COMMISSIONER OF INCOME-TAX VS MOTOR INDUSTRIES CO. LTD. (N0.2)
1999 P T D 2912
[229 I T R 137]
[Karnataka High Court (India)]
Before S. Rajendra Babu and R. V. Raveendran, JJ
COMMISSIONER OF INCOME-TAX
Versus
MOTOR INDUSTRIES CO. LTD. (N0.2)
(and vice versa)
I.T.R.C. Nos. l to 3 of 1994. decided on 27/08/1999.
(a) Income-tax---
----Business expenditure---General principles---Provision for contingent liabilities is not deductible---Provision for salaries and wages payable for unutilised leave---Contingent liability---Provision not deductible---Indian Income Tax Act, 1961, S.37---Indian Factories Act, 1948.
(b) Income-tax-
----Business expenditure---Company---Surtax not deductible---Income Tax Act, 1961, S.37---Indian Companies (Profits) Surtax Act, 1964.
(c) Income-tax---
----Capital or revenue expenditure---Company---Expenditure incurred on issue of rights shares---Capital expenditure---Indian Income Tax Act, 1961, S.37.
(d) Income-tax---
----Business expenditure---Disallowance---Expenditure on perquisites and benefits to employees ---Accesses building used as residential quarters of employees---Depreciation, property tax and ground rent and repairs for normal and routine maintenance cannot be disallowed---Indian Income Tax Act, 1961, S.40-A(5).
(e) Income-tax ---
----Depreciation---Rate of depreciation---Building---Factory building-- Canteen is part of factory building---Entitled to higher rate of depreciation-- Indian Income Tax Act, 1961, S.32.
(f) Income-tax---
----Depreciation---Actual cost---Foreign exchange---Increase in value of asset due to fluctuation in rate of foreign exchange---Depreciation allowable on such increase---Indian Income Tax Act, 1961, Ss.32 & 43-A.
(g) Income-tax---
----Depreciation---Building---Roads and drains laid within factory premises must be regarded as building---Entitled to depreciation---Indian Income Tax Act, 1961, S.32.
(h) Income-tax-
----Depreciation---Plant---Pipelines, sanitary fittings and storage tank-- Functional test to be applied to determine whether they are plant---Matter remanded---Indian Income Tax Act, 1961, S.32.
(i) Income-tax-
----Depreciation---Initial depreciation---List in Ninth Schedule---Components of agricultural machinery not entitled to initial depreciation---Indian Income Tax Act, 1961, Sched. IX.
(j) Income-tax--
----Export markets development allowance---Weighted deduction---Insurance premium paid to Export Credit Guarantee Corporation---Entitled to weighted deduction---Indian Income Tax Act, 1961, S.35-B.
(k) Income-tax---
----Appeal to CIT (Appeals)---Powers of CIT (Appeals)---Assessment not made under S.143(1)---C.I.T. (Appeals) can permit assessee to claim deduction not claimed before I.T.O. when relevant materials are on record-- Indian Income Tax Act, 1961, Ss. 143 & 246.
Expenditure which is deductible for income-tax purposes is one which is towards a liability actually existing at the time; but the putting aside of money which may become expenditure on the happening of an event is not expenditure. Where the liability itself is contingent, as contrasted from payment being contingent, there can be no deduction.
Chapter VIII of the Factories Act, 1948, deals with annual leave with wages. Under the scheme relating to annual leave, an employee who works for the required number of days during a calendar year, does not become entitled to any monetary benefit on account of leave earned during that year. He becomes entitled to leave with wages calculated at the rate of one day for every 20 days of work performed by him during the previous calendar year. Thus, the leave earned during a year may be availed of during the succeeding year or carried over to the next year. When it is not availed of during the succeeding year, it can be carried over only if he has not already accumulated the maximum number of days of carried over leave. If he has already accumulated the maximum days of unutilised leave and if the leave earned during a year is not utilised during the next year, it will lapse. The only thing certain about the whole matter is the earning of leave in regard to each year of service. But, thereafter, any of the following three things may happen: (a) it may be utilised during the next year in which event he gets paid for it during that year; or (b) it may get accumulated, in which event, wages therefore become payable as encashment of unutilised leave at the time of termination of service; or (c) it may lapse on account of non-utilisation during the next year and maximum accumulation having already been reached in regard to unutilised leave. Allowing the leave to lapse is not uncommon. In respect of the period of leave availed of, a person is not entitled to bonus; nor will he be able to earn overtime during that period. Hence, several employees may choose not to avail of the leave and allow it to lapse, to enable them to earn overtime or, to have the maximum bonus permissible. Thus, what happens to the leave is wholly uncertain. There is no way of ascertaining beforehand whether the employee will utilise the leave during the year following the year in which it is earned, or whether he will accumulate it or allow it to lapse. Therefore, there is no reasonable certainty that the provision made for unutilised leave, will be used at all. Leave encashment, on retirement, is considered as a retirement benefit. The American Accounting Standard (section C-44) relating to "compensation to employees: paid absences" provides that. a liability shall be accrued for vacation benefits that employees have earned but have not yet taken. But, that would be only if the leave earned during each year of service, is accumulated without any lapsing and wages therefor become payable on retirement. Where the accumulation permissible is limited and the earned and unutilised leave, in excess of the permissible limit lapses, obviously the said accounting practice cannot be applied. In fact this is made clear in the American Accounting Standard (section C-44) which recognises the difference between cases where the accrued rights expire or lapse after a period specified, and cases where accrued rights are carried forward and accumulated without expiry. Hence, a provision for salaries and wages for unutilised leave cannot be deducted as an expenditure against the profit for the year when the leave was earned.
Indian Molasses Co. (P.) Ltd. v. CIT (1959) 37 ITR 66 (SC) applied:
Surtax payable under the Companies (Profits) Surtax Act, 1964, on the chargeable profits is nothing but an additional tax on the profits and gains of an assessee's business and, therefore, surtax cannot be deducted while computing total income.
CIT v. International Instruments (P.) Ltd. (1983) 144 ITR 936 (Kar.) fol.
Expenses incurred in connection with the issue of rights shares does not constitute revenue expenditure and is not deductible in computing business income.
CIT v. Motor Industries Co. Ltd. (1988) 173 ITR 374 (Kar.) fol.
Municipal taxes and ground rent, and depreciation in respect of the assessee's own buildings allowed to be used as residential quarters by its employees, cannot be considered as perquisites for purposes of section 40-A(5) of the Income Tax Act, 1961. In, so far as repairs are concerned, what cannot be added under section 40(A)(5) is only the amount spent for normal and routine upkeep and maintenance; and any amount spent in excess to meet the special requirements of the employee in occupation can be added under section 40(A)(5) of the Act.
CIT v. Motor Industries Co. Ltd. (1988) 173 ITR 374 (Kar.) fol.
Canteen building should be regarded as part of factory building and is entitled to higher depreciation.
CIT v. Engine Valves Ltd. (1980) 126 ITR 347 (Mad.) and CIT v. Motor Industries Co. Ltd. (1986) 158 ITR 734 (Kar.) fol.
Roads and drains laid within the factory premises are necessary adjuncts to factory buildings to carry on the business activity of the assessee and would fall under the definition of "building" and under section 32 of the Income Tax Act, 1961, and the capital expenditure incurred thereon is admissible to depreciation.
CIT v. Gwalior Rayon Silk Manufacturing Co. Ltd. (1992) 196 ITR 149 (SC) fol.
Depreciation has to be allowed on increase in the value of assets due to fluctuation in exchange rate.
CIT v. Arvind Mills (1992) 193 ITR 255 (SC) fol.
The question whether water supply system (pipelines/sanitary fittings) and storage tanks are "plant" or not, depends on their relation to the nature of the business carried on by the assessee and the question will have to be decided in each case, on the facts and circumstances, by applying the "functional test" evolved by the High Court of Allahabad in CIT v. Kanodia Warehousing Corporation (1980) 121 ITR 996.
Section 32(1)(vi) of the Income Tax Act, 1961, gives the benefit of initial depreciation in respect of plant and machinery installed for the manufacture or production of any article or thing by a small scale industrial undertaking; but in regard to the assessees other than small scale industrial undertakings, initial depreciation is admitted only in regard to the manufacture or production of any one or more of the articles or things specified in Items Nos. l to 24 in the list in the Ninth Schedule. If the legislative intent was to include components or accessories, it would have been specifically mentioned in the list. When the section specifically states that initial depreciation is available in respect of articles or things specified in Items Nos. l to 24 in the Ninth Schedule, it is not possible or permissible to include something which is not in the list and read Item No.8 as "Industrial and agricultural machinery and its components". In fact, a comparison with section 33(1)(b)(B)(i) read with the Fifth Schedule is of some assistance to show that where the Legislature intended to include components, it specifically did so. Hence, manufacture or production of spark plugs and fuel injection equipment for "agricultural machinery" cannot be equated to production of "agricultural machinery' and the assessee would not be entitled to initial depreciation in respect of it.-
The premium paid to the Export Credit Guarantee Corporation Ltd. was for obtaining information regarding markets outside India in respect of goods in which it was doing business and, therefore, it would fall under section 35-B(1)(b) of the Act.
CIT v. J.B. Advani & Co. (Mysore) (Pvt.) Ltd. (1987) 163 ITR 638 (Kar.) fol.
When the assessment is not under section 143(1) of the Income Tax Act, 1961, the Appellate Authority may, permit the assessee to claim a deduction or exemption in appeal, which he had not claimed before the Income-tax Officer, particularly when the relevant material is on record.
Jute Corporation of India Ltd. v. CIT (1991) 187 ITR 688 (SC) and CIT v. Sayaji Mills Ltd. (1974) 94 ITR 26 (Guj.) fol.
Bengal Enamel Works Ltd. v. CIT ILR 2 Cal. 13; Calcutta Co. Ltd. v. CIT (1959) 37 ITR 1 (SC); Chimanlal Textile Mills (P.) Ltd. v. CIT (1966) 62 ITR 274 (MP); CIT v. Bharat Earth Movers Ltd. (1995) 211 ITR 515 (Kar.); CIT v. Colour Chem. Ltd. (1977) 106 ITR 323 (Bom.); CIT v. Hindustan Aeronautics Ltd. (1988) 174 ITR 340 (Kar.); CIT v. Kanodia Warehousing Corporation (1980) 121 ITR 996 (All.); CIT v. Lucas T:'V.S. Ltd. (No.2) (1977) 110 ITR 346 (Mad.); CIT v. Rajkumar Mills Ltd. (1971) 80 ITR 244 (Bom.); CIT v. Sileman Khan Mahaboob Khan (1988) 174 ITR 200 (AP); CIT v. Travancore Tea Estates Co. Ltd. (1980) 122 ITR 557 (Ker.); Delhi Flour Mills Co. Ltd. v. CIT (1974) 95 ITR 151 (Delhi); Metal Box Co. of India Ltd. v. Their Workmen (1969) 73 ITR 53; 39 Comp. Cas. 410; 35 FJR 181 (SC); Shree Sajjan Mills Ltd. v. CIT (1985) 156 ITR 585 (SC); Southern Railway of Peru Ltd. v. Owen (1957) 32 ITR 737; (1957) AC 334 (HL) and Union Coal Co. Ltd. v. CIT (1968) 70 ITR 45 (Cal.) ref.
M.V. Seshachala for the Commissioner.
S.E. Dastur for King and Partridge for the Assessee.
JUDGMENT
R. V. RAVEENDRAN, J.---These three references under section 256(1) of the Income Tax Act, 1961 ("Act" for short), relate to the order of assessment, dated August 11, 1978, passed in regard to the assessment year 1976-77 (year ending December 31, 1975). Feeling aggrieved by the disallowance of certain expenditure in computing income chargeable under the head "Profits and gains of business" and disallowance of certain deductions in computing the total income, the assessee filed an appeal before the Commissioner of Income-tax- (Appeals) 1, Bangalore. The appeal was partly allowed by order, dated February 28, 1980. Feeling aggrieved, the assessee filed I.T.A. No.322/Bang. of 1980 and the Department filed I.T.A. No.340/Bang of 1980. The Tribunal by a common order, dated October 31, 1981, partly allowed both the appeals. The assessee sought reference of some questions of law in regard to the decision of the Tribunal in I.T.A. No.322/Bang. of 1980 in R.A. No.962/Bang. of 1981. The Department sought reference of some questions arising out of the order of the Tribunal in I.T.A. No.322/Bang. of 1980 and I.T.A. No.340/Bang of 1980 in R.As. Nos.2 and 3/Bang. of 1980.
In pursuance of the said applications, the Tribunal by order, dated November 30, 1982, has referred the following 12 questions (questions 4os.l to 9 at the instance of the Revenue and questions Nos. 10 to 12 at the instance of the assessee) for opinion:
"Whether, on the facts and in the circumstances of the case
(1) The Appellate Tribunal is right in law in holding that the assessee was entitled to get higher depreciation on canteen building?
(2) The Appellate Tribunal is right in law in holding that the provision for salary and wages payable for non-utilised leave amounting to Rs.75,51,000 is an admissible deduction?
(3) The Appellate Tribunal is right in law in holding that expenses incurred in connection with issue of rights shares, constitutes revenue expenditure deductible in computing the business income?
(4) The Appellate Tribunal is right in law in holding that depreciation has to be allowed on increase in the value of assets due to fluctuation in exchange rate?
(5) The Tribunal was right in upholding the jurisdiction of the Commissioner of Income-tax (Appeals) in entertaining the additional claim of the assessee for weighted deduction under section 35-B on expenses incurred on advertisement and technical literature?
(6) The Appellate Tribunal is right in law in holding that the assessee is entitled to depreciation on roads, culverts and drainages around the assessee's factory?
(7) The Appellate Tribunal is correct in holding that ground rent, repairs, municipal tax and depreciation in respect of the buildings owned by the assessee and used as residential quarters by an employee, cannot be treated as expenditure resulting in benefit or amenity granted to the employees by the assessee and considered as perquisite' for the purposes of section 40-A(5)?
(8) The Appellate Tribunal is right in holding that the depreciation allowance has to be allowed on the pipe-line and sanitary fittings treating it as plant and machinery?
(9) The Appellate Tribunal is correct in holding that the assessee is entitled for extra-shift allowance on the storage tank as the same is part of plant and machinery?
(10) The Income-tax Appellate Tribunal was right in law in holding that the assessee would not be entitled to the benefit of initial depreciation under section 32(1)(vi) of the income-tax Act?
(11) The Tribunal was right in law in holding that the surtax payable is not a proper deduction in computing the total deduction for income tax purposes?
(12) The Income-tax Tribunal was justified in holding that the assessee was not entitled to weighted deduction under section 35-B in respect of insurance premium of Rs.35,581 paid to the Export Credit Guarantee Corporation Limited?"
Though in paragraph 21 of the statement of case, the Tribunal states that 13 questions are referred, it is seen that only 12 questions are referred. Though the reference sought in regard to the question referred to in paragraph 9 has been rejected, apparently by oversight the Tribunal has stated in paragraph 21 that the question referred to in paragraph 9 is also referred. This is ignored. Question No.(5) has been reframed by the Tribunal.
Re: Question No.(1):
This relates to a claim for depreciation on canteen buildings at the same rate applicable for factory buildings, on the basis that they formed part of the factory buildings. The Income-tax Officer disallowed the claim. This was confirmed in appeal. The Tribunal, however, upheld the assessee's claim for higher depreciation. The same question arose in regard to the earlier assessment year 1974-75 and this Court, following the decision of the Madras High Court in CIT v. Engine Valves Ltd. (1980) 126 ITR 347 answered the question in favour of the assessee holding that canteen building should be regarded as part of factory buildings. Following the said decision relating to the earlier year, in CIT v. Motor Industries Co. Ltd. (1986) 158 ITR 734 (Kar.), this question is answered in the affirmative, against the Revenue and in favour of the assessee.
Re: Question No.(3):
This question relates to the expenses incurred by the assessee in connection with the issue of rights shares. The assessee contended that it is a revenue expenditure deductible in computing business income. The Income tax Officer rejected the contention and held it to be a capital expenditure. The Appellate Assistant Commissioner and the Tribunal accepted the contention of the assessee. This question arose in regard to the assessment year 1974-75 and this Court held it to be a capital expenditure--vide CIT v. Motor Industries Co. Ltd. (1988) 173 ITR 374. Following the said decision, this question is answered in the negative, against the assessee and in favour of the Revenue.
Re: Question No.(4):
This question relates to entitlement to the benefit under section 43-A on the increase in liability on account of fluctuations in the exchange rates. On account of fluctuations in exchange rates, the assessee revalue its liability in respect of foreign currency loans obtained for purchase of machinery, tools and spare parts as on December 31, 1975, and made a provision of Rs.3,44,838. Out of it, Rs.2,89,582 relatable to machinery was capitalised and apportioned among various assets and depreciation was claimed; and the balance of Rs.55,256 relatable to tools/spares was debited to the profit and loss account as revenue expenditure. The claims were rejected by the Income-tax Officer. The Appellate Assistant Commissioner and the Tribunal held that the assessee was entitled to the benefit of section 43-A. The same question arose in regard to the assessment year 1974-75 and this Court upheld the view of the Tribunal holding that the claim of the assessee also attracted the Board's Circular F. No. 1(408/ 67-TPL), dated October 9, 1967, which properly interpreted the scope and ambit of section 43-A--vide CIT v. Motor Industries Co. Ltd. (1988) 173 ITR 374 (Kar). The Revenue also conceded the correctness of the decision of the Tribunal having regard to the subsequent decision of the Supreme Court in CIT v. Arvind Mills Ltd. (1992) 193 ITR 255. The question is, therefore, answered in the affirmative, against the Revenue and in favour of the assessee.
Re: Question No (5):
In the appeal filed against the order of assessment, the assessee claimed weighted allowance under section 35-B in regard to expenses incurred for advertisement and technical literature. The Appellate Assistant Commissioner held that the assessee was eligible for weighted allowance under section 35-B. The Department challenged the same before the Tribunal on the ground that the claim had not been made before the Income-tax Officer. The Tribunal held that as the material and details were available on record, the Appellate Assistant Commissioner was justified in admitting the additional claim. In this context, the question whether the Commissioner of Income-tax (Appeals) could have entertained the claim of the assessee for weighted deduction under section 35-B is referred.
Though the assessee had not claimed such weighted deduction before the Income-tax Officer, the Commissioner of Income-tax (Appeals) entertained the claim as the material and details were available in the records. When the necessary material was available and the weighted deduction is permissible under section 35-B, the claim cannot be rejected merely on the ground that it was not made before the Income-tax Officer. It is now well settled that when the assessment is not under section 143(1), the appellate authority may permit the assessee to claim a deduction or exemption in appeal, which he had not claimed before the Income-tax Officer, particularly when the relevant material is on record--See the decision of the Supreme Court in Jute Corporation of India Ltd. v., CIT (1991) 187 ITR 688; Union Coal Co. Ltd. v. CIT (1968) 70 ITR 45 (Cal) and CIT v. Sayaji Mills Ltd. (1974) 94 ITR 26 (Guj). We, therefore, answer question No.(5) in the affirmative and against the Revenue.
Re: Question No.(6):
This question relates to the claim for depreciation on the written down value of roads, culverts and drains within the factory premises. The. Income-tax Officer disallowed the claim. The Commissioner of Income-tax (Appeals) and the Tribunal held that the assessee is eligible for such depreciation following the decision of the Bombay High Court in CIT v. Colour Chem. Ltd. (1977) 106 ITR 323 and of the Madras High Court in CIT v. Lucas-TVS Ltd. (No.2) (1977) 110 ITR 346. The matter is now covered by the decision of the Supreme Court in CIT v. Gwalior Rayon Silk Mfg. Co. Ltd. (1992) 196 ITR 149 wherein it is held that roads and drains laid within the factory premises are necessary adjuncts to the factory buildings to carry on the business activity of the assessee and would fall under the definition of "building" under section 32 and the capital expenditure incurred thereon is admissible to depreciation of written down value. We, therefore, answer question No.(6) in the affirmative, against the Revenue and in favour of the assessee.
Re: Question No.(7):
This relates to the addition of Rs.44,269 by the Income-tax Officer being the amount spent on repairs, municipal taxes and ground rent, and depreciation in respect of the assessee's own buildings allowed to be used as residential quarters by its employees, treating them as expenditure resulting in a benefit or amenity granted to the employees by the assessee considered as a perquisite for the purpose of section 40-A(5). The addition was deleted by the Commissioner of Income-tax (Appeals) and that was affirmed by the Tribunal by following the decision in CIT v. Travancore Tea Estate Co. Ltd. (1980) 122 ITR 557 (Ker). The matter is now covered by the decision of this Court in the case of the petitioner relating to the assessment year 1974-75. (CIT v. Motor Industries Co. Ltd. (1988) 173 ITR 374). Following the said decision, question No.(7) is answered in the affirmative, against the Revenue and in favour of the assessee in regard to (i) depreciation on buildings, and (ii) payment of property tax and ground rent, and (iii) expenditure on repairs. This is subject, however, to a rider in so far as repairs are concerned; what cannot be added under section 40-A(5) is only the amount spent for normal and routine upkeep and maintenance; and any amount spent in excess to meet the special requirements of the employee in occupation can be added under section 40-A(5). Having regard to the modest amount involved in this case, it has to be held that nothing need be added under section 40-A(5).
Re: Questions Nos.(8) and (9):
Question No.(8) is whether depreciation is admissible on pipelines and sanitary fittings treating them as plant and machinery. The Income-tax Officer held that pipelines and sanitary fittings, tanks, cannot be held to be plant. He allowed depreciation of only five per cent. and held that extra-shift allowance was not admissible. The Commissioner of Income-tax (Appeals) held that they should be treated as plant and depreciation should be allowed at 10 per cent. This was upheld by the Tribunal.
Question No.(9) is whether extra shift allowance is admissible on storage tanks treating them as part of plant and machinery. The Income-tax Officer held that storage tanks were not "plant", but only formed part of building. The Commissioner of Income-tax (Appeals) and the Tribunal have accepted the assessee's claim that storage tanks will have to be classified as "plant", and entitled to extra-shift allowance.
These are covered by the decision of this Court in the case of the petitioner relating to the assessment year 1974-75 in CIT v. Motor Industries Co. Ltd. (1988) 173 ITR 374. Following the said decision, this question has to be answered in the negative and against the assessee. This Court held that the question whether water supply system (pipelines/sanitary fittings) and storage tanks are "plant" or not, depends on their relation to the nature of the business carried on by the assessee and the question will have to be decided in each case, on the facts and circumstances, by applying the "functional test" evolved by the High Court of Allahabad in CIT v. Kanodia Warehousing Corporation (1980) 121 ITR 996. As the Tribunal had not determined the matter by applying such principle, this Court answered the question in the negative and held that the Tribunal should apply the functional test evolved in Kanodia' s case (1980) 121 ITR 996 (All) and re determine the facts afresh.
We find that neither the Income-tax Officer nor the Commissioner of Income-tax (Appeals) nor the Tribunal has examined the matter by applying the functional test. Hence, following the decision in CIT v. Motor Industries Co. Ltd. (1988) 173 ITR 374, we answer questions Nos.(8) and (9) in the negative and hold that the Tribunal shall re-examine whether pipelines, sanitary fittings and storage tanks are "plant" by applying the functional test, and then decide the rate of depreciation and decide whether extra shift allowance is admissible.
Re: Question No. (10):
The assessee claimed initial depreciation of Rs.43,08,219 on machinery, under section 32(1)(vi). The Income-tax Officer denied the same on the ground that manufacture of spark plugs and fuel injection equipment are not manufacture or production of any of the items specified in the Ninth Schedule to the Act. This was confirmed by the Commissioner of Income-tax (Appeals) and also by the Tribunal.
The assessee contends that section 32(1)(vi) allowed a deduction of 20 per cent. of the actual cost of machinery or plant installed for the manufacture or production of any of the articles specified in Items Nos. i to 24 in the list in the Ninth Schedule; that Item No.8 enumerated in the said list is "industrial and agricultural machinery'; the assessee inanufactures spark plugs and fuel injection equipment which are fitted in agricultural machines like tractors; that "industrial and agricultural machinery" will include their components also: and, therefore, the assessee is entitled to the benefit of initial depreciation under section 32(1)(vi).
The Ninth Schedule does not refer to components of industrial and agricultural machinery. Section 32(1)(vi) gives the benefit of initial depreciation in respect of plant and machinery installed for the manufacture or production of any article or thing by a small scale industrial undertaking; but in regard to assessees other than small scale industrial undertakings, initial depreciation is admitted only in regard to manufacture or production of any one or more of the articles or things specified in Items Nos. l to 24 in the list in the Ninth Schedule. If the legislative intent was to include components or accessories, it would have been specifically mentioned in the list. When the section specifically states that the initial depreciation is available in respect of articles or things specified in Items Nos. l to 24 in the Ninth Schedule, it is not possible or permissible to include something which is not in the list and read Item No. 8 of "industrial and agricultural machinery and its components". In fact, a comparison with section 33(1)(b)(B)(i) read with the Fifth Schedule is of some assistance to show that where the Legislature intended to include components, it specifically did so. Section 33(1)(b)(B)(i) provided for development rebate at the rates specified in regard to machinery or plant installed for the purpose of business of construction, manufacture or production of any one or more of the articles or things specified in the list in the Fifth Schedule. In the list contained in the Fifth Schedule, Item No.4 is industrial machinery as specified, Item No.9 is tractors, earth-moving machinery and agricultural implements, and Item No.(24) is component parts of the articles mentioned in Items Nos.4, 9 and other articles specified. It is thus, clear that manufacture or production of spark plugs and fuel injection equipment for "agricultural machinery" cannot be equated to production of "agricultural machinery'. In fact, in regard to the assessment year 1975-76, a similar view has been taken by this Court in the case of the assessee, by order, dated March 28, 1989, in I.T.R.C. Nos.189-193 of 1980. The decision of the Income-tax Officer, the Commissioner of Income-tax (Appeals) and the Tribunal is in accordance with law. Question No.(10), is, therefore, answered in the affirmative, against the assessee and in favour of the Revenue.
Re: Question No.(11):
The assessee claimed deduction of surtax liability in computing the total income for purposes of income-tax. The Income-tax Officer rejected it on the ground that surtax is a tax on income. The Commissioner of Income tax (Appeals) and the Tribunal confirmed the said rejection.
Section 40(a)(ii) provides that notwithstanding anything to the contrary in sections 30 to 39, any sum paid on account of any rate or tax levied on the profits or gains of any business or profession or assessed at a proportion of, or otherwise on the basis of, any such profits or gains shall not be deducted in computing the income chargeable under the head "Profits and gains of business or profession". Even apart from the provisions of this clause, a sum paid as tax on profits or gains of any business cannot be deducted in computing the profits for purposes of income-tax, under the general law of income-tax. This Court in CIT v. International Instruments (P.) Ltd. (1983) 144 ITR 936, has held that surtax payable under the Companies (Profits) Surtax Act, 1964, on the chargeable profits is nothing but an additional tax on the profits and gains of an assessee's business and, therefore, surtax cannot be deducted for computing the total income. Hence, question No.(11) is answered in the affirmative, against the assessee and in favour of the Revenue,
Re: Question No.(12):
The assessee claimed weighted deduction under section 35-B(1) (b)(ii) in respect of insurance premium paid to the Export Credit Guarantee Corporation Ltd. The Income-tax Officer did not allow weighted deduction in that behalf. In fact, he clubbed it with certain other matters in regard to which weighted deduction was claimed and disposed of the matter without any independent consideration of this claim. The Commissioner of Income tax (Appeals) confirmed the said decision. He also did not consider the matter separately. The Tribunal also confirmed the disallowance following its decision on a similar question in regard to the assessment year 1975-76. The matter is now covered by the decision of this Court in CIT v. J.B. Advani & Co. (Mysore) (Pvt.) Ltd. (1987) 163 ITR 638, wherein this Court held that premium paid to ECGCL is for obtaining information regarding markets outside India in respect of goods in which it was doing business and, therefore, it would fall under section 35-B(1)(b). Following the said decision, question No.(12) is answered in the negative, i.e., in favour of the assessee and against the Revenue.
Re: Question No.(2):
This question relates to a provision of Rs.75,51,000 made and debited by the assessee, under the head "Salary and wages" in respect of unutilised leave by its employees as on December 31, 1975. During the earlier years, the assessee had not made any such provision, as it used to debit only the actual payments made in the accounting year, towards unutilised leave.
The assessee contended that the provision of Rs.75,51,000 was made by evaluating the number of days of leave standing to the credit of the individual employees, with reference to their salary, as at the end of the accounting year; that a systematic and regular record of leave earned and utilised by its employees was maintained and the liability had been quantified with reference to the individual rate of salary, as at the end of December, 1975. It was stated that the leave entitlement was as per the provisions of the Factories Act, 1948, read with memoranda of settlement entered into between the assessee and the employees' association from time to time and there was no separate scheme governing the matter.
The Income-tax Officer held that the provision made was only to meet a contingent liability and not an ascertained liability and, therefore, disallowed the expenditure relying on the decision of the Madhya Pradesh High Court in Chhaganlal Textile Mills (P.) Ltd. v. CIT (1966) 62 ITR 274 (MP) and the decision of the Bombay High Court in CIT v. Rajkumar Mills Ltd. (1971) 80 ITR 244.
In an appeal by the assessee, the Commissioner of Income-tax (Appeals) found that the assessee had got regular leave records for all its employees in conformity with the Factories Act, 1948, and had given full details in regard to the provision made; that apart from annual leave, the employees were also entitled to premium leave depending on the length of their service as also sick leave; that the assessee had a systematic and regular record of leave earned and utilised during the year in respect' of each employee and the liability of Rs.75,51,000 had been quantified from such records. He, therefore, held that the provision of Rs.75,51,000 was not a contingent liability, but an expenditure that was allowable. He purported to follow two decisions of the Supreme Court in Calcutta Co. Ltd. v. CIT (1959) 37 ITR 1 and Metal Box Co. of India Ltd. v. Their Workmen (169) 73 ITR 53. The Revenue filed a second appeal before the Tribunal. The Tribunal upheld the decision of the Commissioner of Income-tax (Appeals), holding that the assessee was entitled to claim the said provision as an expenditure. Feeling aggrieved, the Revenue has sought this reference.
Before examining the rival contentions, it is necessary to notice the provisions relating to leave, as applicable to the employees of the assessee. The assessee does not have any "scheme" in regard to leave. The certified standing orders for employees of the assessee provides that an employee shall be allowed leave with salary/wages subject to and in accordance with the Indian Factories Act.
Chapter VIII of the Factories Act, 1948, deals with annual leave with wages. Section 78 provides that the provisions of the said Chapter shall not operate to the prejudice of any right to which a worker may be entitled under any law or under the terms of any award, agreement (including settlement) or contract of service.
Section 79 deals with annual leave with wages. Section 80 deals with wages during leave period.
Subsection (1) of section 79, inter alia, provides that every worker who has worked for a period of 240 days or, more in a factory during a calendar year shall be allowed during the subsequent calendar year, leave with wages at the rate of one day for every twenty days of work performed by him during the previous calendar year. Explanation 1 clarifies that the leave earned in the year prior to that in which the leave is enjoyed shall be deemed to be days on which the worker has worked in a factory for the purpose of computation of the period of 240 days or more, but he shall not earn leave for those days.
Subsection (3) of section 79 provides that if a worker is discharged 6'' dismissed from service or quits his employment or is superannuated or dies while in service, during the course of the c4lendar year, he or his heir/nominee, as the case may be, shall be entitled to wages in lieu of the quantum of leave to which he was entitled immediately before such date, even if he had not worked for the entire period specified for making him eligible to avail of such leave.
Subsection (5) of section 79 provides that if a worker does not, in any one calendar year, take the whole of the leave allowed to him, any leave not taken by him shall be added to the leave to be allowed to him in the succeeding calendar year: Provided that the total number of days of leave that may be carried forward to a succeeding year shall not exceed thirty days. Provided further that a worker, who has applied for leave with wages but has not been given such leave shaft be entitled to carry forward the leave refused without any limit.
Section 80 of the factories Act provides that for the leave allowed to a worker under section 78 or 79, he shall be entitled to wages, at a rate equal to the daily average of his total full time earnings for the days on which he actually worked, during the month immediately preceding his leave, exclusive of any overtime and bonus.
The memorandum of settlement for the period 1965-67 provides that the entitlement and availing of annual or earned leave by workmen will be strictly in accordance with the provisions of the Factories Act. The next settlement for the period 1968-70 provides that the workmen will be entitled to accumulate unveiled sick leave to the maximum extent of 18 days in the case of workmen covered under the Employees' State Insurance Scheme and 33 days in the case of others. It also provides that with effect from January 1, 1968, workmen will be entitled to premium days as annual leave (one day for workmen with service of five years and above but below ten years; two days for workmen with service of ten years and above but below fifteen years; three days for workmen with service of 15 years and above but below 20 years; and four premium days for workmen with service of 20 years and above) depending upon the workmen's period of service with the company as on the first of January of the every calendar year in addition to the annual leave. The same leave benefits were continued subsequently.
The memorandum of settlement for the period 1971-73 provides that the workmen will continue to have sick leave facility (six days in a year for those covered under the Employees' State Insurance Scheme and eleven days for those who are not) and enabled the workmen to an cash the unavailed sick leave at the end of each calendar year in such a manner that they will have a balance of six days/eleven days as .the case may be, to their credit, to carry forward to the following calendar year.
The assessee claims to have calculated the leave entitlement of each employee for the year ended December 31, 1975, and calculated the salary/wage for such period and made a provision for payment of such amount aggregating to Rs.75,51,000. It is the case of the assessee that as and when aft employee utilises such leave, the wages to be paid for the leave period will be paid from that account; and when an employee retires from service, leave encashment amount will also be paid from the account; and, therefore, it is an admissible deduction.
On behalf of the Revenue, it was contended before us that a provision for leave salary in the accounting year cannot be considered as a provision for a liability in praesenti, as it is a contingent liability. It is further contended that the question is now covered by two decisions of this Court in CIT v. Hindustan Aeronautics Ltd. (1988) 174 ITR 340 and CIT v. Bharat Earth Movers Ltd. (1995) 211 ITR 515, and, therefore, the question should be answered in favour of the Revenue.
In the case of Hindustan Aeronautics Ltd. (1988) 174 ITR 340 (Kar.) the question considered was whether provision for accrued leave salary is an admissible deduction to arrive at the assessable profits of a company. This Court held that payment on account of encashment of leave to a workman could arise only was his employment is terminated and till then, the liability that rests on the employer to pay a worker, wages in accordance with the rules for the unutilised leave period, remains a contingent liability which the employer may or may not be called upon to discharge. Hence, if any amount is set apart by an employer in a year for meeting such contingency, it cannot be regarded as a permissible deduction. This Court followed the decision of the Calcutta High Court in Bengal Enamel Works Ltd. v. CIT (1955) ILR 2 Cal 13, and the decision of the Madhya Pradesh High Court in Chhaganlal Textile Mills (P.) Ltd. v. CIT (1966) 62 ITR 274.
In the case of Bharat Earth Movers Ltd. (1995) 211 ITR 515, (Kar.) also, the question that arose for consideration was whether provision for making the liability for encashment of earned leave is an admissible deduction. This Court held that neither leave salary nor leave encashment benefit payable to the employees can be said to be a present liability and it is only a contingent liability and, therefore, the assessee-company is not entitled to deduction in regard to the provision made to meet such a liability.
In Bengal Enamel Works' case, (1955) ILR 2 Cal. 13, the Calcutta High Court considered whether an assessee is entitled to deduction of an amount which was debited to its expenses account to meet the liability to the employees on account of holiday wages which would have to be paid to them' in the following year. The Court held:
"It should be clear from what I have stated above that such statutory liability for holiday wages as the Factories Act creates is only a contingent liability which may or may not have to be discharged; and, secondly, the measure of that liability can never be known in advance. It cannot be so known, because it cannot be known in advance how many employees will avail themselves of how many holidays and when and, necessarily, at what rate, holiday wages would be payable. In those circumstances, it is perfectly clear that not only is the amount claimed not allowable as an item of expenditure, because, in fact, no expenditure had been incurred and not a pie had gone out of the funds of the company, but also that the amount does not even represent a certain liability which will have to be discharged in any event. It may be that although a particular amount is pot actually expended during the currency of a particular accounting year, the assessee will still be entitled to a deduction if a certain liability for its payment has arisen so that it may be said that the expenditure is as good as made. The amount claimed in the present case is certainly not even of that character and, as I have already pointed out it is not an amount, which was actually spent.
Mr. Bose contended that his client kept its accounts in. the mercantile method and, therefore, the fact that it had debited the amount in its books would be sufficient to establish expenditure. I entirely disagree. It is true that under the mercantile system of accounting a debit can often be equated with actual expenditure provided a liability has been incurred, but on the facts I have stated, the debit in the present case is no better than a fictitious debit and is liable to be disregarded on that account."
In Chhaganlal' s case, (1966) 62 ITR 274 (MP), the question considered was whether an assessee is entitled to a deduction of an amount set apart in the balance-sheet for payment to be made to workers in respect of leave under section 79 of the Factories Act. The Court held that under section 10(2)(xv) of the Indian Income-tax Act, 1922, deduction is not permissible for a contingent liability, as it is not an "expenditure"; that liability for holiday wages under section 79 is only a contingent liability; and any sum set apart by an employer in any year to meet the contingency of some workers going on leave the next year cannot be regarded as a permissible expenditure; and every amount set apart by an assessee out of prudence, to meet a contingent liability will not become an "expenditure".
A similar view was taken by the Andhra Pradesh High Court in CIT . Sileman Khan Mahbub Khan (1988) 174 ITR 200 and by the Bombay High Court in CIT v. Rajkumar Mills Ltd. (1971) 80 ITR 244.
The assessee contends that the liability for unutilised leave arises in the year in which such leave was earned and not in the year in which it is availed of or encashed; and the liability for salary for such leave being a component of the remuneration payable to the employee for service rendered during the year, the profits for the year in which the leave is earned, should bear the charge in respect of the salary for such leave. It is pointed out that the employee has an option of either availing of leave in the subsequent year or encashing the leave in certain circumstances; and if he avails of the leave, he will be paid the salary for the period for which he would not be working and if it is debited to the profits of the subsequent year, the profits of the subsequent year would be understated. Therefore, if an employee avails of leave earned in an earlier year, during the subsequent year, the salary for the period the employee ors on leave is debited to the provision account and not against the profits of the subsequent year in which the leave is availed of. On the other hand, if the employee encashes his leave, the employer will pay the employee, the monetary equivalent and debit it to the provision account and not against the profits for the year in which such leave is encashed. It is, therefore, contended that the provision made for salary/wages payable on account of unutilised leave of employees is a provision for a known liability and must accordingly be allowed as a deduction. It is pointed out that the liability is certain, but only the method by which the liability has to be discharged is uncertain. Elaborating on this submission, Mr. Dastur. learned senior counsel for the assessee, argued that it is a certainty that the liability in respect of leave earned, will be discharged by the employer either by "detriment" or by "disadvantage", and the only uncertainty is the manner in which the said liability will be discharged that is whether by "detriment" (monetary outflow) or by disadvantage (non-availability of the service of the employee during the subsequent year if the employee utilises the leave), and the only contingency is that leave may be forfeited under certain circumstances. But, such forfeiture is a remote possibility; and even a contingent liability which is properly ascertainable can be taken into account in computing the profits for the year.
The assessee relied on the decision in Delhi Flour Mills Co. Ltd. v. CIT (1974) 95 ITR 151 (Delhi), to contend that if an amount represents a part of the emoluments payable to an employee for rendering services during a year, such amount accrues to the employee as soon as he completes each year of service and there is a corresponding liability on the part of the employer to pay such amount to the employee at the end of each year; and if the amount of liability is ascertainable, then, the same has to be allowed as a deduction; and the mere fact that the employer has not actually paid the amount, but has merely created a liability in the books of account in accordance with the mercantile system of accounting adopted by the assessee, would not mean that the assessee is not entitled to the deduction in that behalf.
The assessee also contended that leave encashment is a part of retirement benefit; and the cost of retirement benefits, to an employer, results from receiving services from the employees, who are entitled to receive such benefits; and, consequently, the cost of retirement benefits is to be accounted for in the period, during which such services are rendered. The assessee relied on Accounting Standard No. 15 relating to "Accounting for Retirement Benefits in the Financial Statements of Employers" from the Statement of Auditing Practices of Institute of Chartered Accountants of India (1995) in this behalf.
Learned counsel for the assessee relied on the decision of the Supreme Court in Metal Box Co. of India Ltd. v. Their Workmen (1969) 73 ITR 53 (SC) and the decision of the House of Lords in Southern Railway. of Peru Ltd. v. Owen (1957) 32 ITR 737; (1957) AC 334, which is approved and followed in Metal Box Co.'s case (1969) 73 ITR 53 (SC). He contended that in Metal Box Co.'s case (1969) 73 ITR 53, the Supreme Court following the decision of the House of Lords in Southern Railway of Peru Ltd. (1957) 32 ITR 737, has held that even a contingent liability if properly ascertainable was deductible. He submitted that the decisions of this Court in the cases of Hindustan Aeronautics Ltd. (1988) 174 ITR 340 and Bharat Earth Movers Ltd. (1995) 211 ITR 515 and the decisions of the High Courts of Calcutta, Madhya Pradesh, Bombay and Andhra Pradesh referred to above which held that a contingent liability is not deductible, are contrary to the decision of the Supreme Court in Metal Box Co.'s case (1969) 73 ITR 53 and, therefore, not good law. We will now consider the decisions relied on by the assessee.
In the case of Southern Railway of Peru Ltd. (1957) 32 ITR 737 (HL) the point in dispute related to the principle on which the profits should be computed with reference to certain payments which the appellant-company made, under the laws of the Republic of Peru, to its employees on their retirement from their service with it. The question was whether the amounts to be deducted as outgoings in each year of account were the payments made or actually owing to an employee who had retired in that year (as contended by the Revenue) or whether the amounts to be deducted were a proportionate amount of each payment estimated as ultimately to be paid on retirement, on the basis of that proportionate amount having accrued at the end of each period of account, though the employee had not retired and was still in the service of the appellant-company (as contended by the assessee). In that case as per the statutory scheme in force, the employer assessee was liable to pay to the employees a lump sum payment on termination of their services and the said payment did not depend on any prescribed length of service. An employee could, however, forfeit his right to the said payment by wrongful conduct or certain other given circumstances. The House of Lords held that the assessee was not entitled to make the said deduction on the ground that the assessee had not taken note of the discount factor while calculating the deduction. But the House of Lords, however, recognised the important principle that the company was entitled to charge against each year's receipts, the cost of making provision for the retirement payments which would ultimately be payable, as the employer had the benefit of the employees' services during that year, provided the present value of the future payment could be fairly estimated. The House of Lords found that where an employer dealt with a number of similar obligations that arose from its business, although it was true to say that each separate obligation may never mature, if the aggregate of the obligations can be fixed with some precision while each of the obligations may remain uncertain, the aggregate can be accepted as a recognised obligation. The House of Lords also came to the conclusion that even though the liability to pay a lump sum could be avoided on the breach of contract or misconduct on the part of the employee and to that extent the liability of the employer was contingent, such contingency would seem to be too remote which would justify a prudent employer in ignorance the said liability until the day for such payment arrived. On a consideration of the relevant provisions which entitled the employee to such payment, the Court came to the conclusion that the lump sum payment was to be regarded as a deferred remuneration in respect of the entire period of service. The following observations of the House of Lords are relevant (pages 754: 758):
"What the appellant claims the right to do is to charge against each year's 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 benefit 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 year's employment. This is a long-term application of the practice by which provision for holidays with pay in the coming year is charged in part against the receipts of the previous year. It does not seem to me inconsistent with the theory on which the claim is based that in the year when an increase of salary takes place and the expectation of a larger ultimate payment materializes an adjustment has to be made to take care of what has, thus, become the under provision of the earlier years. I agree that it is arbitrary to describe such an adjustment as accruing in respect of that year's service; but, on the other hand, it is a provision which is required in that year to take account of the increased burden which the year's salary for the year's service has thrown upon the employer .
where you are dealing with a number of similar obligations that arise from trading, although it may be true to say of each separate one that it may never mature, it is the sum of the obligations that matters to the trader, and experience may show that, while each remains uncertain, the aggregate can be fixed with some precision. For the trader the practical question is always the same in these cases: How much more shall I have to pay out or shall I be able to get in, than my current accounts of the year are recording? Legal analysis of the obligation may present it in a variety of different forms. There is the deferred payment which is subject to nothing more than the practical contingency that it may not be received. That is dealt with, as we know, by bringing it in at its face value, subject to allowance, or, in some cases, at a valuation. There is the future payment for work done, which is only legally exigible if the whole work is completed. A large part of this particular aspect must be covered by such items of receipt as work in progress, but I do not know enough of the methods of valuing or allowing for this to speak with any confidence about it. And, lastly, there is the contingent obligation to make a future payment, which is our present case. But, whatever the legal analysis, I think that for liabilities as for debts their proper treatment in annual statements of profit depends not upon the legal form but upon the trader's answers to two separate questions. The first is: Have I adequately stated my profits for the year if I do not include some figure in respect of these obligations? The second is: Do the circumstances of the case, which include the techniques of established accounting practice make it possible to supply a figure reliable enough for the purpose?"
In Metal Box Co.'s case (1969) 73 ITR 53 (SC), the question that arose for consideration was whether a liability under a scheme of gratuity in respect of the accounting year stated in the profit and loss account could be deducted for the purpose of computation of bonus under the Payment o1 Bonus Act. The Supreme Court held that 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 taking them into consideration. An estimated liability under a scheme of gratuity, if properly ascertainable and its present value is discounted, is deductible from the gross receipts while preparing the profit and loss account. This is recognised in trade circles and there is nothing in the Bonus Act which prohibits such a practice. Such a provision provides for a known liability of which the amount can be determined with substantial accuracy. It cannot, therefore, be termed a "reserve". Therefore, the estimated liability for the year on account of a scheme of gratuity should be allowed to be deducted from the gross profits. The allowance is not restricted to the actual payment of gratuity during the year.
The question whether a provision for such liability could be deducted in the computation of profits and gains of the previous year, under the Income Tax Act, 1961, was not considered in Metal Box Co.'s case (1969) 73 ITR 53 (SC) as it was rendered while considering the question whether such a liability could be deducted for the purpose of bonus under the Payment of Bonus Act. But in view of the principles laid down in Metal Box Co.'s case (1969) 73 ITR 53 (SC) several High Courts held that it was permissible for an assessee to make a provision in his profit and loss account for the estimated liability under a gratuity scheme, by ascertaining its present value on the basis of actuarial valuation, to claim that such liability is an ascertained liability in praesenti, though payable in future, to be deducted in the computation of the profits and gains of the previous year. Subsection (7) of section 40-A was introduced with effect from April 1, 1973, clause (a; made it clear that whatever is provided for future use by the assessee out o1 the gross profits of the year of account for payment of gratuity to employees on their retirement or on the termination of their services would not be allowed as deduction in the computation. of profits and gains of the year of account subject to the exceptions contained in clause (b). The intention of the Legislature in enacting section 40-A(7) is made evident in the Notes on Clauses (see (1975) 98 ITR (St.) 194) of amendment thus:
"A reading of these two provisions (that is, sections 37(1) and 36(i)(v) of the Act) clearly shows that the intention has always been that deduction in respect of gratuities should be allowed either in the year in which the gratuity is actually paid or in the year in which contributions are made to an approved gratuity fund. A doubt has been expressed that the relevant provisions, as presently worded, do not secure the underlying objective and that a provision made by a taxpayer in his accounts in respect of estimated service gratuity payable to employees will be deductible in computing the taxable income in a case where the provision has been made on a scientific basis in the form of an actuarial valuation. In order to remove uncertainty in the matter, it is proposed to specifically provide in the law that no deduction will be allowed, in the computation of profits and gains of a business or profession, in respect of any reserve created or provision made for the payment of gratuity to the employees on retirement or on termination of employment for any reason. This restriction will, however, not apply in relation to a provision made for the purpose of payment of a sum by way of contribution towards an approved gratuity fund that Chas become payable during the relevant account year, or for the purpose of meeting actual liability in respect of payment of gratuity to the employees that has arisen during such year. "
Another aspect that requires to be noticed is that the practice of making a provision for meeting the liability relating to gratuity was recognised among employers, by determining the liability on actuarial valuation basis by discounting the present value. But there is no such actuarial valuation basis for the provision for salary and wages for unutilised leave. Hence, the principle laid down in Metal Box Co.'s case (1969) 73 ITR 53 (SC) has no bearing on the question relating to provision for leave wages.
The decision of the House of Lords in the case of Southern Railway of Peru Ltd. (1957) 32 ITR 737 can also be of no assistance to the petitioner. While the said decision was followed in Metal Box Co.'s case (1969) 73 ITR, while dealing with a case arising under the Payment of Bonus Act, the Supreme Court did not follow the said decision while dealing with cases under the Income-tax Act. In Indian Molasses Co. (P.) Ltd. v. CIT (1959) 37 ITR 66, the Supreme Court noticed the principle laid down in Southern Railway of Peru Ltd. (1957) 32 ITR 737 (HL) that the recurring liability of a pension which is comprised into a lump sum payment, should itself be a legal obligation, and that, if contingent, the present value of the future payments should be fairly estimable; and what could be deducted is not the whole of the amount, but only the present value of the future liability. The Supreme Court, however, held that the said decision was of no assistance, as it did not deal with the term "expenditure" which is relevant under the provisions of the Income-tax Act. To claim deduction, an assessee should make out that the "provision" made is a deduction permissible under section 36 or is a deduction specified in sections 30 to 35-E or an expenditure under section 37. The deduction claimed by the assessee does not fall under sections 30 to 36. Let us examine whether it can fall under section 37.
In Indian Molasses Co.'s case (1959) 37 ITR 66, the Supreme Court held that "expenditure" is what is "paid out or paid away" and is something which is gone irretrievably. The Supreme Court held (page 79):
"To be a payment which is made irrevocably there should be no possibility of the money forming, once again, a part of the funds of the assessee-company. If this condition be not fulfilled, and there is a possibility of there being a resulting trust in favour of the company, then the money has not been spent, i.e., paid out or away, but the amount must be treated as set apart to meet a contingency, There is a distinction between a contingent liability and a payment depending upon a contingency. The question is whether in the years of account, one can describe the assessee company's liability as contingent or merely depending upon a contingency.
The income-tax law does not allow as expenses all the deductions a prudent trader would make in computing his profits. The money may be expended on grounds of commercial expediency but not of necessity. The test of necessity is whether the intention was to earn trading receipts or to avoid future recurring payments of a revenue character. Expenditure in this sense is equal to disbursement which, to use a homely phrase, means something which comes out of the trader's pocket.. Thus, in finding out what profits there be, the normal accountancy practice may be to allow as expenses any sum in respect of liabilities which have accrued over the accounting period and to deduct such sums from profits. But the income-tax laws do not like every such allowance as legitimate for purposes of tax. A distinction is made between an actual liability in praesenti and a liability de futuro which, for. the time being, is only contingent. The former is deductible but not the latter What a prudent trader sets apart to meet a liability, not actually present but only contingent, cannot bear the character of expense till the liability becomes real (page 75)."
The Supreme Court held that where the liability itself is contingent, as contrasted from the payment being contingent, there can be no deduction. In the words of the Supreme Court (page 80) "Expenditure which is deductible for income-tax purposes is one which is towards a liability actually existing at the time; but the putting aside of money which may become expenditure on the happening of an event is not expenditure".
The principle in Indian Molasses' case (1959) 37 ITR 66 (SC) is followed and reiterated in Shree Sajjan Mills Ltd. v. CIT (1985) 158 ITR 585. The Supreme Court held (page 598):
"Contingent liabilities do not constitute expenditure and cannot be the subject-matter of deduction even under the mercantile system of accounting. Expenditure which was deductible for income-tax purposes is towards a liability actually existing at the time but setting apart money which might become Expenditure on the happening of an event is not expenditure ....A distinction is often made between an actual liability in praesenti and a liability de futuro, which for the time being is only contingent. The former is deductible but not the latter."
We will now consider the nature of liability for payment of wages for unutilised leave by applying the said principles. Under the scheme relating to annual leave, an employee who works for the required number of days during a calendar year, does not become entitled to any monetary benefit on account of leave earned during that year. He becomes entitled to leave with wages calculated at the rate of one day for every 20 days of work performed by him during the previous calendar year. That is, an employee who worked for a period of 240 days during January 1, 1975, to December 31, 1975, became entitled to avail of 12 days of leave with wages during the calendar year 1976, that is, between January 1, 1976, and December 31, 1976. The employee does not become entitled to leave earned in a calendar year, during that calendar year. Therefore, the entitlement relating to leave with wages cannot be equated to entitlement to a money payment. What is earned as "leave" during an accounting year cannot, therefore, be treated as "money earned" during that year, to be paid later.
Having regard to section 79, the period of such leave, if availed of by an employee during the year 1976, shall be deemed to be days on which the employee had worked in the factory during 1976, and he becomes entitled to wages for the said period of leave at the rates applicable during the month immediately preceding the leave and not at the rate that was prevailing in the year 1975 when he earned the said leave. An employee had the option to either avail during the year 1976 of the leave earned in 1975, or accumulate the same in which event, the unused leave gets added to the leave to be allowed in the succeeding accounting year provided, the total number of days of leave that may be carried forward to a succeeding year cannot, however, exceed 30 days (subject to the further proviso that a person who applied for leave with wage but has not been given such leave, shall be entitled to carry forward such leave without any limit). Thus, the leave earned during a year may be availed of during the succeeding year or carried over to the next year. When it is not availed of during the succeeding year, it can be carried over only if he has not already accumulated the maximum number of carried over leave. If he has already accumulated the maximum days of unutilised leave and if the leave earned during a year is not utilised during the next year, it will lapse. Thus, so far as accumulated leave is concerned, what can be encashed at the end, on termination, can never be more than 30 days (unless the leave applied for has been refused).
Therefore, the only thing certain about the whole matter is earning of leave in regard to each year of service. But, thereafter, any of the following three things may happen: (a) it may be utilised during the next year in which event he gets paid for it during that year; or (b) it may get accumulated in which event, wages therefor .become payable as encashment of utilised leave at the time of termination of service; or (c) it may lapse on account of non-utilisation during the next year and maximum accumulation having already been reached in regard to unutilised leave.
Allowing the leave to lapse is not uncommon. In respect of the period of leave availed of, a person is not entitled to bonus; nor will he be able to earn overtime during that period. Hence, several employees may choose not to avail of the leave and allow it to lapse, to enable them to earn overtime or to have the maximum bonus permissible. Thus, what happens to the leave is wholly uncertain. If the employer sets apart 12 days wages at 1975 rates out of the profits for the year 1975, there is more than a reasonable possibility of the said amount not being used at all, for payment to the employee.
There is no way of ascertaining beforehand whether the employee will utilise the leave during the year next to the year in which it is earned or whether he will accumulate it or allow it to lapse. Therefore, there is no reasonable certainty that the provision made for unutilised leave, will be used at all. This may be demonstrated by an illustration. Take an example of an employee who normally works for 240 days in a year. He becomes entitled to 12 days of leave every year. If the assessee's contention should be accepted, then, in the case of an employee who has been in service for 25 years, the assessee will make a provision for payment of salary for 12 days every year, in all a provision for 300 days. If the employee does not utilise any leave, and allows the leave to lapse what could actually be paid as retirement benefit on account of accumulated leave encashment is salary for only 30 days. It would, thus, be seen that if the provision is to be permitted as an expenditure every year, there is every likelihood that as against a provision made for 300 days, which may be claimed as expenditure during a period of 25 years, the employer may ultimately be paying for only 30 days and the remaining amount equivalent to the salary for 270 days reverts back o the employer. On the other hand, if the employee uses the leave earned in a year, during the next year, he gets paid for the leave period during the next year and there is no possibility of using the provision made for the unutilised leave at all. Let us take another example. If an employee has already accumulated the maximum leave as at the end of December 31, 1974, the leave earned during the period January 1, 1975, to December 31, 1975, will, unless used during the calendar year 1976, lapse; and the provision if any made will never be utilised. Thus, setting apart the wages for the leave earned by every employee during a year, by way of a provision will be, to a large extent, to meet a liability, which is either contingent or non-existent (on account of lapse of leave). Therefore, when a provision is made and a part of the profits is set apart by the employer to meet the salaries and wages payable for unutilised leave, there is a very real possibility of the amount not being used-at all and remaining in the coffers of the assessee-company.
A provision for unutilised leave is not a provision for payment of an amount which has become due and payment of which has got postponed depending on a contingency. If the amount has become due, but payment is to be made on the happening of an event, then, it is a case of the amount being irrevocably set apart and there is no chance of the fund coming back to the assessee-company. In such an event, the payment is certain, but it is postponed to be made on the happening of a certain event. But where the amount is set apart to meet a liability which may or may not arise at all, it is a contingent liability and no provision can be made towards such liability.
Learned counsel for the assessee lastly contended that making a provision for payment of leave salary is recognised as an accounting practice and recognised and accepted accounting practices entitled the assessee to claim deductions for purposes of taxation and, therefore, a deduction should be admitted in regard to the provision for salary/wages for utilised leave. He relied on Accounting Standard No. 15 of the Institute of Chartered Accountants of India and Accounting Standards of Financial Accounting Standard Board of USA (1994). At the outset it has to be noticed, that merely because a provision can be made in accounts, that does not necessarily mean that the provision so made becomes a permitted expenditure for the purpose of taxation. As observed by the Supreme Court in Indian Molasses' case (1959) 37 ITR 66, in finding out what is the profit, the normal accountancy practice may allow as expense any sum in respect of liabilities which have accrued over the accounting period and to deduct such sum from profits; but the income-tax laws do not take every such allowance as legitimate deduction for the purpose of tax. That apart, the contention that the said Accounting Standards recognise such provision is not correct. Accounting Standard No. 15 relied on by the assessee relates to accounting for retirement benefits in the financial statements of employers. It is no doubt true that leave encashment on' retirement, is considered as a retirement benefit. Paragraph 12 of the Accounting Standard No. 15 provides that the cost of retirement benefits to an employer, results from receiving services from the employees who are entitled to receive such benefits; and, consequently, the cost of retirement benefits is accounted for in the period during which such services are rendered. The American Accounting Standard (section C-44) relating to "Compensation to employees: paid absences" relied on by the petitioner (?) provides that a liability shall be accrued for vacation benefits that employees have earned but have not yet taken. But, that would be only if the leave earned during each year of service, is accumulated without any lapsing and wages therefor' become payable on retirement. Where the accumulation permissible is limited and the earned and unutilised leave, in excess of the permissible limit lapses, obviously, the said accounting practice cannot be applied. In fact this is made clear in the American Accounting Standard (section C-44) relied on by the petitioner, which recognises the difference between cases where the accrued rights expire or lapse after a period specified, and cases where accrued rights are carried forward and accumulated without expiry. The relevant portions from the said Accounting Standard is extracted below:
"An employer shall accrue a liability for employees' compensation for future absences if all of the following conditions are met:
(a) The employer's obligation relating to employees' rights to receive compensation for future absences is attributable to employees' services already rendered;
(b) The obligation relates to rights that eventually vest or accumulate. (c) Payment of the compensation is probable.
(c)The amount can be reasonably estimated ....
If the rights expire a liability for future absences should not be accrued at year end, because the benefits to be paid in subsequent years would not be attributable to the employee's service rendered in prior year. " (emphasis supplied).
Hence, a provision for salaries and wages for unutilised leave cannot be deducted as an expenditure against the profits for the year when the leave was earned.
In the result, we answer the references as follows:
(i) Questions Nbs.1, 4, 5, 6 and 7 are answered in the affirmative, against the Revenue and in favour of the assessee; (The answer to question No. 7 is subject to the clarification in paragraph 9 (at page 146) above.
(ii) Questions Nos.2. 3. 8 and 9 are answered in the negative, against the assessee and in favour of the Revenue; and in regard to questions Nos.8 and 9. the Tribunal is directed to re-examine the matter as directed in paragraph 10.4 (page 147) above.
(iii) Questions Nos. 10 and 11 are answered in the affirmative, against the assessee and in favour of the Revenue;
(iv) Question No. 12 is answered in the negative, against the Revenue and in favour of the assessee.
M.B.A./3052/FC Order accordingly.