Pre-transfer gratuity liability treated as capital expenditure when assumed in business acquisition and later discharged.

Where a transferee takes over an ascertained gratuity liability relating to employees' pre-transfer service as part of the acquisition of a business undertaking, the liability is treated as embedded in the purchase cost and its later discharge is capital in nature. The Madras HC noted that the obligation was capable of actuarial valuation on the date of transfer and formed part of the fixed consideration for the transfer of the unit with assets and liabilities. The payment was therefore not a deductible revenue expense, and the disallowance was upheld against the assessee.

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Issues: Whether gratuity paid by the assessee to employees taken over from the transferor-company, for the period of service rendered before the transfer of the undertaking, was deductible as business expenditure or was capital in nature.

Analysis: The liability to pay gratuity for the employees' pre-transfer service was an ascertained liability on the date of transfer, capable of valuation on actuarial principles. Where such liability of the transferor is taken over by the transferee and forms part of the computation of the purchase price for the business or undertaking, the subsequent discharge of that liability is not a revenue outgoing. The agreement for transfer showed that the unit was transferred with assets and liabilities for a fixed consideration, and the gratuity burden attributable to the period before transfer was treated as embedded in the acquisition cost. Decisions allowing deduction in different factual settings, including amalgamation cases where the capital nature of the liability was not in issue, did not assist the assessee.

Conclusion: The gratuity paid for pre-transfer service was capital expenditure and not allowable as a deduction; the disallowance was upheld, and the issue was decided against the assessee.

Ratio Decidendi: Where a transferee takes over an ascertained pre-existing gratuity liability of the transferor as part of the acquisition of a business undertaking, the later payment discharging that liability is capital expenditure and not a deductible revenue expense.

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