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Judgment
Rajagopalan, Offg. C.J.
The Associated Publishers Ltd., to which we shall refer hereafter as the predecessor company, carried on the business till January 31, 1950. It
was transferred to the assessee company which continued the business from February 1, 1950, without any break. Both were private companies,
and a third company, Amalgamations Ltd., was the principal shareholder of both. The year of account of that business ended on January 31 each
year. When the business changed hands on February 1, 1950, the claim of the workmen for Deepavali bonus for 1949 was the subject of an
industrial dispute pending adjudication before the Industrial Tribunal constituted under the Industrial Disputes Act. The award of the Tribunal,
directing the grant of bonus of one and a half months basic wages to each of the workmen, was published on February 9, 1951. The assessee
company was a party to that award. Section 18 of the Industrial Disputes Act provided for the enforcement of the award against the successor,
where there had been a succession to business. The claim for bonus for Deepavali in 1950 was settled by direct negotiation between the assessee
company and its workmen on the same lines, namely, one and a half months wages. That agreement was arrived at on June 30, 1961. The total
amount thus payable as bonus for the two years amounted to Rs. 54,140, and that amount was debited in the accounts of the assessee company in
its year of account which ended on January 31, 1952. Out of this amount Rs. 51,936 appears to have been disbursed to the workmen in the
course of that year. The balance of Rs. 3,204 remained undisbursed even in the next year, and it was shown as a liability of the assessee company
in the next years account. The assessee company deducted the amount of Rs. 54,140 as an allowable item of expenditure in computing its losses in
the assessment year 1952-53. That claim was disallowed by the Income Tax Officer, who added back the sum of Rs. 54,140 to compute the loss
that the assessee could be allowed to carry forward. In the assessment year 1953-54 the undisbursed bonus of Rs. 3,204 was added back by the
Income Tax Officer to compute the assessable profits of the year of account 1952-53. The learned counsel for the assessee represented that the
assessee company did not claim Rs. 3,204 over again as an allowable item of expenditure in the year of assessment of 1953-54. The Assistant
Commissioner, to whom the assessee company appealed allowed the claim of the assessee for : both the years. On appeal preferred by the
department, the Tribunal set aside the orders of the Assistant Commissioner and restored the orders of the Income Tax Officer.
The Tribunal referred the following question to this court u/s 66(1) of the Indian Income Tax Act :
Whether the amounts of Rs. 54,140 and Rs. 3,204 aforesaid are allowable as deductions form the business profits of the assessee for the
assessment years 1952-53 and 1953-54 ?
The real question for determination is, whether the liability to pay Rs. 54,140 as bonus for 1949 and 1950, which was undertaken by the
assessee company in its year of account 1951-52, was an allowable item of expenditure in assessing the profits and losses of that year of account
in the assessment year 1952-53. It would appear that the department and the Tribunal did not quite realise that the sum of Rs. 3,264 added back
in the next year was included in this sum of Rs. 54,140. Whether the claim of the assessee company that Rs. 54,140 was an allowable item of
expenditure is allowed or not, if the sum of Rs. 3,204 was included in Rs. 54,140, Rs. 3,204 will have to be excluded in computing the profits of
the assessee company in the assessment year 1953-54. The learned counsel represented that an application for rectification was preferred to the
Income Tax Officer on July 28, 1956, and that petition has not yet been disposed of.
We may advert even at this stage to one feature which cannot be a matter of controversy. Had there been no disputes at all between the
workmen and the management, and had there been no transfer of the business, the Deepavali bonus for 1949 would have been based on the
profits of the year of account that ended on January 31, 1949, but would have been paid only in the year of account that ended on January 31,
1950. Similarly, the Deepavali bonus for 1950 would have been paid in the year of account that ended on January 31, 1951. The assessee
company succeeded to the business on February 1, 1950. The dispute over the 1949 bonus was settled by an award which became enforceable
on February 9, 1951, and the claim for the 1950 bonus was settled by agreement on June 30, 1951. Consistently with the mercantile system of
accounting the assessee company adopted, the liability that accrued under the award and under the agreement was shown in the books of account
the same year. That the assessee treated it as a liability of its year of account 1951-52 did not admit of any doubt. The genuineness of that liability
and that of its discharge were never in issue either.
The grounds on which the Tribunal disallowed the claim of the assessee that the payment of the bonus constituted an allowable item of its trading
expenses of its year of account 1951-52 were summarised in paragraph 15 of the statement of the case :
The Tribunal held in the above appeals in the absence of annexure A aforesaid which was not before it at that time :
(i) that the liability of the workers under the awards was primarily the liability of the predecessors;
(ii) by an omission to evaluate the contingent liability for purposes of transfer, the assessee had only voluntarily lost the amount in favour of the
predecessor which was, after all, another private limited company with more or less identical shareholders;
(iii) that such loss is referable only to goodwill adjustment and so only capital in nature;
(iv) that the assessee received no direct benefit of such payments as the award related to the period of employment of the labour force by the
predecessors; and
(v) that consideration of commercial expediency had to be ruled out as the payments were made only under a legal obligation and necessity which
would not be by any means avoided.
We shall deal first with the question, whose liability it was that the assessee company discharged when it paid the bonus for 1949 and 1950 in
the year of account 1951-52. The Tribunal held that the primary liability was that of the predecessor 6. company. It was no doubt for services
rendered to the predecessor company that the Deepavali bonus for 1949 was claimed and was eventually paid under the award of the Industrial
Tribunal. The bonus payable on the occasion of Deepavali in 1950 could not be viewed as payable wholly for services rendered to the
predecessor company. Before that bonus could be claimed, that is, even before the Deepavali in 1950, the assessee company had taken over the
business, and after February 1,1950, the services were to the assessee company. That the profits earned in the year of account ended on January
31, 1950, would, in the normal circumstances, have furnished the basis for determining the quantum of bonus payable on the occasion of Deepavali
in 1950 did not alter the position, that the bonus was climbable and if there had been no dispute, would have been payable only in the year of
account that ended on January 31, 1951. Apart from this aspect of the case, it was a statutory liability that the assessee company discharged when
it paid the bonus for 1949. Section 18 of the Industrial Disputes Act made the award enforceable against the successor in business. The assessee
company was itself made a party to the industrial dispute, and even as a party it was bound by that award u/s 18 of the Industrial Disputes Act. It
is true that there was no statutory liability as such when the assessee company undertook to pay bonus for 1950. Had there been no direct
settlement with the workmen there would have certainly been an industrial dispute and, section 18 of the Industrial Disputes Act would then have
imposed a statutory liability on the assessee company. It was in form a contractual liability under a contract with the workmen, but it was obviously
undertaken to avoid an industrial dispute. Thus it was a liability legally enforceable against it that the assessee company discharged by providing for
the payment of bonus for the two years 1949 and 1950.
The liability itself accrued only after the date of the transfer. It is not clear when the claim for 1949 was preferred by the workers. Obviously it
was not admitted, as that claim was eventually referred as an industrial dispute for adjudication by the Industrial Tribunal. The claim for bonus, to
whatever period it relates, is at best a contingent liability even at the stage the claim is preferred. It becomes an accrued liability even at the stage
the claim is preferred. It becomes an accrued liability if the claim is admitted by the employer. If the claim is denied and the workmen do not
pursue the claim it will never accrue as a liability. If the claim is denied by the employer and it is referred as an industrial dispute, no liability
accrues, if the Industrial Tribunal after adjudication, it becomes an accrued liability when the award becomes enforceable. If, as happened in the
case of the claim for 1950, the claim for bonus is settled by agreement between the employer and the employees, it becomes an accrued liability on
the date of the agreement.
In Muir Mills Co. Ltd. v. Suti Mills Mazdoor Union the Supreme Court pointed out :
This imports the conception that even though the payment be not strictly due to the recipient nor legally enforceable by him, a claim to the same
may be laid by the employee under certain conditions and if such claim is entertained either by an agreement with the employer or by adjudication
before a properly constituted Tribunal as on an industrial dispute arising, the same would ripen into a legally enforceable claim.
In Commissioner of Income Tax v. Burmah Oil Co. (Burma Concessions) Ltd. The claim of workmen for wages during the period of
occupation of Burma by the enemy forces, which claim was barred by limitation, was allowed in part by the court of industrial arbitration. The
amount was ordered to be paid without reference to any particular period of time. The Rangoon High Court held that the liability to pay the amount
was incurred by the company only in the year when the industrial court made its award. That was another instance where a claim not legally
enforceable becomes an accrued liability when the claim itself becomes legally enforceable.
In the case of the assessee company, when the liability to pay the bonus for 1949 and 1950 became an accrued liability, the law imposed that
liability on the assessee. Thus it was its own legal liability that the assessee company discharged when it provided for the bonus payments in the
year of account 1951-52.
Annexure ""A"" to the statement of the case, which evidenced the terms of the transfer of the business from the predecessor company, made it
clear that the liability to pay bonus neither for 1949 nor for 1950 was taken into account in fixing the price paid by the assessee company for the
transfer. It was not part of the price payable by the assessee company for the transfer of the business. Whether or not legally the assessee
company could recoup itself in full or in part from its predecessor the bonus payments it made in discharge of the liability the law imposed on the
assessee company, the assessee company had no contractual right to recover it from its vendor predecessor company. As we pointed out,
factually that liability - the Tribunal itself was alive to the feature that it was only a contingent liability at that stage - was not one of the factors taken
into account in determining the price the assessee company had to pay for the transfer of the business. Though annexure ""A"" was not before the
Tribunal when it disposed of the appeal, there fact that the liability to pay bonus payments did not enter the determination of the purchase price
was apparently never in dispute, because the Tribunal took the view that ""by the omission to evaluate the contingent liability for purposes of
transfer, the assessee only voluntarily lost the amount in favour of the predecessor."" The assessee company was not bound to evaluate that
contingent liability before effecting the purchase of the business. Factually it did not. When the legal liability to pay the bonus for 1949 and 1950
accrued, and that legal liability was that of the assessee company, it would be erroneous to view the discharge of that liability as constituting a loss
voluntarily undertaken by the assessee company for the benefit of the predecessor company.
We shall next consider the question, whether the expenditure incurred by the assessee company in discharge of its legal liability was of a capital
nature. Under normal circumstances the payment of bonus to the employees would be a trading expense, and it would not be an expenditure of a
capital nature. If the liability to pay the bonus had been that of the transferor as an accrued liability, and that liability was transferred to the
transferee under the terms of the contract of the transfer, that is, if the liability so transferred was one of the factors taken into account to fix the
price payable by the transferee, then the amount expanded in discharge of the liability so transferred would have been part of the price paid by the
transferee for the acquisition of the business. Whether the accrued liability that was so transferred was a liability to an employee, or any other trade
liability, can make no difference in principle.
In Royal Insurance Co. v. Watson on which the learned counsel for the department relied, it was expressly held that what the transferee paid
to the manager when dispensing with his services was part of the consideration for the transfer of the business. At page 504 of the report the Lord
Chancellor observed :
it may be said that the bargain between the two companies involved a liability, which was discharged by the payment of this sum, and therefore I,
as a matter of fact, come to the conclusion that this was part of the purchase money (and when I use the compendious phrase purchase money, of
course I include the arrangement made in respect of shares, because it matters not whether it was paid in money or was paid in moneys worth), but
the result is that one of the companies sells to the other, and part of the consideration which was contemplated by both parties, and in respect of
which the bargain was made, and without which the bargain could not have been made, was the manager, and all that was incident to the manager
in respect of the payments to be made to him, whether made at once, or made in this form of commutation.
That case is certainly not authority for the proposition which the learned counsel for the department advanced, that where there is succession to
business on transfer by sale, payments made by the vendee in discharge of the liability of its predecessor vendor would constitute expenditure of a
capital nature in the absence of any express provision in the contract of transfer for the discharge of that liability. We are unable to see anything in
principle or authority to support this contention. The payment made in discharge of a contractual liability imposed in express terms by the contract
of transfer or sale and equated to payment in part of the purchase price is laid out to complete the purchase and to discharge the purchasers
liability. The principle applicable to such payments, that they constitute expenditure of a capital nature, cannot be extended to a case like the
present, where the liability devolved on the assessee company by operation of law. That liability itself accrued only after the transfer, that is the
liability under the award and the subsequent liability under the agreement between the workmen and the assessee company. As we have pointed
out, factually the discharge of that liability was not part of the contract of transfer, and the payment of bonus was not : part of the purchase price.
The discharge of the legal obligation was not part of the contract of transfer.
In Cooke v. Quick Shoe Repair Service the sale of the business was on October 2, 1945. The terms of the sale provided that the vendor
should discharge the business liabilities he had incurred before September 30, 1945. The vendor was unable to discharge all of them, and in the
year after the sale, 1946-47, the vendee discharged some of these liabilities amounting to Pounds 613 18s. 7d. The Commissioners found ""the said
liabilities of Mr. Dent (vendor) were discharged by the respondents (vendees) because the respondent found that the creditors of Mr. Dent who
had traded in the normal course. The payments were made generally in order to preserve the goodwill of the business and to ensure continuity of
supply of material and labour."" Croom-Johnson J. upheld the claim of the vendee that these payments constituted an allowable deduction in the
assessment year 1946-47. At page 464 the learned judge observed :
The purchase having been completed, the vendor found himself unable to pay and did not pay the debts in question, and inasmuch as the
purchasers had purchased the goodwill of the business as well as other assets, they found themselves in this position-that if they did not pay, to use
a popular expression, their name would be mud (that really is to put this case in its simplest form)-and accordingly they paid voluntarily the debts
which the vendor owed and which the vendor ought to have paid. What the Commissioners have found is that those payments were made in order
to preserve the value of the capital assets, namely, the purchase of the goodwill, which they had bought. How can I say in those circumstances that
there is no evidence to support such a finding ?
That was a case of an accrued liability, and the legal and contractual liability to discharge it was that of the vendor. Even so, when the vendee
paid these debts, they were treated as normal trading expenses. The point to remember is that it was not part of his purchase price. Whether he
had a legal remedy to recover this sum from his vendor made no difference. If he recovered them they would obviously be trading receipts.
The claim of the assessee before us is on an even better footing. The liability to pay bonus did not accrue until the transfer on February 1,
1950. Once again, we have to point out that the legal liability to pay the bonus was that of the assessee company. It was a business that continued
without a break. Unless the workmen were paid the bonus, apart from the statutory penalties to which the assessee company would be exposed
for failing to implement the award for 1949 and the agreement for 1950, continuance of the business itself would have been imperiled. It was an
expenditure incurred to continue the business and to secure industrial peace and harmony in which the business could be continued. By no known
test could such an expenditure be viewed as a capital expenditure.
In S. R. V. G. Press Co. v. Commissioner of Excess Profits Tax while holding that the payment towards sales tax was an item of expenditure
that could be lawfully deducted to ascertain the assessable profits the learned judge observed :
Sales tax is a compulsory levy under the sanction of the Legislature and there is no discretion left to the assessee as regards the extent of the
payment... The expenditure is unremunerative but is not the less a proper deduction, for without such expenditure the business of purchasing and
selling could not be carried on... The payment of sales tax has no doubt the effect of diminishing the assessees taxable income but such payment is
necessary if the assessee is to carry on business at all and this is not a case where the assessee having a discretion to lay out money for the purpose
of earning profits in a business spends an unnecessarily large amount during the chargeable accounting period.
As we have pointed out, the assessee company was under a legal obligation to pay the bonus for 1949 and 1950. Even apart from that feature
of the case that the obligation to pay bonus was legally enforceable against the assessee company, the discharge of that liability after it had accrued
was necessary for the continuance of the business. It was an expense incurred not for the acquisition of the business, but for its continuance. It was
certainly not an expenditure of a capital nature.
The learned counsel for the department referred us to the decision of the Privy Council in Tata Hydro-Electric Agencies Ltd. v. Commissioner
of Income Tax. But the express basis on which the contention of the assessee was negatived in that case was, in the words of their Lordships :
They must have taken this liability into account when they agreed to take over the business. In short, the obligation to make these payments was
undertaken by the appellants in consideration of their acquisition of the right and opportunity to earn profits, that is, of the right to conduct the
business, and not for the purpose of producing profits in the conduct of the business. If the purchaser of a business undertakes to the vendor as
one of the terms of the purchase that he will pay a sum annually to a third party, irrespective of whether the business yields any profits or not, it
would be difficult to say that the annual payments were made solely for the purpose of earning thee profits of the business.
Commissioner of Income Tax v. Kameshwar Singh does not help the department either. In that case the assessee paid the arrears of rent that
had accrued before the transfer. The claim that they constituted allowable deductions was negatived. Their Lordships of the Privy Council Pointed
out :
It is a sum which was payable by him in order to get possession of the colliery, not a sum expended by his in the carrying out of the colliery. It is
not rent for any period of his possession, nor is it an expenditure incurred by the assessee for the purpose of earning the profits or gains of the
colliery business. If the assessee paid it without any legal liability or necessity on his part to do so, such a voluntary payment is not a permissible
deduction from income.
In the present case we are dealing with a payment made by the assessee company in discharge of a legal liability imposed on it.
The next question is, whether the payment satisfied the other requirement of section 10(2)(xv), that the expenditure was laid out wholly and
exclusively for purposes of the business of the assessee. It was common ground that this was not a claim that fell within the scope of section 10(2)
(x). What we have already pointed out, that it was an obligation legally enforceable against the assessee, and that even independently of that, the
assessee had to discharge that obligation to carry on the business to secure the industrial peace and harmony necessary to carry on that business,
should suffice to hold that the further requirement of section 10(2)(xv) has also been satisfied in this case. The Tribunal was of the view, that the
assessee received no direct benefit by such payments as the award related to the period of employment of the labour force buy the predecessors.
Even if the test of direct benefit were to apply, that was satisfied. The assessee company did benefit itself, in that it enabled itself to continue its
business with a contented set of employees. The test is not whether the assessee company had the exclusive benefit of the bonus payment. While it
would be true to say that the predecessor company had the benefit of the service during the major portion of the period to which the claims for
bonus related, the assessee company had obviously the benefit of the payments made after the liability to pay the bonus had accrued. Another of
the grounds on which the Tribunal negatived the claim of the assessee company was that the consideration of commercial expediency had to be
ruled out as the payments were made only under a legal obligation and necessity which could not be any any means avoided. If the Tribunal meant
that payment made in discharge of a legal obligation would never constitute a deduction u/s 10(2)(xv) we must firmly reject such an unwarranted
restriction of the scope of section 10(2)(xv).
We differ from the Tribunal and we hold that the sum of Rs. 54,140 constituted an allowable item of expenditure in computing the profits and
losses of the assessee company. The requirements of section 10(2)(xv) were satisfied.
The assessees claim, it should be remembered, was to deduct this sum in computing its profits and losses for the year of account that ended on
January 31, 1952. The learned counsel for the department urged that, even if the requirements of section 10(2)(xv) were satisfied, the deduction
should not be permitted in the assessment year 1952-53, and that the bonus payments for 1949 and 1950 were properly debitable only to the
years of account that ended on January 31,1950, and January 31, 1951, respectively. That was not one of the grounds on which the Tribunal
negatived the claim of the assessee company. Such a contention was never put forward by the department for adjudication by the Tribunal. Such a
contention does not arise for consideration at this stage. As a question of law it does not arise on the order of the Appellate Tribunal.
Were it necessary to decide that question, we should hold that the expenditure was properly debitable in the year of account that ended on
January 31, 1952. It was only in that year that the liability accrued. In the earlier years it was at best a claim for bonus, a contingent liability. That a
provision for meeting a contingent liability is not an allowable item of deduction was clearly explained by the Supreme Court in Indian Molasses
Co. v. Commissioner of Income Tax 1. At page 76 Hidayatullah J. said :
Expenditure in this sense is equal to disbursement which, to use a homely phrase, means something which comes out of the traders pocket. Thus, in
finding out what profits there be, the normal accountancy practice may be to allow as expense any sum in respect of liabilities which have accrued
over the accounting period and to deduct such sums from profits. But the Income Tax laws do not take every such allowance as legitimate for
purposes of tax. A distinction is made between an actual liability in praesenti and a liability de futuro which, for the time being, is only contingent.
The former is deductible but not the latter.
This principle was reaffirmed at page 79 :
To be a payment which is made irrevocably there should be no possibility of the money forming, once again, a part of the funds of the assessee
company. If this condition be not fulfilled and there is a possibility of there being a resulting trust in favour of the company, then the money has not
been spent, i.e., paid out or away, but the amount must be treated as set apart to meet a contingency. There is a distinction between a contingent
liability and a payment depending upon a contingency. The question is whether in the years of account, one can describe the assessee companys
liability as contingent or merely depending upon a contingency.
In Ford & Co. Ltd. v. Commissioners of Inland Revenue 1 it was laid down that so long as it was only a contingent liability it was not an
allowable item of expenditure.
The learned counsel for department referred to Commissioner of Income Tax v. Nagri Mills Co. Ltd. 2 There the assessee company
maintained its accounts on the mercantile basis. It did not make any entry towards bonus for the calendar year 1951. The bonus became payable
under the award in June, 1952. The company was directed to pay the bonus out of the profits of 1951. The company in making the return claimed
to deduct in the year 1951 bonus which it actually disbursed only in December, 1952. The learned judges upheld the claim. But the learned judges
proceeded to deal with the question, as if it were really of no importance from which years profits the bonus payments should be deducted. At
page 684 the learned judges observed :
... Whether the deduction in respect of bonus was granted in the assessment year 1952-53 or in the assessment year corresponding to the
accounting year 1952, that is, in the assessment year 1953-54, should be a matter of no consequence to the department; and one should have
thought that the department would not fritter away its energies in fighting matters of this kind.
Nor did the learned judges go into the question whether it was only a contingent liability in 1951. We are unable to accept that case as
authority for the contention of the learned counsel for the department; that an expenditure incurred for the payment of bonus was not debitable in
the year in which the liability accrued.
Since we have held that the department is not entitled at this stage to seek a determination of the further question, whether the expenditure
incurred by the assessee in the year of account that ended on January 31, 1952, should be related back to the years for which bonus was claimed,
we shall refrain from a detailed examination of all the cases cited during the arguments before us. Without a detailed examination, we shall merely
mention that Southern Railway Co., of Peru Ltd. v. Owen, to which the learned counsel for the department referred, was considered by the
Supreme Court in Indian Molasses Co. v. Commissioner of Income Tax. The relevant passage is at page 79. The learned counsel for the assessee
also referred to the criticism of the decision of the House of Lords in Southern Railway of Peru Ltd. v. Owen 1 in 72 Law Quarterly Review at
page 486 ff. Our answer to the reference is that Rs. 54,140 is an allowable deduction in the assessment year 1952-53. The Tribunal should verify
if Rs. 3,204 added back in the assessment year 1953-54 was included in the sum of Rs. 54,140, and if it was, it should be excluded. The assessee
will be entitled to the costs of this reference. Counsels fee Rs. 250.