Whether provisions of Sec 40A(9) would hit on mere making of provision for retirement benefits to employees - NO: Madras HC

THE issues before the Bench are - Whether where a provision was made that to pay the service weightage to the employees on the eve of their retirement even if there was no sum credited to an individual account, the contribution could be termed as contribution to a fund or a trust; Whether where a mere provision for retirement benefit was made in the accounts and there being no fund, the assessee’s case would be hit by Section 40A(9) of the Income Tax Act and Whether where a provision was made in the books of account for retirement benefit based on the service weightage, and the scheme was not a recognised one, the claim would be hit by Section 40A(7)(a) of the Income Tax Act. And the verdict goes in favour of the assessee.

Facts of the case

The assessee-company entered into an arrangement with the employees that on completion of every year, the service of each employee would be provided with service weightage, which would get accumulated during period of service and the same could be withdrawn by the employees at the time of retirement or termination of service. As per the Scheme, the service weightage was payable in respect of each year of service, based on actuarial valuation on the services of the employee. According to the assessee, such valuation on actual basis was a scientific method of determination of its liability at the end of each year. In view of this actuarial valuation and scientific determination of the liability, the assessee viewed that making provision in the accounts could not be considered to be a contingent liability and hence, entitled to deduction. Thus, assessee-company claimed deduction on provision made by way of retirement benefit based on service weightage of the employee. The Assessing Officer viewed that the service weightage was neither a gratuity nor a payment to any welfare fund. Being just a provision, the same could not be allowed.

In appeal, the first Appellate Authority viewed that even though the payment was not for gratuity or provident fund, yet, being worked out on a scientific basis on actuarial valuation, the claim could not be termed as contingent liability nor could it be termed under Section 43B(b) of the Income Tax Act. Thus the Commissioner of Income Tax (Appeals) allowed the appeal. In further appeal, the Tribunal viewed that the claim of the assessee was not hit by Section 40A(9) of the Income Tax Act. It affirmed the order of the Commissioner of Income Tax (Appeals).

Revenue contended that the Tribunal failed to consider the fact that the service weightage paid was neither a gratuity nor a payment to any welfare fund. The Tribunal also failed to consider the applicability of Section 40A(9) of the Income Tax Act to the facts of the case herein. It was submitted that the assessee was having service weightage scheme even prior to this assessment year. Under the Scheme, on the eve of retirement, the employees would be given retirement benefits, calculated on the basis of last drawn salary and other relief for three days multiplied by the number of years of service put in, in the organization, hence, the scheme was not one which fell for consideration under Section 36(1)(iv) or 36(1)(v) of the Income Tax Act. It was further submitted that under Section 40A(9), no deduction would be allowed in respect of any sum paid by the assessee, as an employer, towards the setting up or formation of, or as contribution to, any fund, or trust, or other institution for any purpose, the only exception being where the sum is paid for the purposes and to the extent provided by or under Clause (iv) or (iva) or (v) of sub-section (1) of Section 36, or as required by or under any other law for the time being in force. In the context of specific provision in Section 43B and particularly the prohibition under Section 40A(9), it was submitted that the crucial expression under Section 40A(9) are "sum paid by the assessee", as a contribution to any fund for any purpose. On the admitted fact that the provision created based on the service weightage was not on account of any of those recognised clauses, namely, Clause (iv), (iva) and (v) of Section 36(1) or in any event, the settlement between the employee union and the employer not being one as required by or any other law for the time being in force, the claim of the assessee is directly hit by sub-section (9) of Section 40A of the Income Tax Act. It was submitted that the assessee had taken note of every individual employee's account and scientifically worked out its liability and took it to a collective account, viz., the provision made therein; hence, contributing to a common fund by charging the profit, thereby making a provision, would satisfy the second limb of Section 40A(9), i.e, on the aspect of a contribution by the employer. It was further submitted that the systematic accumulation by charging on the profit was admittedly there for the specific purpose of meeting out its liability on the eve of retirement of an employee, making provision in the accounts would tantamount to contribution to a fund.

Assessee, relying on a number of judgments submitted that the claim was maintainable under Section 43B(b) of the Income Tax Act. He pointed out that the Revenue does not deny the fact that the provision was made on actuarial basis on the future liability that the assessee had to face. He referred to the order of the Tribunal relating to the assessment year 2002-2003 and pointed out to the agreement that the assessee had with the Trade Union and that it made this provision in the accounts, the assessee was liable to make the payment as worked out in the formula and that such making of provision could not be treated as hit by Section 40A(9) of the Income Tax Act. It was further submitted that a provision made in the accounts cannot be called as a fund as the provision made was not credited to a separate account or to a fund to call it so for the purpose of attracting Section 40A(9). The requirement under the Section being a factual contribution, that the said amount should be parted to the employees account, so that, there, in fact, exists a factual contribution to a trust or a fund for invoking Section 40A(9) of the Income Tax Act.

Having heard the parties, the Court held that,

++ for attracting the provision under Section 40A(9), the basic requirements are that the payment is to be by an employer towards creation of a trust, fund, company, association of persons, Societies etc. for any purpose and the payment by an assessee as an employer is towards setting up or formation of, or as a contribution to, any fund, trust, company or association of persons, body of individuals etc. Thus, the crucial words on which much of the arguments were advanced before us for the purpose of deciding the issue are "setting up or formation of, or as a contribution to, any fund, trust etc." and "contribution for any purpose". Admittedly, the Scheme floated herein is not a one required by or under any law. Therefore, the case of the assessee would not fall for consideration under Section 36(1)(iv) or (iva) or (v) of the Income Tax Act. The definite case of the Revenue is that by making a provision in the accounts, there is a "contribution" to a "fund" and the provision itself is to be construed as 'fund'. Hence, Section 40A(9) of the Income Tax Act stands attracted;

++ the word 'contribution' is understood legally as referable to an amount credited in a provident fund as given under the Provident Fund Act; a sum of money payable by a principal employer in respect of an employee as in the case of ESI Act and for the purpose of Section 10(13)(iv) of the Income Tax Act, 1961, it is understood as an act of contributing; the payment by each of the parties interested in any common loss or liability; amount so payable and proportionate discharge of liability. Under Schedule IV, Part A, Rule 2(c) of the Income Tax Act, 1961, 'contribution' is defined to mean any sum credited by or on behalf of any employee out of his salary, or by an employer out of his own monies, to the individual account of an employee (Refer Gestener Duplicators Pvt. Ltd. V. Commissioner of Income Tax, West Bengal, 117 ITR 1). The meaning thus ascribed to the expression 'contribution' shows that a factual contribution, in the sense, that there is, in fact, a sum credited to a specific individual account. Individual is referrable to the head of account and not to an individual employee/person;

++ in making a provision, it is not necessary that the same should be to the credit of each and every employee; but we do agree with the submission of the assesee that in any event there must be an identifiable separation of funds as by way of making provision towards the service weightage scheme. Thus, even if there be no sum credited to an individual account and that the provision made is on the totality of the employer's commitment to pay the service weightage to the employees on the eve of their retirement, yet, as is evident from the reading of the Section, the contribution has to be to a fund or a trust;

++ the expression 'fund' denotes the particular category/head and the expression 'payment' is explained on cash payment or debiting to the head of account, which is in contradistinction to actual method of payment. In either case, be it cash or debiting for the account, the crediting has to be to the particular head. 'Fund' in the context of Section 40A(9) of the Income Tax Act refers to money set apart for the specific purpose, the contribution to which may be either by cash remittance or by account entry transfer or a provision made therefor. Thus, as pointed out in the decision reported in (2003) 1 ALL ER 1168 (Myers v. Design Inc.(International) Ltd.), the word 'fund' is not a term of art and (like so many other words) is capable of a variety of meanings depending on the context in which it is used;

++ to attract Section 40A(9), there must be a fund specifically available and there, in fact, is a contribution to that fund. In the absence of either of these facts, a mere making of a provision will not attract the provision under Section 40A(9) of the Income Tax Act;

++ even if there be an actuarial valuation, the charging of the profit as by way of a provision made, no doubt, satisfies the requirement on the declaration of a dividend, but then, the actuarial valuation charged on the profits must find its place in the form of a creation of a separate fund identified for such purpose with systematic accumulation thereon. The sum of money set apart to meet the scheme has to be there visibly without any probability further, either into the balance sheet entries/or the Profit and Loss account, to call it as a fund;

++ a mere provision made in the accounts, per se, cannot be equated to the creation of fund, the fact that every year there is a systematic accumulation to the provision already made, does not, however, satisfy the requirements of law under Section 40A(9) of the Income Tax Act. It is not denied by the Revenue that the assessee cannot pin point out any particular head created under the accounts as a sum of money available immediately for that particular purpose; the mere charging of profits towards the particular liability, does not, satisfy the Section, except beyond the requirement of making a provision, when Section 40A(9) contemplates the contribution towards the setting up or formation of a fund and the contribution to a fund thus created for any purpose;

++ the provision made in the accounts must find its route under a specific head, ultimately to the money set apart for the specific purpose of meeting out the liability on the service weightage scheme. On the admitted facts herein, except for mere creation of a provision in the accounts, there being no fund in fact created, the case of the assessee is not hit by Section 40A(9) of the Income Tax Act. To that end, we reject the case of the Revenue;

++ the decision of the Supreme Court reported in (1969) 73 ITR 53 (Metal Box Company of India Ltd. v. Their Workmen), is relevant for understanding the expression 'provision and reserve' and in the context of the facts narrated in the present case and in the light of the provision under Section 40A(9) and of the decision of the Supreme Court reported in (1996) 219 ITR 121 (Commissioner of Income Tax (Appeals) V. Duncan Brothers & Co. Ltd.), the claim of the assessee could not be brought under Section 40A(9) of the Income Tax Act;

++ Section 43B(b) contemplates deduction only on payment actually made and not otherwise. The Section states that a deduction under the said provision would be allowed in computing the income referred to in Section 28 of the previous year in which such sum is actually paid by him. The second proviso relating to the claim falling under Section 43B(b) clearly points out that no deduction in respect of sum payable by the assessee as an employer by way of contribution to any superannuation fund or provident fund or gratuity fund or any other fund for the welfare of the employees, shall be allowed unless such sum has actually been paid in cash or by way of cheque or draft or by any other mode before the due date as defined in the Explanation to Section 36(1)(va). In the light of the above provision, we respectfully disagree with the decision of the Delhi High Court in this regard;

++ Section 40A(7) negatives any claim for deduction in respect of any provision made by an assessee for payment of gratuity to an employee on the retirement or on termination of the employment for any reason. Thus, Section 40A(7)(b) states that a provision made by the assessee by way of contribution towards an approved gratuity fund or for the purpose of payment of any gratuity that has become payable during the previous year, however, would not be hit by Section 40A(7)(a). Unlike in sub-section (9) of Section 40A of the Income Tax Act, where the said provision contemplates setting up or formation of or contribution to a fund or a trust, sub-section (7) of Section 40A deals specifically about disallowing a claim for deduction made in the accounts as regards payment of gratuity to an employee on his retirement or on termination of his employment. Although sub-Section (2) to Section 43 of the Income Tax Act defines for the purpose of Section 28 to 41 of the Income Tax Act that 'paid' means actually paid or incurred according to the method of account upon the basis of which the profits and gains are computed under the head "Profits and gains of business or profession", yet, sub-section (9) of Section 40A specifically rejects a claim for deduction in respect of any sum 'paid' by the employer/assessee towards setting up or formation of, or as contribution to, any fund, trust, company, association of persons, body of individuals, society registered under the Societies Registration Act, 1860 (21 of 1860), or other institution for any purpose, except where the sum is paid. Sub-section (7) of Section 40A specifically refers to the non-allowability of a claim for deduction as "any provision" made for the payment of gratuity to his employees on their retirement or on termination of their employment for any reason;

++ thus, one finds the marked distinction between sub-section (9) to Section 40A which considers an identifiable head like a fund or a trust to be created and a contribution there for to it for any purpose and Section 40A(7) which rejects the claim of deduction in a case where a provision is made in the accounts for payment of gratuity;

++ the expression 'gratuity' itself suggests that it is a gratuitous payment given to an employee on discharge, superannuation or death. Gratuity is an amount paid unconnected with any consideration and not resting upon it and has to be considered as something given freely, voluntarily or without recompense. It is a sort of financial assistance to tide over post-retiral hardships and inconveniences;

++ when we look into the agreement between the employee union and the employer, we find that the scheme seems to be in vogue for quite sometime even before this accounting year relevant to this assessment year and as far as the relevant assessment year under consideration is concerned, the scheme which had come into existence from 01.01.1997 would be relevant. As per this, at the time of retirement or superannuation or relieving from his employment, an employee shall be entitled to a payment based on the service weightage, the payment being the last drawn salary multiplied by 3 days and the number of years put in by the employee. Admittedly, the scheme is not a recognised one, but one reached as per the agreement between the parties. It is not denied by the assessee that a provision was made in the accounts as regards the gratuity payable based on the service weightage. Being a provision made for payment of gratuity to the employees on the retirement or termination of their employment, the claim stands clearly hit by Section 40A(7)(a) of the Income Tax Act;

++ the grounds taken by itself automatically cannot stand in the way of this Court considering the legal issue on the claim of deduction on the provision made by the assessee as to whether it would be covered by Section 40A(9) or under any other provisions of the Act, which includes Section 40A(7) too. It is no doubt true that neither the Assessing Officer nor in the course of the assessment proceedings or before any other authority, the issue was tested on the provisions of Section 40A(7). However, when the question of deductibility is a matter of dispute and being a pure question of law, on the facts found, we have no hesitation in holding that this Court has the jurisdiction to consider the applicability of Section 40A(7) too to the facts of the case;

++ what was created was admittedly only a provision in the books of accounts, hence, not a fund or a contribution to a fund to be considered under Section 40A(9) of the Income Tax Act; the only other provision, which would hit the claim of the assessee herein would be Section 40A(7) of the Income Tax Act. Thus, going by Section 40A(7) of the Income Tax Act, on the facts admitted, we hold that the assessee's claim for deduction is hit by Section 40A(7) of the Income Tax Act. The provision had been in the statute book with effect from 01.04.1973, inserted by Finance Act 1975, subsequently substituted by Finance Act, 1999, with effect from 1.4.2000. The provision as is relevant to the assessment year under consideration is one what prevailed prior to the substitution by Finance Act, 1999, effective from 1.4.2000.