1986 (8) TMI 152 - AT - Income Tax

Gratuity liability deductible under Section 40A(7) for business sale termination.

Income Tax Officer. Versus Mount Stuart Tea Estate.

The Tribunal held that the provisions of section 40A(7) are applicable to the assessee's claim for gratuity payments. The Tribunal found that the gratuity ... Business Expenditure, Allowability of, Business Disallowance, Gratuity Issues Involved:1. Whether the gratuity payments claimed by the assessee as business expenditure are allowable under section 37(1) of the Income-tax Act, 1961.2. Applicability of section 40A(7) of the Income-tax Act, 1961 to the gratuity payments.3. Interpretation of the term 'provision' under section 40A(7).Issue-wise Detailed Analysis:1. Allowability of Gratuity Payments under Section 37(1):The assessee, a registered firm, claimed a deduction of Rs. 5,40,000 as business expenditure under section 37(1) of the Income-tax Act, 1961, for gratuity payments. The Income Tax Officer (ITO) disallowed this claim on three grounds: (i) the gratuity was not paid to the employees, (ii) the payment to the purchaser on behalf of the employees does not entitle the assessee to the deduction, and (iii) there was no evidence that the employees were parties to the agreement between the seller and the buyer of the estate.The Commissioner (Appeals) allowed the claim by applying the decision in CIT v. Sarada Binding Works [1985] 152 ITR 520, which held that payment made to discharge an obligation incurred while the business was carried on by the assessee should be allowed as a deduction. However, the Commissioner (Appeals) did not follow the decisions in Stanes Motors (South India) Ltd. v. CIT [1975] 100 ITR 341 and CIT v. Salem Bank Ltd. [1979] 120 ITR 224.2. Applicability of Section 40A(7):The department contended that section 40A(7), which concerns the provision for gratuity, overrides section 37. Section 40A(7) disallows any provision for gratuity unless it is a contribution towards an approved gratuity fund or based on actuarial valuation of ascertainable liability. The assessee argued that the provision under section 40A(7) should be understood in the accounting sense and that the actual payment was made to the transferee to cover the gratuity liability.The Tribunal examined the width and ambit of section 40A(7) as explained by the Supreme Court in Shree Sajjan Mills Ltd. v. CIT [1985] 156 ITR 585, which clarified that any provision for future use for payment of gratuity is not deductible unless specific conditions are met. The Tribunal rejected the assessee's contention that section 37 would apply and held that section 40A(7) governs the provision for gratuity.3. Interpretation of 'Provision' under Section 40A(7):The Tribunal referred to the Supreme Court's interpretation in Shree Sajjan Mills Ltd.'s case, which stated that the term 'provision' should be understood in its ordinary sense and not in any artificial sense. The Tribunal concluded that section 40A(7) applies to the facts of the case and that the assessee's claim must be examined under this section.Conclusion:The Tribunal held that the provisions of section 40A(7) are applicable to the assessee's claim. The gratuity liability had become presently payable due to the termination of employment upon the sale of the business. The assessee had provided for this liability by accepting a reduction in the sale consideration, which the purchaser agreed to discharge. Therefore, the assessee's provision for gratuity was exigible for deduction under the second limb of section 40A(7)(b)(i).The Tribunal upheld the order of the Commissioner (Appeals) not under section 37 but under section 40A(7)(b)(i). The departmental appeal was dismissed.