the entire payment of gratuity under s. 28 and/or s. 37 (this question was referred at the instance of the assessee)?

Arguments of the Parties

Revenue / Income-tax Officer (and AAC) — Key Points

The ITO disallowed the provident fund deduction for the Rs. 32,245 on the ground that the payments related to the period prior to 1 July 1965 (the date of recognition of the provident fund) and therefore were not a liability under the Employees' Provident Funds Act, 1952; consequently they did not fall under s. 36(1)(iv) of the Income-tax Act, 1961.
The ITO considered the Supreme Court decision in CIT v. Mysore Spinning & Mfg. Co. Ltd. [1970] 78 ITR 4 not applicable to the assessee's case.
Both the ITO and the AAC rejected the assessee's gratuity claims on the basis that there were no formal rules or scheme for payment of gratuity and no basis for those payments to widows and dependents; therefore gratuity payments were not allowable.

Assessee — Key Points

The assessee claimed a deduction of Rs. 32,245 (out of a total contribution of Rs. 58,871) made to the provident fund for the relevant previous year, including payments referable to the period before recognition of the fund.
Before the AAC the assessee contended that the business was originally carried on by a firm and later taken over by the limited company; the assessee argued that the liability to the provident fund was attached to the business (not to the owners), and therefore when the business was carried on by the limited company the liability applied to it.
Regarding gratuity, the assessee sought deduction for gratuity payments made to legal representatives or widows/dependents of employees; the assessee's grievance (as to Question (3)) was that the Tribunal did not allow the entire payments of gratuity as deductions under s. 28 and/or s. 37.
The assessee obtained a partial allowance from the Tribunal (which allowed a reasonable gratuity amount based on 12 months' salary last drawn); the assessee nevertheless sought a reference on whether the entire gratuity payments should have been allowed.

Table of Precedents Cited

Precedent	Rule or Principle Cited For	Application by the Court in This Opinion
CIT v. Mysore Spinning & Mfg. Co. Ltd. [1970] 78 ITR 4	Referred to by the ITO; invoked in relation to deductibility questions (ITO considered it not applicable).	The opinion records that the ITO regarded this decision as not applicable to the assessee's facts. The High Court did not rely upon it in allowing the provident fund deduction.
CIT v. Raipur Manufacturing Co. Ltd. [1972] 84 ITR 508	Illustrates the concept of "commercial expediency" underpinning s. 37 and when deductions under s. 37 can be made.	The Tribunal relied on this High Court decision; the present court accepted Raipur as supporting allowance under s. 37 for commercially expedient payments such as provident fund contributions prior to formal recognition.
Tata Sons Ltd. v. CIT [1950] 18 ITR 460 (Bombay High Court)	Earlier authority referred to for the purpose of explaining commercial expediency under s. 37.	The Tribunal referred to this case for the concept of commercial expediency. The present court treated it as relevant background authority in assessing whether payments satisfied s. 37.
Sassoon J. David and Co. P. Ltd. v. CIT [1979] 118 ITR 261 (Supreme Court)	Held that "wholly and exclusively" does not mean "necessarily"; expenditures voluntarily incurred to promote business may be deductible; explained treatment of gratuity, bonus and similar payments as business expenditure; approved reading of Gordon Woodroffe tests disjunctively; approved Laxmi Cement decision.	The court relied on Sassoon J. David as authoritative: it supported allowing provident fund contributions made before recognition (as commercially expedient under s. 37) and supported the Tribunal's approach of allowing a reasonable gratuity (12 months' salary) as deductible under s. 37.
Gordon Woodroffe Leather Manufacturing Company v. CIT, Madras [1962] 44 ITR 551	Set out three tests that the Supreme Court later directed should be read disjunctively in assessing deductibility.	The opinion records that the three tests from Gordon Woodroffe should be read disjunctively (as explained by the Supreme Court in Sassoon J. David). The present court used that guidance in upholding the Tribunal's allowance of reasonable gratuity.
CIT v. Laxmi Cement Distributors P. Ltd. [1976] 104 ITR 711	Decision of the High Court which the Supreme Court approved in Sassoon J. David's case when addressing the tests for deductibility.	The Supreme Court's approval of Laxmi Cement was noted; the present court treated these authorities collectively in applying s. 37.
CIT v. V. Damodaran [1980] 121 ITR 572 (Supreme Court)	Principle: only the party applying for a reference (under the relevant provision) is entitled to specify questions of law to be referred; a non-applicant cannot secure a reference based on an applicant's reference application.	The court invoked V. Damodaran to conclude that Question (3) (referred at the instance of the assessee / non-applicant) should not have been referred by the Tribunal and therefore declined to answer it.

Court's Reasoning and Analysis

The court proceeded through the referred questions and the relevant legal framework as follows (based strictly on the statements in the opinion):

Competency to refer Question (3).
The court emphasized the procedural rule (as stated in CIT v. V. Damodaran) that only the party who applies for a reference under the statutory provision (s. 256(1) of the I.T. Act) is entitled to specify questions of law for reference. The Tribunal's order had been partly for and partly against the assessee; therefore it was the assessee's duty to file an application under s. 256(1) for questions arising from the part of the order against it. The opinion finds no such application by the assessee was filed; accordingly, it was not competent for the Tribunal to refer Question (3) at the instance of the assessee (a non-applicant). The court therefore declined to answer Question (3).
Provident fund contribution (Question (1)).
The court first observed that payments made prior to 1 July 1965 (the date when the recognised provident fund came into force) could not fall under s. 36(1)(iv) because that section refers to contributions to a recognised provident fund. Accordingly, the ITO's ground for disallowance under s. 36(1)(iv) was correct in principle for pre-recognition payments.

However, the court then considered s. 37: "Any expenditure ... wholly and exclusively for the purposes of the business ... shall be allowed ...". The Tribunal relied on prior authority (Raipur Manufacturing, Tata Sons) to invoke the concept of commercial expediency in applying s. 37. The Supreme Court's decision in Sassoon J. David was cited as clarifying that "wholly and exclusively" does not mean "necessarily" and that voluntary expenditures incurred to promote business (including reasonable payments by management for gratuity or similar payments) can be deductible.

Applying that reasoning, the court concluded that the assessee's contributions to the provident fund, even though made prior to formal recognition, were made for commercial expediency: to keep workers satisfied and to ensure they got the benefit of provident fund arrangements, thereby promoting the business and earning profits. Consequently, the court held that such contributions satisfied s. 37's conditions and that the Tribunal was correct in allowing the Rs. 32,245 as a deduction under s. 37.
Gratuity payments (Question (2)).
The Tribunal had found that actual gratuity payments made by the assessee bore no consistent relation to months of service or last pay drawn, and therefore, as a sensible measure, allowed a reasonable gratuity deduction equal to 12 months' salary last drawn. The court relied on Sassoon J. David which approves treating reasonable gratuity payments as business expenditure falling under the predecessor provision (s. 10(2)(xv) of the 1922 Act) and, by implication, under s. 37 of the 1961 Act.

Given Sassoon J. David's authoritative position and the explanation of Gordon Woodroffe's tests, the court accepted that a reasonable gratuity (reasonableness judged by salary last drawn and length of service or related metrics) is deductible under s. 37. Therefore the court held the Tribunal was right in allowing a gratuity deduction on the basis of twelve months' salary last drawn.

Holding and Implications

Holding:

Question No. (1): Answered in the affirmative — the Tribunal was right in law to allow the provident fund contribution of Rs. 32,245 as a deduction under s. 37 (decision in favour of the assessee and against the revenue).
Question No. (2): Answered in the affirmative — the Tribunal was right in law to allow the claim for gratuity on the basis of twelve months' salary last drawn as a reasonable deduction under s. 37 (decision in favour of the assessee and against the revenue).
Question No. (3): The court declined to answer — it was not competent for the Tribunal to refer this question at the instance of the assessee, because no application for a reference under s. 256(1) was filed by the aggrieved party as required.

Implications and Direct Effects:

The provident fund contribution of Rs. 32,245 referable to the period prior to recognition is allowable as a deduction under s. 37 for the relevant assessment year (1966-67) in the assessee's favour.
The Tribunal's allowance of gratuity on the basis of twelve months' salary last drawn is upheld as a reasonable and allowable deduction under s. 37.
Question (3) was not decided on the merits; the court refused to answer it on procedural grounds — no substantive decision on whether the entire gratuity payments would have been deductible under s. 28 and/or s. 37 was given.
The court ordered costs of the reference to be paid by the Commissioner to the assessee.
No explicit new legal principle or landmark precedent was proclaimed by the court in this opinion; the court applied and relied upon existing authorities (as referenced above) to resolve the questions.

Note: This summary strictly reflects only the content and conclusions contained in the provided opinion text. No facts, arguments, or legal holdings have been added beyond what appears in that opinion.

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Commissioner Of Income-Tax, Gujarat-I v. Chhotabhai Jethabhai Patel Tobacco Products Co. Ltd.

1. In this case, the following two questions have been referred to us at the instance of the revenue :

"(1) Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that the expenditure of Rs. 32,245 incurred by the assessee by way of contribution to the provident fund, before the date of recognition, is an allowable deduction under the provisions of section 37 of the Income-tax Act, 1961 ?

(2) Whether, on the facts and in the circumstances of the case, the Tribunal was right in allowing the claim of the assessee in respect of payment of gratuity on the basis of 12 months' salary last drawn under the provisions of section 37 of the Income-tax Act, 1961 ?"

The third question which has been referred to us at the instance of the assessee is :

"(3) Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in not allowing the entire payment of gratuity under section 28 and/or under section 37 ?"

2. The facts leading to this reference are as follows : The assessment years under reference are assessment years 1966-67 to 1969-70. The assessee is a limited company carrying on business as the sole distributor of the products of M/s. Chhotabhai Jethabhai Patel & Co., a registered partnership firm and this distributorship started from July 1, 1962. The assessee-company purchase "bidis" at fixed rates and sells them at fixed rates to various merchants. The assessee-company had a head officer at Nadiad and several branches all over India at different places. Question No. (1) relates to assessment year 1966-67. The previous year is Samvat year 2021, that is, the period from November 5, 1964, to October 24, 1965. Before the ITO, the assessee claims a deduction of the sum of Rs. 32,245 out of a contribution of Rs. 58,871 made to the provident fund by the assessee. The ITO disallowed the claim of the assessee on the ground that these payments related to the period prior to July 1, 1965, that is, before the date of the recognition of the fund by the Commissioner. According to the ITO, this liability was not a liability under the Employees' Provident Funds Act, 1952, and hence was not allowable and s. 36(1)(iv) of the Act. According to the ITO, the decision of the Supreme Court in CIT v. Mysore Spinning & Mfg. Co. Ltd. [1970] 78 ITR 4 was not applicable to the facts of the assessee's cases. The assessee went up in appeal to the AAC and it was urged at the stage of that appeal that the business was originally carried on by the firm (the assessee) and later on taken over by the limited company. It was contended on half of the assessee that the liability to the provided fund was attached to the business and not to the owners and, therefore, when the said liability applied to the firm, it could be said to apply to the assessee-company which carried on the said business. The AAC did not agree with this contention and the confirmed the order of the ITO, so far as this amount of provident fund contribution was concerned.

3. Against the decision of the AAC, the assessee took matter in appeal before the Income-tax Appellate Tribunal and the Tribunal ultimately held that the assessee's claim for deduction of the impugned amount was allowable under the provisions of s. 37 of the I.T. Act, 1961, and the claim for provident fund contribution in the sum of Rs. 32,245 was allowed.

4. Question No. (2) relates to the disallowance, of gratuity payments made during the concerned previous year relevant to the assessment year under reference before us. It appears from the table which has been set out in the statement of the case that payments to legal representatives or widows and dependents of different employees of the assessee-company who died while in service were made from time to time but, as the Tribunal has pointed out, there was no co-relation between the payments made and the months of service or the last pay drawn by the employee concerned prior to his death. In view of this peculiar position regarding these so-called gratuity payments, the Tribunal held that only the payment of an amount equivalent to twelve months' salary on the basis of salary last drawn before death would be a reasonable amount to be allowed as deduction under the provisions of s. 37 of the I.T. Act.

5. As regards question No. (3) which has been referred to us at the instance of the assessee, the grievance of the assessee, so far as that question is concerned, is that the entire payment of gratuity made by the assessee-company during the course of the different assessment years was not granted as a deduction by the Tribunal. It is clear from what we have stated that as regards the question of gratuity, the appeal of the assessee-company was partly allowed and partly disallowed. The ITO and the AAC had both rejected the claim of the assessee-company for the deduction of these so-called gratuity payments because, according to those two authorities, there were no rules and no scheme for the payment of gratuity and there was no basis for making these payments to the widows and dependents of the different employees. Thus, when the appeal of the assessee was partly dismissed, it was for the assessee-company to seek a reference by making an application under s. 256(1) of the I.T. Act but no such application for reference under s. 256(1) was made. It has been held by the Supreme Court in CIT v. V. Damodaran [1980] 121 ITR 572 that it is only the party applying for a reference who is entitled to specify the question of law which should be referred. Nowhere in the I.T. Act, 1961, is there a right given to the non-applicant to ask for a reference of questions of law on the applications made by the applicant. Where the order of the Tribunal under s. 254 has decided the appeal partly against one party and partly against another, the party who is aggrieved and who desires a reference to the High Court must file a reference application. It is not open to him to make a reference application filed by the other party the basis of his claim that a question of law sought by him should be referred. Where, however, the order made by the Tribunal operates entirely in favour of one party, although in the course of making the order the Tribunal may have negatived some points of law raised by that party, not being a party aggrieved by the result of the appeal, it is not open to that party to file a reference application. On a reference application being field by the aggrieved party, it is open to the non-applicant to ask for a reference of those questions of law which arise on its submissions negatived in the appeal by the Tribunal. In the instant case, since the order of the Tribunal under s. 254 was partly in favour of the assessee and partly against it, on those questions of law which arise from the appeal which was partly disallowed, it was for the assessee-company to ask for a reference under s. 256(1) and since no such application was filed by it, question No. (3) which has been referred to us at the instance of the assessee should not have been referred and it was not competent for the Tribunal to refer that question No. (3) at the instance of the assessee, the non-applicant, for the opinion of this court. Under these circumstances, we decline to answer question No. (3) which has been referred to us since it was not competent to the Tribunal to refer that question to us.

6. As regards the question of provident fund contribution made by the assessee-company during the assessment year 1966-67 and that too being the amount referable to the period prior to the coming into force of the recognised provident fund which came into force from July 1, 1965, it is clear that the amount of Rs. 32,245 referable to the period prior to July 1, 1965, would not fall under s. 36(1)(iv) of the I.T. Act, 1961. That section speaks of contribution paid by the assessee concerned as an employer by way of contribution towards a recognised provident fund or an employer by way of contribution towards a recognised provident fund or an approved supperannuation fund, subject to such limits as may be prescribed for the purpose of recognising the provident fund or approving the superannuation fund, as the case may be. Since the recognised provident fund came into force only from July 1, 1965, it is obvious that all payments made during the relevant previous year, that is samvat year 2021, prior to July 1, 1965, would not fall under s. 36(1)(iv) of the I.T. Act, 1961. However under section 37 :

"Any expenditure (not being expenditure of the nature of capital expenditure or personal expenses of the assessee), laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head 'profits and gains of business of profession'......"

7. The Tribunal in the instant case relied upon the decision of this High Court in CIT v. Raipur Manufacturing Co. Ltd. [1972] 84 ITR 508 and also the earlier decision of the Bombay High Court in Tata Sons Ltd. v. CIT [1950] 18 ITR 460. These cases were referred to for the purpose of indicating the concept of commercial expediency on which s. 37 is based and when deductions can be made if the other conditions of s. 37 are satisfied and when the principle of commercial expediency in making the payments in question can be invoked. The position has been very much clarified now by the decision of the Supreme Court in Sassoon J. David and Co. P. Ltd. v. CIT [1979] 118 ITR 261. There, the Supreme Court held that the expression "wholly and exclusively" used in s. 10(2)(xv) of the Indian I.T. Act, 1922, did not mean "necessarily". Ordinarily, it was for the assessee to decide whether any expenditure should be incurred in the course of his or its business. Such expenditure might be incurred voluntarily and without any necessity and if it was incurred for promoting the business and to earn profits, the assessee could claim deduction under s. 10(2)(xv) of the Act even though there was no compelling necessity to incur such expenditure. The fact that somebody other than the assessee was also benefited by the expenditure should not come in the way of an expenditure being allowed by way of deduction under s. 10(2)(xv) of the Act if it otherwise satisfied the tests laid down by law, and it was pointed out that the three tests laid down by the Supreme Court in Gordon Woodroffee Leather Manufacturing Company v. Cit, Madras. [1962] 44 ITR 551 should be read disjunctively, and in that connection, the decision of this High Court in CIT v. Laxmi Cement Distributors P. Ltd. [1976] 104 ITR 711 was approved by the Supreme Court. It was also observed by the Supreme Court in Sassoon J. David's case [1979] 118 ITR 261, 271 :

"It is too late in the day now, whatever may have been the position about two decades ago, to treat the expenditure incurred by a management in paying reasonable sums b way of gratuity, bonus, retrenchment compensation for termination of service as not business expenditure. Such expenditure would ordinarily fall within the scope of s. 10(2)(xv) of the Act......"

8. In view of the decision of the Supreme Court in Sassoon J. David's case [1979] 118 ITR 261 and also in view of the decision of this court in Raipur Manufacturing Co.'s case [1972] 84 ITR 508, it is obvious that in the instant case, when contribution was made by the assessee-company for the provident fund amount of the employees even when there was no recognised fund in existence, it would be justifiable on the ground of commercial expediency, so as to keep their worker satisfied and to see to it that the workers get the benefit of provident fund, and thus this was a payment made for the purpose of earning the profits of the business by the assessee or in the course of earning profits of the business by the assessee. Hence, the payment would satisfy all the conditions of s. 37 of the I.T. Act of 1961 and, therefore, the Tribunal was right in holding that the amount of Rs. 32,245 paid by the company by way of provident fund contribution even during the period prior to the recognition of the provident fund would be an allowable deduction under the provision of s. 37 of the I.T. Act, 1961. Question No. (1) is, therefore, answered in the affirmative, that is, in favour of the assessee and a gains the revenue.

9. As regards the Tribunal's conclusion that the claim of the assessee in respect of the payment of gratuity on the basis of twelve months' salary last drawn would be a reasonable payment of gratuity, as observed by the Supreme Court in Sassoon J. David's case [1979] 118 ITR 261, if the expenditure incurred by the management in paying a reasonable sum by way of gratuity is claimed as a deduction, then such business expenditure would be falling within the scope of s. 10(2)(xv) of the Act of 1922 and under s. 37 of the Act of 1961. In view of these observations of the Supreme Court, it is clear that, in the instant case, payment of gratuity on the basis of twelve months' salary last drawn is certainly a reasonable amount and the Tribunal was right in law in allowing that reasonable amount by way of deduction to the assessee-company. Since the earlier decision of the Supreme Court in Gordon Woodroffe's case [1962] 44 ITR 551 has now been explained by the Supreme Court in Sassoon J. David's case [1979] 118 ITR 261, it must be held that so long as a reasonable amount is paid, the reasonableness being judged by the quantum of salary last drawn or by length of service or the period of service for which the gratuity is calculated, the amount would be deductible under s. 37 of the Act of 1961. Under these circumstances, question No. (2) is answered in the affirmative, that is, in favour of the assessee and against the revenue.

We, therefore, answer the questions referred to us as follows :

Question No. (1) in the affirmative, as above. Question No. (2) in the affirmative, as above. Question No. (3) we decline to answer that question as it was not competent for the Tribunal to refer that question to us.

10. The Commissioner will pay the costs of this reference to the assessee.

Commissioner Of Income-Tax, Gujarat-I v. Chhotabhai Jethabhai Patel Tobacco Products Co. Ltd.

Structured Summary of the Provided Opinion

Factual and Procedural Background

Legal Issues Presented

Arguments of the Parties

Revenue / Income-tax Officer (and AAC) — Key Points

Assessee — Key Points

Table of Precedents Cited

Court's Reasoning and Analysis

Holding and Implications

Commissioner Of Income-Tax, Gujarat-I v. Chhotabhai Jethabhai Patel Tobacco Products Co. Ltd.

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