CHANDAMAMA PUBLICATIONS Vs. COMMISSIONER OF INCOME TAX

JUDGEMENT

(1.) THE assessee is a registered firm. In relation to the assessment years 1973-74 to 1975-76, the assessee claimed deduction in respect of the provision made for retrenchment compensation in sums of Rs. 18,561, Rs. 9,318 and Rs. 19,142, respectively. THE Income-tax Officer disallowed the claim so made by the assessee and on further appeal to the Appellate Assistant Commissioner, it was held that there was no certainty of Payment with regard to retrenchment compensation as in the case of gratuity payment and that there was also no method of working out the basis of quantification of the prospective retrenchment compensation if and when it was required to be paid and, therefore, the claim for deducting the provision for retrenchment compensation from the profits and gains cannot be countenanced. In the appeals preferred by the assessee before the Tribunal, the disallowance was upheld on the ground that there was no ascertained liability and the possibility of such a liability arising may or may not happen and that there was no method of evaluating or quantifying such liability, if any, in the accounting years in question and further that the unilateral action on the part of the firm in making a provision would enable it to use funds for any of its purposes.

(2.) AT the instance of the assessee, under section 256(1) of the Income-tax Act, 1961 (hereinafter referred to as "the Act"), the following common question of law has been referred to this court its opinion :

(3.) WE now proceed to make a brief reference to the decision cited by learned counsel for the Revenue CIT v. Indian Metal and Metallurgical Corporation [1964] 51 ITR 240 (Mad) dealt with the question of a claim by the assessee as business expenditure under section 10(2)(xv) of the Indian Income-tax Act, 1922, of the amounts credited to a fund to meet an eventual liability under section 25F of the Industrial Disputes Act. Such a liability, it was pointed out, may arise de futuro on the happening of a particular contingency and need not be allowed as a deduction either under section 10(2)(xv) or on commercial principles as to computation of profits. Further, it was also pointed out that the liability of the assessee in respect of retrenchment compensation under section 25F of the Industrial Disputes Act was not a liability in praesenti, but was only a contingent liability, which cannot be taken into account as an accrued liability, even though the assessee has been maintaining accounts on the mercantile system and that the assessee had still control or dominion over the reserve, which it was at liberty to recall for use for its own business purposes and the claim for deduction as an "expenditure" cannot be countenanced. In CIT v. Gemini Cashew Sales Corporation , a firm stood dissolved by the death of one of the partners and its business was taken over the continued by the surviving partner and while settling the accounts of the firm, an amount was taken into account as retrenchment compensation payable to the employees under section 25FF of the Industrial Disputes Act, which would arise on a transfer of ownership. The question arose whether the sum constituted an allowable expenditure in computing the income of the firm for the assessment year 1958-59. The Supreme Court pointed out that the present value, on commercial evaluation of money to become due in future, under a definite obligation, will be trader, even if, in certain conditions, the obligation may cease to exist because of forfeiture of the right. Where, however, the obligation of the trader is purely contingent, no question of estimating the present value may arise, for, to be a permissible outgoing or allowance, there must, in the year of account, be a present obligation capable of commercial valuation. Considering the question whether the amounts taken into account as retrenchment compensation can be regarded as wholly for the business, the court ruled that where the liability is, during the whole of the period that the business is carried on, wholly contingent does not rise any definite obligation during the time the business is carried on, it cannot fall within the expression "expenditure laid out or expended wholly and exclusively" for the purpose of the business. The admissibility as permissible expenditure of a sum set apart by an employer for meeting a contingency of his workers going on leave in the next year came to be considered in CIT v. Rajkumar Mills Ltd. [1971] 80 ITR 244 (Bom). The claim for deduction was negatived holding that the question of payment of wages for leave to a worker would arise only if he went on leave or was discharged or refused leave or he quit his employment and till those circumstances arose, the liability that rested on the employer remained a contingent liabilty which the employer may or may not be called upon to discharge and any sum set apart by an employer for meeting the contingency of his workers going on leave in the next year cannot be regarded as a permissible expenditure under section 10(2)(xv) of the Indian-tax Act, 1922. In CIT v. Otis Elevator Co. (India) Ltd. [1977] 107 ITR 241 (Bom), a question arose whether a reserve for paying retrenchment compensation to employees could be included in the computation of the capital for purposes of surtax. The assessee-company had appropriated various sums to an account called "Reserve for Employees' Indemnities" with a view to meet any claim of retrenchment compensation arising out of retrenchment of any member of the staff. All the authorities took the view that the appropriation was not designed to meet any known liability and that the amount of reserve would be includible for purposes of the capital computation for surtax. It was held that the setting apart of the amount by way of provision for employees'indemnities intended to be spent for payment of retrenchment compensation arising out of a future retrenchment of any member of the staff could not be regarded as one for any known or existing liability and, therefore, the setting apart of this item would have to be regarded as a reserve which would be properly includible in the capital computation for surtax purposes. Though the decision was rendered with reference to the includibility of the amount set apart in the capital for surtax purposes, we are of the view that that would not make any difference to the applicability of the principle. In Shree Sajjan Mills Ltd. v. CIT [1985] 156 ITR 585, the Supreme Court had occasion to consider the question whether a provision made for gratuity would qualify as an item of expenditure prior to and after the introduction of section 40A(7) of the Act. At page 598, the Supreme Court pointed out that the payment of gratuity made on retirement or termination of service was not for the service rendered during the year in which the payment is made, but is in consideration of the entire length of service and the right to receive the payment by the employee on retirement or on termination of service is a contingent right and the liability to pay gratuity continues to be a contingent liability for the employer. It has also been further laid down that an employer may pay gratuity when the employee retires or his service is or terminated and claim the expenditure as made for the purpose of bussiness or he may provide for the payment of gratuity which became payable during the previous year and claim the expenditure on accrued basis, if he followed the mercantile system and that contingent liabilities do not constitute expenditure and that expenditure deductible for income-tax purposes should be towards the liability actually existing at the time of setting apart, and that which might become expenditure on the happening of an event is not expenditure. Referring to the distribution between an actual liability in praesenti and a liability in futuro, the Supreme Court pointed out that a distinction is often made between an actual liability in praesenti and a liability de futuro, which for the time being is only contingent and the former is deductible, but not the latter. Though this decision has been rendered with reference to the provisions of section 40A(7) of the Act, the principles enunciated therein prior to the introduction of section 40A(7) of the Act would be equally applicable to the present case as well. WE are, therefore, of the view that as per the principles laid down in the decisions relied on by learned counsel for the Revenue, the liability to pay retrenchment compensation is only in the nature of a contingent liability and there is also no satisfactory method of evaluating or quantifying the value of that liability in any particular year of account and cannot, therefore, appropriately form the subject-matter of a claim for deduction.