Relevant provisions and links:
Section 28, 36(1)(v) of the Income-tax Act, 1961.
Part XIV (Rules 98-111) of Income Tax Rules, 1962 governing Approved Gratuity Fund.
Gratuity Funds- simplification is required:
We find lot of complications and procedural delays in setting up and approval of gratuity funds. This can be simplified and any payment made for funding gratuity liability made to insurers like the Life Insurance Corporation of Indian can be allowed.
At present a Gratuity Fund Trust Deed is to be executed which needs approval of Gratuity fund investment agency like LICI, and the Commissioner of Income Tax. As a rule of thumb and just to show some work having been done, the LICI as well as CIT asks to makes some amendments in the Trust Deed. This causes delay in approval of gratuity fund.
Instead of this process standard terms and conditions for Trust deed of gratuity Fund can be provided and if the payment is made to approved insurer or other similar agencies, the payment can be allowed to avoid un-necessary work on part of assessee, insurer, and the CIT.
Gratuity funds- unnecessary complications.
We find provision for contribution to a recognized gratuity fund. The funds are governed by Rules 98 and 111 of the Income-tax Rules, 1962. The deduction for contribution made to gratuity fund is allowed u/s 36(1)(v). The relevant provision read as follows:
36. (1) The deductions provided for in the following clauses shall be allowed in respect of the matters dealt with therein, in computing the income referred to in section 28 –
(v) any sum paid by the assessee as an employer by way of contribution towards an approved gratuity fund created by him for the exclusive benefit of his employees under an irrevocable trust;
To avail this deduction the employer has to create an employees gratuity fund, that need to be approved by the Commissioner of income-tax. The process of creation of trust, and its approval is quite lengthy and cumbersome. Even if a trust is created as per standard form of trust deed (as suggested by group policy issuer like LICI), the CIT will suggest some changes before he approves the gratuity fund- this is just a normal practice. Some times it takes years together before the CIT approves the trust. Now a days most popular form of investment is through group policies taken from insurers like LICI and other approved insurance companies.
As per the provision the employer has to pay the amount to gratuity fund, from where the trustees can make investment in approved investment manner. The approved investment manner includes contribution to group gratuity schemes of insurers like LICI.
The gratuity fund get all funds from employer. It is therefore, in one sense an arm of the employer, it is regulated as per the provisions of the Act and Rules. Though the fund is separate however, for funds it is dependent of employer who creates the trust. The purpose of separate fund is to keep the funds for payment of gratuity separately and where employer has no direct control. However, if the employer does not make contribution, the trustees of gratuity fund will have no further funds except income or realization of old investments.
Payment on behalf of other person a common practice:
It is normal commercial practice that one person can make payment to another person for and on behalf of third persons. For example A, pays to B on behalf of C. A debits account of C ( and not B -payee). C debits account of B and credit a/c of A. B. will credit a/c of C. In this case A has made payment to C by paying to B on behalf of C. C has received payment from A through B.
The case before the Supreme Court:
The assessee Textool Ltd. An employer paid directly to the Life Insurance Corporation of India on behalf of its employees gratuity fund. The A.O. disallowed the said sum as the employer did not paid money to the employees gratuity fund but to LICI. As per AO the employer should have first paid to employees gratuity fund, and then the trustees could have paid to LICI. A direct payment to LICI , did not meet conditions of s. 36 so he disallowed the amount. It appears that the learned A.O. perhaps deliberately ignored the fact that the payment was made to LICI, for and on account of gratuity fund, the a/c of gratuity fund was debited, the LICI also received payment on behalf of gratuity fund.
The CIT(A) allowed the deduction, on appeal by revenue the order of CIT(A) got confirmed by ITAT, on further appeal by revenue the order of Tribunal was confirmed by the High Court. Still not satisfied the revenue appealed against the judgment of the High Court before the Supreme Court, the Supreme Court also confirmed orders of authorities below.
This shows that how revenue is indulging into unnecessary litigation.
An analysis of the matter before SC:
Appeal was by revenue by way of special leave petition against the judgment, dated 4th February, 2002, rendered by Madras High Court. High court has answered the question of law, referred to it by the Income Tax Appellate Tribunal, Madras Bench under Section 256(1) of the Income Tax Act, 1961, at the instance of the Revenue.
The question of law, so referred, was as follows:
“…Whether on the facts and in the circumstances of the case, the Appellate Tribunal is right in allowing the deduction of Rs. 55,84,754/- being the payment made by the assessee company directly to Life Insurance Corporation towards Group Gratuity Fund under Section 36 (1)(v) of the Income Tax Act, 1961?”
The assessee claimed a deduction of Rs. 92,06,978/- as contribution/provision towards the approved gratuity fund. For the assessment year, 1983-84, for which the relevant previous year ended on 30th April, 1982,
An amount of Rs. 5,84,754/- was paid as annual premium to the Life Insurance Corporation(“LIC” for short);
a sum of Rs. 50,00,000/- was paid to the LIC as initial contribution in the group Life Assurance Scheme framed by the LIC for the benefit of the employees of the assessee.
Balance amount of Rs. 36,22,224/- was shown as provision for initial contribution.
It is common ground that assessee company’s gratuity fund, viz., the Textool Company Ltd. Employees Group Gratuity Fund was approved by the Commissioner of Income Tax, coimbatore, w.e.f. 25th February, 1983.
The Assessing Officer allowed a deduction of Rs. 36,22,224/- under Section 40A(7) of the Act. (the amount of provision was allowed by AO)
Balance amounts which were actually paid by employer were disallowed on the ground that payment towards the gratuity fund was made by the assessee directly to the LIC and not to an approved gratuity fund and, therefore, it was not allowable under Section 36(1)(v) of the Act.
In first appeal of assessee the Commissioner (Appeal) observed that the initial payment of Rs. 50,00,000/- and the annual premium of Rs. 5,57,943/- was made by the assessee directly to the LIC instead of as a contribution towards the approved gratuity fund; the LIC had accepted the said payment on behalf of the Group Life Assurance Scheme for the exclusive benefit of the employees of the assessee under the policy issued by it. Upon perusal of the original Master policy issued by the LIC, the Commissioner recorded his satisfaction that the initial contribution as well as annual premium had been credited by the LIC to the Group Life Assurance Scheme on behalf of the Textool Company Ltd. Employees Group Gratuity Fund only, meaning thereby that the insurance policy had been taken in the name of the approved gratuity fund only; this fund was shown as the payee in the policy.
Vide its letter dated 20th November, 1985, addressed to the I.A.C., the assessee had confirmed that in the subsequent assessment years, they had contributed funds to the Employees Group Gratuity Fund and the trustees in turn had made payment to the LIC in respect of the Textool Co. Ltd.; Employees Group Gratuity Assurance Scheme under the said policy and it was only the initial payment and first annual premium had been made directly to the LIC against the said policy.
The Commissioner (Appeal) being convinced that by making payment of the amounts in question directly to the LIC, the assessee had not violated any of the conditions stipulated in Section 36(1)(v) of the Act. Accordingly, the Commissioner (Appeals) came to the conclusion that since, on the facts of the case, the objective of the fund was achieved, a narrow interpretation of the provision would be straining the language of Section 36(1)(v) of the Act so as to deny the deduction claimed by the assessee.
Consequently, the Commissioner (Appeal) allowed the said amount of Rs. 58,84,754/- as deduction for the relevant assessment year.
The Revenue took the matter in further appeal to the Tribunal. Relying on its earlier decision in the case of Janambikai Mills Ltd, the Tribunal dismissed the appeal.
Revenue carried the matter before the High Court. While answering the question, the High Court has observed as follows:
“In our opinion, the Commissioner of Income Tax (Appeals) as well as the Tribunal have correctly held that merely because the payments were made directly to the LICI, the company could not be denied the benefit under Section 36(1)(v) and the amount had to be credited in favour of the assessee. Both the Commissioner (appeals) as well as the Tribunal have correctly read the law and have correctly relied upon the aforementioned Supreme Court judgment. In our opinion, since the finding of fact is that all the payments made were only towards the Group Gratuity Fund, there would be no question of finding otherwise.”
Learned counsel appearing on behalf of the Revenue has submitted before us that the provisions of Section 36(1)(v) of the Act have to be construed strictly and for claiming deduction, conditions laid down in Section 36(1)(v) of the Act must be fulfilled. It is urged that since during the relevant previous year the contribution by the assessee towards the gratuity fund was not in an approved gratuity fund the High Court was not justified in affirming the view taken by the Commissioner as also by the Tribunal while answering the reference in favour of the assessee. Their lordship of the Supreme Court placed a query as to whether the contribution made by the assessee in the approved gratuity fund credited by the LIC for the employees of the assessee and ultimately the entire amount deposited with the LIC came back to the fund created by the assessee for the benefit of its employees and approved by the Commissioner w.e.f. 25th February, 1983, or not. However, learned counsel of revenue was not in a position to make a categorical statement in that behalf.
The Supreme Court held as follows (with high lights provided):
“Having considered the matter in the light of the background facts, we are of the opinion that there is no merit in the appeal. True that a fiscal statute is to be construed strictly and nothing should be added or subtracted to the language employed in the Section, yet a strict construction of a provision does not rule out the application of the principles of reasonable construction to give effect to the purpose and intention of any particular provision of the Act. (See: Shri Sajjan Mills Ltd. vs. Commissioner of Income Tax, M.P. & Anr. (1985) 156 ITR 585). From a bare reading of Section 36(1)(v) of the Act, it is manifest that the real intention behind the provision is that the employer should not have any control over the funds of the irrevocable trust created exclusively for the benefit of the employees. In the instant case, it is evident from the findings recorded by the Commissioner and affirmed by the Tribunal that the assessee had absolutely no control over the fund created by the LIC for the benefit of the employees of the assessee and further all the contribution made by the assessee in the said fund ultimately came back to the Textool Employees Gratuity Fund, approved by the Commissioner with effect from the following previous year. Thus, the conditions stipulated in Section 36(1)(v) of the Act were satisfied. Having regard to the facts found by the Commissioner and affirmed by the Tribunal, no fault can be found with the opinion expressed by the High court, warranting our interference.”
Therefore resultantly, the appeal was dismissed by the Supreme Court but without allowing any cost in favor of assessee.
Commercial aspects should be taken into account:
The revenue authorities should also consider commercial aspects of transactions. When Employer paid to LICI, on behalf of Gratuity Fund, the employer debited a/c of gratuity fund and gratuity fund credited the account of contribution from employers and debited investment in group gratuity policy. Merely because a cheque is issued by employer in favor of LICI on behalf of gratuity fund should not have been considered so technically. In fact, this situation prevails in many cases and deduction is allowed. It is only because of a whimsical view taken by an officer that the matter was carried up to Supreme Court. It is really unfortunate that in this case senior authorities as well as counsels of revenue has taken decision to appeal from one forum to other forum till the Supreme Court. This clearly shows that the law administration and also their counsel take narrow view and waste valuable public money in unnecessary litigation.
Courts could have allowed cost in favor of assessee:
It can be said that the case before the Tribunal, the High Court as well as the Supreme Court was fit for allowing costs in favor of assessee who suffered lot of harassment, faced unnecessary contingency. By granting substantial costs in such cases, perhaps a check can be placed on unnecessary litigation by the revenue.
Direct payment to policy issuer can be better option:
In the changed circumstances, it is desirable that the provisions should be made straight and simple. Instead of requirement of contribution to gratuity funds, direct investment in group gratuity policies of insurance companies can be a better option. The insurance companies are governed by and can be further governed by strict Rules about investments, returns and payment in specified circumstances. The need to have an employee’s gratuity trust/ fund can be avoided for simplicity and unnecessary work.
Author is a member of ICAI and he can be reached at email@example.com