Contingent gratuity liability is not deductible unless section 40A(7) conditions are satisfied under income tax law

An assessee on the mercantile system could not claim deduction of actuarially valued gratuity liability under section 28 or section 37 where no provision was made in the accounts and the conditions of section 40A(7) were not satisfied. The liability was treated as contingent, and the fact that the assessee maintained mercantile accounting did not change its character into deductible expenditure. Section 40A overrides the general deduction provisions, so gratuity becomes deductible only when the statutory requirements are met. The deduction claim was therefore rejected and the question was answered in favour of the Revenue.

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Issues: Whether an assessee following the mercantile system of accounting could claim deduction of actuarially valued gratuity liability under section 28 or section 37 of the Income-tax Act, 1961, when no provision had been made in the accounts and the conditions of section 40A(7) were not satisfied.

Analysis: The liability for gratuity was held to be contingent in nature, and the Supreme Court had already settled that such liability is not deductible on general commercial principles or under the other provisions of the Act. Section 40A(1) gives overriding effect to section 40A, and for gratuity to be deductible the conditions laid down in section 40A(7) must be fulfilled. The fact that the assessee followed the mercantile system did not alter the character of the liability as contingent expenditure.

Conclusion: The assessee was not entitled to deduction of the actuarially valued gratuity liability under section 28 or section 37 of the Income-tax Act, 1961. The question was answered in the negative, in favour of the Revenue and against the assessee.

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