1985 (10) TMI 2 - SC - Income Tax

Gratuity deductible only when accrued and payable; Section 40A(7)(a) bars current profit provisions, exceptions in 40A(7)(b)

Shree Sajjan Mills Limited Versus Commissioner of Income-Tax, MP And Another

SC held that gratuity becomes deductible only when it accrues and is payable on an employee's retirement or termination; until then it remains a ... Deduction of gratuity liability under Section 37 - non-compliance with the provisions of section 40A(7) - HELD THAT:-The right to receive the payment accrued to the employees on their retirement or termination of their services and the liability to pay gratuity became the accrued liability of the assessee, when the employees retired or their services were terminated. Until then the right to receive gratuity is a contingent right and the liability to pay gratuity continues to be contingent liability qua the employer. An employer might pay gratuity when the employee retires or his service is terminated and claim the payment made as an expenditure incurred for the purpose of business under section 37. As there were several methods which the assessee might choose to adopt in meeting his liability to pay gratuity, the treatment which he would receive under the Income-tax Act would depend upon the method adopted by him. The assessee is only under an obligation to pay gratuity when it became due and payable. The other methods adopted by the assessee for meeting the liability for gratuity as and when it arose are provisions or arrangements made by him at his option. It is not obligatory on him to make any such provision and if no such arrangement or provision was made, no question arose to consider its deductibility or allowance under the Act. On a plain construction of clause (a) of sub-section (7) of section 40A of the Act, what it means is that whatever is provided for future use by the assessee out of the gross profits of the year of account for payment of gratuity to employees on their retirement or on the termination of their services would not be allowed as deduction in the computation of profits and gains of the year of account. The provision of clause (a) was made subject to clause (b). The embargo is on deductions of amounts provided for future use in the year of account for meeting the ultimate liability to payment of gratuity. Clause (b)(i) excludes, from the operation of clause (a) contribution to an approved gratuity fund and amount provided for or set apart for payment of gratuity which would be payable during the year of account. Clause (b)(ii) deals with a situation where the assessee might provide by the spread-over method and provides that such provision would be excluded from the operation of clause (a) provided the three conditions laid down by the sub-clauses are satisfied. The principle that fiscal statutes should be strictly construed does not rule out the application of the principles of reasonable construction to give effect to the purpose or intention of any particular provision as apparent from the scheme of the Act, with the assistance of such external aids as are permissible under the law. Appeals dismissed. Issues Involved:1. Deduction of gratuity liability under Section 37 of the Income-tax Act, 1961.2. Applicability and interpretation of Section 40A(7) of the Income-tax Act, 1961.3. Compliance with statutory provisions for claiming deductions for gratuity.Detailed Analysis:1. Deduction of Gratuity Liability under Section 37 of the Income-tax Act, 1961:The assessee, a public limited company, claimed deductions for gratuity liability determined actuarially for the assessment years 1973-74 and 1974-75. For 1974-75, the assessee sought to deduct Rs. 18,37,727, but the Income-tax Officer allowed only Rs. 2,65,872, disallowing the rest due to non-compliance with Section 40A(7). The Tribunal allowed the deduction of Rs. 15,71,855, which was not provided for in the books. For 1973-74, the Tribunal allowed Rs. 28,59,431 out of Rs. 48,59,431, disallowing Rs. 20,00,000 due to non-compliance with Section 40A(7). The High Court held that the assessee was not entitled to deductions without complying with Section 40A(7).2. Applicability and Interpretation of Section 40A(7) of the Income-tax Act, 1961:Section 40A(7)(a) prohibits deductions for any provision made for gratuity payment unless it meets specific conditions under Section 40A(7)(b). The High Court emphasized that Section 40A has an overriding effect on other provisions for computing income under 'Profits and gains of business or profession.' The High Court agreed with the Calcutta High Court's view that Section 40A(7) precludes deductions for gratuity liability unless statutory conditions are met, regardless of whether the liability is reflected in the books.3. Compliance with Statutory Provisions for Claiming Deductions for Gratuity:The High Court noted that Section 40A(7) required strict compliance for deductions related to gratuity. The assessee argued that Section 40A(7) should be strictly construed and only applied if a provision was made in the books. The Court rejected this, stating that allowing deductions without compliance would defeat the purpose of Section 40A(7). The Court highlighted that the legislative intent was to ensure that deductions for gratuity were only allowed under specific conditions, which the assessee did not meet.Conclusion:The Supreme Court upheld the High Court's decision, emphasizing that Section 40A(7) must be strictly followed for deductions related to gratuity. The appeals were dismissed with costs, affirming that the assessee's claims for deductions without meeting the statutory requirements were not permissible. The judgment clarified that the legislative intent behind Section 40A(7) was to regulate and restrict deductions for gratuity, ensuring compliance with specified conditions.