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Case Number

Income-tax Referred Case No. 94 of 1974

Advocates

For the Appellant: C.M. Devan P.E. Narayanaswamy

Judges

P. Govindan Nair, C.J
T. Kochu Thommen, J.

Acts

KERALA INDUSTRIAL EMPLOYEES PAYMENT OF GRATUITY ACT 1970
section 27(1) of the Wealth-tax Act, 1957, for short, the Act,
clauses (a), (b) and (c) of sub-section (1),
WEALTH TAX ACT
section 2(m)

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Smart Summary

High Court Opinion Summary — Reference under section 27(1), Wealth-tax Act

Factual and Procedural Background

This reference was made under section 27(1) of the Wealth-tax Act, 1957. The question referred to the High Court was whether the Tribunal was right in law in holding that the provision made by the assessee towards gratuity payable to its workmen is an allowable deduction in computing the assessee's net wealth.

Relevant factual and procedural points (as stated in the opinion):

The assessment year in issue was 1971–72.
The assessee claimed Rs. 8,60,690 as a liability towards gratuity payable to workmen as a deduction under section 2(m) of the Wealth-tax Act.
The Wealth-tax Officer rejected the claim; the Appellate Assistant Commissioner dismissed the appeal; on further appeal the Tribunal allowed the appeal in part and upheld a modified claim of Rs. 6,22,459, treating that sum (as urged by the assessee) as representing, on an actuarial calculation, the extent of the debt on the valuation date.
The Tribunal relied on an earlier Tribunal decision in W.T. A.s Nos. 7 & 8 Coch/72-73 dated 11-3-1974, which had held that under the Kerala Gratuity Act there was an accrued liability and a perfected debt.
The Commissioner of Wealth-tax referred the question to the High Court (the reference came at the instance of the Commissioner).

Legal Issues Presented

Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that the provision made by the assessee towards liability on account of gratuity payable to the workers is an allowable deduction while computing the assessee's net wealth (i.e., whether that provision constituted a "debt owed by the assessee on the valuation date" within section 2(m) of the Wealth-tax Act)?

Arguments of the Parties

Appellant / Assessee (as arising from the record)

The assessee claimed a deduction under section 2(m) for a provision of Rs. 8,60,690 towards gratuity payable to workmen.
On appeal before the Tribunal the assessee urged that an actuarial calculation established that Rs. 6,22,459 represented the extent of the debt owed on the valuation date; the Tribunal accepted this modified claim.
Counsel for the assessee relied on certain judicial decisions (for example, the Madras High Court decision in Commissioner of Wealth-tax v. Ranganayaki Gopalan and the Calcutta High Court decision in Commissioner of Wealth-tax v. Phipson and Co. Pvt. Ltd.) to support the contention that such liabilities could be treated as present debts in particular circumstances (e.g., where funding or other arrangements created a present liability).

Respondent / Revenue (as arising from the record)

The Commissioner of Wealth-tax referred the question, challenging the Tribunal's conclusion that the gratuity provision qualified as a debt under section 2(m).
The revenue relied upon the Supreme Court authorities (in particular Standard Mills Co. Ltd. v. Commissioner of Wealth-tax and the subsequent Bombay Dyeing decision) that had held that gratuity obligations which are contingent on future events are not debts in praesenti for the purposes of section 2(m).

Table of Precedents Cited

Precedent	Rule or Principle Cited For	Application by the Court
Standard Mills Co. Ltd. v. Commissioner of Wealth-tax [1967] 63 ITR 470 SC	The Supreme Court held that gratuity rights under an award arise only when employment is determined; the liability is contingent and does not constitute a present debt (debitum in praesenti) for section 2(m) purposes.	The High Court treated this pronouncement as decisive: it applied the principle that a gratuity obligation contingent upon future events is not a debt owed on the valuation date and concluded that the assessee's claim could not be sustained under section 2(m).
Bombay Dyeing & Mfg. Co. Ltd. v. Commissioner of Wealth-tax [1974] 93 ITR 603 SC	Followed and applied the Supreme Court's approach (as in Standard Mills) regarding the nature of contingent gratuity liabilities for wealth-tax purposes.	The High Court noted that the Supreme Court's ruling in Bombay Dyeing followed the Standard Mills principle and regarded those decisions as concluding the matter against treating contingent gratuity liabilities as debts under section 2(m).
W.T. A.s Nos. 7 & 8 Coch/72-73 (Tribunal, order dated 11-3-1974)	The Tribunal in that earlier decision held that under the Kerala Industrial Employees' Payment of Gratuity Act there is an accrued liability and a perfected debt, making the amounts deductible.	The present Tribunal relied on that earlier Tribunal decision in allowing the assessee's modified claim; the High Court recorded the Tribunal's reliance but distinguished and disagreed with the legal conclusion in light of Supreme Court authority.
Commissioner of Wealth-tax v. Ranganayaki Gopalan (Madras High Court)	Held that where a company transfers a gratuity fund to trustees (trust deed), and the company is contractually liable to the trustees for a specified amount (with only payment timing optional), such interposition of a trust can create a definite, present liability rather than a contingent one.	The High Court observed this decision but found it not helpful in the present case because here there was no provision for funding amounts to a trust; accordingly, the Madras decision did not support the assessee's position on section 4 of the Kerala Gratuity Act.
Commissioner of Wealth-tax v. Sayaji Mills Ltd. [1974] 94 ITR 54 (Guj.)	The Gujarat High Court appeared to take the view that a statutory liability (liability arising under a statute) could itself give rise to a debt for wealth-tax purposes.	The High Court rejected drawing any principled distinction between liabilities arising under an award and those created by statute; if the liability is contingent it does not attract section 2(m), so the Gujarat view did not alter the conclusion drawn from the Supreme Court authorities.
Commissioner of Wealth-tax v. Phipson & Co. Pvt. Ltd. (Calcutta High Court)	Dealt with funded pensions where the liability for payment arose on retirement; the court held that such funded pension liabilities (arising after retirement) were debts within section 2(m).	The High Court found that decision concerned a different factual matrix (pensions funded after retirement) and therefore stated it was not useful for deciding the present issue under the Kerala Gratuity Act where liability arises only on certain future events.
Kesoram Industries & Cotton Mills' case (referenced in Standard Mills)	Provided an accepted definition of "debt": "a sum of money which is now payable or will become payable in future by reason of a present obligation: debitum in praesenti, solvendum in futuro."	The High Court cited the definition to explain the concept of "debt" and to show that contingent liabilities which lack a present obligation do not qualify as debts under section 2(m).

Court's Reasoning and Analysis

The Court's analysis proceeded in the following steps, using only the reasoning as stated in the opinion:

Identification of the statutory provision governing gratuity: The Court extracted section 4 of the Kerala Industrial Employees' Payment of Gratuity Act, 1970, and noted that gratuity is payable on specific events — superannuation, retirement/resignation/retrenchment/discharge/dismissal after a minimum period of five years, death or total disablement — and that the prescribed formula determines the amount payable.
Question framed against the definition of "net wealth" under section 2(m): The sole legal question was whether the assessee's claimed provision represented a "debt owed by the assessee on the valuation date" within section 2(m).
Comparison with Supreme Court authority: The Court relied primarily on the Supreme Court decision in Standard Mills, which held that gratuity rights under an award arise only upon determination of employment and therefore the liability is contingent (not a present debt). The Court observed that the award considered in Standard Mills had provisions similar in nature to section 4, and that the Supreme Court had treated the liability as contingent.
Application of the definition of "debt": Citing the accepted definition (debitum in praesenti, solvendum in futuro), the Court reasoned that if liability depends upon future events (such as termination of service), it does not amount to a present obligation constituting a debt on the valuation date.
Consideration of distinguishing authorities relied on by the assessee: The Court examined the Madras High Court decision (Ranganayaki Gopalan) where funding to a trust and an express contractual liability to trustees created a present, ascertained liability; however, the Court observed that in the present case there was no provision for funding to a trust, so that decision did not assist the assessee. The Gujarat decision (Sayaji Mills) suggesting that statutory liabilities automatically create debts was rejected on principle — the Court found no basis to distinguish between liabilities created by award and those by statute if in either case the liability is contingent. The Calcutta decision (Phipson) concerned funded pensions arising after retirement and was not germane to the issue before the Court.
Conclusion drawn from authorities: The Court considered the Supreme Court pronouncements (Standard Mills and the Bombay Dyeing decision that followed it) to be dispositive: where the liability to pay gratuity is contingent on future events, it does not qualify as a debt for section 2(m) of the Wealth-tax Act.

Holding and Implications

Holding: The Court answered the referred question in the negative — that is, in favour of the revenue and against the assessee. The Court directed that the parties bear their respective costs.

Implications (as stated or reasonably confined to the opinion's text):

Direct effect on the parties: The Tribunal's allowance of the gratuity provision as a deduction (to the extent it treated the provision as a debt under section 2(m)) is not sustained by the High Court; the assessee's claim is not allowable on the basis asserted because the liability under section 4 of the Kerala Gratuity Act is contingent on future events and therefore is not a present "debt" on the valuation date.
Status of precedent: The Court treated the Supreme Court's decisions (Standard Mills and Bombay Dyeing) as controlling and did not purport to create any new legal principle; the opinion applies existing Supreme Court authority to the case facts rather than establishing a new precedent.

Registry direction: A copy of this judgment was to be forwarded to the Income-tax Appellate Tribunal, Cochin Bench (as recorded in the opinion).

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Commissioner Of Wealth-Tax, Kerala v. K. Gopinathan Nair.

Govindan Nair, C.J:— This is a reference under section 27(1) of the Wealth-tax Act, 1957, for short, “the Act”, and the question referred is in these terms:

“Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that the provision made by the assessee towards liability on account of gratuity payable to the workers is an allowable deduction while computing the assessee's net wealth?”

2. The year of assessment with which we are concerned is 1971-72. The assessee had claimed a sum of Rs. 8,60,690 as liability towards gratuity payable to its workmen as a deduction under section 2(m) of the Act. section 2(m) runs thus:

“‘Net wealth’ means the amount by which the aggregate value computed in accordance with the provisions of this Act of all the assets, wherever located, belonging to the assessee on the valuation date, including assets required to be included in his net wealth as on that date under this Act, is in excess of the aggregate value of all the debts owed by the assessee on the valuation date other than……”

3. We are not concerned in this case with the exclusions enumerated under clauses (i), (ii) and (iii) and the only question is whether the claim made by the assessee was a “debt owed by the assessee on the valuation date”. The Wealth-tax Officer rejected the claim. The appeal before the Appellate Assistant Commissioner was dismissed. In further appeal by the assessee the Tribunal, relying on an earlier decision of the Tribunal in W.T As. Nos. 7 & 8.Coch/72-73 dated March 11, 1974, allowed the appeal and upheld the modified claim of the assessee for the deduction of a sum of Rs. 6,22,459 which it was urged represented on an actuarial calculation the extent of the debt on the valuation date. The relevant part of the order of the Tribunal in W.T As. Nos. 7 and 8.Coch/72-73 has been extracted in paragraph 4 of the statement of case. And in the order passed in appeal relating to the assessment year 1971-72 in W.T.A No. 3/72-73, the Tribunal observed thus:

“5. We have had an occasion to consider the provisions of the Kerala Industrial Employees' Payment of Gratuity Act in our order in W.T As. Nos. 7 & 8.Coch/72-73 dated 11-3-1974 and we have held that there is an accrued liability and a perfected debt and, therefore, the assessee is entitled to claim these amounts as a deduction. We have pointed out in our above-said order that the gratuity provisions of the Kerala Industrial Employees' Payment of Gratuity Act are different from the provisions which the Supreme Court had considered in the Standard Mills' case [1967] 63 ITR 470 SC.. We have held that under the Kerala Gratuity Act, at the end of a 5 year period, the employee gets absolute right for the gratuity and only the payment of such gratuity is postponed to a later date. Under no circumstances can an employee who had completed 5 years of service be denied the gratuity. In the Standard Mills' case, the payment of gratuity depended on the good behaviour of the employee till the date of his retirement, dismissal, etc. Therefore, in that case, the payment was entirely contingent, whereas in the assessee's case, it is clearly an accrued liability.”

4. This reference has come to us at the instance of the Commissioner of Wealth-tax. The section in the Kerala Industrial Employees' Payment of Gratuity Act, 1970, for short, “the Gratuity Act”, which imposes the liability to pay gratuity is section 4 and we shall extract that section:

“4. Payment of gratuity.—(1) Gratuity shall be payable to an employee—

(a) on his superannuation;

(b) on his retirement, resignation, retrenchment, discharge or dismissal from service after completion of a minimum period of five years of continuous service;

Explanation.—For the purpose of this section, total disablement means such disablement, whether of temporary or permanent nature, as incapacitates an employee for all work which he was capable of performing at the time of accident resulting in such disablement.

(2) In case of death of an employee, the gratuity shall be payable to the nominee of the employee or in the absence of a nominee to the family of the employee.

(3) In the cases referred to in clauses (a), (b) and (c) of sub-section (1), the employer shall pay gratuity to each of his employees at the rate of fifteen days' wages based on the last drawn wages for every completed year of service or part thereof in excess of six months:

Provided that the maximum amount of gratuity payable to an employee shall not exceed fifteen months' wages:

Provided further that nothing in this section shall affect the right of any better terms of gratuity or retirement benefits under any award or agreement or contract with the employer:

Provided also that in the case of voluntary retirement or resignation from service in any particular year, not more than five per cent. of the total number of employees in the factory, plantation, establishment or undertaking shall be entitled to payment of gratuity and if the number of employees who voluntarily retire or resign from service exceeds five per cent. of the total number of employees, the eligibility of an employee for payment of gratuity shall be determined on the basis of the strength of the service of the employee in the factory, plantation, establishment or undertaking:

Provided further that an employee who voluntarily retires or resigns from service shall be eligible to claim gratuity only if one month's notice in writing of his intention so to retire or resign had been given to the employer.”

5. In Standard Mills Co. Ltd. v. Commissioner of Wealth-tax the Supreme Court had to consider the effect of the terms of an award passed by an Industrial Tribunal. The question whether the award had created a liability in praesenti for payment of gratuity which could be claimed to be a debt, under section 2(m) of the Act, owed by the assessee for the purpose of determining the value of his assets on the valuation date was answered by the Supreme Court in the negative. We shall extract the relevant provisions of that award which are referred to in the judgment of the Supreme Court at page 474:

“Gratuity should be paid……………………on the following scales:

1. On the death of an employee, while in service of the company or on his becoming physically or mentally incapacitated for further service— one months' salary for each year of service…………………….

2. On voluntary retirement or resignation of an employee—

After 15 years' continuous service in the company—15 months' salary.

3. On termination of his service by the company—

(a) After 10 years' continuous service but less than 15 years' service in the company—¾ths of one month's salary for each year of service.

(b) After 15 years' continuous service in the company—15 months' salary.

4. A gratuity will not be paid to any employee who is dismissed for dishonesty or misconduct.”

6. It will be noticed that the provisions in the award construed by the Supreme Court are on very similar terms to section 4 though there are differences which we consider to be immaterial. Dealing with the provision, the Supreme Court had no hesitation to state:

“The right to obtain gratuity under the awards arises only when there is determination of employment and not before. The liability does not exist in praesenti; it is contingent upon the determination of employment. This court pointed out in Kesoram Industries & Cotton Mills' case:

“………………..the following definition is unanimously accepted:

‘a debt is a sum of money which is now payable or will become payable in future by reason of a present obligation: debitum in praesenti, solvendum in futuro’.”

7. Under the award, as under section 4, certain events have to happen when gratuity would become payable. That is clear from the terms of the award. The terms of the award started with death and the terms of the section ended with death. But this makes no difference. The circumstances under which services can end or terminate such as superannuation, resignation, retirement, retrenchment or dismissal are there in the section and the award. What is to be noted is that the liability would arise only on the happening of any of those events. The fact that if one of those events occurred before the qualifying period expired, five years under the Act, no liability at all would arise, would also indicate that there was no present liability. No distinction can, therefore, be sought on the basis of the different periods provided under the Act and the award we have referred to for making out a case that under the Act a liability in praesenti arose on the coming into force of the Act. The fact that the contingent liabilities are taken into account for the purpose of calculating, on the basis of commercial expediency, the profits and gains of a business for the purpose of income-tax rests on a different principle. For the purpose of the Wealth-tax Act there must be actual debt owing on the valuation date. The ruling of the Supreme Court which we have referred to and which has been followed by the Supreme Court in the decision in Bombay Dyeing and Manufacturing Co. Ltd. v. Commissioner of Wealth-tax [1974] 93 ITR 603 SC., we think, concludes the matter.

8. We shall now refer to certain decisions relied on by counsel on behalf of the assessee. Those decisions are in Commissioner of Wealth-tax v. Ranganayaki Gopalan and Commissioner of Wealth-tax v. Phipson and Company Private Ltd., the former decision being that of the Madras High Court and the latter of the Calcutta High Court. In the case before the Madras High Court, the question arose from the terms of a trust deed which provided that the company should transfer to a proposed trust a sum of Rs. 19,50,000 towards the liability for gratuity up to a particular date on the basis of an actuarial valuation. The proposed trust deed contained a clause that the company had the option to pay to the fund either the entire sum in one lump sum or in such instalments and at such times as the board of directors of the company may determine subject to payment of interest at 3\2 per cent. per annum with yearly rests. During the year ended June 30, 1961, the company paid Rs. 38,880 to the fund leaving a balance of Rs. 19,11,620. In valuing the equity shares of the company for the purposes of wealth-tax in the hands of its shareholders, this liability of Rs. 19,11,620 was held to be deductible by the Tribunal. The view taken by the Tribunal has been upheld by the High Court. The High Court referred to the decision of the Supreme Court in Standard Mills Co. Ltd. v. Commissioner of Wealth-tax [1967] 63 ITR 470 SC. and observed4:

“But, in the present case, in our opinion, the interposition of a trust and vesting the gratuity fund in the trustees makes a difference.”

9. Thereafter, reference was made to the terms of the trust deed and the court was able to spell out that the “company was liable to pay the sum of Rs. 19,50,000 under the trust deed to the trustees”. The court observed that “the only option that was given to the company was that it could either pay the amount in one lump sum or in instalments. The liability is thus not a contingent liability. It is a definite, ascertained and present liability”. It was, therefore, possible to hold that a present liability had accrued on the valuation date. We are not called upon in this case to examine the correctness or otherwise of the view which was taken by the Madras High Court on the terms of the trust deed. In the case before us, there is no provision for funding amounts towards gratuity to a trust fund. We, therefore, express no opinion on that aspect. The decision is not helpful in construing the effect of section 4 of the Act. Counsel invited our attention to the decision of the Gujarat High Court in Commissioner of Wealth-tax v. Sayaji Mills Ltd. [1974] 94 ITR 54 Guj., wherein the view seems to have been taken that a debt would arise from the mere fact of the liability under a statute unlike in the case of a settlement or of an award. We do not think that on principle there can be any distinction between the liability under an award and that created by a statute. If the liability created either by the award or the Act is only a contingent liability, then section 2(m) would not be attracted.

10. The Calcutta High Court in the decision in Commissioner of Wealth-tax v. Phipson and Company Private Ltd. had to deal with the matter which is not germane to the issue before us. The question there was whether amounts that have been funded as payable to certain ex-employees of the assessee as pension and funded after the employees had retired have to be taken into account as a debt for the purpose of section 2(m) of the Act. If we may say so with respect the court was right in holding that the liability was a debt within the section. The liability for payment of pension had arisen on the retirement of a person. The fact that it was payable in future does not touch the question as to the present nature of the liability. The decision is not useful for our purpose in the present case.

11. We consider that this matter is concluded by the pronouncement of the Supreme Court in Standard Mills Co. Ltd. v. Commissioner of Wealth-tax. We, accordingly, answer the question referred to us in the negative, that is, in favour of the revenue and against the assessee. We direct the parties to bear their respective costs.

12. A copy of this judgment under the seal of the High Court and the signature of the Registrar will be forwarded to the Income-tax Appellate Tribunal, Cochin Bench.

Commissioner Of Wealth-Tax, Kerala v. K. Gopinathan Nair.

High Court Opinion Summary — Reference under section 27(1), Wealth-tax Act

Factual and Procedural Background

Legal Issues Presented

Arguments of the Parties

Appellant / Assessee (as arising from the record)

Respondent / Revenue (as arising from the record)

Table of Precedents Cited

Court's Reasoning and Analysis

Holding and Implications

Commissioner Of Wealth-Tax, Kerala v. K. Gopinathan Nair.

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