Commissioner of Income Tax vs Bharat Earth Movers Limited

R.V. Vasanthakumar, J.-At the instance of the revenue, the following question of law has been referred to this Court under Section 256(1) of the Income Tax Act, 1961:

"Whether on the facts and in the circumstances of the case the provision for making the liability for encashment of earned leave by the employee is an admissible deduction"?

Assessee-Company introduced a Scheme by virtue of which employees of the assessee-Company were entitled to encash leave at their credit. The assessee in its books of account maintained an entry as accrued leave reserve to which it credited every year liability in respect of leave based on leave entitlement of every employee and having made such provision to meet the liability in regard to payment of leave with wages claimed deduction in respect of that provision. Original Assessing Authority disallowed the claim on an appeal, first Appellate Authority placing reliance on an order passed in I.T.A. No. 3222340/Bang/80 pertaining to Motor Industries Co. Ltd. v I.T., upheld the contention of the assessee. Aggrieved by the order of the first Appellate Authority, revenue brought the matter before the Income Tax Appellate Tribunal which also confirmed the order of the first Appellate Authority. Later on revenue under Section 256(1) of the Act sought reference to this Court.

The main contention advanced by the assessee is that it is entitled for deduction of the amount of Rs. 62,25,483/- in respect of provision for accrued leave on the ground that the amount standing to the credit of the reserve account as at the end of the accounting year 31-3-1978 represented an ascertained liability only to be discharged in the foreseeable future depending on the actual utilisation of the employee, such utilisation being a certainty. It is contended that the employee is entitled under the rules to encash the leave and he can accumulate for a certain period and as such encashed leave is earned by employee and it gets credited to his account. It is also contended that though payment is deferred, the liability of the assessee to pay for accumulated leave stands accrued. The said liability is a liability in present and not a contingent liability. It is further contended by the assessee that leave salary payable to employee can be ascertained at the end of accounting year depending on the accumulated leave to the credit of an employee and that the same is not a contingent liability but a liability in praesenti since out of the provision made, leave salary would be paid to the employees and that the leave encashment benefit is ascertainable.

As against the above contention, the revenue contends that provision for leave salary is not an allowable deduction and the said liability is a contingent liability and not a liability in praesenti. It is contended that question of leave salary arises when a person goes on leave and for the particular period leave salary is payable, person is entitled to avail of leave encashment benefit under scheme and the same is optional. This will depend on whether he actually avails himself of the leave or not. If leave is due to a person he has the option either to accumulate the leave or he may avail of the leave. If he avails of the leave, he would be entitled to the leave salary. If he does not, he will be entitled to the benefit of encashment of the leave; these events are uncertain events and are contingent.

Test is whether a provision provides for a known liability of which amount can be determined with substantial accuracy. Decisive factor is not the methodology of accountancy or the practice followed by the Company and the intentions of the employee in getting the benefit of encashment of the leave but principle is whether such a liability is contingent or liability in praesenti. When once element of option is there, encashment of leave may or may not arise, liability would only be contingent and uncertain which may or may not have to be discharged. The Counsel for the assessee relies on the ratios of the decisions in Commissioner of Wealth-tax, Kerala-I, Ernakulam v Prema Laxman and Another, (1984)150 ITR 170 (Ker.); Commissioner of Income-tax v C. Tharian and Sons, (1987)166 ITR 607 (Ker.) and Metal Box Company of India Ltd. v Their Workmen, (1969)73 ITR 53 (SC).

In Metal Box Company''s case, supra, the Supreme Court laid down certain guiding principles in respect of liabilities arising under a Scheme of Gratuity which is to be stated is not of much assistance to the contentions advanced by the assessee. Supreme Court in that case was concerned, inter alia, with the question whether it is legitimate in a Scheme of Gratuity to estimate the liability on actuarial valuation and deduct such estimated liability in the profit and loss account while working out net profit. Supreme Court held that if liability is properly ascertainable and if it is possible to arrive at its discounted present value even if the liability is contingent liability it can be taken into account. That question does not arise here.

Counsel for the revenue invites attention of the Court to the ratio decided in Commissioner of Income-tax, Karnataka-II, Bangalore v M/s. Hindustan Aeronautics Ltd., Bangalore, 1988(2) Kar. L.J. 76, wherein one of us namely S. Rajendra Babu, J., was a Member, who delivered the judgment wherein it is observed that the provision for accrued leave salary as being a contingent liability and the same as not being a permissible deduction.

Leave salary are payable only when a person goes on leave and during the period of leave the salary paid to him are known as leave salary. It cannot be ascertained with any certainty whether in a particular year, the employee would go on leave. It will depend upon the option of the employee. Unless employee goes on leave, the assessee is not required to pay leave salary. The liability will only arise when a person goes on leave and it is only for that particular period he is on leave the leave salary is payable. We are unable to accept the contention of the assessee that at the end of the accounting year, it is known what is the quantum of leave due to a particular employee and on that basis a calculation could be made with accuracy. No one makes a provision for salary because salary is only payable after the employee renders the service and then only it will accrue to him. Similarly in case of salary which are paid during the leave period the employee becomes entitled to such leave salary only when he goes on leave. Accumulated leave to the extent permissible under various Schemes in question can only be encashed at the time of happening of event as envisaged under the conditions of service either under the rules or scheme applicable to the employees in question. As such, this is nothing but a contingent liability and not a certain liability. We respectfully disagree with the ratio laid down in Prema Laxman''s case, supra, which decided the same while dealing with provisions of Wealth-tax Act. We are of the view that neither the leave salary nor the leave encashment benefit payable to the employees can be said to be a present liability, but it is only a contingent liability and assessee is not entitled to deductions. Hence our answer to the question is in favour of revenue.