Commissioner Of Income-Tax v. Orient Paper Mills Ltd.

Dipak Kumar Sen, J.:— Orient Paper Mills Ltd., the assessee, was assessed to income-tax in the assessment year 1971-72, the relevant accounting year ending on March 31, 1971. In its return and in the assessment, the assessee claimed deduction of Rs. 46,798 incurred on tea, tiffin and refreshments at a conference of the salesmen and distributing agents of the assessee at its mill. The Income-tax Officer held that 75 per cent, of the said expenditure was in the nature of entertainment and disallowed an amount of Rs. 34,100 out of the said Rs. 46,798 under section 37(2) of the Income-tax Act, 1961 (“the Act”), which was included in the total income of the assessee.

2. In the said assessment year, the assessee at its mill premises provided boarding and lodging facilities to its employees and visitors who were charged for such facilities. In respect of the aforesaid, the assessee incurred an expenditure of Rs. 1,59,407 in the said assessment year and also recovered charges in respect thereof in a sum of Rs. 1,31,162. The difference of Rs. 28,245 was claimed by the assessee as a deductible expenditure. The Income-tax Officer disallowed the claim on the ground that the assessee maintained a guest house and was not entitled to claim deduction in respect of expenditure incurred for the same under section 37(4). In the assessment year involved, the assessee introduced a scheme for payment of gratuity to its employees, since an enactment on an all-India basis for payment of gratuity by employers to their employees was being contemplated by the Legislature. The assessee obtained an estimate of its liability on account of such gratuity as on March 31, 1971, from qualified actuaries which was ascertained at Rs. 1,16,57,966. A deduction of the said amount was claimed from the total income of the assessee. The Income-tax Officer in making the assessment allowed only the amount of Rs. 12,75,558 as liability pertaining to the assessment year involved. Deduction of the balance was not allowed on the ground that the same constituted liability pertaining to the years prior to the accounting year involved.

3. Being aggrieved by the aforesaid, the assessee preferred an appeal from the order of assessment to the Appellate Assistant Commissioner. The Appellate Assistant Commissioner upheld the decision of the Income-tax Officer in respect of the disallowance of Rs. 34,100 on account of expenditure incurred for supply of tea, tiffin and refreshments. He also upheld the decision of the Income-tax Officer disallowing the deduction of Rs. 28,244 claimed on account of expenditure incurred in providing boarding and lodging facilities at the guest house at the mill of the assessee on the grounds that the same was a guest house, that no register for such guest house was maintained and that no expenditure incurred on a guest house would be admissible for deduction.

4. The Appellate Assistant Commissioner also upheld the decision of the Income-tax Officer in disallowing the balance of Rs. 1,03,82,408 of the provision made on account of gratuity, inter alia, on the ground that it was not permissible to debit the expenditure relating to earlier years or anticipated expenditure of later years as a liability for the year involved and that there was no legal necessity to make any provision for gratuity in the year involved as the Payment of Gratuity Act, 1972, came into force only in 1972. He held further that the assessee had not specifically earmarked or invested the amount provided for gratuity in its accounts as required under the Payment of Gratuity Act. He also held that the liability for payment of gratuity in the assessment year involved was only a contingent liability.

5. Being aggrieved, the assessee preferred an appeal from the decision of the Appellate Assistant Commissioner to the Tribunal. It was contended on behalf of the assessee before the Tribunal that the provision for tea, tiffin and refreshments by the assessee was by way of ordinary courtesy and had been incurred in connection with the sale promotion conference held by the assessee at its mill. Relying on a decision of the Gujarat High Court in CIT v. Patel Bros. & Co. Ltd., [1977] 106 ITR 424, it was submitted that the said expenditure is allowable as a deduction.

6. The Revenue relied on a decision of the Allahabad High Court in Brij Raman Dass & Sons v. Commissioner Of Income-Tax, Lucknow., [1976] 104 ITR 541, where the Allahabad High Court took a view different from that of the Gujarat High Court and held that expenditure of the same nature as that of expenditure involved in the instant case should be held to have been incurred on account of entertainment and not admissible as a deduction. The Tribunal followed the decision of the Gujarat High Court in Patel Bros. & Co. Ltd.'s case, [1977] 106 ITR 424 and accepted the contention of the assessee. The addition of Rs. 34,100 was directed to be deleted from the total income of the assessee.

7. On the assessee's claim for deduction of Rs. 28,245, the expenditure incurred in respect of the residential accommodation in the mill of the assessee, the Tribunal found that the assessee had realised to a large extent the actual expenses incurred in providing boarding, lodging and accommodation from the persons enjoying the same and held that the persons who occupied the said house could not be called the guests of the assessee. The Tribunal found further that at the places where the assessee's mills were situated, there was no hotel or other accommodation available where the employees or customers of the assessee could be put up. The Tribunal held that the accommodation provided by the assessee was part and parcel of its business assets and the expenditure incurred thereon could not be held to be an expenditure on the maintenance of a guest house within the meaning of section 37(4). The Tribunal allowed the claim of the assessee for deduction of Rs. 28,245.

8. On the claim of the assessee for deduction of Rs. 1,03,82,408 representing the provision for payment of gratuity, it was contended before the Tribunal on behalf of the assessee that such provision was made in the books of account of the assessee and approved by its shareholders and as such the assessee was liable to its employees for the same. Relying on an unreported decision of this court in Budge Budge Amalgamated Mills Ltd. (Civil Rule 5552(W) of 1975), where a decision of the Bombay High Court in Tata Iron & Steel Co. Ltd. v. D.V Bapat, ITO, [1975] 101 ITR 292, was followed, it was contended that the assessee was entitled to claim such deduction.

9. It was contended on behalf of the Revenue that in Tata Iron & Steel Co. Ltd.'s case, [1975] 101 ITR 292 (Bom), the claim of the assessee pertained only to the liability for gratuity for the current year and not of earlier years. The Tribunal examined in detail the facts before this court in the case of Budge Budge Amalgamated Mills Ltd. (Civil Rule No. 5552(W) of 1975) and noted that the liability for gratuity for which deduction was claimed included the liability for the current year as also the liability for earlier years calculated on an actuarial basis. The Tribunal accepted the contention of the assessee and allowed the deduction claimed.

10. On an application of the Revenue under section 256(1) of the Act, the Tribunal has referred the following questions as questions of law arising out of its order for the opinion of this court:

“1. Whether, on the facts and in the circumstances of the case, the assessee's claim for deduction of Rs. 34,100 was rightly accepted, by the Tribunal?

2. Whether, on the facts and in the circumstances of the case, the assessee's claim for deduction of Rs. 28,245 was rightly accepted by the Tribunal?

3. Whether, on the facts and in the circumstances of the case, the assessee's claim for deduction of Rs. 1,03,82,408 was rightly accepted by the Tribunal?”

11. On question No. 1, no submission was made on behalf of the Revenue at the hearing before us.

12. Learned advocate for the assessee drew our attention to a decision of this court in Commissioner Of Income-Tax v. Agarpara Co. Ltd, [1987] 167 ITR 866 (Cal). I was a party to the said decision. In that case, it was held by the Division Bench that Explanation (2) introduced in section 37(2A) was made effective retrospectively on and from April 1, 1976. It was held that the law as it stood before the said date was required to be considered to determine such controversy where it arose prior to April 1, 1976. The High Court had taken different views. This court followed and applied the decision of the Gujarat High Court in Patel Bros. & Co. Ltd.'s case, [1977] 106 ITR 424 and held that there was a difference between the expenditure in the nature of hospitality and expenditure in the nature of entertainment. In the facts, it was held that the expenditure incurred by the assessee for providing tea, cold drinks and other refreshments to its customers was an expenditure incurred for the purpose of hospitality and not incurred for the purpose of entertainment.

13. Following the said decision in the case of Agarpara Co. Ltd.'s case, [1987] 167 ITR 866 (Cal), we hold that the expenditure incurred in the instant case for supply of tea and refreshments at the conference of its salesmen and distributing agents was an expenditure in the nature of hospitality and not entertainment and, therefore, it is a deductible expenditure.

14. We answer the question in the affirmative and in favour of the assessee.

15. On question No. 2, learned advocate for the Revenue also did not make any submissions except that he relied on a decision of the Karnataka High Court in N.G.E.F Ltd. v. CIT, [1985] 153 ITR 197. There the assessee concerned incurred an expenditure in maintaining two flats in Bombay and Delhi as guest houses. Under section 37(4) which was introduced with effect from April 1, 1970, allowances in respect of the expenses on the maintenance of guest houses were totally prohibited. On these facts, the High Court held that the expenditure incurred by the assessee in maintaining the said flats in the assessment years 1973-74 to 1975-76 were not allowable as deduction.

16. Learned advocate for the assessee contended, on the other hand, that the accommodation provided in the instant case in the mills of the assessee were not guest houses. In the area where the mills were situated, no accommodation of any kind was available and, therefore, the assessee had provided for boarding and lodging facilities at its mills against payment of charges by the persons using them. It was submitted that almost the entire expenditure incurred by the assessee in providing such facilities had been recovered from the persons utilising the said accommodation and only a minimal difference was being sought to be deducted. He submitted that in such cases, the accommodation facilities provided should not be treated as a guest house and the expenditure should be allowed as deduction. In support of his contentions, learned advocate for the assessee relied on and cited a decision of this court in Commissioner Of Income-Tax v. Parshva Properties Ltd., [1987] 164 ITR 673. In that case, it was found that the assessee maintained a bungalow at a remote place in the State of Bihar where the employees of the assessee and auditors, engineers and the Government officials who visited the place on duty stayed there temporarily. No one utilised the bungalow for entertainment or relaxation. On these facts, it was held that the said bungalow was not a guest house within the meaning of section 37(4).

17. The decision of this court in the above case is binding on us. It has been found as a fact in the instant case that the assessee was providing accommodation at places where no accommodation of any kind was available. The same was obviously not meant for entertainment or relaxation. It has also been found as a fact that the persons availing of the accommodation had been paying charges covering almost the entire expenditure.

18. In view of the above, we answer question No. 2 in the affirmative and in favour of the assessee.

19. On question No. 3, it was contended on behalf of the Revenue that the provision for payment on account of gratuity should not be held to be allowable as deduction in the instant case for a number of reasons. It was contended that there was no actual payment but it was merely a provision for a contingent liability. It was further contended that the assessee did not set apart any amount on account of gratuity nor deposit the same in any fund to be held exclusively for the purpose of payment of gratuity. The assessee retained full user of the amount. It was further contended that the liability for payment of gratuity was not a statutory liability as in the relevant assessment year there was no statute under which the assessee had to provide for and pay gratuity.

20. In support of the respective contentions of the parties, a large number of decisions were cited at the Bar including Madho Mahesh Sugar Mills (P.) Ltd. v. Commissioner Of Income-Tax., [1973] 92 ITR 503 (All), M/S. Delhi Flour Mills Co. Ltd.… v. Commissioner Of Income-Tax…, [1974] 95 ITR 151 (Delhi), India United Mills Ltd. v. CIT, [1975] 98 ITR 426 (Bom), Commissioner Of Income-Tax, Madras-I. v. Carborundum Universal Ltd., [1977] 110 ITR 621 (Mad), CIT v. Andhra Prabha (P.) Ltd., [1980] 123 ITR 760 (Mad) and Commissioner Of Income-Tax (Central-I) v. Eastern Spinning Mills Ltd., [1980] 126 ITR 686 (Cal).

21. The following decisions were also cited and as they appear to us to be relevant to the controversy before us, we deal with the same in some detail:

(a) Shree Sajjan Mills Ltd. v. CIT, [1985] 156 ITR 585, where the Supreme Court laid down the law as follows (p. 599):

“It would thus be apparent from the analysis aforesaid that the position till the provisions of section 40A(7) were inserted in the Act in 1973 was as follows:

(1) Payments of gratuity actually made to the employee on his retirement or termination of his services were expenditure incurred for the purpose of business in the year in which the payments were made and allowed under section 37 of the Act.

(2) Provision made for payment of gratuity which would become due and payable in the previous year was allowed as an expenditure of the previous year on accrued basis when mercantile system was followed by the assessee.

(3) Provision made by setting aside an advance sum every year to meet the contingent liability for gratuity as and when it accrued by way of provision for gratuity or by way of reserve or fund for gratuity was not allowed as an expenditure for the year in which such sum was set apart.

(4) Contribution made to an approved gratuity fund in the previous year was allowed as deduction under section 36(1)(v).

(5) Provision made in the profit and loss account for the estimated present value of the contingent liability properly ascertained and discounted on an accrued basis as falling on the assessee in the year of account could be deductible either under section 28 or section 37 of the Act.”

(b) CIT v. Andhra Prabha (P) Ltd., [1986] 158 ITR 416 (SC): In this case, in the assessment year 1969-70, the assessee had made provision for payment of gratuity to its employees payable partly under a statute, viz., the Working Journalists (Conditions of Service and Miscellaneous Provisions) Act, 1955, and partly under an agreement with the non-working journalists dated March 13, 1968. The Supreme Court, following its decision in Shree Sajjan Mills Ltd.'s case, [1985] 156 ITR 585, allowed the claim of the assessee and held that the said amount was deductible, as in the assessment year 1960-70, sub-section (7) had not been incorporated in section 40A of the Act.

(c) Ishwar Industries Ltd. v. Commissioner Of Income-Tax, New Delhi., [1984] 149 ITR 301 (Delhi). In this case, on March 31, 1970, the assessee introduced with effect from January 1, 1970, a gratuity scheme for its employees and in the assessment year 1971-72 claimed deduction of the provision made for payment of such gratuity on the basis of actuarial valuation. The income-tax authorities allowed part of the said amount on the ground that the same related to the year in question but the balance was disallowed on the ground that they related to earlier accounting years. The Tribunal affirmed the decision of the income-tax authorities. On a reference, a Division Bench of the Delhi High Court held that the liability of the assessee to pay gratuity under the scheme arose only when the scheme came into operation and became a known liability on calculation. The liability which related to the period before the assessment also arose in the same year and had to be allowed in the same manner as a liability which actually arose during the year. It was further held that the fact that the calculation of the liability was deferred till after the close of the accounting year made no difference to the question of allowability.

(d) CIT v. Remington Rand India Ltd., [1986] 159 ITR 922 (Cal): This is a decision of a Division Bench of this court to which I was party. In this case, the assessment year involved was 1972-73 when the provisions of the West Bengal Employees' Payment of Compulsory Gratuity Act, 1971, came into force. The assessee also introduced a scheme for payment of gratuity in the said year. The liability to pay gratuity was calculated actuarially and provision was made for payment of the same. The question arose whether the amount provided for was deductible. It was held, following the earlier decision of this court in Eastern Spinning Mills' Ltd.'s case, [1980] 126 ITR 686 (Cal), that the said amount was deductible in the said assessment year. It was held further that apart from the liability under the statute, there was a liability to, pay gratuity under the scheme introduced by the assessee. The expectation of the employees was raised of receiving gratuity from their employer. Gratuity paid on grounds of commercial expediency indirectly facilitated the carrying on of the business and such payment would be an allowable deduction.

22. The controversy raised on behalf of the Revenue that the provision made for payment of gratuity would not be deductible as the amount had not been deposited in an approved fund as required under the amended section 40A(7) and that the same is not deductible under section 28 or section 36 of the Act in view of the specific provision of section 37, in our view, stands concluded by the decision of the Supreme Court in Shree Sajjan Mills Ltd.'s case, [1985] 156 ITR 585, which has been followed by the Supreme Court in a number of subsequent decisions. We have applied and followed the said decisions of the Supreme Court in a recent judgment delivered by this Bench in CIT v. Steel Rolling Mills oj Bengal Ltd. (Income-tax Reference No. 166 of 1978 dated 11-6-1987—[1988] 169 ITR 430).

23. It remains to be considered by us in this reference whether the amount provided for by the assessee on account of its liability to pay gratuity could be disallowed as a deduction as there was no statutory liability in the assessment year of the assessee to pay such gratuity.

24. This aspect of the controversy in our view is also concluded by the decision of the Supreme Court in Andhra Prabha (P.) Ltd.'s case, [1986] 158 ITR 416 (SC), where the Supreme Court allowed the provision made for payment of gratuity under an agreement between the assessee and the non-working journalists. In the earlier decision of this court in Remington Rand India Ltd.'s case, [1986] 159 ITR 922, it was observed that liability to pay gratuity under an agreement or scheme would be more or less in the nature of a liability under a statute as the scheme was binding on the assessee.

25. The Delhi High Court has taken the same view in Ishwar Industries Ltd.'s case, [1984] 149 ITR 301. We are unable to hold that the assessee incurred no liability to pay gratuity to its employees as the same was not imposed by a statute but arose under a scheme. The scheme was binding on the assessee and enforceable by the employees. In fact, part of the liability pertaining to the relevant year has been allowed by the Income-tax Officer.

26. For the reasons as aforesaid, we answer question No. 3 also in the affirmative and in favour of the assessee. On the facts and circumstances, there will be no order as to costs. Oral application was made by learned advocate for the Revenue only in respect of question No. 3 for certificate that the said question was of sufficient importance for appeal to the Supreme Court. In our view, we have answered the question following the decisions of the Supreme Court in Shree Sajjan Mills Ltd.'s case, [1985] 156 ITR 585 and Andhra Prabha (P.) Ltd.'s case, [1986] 158 ITR 416. Such application of the Revenue is, therefore, rejected.

Shyamal Kumar Sen, J.:— I agree.