Case: Commissioner Of Income-Tax, Kerala Vs. Gemini Cashew Sales Corporation, Quilon

the true costs of trading in the particular year into account for that year and thus promotes the ascertainment of the annual profits or gains arising or accruing from the trade." Lord MacDermott was of the view that the provision made by the Company led to anomalies, and was not admissible as made, and the case should be remitted to the Special Commissioner whether it is practicable to arrive at satisfactory deductions. Lord Radcliffe with whom the Lord Chancellor and Lord Tucker agreed was of the view that there is no rule of law which forbids the introduction of a provision for future payments in or payments out, if the right to receive them or the liability to make them is in legal terms contingent at the closing of the relevant year. 10. The question which arises in the present case is not about the admissibility of a provision made by a trader by the adoption of a reasonably satisfactory method estimating the present value of an obligation which may arise in future to pay a sum of money to his employees. The question that falls to be determined is whether the liability which arises on transfer of the business is to be regarded as a permissible outgoing in the account of the business which is transferred. Broadly stated, the present value on commercial valuation of money to become due in future, under a definite obligation will be a permissible outgoing or deduction in computing the taxable profits of a trader, even if in certain conditions the obligation may cease to exist because of forfeiture of the right. Where, however, the obligation of the trader is purely contingent, no question of estimating its present value may arise, for to be a permissible outgoing or allowance, there must in the year of account be a present obligation capable of commercial valuation. 11. As already observed, the liability to pay retrenchment compensation arose for the first time after the closure of the business and not before. It arose not in the carrying on of the business, but on account of the transfer of the business. During the entire period that the business, was continuing, there was on liability to pay retrenchment compensation. The liability which arose on transfer of the business was not of a revenue nature. Profits of a business involve comparison between the state of the business at two specific dates. Normally the liability which occurs after the last date, unless its source is in a pre-existing definite obligation, cannot be regarded as a part of the outgoing of the business debitable in the profit and loss account. A deduction which is proper and necessary for ascertaining the balance of profits and gains of the business is undoubtedly properly allowable, but where a liability to make a payment arises not in the course of the business, not for the purpose of carrying on the business, but springs from the transfer of the business, it is not, in our judgment, a properly debitable item in its profit and loss account as a revenue outgoing. The claim of the firm to treat it as an item in the determination of the profits of the firm under S. 10 (1) of the Income-tax Act cannot, therefore be sustained. 12. Under S. 10 (2) (xv) of the Indian Income-tax Act in the computation of taxable profits (omitting parts of the clause not material) "any expenditure laid out or expended wholly and exclusively for the purpose of such business, profession or vocation", i. e. business, profession or vocation carried on by the assessee, is a permissible allowance. But to be a permissible allowance the expenditure must be for the purpose of carrying on the business. Where accounts are maintained on the mercantile system, if liability to make the payment has arisen during the time the business is carried on, it may appropriately be regarded as expenditure. But where the liability is, during the whole of the period that the business is carried on, wholly contingent and does not raise any definite obligation during the time that the business is carried on, it cannot fall within the expression "expenditure laid out or expended wholly and exclusively" for the purpose of the business. 13. Two cases illustrative of the principle may be noticed. It was held by the Madras High Court in Commissioner of Income-tax, Madras v. Indian Metal and Metallurgical Corporation (1964) 51 ITR 240 (Mad) that a provision made in the annual accounts maintained by an employer setting apart by way of a reserve to meet the liability, if any, to which the employer may become subject in the event of retrenching workmen because of the necessity of retrenchment of the services of the staff, was not a liability in praesenti in the year of account, but was only a contingent liability which may arise on the happening of a particular contingency and was not allowable as a deduction in assessment of tax. This Court in dealing with a case under the Wealth Tax Act in Standard Mills Company Ltd. v. Commissioner of Wealth-tax Bombay, 1967-63 ITR 470 : (AIR 1967 SC 595 ) held that a liability under the award of the Industrial Court to pay gratuity to its employees at certain rates on death while in service, or on voluntary retirement or resignation after fifteen years continuous service, or on termination of service after certain specified periods, but not if the employee was dismissed for dishonesty for dishonesty or misconduct, was a mere contingent liability which arose only when the employment of employee was determined by death, incapacity, retirement or resignation : the liability did not exist in praesenti. 14. The amount of Rs. 1,41,506 claimed as a permissible allowance by the assessee in the profit and loss account cannot, in our judgment be regarded as properly admissible either under S. 10 (1) or S. 10 (2) (xv) of the Income-tax Act. The answer to the question must, therefore, be in the negative.

Decision (1 = appeal accepted, 0 = rejected): 1

Explanation:
1[ds]That case can have no application to the present case6. In the view we take, that the allowance claimed is not a proper outgoing or allowance in computing the profits of the assessee, we do not express any opinion on the question whether the workmen of the undertaking became entitled to retrenchment compensation on the transfer of the undertaking to WalterThe obligation to pay compensation becomes definite only when there is retrenchment by the employer, or when the ownership or management of the undertaking is, except in the cases contemplated by the proviso transferred to a new employer, and not till then. The right therefore arises from determination of employment, or from transfer of the undertaking it has no existence before these events take place, thepresent value on commercial valuation of money to become due in future, under a definite obligation will be a permissible outgoing or deduction in computing the taxable profits of a trader, even if in certain conditions the obligation may cease to exist because of forfeiture of the right. Where,, theobligation of the trader is purely contingent, no question of estimating its present value may arise, for to be a permissible outgoing ore must in the year of account be a present obligation capable of commercial valuation11. As already, theliability to pay retrenchment compensation arose for the first time after the closure of the business and not before. It arose not in the carrying on of the business, but on account of the transfer of the business. During the entire period that the business, wasthere wason liability to pay retrenchment compensation. The liability which arose on transfer of the business was not of a revenue nature. Profits of a business involve comparison between the state of the business at two specific dates. Normally the liability which occurs after the last date, unless its source is in a pre-existing definite obligation, cannot be regarded as a part of the outgoing of the business debitable in the profit and loss account. A deduction which is proper and necessary for ascertaining the balance of profits and gains of the business is undoubtedly properly allowable, but where a liability to make a payment arises not in the course of the business, not for the purpose of carrying on the business, but springs from the transfer of the business, it is not, in our judgment, a properly debitable item in its profit and loss account as a revenue outgoing. The claim ofthe firmto treat it as an item in the determination of the profits ofthe firmunder S. 10 (1) of the Income-tax Actcannot,thereforebe sustained12. Under S. 10 (2) (xv) of the Indian Income-tax Act in the computation of taxable profits (omitting parts of the clause not material) "any expenditure laid out or expended wholly and exclusively for the purpose of such business, profession or vocation", i. e. business, profession or vocation carried on by the assessee, is a permissible allowance. But to be a permissible allowance the expenditure must be for the purpose of carrying on the business. Where accounts are maintained on the mercantilesystem,if liability to make the payment has arisen during the time the business is carried on, it may appropriately be regarded as expenditure. But where the liability is, during the whole of the period that the business is carried on, wholly contingent and does not raise any definite obligation during the time that the business is carried on, it cannot fall within the expression "expenditure laid out or expended wholly and exclusively" for the purpose of the business14. The amount of Rs. 1,41,506 claimed as a permissible allowance by the assessee in the profit and loss accountcannot,in our judgment be regarded as properly admissible either under S. 10 (1) or S. 10 (2) (xv) of the Income-tax Act. The answer to the question, be in the negative.