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

1. Two persons-Walter and Ramasubramony - carried on business in cashewnuts as partners in the name and style of Messrs. Gemini Cashew Sales Corporation. The partnership was dissolved on the death of Ramasubramony on August 24, 1957, and the business was taken over and continued by Walter on his own account. The services of the employees were not interrupted and there was no alteration in the terms of employment of the employees of the establishment2. In proceedings for assessment of tax it was urged on behalf of the firm that an amount of Rs. 1,41,506/- taken into account under the head "Gratuity payable to workers of the business" in settling the accounts of the firm till August 24, 1957, was a permissible outgoing. The Income-tax Officer rejected the claim and the Appellate Assistant Commissioner confirmed that order. The Income-tax Appellate Tribunal held that by the transfer of the undertaking to Walter, there was no interruption in the employment of the workmen of the establishment, that the terms and conditions of service applicable to the workmen were not altered to their detriment, that Walter had not expressly agreed to take over the liability for compensation payable under S. 25-FF ofthe Industrial Disputes Act, 1947, and since there was dissolution of the partnership on August 24, 1957 and the undertaking was transferred, the workmen became entitled to retrenchment compensation, which the firm was liable to pay. The Tribunal accordingly held that the firm was entitled to deduct the sum of Rs. 1,41,506/- in the computation of income in the assessment year 1958-593. In recording their opinion on the following question submitted by the Tribunal:"Whether the allowance of Rs. 1,41,506/- constitutes an allowable expenditure in the assessment of the firm for the year 1958-59",the High Court of Kerala observed that in the determination of the taxable profits of the firm till its dissolution considerations about the liability to pay retrenchment compensation devolving upon Walter as the assignee of the business for valuable consideration were irrelevant, and since it was maintaining accounts on mercantile system, the firm could claim as a permissible outgoing the amount for which liability was incurred though no actual payment was made to the workmen. The Commissioner of Income-tax appeals with special leave, against the order of the High Court recording an answer in the affirmative.

Reasoning: 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.