Capital Characterisation of Gratuity: isolated ex gratia payments without a prior scheme are not deductible under income tax rules.

Whether a payment characterised the transferee company's liability under a business transfer or was an expenditure incurred in the ordinary course for employee remuneration was determinative; the claimant bore the burden to prove a pre existing scheme, practice or undertaking that gratuity formed part of remuneration or that the payment was wholly and exclusively for business purposes, and led no such evidence. The court treated the payment as isolated ex gratia and therefore of capital character, concluding it was not admissible as a deduction under the relevant income tax provision.

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Issues: Whether the payment of Rs. 38,509 was an expenditure in the nature of capital and therefore not admissible as a deduction under Section 10(2)(xv) of the Income-tax Act, 1961.

Analysis: The court examined whether the payment was made as part of the liabilities undertaken under the agreement transferring the predecessor firm's business to the company or, alternatively, whether it was an expenditure incurred by the company in the ordinary course of business supported by an established undertaking, understanding or practice to pay gratuities. The court noted that the Tribunal treated the payment as arising from the company s undertaking of the predecessor firm's liabilities under the transfer agreement. The court further observed that, even if treated as a direct payment by the company, there was no evidence of any scheme, practice, undertaking or expectation by employees that gratuity formed part of their remuneration; the payment appeared to be an isolated ex gratia payment. The burden to prove that the payment formed part of remuneration or was incurred wholly and exclusively for the purpose of business rested on the claimant, who led no such evidence. The court relied on similar precedent holding isolated gratuity payments without a supporting scheme or practice to be non-deductible.

Conclusion: The payment of Rs. 38,509 was a capital expenditure and therefore not an admissible deduction under Section 10(2)(xv) of the Income-tax Act, 1961; the Tribunal s conclusion is affirmed.

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