Actuarially valued gratuity provisions are deductible when backed by an approved fund and accrued employee liability.
Gratuity provisions are deductible only when they fall within the statutory exception for an actuarially valued provision backed by an approved gratuity fund under an irrevocable trust, with the prescribed contribution conditions satisfied; a mere reserve or contingent liability remains disallowable. Where employees' right to gratuity has matured on retirement or cessation of service, the liability is treated as accrued and ascertainable, and not as a future contingency. On those principles, the provision relating to employees whose entitlement had crystallised by the end of the relevant year was regarded as deductible in the corresponding assessment year.
Issues: (i) Whether the assessee satisfied the conditions for deduction of the gratuity provision under section 40A(7)(b)(ii) of the Income-tax Act, 1961. (ii) Whether the gratuity liability for employees who retired or ceased service up to 31 March 1973 crystallised in the previous year 1972-73 and was deductible for the assessment year 1973-74.
Issue (i): Whether the assessee satisfied the conditions for deduction of the gratuity provision under section 40A(7)(b)(ii) of the Income-tax Act, 1961.
Analysis: Section 40A(7) generally disallows deduction for a mere provision for gratuity, but clause (b)(ii) permits deduction where the provision is made on actuarial valuation, an approved gratuity fund is created under an irrevocable trust, and the prescribed contribution conditions are met. The assessee had created such a trust, the fund was approved, and the provision was within the admissible amount. The liability related to employees whose gratuity had already become payable under the statutory regime and was not an unascertained reserve.
Conclusion: The assessee satisfied the statutory conditions and the deduction was allowable.
Issue (ii): Whether the gratuity liability for employees who retired or ceased service up to 31 March 1973 crystallised in the previous year 1972-73 and was deductible for the assessment year 1973-74.
Analysis: Gratuity becomes an accrued liability when the employee's right to receive it matures on retirement or termination, and before that it remains contingent. On the facts, the claim was confined to amounts payable to employees whose entitlement had already arisen by the end of the relevant financial year. The provision was made on actuarial valuation for that ascertained liability, and the mercantile system did not convert a contingent liability into a deductible expenditure. The liability for the relevant employees had crystallised in 1972-73.
Conclusion: The liability crystallised in the previous year 1972-73 and the deduction was allowable for assessment year 1973-74.
Final Conclusion: The reference was answered in favour of the assessee, and the gratuity provision was held deductible under the statutory exception applicable to approved gratuity fund arrangements and ascertained liabilities.
Ratio Decidendi: A gratuity provision is deductible only where it represents an ascertained and accrued liability falling within the statutory exception for actuarially valued provision backed by an approved irrevocable gratuity fund; a contingent liability or mere reserve remains disallowable.
TaxTMI 
AI Drafter ✕
TaxTMI 
