1981 (8) TMI 38 - HC - Income Tax

Court Allows Gratuity Payment to Deceased Director's Widow as Legitimate Business Expenditure

The court ruled in favor of the assessee, allowing the gratuity paid to the deceased director's widow as a legitimate business expenditure for the ... Allowability of gratuity as business expenditure - status of paid directors as employees/service directors - commercial expediency doctrine regarding gratuity - enforceability under articles of association - timing of board resolution and deductibilityAllowability of gratuity as business expenditure - commercial expediency doctrine regarding gratuity - status of paid directors as employees/service directors - enforceability under articles of association - The gratuity of Rs. 35,000 paid to the widow of the deceased paid director is an admissible business expenditure and not an ex gratia payment. - HELD THAT: - The Tribunal found, and this Court accepted, that the assessee's articles of association (article 72(d)) expressly entitled paid directors to benefits on the same scale as staff, and the amount was computed in accordance with the company's gratuity rule (half month's salary for each completed year). The Court observed that modern corporate practice recognises 'service directors' whose position may, for certain purposes, be akin to employees, and there is no legal impediment to treating a paid director as entitled to gratuity where the articles or agreements so provide. The Court relied on the principle, as stated by the Supreme Court in Sassoon J. David and Co. P. Ltd. v. CIT , that gratuity payments in business are not to be regarded as merely ex gratia but may be payments of commercial expediency or necessity; that principle was held applicable to a service director. The Court also noted that the ITO may, in appropriate cases, disallow gratuity or part of it if it is excessive or unrelated to business purposes, but no such contention was made here. Applying these conclusions to the facts, the gratuity paid to the widow was held deductible as business expenditure.Deduction allowed; gratuity paid to the deceased paid director's widow is a legitimate business expenditure.Timing of board resolution and deductibility - enforceability under articles of association - The subsequent board resolution (dated after the accounting year) ratifying the gratuity payment does not justify disallowance where the payment was made in the relevant year pursuant to the articles. - HELD THAT: - The board resolution of August 9, 1963 merely approved and ratified a payment already made during the relevant accounting year pursuant to article 72(d). The Court held that the fact that the formal resolution was passed after the close of the year is immaterial where the gratuity had been paid earlier in accordance with the articles; the Department cannot rely on the timing of ratification to disallow an expenditure properly incurred and paid within the accounting year.Timing of the board's later resolution does not affect the admissibility of the gratuity paid during the relevant year.Final Conclusion: The reference is answered in favour of the assessee: the gratuity of Rs. 35,000 paid to the widow of the deceased paid director is deductible as a business expenditure for financial year 1962-63 / assessment year 1963-64; the subsequent board resolution ratifying the payment does not justify disallowance. Issues:1. Allowability of gratuity paid to deceased director's widow as a business expenditure.Analysis:The judgment pertains to the allowability of gratuity paid by a private limited company to the widow of a deceased director as a business expenditure for the relevant assessment year 1963-64. The Income Tax Officer (ITO) initially disallowed this expenditure, but the Appellate Assistant Commissioner (AAC) and the Appellate Tribunal held it as an allowable item of expenditure. The Tribunal found that the company had a gratuity scheme for staff, and the deceased director was entitled to provident fund and other benefits as per the articles of association. The gratuity amount was determined based on the deceased director's years of service, and a resolution confirmed this basis for calculation, leading the Tribunal to allow the deduction as a business expenditure.The argument raised by the I.T. Department's standing counsel was that gratuity is not applicable to company directors as they are not employees. However, the judgment highlighted the evolving trend of having service directors on boards, blurring the distinction between directors and employees. The court referenced landmark decisions emphasizing that directors can be considered employees under certain circumstances. Additionally, the court cited a Supreme Court decision establishing that gratuity payments are no longer ex gratia but based on commercial expediency, applicable not only to employees but also to service directors.Regarding the timing of the gratuity payment resolution, the court dismissed its significance as the payment was made before the resolution, in accordance with the articles of association. The resolution merely approved and ratified the payment already made. The court concluded that the gratuity paid to the deceased director's widow was a legitimate business expenditure, not ex gratia, and upheld the Tribunal's decision. Consequently, the court answered the question in the affirmative, ruling in favor of the assessee and awarding costs.