Nathalal Asharam vs Commissioner of Income Tax

R.K. Abichandani, J.—The assessee-registered firm filed its return for Samvat year 2030, i.e., year ended on 13-11-1974 showing total income of Rs. 11,34,329. Admittedly, the business of the firm was closed at the end of the year. The assessee made a provision of Rs. 74,500 in the gratuity account at the close of the year for all the six employees of the firm. Before the ITO, the assessee had claimed deduction in respect of the said amount on the ground that the provision was made on account of the retrenchment of those employees due to closure of the firm and considering their past services. The ITO considered the said claim of the assessee u/s 40A(7)(a) and (b) of the income tax Act, 1961 (''the Act'') and held that no such deduction was allowable to the assessee. In its appeal before the AAC, it was contended by the assessee that, though he payment was described as gratuity, it was not by way of gratuity but was compensation for the termination of the services of the employees of the firm. It was in terms contended that there was a statutory obligation on the assessee to pay such retrenchment compensation in view of the provisions of section 25FFF of the Industrial Disputes Act, 1947. The AAC, after examining the relevant provisions of the Industrial Disputes Act, upheld the contention of the assessee that it was under a statutory obligation to pay to its employees compensation in view of the provisions of section 25FFF. The assessee had worked out the compensation amount under the said provision payable to the employees at Rs. 51,800 and the AAC accepting that figure, partly allowed the appeal to that extent.

The revenue feeling aggrieved by the order of the AAC allowing deduction of Rs. 51,800 on account of statutory liability of the assessee-firm in respect of retrenchment compensation provided for in its accounts for paying to the retrenched employees, appealed before the. Tribunal and the assessee, feeling aggrieved by the order insofar as it disallowed the remaining amount of Rs. 22,700, also appealed. Before the Tribunal, it was contended on behalf of the assessee that, though the business of the firm was closed with effect from 18-11-1974, the amounts were credited to the accounts of these employees on the same date and, therefore, the payment was made during the continuance of the business and not after its closure. It was contended that when the business was to be closed, it was but proper that the employees of the firm should have been remunerated adequately in this manner. On being specifically asked as to whether there was any liability to pay gratuity, the learned counsel for the assessee conceded before the Tribunal that the provisions of the Payment of Gratuity Act were not applicable to the assessee and that there was no gratuity scheme adopted by the assessee-firm. It was, however, contended that the deduction of remaining sum of Rs. 22,700 may be allowed as retrenchment compensation or gratuity or some extra payment to the employees for meritorious service on the ground of commercial expediency. On the other hand, it was submitted on behalf of the revenue that the AAC had gone wrong in allowing the amount of Rs. 51,800 as deduction u/s 37(1) of the Act, by way of retrenchment compensation because such expenditure could never be said to have been made for the purpose of carrying on of the business firm. The Tribunal concluded that the compensation payable u/s 25FFF to the retrenched employees of the assessee-firm could not be said to be an expenditure incurred for carrying on the business or an expenditure laid out wholly and exclusively for the purpose of the business of the firm. The Tribunal found that, in fact, it was an expenditure incurred for closing down the business of the firm. The Tribunal, therefore, held that the matter was squarely covered by the decision of the Supreme Court in Commissioner of Income Tax, Kerala Vs. Gemini Cashew Sales Corporation, Quilon, and, therefore, no part of the expenditure amounting to Rs. 74,500 was allowable under the provisions of the Act. The Tribunal, therefore, allowed the appeal of the revenue dismissing the assessee''s appeal.

The assessee, feeling aggrieved by the decision of the Tribunal, sought reference and, at its instance, the following question has been referred to us, for our opinion, u/s 256(1):

Whether, on the facts and in the circumstances of the case, the Tribunal was justified in law in holding that no part of the expenditure amounting to Rs. 74,500 is allowable under the income tax Act, 1961?

From the record, it is clear that the assessee-firm had closed down its business from 13-11-1974 and due to the closure, the services of all the six employees of the firm were terminated. The assessee had made provision of Rs. 74,500 in the gratuity account, but it was its consistent stand that the amount was intended to be paid by way of compensation for their retrenchment from services which resulted due to closure of the firm. Admittedly, the provisions of the Payment of Gratuity Act were not applicable to the assessee-firm and it never had adopted any scheme of gratuity for its employees. Before the AAC, the assessee in terms contended that the said amount was provided for by way of retrenchment compensation for its employees in view of the provisions of section 25FFF and, accordingly, its appeal was partly allowed accepting the figures worked out by it. u/s 37(1) any expenditure of the nature referred to therein laid out or expended wholly and exclusively for the purpose of the business or profession of the assessee has to be allowed in computing the income chargeable under the head ''Profits and gains of business or profession''. In Gemini Cashew Sales Corpn.''s case (supra), the question whether deduction was allowable in respect of retrenchment compensation which was payable on transfer of business came to be considered by the Supreme Court and, it was, in terms, held that the liability to pay retrenchment compensation u/s 25FF arose for the first time after the closure of the business and not before and it arose not due to the carrying on of the business but on account of the transfer of the business and, therefore, such expenditure was not of revenue nature and could not be deducted u/s 10(1) of the Indian income tax Act, 1922. It was further held that, since the liability u/s 25FF was wholly contingent and did not raise any definite obligation during the whole of the period that the business was carried on, it could not fall within the expression ''expenditure laid out or expended wholly and exclusively for the purpose of the business u/s 10(2)(xv) of the 1922 Act. In Mysore Standard Bank Ltd. (In Liquidation) Vs. Commissioner of Income Tax, Mysore, , where on account of closure, salary for two months for each year of service by way of compensation for termination of their services was paid to the employees of the assessee as a gesture of generosity, it was held that such expenditure could not be said to have been incurred for the purpose of the business of the assessee as the business was closed and was, therefore, not allowable u/s 10(2)(xv). In J.K. Cotton Manufacturers Vs. Commissioner of Income Tax, , the assessee-private limited company had gone into voluntary liquidation and by a subsequent resolution approved and confirmed payment of a sum of Rs. 10,000 to the Ex-Director in recognition of his past services to the assessee, which, as was held by the Allahabad High Court, was not expenditure incurred wholly and exclusively for the purposes of the business of the assessee. In India Manufacturers (Madras) P. Ltd. Vs. Commissioner of Income Tax, , relying upon the ratio of the decision in Gemini Cashew Sales Corpn.''s case (supra), the Madras High Court held that retrenchment compensation on closure of servicing department was not allowable. Earlier, in M. Seshadri Iyengar and Sons Vs. Commissioner of Income Tax, , the Madras High Court, relying upon the ratio of the decision of the Supreme Court in Gemini Cashew Sales Corpn.''s case (supra) held that, in order to be a permissible allowance, the expenditure must be for the purpose of carrying on business and where the business is closed and as a result of closure of business the liability to pay retrenchment compensation has arisen, such liability cannot be said to be a liability which arose at the time when the business was carried on and cannot be termed as expenditure wholly and exclusively incurred for purpose of business.

It, is therefore, a settled legal position that, any expenditure by way of retrenchment compensation on account of closure of the business cannot be considered to be an expenditure incurred for the purpose of business. Since the liability to make such payment arises on account of retrenchment and when the business is closed down resulting in retrenchment, it can never be said that the retrenchment compensation is paid for the purpose of the business. In our view, therefore, the Tribunal was right in holding that the compensation payable by the assessee to its employees in view of the provisions of section 25FFF could not be said to be an expenditure incurred for carrying on the business or an expenditure laid out wholly and exclusively for the purpose of business. The Tribunal rightly relied upon the decision of the Supreme Court in Gemini Cashew Sales Corpn.''s case (supra), for holding that the assessee was not entitled to any such deduction. In this view of the matter, we answer the question referred to us in the affirmative and against the assessee. Reference stands disposed of, accordingly, with no order as to costs.