However, where one business activity has been discontinued and another continues to exist, it is a mixed question of fact and law whether the discontinued activity was separate and distinct from the existing business, or whether it was merely a branch and the two constituted one and the same business.

In the latter case, the allowances pertaining to the discontinued activity can be deducted in computing the profits of the existing business (Arunachalam v. C.I.T. (3 I.T.C. 209 (S.B.)), but not in the former case (Chhabda v. C.I.T. (65 I.T.R. 638 (S.C.)).

The Supreme Court had occasion to consider this point earlier this year when one of the units (a subsidiary company) was closed down and the business was taken over by the parent company together with the liability of the employees.

A lumpsum amount was paid by the subsidiary company to cover thegratuity liability which would subsequently be discharged by the company taking over the business as and when the employees retired.

The question whether such liability was deductible was discussed by the Supreme Court in W.T. suren & Co. Ltd. v. C.I.T. ((1998) 97 Taxman 126). The facts in this case were that the assessee, a subsidiary company of R, had closed one of its distribution units and the same had been taken over by 'R'. The employees of the assessee were offered similar employment with 'R' on the same terms and conditions as with the assessee. Some of the employees accepted the offer given by R and some did not.

In respect of the employees whose services had been terminated and who had accepted the offer to join R with continuity of services as offered, their gratuity amount was paid over by the assessee to R, which amount was held by R on trust for the benefit of the assessee's employees. R made a declaration that it had no beneficial interest in the said sum or any part thereof.

Though apart of the assessee's business was closed and taken over by R, the other business continued. The assessee claimed the gratuity amount paid as a deduction.

The Assessing Officer held that R alone would be entitled to claim the amount when paid by them to the assessee's employees at the time of their respective retirement. He, therefore, disallowed the assessee's claim.

On appeal, the Commissioner (Appeals) held that there was no actual termination of the services of the employees and the discharge of the liability in question was capital in nature. He, therefore, upheld the Assessing Officer's order.

On second appeal, the Tribunal held that there was termination of the employment of the employees from the service of the assessee, and there was valid discharge of the payment of gratuity. The assessee was still functioning and the payment of the gratuity amount was rightly claimed as a deduction.

The High Court held that since the employees had been given the benefit of continuity of employment, in law,there was no retirement from the employment of the assessee, giving rise to the right in favour of the employees to claim gratuity from the assessee.

As such, the amount paid by the assessee to R could not be considered as a payment of gratuity to the employees of the assessee and could not, therefore, be held to be an allowable deduction.

The Supreme Court referred to several decisions on the subject. In C.I.T. v. Standard furniture Co. Ltd. (116 I.T.R. 751 (Ker.) (FB)), the question before the Court was whether the expenditure of Rs 4,44,988 was incurred wholly and exclusively for the purposes of the business within the meaning of section 37(1) as applied to the assessment year 1971-72.

In this case, the assessee went into voluntary liquidation. It sold its stock and machinery to one Sudarsan Trading Co. for a consideration of Rs.20,09,962. The purchaser agreed to take over the services of such of the assessee's employees to whom the provisions of the Industrial Disputes Act applied.

Under aprovision of law relating to payment of gratuity as in force in the State of Kerala, the assessee had incurred a liability for the payment of gratuity to its workers which was estimated at Rs.4,44,988.

The liability of the assessee for payment of this amount was agreed to be paid by the purchaser at a future date. The purchaser paid the purchase price of the stock and machinery of the assessee minus the amount of gratuity payable to the employees, which arrangement was made with the consent of the concerned employees.

The High Court upheld the view of the Tribunal that the liability for payment to the workers to which the employer was subject under the local Gratuity Act, was an expenditure wholly and exclusively laid out or expended for the purposes of the business of the assessee. The Court disagreed with the view of the Revenue that the incurring of the expenditure for payment of gratuity much ahead of the actual time for payment of gratuity could not amount to an expenditure incurred "wholly andexclusively for the purpose of the business".

In C.I.T. v. Salem Magnesite (P.) Ltd. (189 I.T.R. 154), the services of the employees in one of the departments of the assessee were discontinued, which department was taken over by the State of Tamil Nadu.

The liability of the assessee in respect of payment of gratuity to those employees had become due, which the assessee was prepared to pay to the employees directly.

However, the concerned employees desired that the payment be made to the State Government as they wanted to take advantage of continuity of service.

The State Government agreed to accept the proposal and payment was made by the assessee to the State Government on behalf of the employees. The court was of the view that the Tribunal was right in holding that the said amount was allowable as a deduction in computing the taxable profits of the assessee.

In C.I.T v. Pathinen Grama Arya Vysya Bank Ltd. (109 I.T.R. 788), the question before the High Court was whether the sum of Rs.18,931 whichformed part of the total sum transferred by the assessee to the Karur Vysya Bank Ltd., by way of gratuity to the employees for the services rendered to it, was admissible as a deduction.

The High Court held that the principle of the decision of the Supreme Court relating to retrenchment compensation paid to employees equally applied to the payment of gratuity to the employees of an assessee whose business had been transferred to another and where the transferee took over the employees with the benefit of continuity of service.

The Supreme Court after considering W.T. Suren & Co. Ltd.'s case, took the view that retrenchment compensation was not the same thing as gratuity. In C.I.T. v. Gemini Cashew Sales Corpn. (65 I.T.R. 643), the Supreme Court considered the question of payment of retrenchment compensation under the provisions of the Industrial Disputes Act, 1947, which states the circumstances in which a workman is entitled to retrenchment compensation.

While section 25-F of that Act prescribesconditions precedent to the retrenchment of workmen, section 25-FF provides for compensation to workmen in case of transfer of undertakings. Right to claim retrenchment compensation remains contingent and there may be varying circumstances under which employment may cease.

There may not be any right to such compensation, like death, retirement, resignation, etc. Under the law, right to retrenchment compensation arises when an employer terminates the employment or the undertaking of the employer is transferred and, in the later case, that too if the case does not fall under the proviso to section 25-FF.

It was held that these provisions could not be applied in the case of payment of gratuity. The scheme of gratuity as applicable to the members of the staff of the assessee provided as to how much gratuity would become due and payable to an employee, except the one who was dismissed for misconduct, etc.

The payment of gratuity to R was made as per the scheme of the assessee and it was not an ex-gratia orsome isolated payment. It was never disputed and, in fact, no question was raised regarding the termination of the services of the employees of the assessee. That being the position, the obligation of the assessee to make payment of gratuity to its employees was an obligation in praesenti. The payment of gratuity was with the consent of the employees transferred.

Thus, the payment of gratuity awarded by the assessee in the circumstances of the case was an expenditure wholly laid out or expended for the purposes of its business and was an allowable deduction. It could not be said that it was an expenditure incurred much ahead of time as the services of the employees with the assessee were terminated.

The Tribunal found that the assessee was a going concern and only one of its department was closed. The assessee had not wound up all of its affairs.

Only a part of its business was closed and transferred.

In these circumstances, the Tribunal was right in holding that the payment of gratuity was not onaccount of closing the business of the assessee but for the purposes of its business. Thus, it was entitled to deduction under section 37(1) of the Act.

The important point which emerges from the aforesaid decision is that when one of the businesses or activities of a tax-payer closes down, any expenditure pertaining to such discontinued business or activity can be set-off against the profits of the other business which is continued.

This is because all businesses would be considered to be the same so long as they satisfy the tests of unity of management and control, and financial inter-dependence.