Section 40A(7)

Business disallowance - gratuity

Scope of provision

Prescribed conditions must be satisfied - For gratuity to be deductible, it must fulfil the conditions laid down in section 40A(7), and the deduction could not be allowed on general princi­ples under any other section of the Act, in view of the overrid­ing effect given to that provision. The submission that if no provision was made by the assessee for gratuity still the same will be deductible and section 40A(7) will have no application would defeat the very purpose and object of that provision - Shree Sajjan Mills Ltd. v. CIT [1985] 156 ITR 585 (SC).

Actual payments are not covered - Section 40A(7)(a) prohibits the deduction of any provision made for payment in future to an employee of gratuity, unless it satisfies the requirements of section 40A(7)(b). This provision does not deal with any actual payment of gratuity amount during the relevant previous year - CIT v. Colgate Palmolive (India) (P.) Ltd. [1994] 74 Taxman 68 (Bom.).

Even after the introduction of the provisions of section 40A(7), there is no change in the legal position so far as the actual payment of gratuity is concerned. Hence, the actual pay­ment made towards gratuity liability is allowable in the year in which it is paid - Triplicane Permanent Fund Ltd. v. CIT [1989] 179 ITR 492 (Mad.).

‘Payable’ covers both contributions to fund and actual payments - Expression ‘that has become payable during the previous year’ in section 40A(7)(b)(i) qualifies both the parts of the said clause (b)(i), viz., (A), ‘any provision made by the assessee for the purpose of payment of any contribution towards an approved gratu­ity fund’, and (B) ‘any provision made by the assessee for the purpose of payment of any gratuity’ and not only the latter part, viz., ‘any provision made by the assessee for the purpose of payment of any gratuity’ - CIT v. Loyal Textile Ltd. [1997] 95 Taxman 293 (Mad.).

Gratuity fund

Existence of approved fund is a must - An assessee’s claim for gratuity liability cannot be allowed when the assessee did not have an approved gratuity fund. - CIT v. Petroleum & Miner­als (P.) Ltd. 1989 Tax LR 703 (Bom.)/CIT v. Perfect Pottery Co. Ltd. [1989] 175 ITR 562 (MP).

Where there was no approved gratuity fund during the relevant period, nor was any liability created during the previous year so as to make a provi­sion for payment of gratuity, no deduction would be admissible - Bitoni Lamps Ltd. v. CIT [1989] 178 ITR 421 (Punj. & Har.).

u What is contemplated by section 40A(7)(b)(i) is definite or clear provision by the assessee for the purpose of payment of a sum by way of contribution towards an approved gratuity fund; it is not sufficient if a mere ‘reserve’ or mere ‘provision’ without anything more is made - CIT v. Chackolas Spg. & Wvg. Mills Ltd. [1989] 178 ITR 603 (Ker.).

Year of deductibility

Existing liability on date of introduction of gratuity scheme is deductible in that very year - When a gratuity scheme is introduced for the first time the gratuity payable to the existing employees who have already ren­dered some years of service and are still in service shall have to be considered to make a provision, because the gratuity pay­able depends on the entire length of service of an employee. Where the provision made for payment of gratuity in future is a liability but its current value can be fairly estimated, it can be deducted as a business expenditure. Where the liability was first recognised and sought to be enforced when the gratuity scheme was first introduced, the existing liability as valued on the said date shall necessarily have to be considered a deducti­ble expenditure out of the profits of the said year, because the provision was during that year for the first time and legal liability also arose during the said year - CIT v. Kelvinator of India Ltd. [1994] 76 Taxman 309 (Delhi).

Application of outer limit

Limit applies to each employee and for each year or service -The outer limit of 81/3 per cent laid down in Explanation 1 to section 40A(7)(b), is for each employee and is in respect of each year of his service for which provision is made by the assessee after satisfying other conditions laid down in that provision. - CIT v. Shri Arbuda Mills Ltd. [1994] 122 CTR (Guj.) 4. Also see CIT v. Petlad Turkey Red Dye Works Co. Ltd. [1994] 121 CTR (Guj.) 251; CIT v. Nanikram Sobhraj Mills (P.) Ltd. [1994] 209 ITR 283 (Guj.).