Commissioner of Income Tax vs Travancore Timbers and Products

T. Kochu Thommen, J.—The following two questions have been referred to us by the Tribunal, Cochin Bench: "1. Whether, on the facts and in the circumstances of the case, the Tribunal was correct in not following the earlier order dated 17-1-1974, in IT Appeal No. 304 (Coch.) of 1973-74 and holding that the department was not estopped from contending that the gratuity was not allowable?

Whether, on the facts and in the circumstances of the case, and also in view of the eligibility of the assessee to claim deduction for the provision of gratuity under the Kerala Industrial Employees'' Payment of Gratuity Ordinance, 1969, for the assessment year 1970-71, the assessee is entitled to claim in the assessment year 1972-73, deduction of gratuity relatable to the earlier years'' services of employees on the basis of the voluntary scheme for gratuity created by the assessee by agreement with the employees?"

The first question has been referred at the instance of the assessee and the second at the instance of the revenue. 2. The assessee is a registered firm engaged in the manufacture and sale of plywood. It follows the mercantile system of accounting. For the financial year ended 31-3-1972, relevant to the assessment year 1972-73, the assessee, in the computation of its profits and gains for the relevant period, claimed deduction of a provision in the sum of Rs. 1,91,385 towards its liability for payment of gratuity in respect of the relevant financial year as well as for the earlier years. The claim for deduction in excess of Rs. 16,082 was disallowed by the ITO by his order dated 31-3-1973 as, according to him, that was the only amount for which a provision could be made in the relevant accounting year. The order of the officer was confirmed in appeal by the AAC by his order dated 22-8-1973. The assessee, appealed before the Tribunal, contending that it had made provision for payment of gratuity not only in respect of the year in question but also for the earlier years in terms of a scheme adopted by it as from 1-5-1971. It may be noticed at this stage that reference to the scheme was made by the assessee for the first time before the Tribunal. The Tribunal, there fore, remanded the matter to the AAC to ascertain whether a scheme in fact existed and if so, to allow the deduction in accordance with the scheme and the law.

This is what the Tribunal stated in its order of remand:

"In the interests of justice, therefore, we think the matter should go back to the Appellate Assistant Commissioner for examining whether there was a voluntary scheme for gratuity payment created by the assessee by agreement with the workmen. The Appellate Assistant Commissioner would consider the evidence produced and if he finds that there was no voluntary scheme proved as a fact, allow (disallow) the deduction. If no scheme is provided, the provision of Rs. 1,75,303 on account of the earlier years would not be allowable. We, therefore, remit the case back to the Appellate Assistant Commissioner for examining the case as above and pass orders according to law."

The matter was, therefore, reconsidered by the AAC. He held by his order dated 22-8-1973, that a scheme did exist in terms of which the assessee was entitled to provide for the total sum of Rs. 1,91,385 as claimed by it.

Against that order, the revenue applied to the Tribunal. The assessee, however, contended that the only question which was open for decision by the Tribunal at the second stage of the appeal was as to the correctness of the finding of the AAC as regards the existence of the scheme. If the scheme did exist, as found by the AAC, the question whether it entitled the assessee to provide for the liability of the earlier years and claim deduction therefor was no longer open. The Tribunal did not agree. It held that the whole question was still open. This is what the Tribunal said:

"... We disagree with the assessee. The scope of appeal is as wide as any other appeal. No question had been finally decided by the Tribunal when the matter was restored to the Appellate Assistant Commissioner."

It is from this finding that the first question arises.

We agree with the observation of the Tribunal in regard to the scope of the appeal. All that the Tribunal said at the time of the remand was that the assessee''s contention as regards the existence of the scheme had to be considered. If the AAC found that there was a scheme, he was to apply the scheme by allowing the provision for deduction in accordance with the law. The contention of the revenue, that the law did not recognise provision being made except for the liability which arose in the relevant accounting year and not for the earlier years, was a matter which was still open for consideration by the Tribunal at the second stage of the appeal.

Having found that the whole question was open for its consideration, this is what the Tribunal held:

"5.... The assessee in an employer governed by the provisions of the Kerala Industrial Employees'' Payment of Gratuity Act, 1970, which came into force on February 18, 1970. So, according to the judgment of the Kerala High Court, the assessee is allowed to claim the provision as a deduction. But in determining the quantum of provision allowable as a deduction the past services of the employees could be taken into the computation only in the first year of liability [that is, for the assessment year 1970-71, accounting year April 1, 1969 to March 31, 1970, because the liability was first fastened on the assessee on February 18, 1970]. In this year the provision can be allowed only for one year''s service. So, according to the Kerala High Court judgment, what the income tax Officer did is right. Nothing more should have been allowed."

Having found that the liability arose under the income tax Act, 1961 (''the Act'') for the first time in the accounting year ended 31-3-1970, the Tribunal found that the assessee had a right to claim deduction in respect of the liability for the earlier years in terms of the scheme. It is from that finding that the second question (referred to us at the instance of the revenue) arises for consideration.

The liability of the assessee for payment of gratuity arose for the first time under the Kerala Industrial Employees'' Payment of Gratuity Ordinance, 1969, which came into force on 10-12-1969. The Ordinance was repealed and replaced by the Kerala Industrial Employees'' Payment of Gratuity Act, 1970 (''the Kerala Act''), which came into force on 18-2-1970. The statutory liability thus arose as early as 1970 during the financial year ended 31-3-1970.

The right of an assessee to provide for the liability of earlier years in respect of gratuity was considered by this Court in several decisions. In CIT v. Kerala Nut Food Co. [1978] 111 ITR 252 the Court observed:

"... In Commissioner of Income Tax Vs. High Land Produce Co. Ltd., , this Court held that deductions were permissible in respect of liability for gratuity arising during the relevant accounting year. This Court said that the liability should be valued for a particular accounting year by ascertaining the present value of the contingent liability which arose during the accounting period on actuarial principles. In L.J. Patel and Company Vs. Commissioner of Income Tax, , this Court held that the liability that had accrued in an earlier year could not be taken into account for computing the income of a subsequent year.

Applying this principle, the arrears of the earlier years towards gratuity cannot be taken into account in computing the income of the subsequent accounting period. The assessee having adopted the mercantile system of accounting, it ''is entitled to deduct from the profits and gains of the business such liability which had accrued during the period for which the profits and gains were being computed'': [ The Kedarnath Jute Mfg. Co. Ltd. Vs. The Commissioner of Income Tax, (Central), Calcutta, . The assessee can take into account only such liability as it had incurred during the relevant accounting year, which in the instant case is the year ended on December 31, 1970."

In the present case the liability having thus arisen under the statute during the period ended on 31-3-1970, the claim of the assessee for deduction of the amounts relating to the earlier years is on the face of it unsustainable. However, the counsel for the assessee submits that the assessee is bound by the scheme which it adopted for payment of gratuity as from 1-5-1971. That scheme fastened a liability on the assessee for the earlier years too. By notification dated 7-10-1977 (G.D. Rt. Nos. 1199 and 432 of 1977), as subsequently clarified by a Government letter dated 31-3-1978, exemption was granted to the assessee from the provisions of the Payment of Gratuity Act, 1972 (''the Central Act'') as well as from the provisions of the Kerala Act. He, therefore, contends that the principle laid down by the decision of this Court would not apply in respect of the present claim which is based on the liability arising under the scheme.

There cannot be any doubt that the assessee is not entitled to claim exemption from the statutory provisions except in terms of section 5 of the Central Act or section 5 of the Kerala Act. Both the enactments confer power upon the appropriate Government (the State Government) to grant exemption by a notification from the provisions of the Act. The section does not specifically say that the Government can exempt with retrospective effect. The notification dated 7-10-1977 does not in any case retrospectively grant exemption from the provisions of the Central Act. Section 5 of the Kerala Act does not confer power upon the State Government to grant exemption otherwise than by a notification. We doubt whether the notification dated 7-10-1977 could, by means of a subsequent letter, be amended or improved upon. Whatever that be, there is no doubt that the letter dated 30-3-1978 purports to grant exemption from the provisions of the Kerala Act only for a limited period, that is, from 1971 till the coming into force of the Central Act in 1972. This means that, assuming that the letter dated 31-3-1978, had the effect of granting exemption from the provisions of the Kerala Act, such exemption has been granted to the assessee only as from 1971 and not from an anterior date. That shows that at the time when the statutory liability arose in the relevant accounting year, which ended on 31-3-1970, the assessee enjoyed no exemption from the provisions of the statute. It was, therefore, necessary for it to provide for deduction in that period in respect of the liability of the earlier years, if so desired.

The Tribunal noticed that the assessee had not provided for deduction during the relevant accounting year in respect of the statutory liability for the past years, but found that, in view of the scheme, the assessee was entitled to make such deduction even in the subsequent year relevant to the assessment year 1972-73. We are of the view that the Tribunal was in error in so holding. Insofar as the assessee enjoyed no exemption from the statute at the relevant time, it was not entitled to claim deduction de hors the statute and on the basis of its own scheme. The assessee was entitled to deduction in terms of the statute, but only to the extent of the liability which arose in the relevant period.

We do not see any substance in the contention that the revenue is in any manner estopped by reason of the Tribunal''s order of remand. In any case, there is no question of estoppel as against a statutory provision. In the light of what is stated above, we answer the first question in the affirmative and the second question in the negative, that is, both the questions are answered in favour of the revenue and against the assessee. We direct the parties to bear their respective costs in these tax referred cases.