M.R.A. ANSARI, J.

( 1 ) THE following two questions have been REFERRED TO to this Court by the

Income-tax Appellate Tribunal, Delhi Bench, (hereinafter REFERRED TO to as the

Tribunal) under section 66 (1) of the Indian Income-tax Act, 1922 (hereinafter

REFERRED TO to as the Act:- 1. Whether on the facts and in the circumstances of

the case, the loss of Rs. 66,417. 00 was allowable under section 10 (1) of the Indian

Income-tax Act, 1922 or could be set off against the companys profits of the

business under proviso (a) to Explanation 2 of section 24 (1) of the said Act 2.

Whether on the facts and in the circumstances of the case, Rs. 52,633. 00 claimed

as business expenditure for assessment year 1957-58 and Rs. ll,578. 00 claimed as

such for assessment year 1958-59 under section 10 (2) (xv) of the Indian Income-

Tax Act, 1922, have rightly been disallowed

( 2 ) THE facts relevant to the first question may now be stated. M/s. Delhi Flour

Mills Co. Ltd. , New Delhi, (hereinafter REFERRED TO to as the assessee) carried on

the following businesses:- 1. Grinding of wheat for manufacturing atta and wheat

products. 2. Manufacturing of ice and maintaining a cold storage. 3. Washing,

calendering and dyeing business which is a part of the hosiery department.

( 3 ) DURING the accounting year relevant to the assessment year 1957-58, the

assessee entered into forward transactions in Matra (a substitute of gram ). These

transactions comprised purchases amounting to Rs. 6. 82,141. 00 and sales

amounting to Rs. 6,16,124. 00. There was thus a loss amounting to Rs. 66,417. 00

resulting from these forward transactions. These transactions were concluded not by

actual delivery of the goods but by payment of differences. These transactions were,

therefore, in the nature of "speculative transactions" within the meaning of

Explanation 2 to section 24 (1) of the Act. The assessee claimed a set off of the loss

of Rs. 66,417. 00 which it had sustained in these forward transactions on two

grounds, namely :- (i) that these transactions were in the nature of hedging

transactions which were saved by the proviso (a) to Explanation 2 of section 24 (1)

of the Act; and (ii) that even if these transactions were in the nature of speculative

transactions, the losses sustained by the assessee in such transactions were liable to

set off against its profits in other business.

( 4 ) THE assessees claim was, however, rejected by the Income-tax officer, the

Appellate Assistant Commissioner and also by the Tribunal.

( 5 ) THE second ground state above on which the assessee claimed the set off of

the loss of Rs. 66,417. 00 against its other business profits was based upon two

decision of the Allahabad High Court, namely.- 1. Jagannath Mahadeo Prasad v.

Commissioner of Income- tax (1965) 55 ITR 502 (1) and 2. Gauri Dutt Bhagwan

Dass v. Commissioner of Income- tax (1965) 56 ITR 423 (2 ). in which the view was

taken that an assessee was entitled to a deduction of the loss in speculative

transactions while computing the profits and gains under the head "profits and gains

from business" under section 10 of the Act. Some of the other High Courts, namely,

Bombay, Punjab, Mdaras, Andhra Pradesh, Calcutta and Gujarat, had, however,

taken a contrary view. The controversy was ultimately settled by the Supreme Court

in the case of Commissioner of Income-tax tax v. Kantilal Nathuchand Sami (1967)

63 ITR 318 [LQ/SC/1966/252] (3 ). in which it was held as follows:-"the principal clause of section 24

(11) lays down that, if there be a loss of profits or gains in any year under any of

the heads mentioned in. section 6, that loss has to be set off against the income,

profits or gains of the assessee under any other head in that year. If this provision

had stood by itself without any provisos, the result would have been that. all losses

incurred by an assessee under any of the heads mentioned in section 6 would be

adjusted against profits under all other heads, and then the total income of the

assessee would be worked out on that basis. The first proviso to this sub-section,

however, lays down an exception to this general rule contained in the principal

clause. The exception relates to income from business consisting of "speculative

transactions, and places the limitation that losses sustained in speculative

transactions are not to be taken into account in computing the profits and gains

chargeable under the head profits and gains of business, profession or vocation,

except to the extent that they will be set off against profits and gains in any other

business, which itself consists of speculative transactions. The effect of the proviso

is that if there are profits in speculative business, those profits. are added to income

under the other heads mentioned in section 6 for purposes of computing the total

income of the assessee in order to determine the tax under section 23 of the Act.

On the other hand, losses in speculative business are not to be taken into account

when computing the total income, except to the extent to which they can be set off

against profits from other speculative business. The first proviso, thus, clearly limits

the applicability of the principal clause of section 24 (1); and, when applied, it

governs the manner in which the total income of the assessee is to be computed. "

( 6 ) THE above rule was re-affirmed by the Supreme Court in a latter decision in

Commissioner of Income-tax v. Jagannath Mahadeo Prasad (1969) 71 ITR 296 (4 ).

In view of the above decisions of the Supreme Court, Shri Kirpa Ram Bajaj, learned

counsel for the assessee, did not press before us the second ground on which the

assessee had claimed the set off of the loss of Rs. 66,417. 00.

( 7 ) THE first ground on which the assessee has claimed the set off of its loss in the

forward transactions REFERRED TO to above is based upon proviso (a) to

Explanation 2 of section 24 (1) of the Act which reads as follows:-"provided that for

the purposes of this section,- (a) a contract in respect of raw materials or

merchandise entered into by a person in the course of his manufacturing or

me chanting business to guard against loss through future price fluctuations in

respect of his contracts for actual delivery of goods manufactured by him or

merchandise sold by him shall not be deemed to be a speculative transaction. "

( 8 ) ACCORDING to the learned counsel, a forward transaction in any commodity

which has been entered into for the purposes of guarding against the loss through

future price fluctuations in respect of the goods manufactured or sold by the

assessee would come within the scope of the proviso and that it is not necessary

that the forward transactions should be in respect of the same commodity or goods

which are manufactured or sold by the assessee. His contention, therefore, is that

even though the forward transactions in the present case were in Maira which was

not either the raw material used by the assessee for manufacture of atta or wheat

products or the article sold by it such forward transactions must be treated as

hedging transactions within the meaning of the proviso. The learned counsel has not

cited any decision before us in support of this contention, but has drawn our

attention to the report of the Direct Taxes Administration Enquiry Committee 1958-

59 which contains extracts from the speech of the Finance Minister made in

Parliament while piloting proviso (a) to Explanation 2 of section 24 (1) of the Act, It

is only in cases where the language of any section of the statute is vague and the

language is capable of being interpreted in different ways that a Court may derive

some guidance from the speech of the Minister who was piloting the particular piece

of legislation in the Legislature. In our view, the language of proviso (a) to

Explanation 2 is quite clear and we need not, therefore seek any guidance in the

interpretation of this proviso from the speech of the Finance Minister. Even if we do

refer to the relevant portions of the speech of the Finance Minister, we do not find

anything in them to support the contention of the learned counsel. This is what the

Finance Minister stated in the speach:-"in the Bill, as it is drafted, we have excluded

hedging transactions, the common hedging transactions, that is a mill buys cotton

and sells cloth. There are various other varieties of hedging transactions and after

discussions with the representatives of trade and business, I have come to the

conclusion that they are also legitimate. One category of transactions is the one I

REFERRED TO to just now: a man wants to protect himself against any loss in

certain scripts he holds, but he sells some other scripts which he expects will have a

reverse movement. The object is to save that kind of transactions. The other is

where there are jobbers and brokers and others-it is their regular business and their

ordinary transactions are not transactions such as we want to avoid, namely, selling

and buying of losses. "

( 9 ) THE examples which the Finance Minister gave of hedging transactions are not

of the same nature as the forward transactions entered into by the assessee in the

present case. The learned counsel also REFERRED TO to some other portions of the

report of the Direct Taxes Administration Enquiry Committee. But it is not necessary

for us to express our view regarding the same, because views expressed in such

reports need not necessarily be taken as reflecting the intention of the Legislature.

In fact it may well be that if the views expressed by the Committee were not clearly

reflected in the statute, it may be understood that the Legislature did not accept

such views.

( 10 ) THE learned counsel also REFERRED TO to a decision of the Central Board of

Direct Taxes. Decisions of the Central Board are not binding upon Courts. They are

meant only for the guidance of the departmental authorities. If these departmental

decisions are not in accordance with the provisions of the statute, they have to be

disregarded. The decision REFERRED TO to by the learned counsel appears at page

1110 of Iyengars commentary upon the Income-tax Act and it is to the following

effect :-"attention is invited to Boards letter No. 13 (102) IT/55 dated 8-9-1954 in

which it was stated that as regards hedging in raw materials, the Income-tax

Officers should not be too particular about the quantities and timing so long as the

transactions constitute genuine hedging. Similarly, Income-tax Officers should not

treat genuine hedging transactions in connected commodities as speculative

transactions though the transactions may not be in identically the same commodity.

Thus, hedging transactions in one type of cotton against another type of cotton, one

variety of oil seed against another, one type of grain against another should not be

treated as speculative transactions provided the other conditions of Expln. 2 to s. 24

are satisfied. The conditions mentioned in the last two sentences of the decision on

point (i) above will apply here also. "

( 11 ) EVEN if we apply this decision to the facts of the present case, it is clear that

the forward transactions made by the assessee were not in connected commodities

because Matra comes under the category of pulses, whereas wheat comes under

the category of grain. The two cannot be called connected commodities the nature

mentioned by the Board.

( 12 ) FROM the plain language of the proviso it is quite clear that the raw materials

or merchandise in respect of which the forward transactions have been made by a

person must have a direct connection with the goods manufactured or merchandise

sold by him. Otherwise, the use of the words "raw materials" would have no special

significance. It must be presumed that the Legislature deliberately used these words

so as to give them a special significance in relation to the goods manufactured by

the assessee. In the present case, Malm may be considered to be raw material for

manufacturing Basin or some other articles made out of Matra. Matra cannot

certainly be considered as raw material for the manufacture of atta and other wheat

products. Therefore, the forward transactions made by the assessee in respect of

Matra cannot be treated as hedging transactions within the meaning of proviso (a)

to Explanation 2 and the loss sustained by the assessee in such transactions cannot

be set off against his profits in the business of manufacturing atta and other wheat

products.

( 13 ) WE find support for this view from two reported decisions, one of the Andhra

Pradesh High Court and the other of the Gujarat High Court. In Omkarmal Agarwal

v. Commissioner of Income-tax (1968) 67 ITR 329 (5), the assessee was carrying on

business in buying raw cotton, ginning it, and converting it into lint with the aid of

machinery, and selling lint and cotton seed. The assessee entered into forward

contracts for the delivery of lint at a future date, and these contracts were settled

without effecting delivery of the goods and even before the time fixed for

completion of the contract. There were no contracts in respect of raw materials or

merchandise. The assessee claimed that the transactions were not speculative

transactions since according to him they were hedging contracts to guard against

possible loss from another set of transactions. The High Court rejected the

assessees claim holding that the transactions in question were not in the nature of

hedging transactions. We may usefully refer to the following observations of the

high Court:-"the nature of the business conducted by the assessee was buying

kapas (raw cotton), ginning it and selling lint and cotton seed. In respect of the

impugned transactions there are only one set of contracts and not two sets as

required by clause (a) of the proviso to Explanation 2. That proviso contemplates

two contracts: (i) a contract for actual delivery of goods manufactured by the

assessee or merchandise sold by him, and (2) a contract in respect of raw materials

or merchandise entered into in the course of the assessees manufacturing or

merchanting business to guard against loss through future price fluctuations. In the

present case there were no contracts in respect of raw materials or merchandise.

There were only one set of contracts for the delivery of the manufactured product,

namely, lint at a future date, and even these contracts were settled without making

an actual delivery and even before the time fixed for completion of the contract. So,

as found by the Appellate Tribunal in agreement with the Commissioner, there are

no such contracts here as are contemplated by clause (a) of the proviso to

Explanation 2 of section 24 (1 ). It follows that these transactions are indubitably of

a speculative nature as envisaged by Explanation 2 to section 24 (1 ). The loss

sustained by the assessee in respect of these transactions cannot be set off against

the profits earned by him in any other business. The Appellate Tribunal, in our

opinion, is therefore perfectly right in its view that the speculative transactions in

question are not saved by clause (a.) of the proviso to Explanation 2 of section 24

(1 ). "

( 14 ) IN Chimanlal Chhotalal v. Commissioner of Income-tax (1968) 69 ITR 129 (6),

the assessee carried on business as a dealer in cotton and cotten seeds. The

assessee entered into certain forward contracts of sale of Kapas (unginned cotton in

pods) and cotton bales. The assessee sustained a loss in these forward contracts

and claimed a set off of this loss against his business income on the ground that

these forward transactions were in the nature of hedging transactions. The High

Court rejected the assessees claim. The proviso to Explanation 2 was interpreted by

the High Court in the following manner :-"the proviso takes out of the ambit and

operation of the second Explanation a contract in respect of raw materials or

merchandise entered into by a person in the course of his manufacturing or

merchanting business and, prima facie, these words would include not only a

contract for purchase of raw materials or merchandise but also a contract for sale of

raw materials or merchandise. But such contract, under the proviso, has to be

hedging contract entered into by the person concerned for the purpose of guarding

himself against loss through future price fluctuations in respect of his contracts tor

actual delivery of goods manufactured by him or merchandise sold by him. It is by

way of hedging against contracts for actual delivery of goods manufactured by him

or merchandise sold by him that a person can enter into a contract in respect of

raw materials or merchandise within the meaning of the proviso. Now in the case of

a person carrying on manufacturing business contracts for actual deliver of goods

manufactured by him would obviously be contracts of sale by such person and in

respect of such forward contracts of sale he is permitted to enter into a hedging

contract and the hedging contract in such a case must, therefore, necessarily be a

forward contract of purchase. Similarly, when we turn to contract for actual delivery

of merchandise sold by him, that is, by a person carrying on merchanting business,

it is clear that the contracts which are contemplated are forward contracts for sale of

merchandise and in respect of which such forward contracts of sale, a hedging

contract of purchase can be entered into by such person within the meaning of the

proviso. The hedging contracts contemplated by the proviso are therefore clearly

contracts of purchase and not contracts of sale. It is, therefore, clear that proviso

(a) takes out from the scope and ambit of the second Explanation only forward

contracts of purchase of raw materials or merchandise entered into by an assessee

in the course of his manufacturing or merchanting business to guard against loss

through future price fluctuations in respect of his forward contracts of sale for actual

delivery of goods manufactured by him or merchandise sold by him. Where forward

contracts of sale are entered into by an assessee as hedge contracts for the purpose

of guarding him against loss through future price fluctuations in respect of his

forward contracts of purchase, such forward contracts for sale are not covered by

proviso (a) and they are not taken out of the definition of speculative transactions in

the second Explanation. "

( 15 ) IN order to decide the point at issue in the present case, it is not necessary

for us to express our assent or dissent with the view taken by the Andhra Pradesh

High Court that there must necessarily be two contracts, one for actual delivery of

the goods manufactured by the assessee or merchandise sold by him and the other,

a contract in respect of raw materials or merchandise entered into in the course of

the assessees manufacturing or merchanting business to guard against loss through

future price fluctuations in order to bring the forward transactions within the scope

of proviso (a) to Explanation 2 or with the view of the Gujarat High Court that a

contarct in respect of raw materials or merchandise entered into by a person in the

course of his manufacturing or merchanting business should only be a contract for

the purchase of the raw materials or merchandise and that such a contract does not

include a contract for sale of the raw materials or merchandise. We are, however, in

respectful agreement with the views expressed by these High Courts to the extent

that the raw material in respect of which the assessee has entered into the forward

transactions must be the same raw material which is used by him in his

manufacturing business. The forward transactions in Matra made by the assessee,

thus, do not fall within the scope of proviso (a) to Explanation 2 and the assessee

cannot claim a set off of the loss sustained by it in such worward transactions in

Malia against his profits in the business of grinding wheat for manufacturing atta

and wheat products. The first question is, therefore, answered in the negative,. e. ,

against the assessee and in favour of the Revenue.

( 16 ) THE relevant facts with regard to the second question may now be stated.

Following disputes between the assessee and its employees, a settlement was

reached between them on 14-2-1956. Clause (4) of the memorandum of settlement

which was in Hindi and which has been translated into English by the Tribunal

provided that-"the employees on completing 10 years of service or more will be

paid, on leaving work on their own will, on total service, gratuity at the rate of 15

days basic pay for every years service but not exceeding in any case 10 months

basic salary. In case of death, the condition of 10 years service shall not apply. "

( 17 ) IN pursuance of this agreement, the assessee transferred a sum of Rs.

55,712. 00 and Rs. 12. 001. 00 to the Employees Gratuity Fund as representing the

gratuity payable to its employees under the agreement for the assessment years

1957-58 and 1958-59 respectively. The assessee showed these amounts under the

head "current liabilities and provision" in its balance sheets as on 31-10-1959 and

31-10-1957 respectively. It would also appear from the documents annexed by the

Tribunal along with the statement of the case that on 31-10-1956 The assessee had

made the following entry in the Journal Voucher:-"debit: To amount irrevocably

transferred to gratuity and welfare fund G/c to provide against the liability of the Co.

in terms of agreement dated 14-2-56 including 55, 712-2-3 Rs. 3,078/11. 00 already

paid during the year. Credit : Gratuity and Welfare payable to staff fund by amount

as above against Rs. 55,712-2-3. "

( 18 ) IT would also appear from these documents that the assessee had given

credit of the amount of gratuity payable to the employees under the agreement in

the account of each of the employees. The assessee claimed allowance for these

two amounts from its income for the two assessment years under section 10 (2)

(xv) of the Act. The Income-tax Officer allowed the assessees claim in respect of

the first assessment year only to the extent of Rs. 3,078/11. 00 which was the

amount actually paid to the employees during that year and disallowed the balance

of Rs. 52. 633. 00. Similarly, the Income-tax Officer allowed the assessees claim in

respect of the second year only to the extent of Rs. 425. 00 which was the amount

actually disbursed during that year and disallowed the balance of the assessees

claim amounting to Rs. 11,576. 00. The disallowance made by the Income-tax

Officer was confirmed by the Appellate Assistant Commissioner as well as by the

Tribunal.

( 19 ) THE crucial question to be considered is whether the amount which was

disallowed by the Income-tax Officer represented the liability of the assessee which

had accrued in the respective years under reference. If the answer to this question

is in the affirmative, then the fact that the assessee did not actually pay these

amounts during these years but merely transferred these amounts to the Employees

Gratuity Fund would not Justify the rejection of the assessees claim in view of the

fact that the assessee was following the mercantile system of accounting. According

to the mercantile system of accounting as explained by the Supreme Court in

Keshav Mills Ltd. v. Commissioner of Income-tax (1953) 23 ITR 230 (7), "that

system brings into credit what is due, immediately it becomes legally due and before

it is actually received and it brings into debit expenditure the amount for which a

legal liability has been incurred before it is actually disbursed". The fact that the

assessee continued to have the control and dominion over the amounts in question

would not make any difference. This appears to be the only ground on which the

Tribunal rejected the assessees claim. The learned counsel for the Revenue has,

however, supported the order of the Tribunal on other grounds to which we shall

presently refer.

( 20 ) AS already stated, the assessees case depends upon the answer to the

question whether a liability has arisen to the assessee during the years under

reference in respect of the amounts claimed by him. The assessees case is that

under the agreement dated 14-2-1956 the employees of the assessee were entitled

to receive gratuity at the rate stipulated in the agreement and that there was a

corresponding liability on the assessee to pay the gratuity as soon as the employees

had completed ten years service, although the actual payment of the gratuity was

deferred to a later date, namely, when the employee left the assessees service or

when he died before leaving service. Shri Bajaj, learned counsel for the assessee,

argues that like every prudent businessman, the assessee had to make provision for

the payment of the gratuity to which the employees had become entitled every year

and that it would throw an unnecessary heavy burden on the assessee if it were to

pay the whole gratuity out of the income of the particular year in which the

employee either left service or died. The learned counsel has REFERRED TO to a

decision of the Supreme Court in Metal Box Company of India Ltd. v. Their Workmen

(1969) 73 ITR 53 (8 ). In that case, the question for consideration before the

Supreme Court was whether a sum of Rs. 18. 38 lakhs, being the estimated liability

under two gratuity schemes framed by the assessee-company, which was deducted

from the gross receipts in the profit and loss account, could be taken into account in

arriving at the amount of bonus payable to the employees of the assessee-company

under the Payment of Bonus Act, 1965. In 1960 the assessee-company introduced a

gratuity scheme for its employees other than its officers. Under that scheme,

gratuity was payable on the termination of an employees service either due to

retirement, death or termination of service, the amount of gratuity payable being

dependent on his wages at that time and the number of years of service put in by

him. The company had worked out on an acturial valuation its estimated liability and

made provision for such liability not all at once but spread over a number of years.

Thus in 1959-60, 1960-61 and 1961-62 the company allocated towards this liability

Rs. 5 lakhs. Rs. 10 lakhs and Rs. 5 lakhs respectively from out of the profits,

debiting these amounts in the profit and loss account. In all Rs. 40 lakhs had so far

been provided in the aforesaid manner against the said liability. The practice

followed by the company was that every year the company worked out the

additional liability incurred by it on the employees putting in every additional year of

service. Whenever an employee retired, the amount of gratuity payable to him was

debited against the amount provided for as aforesaid. The amount so paid was not

debited in the profit and loss account as an outgoing of expenditure but against the

estimated liability provided as aforesaid. In 1964-65, the company introduced a

similar gratuity scheme for its officers. According to the company, the estimated

liability under this scheme was worked out at Rs. 20 lakhs. But, instead of providing

the whole of it, it provided only Rs. 11. 31 lakhs. It also provided Rs. 7 lakhs under

the scheme for its non-officers against the liability for service put in by them in that

year. Out of Rs. 18. 38 lakhs so provided. the company paid as gratuity Rs.

1,31,585. 00 and Rs. 87. 295/ to officers and other employees who retired during

1964-65, debiting as aforesaid these amounts not as an outgoing or expenditure but

against the said amounts of Rs. 11 lakhs and Rs. 7 lakhs.

( 21 ) THE company claimed that it was entitled to deduct the balance of Rs. 16

lakhs from the gross receipts in the profit and loss account while working out its net

profit. The workmen contended that the company could deduct from the gross

receipts only Rs. 1. 31 lakhs and Rs. 87,000. 00 actually paid during the year. The

company, on the other hand, maintained that what it had done was legitimate and

was warranted by the principles of accountancy and, therefore, the whole amount of

Ra. 18. 38 lakhs was deductible in arriving at its net profits. The Supreme Court

posed for itself the following two questions :- 1. Whether it is legitimate in such a

scheme of gratuity to estimate the liability on an actuarial valuation and deduct such

estimated liability in the profit and loss account while working out its net profits

and 2. If it is, whether such appropriation amounts to a reserve or a provision

( 22 ) THE Supreme Court then proceeded to answer the first question as follows :-

"in the case of an assessee maintaining his accounts on mercantile system, a liability

already accrued, though to be discharged at a future date, would be a proper

deduction while working out the profits and gains of his business, regard being had

to the accepted principles of commercial practice and account. incy. It is not as if

such deduction is permissible only in case of amounts actually expended or paid.

Just as receipts, though not actual receipts but accrued due are brought in for

income-tax assessment, so also liabilities accrued due would be taken into account

while working out the profits and grains of the business. "the Supreme Court noticed

the distinction between a contingent liability which did not amount to a debt under

section 2 (m) of the wealth-tax Act and a contingent liability under the Income-tax

Act and it observed as follows : -. "though such a liability is a contingent liability and

therefore not a debt under section 2 (m) of the Wealth-tax Act, it would be

deductible under the Income-tax Act while computing the taxable profits. In the

instant case, the question is not whether such estimated liability arising under the

gratuity schemes amounts to a debt or not. The question that concerns us is

whether, while working out the net profits, a trader can provide from his gross

receipts his liability to pay a certain sum for every additional year of service which

he receives from his employees. This, in our view, he can do, if such liability is

properly ascertainable and it is possible to arrive at a proper discounted present

value. Even if the liability is a contingent liability, provided its discounted present

value is ascertainable, it can be taken into account. Contingent liabilities discounted

and valued as necessary can be taken into account as trading expenses if they are

sufficiently certain to be capable of valuation and if profits cannot be properly

estimated without taxing them into account. "

( 23 ) THE Supreme Court also quoted with approval the following observations of

Lord Redcliffe in Southern Railway of Peru Ltd. v. Owen (1957) A. C. 334 :- (9) "now

the question is, how ought the effects of this statutory scheme to be reflected in the

appellants accounts of the annual profits arising from its trade One way, which is

certainly the simplest one, is to let the payments made fall entirely as expenses of

the year of payment and ignore any question of making provision for the maturing

obligation during the years of service that proceed it. . . . It has one considerable

advantage; no element of estimate or valuation appears in the profits assessment

and nothing is charged to profits except the actual cash outgoing. But, when this

has been conceded, I think that there is the very serious disadvantage to be set

against the cash basis that it affords a comparatively inefficient method of arriving

at the true profits of any one year. The retirement benefit is not, obviously, paid to

obtain the service-given in the year of retirement. The incidents of retirement

payments must be variable from year to year, and they may inordinately depress the

profits of one year just as they may in coordinately inflate the profits of another. It is

not charged on the average of its annual profits. Tax rates and allowance

themselves vary and, apart from that, to charge tax on a profit unduly accelerated

or unduly deferred is, in my opinion, no more respectable an achievement than to

admit that the annual accounts of business do in some cases require the

introduction of estimates or valuations if a true statement of profit is to be secured.

Another method is that which the appellant is seeking to establish with regard to its

assessments for the four years 1947-1950. . . What the appellant claims the right to

do is to charge against each years receipts the cost of making provision for the

retirement payments that will ultimately be thrown upon it by virtue of the fact that

it has had the benefit of its employees services during that year. As a corollary it

will not make any charge to cover the actual payments made in the year in respect

of retirement benefits. Only by such a method, it is said, can it bring against the

receipts of the year the true cost of the services that it has used to earn those

receipts. Generally speaking, this must, I think, be true. For, whereas it is possible

that any one of its many employees may forfeit his benefits and so never require a

payment, the substantial facts of the situation are that when the company has paid

every salary and wage that is due for current remuneration of the year it has not by

any means wholly discharged itself of the pecuniary burden which falls upon it in

respect of the years employment".

( 24 ) THE Supreme Court concluded the answer to the first question by observing

that:-"in our view, an estimated liability under gratuity scheme, such as the ones

before us, even if it amounts to a contingent liability and is not a debt under the

Wealth-tax Act, if properly ascertainable and its present value is fairly discounted is

deductible from the gross receipts while preparing the P. and L. account".

( 25 ) THE Supreme Court then answered the second question in the following

manner:-"an amount set aside out of profits and other surpluses, not designed to

meet a liability, contingency, commitment or diminution in value of assets known to

exist at the date of the balance-sheet is a reserve but an amount set aside out of

profit and other surpluses to provide for any known liability of which the amount

cannot be determined with substantial accuracy is a provision. "

( 26 ) THE Supreme Court held that it was only a reserve that could be added back

while computing the gross profits but not a provision.

( 27 ) THE several observations made by the Supreme Court which we have quoted

above, though made in the context of the bonus payable under the payment of

Bonus Act, 1965, are, in our view, equally applicable to the question for

consideration before us, namely, whether the provisions made by the assessee for

the payment of gratuity under the agreement dated 14-2-1956 were in the nature of

an accrued liability of the assessee and which were liable to be taken into account in

computing the income of the assessee for the years under reference.

( 28 ) THE principles enunciated by the Supreme Court in the case of Metal Box

Company of India Ltd. were applied by the Allahabad High Court to a case under the

Income-tax Act which is in many respects similar to the case before us. In Madho

Mahesh Sugar Mills (P) Ltd. v. Commissioner of Income-tax (1973) 92 ITR 503 [LQ/AllHC/1972/270] , (10)

the U. P. Government issued a notification setting out a scheme for working out the

wage structure, etc. , of employees in sugar industry. According to this scheme,

gratuity was payable to the employees according to the rates mentioned therein on

the occurrence of the following events :-1. On death while in employment, 2. On

attainment of the age of superannuation, 3. On retirement or resignation due to

continued ill-health, and 4. On resignation or on termination of employment for any

reason other than for serious misconduct.

( 29 ) IN pursuance of this notification, the assessee in that case set apart a total

sum of Rs. 1,37,811. 00 for payment of gratuity and made an appropriate entry in

its books of accounts crediting the gratuity account and debiting the profit and loss

account. The assessee claimed deduction of this amount in computing its income.

The Income-tax authorities as well as the Tribunal disallowed the assessees claim

on the ground that the liability of the assessee for payment of gratuity in the

relevant accounting period was not ascertained and it was only a contingent liability

which the assessee had to meet at a future date as and when a particular event

took place. The High Court, however, allowed the assessees claim and in doing so,

made the following observations :-"now, it cannot be disputed that every

expenditure incurred by an assessee wholly and exclusively for purposes of business

is to be allowed as deduction in the computation of the net profit of a business for

the purposes of assessment to income-tax. It can also not be disputed that the

payment of gratuity to workmen of a business concern would be an expenditure of

that nature but the expenditure which is allowable in a particular year must be

certain and capable of ascertainment. If the liability is uncertain and contingent, it

cannot be allowed as a deduction. Under the notification aforesaid a liability was

cast upon the assessee to pay gratuity to its workmen in accordance with the scale

provided in that notification. The gratuity is payable when a workman dies, retires,

resigns or is removed from service. These events no doubt take place in the future

but they cannot be said to be uncertain. The services of every workman are bound

to come to an end on account of one or the other causes nominated above. Under

the scheme every employer is bound to pay gratuity to a workman for his past and

future services. In the circumstances every businessman would make provision

every year for his liability under the notification. Under the mercantile system of

accounting an expenditure is admissible not only when it is actually paid but when

the liability for the expenditure is incurred. The only question is as to whether such

a liability can fairly and accurately be ascertained in a particular year. "

( 30 ) APPLYING the principles enunciated by the Supreme Court in Metal Box

Company of India Ltd. to the facts of the case before us, we find that by virtue of

the agreement dated 14-2-1956, every employee of the assessee who has

completed 10 years service is entitled to receive gratuity at the time when he

voluntarily leaves the assesses service and further that even in the case of

employees who have not completed 10 years service gratuity would be payable to

their legal heirs on their death while in service. The gratuity is payable at the rate of

15 days basic pay of each years service subject to a maximum of 10 months basic

salary. As observed by Lord Radcliffe in the case of Southern Railway of Peru Ltd. ,

v. Owen "the retirement benefit is not obviously, paid to obtain the services given in

the year of retirement" and further that "what the appellant claims the right to do is

to charge against each years receipts the cost of making provision for the

retirement payments that will ultimately be thrown upon it by. virtue of the fact that

it has had the benefit of its employees services during that year". In other words,

the gratuity payable to an employee represents a part of the emoluments payable to

him for rendering service during each year. The right to receive gratuity accrues to

the employee as soon as he completes one year of service and as a corollary, the

liability to pay the gratuity to the employee arises to the assesses at the end of each

year. The amount of the liability is also ascertainable and there is no question in the

present case of the discounted present value of the liability being not ascertainable.

It is no doubt true that the actual payment of the gratuity is deferred to a later date

on the happening of a certain event, namely, death or voluntarily retirement of the

employee. But as observed by the Allahabad High Court, these are not uncertain

events. Therefore, the provision made by the assessee for the payment of gratuity

under the agreement dated 14-2-1956 is in the nature of a revenue expenditure in

respect of the assessment years under reference.

( 31 ) SHRI B. N. Kirpal, learned counsel for the Revenue, contends that under the

agreement dated 14-2-1956 gratuity is payable to the employees only on the

happening of two contingencies, namely, death or voluntarily retirement of an

employee after 10 years service and that the gratuity is not payable under other

contingencies, such as, retirement or the employee on attaining the age of

superannuation, retrenchment or dismissal from service. We cannot construe the

agreement as denying gratuity to an employee when he retires from service on

attaining superannuation. It would be unreasonable to say that in order to become

entitled to the gratuity, an employee must leave the service one day before he

attains the age of superannuation. We however, agree with the construction placed

by the learned counsel for the Revenue on the agreement to this extent, namely,

that gratuity will not be payable to an employee if he is dismissed from service or

even in cases of retrenchment. But at the same time, we cannot accept his

contention that for this reason, the liability of the assessee for payment of gratuity

to its employees under the agreement dated 14-2-1956 did not accrue during the

years under reference. The learned counsel seeks support for his contention from

the decision of the Supreme Court in the case of Indian Molasses Co. (Private) Ltd. "

v. Commissioner of Income-tax (1959) 37 ITR 66 [LQ/SC/1959/89] , (II ). In that case, H was the

managing director of the assessee company, who had by 1948 served the company

for 13 years and was due to retire at the age of 55 years on September 20, 1955. In

implementation of an agreement to provide a pension for him after his retirement

the company paid a sum of 8,208 to certain trustees and executed a trust deed on

September 16, 1948, whereby it undertook to pay annually 326 for six consecutive

years. The trustees undertook to hold the sums upon trust for taking out a deferred

annuity policy in the name of the trustees with an insurance society on the life of H

under which. 720 per annum would be payable to H for life from September 20,

1955. The trust deed also provided that the trustees could, if they so desired, take

out instead a deferred longest life policy in favour of H and Mrs. H for an annuity of

558 payable during their joint lives from that date, provided that if H died before he

attained the age of 55 years the annuity payable to Mrs. H would be 611. Should H

die before attaining the age of 55 years the trustees were to purchase with the

capital value of the deferred annuity policy an annuity for Mrs. H. The trustees took

out a policy providing for an annuity of 563 if both H and Mrs. H be living on

September 20, 1955, an annuity of 720 if Mrs. H should die before that date and an

annuity of 645 if H should die before that date leaving Mrs. H surviving him. There

was a special provision in the policy which entitled the trustees to surrender that

annuity for the capital sum of 10,169 after giving notice. Clause III of the Second

Schedule to the policy provided for the return of all premiums paid to the insurance

society should both H and Mrs. H die before September 20, 1955, and under clause

IV the trustees were entitled to surrender the contract any time before that date for

a cash surrender value. In the assessment years 1949-50, 1950-51, 1951-52 and

1952-53, the assesses claimed deduction of the initial sum and the yearly premia

from its profits under section 10 (2) (xv) of the Income-tax Act. The Supreme Court

disallowed the assessees claim on the ground that as until September 20, 1955, the

assessee company had dominion through the trustees over the sums paid at least in

two circumstances, viz. under the special provision and clause III of the Second

Schedule to the policy, and there was a possibility of there being a resulting trust in

favour of the company, the sums paid should be treated as set apart to meet a

contingency, the payment of those sums was not a paying out or away of those

sums irretrievably and did not amount to "expenditure" and a deduction could not

be made in respect thereof under section 10 (2) (xv ). The above observations of

the Supreme Court were made in the context of the special facts of that case and

why the Supreme Court considered the assessees claim to be based upon an

uncertain event is clear from the following observations of the Supreme Court :--"in

the years of account the assessee company did hand out to the trustees, the sums

of money for which deduction is claimed. But was the money spent in so far as the

assessee company was concerned Harvey was then alive and it was not known if

any pension to him would be payable at all. Harvey might not have lived to be 55

years. He might even have abandoned his service or might have been dismissed. Till

September 20, 1955, the assessee company had dominion through the grantees

over the premia paid at least in two circumstances, They are to be found in the

special provision and the third clause of the Second Schedule of the policy. "

( 32 ) THE facts of the case before the Supreme Court are clearly distinguishable

from the facts of the case before us. Under the agreement, every employee was

entitled to receive gratuity for every year of service rendered by him to the assessee

and this gratuity was payable to the employees on the happening of events which

were certain. The possibility of the gratuity not being paid at all to the employees in

the event of dismissal or retrenchment of the employees is certainly too remote to

be taken into account.

( 33 ) THE learned counsel for the Revenue also REFERRED TO to the decision of

the Supreme Court in Standard Mills Co. Ltd. v. Commissioner of Wealth-tax (1967)

63 ITR 470 (12) wherein it was held that the liability of the assessee to pay gratuity

to its employees on determination of employment was a mere contingent liability

which arose only when the employment of the employee was determined by death,

incapacity, retirement or resignation, that the liability did not exist in praesenti and

that amount claimed could not be deducted as a debt in computing the net wealth

of the assessee. This decision will not be of any assistance to the Revenue, because

this decision was actually distinguished by the Supreme Court in the case of Metal

Box Company of India Ltd. and it was held that through a contingent liability may

not amount to a debt for the purposes of Wealth-tax Act, it would be an expenditure

for the purpose of the Income-tax Act.

( 34 ) THE learned counsel also relied upon the decision of the Madras High Court in

Commissioner of Income-tax v. Indian Metal and Metallurgical Corporation (1964) 51

ITR 240, (13) which has also. been relied upon by the Tribunal for rejecting the

assessees claim. For one thing, this decision was given prior to the decision of the

Supreme Court in the case of Metal Box Company of India Ltd. and for another, it is

clearly distinguishable from the facts of the present case inasmuch as in the cage

before the Madras High Court the amount in question was credited only to a reserve

fund called the gratuity reserve fund and it was not credited to the account of each

and every one of the employees concerned, whereas in the present case, the

gratuity amount has been irrevocably transferred not to a reserve fund but to a

gratuity fund as such and also that the amount of gratuity payable to each of the

employees has been credited to their account.

( 35 ) WE, therefore, hold that the assessee is entitled to the deduction of the full

amounts for which it had made provision in the two years under reference. The

second question is answered in the negative,. e. , against the Revenue and in favour

of the assessee.

( 36 ) IN view of the fact that the assessee has only partly succeeded in this

reference, there shall be no order as to costs.