The Judgement Day: Gratuity is not a depreciable asset
In taking over a going concern, the buyer at times has to bear the accrued liabilities of existing employees. One such liability, the payment of gratuity, till the date of transfer is deferred and becomes payable to the employees as and when the e...
Ravi Prakash & Richa Sawhney
In taking over a going concern, the buyer at times has to bear the accrued liabilities of existing employees. One such liability, the payment of gratuity, till the date of transfer is deferred and becomes payable to the employees as and when the employment with the purchaser comes to an end or is terminated.
But what happens when the undertaking (minus such accrued liability) is purchased for a lump sum consideration, and the purchaser takes up the liability of such accrued gratuity? Can such accrued gratuity liability be spread over the assets and depreciation be claimed on depreciable assets on value including the spread-over of gratuity liability?
Recently, the issue, on a slightly different background, reached the apex court in the case of CIT versus Hoogly Mills Co Ltd (2006) 287 ITR 333 (SC). In the case, the undertaking was purchased for a lump sum consideration but the break-up of the same in (a) land, (b) buildings etc. and (c) plant, machinery and other movable assets, was given in the sale agreement itself.
In this context, it is relevant to note that as per the provisions of the Payment of Gratuity Act, 1972, the liability of the employer to pay gratuity to its employees accrues as soon as the concerned employee completes five years��� continuous service, though it is payable on superannuation, retirement, resignation, death or disablement due to accident or disease as the case may be.
ADVERTISEMENT
This liability is worked out on the basis of 15 days��� wages based on the rate of wages last drawn by the employee for every completed year of service or part thereof in excess of six month. In the above case, the assessee had purchased an undertaking for Rs 2 crore. In addition, the assessee also took up the accrued and future gratuity liability of the vendor. The liability towards the gratuity of the existing employees accrued till the date of transfer of the undertaking, based on actuarial valuation, amounted to Rs 3.5 crore. The assessee claimed that this amount of Rs 3.5 crore is capital expenditure on which it is entitled to depreciation under section 32 of Income-Tax Act, 1961 (the Act).
The stand of the assessee found favor with the Commissioner (Appeal), the Tribunal and the Calcutta High Court. The amount in question was apportioned over the cost of other assets acquired and depreciation (on depreciable assets) was allowed on the reworked numbers. This was not accepted by the department and the issue for taken up for adjudication by the apex court.
The apex court has observed that as it is a settled position that an agreement has to be read as a whole, the consideration for the sale was not Rs 2 crore but includes the gratuity liability as well. The gratuity liability thus becomes part of the purchase consideration. The entire amount of consideration constitutes a capital expenditure as it is an expenditure incurred for acquiring an asset of an enduring nature.
On the issue whether it can be said to be a capital expenditure on which depreciation is allowable, the apex court has held that though the expenditure on taking over the gratuity liability is a capital expenditure, however no depreciation is allowable on the same.
Section 32 of the Act permits claim of depreciation only in respect of certain specified tangible and intangible assets, and gratuity liability taken over by the vendor does not fall under any of the specified categories, hence the claim of depreciation by the assessee is not sustainable.
Probably, the apex court was primarily influenced by the fact that the consideration of Rs 2 crore was split in various assets in the sale agreement itself. But even then, how can the gratuity liability by itself constitute an asset? There must be some reason why the assessee undertook the gratuity liability, and such reasoning, in all probability can be assigned to the undertaking being purchased by the assessee.
If that be so, the gratuity liability which is taken by the assessee must be spread over or assigned to some asset rather than treating ���gratuity liability��� itself as an asset. Will the same consequence emerge had the parties to the sale agreement not given the break-up of Rs 2 crore in the sale agreement?
ADVERTISEMENT
In such a case, probably, one could argue that the consideration for net assets acquired by the assessee is Rs 5.5 crore (i.e. Rs 2 crore as paid to the vendor and Rs 3.5 crore to be discharged by way of payment of gratuity to employees taken over), which should rightly be spread over various assets based on a valuation report.
(The authors are with PricewaterhouseCoopers)
Download
The Economic Times Business News App for the Latest News in Business, Sensex, Stock Market Updates & More.
The Economic Times Business News App for the Latest News in Business, Sensex, Stock Market Updates & More.
Download
The Economic Times News App for Quarterly Results, Latest News in ITR, Business, Share Market, Live Sensex News & More.
The Economic Times News App for Quarterly Results, Latest News in ITR, Business, Share Market, Live Sensex News & More.
ADVERTISEMENT
