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PETITIONER: M/S. W. T. SUREN & CO. LTD.

       Vs.

RESPONDENT: THE COMMISSIONER OF INCOME TAX. BOMBAY

DATE OF JUDGMENT:       23/02/1998

BENCH: SUJATA V. MANOHAR, D.P. WADHWA

ACT:

HEADNOTE:

JUDGMENT:                       J U D G M E N T D.P. Wadhwa. J.      This is  assessee’s appeal against judgment dated April 89, 1981 of the Division Bench of the Bombay High Court on a reference under  Section 66(1)  of the  Income-tax Act, 1922 (1922 Act, for short) on the following question:      "Whether on  the facts  and in  the      circumstances  of   the  case,  the      payment of  gratuity in  the sum of      Rs. 4,08,622/-  which  the assessee      made to  M/s. Rallies  India  Ltd.,      was an allowable deduction?"      The High  Court answered  the question in favour of the revenue and against the assessee.      As to  how the  reference arose,  we may  notice a  few facts. The  assessee, a  private limited company, was wholly owned subsidiary  of Rallis India Ltd. One of its activities was the  distribution of  the products of M/s. Taddington on Chemical Factory  Private Ltd. which was also another wholly owned subsidiary  of the  Rallis India Ltd. With effect from May 1, 1959 the assessee closed its unit for distribution of the products  of Taddington  Chemical Factory  Private  Ltd. which business  was taken over by Rallis India Ltd. On April 22, 1959, the assessee wrote letters to employees working in the unit dealing with distribution stating that arrangements had been  made for the business conducted by the assessee to be taken  over by  Rallis India  Ltd. and  that the transfer would take  effect from  May 1,  1959. By  this  letter  the employees were  further informed  that arrangements had also been made  whereby all  the employees  f the assessee of the distribution unit  would be  offered similar employment with Rallis India  Ltd. on  and from  May 1,  1959. The employees were, therefore, informed that their employment was to cease on and  from April 30, 1959. The employees were further told as under:      "A) If , for any reason, any member      of  the  staff  does  not  wish  to      accept employment with Rallis India      Ltd.,  retiring   gratuity  on  the      normal scale will be paid to him on

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    the close of his service with us as      also our  month’s salary in lieu of      notice.      (B)...      (C)....      (D) You  will see  that,  in  their      offer of  employment, Rallis  India      Ltd. undertake  that, if you accept      service with  them  from  1st  May,      1959, it  shall be  assessment that      there  has   been   no   break   or      interruption in your employment and      they undertake  to assume liability      to   pay    on   that   basis   any      retrenchment compensation  that may      become payable  in the event of any      subsequent retrenchment."      By separate  letter  of  the  same  date  Rallis  India Private Ltd.  also informed  the employees  of the  assessee offering employment  with that  company from  May 1, 1959 on the following terms and conditions:      "1.   The    General   terms    and      conditions, grades and rates of pay      are  set   out  in   the  terms  of      services  of   which  a   copy   is      attached.      2.   Your actual  work and position      in the office will remain as it has      been herebefore.      3.  ...      4.  ...      5.   As mentioned by W.T. Suren and      Co. Private  Ltd. In their separate      letter to  you of  today’s date, we      confirm that your past service with      W.T. Suren  and  Co.  Private  Ltd.      shall  count   as  continuous  with      future service  with  Rallis  India      Limited  and  that  the  change  of      employment on  1st May,  1959 shall      not  constitute   a  break   in  or      interruption of  employment and  we      hereby assume  liability to  pay on      that   basis    any    retrenchment      compensation   that    may   become      payable  in   the  event   of   any      subsequent retrenchment.      If  you   accept  this   offer   of      employment, will  you  please  sign      and return  to us  immediately  the      letter  of   acceptance  which   is      attached." Some of  the employees  of the assessee did accept the offer given by  Rallis India Ltd. and some did not. On May 1, 1959 Rallis India  Ltd. issued  a circular  No.1/59/60 to all the members of  the staff.  A part  of  the  circular  concerned payment of  gratuity to  the employees who had come from the assessee and this was to the following effect:      "Re : Gratuity.      In order  to dispel any doubt which      might have  arisen from  our letter      of appointment  dated  22nd  April,      1959, we wish to make it clear that      continuity of  service will operate      in  all   respect,  including   the

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    computation of  gratuity.  In  this      respect, as  there may  be  certain      cases  in   which  there   will  be      difference  between   the  gratuity      accrued  in  the  service  of  W.T.      Suren and  Co. Private Ltd. and the      Gratuity as calculated Ltd. and the      gratuity as  calculated  under  our      gratuity scheme,  it is  understood      that any  members of  the staff  so      affected  will,   on  leaving   the      company  be   paid   the   gratuity      accrued to  them in  the service of      W.T. Suren  and Co. Pvt. Ltd. as at      30th April.  1959, if  it is higher      than  the  gratuity  as  calculated      under our scheme."      The assessee  had announced  a gratuity  scheme for its employees on August 31, 1953. It is as under :           "The Management  have pleasure      in announcing a gratuity scheme for      the members  of the  staff as under      :-      No. of completed           For each      year  of service           Years of      equivalent to:-            service.                                Gratuity     5,6, and 7 ...             Half-a-                            month’s basic                                salary.    8 and 9                    3/4 moth’s                            basic salary.    10 and above...           1 month’s                             basic salary                             with a                            maximum of 15                           month’s or Rs.                            15.000/-                          which is lower.      Gratuity will  not  be  payable  to      those staff  members who  have been      dismissed for  misconduct, etc. The      above Scheme is being introduced as      from 1-9-1953."      In respect  of the   employees  whose services had been terminated and  who had  accepted the  offer to  join Rallis India Ltd.  with continuity  of  service  as  offered  their gratuity amounting  to Rs.4.10.177.75  was paid  over by the assessee to Rallis India Ltd. on April 30, 1959. This amount was held  by Rallis  India Ltd.  on trust for the benefit of the staff  of the assessee and a declaration was made to the effect that  Rallis India Ltd. had no beneficial interest in the said sum of Rs. 4,10,177.75 or any apart thereof. Though a part  of the business of the assessee was closed and taken over by Rallis India Ltd. the other business of the assessee continued. In  its return  of income for the assessment year 1960-61 the  assessee claimed  the amount  of Rs.4,08,622 as deduction. The  Income-tax Officer was, however, of the view that the  correct procedure was that Rallis India Ltd. alone would be  entitled to  claim the amount when paid by them to the  employees   of  the  assessee  at  the  time  of  their respective retirement.  He, therefore, declined to allow the claim of  deduction  of  gratuity  to  the  assessee.  Being aggrieved the  assessee appealed  to the Appellate Assistant Commissioner contending  that payment  of gratuity to Rallis

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India Ltd.  should be  held to  be an allowable deduction on the ground  that the  assesses had  a liability  to pay such amount on  the date  when the employees of the assessee were transferred to  Rallis India Ltd. It was also the contention of the  assessee that  the amount  of gratuity  was actually paid to  trustees of Rallies India Ltd. and that, therefore, the payment  of the  gratuity  to  the  trustees  should  be treated as  the discharge  of the liability of the assessee. The Appellate  Assistant Commissioner  concurring  with  the Income-tax Officer held that there was no actual termination of the  services of  the employees  and the discharge of the liability in  question was  capital in  nature and  he  also rejected the  claim of  the assessee.  The appeal  was  then taken by  the assessee  to the Income-tax Appellate Tribunal where again  the assessee  asserted that  the payment of the amount  to  Rallis  India  Ltd,  had  been  necessitated  by business  considerations   viz.,  to   keep  the   employees contented and satisfied and, therefore, the amount should be allowed as deduction. It was submitted that the assessee had addressed a  letter dated  April 23,  1959  to its employees about ceasing  of their  employment on  and from  April  30, 1959. According  to  assessee  this  letter  terminated  the services of  the employees and the assessee was bound to pay gratuity till that point of time. It, therefore could not be said that there existed no liability to pay any gratuity. It was submitted  that if  the assessee  had not  paid gratuity amount to  Rallis India  Ltd. the employees were well within their legal  right to claim it from assessee. Revenue on the other hand  asserted that  the employees  had  waived  their claim with  the assessee  in regard  to their  gratuity and, therefore,  no  liability  survived  in  the  hands  of  the assessee. Revenue  also submitted  that the  payment made to Rallis India Ltd was in pursuance of an arrangement with the assessee who  was ceasing  to carry  on  its  main  business activities which  formed the  structure of  the assessee and thus this  was nothing  but in  the nature  of  transfer  of business by  the assessee  to Rallis India Ltd. According to the revenue,  therefore, payment  was rightly treated as not deductible from the business income of the assessee company. After considering rival contentions of the parties. Tribunal allowed the  appeal in favour of the assesses. Tribunal held that there  was termination  of employment  of the employees from the  service of  the assessee  and also  that there was valid discharge  of the  payment of  gratuity; that assessee was still  functioning and  payment of  gratuity amount  was rightly claimed  as deduction.  At the  instance amount  was rightly  claimed  as  deduction.  At  the  instance  of  the revenue, the Tribunal referred the aforesaid question to the High Court  for  its  opinion.  No  question  if  there  was termination of the services of the employees of assessee was sought to  be referred  or that  if the  assessee was  still functioning. High  Court in  the impugned  judgment answered the question  in favour  of  the  revenue  and  against  the assessee holding  that the  amount paid  by the  assessee to Rallis India  Ltd. could  not be  considered as a payment of gratuity to  the employees  of the  assessee and  could not, therefore, be  held to  be an  allowable deduction  for  the purpose of  Section 10(2)(xv)  of the  Income-tax Act, 1922. High Court  said that since the employees had been given the benefit or  continuity of  employment, in  law, there was no retirement from  employment of  the assessee  giving rise to the right  in favour of the employees to claim gratuity from the assessee. In this circumstances, it was of the view that the amount  paid to  M/s Rallis  India Ltd.  by the assessee could not  be considered  as a  payment of  gratuity to  the

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employees and  could not, therefore, be held to be allowable deduction for  the purpose  of Section 10(2)(xv) of the 1922 Act. High  Court referred  to a number of judgments of other courts but  it was  the judgment  of this Court which formed the base for the impugned decision and that was Commissioner of Income  Tax. Kerala  vs. Gemini  Cashew Sales Corporation [(1967) 65  ITR 643].  This judgment considered the question if retrenchment  compensation payable  under Section 25FF of the Industrial  Disputes  Act,  1947  constituted  allowable deduction which  was answered  in negative, in favour of the Revenue. High Court, however, granted certificate of fitness to appeal  to this Court under Section 261 of the Income-tax Act, 1961  (for short,  ‘1961 Act’)  as in  its opinion  the question involved  in the  present case  was  a  substantial question of  law of  general importance  which needed  to be decided by  this Court. The impugned judgment is reported in (1982) 138 ITR 91.      Before we  consider the  rival contentions, we may note down the  relevant provisions  of law  both in  1922 Act and 1961 Act.      I.T. ACT. 1922      "10_ Business. (1) The tax shall be      payable by  an assessee  under  the      head   "Profits    and   gains   of      business, profession  or  vocation"      in respect  f the profits and gains      of  any   business,  profession  or      vocation carried on by him.      (2) Such  profits or gains shall be      computed after making the following      allowance, namely :-      xxx    xxx             xxx      (x) any  sum paid to an employee as      bonus or  commission  for  services      rendered, where  such sum would not      have been payable to him as profits      or dividend if it had not been paid      as bonus or commissions:      Provided that  the  amount  of  the      bonus  or   commission  is   of   a      reasonable  amount  with  reference      to-      (a) the pay of the employee and the      conditions of his service:      (b) the  profits of  the  business,      profession or vocation for the year      in question; and      (c) the general practice in similar      business, professions vocations;      xxx       xxx                   xxx      (xv) any  expenditure not  being an      allowance of  the nature  described      in any  of the clauses (i) to (xiv)      inclusive, and  not  being  in  the      nature of  capital  expenditure  or      personal expenses  of the  assessee      laid out  or  expended  wholly  and      exclusively for the purpose of such      business, profession or vocation."      I.T. ACT, 1961      "36.(1) The deductions provided for      in the  following clauses  shall be      allowed in  respect of  the matters      dealt with  therein,  in  computing      the income  referred to  in Section

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    28-      (i)................................      (ii) any sum paid to an employee as      bonus or  commission  for  services      rendered, where  such sum would not      have been payable to him as profits      or dividend if it had not been paid      as bonus or commission.      37.(1) Any  expenditure (not  being      expenditure of the nature described      in sections  30 to 36 and not being      in   the    nature    of    capital      expenditure or personal expenses of      the assessee), laid out or expended      wholly  and   exclusively  for  the      purposes   of   the   business   or      profession  shall   be  allowed  in      computing  the   income  chargeable      under the head "Profits and gain of      business or profession".      It may  be noticed  that provisions  where no deduction shall be  allowed in  respect of  any provision  made by the assessee for  the payment  of gratuity  to his  employees on their retirement  or on  termination of their employment for any reason  was made  in the Income Tax Act, 1961 by Section 40A(7) introduced by the Finance Act w.e.f. April 1, 1973.      It was submitted by Mr. Vellapally that High Court went wrong in  holding that  there  was  no  termination  of  the services of  the employees of the assessee. He said the High Court  wrongly   addressed  itself   to  this   question  of termination of  services of  the employees of assessee which had never  been referred  to it  and  the  consequent  error committed by  the High  Court when the High Court did not in effect refer  to the  question referred to it. Commenting on the decision  of the  Supreme Court  in Gemini  Cashew Sales Corporation   (Supra)    Mr.   Vellapally    said   it   was distinguishable and submitted that retrenchment compensation payable to  an employee  was not the same thing as gratuity. While right  to gratuity  accrue  year  after  year  and  is payable at  the termination  of  employment  voluntarily  or otherwise except  when it  is on account  of misconduct, the right to  retrenchment is not always by reason of closure of the unit  or otherwise  termination of  employment.  If  the employees did  not suffer  any disadvantage  on being  taken over  by  Rallis  India  Ltd.  it  was  the  affair  of  the transferee company  but it  could not be said that there was no termination of services of the employees of the assessee. Mr. Iyer,  learned counsel  for revenue, did not dispute the fact that  there was  valid termination  of services  of the employees of  the assessee. It was submitted by the assessee that the  amount in  question was certainly business expense and it  was the  liability of  the assessee in praesenti and was discharged  by making  over the  payment of Rallis India Ltd. on behalf of the employees. If we consider the balance- sheet of  Rallis India  Ltd. the  amount in question did not form part  of its  profits and  loss account.  It was  not a revenue receipt.  It entered  ion the balance-sheet as trust amount. Mr. Vellapally said as to how the amount is received and utilised by Rallis India Ltd., the transferee, is also a relevant consideration,  if the  service of  the employee is terminated, he  would become  entitled  to  the  payment  of gratuity as  per the  scheme of  the assessee and instead of getting the amount directly it was paid to Rallis India Ltd. which created  trust for  that amount  for the  employees so transferred from  assessee it  to. This  amount could not be

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forfeited by  the transferee  company even  if  an  employee transferred from  assessee is  ultimately dismissed  on  the ground of alleged misconduct. He may in that can forfeit his right to get gratuity from Rallis India Ltd. accruing to him after May  1, 1959 while to the service of Rallis India Ltd. Mr. Vellapalli, in support of his submissions, relied upon a Full Bench  decision of Kerala High Court in Commissioner of Income-Tax. Tamil  Nadu-III Vs.  Sri Venkateswara  Bank Ltd, [(1979) 120  ITR (Ker)  152], Commissioner of Income-Tax vs. Sarada Binding  Works    [(1905)  152  ITR  (Mad)  520]  and Commissioner of  Income-Tax vs.  Salem Magnisite  Pvt.  Ltd. [(1991) 189 ITR (BOM) 154].      Mr. Iyer  in response  said the amount was not paid for carrying on  the business  of the assessee and rather it was for closing its business and therefore could not be business expense deductible  under Section  10(2)(xv) of the old Act. It was  submitted that  the arrangement of payment of amount to M/s.  Rallis India Ltd. by the assessee was between these two parties  and the  employees of  the assessee were not to fall back  upon it  for payment  of gratuity.  There    was, therefore, no  liability existed for the assessee to pay the gratuity to  the employees. In support of his submissions he relied on three judgments of the Madras High Court in Stanes Motors (South  India) Ltd.  vs. Commissioner  of Income-Tax. Madras [(1975)  100 ITR  341]; Commissioner  of  Income-Tax. Madras-II vs.  Pathinen Grama  Arya Vysya  Bank Ltd. [(1977) 109 ITR 788]; and Commissioner of Income-Tax. Tamil Nadu-III vs. Salem  Bank Ltd..  [(1979) 109  ITR  224].  These  three judgments were considered by the Madras High Court itself in its later  judgment in Commissioner of Income-Tax Vs. Sarada Binding Works  [(1985) 152  ITR 520]. Mr. Vellapalli pointed out that  the impugned judgment was considered by the Bombay High Court  in Commissioner of Income-Tax vs. Salem Magesite Pvt. Ltd.  [(1991) 189  ITR 154] where it was distinguished. Mr. Oyer’s  stress was  that the ratio of judgments cited by him was  here the expense was not laid down for the business of the  assessee and  so was  not deductible and that it was not for  conducting or  carrying  on  the  business  of  the assessee but  for closing the same. But then what we find is that before  the Tribunal  and in  the High Court, the whole edifice of  the department was built on the stand that there was no  termination of  employment of  the employees  by the assessee and  as such  no liability  had arisen and that the assessee was  not liable  to  pay  any  gratuity.  It,  was, however, admitted  that there  was no dispute as to the fact that gratuity  would be  allowable deduction  as and when it becomes payable.  The contention  of the Revenue was that so far as  the assessee  was concerned,  there was no liability for payment of gratuity to the employees directly arising as the employees  would have  to look forward to their claim of gratuity from M/s. Rallis India Ltd.      Since many  a judgment  of the  Madras and  Kerala High Courts rendered  earlier to  Full Bench  of the  Kerala High Court and  of Sarada  Binding Works  of  Madras  High  Court extensively relied  upon the decision of the Court in Gemini Cashew  Sales  Corporation’s  case,  we  may  consider  that judgment in somewhat detail.      In Commissioner of Income Tax, Kerala vs. Gemini Cashew Sales Corporation  [(1967) 65  ITR 643] question before this Court was whether the allowance of Rs.1,41,506/- constituted an allowable  expenditure in  the assessment of the firm for the year  1958-59 being  retrenchment  compensation  payable under Section 25FF of the Industrial Disputes Act. The facts giving rise  to  the  question  were  that  there  were  two partners constituting  the firm.  One partner died on August

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24, 1957  and the  partnership stood dissolved. The business was taken over and continued by the surviving partner on his own account.  The services of the employees of the firm were not interrupted  and there was no alteration in the terms of their employment.  It was  urged that  since the  firm stood dissolved  on  August  24,  1957  and  the  undertaking  was transferred, the  employees became  entitled to retrenchment compensation which  the firm  was liable  to pay. Though the assessee failed  in its  claim before the Income-tax Officer and Appellant Assistant Commissioner, the Appellate Tribunal held that  the firm  was entitled  to deduct  the sum of Rs. 1,41,506/- in  computation of  its income  in the assessment year 1958-59.  Kerala High  Court on reference made to it at the instance  of the  revenue agreed  with the  view of  the Appellate Tribunal  and said  that the  firm could  claim as permissible outgoing amount for which liability was incurred though no  actual payment was made to workmen since the firm was maintaining  accounts on  mercantile system,. This Court noticed the  provision  of  Section  25F  and  25FF  of  the Industrial Disputes Act and also the proviso to Section 25FF which provided where there has been a change of employers by reason of the Transfer of -      "(a) the service of the workman has      not  been   interrupted   by   such      transfer;      (b) the  terms  and  conditions  of      service applicable  to the  workman      after such  transfer are not in any      way less  favrouable to the workman      than  those   applicable   to   him      immediately  before  the  transfer;      and      (c) the  new employer is, under the      terms   of    such   transfer    or      otherwise, legally liable to pay to      the workman,  in the  event of  his      retrenchment, compensation  on  the      basis that  his  service  has  been      continuous   and   has   not   been      interrupted."      This Court said:      "Liability  to   pay   retrenchment      compensation arises  under  Section      25FF when  there is  a transfer  of      the ownership  or management  of an      undertaking:  it   arises  on   the      transfer of the undertaking and not      before. Transfer  of  ownership  or      management of an undertaking in law      operates, except  in the conditions      set  out   in   the   proviso,   as      retrenchment of  the  workmen.  But      until there  is a  transfer of  the      undertaking      resulting       in      determination  of  employment,  the      workmen do  not become  entitled to      retrenchment compensation.  So long      as the  ownership of  the  business      continues with  the  employer,  the      right  of   the  workmen  to  claim      compensation remains  contingent. A      workman may, before the transfer of      ownership of  the business, himself      terminate the  employment:  he  may      die or he may become superannuated:

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    in none of these cases the owner of      the   business    is   under    any      obligation  to   pay   retrenchment      compensation to  the  workman.  The      obligation  to   pay   compensation      becomes definite only when there is      retrenchment  compensation  to  the      workman.  The   obligation  to  pay      compensation becomes  definite only      when there  is retrenchment  by the      employers, or when the ownership or      management of  the undertaking  is,      except in the cases contemplated by      the proviso,  transferred to  a new      employer, and  not till  then.  The      right   therefore    arises    from      determination  of   employment,  or      from transfer  of the  undertaking:      it has  no existence  before  these      events take place."      This Court  also referred  to its  earlier judgment  in Calcutta Co, Ltd.  vs. Commissioner of Income-Tax [(1959) 37 ITR 1].  It said that in that case, expenditure which it was estimated had  to be  incurred to  discharge an existing and definite obligation  enforceable  against  the  assessee  in praesenti  was   held  a   permissible  deduction   in   the commutation of income.      This  Court   held  that   the  amount   claimed  as  a permissible allowance by the assessee in its profit and loss account cannot,  in its  judgment, be  regarded as  properly admissible either under Section 10(1) or Section 10(2)(v) of the 1922 Act. This is how the Court said:      "As already observed, the liability      to  pay  retrenchment  compensation      arose for  the first time after the      closure of  the  business  and  not      before.  It   arose  not   in   the      carrying on   of  the business, but      on account  of the  transfer of the      business. During  the entire period      that the  business was  continuing,      there  was   no  liability  to  pay      retrenchment   compensation.    The      liability which  arose in  transfer      of  the   business  was  not  of  a      revenue  nature.   Profits   of   a      business involve comparison between      the state  of the  business at  two      specific   dates.    Normally   the      liability which  occurs  after  the      last date,  unless its source is in      a pre-existing definite obligation,      cannot be regarded as a part of the      outgoing of  the business debitable      in the  profit and  loss account. A      deduction  which   is  proper   and      necessary  for   ascertaining   the      balance of  profits and gais of the      business  is  undoubtedly  properly      allowable, but where a liability to      make a  payment arises  not in  the      court of  the business, not for the      purpose   of    carrying   on   the      business,  but   springs  from  the      transfer of the business, it is not

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    in   our   judgment,   a   properly      debitable item  in its  profit  and      loss account as a revenue outgoing.      The claim  of the  firm to treat it      as an  item in the determination of      the  profits   of  the  firm  under      section 10(1) of the Income-tax Act      cannot, therefore, be sustained.                Under section  10(2) (xv)      of the Indian Income-tax Act in the      computation  of   taxable   profits      (omitting parts  of the  clause not      material) "any expenditure laid out      or expended  wholly and exclusively      for the  purpose of  such business,      profession  or   vocation",   i.e.,      business,  profession  or  vocation      carried on  by the  assessee, is  a      permissible allowance.  But to be a      permissible      allowance      the      expenditure must be for the purpose      of carrying  on the business. Where      accounts  are  maintained  don  the      mercantile system,  if liability to      make the  payment has arisen during      the time  the business  is  carried      on,   it   may   appropriately   be      regarded as  expenditure. But where      the liability  is, during the whole      of the  period that the business is      carried on,  wholly contingent  and      does   not   raise   any   definite      obligation during the time that 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 Tribunal  when decided that matter in favour of the appellant in  the present  case referred  to  the  aforesaid statement of  law by  this Court  in the  case of  the  same Gemini Cashew  Sales Corporation  and observed that facts in the case  before it  were not the same as before the Supreme Court in  that case.  In our  view, the  Tribunal  was  just right.      In Stanes Motors (South India) Ltd. vs. Commissioner of Income-Tax, Madras  [(1975) 100 ITR 341 (Mad)], the assessee claim deduction  of Rs.56,275/- under section 37 of the 1961 Act  which   amount  represented  gratuity  payment  to  its employees transferred  to the  new company.  The amount  was calculated on  the basis  of the  scheme of the assessee and was from  the pension  and gratuity reserve of the assessee. The claim  of the  assessee that  the amount was paid in the discharge of  the liability  of gratuity  to  the  employees transferred to  the  new  company  and  hence  allowable  as deduction was  negatived. High  Court relied on the decision of this  Court in Gemini Cashew Sales Corporation’s case. It observed as under:      "As   already   pointed   out   the      liability to  make payment  to  the      employees had not arised during the      accounting period. The liability if      at all  was wholly  contingent. The      transfer of  gratuity reserve  from      the  assessee-company  to  the  new

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    company did  not also  arise in the      course of  the business  or for the      purpose of carrying on the business      but springs  from the  transfer  of      the business.  Therefore, it cannot      be said  the expenditure  was  laid      out   or    expended   wholly    or      exclusively  for   the  purpose  of      business  or   it  was  a  properly      debitable item  in its  profit  and      loss account as a revenue outgoing.      For the foregoing reasons we answer      the first  question in the negative      and    against    the    assessee."      In CIT  Vs. Pathinen Grama Arya Vysya Bank Ltd. [(1977) 109 ITR  788 (Mad)]  question  before  the  High  Court  was whether a  sum of  Rs. 18,931 which formed part of the total sum transferred  by the  assessee to  the Karur  Vysya  Bank Ltd., by  way of  gratuity to the employees for the services rendered to it, was admissible as a deduction. Again relying on  the   aforesaid  decision   in   Gemini   Cashew   Sales Corporation’s case,  the High  Court said that the principle of  the   decision  of   the  Supreme   Court  relating   to retrenchment compensation  to the  employees equally applied to the  payment of  gratuity to the employees of an assessee whose business had been transferred to another and where the transferee took  over the  employees  with  the  benefit  of continuity of service.      In Commissioner  of Income-Tax,  Tamil Nadu-III vs. Sri Venkateswara Bank  Ltd. [(1979)  120  ITR  207  (Mad)],  the assessee transferred as substantial part of its business  to the Indian  Overseas Bank  Ltd. At the time of the transfer, the assessee  paid a sum of Rs.20,032/- as "gratuity" to its employees  and   claimed  the   same  as  deduction  in  the computation of  its income.  The question  before  the  High Court was  whether on  the facts and in circumstances of the case, the  Appellate Tribunal was right in allowing the said sum as admissible deduction under Section 36(1)(ii) or under Section 37(1)  of  the  1961  Act.  The  Income-tax  Officer referred to  the amount as "retrenchment compensation" while the assessee  claimed it  as gratuity.  The High  Court said that in  either  case,  the  amount  cannot  be  allowed  as deduction under  Section 36(1)(ii).  It was  found that  the assessee was continuing to carry on its business. High Court observed as under:      "The point  now to be considered is      whether  the  payment  of  gratuity      with reference to its employees who      were found  to be  surplus  at  the      time of  the transfer  of a part of      the  business   is   an   allowable      deduction under  s.37(1). A payment      made in  the course  of carrying on      its business  as gratuity cannot be      equated to  a terminal  payment  on      the closure  of the  business so as      to  be  disallowed.  There  was  no      closure on  the  facts.  Therefore,      such a claim cannot also be equated      to a  payment made  at the  time of      the transfer  of the undertaking of      the assessee as in the cases cited.      It is  not necessary, therefore, to      go Cashew Sales Corporation [(1967)      65  ITR   643  (SC)]   and  CIT  v.

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    Pathinem Grama Arya Vysya Bank Ltd.      [(1977) 109  ITR 788  (Mad)]. Those      are cases  where there  had been  a      cessation  of  the  business  or  a      transfer  of   the  undertaking  as      such.  On   the  facts  found,  the      assessee will  be eligible  for the      allowance   under    s.37(1).   The      several clauses  under s.36  do not      apply  here.   The   question   is,      therefore,    answered    in    the      affirmative as  far as allowability      under  s.37  is  concerned  and  in      favour of the assessee."      In Commissioner of Income-Tax, Tamil Nadu-III vs. Salem Bank  Ltd.   [(1979)  120   ITR  224  (Mad)],  the  assessee transferred its banking business to the Indian Bank Ltd. and deposited a  sum of Rs.37,560/- with the transferee bank for the purpose  of ultimate  disbursement to  its 237 employees (who were  transferred to  the Indian  Bank  Ltd.)  for  the purpose of  ultimate disbursement  to them  at the  time  of their retirement  or earlier  as per  the provisions  of the gratuity scheme  of the  as expenditure  under Section  3(1) (ii) or  Section 37(1)  of the  1961 Act.  The plea  of  the assessee of its case falling under Section 36(1)(ii) was not considered. The  Court distinguished its earlier judgment in the case  of Sri  Venkateswara Bank Ltd. [(1979) 120 ITR 207 (Mad)] and  said that Section 37(1) was not attracted in the case and  the  question  referred  to  it  was  answered  in negative in  favour of the revenue and against the assessee. The Court  observed that liability to pay gratuity could not be said  to have  reason at  the time  of the  transfer as a result of  the assessee  carrying on  its business.  It said that firstly  there was no present liability to pay gratuity and the  amount had  been deposited with the transferee bank only in  pursuance of understanding or agreement between two and not  on the  basis of the liability which has accrued on the date  of transfer and that if the transfer had not taken place, the  assessee’s liability  would arise  as and when a particular employee  got a  right or receive gratuity as per the scheme applicable to the assessee. The court, therefore, said that a liability which could not have been there if the business was  continued in  the year  of account  and  which arose as  a  result  of  the  transaction  under  which  the business of  the assessee  had been transferred could not be said to  be an expenditure incurred for the purpose carrying on the business in the accounting year in question.      In CIT  Vs. Standard Furniture Co. Ltd. [(1979) 116 ITR 751 (Ker)  (Full Bench)],  the question before the court was whether the  expenditure of Rs. 44,44,988 was an expenditure incurred wholly  and exclusively  for  the  purpose  of  the business within the meaning of Section 3791) of the I.T. Act 1961 as applied to the assessment year 1979-72. In this case the assessee  went into  voluntary liquidation.  It sold its stock and  machinery to  one Sudarsan  Trading Company for a consideration of  Rs.20,09,962. The purchaser agreed to take over the  services of  such of  the assessee’s  employees to whom the  provision of  the Industrial Disputes Act applied. Under a  provision of law relating to payment of gratuity as in force in the State of Kerala, the assessee had incurred a liability for  the payment  of gratuity to its workers which was estimated  at Rs.4.44.988. Liability of the assessee for payment of  this  amount  was  agreed  to  be  paid  by  the purchaser at  a future date. The purchaser paid the purchase price of  the stock  and machinery of the assessee minus the

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amount  of   gratuity  payable   to  the   employees   which arrangement was  made with  the  consent  of  the  concerned employees. The  High Court  considered various  judgments of the High Courts and also that of this Court in Gemini Cashew Sales Corporation  and held  that the amount in question was an expenditure  incurred  wholly  and  exclusively  for  the purpose of  the business  of the assessee within the meaning of Section  37(1) of the 1961 Act. It upheld the view of the Appellate Tribunal  that liability  for payment to which the employer was  subject under  the local  Gratuity Act, to the workers was  an expenditure  wholly and exclusively laid out or expended for the purpose of the business of the assessee. The court  disagreed with  the view  of the revenue that the incurring of  expenditure for payment of gratuity much ahead of the  actual time for payment of gratuity could not amount to an  expenditure incurred  "wholly and exclusively for the purpose of the business".      In CIT  Vs. Sarade  Binding Works  [(1985) 152  ITR 520 (Mad)] the  High Court  struck a  different note. It had the advantage of  the Full  Bench decision  of the  Kerala  High Court in Standard Furniture Company Ltd. [(1979) 116 ITR 751 (Ker)] In  this case  the assessee,  a registered  firm, was doing business  in the  name Sarada Binding Works as also in the name of Chandamama Publications. Under an agreement, the assessee  gave   up  possession   of  all   the  assets  and liabilities in  Chandamama publications.  On a settlement of the assets  and liabilities  as described in the schedule to the agreement, the excess of liabilities over assets came to Rs. 67,687/-  and the  assessee paid  the said  sum  to  the transferee who  succeeded  to  the  business  of  Chandamama Publications. One  of the  clauses of the agreement was that all the employees in that business would become employees of the transferee  on terms  no less  favourable   to them with continuity of  service. Liabilities  as worked  out  in  the schedule included  an amount  of  Rs.80,309/-  which  was  a provision for  gratuity due to the employees of the business taken over  by the  transferee. The  assessee  claimed  this amount as  deduction. The question before the High Court was whether the  appellate tribunal  was right, on the facts and in the  circumstances of  the case, in allowing deduction of gratuity liability  of Rs. 80,309/- . The Court answered the question in  favour of  the assessee and against the revenue holding that in respect of the business that was transferred though the payment under the agreement was not made directly to  the   employees  as   such,  the  amount  was  paid  for discharging the  assessee’s liability to pay gratuity to its employees for  the period  ending with  the date of transfer and, hence, the payment should be taken to be a payment made to discharge  the assessee’s  liability  for  gratuity  and, hence, had to be allowed as a deduction.      In CIT  Vs. Salem  Magnesite Pvt.  Ltd. [(1991) 189 ITR 154 (Bom)  the services  of the  employees  in  one  of  the departments  of   the  assessee   were  discontinued   which department was  taken over  by the  State of Tamil Nadu. The liability of  the assessee in respect of payment of gratuity to its those employees had become due which the assessee was prepared to  pay to  the employees  directly.  However,  the concerned employees desired that the  payment be made to the State  Government  as  they  wanted  to  have  advantage  of continuity of service. The State Government agreed to accept the proposal  and payment  was made  by the  assessee to the State Government  on behalf  of the employees. The Court, in which one  of us  was a party (Sujata V. Manohar, J.) was of the view  that the  Tribunal was  right in  holding that the said amount  was allowable  as deduction  in  computing  the

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taxable profits  of the assessee. Another question which was referred in that case for decision of the court was:      "Whether on  the facts  and in  the      circumstances  of   the  case,  the      Tribunal should not have upheld the      disallowance of  the said amount in      view of  the decision of the Bombay      High Court in CIT v. W.T. Suren Co.      Ltd. [1982] 138 ITR      In  answer   to   this   question,   the   High   Court distinguished the  impugned judgment by saying that no right to gratuity  had accrued  in favour  of the  employees whose services were  alleged to  have been terminated. This is how the Court  considered its earlier case in W.T. Suren and Co. Ltd.:      "We have  been  taken  through  our      decision in  CIT v.  W.T. Suren and      Co. Ltd  [1982] 138 ITR 91. In this      case,  no  right  to  gratuity  had      accrued in  favour f  the employees      whose services were alleged to have      been terminated.  This  was  so  in      view of  the  assessee’s  agreement      with the transferee-company to take      them   up    in   employment   with      continuity of employment. There was      thus no  liability to  pay gratuity      to  the   employees  as  such.  The      assessee-company  had  merely  made      the payment in connection therewith      to the  transferee-company under an      agreement.      In the  present case, the assessee-      company had  not only  computed the      amount payable to the employees but      was also willing to make payment to      them. It  was the  workers who  did      not want  to  receive  the  payment      direct as they wanted continuity of      service.  There  were  negotiations      between   the   workers   and   the      Government of Tamil Nadu. After the      agreement   between    them,    the      assessee-company  paid   the   said      amount of  Rs.44 lakhs to the Tamil      Nadu Government.  Thus, even though      the  workers  had  the  benefit  of      continuity of  service, it  was not      on account  of the assessee-company      but  as  a  result  of  a  separate      arrangement/agreement  between  the      workers and the Government of Tamil      Nadu. This  Court’s decision in CIT      v. W.T.  Suren and Co. Ltd. ’s case      [1982] 138  ITR 91  was, therefore,      rightly distinguished."      In our  view, Kerala  High Court  in Standard Furniture Co. Ltd.’s  case [116  ITR 751], Madras High Court in Sarada Binding Works  case [152  ITR 520]  AND Bombay High Court in Salem Magnisite  Pvt. Ltd.’s case [189 ITR 154] have rightly distinguished the  judgment of  this Court  in Gemini Cashew Sales Corporation’s  case. Retrenchment  compensation is not the  same   thing  as   gratuity.  In  Gemini  Cashew  Sales Corporation’s case,  the Court  considered the  question  of payment of retrenchment compensation under the provisions of

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the  Industrial   Disputes  Act.   That  Act   contains  the provisions under what circumstances a workman is entitled to retrenchment compensation.  While Section  25F of  that  Act prescribed  conditions  preceding  to  the  retrenchment  of workmen, Section  25FF provides  for compensation to workmen in  case   of  transfer  of  undertakings.  Right  to  claim retrenchment compensation  remains contingent  and there may be varying  circumstances under  which employment may cases. Yet there  may not  be any  right to such compensation, like death, retirement,  resignation  etc.  Under  law  right  to retrenchment compensation  arises when  employer  terminated the employment or undertaking of the employer is transferred and in  the later  case that  too if  the case  does to fall under the proviso to Section 25FF of the Industrial Disputes Act. Those  provisions cannot  certainly be  applied in  the case of  payment of  gratuity. The  scheme  of  gratuity  as applicable to  the members  of the  staff  of  the  assessee provided as  to how  much  gratuity  would  become  due  and payable to an employee for each of service except to one who is dismissed  for misconduct etc. Gratuity is, thus, payable on the  termination of  employment of  the employee  on  any account except  dismissal and  calculated on  the  basis  of number of years of service and at the rate prescribed in the scheme. In  the present  case, the  amount of gratuity which was paid  to  M/s.  Rallis  India  Ltd.  on  behalf  of  the employees was not on account of transfer of the distribution unit to  the assessee  but on  account of  stopping of  that business and  the employees  working in  that unit  becoming surplus resulting  in termination  of their  services. Other business  of   the  assessee,   as  held  by  the  Tribunal, continued. Payment  of gratuity  amount to M/w. Rallis India Ltd. was  not made  by the  assessee of  its own  but at the instance and  on behalf  of  the  employees  whose  services though terminated in the assessee company were taken over by M/s. Rallis  India Ltd.  with the  promise of  continuity of service in  M/s. Rallis India Ltd. As far as the assessee is concerned, it  was bound  to make payment of gratuity to the employees whose  services were  terminated and,  in fact, as noticed above,  the employees  who did  not join M/s. Rallis India Ltd. were directly paid gratuity. Assessee was obliged to pay gratuity to those employees who had joined M/s Rallis India Ltd.  Instead of  those employees getting the gratuity amount directly,  got that  amount in  trust in  a  separate account for  the exclusive  use of the transferred employees and payable  to them  after their  services in  M/s.  Rallis India Ltd.  terminated including the gratuity due on account of service  rendered in  M/s. Rallis  India Ltd.  as per the scheme relating  to gratuity  of that  company.  Payment  of amount of  gratuity to M/s Rallis India Ltd. was made as per the scheme  of the  assessee and  it was not an ex-gratia or some isolated  payment. It  was never disputed and, in fact, no question  raised if  the service  of the employees of the assessee were  not terminated  and that  being the position, the obligation  of the  assessee to make payment of gratuity to its  employees was an obligation in praesenti. Payment of gratuity amount to M/s. Rallis India was with the consent of the employees  transferred there.  We are, thus, of the view that payment  of gratuity  awarded by  the assessee  to M/s. Rallis   India Ltd.  in the circumstances of the case was an expenditure wholly  laid or  expended for the purpose of the business of  the assessee  and was  allowable deduction.  It cannot certainly be said that it was an expenditure incurred much ahead  of time as the service of the employees with the assessee were  terminated.  Tribunal  also  found  that  the assessee was  a going concern and only one of its department

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was closed.  The assessee  had  not  wound  up  all  of  its affairs.  Only  a  part  of  its  business  was  closed  and transferred   to   M/s.   Rallis   India   Ltd.   IN   these circumstances, in  our view,  Tribunal was  right in holding that the  payment of  gratuity amount  was not on account of closing the  business of the assessee but for the purpose of business of  the assessee  and, thus,  entitled to deduction under clause  (xv) of  sub-section (2) of Section 10 of 1922 Act corresponding  to Section  37(1) of  the 1961  Act.  We, therefore, hold  that the assessee, the appellant herein, is entitled to  the payment of gratuity amount of Rs. 4.8,622/- made to M/s. Rallis India Ltd. as an allowable deduction.      We allow the appeal, set aside the judgment of the High Court and  answer the  question in  affirmative in favour of the assessee and against the revenue.