1985 PLP 413 (PTD)

Examples of capital reserves are share premium account, development rebate reserve and fixed assets revaluation reserve. . Revenue Reserve.‑A revenue reserve is any reserve which is not a capital reserve, and which is, therefore, available for distri bution as dividend. Examples of Revenue reserves are general reserve, dividend equalisation reserve staff welfare reserve, debenture redemption reserve, investment depreciation reserve, etc." (iii) Commissioner of Income-tax, Madras v. Indian Metal and Metallurgical Corporation, 1964 P T D 194, in which the facts were that the respondent assessee who kept its accounts on the mercantile system, credited to a separate account called the gratuity reserve account' a sum of Rs. 5,600 being approximate fifteen days wages of all employees and workmen who were in its service during the year of account, with the object of maintaining a fund to meet its eventual liability under section 25‑F of the Industrial Disputes Act, in case any of the employees or workmen had to be retrenched. This amount was claimed as business expenditure under section 10 (2)(xv) of the Income‑tax Act, which was disallowed on the ground that it was only a prospective liability of a contingent nature. Upon reference before the High Court it was held that the credit of Rs. 5,600 being merely a provision by way of reserve by the assessee to meet the liability, if any, to which the assessee may become subject in the event of retrenchment: It was further held that it was not a liability in praesenti in the year of account but a liability which may arise de futuro on happening of a particular contingency and, therefore, could not be allowed as a deduction either under section 10(2)(xv) or on commercial principles as to computation of profits. It was also held that though in the mercantile system of accounting, a debit of an accrued liability would be a proper charge on the reve nue receipts and it is not necessary that there should have been any actual disbursement in such system of accounting to enable the assessee to make the claim of deduction. It may be pointed out that in this case the liability of the assessee was contingent in the sense that he would have been liable to pay gratuity only in the event of his retrenching any workman in terms of section 25‑F of the Indian Industrial Disputes Act. The provision was made for all the employees though the eventuality of retrenching them or any one of them might have not arisen. (iv)Gordon Woodroffe Leather Manufacturing Company v. Commis sioner of Income‑tax, Madras (1962) 44 I T R

551. In the above case the facts were that a person who was an employee of the managing agent of the assessee company from 1922 to 1935 and was an employee of the assessee from 1935 and also its Director from 1940, was paid gratuity of Rs. 40,000 by the assessee company in appreciation of his long and valuable services to the company. The company had no scheme for payment of gratuities nor it was a practice followed by the company. There was Nothing on record to indicate that the employee in question had accepted the low salary in expectation of a gratuity on retirement. The question before the Indian Supreme Court was, whether the judgment of the Madras High Court that the above amount of Rs. 40,000 could not be claimed as a deduction within the meaning of sec tion 10 (2) (xv) of the Act was proper. While dismissing the above appeal against the judgment of the High Court it was held by the Indian Supreme Court that the proper tests to apply in. a case like this are whether the payment was made as a matter of practice which affected the quantum of salary or there was any expectation by the employee of getting a gratuity or the sum of money was paid on the ground of commercial expediency and in order indirectly to facilitate the carrying on of the business. It was further held that the above payments did not satisfy the above test and were rightly disallowed. (v) Lakhamichand Muchhal v. Commissioner of Income‑tax, M. P. (1963) 48 I T R 562 in which the facts were that the assessee, a registered firm paid to its munim as gratuity on his retirement a sum of Rs. 21,000 and claimed the amount as a deduction. The question before the Division Bench of the Madhya Pradesh High Court was whether the above payment was deductible under section 10 (2) (x v) of the Act. While answering the above question in the negative it was observed that there was no practice of the assessee firm to give gratuity to its employees and that the payment of gratuity to Munim was the first instance of its kind and that there was no evidence to show that the Munim expected to get gratuity when he entered the service of the firm on a salary of Rs. 150 per month and, therefore, the above payment could not be claimed as a deduction under the above provision of the Income‑tax Act as revenue expenditure. (vi) The Indian Molasses Company (Private) Ltd. v. The Commissioner of Income‑tax, West Bengal A I R 1959 S C 1049. In the above case the facts were that one Mr. Harvey was the Managing Director of the assesses Company in 1948. He had been serving the Company by then for 13 years and was due to retire at the age of 55 years on 20th September 1955. There was an agree ment by which the Company undertook to provide a pension to Harvey after his retirement. On 16th September 1948 the Company executed a Trust Deed in favour of three Trustees to whom the Company paid a sum of 8,208‑19‑0 (Rs. 1,09,643) and further undertook to pay annually Rs. 4,364 ( 326‑14 sh.) for six consecutive years, and the trustees agreed to execute a declaration of trust. There was also provision for the management of the above fund by the trustees in the form of taking deferred annuity policy from the Norwich Union Life Insurance etc. Mr. Harvey died before he attained the age of 55 years. The assessee company paid the initial sum and the yearly premier before Harvey died for the assessment years 1949‑50, 1950‑51, 3951‑52 and 1952‑53, it claimed a deduction of these sums its profits or gains under section 10 (2) (xv) of the Act. Inter alia the question before the Indian Supreme Court was, whether the Calcutta High Court was right in answering the question namely, whether the income from the trust profits comes within the scope of section 4 (3)(1) and, therefore, was entitled to exemption, in the negative. The Supreme Court while allowing the appeal held that the income from the trust profits comes within the scope of above section 4 (3) (1) and therefore was subject to exemption. While deciding the above question inter alia, it was observed by the Supreme Court that if the pension itself be not payable as an obligation, and if there be a possibility that no such payment may be necessary in the future, the whole of the amount cannot be deducted but only the present value of the future liability, if it can be estimated. (vii) Commissioner of Income‑lax v. Sri Ranilakshmi Ginning, Spin ning and Weaving Mills (P.) Ltd. 1982 P T D 277 in which the facts were that there was a settlement between the assessee company and the labour union on 7th September, 1971 by which the assessee company agreed to introduce the gratuity scheme with effect from Ist January, 1969. It was agreed that the assessee would pay gratuity to its employees, who retired after December 31; 1968 and who had put in a minimum qualifying service mentioned therein. After that the assessee employed an actuary for determining the liability towards gratuity as on December 31, 1970 amounting to Rs. 1,20,

338. The assessee made the necessary provision and claimed the amount as a deduction in the assessment year 1971‑

72. The Income‑tax Officer rejected this claim. He allowed only to the extent of the provision made in respect of the current year and holding that the gratuity on the basis of the actuarial valuation relating to past years would be allowed as deduction as and when the payments were to be made to the workers. The assessees appealed before the Assistant Appellate Commissioner who held that the entire liability was an admissible deduction under section 37 (1) of the Indian Income‑tax Act, 1961, as the assessee had introduced the scheme with effect from 1st January, 1969. The department's appeal before the Income‑tax Tribunal was dismissed. Upon reference before the Madras High Court a Division Bench maintained the order of the Tribunal and observed as follows: "That the expenditure was incurred wholly and exclusively for the purposes of the assessee business cannot be open to doubt. The assessee made the provision only to pay its employees when they retired. The assesses had also been forced to adopt the scheme by giving it retrospective operation from 1st January 1969. The effect of the retrospective introduction of the scheme was to permit payment of gratuity even to persons who had retired on or after 1st January 1969 and before the scheme was actually agreed with the labour on 7th September 1971. The agreement with the labour was arrived at bona fide. In these circumstances, the only question that arises for consideration is whether by reason of the fact that the amount of actuarial valuation was obtain with reference to the period of service of earlier years, the amount referable to the earlier period of service cannot 6e 'allowed as deduction in this year. The assessee has been maintaining its accounts on the mercantile system. It is, therefore, not necessary for the allow ability of the expenditure that there should be an actual payment made by the assessee before he could get the deduction. In a case like this, the amount may be allowed as deduction provided that the amount of expenditure had accrued as liability.' (viii) Commissioner of Income‑tax v. Seshasayee Bros. (P) Ltd. 1983 P T D

435. In the above case the question before a Division Bench of the Madras High Court was, whether on the facts and in the circumstances of the case the Appellate Tribunal was right in holding that gratuity of Rs. 35,000 paid to Mrs. Akhila Raman as legitimate business expenditure and not ex gratin payment. The High Court while answering the above question in the affirmative observed as follows: "Mr. Jayaraman then contended that the mere fact that the gratuity in this case was paid in terms of the company's articles of association cannot conclude the discussion as to whether the outgoing was wholly and exclusively for the purposes of the assessee's business. The implication in the learned counsel's argument is that there must be an inquiry into the nature and object of the expenditure and not merely into the nature and degree of enforceability of the obligation under which the expenditure is incurred. We are, however, saved from going into this aspect of the discussion, not only because of the nature of the Tribunal's finding, but also because of a recent decision of the Supreme Court in which it has been laid down, almost as an axiom, that payment of gratuity in a business can no longer be regarded as ex gratia, but must nowadays be accepted as one made on grounds of commercial expediency and even of com mercial necessity. Vide Sasoon J. David & Co. (P.) Ltd. v. C. I. T. (1979) 118 I T R 261 (S C). That decision dealt with gratuity paid to an employee. But, in our judgment, that principle applied to gratuity paid to a service director as well." (ix) Commissioner of Income‑Tax v. Sitalakshmi Mills Ltd. 1984 P T D 18, in which the question before a Division Bench of the Madras High Court was, whether in the absence of any specific statutory provision for deduction of certain items in computation of taxable business income, such deduction can be allowed on commercial accounting basis. The High Court while answering the above question in the affirmative observed as under: "The issue arises this way. In the Industrial establishment of each of the assessees before us, there is a gratuity scheme for the workers and the staff. Gratuity would be payable on certain events happening, such as the employee's retirement, resignation, retrenchment or death. In this sense, the liability is said to be a 'contingent liability'. But owing to modern systems of actuarial valuation, it would be possible to ascertain the present discounted value of the employer's commitment to pay gratuity to his entire labour force as and when the time comes. This value, if ascertained on actuarial basis, would be progressively increasing every year, even if the strength of the workmen and staff remains constant. As between one year and the next, the figure of discounted value would register an increase. This actuarial increase is often called 'incremental value'. According to sound principles of commercial accounting, the annual increment in the discounted value will be a proper charge, which the employer can make against the year's profits. That is to say, the net profits of the year will be properly ascertained only after allowing for this charge. In the balance‑sheet too, the amount will figure as a 'provision for gratuity'. The Supreme Court in Vazir Sultan's case (1981) 132 I T R 559, has laid down that if a provision of this kind is made for gratuity, then that would have the effect of separating the amount so provided for, from the employer's own capital and reserves. So far as income‑tax computation is concerned, it has now become well‑settled that where an employer has gratuity scheme rendering him liable to pay gratuity to workmen, and where having regard to the liability which might arise under the scheme, the employer obtains a scientific actuarial calculation under which the present discounted value of the gratuity liability is ascertained, and where the employer charges his P & L account with the incremental value of the year and also makes a provision for that amount, then the employer will be entitled to compute his net profits after deducting the figure of incremental value. The Tribunal has clearly found that each of the assessees figuring in these references, has charged its P&L account with the incremental value appertaining to the account year concerned, on the basis of actuarial valuation in order to build up, little by little, an overall provision for its liability under the gratuity schema. We, therefore, hold that the provision made was rightly allowed by the Tribunal as a deduction in the computation of the business income of the concerned account year of the respective assessee." (b) On the other hand Mr. Ali Athar has referred to the following books and cases: (i) Modern Company Law by L. C: B. Gower Second Edition on the question of statutory provision under the Companies Act for the preparation of the Balance Sheet at page 423, which reads as follows: "The object of the statutory provisions is to ensure, so far as possible, that the balance‑sheet reveals accurately and in some detail sufficient information to enable these deductions .to be made. Once again the primary rule is that it must give a 'true and fair view', this time of 'the state of affairs of the company as at the end of its financial year'. And, once again this is supplemented by the detailed requirements of the Eighth Schedule. Among other rules, it is laid down that fixed assets shall be distinguished from current assets (as we have seen, this is necessary in order to enable the company's liquidity to be . deter mined), and the method used to arrive at the amount of the fixed assets must be stated. The aggregate amount of capital reserves, revenue reserves and provisions are to be stated under separate headings. These are defined, and the essential distinction between them is that a provision is an amount set aside to meet a known liability the exact amount of which cannot be determined with accuracy, whereas a reserve is an amount retained to meet unknown eventualities. If the reserve is not considered as free for distribution by way of dividend it is to be called a capital reserve, any other being a revenue reserve," (ii) Kanga and Palkhivala's Income‑Tax Seventh Edition, Volume 1, page 450 which reads as follows: "In Calcutta Co. Ltd. v. C. I. T. the Supreme Court held that if a liability has been definitely incurred in the accounting year, e.g. an unconditional contractual liability, it cannot be regarded as contingent merely because it is to be discharged at a future date and the cost of discharging it is not definite but has to be estimated. , In that case the Supreme Court allowed the estimated cost of discharging a contractual liability to undertake a development scheme within reasonable time in the future, as a proper deduction in computing the commercial profits, apart from the express statutory provisions for deductions. See further under section 28 'profits and gains', page 340, and under section 29, 'List of allowances is not exhaustive', p. 352." (iii) Carter's Advanced Accountancy by Douglas Garbood, 1969 Edition at page 2202 defining the terms reserves, provisions and of the Tribunal's finding, but also because of a recent decision of the Supreme Court in which it has been laid down, almost as an axiom, that payment of gratuity in a business can no longer be regarded as ex gratia, but must nowadays be accepted as one made on grounds of commercial expediency and even of com mercial necessity. Vide Sasoon J. David & Co. (P.) Ltd. v. C. I. T. (1979) 118 I T R 261 (S C). That decision dealt with gratuity paid to an employee. But, in our judgment,' that principle applied to gratuity paid to a service director as well." (ix) Commissioner of Income‑Tax v. Sitalakshmi Mills Ltd. 1984 P T D 18, in which the question before a Division Bench of the Madras High Court was, whether in the absence of any specific statutory provision for deduction of certain items in computation of taxable business income, such deduction can be allowed on commercial accounting basis. The High Court while answering the above question in the affirmative observed as under: "The issue arises this way. In the Industrial establishment of each of the assessees before us, there is a gratuity scheme for the workers and the staff. Gratuity would be payable on certain events happening, such as the employee's retirement, resignation, retrenchment or death. In this sense, the liability is said to be a 'contingent liability'. But owing to modern systems of actuarial valuation, it would be possible to ascertain the present discounted value of the employer's commitment to pay gratuity to his entire labour force as and when the time comes. This value, if ascertained on actuarial basis, would be progressively increasing every year, even if the strength of the workmen and staff remains constant. As between one year and the next, the figure of discounted value would register an increase. This actuarial increase is often called 'incremental value'. According to sound principles of commercial accounting, the annual increment in the discounted value will be a proper charge, which the employer can make against the year's profits. That is to say, the net profits of the year will be properly ascertained only after allowing for this charge. In the balance‑sheet too, the amount will figure as a 'provision for gratuity'. The Supreme Court in Vazir Sultan's case (1981) 132 I T R 559, has laid down that if a provision of this kind is made for gratuity, then that would have the effect of separating the amount so provided for, from the employer's own capital and reserves. So far as income‑tax computation is concerned, it has now become well‑settled that where an employer has gratuity scheme rendering him liable to pay gratuity to workmen, and where having regard to the liability which might arise under the scheme, the employer obtains a scientific actuarial calculation under which the present discounted value of the gratuity liability is ascertained, and where the employer charges his P & L account with the incremental value of the year and also makes a provision for that amount, then the employer will be entitled to compute his net profits after deduct ing the figure of incremental value. The Tribunal has clearly found that each of the assessees figuring in these references has charged its P&L account with the incremental value appertaining to the account year concerned, on the basis of actuarial valuation in order to build up, little by little, an overall provision for its liability under the gratuity scheme. We, therefore, hold that the provision made was rightly allowed. by the Tribunal as a deduction in the computation of the business income of the concerned account year of the respective assessees." (b) On the other hand Mr. Ali Athar has referred to the following books and cases: (i) Modern Company Law by L. C. B. Gower Second Edition on the, question of statutory provision under the Companies Act for the preparation of the Balance Sheet at page 423, which reads as follows: "The object of 'the statutory provisions is to ensure, so far as possible, that the balance‑sheet reveals accurately and in some detail sufficient information to enable these deductions .to be made. Once again the primary rule is that it must give a 'true and fair view', this time of `the state of affairs of the company as at the end of its financial year'. And, once again this is supplemented by the detailed requirements of the Eighth Schedule. Among other rules, it is laid down that fixed assets shall be distinguished from current assets (as we have seen, this is necessary in order to enable the company's liquidity to be deter mined), and the method used to arrive at the amount of the fixed assets must be stated. The aggregate amount of capital reserves, revenue reserves and provisions are to be stated under separate headings. These are defined, and the essential distinction between them is that a provision is an amount set aside to meet a known liability the exact amount of which cannot be determined with accuracy, whereas a reserve is an amount retained to meet unknown eventualities. If the reserve is not considered as free for distribution by way of dividend it is to be called a capital reserve, any other being a revenue reserve," (ii) Kanga and Palkhivala's Income‑Tax Seventh Edition, Volume 1, page 450 which reads as follows: "In Calcutta Co. Ltd. v. C. I. T. the Supreme Court held that if a liability has been definitely incurred in the accounting year, e.g. an unconditional contractual liability, it cannot be regarded as contingent merely because it is to be discharged at a future date and the cost of discharging it is not definite but has to be estimated. In that case the Supreme Court allowed the estimated cost of discharging a contractual liability to undertake a development scheme within reasonable time in the future, as a proper deduction in computing the commercial profits, apart from the express statutory provisions for deductions. See further under section 28 'profits and gains', page 340, and under section 29, 'List of allowances is not exhaustive', p. 352." (iii) Carter`s advanced Accountancy by Douglas Garbood, 1969 Edition at page 2202 defining the terms reserves, provisions and current liabilities which reads as follows: "Reserves, Provisions and current liabilities. ‑ At one time, the terms Reserves, Provisions and Current Liabilities were regarded as interchangeable and the distinction still presents many difficulties. The following definitions are based upon the Recommendations of the Institute of Chartered Accountants. Reserves, Provisions and current liabilities are all created by a debit to profit and loss account. Reserves are debited to profit and loss appropriation account. Provisions and current liabilities to the general profit and loss account. (i) Reserves are free, provisions are for specific requirements. (ii) Reserves are not intended to meet any contingency, liability or loss known to exist at the time of the balance‑sheet. (iii) Provisions may be for specific items existing at the date of the balance‑sheet, which cannot be closely estimated. 1t follows that an excessive provision should, in fact, be treated as a reserve. Current Liabilities are sums set aside to meet accrued charges and items, which can be closely estimated, e.g. telephone bill, rates, proposed dividends, income‑tax due. Provisions may be made for depreciation, bad debts, discounts on debtors, and repairs and renewals, and the student should refer to the examples of these given elsewhere in this book." (iv) R. Sim & Co. Ltd. v.' Commissioner of Income‑tax,` East Bengal, Dacca (1955) 27 I T R 530, in which the question before a Division Bench of East Bengal High Court was, whether on the facts and in the circumstances of the case the amount of Rs. ' 15,98,068 un appropriate balance of profit and loss account is a part of the reserves within the meaning of Article 2 (1.) of Schedule II of the Business Profits‑Tax Act, while answering the above question in the negative reference was made to the case of Commissioner of Income‑Tax, Bombay City v. Century Spinning and Manufactur ing Co. Ltd. (1953) 24 I T R 499 in which the word `reserve' was construed with reference, to the definitions given in the Oxford and Webster's New International Dictionary by the Indian Supreme Court. It was pointed out that the word reserve carried with it the idea of setting apart or retaining or preserving or keeping in store or keeping in back for special or general use. It was held that the above amount was not kept apart before the crucial date for any general or special purpose. (v) Commissioner of Income‑Tax, North Zone West Pakistan v. The Lyallpur Cotton Mills, Ltd. Lyallpur, P L D 1960 S C Pak. 48, in which the question before the Supreme Court was, whether un appropriated balance of profits carried from year to year Constitute reserve. It was held by the Honourable Supreme Court of Pakistan that they do not constitute reserve within the, meaning of rule 2(i) Schedule 11 of the Business Profits‑Tax Act. The above case of the Division Bench of the East Bengal High Court was approved. (vi) Owen (H. M. Inspector of Taxes) v. Southern Railway of Peru, Ltd. 1953‑56 Tax Cases,

602. In the above case facts were that the respondent assessee company was bound to pay its employees in Peru prescribed compensation payments upon the termination of their services with the Company. The amount was to be determined on the basis of length of service, rate of pay at the end of the period of service. It was contended by the assessee company that upon proper principles of commercial accountancy amounts of compensation calculated to have accrued to each employee from year to year as deferred remuneration should be allowed as a deduction. The Special Commissioner held that it was 'a matter of correct accountancy practice to make provision in the accounts for the sums in question. The Chancery Division held that the deferred payments must be brought into account for income‑tax purposes at the time when they became payable and not before. Upon an appeal the Court of Appeal confirmed the decision of the Chancery Division. However, the matter went before the House of Lords, which gave the judgment in favour of the Crown on the facts of the case but the majority view was that there is no rule of law which prevents the deduction of a provision from the profits in respect of sufficiently' accurate estimate of the obligation. It may be advantageous to reproduce hereinbelow relevant observation of Lord Radcliffe at page 641,, which reads as follows: "What the Appellant claims the right to do is to charge against each year's receipts the cost of making provision for the retirement payments that will ultimately be thrown upon it by virtue of the fact that it has had the benefit of its employees' services during, that year. As a corollary it will not make any charge to cover the actual payments made in the year in respect of retirement benefits. Only by such a method, it is said, can it bring against the receipts of the year the true cost of the services that it has used to earn those receipts. Generally speaking, this must, I think, be true. For whereas' it is possible that any, one of its many employees may forfeit his benefit and so never 'require a payment the substantial facts of the "situation are that when the s. company has paid every salary and wage that is due for current remuneration of the year it has not by any means wholly discharged itself of the pecuniary burden which falls upon it in respect of the year's employment. This is a, long‑term application of the practice by which provision for holidays with pay in the coming year is charged in part against the receil5ts of the previous year. It does not seem to me inconsistent with the theory on which the claim is based that in the year when an increase, of salary takes place and the expectation of a‑larger ultimate payment materializes and adjustment has to be made to take care of what has thus become the under provision of earlier years. 1 agree that it is required in that year to take account of the increased burden which the year's salary for the year's service has thrown upon the employer." (vii) Metal Box Company of India Ltd. v. Their Workmen (1969) 73 I T R 53, in which the question before the Indian Supreme Court was, whether the assessee company was entitled to claim deduc tion on account of bonus and gratuity payable to its employees. While allowing the appeal of the assessee company it was held by the Indian Supreme Court that the assessee was entitled to make provision for gratuity amounts. In this regard following observation was made :‑ "Two questions, therefore, arise: (1) whether it is legitimate in such a scheme of gratuity to estimate the liability on an actuarial valuation and deduct such estimated liability in the P & L account while working out its net profits ; and (2) if it is, whether such appropriation amounts to a reserve or a provision. If it is a reserve, obviously the amount has to be added back while computing the gross profits. But in that event the company would be entitled to interest thereon at 6 per cent per annum under item i(iii) of the Third Schedule to the Act. In the case of an assessee maintaining his accounts on mercantile system, a liability already accrued, though to be discharged at a future date, would be a proper deduction while working out the profits and gains of his business, regard being had to the accepted principles of commercial practice and accountancy. It is not as if such deduction is permissible only in case of amounts actually expended or paid. Just as receipts, though not actual receipts but accrued due are brought in for income‑tax assessment so also liabilities accrued would be taken into account while working out the profits and gains of the business. A company carrying on business of buying land and selling it after development sold certain plots, received a part of the price but entered the whole of the price receivable as it maintained its books of accounts on mercantile method. It also debited a certain sum, being the estimated expenditure for the developments it undertook to carry out within six months from the execution of the sale deeds although no part of such expenditure was actually incurred during that year. It was held that, having regard to the accepted commercial practice and trading principles and there being no prohibition against it in the Income‑tax Act, deduction of such estimated liability, even though it did not come under any specific pro visions of section 10 (2) of the Income‑tax Act, 1922, was permissible: See Calcutta Company Ltd v. Commissioner of Income‑tax (1960) 1 S C R 185." (viii) Commissioner of Wealth Tax (Central), Karachi v. Paracha Textile Mills Ltd., Karachi 1983 P T D

335. In the above case a Division Bench while construing the term `net wealth' used in section 2(m) of the Wealth Tax Act, held that the assessee is entitled to adjust a debt owed by him while computing the net wealth. It was held that an income‑tax is a debt owed by an assessee though it might have not been paid.

6. From the above‑cited books and cases the following principles are deducible: (i) The ordinary natural meaning of the word, `reserve' seems to be, setting apart or retaining or preserving or keeping in store or keeping back for special or general use. (ii) That the terms `reserves, provisions and current liabilities' by now carry different meanings in accountancy parlance, namely, reserves are debited to profit and loss appropriation account and are not intended to meet any contingency, liability or loss known to exist at the time of the preparation of the balance‑sheet, pro visions are also debited to profit and loss account but the same are for specific items existing on the date of the balance‑sheet which cannot be closely estimated and whereas current liabilities are sums set aside to meet accrued charges and items which can be closely estimated on the, date of the preparation of the balance‑sheet. (iii) That provisions are intended to cover items like depreciation, bad debts, taxation and contingencies etc. (iv) That reserves can be classified into capital reserves and revenue reserves. The former are intended to provide for, issuing bonus shares and the latter are available‑for distribution as dividend. (v) That under the mercantile system of accounting a debit entry of an accrued liability would be a proper‑charge on the revenue receipts and an allowable deduction therefrom, and it is not necessary that there should have been any actual disbursement just like receipts though not actual receipts but accrued due are brought in for income‑tax assessment. (vi) That an assessee cannot charge on the revenue receipts gratuity paid by him to his employees, which he was neither under any contractual nor statutory obligation to pay, nor there was no practice ilk the Assessee establishment to pay gratuity to his employees on their retirement. (vii) That it is by now a well established axiom that payment of gratuity in a business can no longer be regarded as ex gratis but is accepted as one made on ground of commercial expediency and even of commercial necessity. (viii) That owing to modern system of actuarial valuation it would be possible to ascertain the present discounted value of an employer's commitment to pay gratuity to his entire staff as and when time comes. (ix) That the value ascertained on actuarial basis is subject to the progressive increase every year even if the strength of the workmen and staff remains constant and such actuarial increase in the value is also called incremental value. (x) That according to sound principles of commercial accounting the annual incremental value would be a proper charge, which an employer can make against P & L account of the year. (xi) That an assessee under the, principles of commercial accounting is entitled to charge against each year's receipts the retirement payments that will ultimately be thrown upon him by virtue of the fact that he has had the benefit of his employees service during that year and the fact that any one of his many employees may forfeit his benefit and so never require a payment will not alter the above position. . (xii) That the object of the statutory provisions in the Companies Act and the schedule thereto pertaining to the preparation of a balance sheet is to ensure as far as possible that the balance‑sheet should reveal accurately and in some detail sufficient information and should give true and fair view of the financial position of a company.

7. We have quoted the relevant portion of the order of the Income tax Officer hereinabove in para. 4, from which‑ it is evident that every year the respondent assessee made a provision for the gratuity of the staff on the basis of the emoluments received by them and the amount was credited to this account, on the basis of the accounting principle that the amount of gratuity is earned every year by the employees and thus it is debit able against the profits of the year ill which it is earned, though it is payable only when the employees retire from the service. The learned Income‑tax Appellate Tribunal in its order, dated 3rd April, 1973 has held that the reserve for gratuity has been created to Meet ascertained liability and, therefore, cannot part take of the nature of free reserve. In other words, it is not the case of the department that in the instant case it was not possible to calculate the actual amount of the liability incurred by the respon dent assessee towards its employees in respect of the gratuity of the years in question nor it is the case of the department that the respondent assessee was not liable to pay the above gratuity either under the contract or under the statutory provision. Factually the case proceeded before the Income tax Officer as well as before the learned Income tax Tribunal on the assumption that the respondent assessee's liability to pay gratuity is a legal liability and it is not an ex gratia payment by the respondent to its employees. We may place on record that Mr. Shaikh Haider, learned counsel for the appellant has fairly cited the cases which were in fact against 'the department, namely, the cases referred to hereinabove in ' paras: 5(a) (vii) (viii) and (sac) which are the decisions of the Madras High Court and which clearly lay down that the liability of gratuity ascertained each year is a proper charge against P & L accounts though the liability to pay may accrue subsequently. Reference may also be made to the House of Lord's case Owen (H.M. Inspector of Taxes) v. Southern Railway of Peru. Ltd. 1953‑56 T C 602 referred to hereinabove in para. 5 (b) (vi), in which it was held that provision for the payment of compensation to the assessee employees upon termination of their services on the basis of length of service rate of pay etc. is a proper charge on P & L upon the basis of proper principles of commercial accountancy from year to year. Further, reference may also be made to the case of the Indian Supreme Court reported in 1969 (73) i T R 53 quoted hereinabove in para. 5(b)(vii), in‑which it has been held with reference to a. scheme of gratuity that a liability already accrued though to be discharged at a future date would be a proper deduction while working out the profits and gains of business under the accepted principles of commercial practice and accountancy and that it is not necessary that the amount actually be expended or paid.

8. However, it was urged by Mr. Shaikh Haider that the contention of the respondent assessee before the Income‑tax Officer was that provision for gratuity was in the nature of staff welfare fund excluded from the definition of free‑reserve under the above‑quoted S. R. O. in para. 4 and, therefore, the respondent cannot take a different stand before this Court. It will suffice to observe that even before the Income‑tax Officer the contention of the respondent assessee was that the provision for gratuity cannot be termed as reserve. This contention has been upheld by the learned Income‑tax Tribunal. Even otherwise, there cannot be any estoppel against law as the question, whether a particular item can be treated as free‑reserve or not is a question of law. In this regard reference p may be made to the case of Treasurer of Charitable Endowments for Pakistan v. Central Board of Revenue Islamabad and others (1), in which a Division Bench of this Court, to which one of us was a member (Ajmal Mian, J.) held that no estoppel can be pleaded against statute/law and that consent/acquiescence on the part of the party cannot make a thing valid if otherwise invalid.

9. It will be pertinent to quote section 10 (2‑A) of the Act, which reads as follows: "Section 10 (2‑A).‑Where for the purposes of computing profits or gains under this section, an allowance or deduction has been made in the assessment for any year in respect of any loss, expenditure or trading liability incurred by the assessee, and (i) subsequently, during any previous year, the assessee has received, whether in cash or in any other manner whatsoever, any amount in respect of such loss or expenditure ; (ii) the assessee, during any .previous yeast, has .derived some benefit in respect of such trading liability ; or (iii) such trading liability or a portion thereof has not been paid within three years of the expiry of the previous year in which it was allowed. the amount received under clause (i) or the value of benefit obtained under clause (if) or so much of the portion of a trading liability a3 has not been paid under clause (iii) shall be deemed to be the profits or gains of business; profession or vocation and to have accrued or arisen during the previous year referred so in clause (i) and clause. (ii) or, as the case may be. during any previous year commencing after the expiry of the three years referred to in clause (iii), and the business, profession or vocation from the profits and gains of which such allowance or deduction was made shall, for the purposes of subsection (1), be deemed to be carried on by the assessee in the previous year in which such profits or gains are deemed to haze accrued or arisen under this subsection. Provided that where a trading liability referred to in clause (iii) or a portion thereof is paid in a subsequent year, a deduction of such amount as has been paid shall be made in computing the profits and gains under this section in respect of that year." A perusal of the above‑quoted subsection (2‑A) of section 10 which was enacted by Act No. XI of 1966, indicates that where for the purposes of computing profits or gains under the above section, an allowance or deduction has been made in the assessment for any year in respect of any loss, expenditure or trading liability incurred by the assessee and inter alia such trading liability or a portion thereof has not been paid within three years of the expiry of the previous year in which it was allowed, the portion of the trading liability which has not been paid under clause (iii) shall be deemed to be the profits or gains of business, profession or vocation and to have accrued or arisen during the previous year referred to in clause (i) and clause (ii) as the case may be, during any previous year commencing after the expiry of three year referred to m clause (iii) and the business, profession and vocation from the profits and gains of which such allowance or deduction was made shall, for the purposes of subsection (1), be deemed to be carried on by the assessee in the previous year in which such profits or gains are deemed to have accrued or arisen under the above subsection, and that where a trading liability referred to in clause (iii) or a portion thereof is paid in subsequent year a deduc tion of such amount as has been paid shall be made in computing the profits and gains under the above section in respect of that year. If the amount of gratuity is allowed as a trading liability under section 10 of the Act, the above subsection (2‑A) of the said section of the Act will be attracted to m order to avert the use of the money set apart in respect of gratuity by an assessee for an indefinite period. .

10. We are, therefore, inclined to hold that since the amounts set apart for gratuity; were intended to provide for ascertained liabilities which accrued in the financial years in question, the same were proper charge on the P & L account on the basis of the proper principles of commercial accountancy as held by the learned Income‑tax Tribunal in the relevant years. Our answer to the above‑quoted questions referred to hereinabove in para. 1, is that the gratuity cannot be construed as a free reserve in terms of S. R. O. No. 116 (R)/68 but it is an ascertained liability and therefore it is a proper charge on the P & L account for the assessment years in question on the basis of the proper principles of com mercial accountancy. The above three income‑tax references stand disposed of in .the above terms with no order as to costs. M. B. A. Reference disposed of accordingly,