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Case Number

IT APPEAL NO. 1074 (MAD.) OF 1987

Attorney(S)

S. Sridhar

Judges

N. BARATHVAJA SANKARM.K. CHATURVEDIU.B.S. BEDI

Acts

Departmental Representative section 40A(7) overrides the provisions of section 36(1)(v). Section 40A(7) reads as under:"40A. (1) The provisions of this section
section 40A, the non obstante clause of sub-section (1) of section 40A
section 255(3) of the Income-tax Act, 1961 (hereinafter called the Act)
clause (a) of section 40A(7) of the Income-tax Act, 1961,
provisions of section 36(1)(v)
provision of section 36(1)(v).
sections 36(1)(v) and 43(2)

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Smart Summary

Summary of Special Bench Order (M.K. Chaturvedi, Vice President)

Factual and Procedural Background

The assessee is a company which, in the relevant assessment year, showed a provision for gratuity of Rs. 7,85,600 in its balance sheet and claimed that amount as a deduction in the return of income. The Assessing Officer allowed the deduction in the assessment order without discussion. The Commissioner of Income-tax assumed jurisdiction under section 263 of the Income-tax Act, 1961, considering the assessment order to be erroneous and prejudicial to the interests of the revenue. The Commissioner directed the Assessing Officer to withdraw the excess allowance, finding that the incremental approved gratuity liability for the year was Rs. 3,37,989 and that the Assessing Officer had allowed Rs. 7,85,600, producing an excess allowance of Rs. 4,47,611. The Special Bench was constituted to consider three questions framed by the President of the Tribunal regarding (1) correctness of invoking section 263 to withdraw the larger provision allowed by the Assessing Officer, (2) entitlement of the assessee to claim the full provision of Rs. 7,85,600 under section 36(1)(v), and (3) whether a prior Tribunal order in the assessee's own case (ITA No. 529(Mds.)/1987 dated 21-6-1990) was per incuriam and not binding.

Legal Issues Presented

Whether on the facts and in the circumstances of the case the Commissioner of Income-tax was correct in invoking the provisions of section 263 of the Act in withdrawing the claim of deduction of gratuity provision of Rs. 7,85,600 actually paid to an approved gratuity fund and allowed by the Assessing Officer in the original order of assessment as against incremental actuarial liability worked out at Rs. 3,37,989?
Whether the assessee is entitled to claim deduction of Rs. 7,85,600 being the provision for gratuity in terms of section 36(1)(v) of the Act, actually paid to an approved gratuity fund on the facts and in the circumstances of the case?
Whether the Appellate Tribunal's order dated 21-6-1990 in ITA No. 529(Mds.)/1987 rendered in the assessee's own case for the assessment year 1982-83 could be said to be an order rendered per incuriam and not binding in view of non-consideration of correct legal position in this regard?

Arguments of the Parties

Assessee's Arguments

The assessee contended that the provision for gratuity of Rs. 7,85,600 is deductible under section 36(1)(v) as a sum "paid" by way of contribution to an approved gratuity fund created by the employer under an irrevocable trust.
The assessee's counsel submitted that, under section 43(2), the term "paid" must be interpreted in light of the method of accounting. He asserted the assessee followed the mercantile (accrual) system of accounting so that "paid" may include an increment of liability (i.e., liability incurred) rather than only physical payment.
The counsel argued that section 40A(7) does not override the provisions of section 36(1)(v) where there was an actual payment to an approved gratuity fund, relying on the decision of the Madras High Court in Commissioner of Income-Tax v. Premier Cotton Spg. Mills Ltd. [2002] 258 ITR 253.

Departmental Representative's Arguments

The Departmental Representative contended that section 40A(7) overrides the provisions of section 36(1)(v) and, in particular, disallows deductions in respect of provisions made for payment of gratuity except in the circumstances enumerated in clause (b) of section 40A(7).
The Department relied on authority (specifically Shree Sajjan Mills Ltd. v. CIT [1985] 156 ITR 585) to support the proposition that clause (a) of section 40A(7) disallows provisions for future gratuity and that the exclusion in clause (b) applies only where the conditions in clause (b) are satisfied (for example, when the sum has become payable during the previous year or other specified conditions are met).

Table of Precedents Cited

Precedent	Rule or Principle Cited For	Application by the Court
Rampyari Devi Saraogi v. CIT [1968] 67 ITR 84 (Apex Court)	Interpretation of "erroneous" under section 263 — Commissioner may treat an Assessment Order as erroneous not only when an error is apparent on the face but also where the order is stereotyped and the AO failed to make enquiries which were called for.	The Bench relied on this authority to uphold the proposition that the Commissioner need not make further enquiries before invoking section 263 where the Assessing Officer failed to make necessary inquiries; thus the AO's order could be considered erroneous and prejudicial to revenue.
Shree Sajjan Mills Ltd. v. CIT [1985] 156 ITR 585 (Apex Court)	Construction of clause (a) of section 40A(7): provisions for future use set aside for gratuity are not deductible; section 40A(1) non obstante clause has overriding effect; contingent liabilities and mere provisions are not deductible even under mercantile accounting.	The Bench applied this principle to hold that provisions made for future gratuity are not deductible unless conditions of clause (b) of section 40A(7) are satisfied; used as primary authority to support disallowance of the excess provision.
Commissioner Of Income-Tax v. Premier Cotton Spg. Mills Ltd. [2002] 258 ITR 253 (Madras HC)	Held that section 40A(7) has no application when there was an actual payment to an approved gratuity fund.	The assessee relied on this decision to argue that actual payment to an approved fund should allow deduction under section 36(1)(v); the Bench considered the authority but found that on facts there was no material to show an ascertained liability or that the conditions for clause (b) were satisfied.
Pereira and Roche v. CIT [1966] 61 ITR 371 (Mad.)	Definition of "paid" in section 43(2) depends on method of accounting: under cash system "paid" means actually paid; under mercantile system it may mean increment of liability (liability incurred).	The Bench cited this to explain the legal position on the meaning of "paid" and to frame the assessee's argument that mercantile accounting could make a provision count as "paid". The Bench nonetheless required proof that the liability was ascertained.
Kanpur Tannery Ltd. v. CIT [1958] 34 ITR 863 (All.)	Even under mercantile accounting, a liability cannot be entered as expenditure unless it is an ascertained sum; a vague liability cannot be treated as "incurred" for the purposes of section 43(2).	The Court used this authority to emphasize that, regardless of mercantile accounting, the liability must be ascertained to qualify as "paid" within section 43(2); the Bench found no material showing an ascertained liability here.
Commissioner Of Income-Tax v. Loyal-Textile Ltd. [1998] 231 ITR 573 (Mad.)	Interpretation of section 40A(7)(b)(i): the phrase "that has become payable during the previous year" qualifies both parts of clause (b)(i), i.e., contributions to an approved fund and gratuities payable during the previous year.	The Bench relied on this authority to reject the assessee's contention that a provision for contribution to an approved fund should be allowed under clause (b)(i) without the contribution having become payable in the previous year.
Tribunal (C-Bench) — ITA No. 529 (Mds.)/1987 dated 21-6-1990 (assessee's own case)	Prior decision in the assessee's own case on similar issues concerning gratuity provisions and their allowability.	The Bench found its present view to be in consonance with that prior Tribunal decision and held that the earlier decision was not rendered per incuriam; therefore it remained binding and supportive of the conclusion reached in this matter.

Court's Reasoning and Analysis

The Special Bench's analysis proceeded in the following sequence:

Interpretation of section 263: The Bench began by applying Rampyari Devi Saraogi to explain that a Commissioner can treat an assessment order as "erroneous" under section 263 not only where an error is obvious on the face of the order but also where the Assessing Officer has issued a stereotyped order without making inquiries that the circumstances required. The Commissioner need not first conduct further inquiries before assuming jurisdiction under section 263.
Application to facts on inquiry failure: The Bench found that the Assessing Officer had failed to make any enquiry into the allowability of the provision for gratuity. Given that failure, the assessment order was held to be erroneous and prejudicial to the interests of revenue, thereby satisfying the conditions precedent for exercise of jurisdiction under section 263.
Substance of the assessee's claim under sections 36(1)(v) and 43(2): The assessee maintained that the provision qualified as a "sum paid" to an approved gratuity fund under section 36(1)(v), given the definition of "paid" in section 43(2) and the asserted use of mercantile accounting. The Bench reviewed authorities (Pereira & Roche; Kanpur Tannery) establishing that "paid" may depend on accounting method but that, even under mercantile accounting, the liability must be an ascertained sum.
Interaction with section 40A(7): The Bench analyzed section 40A(7) and observed that clause (a) disallows provisions for future gratuity and clause (b) provides specific exclusions (for example, contributions to an approved fund) only when particular conditions are met. Shree Sajjan Mills was applied to emphasize that section 40A(1)'s non obstante clause gives section 40A(7) an overriding effect over other provisions relating to computation of business income.
Factual conclusion on liability: The Tribunal noted there was no material before it demonstrating that the liability was an ascertained sum. The Commissioner had compared approved gratuity liabilities as on 31-3-1980 and 31-3-1981 (Rs. 51,97,480 and Rs. 55,35,469 respectively) and calculated incremental liability at Rs. 3,37,989. Since the Assessing Officer had allowed Rs. 7,85,600, the Commissioner directed withdrawal of the excess allowance of Rs. 4,47,611.
Application of Loyal-Textile: The Bench relied on Loyal-Textile to show that the phrase "that has become payable during the previous year" in section 40A(7)(b)(i) qualifies both parts of clause (b)(i), thereby making it inappropriate to allow a provision for contribution to an approved fund where the amount had not become payable during the previous year.
On the contention of per incuriam regarding the Tribunal's earlier order: The Bench reviewed the prior Tribunal decision in the assessee's own case (ITA No. 529/1987 dated 21-6-1990), concluded that it had been carefully considered and was not rendered per incuriam, and therefore the earlier decision remained binding and consistent with the present outcome.

Holding and Implications

DISMISSED. The appeal of the assessee was dismissed.

Implications and direct effects:

The Tribunal upheld the Commissioner's exercise of jurisdiction under section 263 because the Assessing Officer failed to make necessary enquiries, rendering the assessment order erroneous and prejudicial to the revenue.
On the merits, the Tribunal held that the assessee did not establish that the liability was an ascertained sum or that the conditions of section 40A(7)(b) (so as to permit allowance) were satisfied. The Commissioner’s calculation showing incremental liability of Rs. 3,37,989 was accepted, and the excess allowance of Rs. 4,47,611 (difference between Rs. 7,85,600 allowed by the AO and Rs. 3,37,989 incremental liability) was directed to be withdrawn.
The Bench recorded that its conclusion is in consonance with an earlier Tribunal decision in the assessee's own case and expressly held that that earlier decision was not per incuriam; no departure from binding precedent was made.
No broader or novel precedent was announced by the Bench; the decision applies the established principles reflected in the authorities discussed (including the overriding effect of section 40A(7) as explained in Shree Sajjan Mills and the requirement that liabilities be ascertained before being treated as incurred under mercantile accounting).

Note: This summary is strictly confined to and based exclusively upon the content of the provided Tribunal order. It does not add or infer facts or legal points beyond those expressly stated in that opinion.

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Rajalakshmi Mills Ltd. v. Income-tax Officer, Company Circle III, Coimbatore

ORDER

M.K. Chaturvedi, Vice President. - Under section 255(3) of the Income-tax Act, 1961 (hereinafter called the Act) the President of the Income-tax Appellate Tribunal (hereinafter called the Tribunal) has constituted this Special Bench to consider the following questions :—

"1. Whether on the facts and in the circumstances of the case the Commissioner of Income-tax was correct in invoking the provisions of section 263 of the Act in withdrawing the claim of deduction of gratuity provision of Rs. 7,85,600 actually paid to an approved gratuity fund and allowed by the Assessing Officer in the original order of assessment as against incremental actuarial liability worked out at Rs. 3,37,989?

2. Whether the assessee is entitled to claim deduction of Rs. 7,85,600 being the provision for gratuity in terms of section 36(1)(v) of the Act, actually paid to an approved gratuity fund on the facts and in the circumstances of the case?

3. Whether the Appellate Tribunal's order dated 21-6-1990 in ITA No. 529(Mds.)/1987 rendered in the assessee's own case for the assessment year 1982-83 could be said to be an order rendered per incuriam and not binding in view of non-consideration of correct legal position in this regard?"

2. We have heard the rival submissions in the light of the material placed before us and the precedents relied upon. This appeal is directed against the order passed under section 263 of the Act. The assessee is a company. For the relevant assessment year in the balance sheet of the assessee a provision for gratuity was reflected at Rs. 7,85,600. The assessee claimed this as deduction in the return of income. The Assessing Officer allowed the same without making any discussion in the order of assessment. Thereafter the Commissioner of Income-tax assumed jurisdiction under section 263 of the Act, as in his opinion the order was erroneous and prejudicial to the interest of the revenue. In the case of Rampyari Devi Saraogi v. CIT [1968] 67 ITR 84 the Hon'ble Apex Court has held that in order that the Commissioner may consider an order to be erroneous for the purposes of section 263, the error of law may not be apparent on the face of the order. The Commissioner may consider an order of the Assessing Officer to be erroneous not only if it contains some apparent error of reasoning or of law or of fact on the face of it but also because it is a stereotyped order which simply accepts what the assessee has stated in his return and fails to make enquiries which are called for in the circumstances of the case.

3. It is not necessary for the Commissioner of Income-tax to make further enquiries before cancelling the assessment orders of the Assessing Officer. The Commissioner can regard the order as erroneous on the ground that in the circumstances of the case the Assessing Officer should have made further inquiries before accepting the statements made by the assessee in his return. The reason is obvious. Unlike the Civil Court which is neutral to give a decision on the basis of evidence produced before it, an Assessing Officer is not only an adjudicator but is also an investigator. He cannot remain passive in the face of a return which is apparently in order but calls for further enquiry. It is his duty to ascertain the truth of the facts stated in the return when the circumstances of the case are such as to provoke inquiry. The meaning to be given to the word 'erroneous' in section 263 emerges out of this context. The word 'erroneous' in that section includes cases where there has been failure to make the necessary inquiries. It is incumbent on the Assessing Officer to investigate the facts stated in the return when circumstances would make such an inquiry prudent and the word 'erroneous' in section 263 includes the failure to make such an enquiry. The order becomes erroneous because such an enquiry has not been made and not because there is anything wrong with the order if all the facts stated therein are assumed to be correct.

4. In the facts of the present case we find that the Assessing Officer failed to make any enquiry in regard to the allowability of the provision for gratuity. As such in our opinion the order was erroneous and prejudicial to the interests of the revenue. Therefore the conditions precedent for assuming jurisdiction under section 263 did exist in the facts of the present case.

5. The learned counsel for the assessee vehemently contended that the claim of the assessee in regard to the provision for gratuity is allowable under section 36(1)(v) of the Act. This section reads as under :—

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

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

The term 'paid' is defined under section 43(2) of the Act as under :—

"43. In sections 28 to 41 and in this section, unless the context otherwise requires—

(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 head "Profits and gains of business or profession."

6. According to the learned Departmental Representative section 40A(7) overrides the provisions of section 36(1)(v). Section 40A(7) reads as under:—

"40A. (1) The provisions of this section shall have effect notwithstanding anything to the contrary contained in any other provisions of this Act relating to the computation of income under the head "Profits and gains of business or profession'

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

(b) Nothing in clause (a) shall apply in relation to any provision made by the assessee for the purpose of payment of a sum by way of any contribution towards an approved gratuity fund or for the purpose of payment of any gratuity, that has become payable during the previous year."

7. The learned counsel for the assessee submitted that the provisions of section 36(1)(v) are applicable to the facts of the case in regard to the claim of the assessee. Incurring of the liability of the amount in dispute would be demonstrated with reference to the method of accounting. According to the learned counsel for the assessee the assessee did follow mercantile system of accounting. Albeit, in the order of assessment the Assessing Officer did not mention anything in this regard. The column for method of accounting is left blank. Shri Sridhar submitted that on a combined reading of sections 36(1)(v) and 43(2) it is evident that the assessee did make the payment. Besides, the provision of section 40A(7) will not override the provision of section 36(1)(v). Reliance was placed on the decision of the Hon'ble Madras High Court rendered in the case of Commissioner Of Income-Tax v. Premier Cotton Spg. Mills Ltd. [2002] 258 ITR 253 . In this case the Hon'ble High Court has held that section 40A(7) has no application when there was an actual payment to an approved gratuity fund.

8. In the case of Pereira and Roche v. CIT [1966] 61 ITR 371 (Mad.) the Hon'ble jurisdictional High Court has held that the definition of the word 'paid' has specifically been made dependent upon the method of accounting upon the basis of which the profits and gains of the assessee's business are to be computed, in case the assessment is on the basis of cash system of accounting, 'paid' means 'actually paid', i.e., there must be a physical transfer of the amount or its equivalent from the payer to the payee. On the other hand if the assessment is made on the basis of mercantile system of accounting the word 'paid' means no more than the increment of the liability by the assessee for payment. In the latter case, 'actually paid' or 'paid' is not to be understood in a physical sense, but in the sense the liability for the expense has been actually incurred. In the case of Kanpur Tannery Ltd. v. CIT [1958] 34 ITR 863 (All.) it was held that even under the mercantile system of accounting a liability incurred cannot be entered in the accounts as an expenditure unless the liability has become an ascertained sum of money. Until ascertained, the liability no doubt exists, but proceedings have yet to be taken in some way or other to determine the exact amount. A vague liability to make a payment cannot be entered into accounts and in that state it cannot be said to have been incurred so as to count as "paid" within the meaning of section 43(2).

9. In the facts of the present case we find that the assessee did not describe with exactitude the true nature of the liability. The Commissioner of Income-tax found that the approved gratuity liability as on 31-3-1981 and 31-3-1980 was Rs. 55,35,469 and Rs. 51,97,480 respectively. Hence the amount payable as contribution to the fund was only Rs. 3,37,989. The Assessing Officer has allowed Rs. 7,85,600. Accordingly the Commissioner of Income-tax directed the Assessing Officer to withdraw the excess allowance of Rs. 4,47,611. In arriving at this conclusion reliance was placed on the decision of the Hon'ble Apex Court rendered in the case of Shree Sajjan Mills Ltd. v. CIT [1985] 156 ITR 585 . In this case the Hon'ble Apex Court has held as under :—

"On a plain construction of clause (a) of section 40A(7) of the Income-tax Act, 1961, whatever is provided for future use by the assessee out of the gross profits of the year of account for payment of gratuity to employees on their retirement or on the termination of their services would not be allowed as a deduction in the computation of profits and gains of the year of account, unless the respective conditions specified in clause (b) were fulfilled. The expression 'provision made by the assessee' is not used in any artificial sense, e.g. of setting apart specifically by the assessee for meeting the liability for gratuity in his account books, but in its ordinary sense. The embargo under clause (a) is on deduction of amounts provided for future use in the year of account for meeting the ultimate liability to payment of gratuity. Clause (b)( i) excludes from the operation of clause (a) contribution to an approved gratuity fund and amount provided for or set apart for payment of gratuity which would be payable during the year of account. Clause (b)( ii) deals with a situation where the assessee might provide by the spread over method and provides that such provision would be excluded from the operation of clause (a) provided the three conditions laid down by the sub-clauses are satisfied.

The marginal note or heading to section 40A is a clear indication that certain payments and expenses which would be otherwise deductible would not be deductible except in certain circumstances indicated in the section.

Actual payments or provisions for payment would have been eligible for deduction or could have been deducted either under section 28 or under section 37 of the Act. But the use of the non obstante expression in section 40A(1) makes it clear that if there is any legislative base dealing with the provision for gratuity, then the same would be applicable in spite of and notwithstanding any other provision of the Act. Read with the marginal note to section 40A, the non obstante clause of sub-section (1) of section 40A has an overriding effect over the provisions of any other section by providing that the provisions of the section will have effect notwithstanding anything to the contrary contained in any other provision relating to the computation of income under the head 'Profits and gains of business or profession'. Expenditures or allowances which mere deductible under any other provision relating to the head 'Business or profession' will be disallowed in cases to which the provisions of section 40A apply.

Contingent liabilities do not constitute expenditure and cannot be the subject-matter of deduction even under the mercantile system of accounting. Expenditure which is deductible for income-tax purposes is towards a liability actually existing at the time but setting apart money which might become expenditure on the happening of an event is not expenditure."

It may be stated that for the assessment year 1973-74 onwards the applicable law would be in accordance with section 40A(7), as declared by the Hon'ble Apex Court in the case of Shree Sajjan Mills Ltd. (supra).

10. It was further alleged by the learned counsel for the assessee that since provision was made by the assessee for the purpose of payment of a sum by way of contribution towards approved gratuity fund, as such the amount of provision should be allowed within the meaning of section 40A(7)(b).

11. We find it difficult to accept the contention raised by the learned counsel because the assessee did not comply with the conditions contained under section 40A(7)(b) of the Act. In the case of Commissioner Of Income-Tax v. Loyal-Textile Ltd. [1998] 231 ITR 573 (Mad.) the Hon'ble jurisdictional High Court has held that the expression 'that has become payable during the previous year' in section 40A(7)(b)(i ) qualifies both the parts of section 40A(7)(b)( i), viz., (a) any provision made by the assessee for the purpose of payment of any contribution towards an approved gratuity fund, and (b) any provision made by the assessee for the purpose of any gratuity. It cannot be said that the said expression qualifies only the latter of the abovesaid two parts of section 40A(7)(b)(i ). Therefore it is not correct to say that the provision made by the assessee in the accounts for the purposes of making contributions to approved gratuity fund should be allowed under section 40A(7)(b)(i ) despite the fact that there was no incremental liability towards the gratuity due for the assessment year under consideration.

12. Nothing was placed before us to demonstrate the nature of the liability. There is absolutely no material to say that the liability in question was an ascertained liability. An expenditure which is deductible for income-tax purposes is towards a liability actually existing at the time, but setting apart money which might become expenditure on the happening of an event is not expenditure allowable under the law. As such we do not find any merit in the contention of the learned counsel for the assessee in this regard.

13. The view which we have taken here is perfectly in consonance with the decision of the C-Bench of this Tribunal rendered in assessee's own case for the assessment year 1982-83 in ITA No. 529 (Mds.)/1987, dated 21-6-1990. The aforesaid decision of the Tribunal cannot be construed to be per incuriam. "Incuria" literally means "carelessness". In practice per incuriam is taken to mean per ignoratium. English courts have developed this principle in relaxation of the rule of stare decisis. The "quotable in law" is avoided and ignored if it is rendered, "in ignoratium of a statute or other binding authority". We find that the Tribunal considered carefully all the relevant provisions of law. As such, we find no merit in the contention of the learned counsel for the assessee that the decision of the Tribunal was rendered per incuriam.

14. In the result the appeal of the assessee stands dismissed.

Rajalakshmi Mills Ltd. v. Income-tax Officer, Company Circle III, Coimbatore

Summary of Special Bench Order (M.K. Chaturvedi, Vice President)

Factual and Procedural Background

Legal Issues Presented

Arguments of the Parties

Assessee's Arguments

Departmental Representative's Arguments

Table of Precedents Cited

Court's Reasoning and Analysis

Holding and Implications

Rajalakshmi Mills Ltd. v. Income-tax Officer, Company Circle III, Coimbatore

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