Gordon Woodroffee Leather... vs The Commissioner Of Income-Tax, Madras

Rewritten Version Notice: This is a rewritten version of the original judgment.

Court: Supreme Court of India

Case Number: Civil Appeal No. 62 of 1961

Decision Date: 20 December, 1961

Coram: J.L. Kapur, Bhuvneshwar P. Sinha, M. Hidayatullah, J.C. Shah, J.R. Mudholkar

In this matter, the appellant was Gordon Woodroffee Leather Manufacturing Co., and the respondent was the Commissioner of Income‑Tax for Madras. The case was decided by the Supreme Court of India on 20 December 1961, and the judgment was authored by Justice J.L. Kapur, who sat with Justices Bhuvneshwar P. Sinha, M. Hidayatullah, J.C. Shah and J.R. Mudholkar. The citation of the decision is reported in 1962 AIR 1361 and in the Supreme Court Reporter Supplement (2) 211, and it is also referenced in the citation index as R 1979 SC 1441 (15, 20). The dispute concerned the applicability of section 10(2)(xv) of the Income‑Tax Act, 1922 (Act 11 of 1922) to a gratuity that the appellant company had paid voluntarily to a former director in recognition of his long and valuable service, a payment that was not made under any established pension or gratuity scheme. The headnote recorded that the company, after accepting the director’s resignation, paid him a sum of Rs 40,000 as gratuity. The company sought to deduct this amount under the cited provision, but the deduction was disallowed by the Income‑Tax Officer on the basis that the company lacked a pension scheme, the payment was voluntary, and the entry in the company’s books classified it as a capital payment. The Supreme Court held that the payment did not fall within the scope of section 10(2)(xv). It observed that the gratuity was not made pursuant to any scheme, nor was it an amount the employee could reasonably expect as a consequence of his long and faithful service; rather, it was a voluntary acknowledgment of such service, unrelated to any commercial expediency or the facilitation of the appellant’s business. The Court noted that the company had no practice of making similar payments, and the gratuity did not affect the employee’s salary. To qualify for a deduction under the provision, the Court explained, the proper test is whether the payment was made as a matter of established practice affecting salary, whether the employee had a legitimate expectation of receiving a gratuity, or whether the outlay was incurred on commercial grounds to indirectly aid the business. The Court referred to the authorities J.P. Hancok v. General Revenue & Investment Co. Ltd. (1918) 7 T.C. 358 and J.W. Smith v. The Incorporated Council of Law Reporting for England and Wales (1914) 6 T.C. 477 in support of its analysis.

The appeal proceeded under the civil appellate jurisdiction as Civil Appeal No. 62 of 1961, having been taken by special leave from the judgment and order dated 20 December 1956 of the Madras High Court in Case Referred No. 85 of 1953. Counsel for the appellant were A. V. Viswanatha Sastri, R. Ganapathy Iyer and G. Gopalakrishnan; counsel for the respondent were K. N. Rajagopala Sastri and P. D. Menon. The judgment was delivered by Justice Kapur, who began by stating that the appeal was filed by special leave and set out the factual background concerning the gratuity payment made to a retiring director. The Court then examined the statutory provision and the nature of the payment, applying the test derived from prior case law to determine whether the deduction was permissible. After a detailed assessment of the facts and the relevant legal principles, the Court concluded that the gratuity did not satisfy the conditions required under section 10(2)(xv) of the Income‑Tax Act, and therefore the claim for deduction was rightly disallowed.

In this appeal the petitioner, who is the assessee, challenged the judgment and order of the High Court of Judicature at Madras. The respondent was the Commissioner of Income‑tax. The question framed before the Court was whether the gratuity paid by the petitioner to one of its officers on his retirement could be allowed as a deduction under section 10(2)(xv) of the Indian Income‑tax Act. The matter concerned the assessment year 1950‑51. The petitioner, M/s Gordon Woodroffee & Co. (Madras) Ltd., was incorporated as a private limited company in 1922 and acted as the Managing Agent of the public limited company M/s Gordon Woodroffee Leather Manufacturing Company Ltd., which was the assessee for tax purposes. J. H. Philips had been employed by the Managing Agent Company from 1922 until 1935, after which he became an employee of the petitioner and was appointed a Director of the petitioner in 1940. On 22 March 1949 he wrote to the petitioner stating his intention to resign from the Board of Directors effective 4 April 1949 upon his retirement and asked that his resignation be accepted. On 24 March 1949 the Board of Directors passed a resolution accepting his resignation and, in appreciation of his long and valuable services, resolved to pay him a gratuity of Rs 50,000, of which the petitioner would pay Rs 40,000 and the Managing Agent Company would pay the balance of Rs 10,000. On 4 April 1949 the Board’s resolution was confirmed, and on the same day an extraordinary general meeting adopted an identical resolution. Before the close of the accounting year on 31 October 1949 the petitioner paid Rs 40,000 to Mr Philips. The petitioner claimed this amount as a deduction under section 10(2)(xv) of the Income‑tax Act, which provides that “any expenditure (not being an allowance of the nature described in any of the clauses (i) to (xiv) inclusive, and not being in the nature of capital expenditure or personal expenses of the assessee) laid out or expended wholly and exclusively for the purpose of such business, profession or vocation” may be deducted. The Income‑tax Officer disallowed the deduction, and the Appellate Assistant Commissioner affirmed the disallowance on the basis that the petitioner had no pension scheme, the payment was voluntary, and the entry in the books was shown as a capital payment. The petitioner appealed to the Income‑tax Appellate Tribunal, which upheld the order of the Appellate Assistant Commissioner. The Tribunal observed that the resolution indicated the gratuity was paid “for long and valuable services to the Company”; that there was no evidence that Mr Philips had accepted a lower salary in expectation of receiving a gratuity at the

In the Tribunal’s findings, it was observed that Mr. J. H. Philips received the payment at the end of his service, that the appellant Company had no established practice of making such payments, and that during his employment he was paid on a graduated salary scale together with a commission of two and a half percent on the profits. The Tribunal noted that there was no expectation that Mr. Philips would receive a reimbursement at the termination of his employment, and that the company had already rewarded him for faithful and efficient service by granting a profit commission intended to encourage his enthusiasm. The Tribunal also pointed out that the company’s books showed the amount was not recorded in the profit and loss account but was entered in the appropriation account, suggesting that the payment was treated as an extra disbursement or as a capital expense. Considering all these circumstances, the Tribunal concluded that it was difficult to regard the expenditure as anything other than a capital expenditure or to hold that it had been laid out wholly and exclusively for the purpose of the assessee’s business.

The appellant Company appealed the Tribunal’s decision to the High Court under section 66(1) of the Income‑tax Act, raising the question whether the sum of Rs 40,000 paid to Mr. J. H. Philips upon his retirement was admissible as a deduction under section 10(2)(xv) of the Income‑tax Act, 1922. The High Court answered the question against the appellant. It held that for the provision of section 10(2)(xv) to apply, the assessee must demonstrate that the amount was laid out or expended wholly and exclusively for the purposes of the company’s business. In the present case, the Court observed that the payment was made on retirement in recognition of valuable services rendered, that there was no evidence that Mr. Philips had an expectancy of receiving the sum, nor that the company had contemplated its payment beforehand. The payment was described as voluntary, and there was no proof that the expenditure was incurred in the future interest of the company’s business. The High Court therefore stated:

“In the case of a payment of a gratuity to a retiring employee as recognition of his past services, and nothing more, cannot, in our opinion, satisfy the requirements of section 10(2)(xv), even if those requirements are judged from the viewpoint of commercial expediency, as it always should be when a claim arises under section 10(2)(xv). Was the expenditure incurred in the future interest of the business of the assessee? Was there any connection between the purpose of the payment and the further conduct of the business of the assessee? These are the tests to be satisfied before it could be said that in paying the gratuity money was laid out or expended wholly and exclusively for the purpose of the business of the Company. These tests the assessee did not satisfy in this case.”

Against this judgment and order, the appellant Company has brought the present appeal by special leave.

The appellant Company instituted the present appeal by way of special leave. Counsel for the appellant contended that the sum in dispute had been disbursed as a matter of commercial expediency and in the interest of the Company, serving as an inducement to other employees that faithful, efficient and honest service would likewise be rewarded. It was submitted that the decisive test was whether such gratuity payments were likely to be made in the future and whether the payment functioned as an incentive for employees to give their best to the employer; if that were so, the payment would be characterized as a matter of commercial prudence. Further, the appellant argued that the Company acted without any oblique motive, that its good‑faith intention was not in doubt, and that several judicial decisions were relied upon in support of this contention.

The Court, after examining the findings, held that the payment did not fall within the ambit of section 10(2)(xv). It observed that the amount was not paid pursuant to any established scheme of gratuity, nor was it an amount which the recipient could have reasonably expected as a result of long and faithful service. Rather, the payment was voluntary, made without the object of facilitating the carrying on of the appellant’s business or of serving a commercial purpose, and was given solely in recognition of the long and faithful service of Mr J H Philips. The Court noted that there was no established practice in the appellant Company of making such payments, and that the sum did not affect the quantum of the employee’s salary. The two cases heavily relied upon by the appellant were J P Hancok v. General Reversionary & Investment Company Ltd.¹ and J W Smith v. The Incorporated Council of Law Reporting for England and Wales². In the former case, the assessee Company sought to treat a lump‑sum payment made for the purchase of an annuity for a former actuary as a trade expense; the court allowed the deduction because it was the Company’s established practice to grant pensions after a considerable period of service, a practice known to employees and which influenced the rate of salary they were willing to accept. In the latter case, the existence of a regular practice of granting gratuities justified allowing the deduction. The Court concluded that the proper test to apply was whether the payment was made as part of a regular practice that affected salary levels or created an expectation of gratuity on the part of the employee, and found that neither condition was satisfied in the present case.

In the matters before the Court, the appellant asserted that a certain sum of money had been incurred on the basis of commercial expediency and that, by reason of that expenditure, the appellant’s business would be indirectly facilitated. The claim rested on the contention that the outlay satisfied the requirement of section 10(2)(xv), which permits a deduction for amounts spent for the purpose of commercial expediency and for the indirect promotion of business operations. The Court examined whether the appellant had established the necessary factual foundation to demonstrate that the expenditure was indeed made for the asserted purpose. The record showed that the appellant offered no evidence, no documentary proof, and no testimony that would substantiate the allegation that the expenditure was undertaken with the intended commercial objective. Because the burden of proving that the payment was made on the ground of commercial expediency and that it indirectly facilitated the carrying on of the business rested upon the appellant, the failure to produce such proof meant that the condition laid down in section 10(2)(xv) was not satisfied. Consequently, the Court concluded that the amount claimed could not be treated as a deductible expense under the statutory provision. On that basis, the Court held that the appeal was bound to fail. The judgment therefore dismissed the appeal and directed that the costs of the proceeding be awarded against the appellant. The order expressly stated that the appeal was dismissed.