Hon’ble High Court of Kerala which held that an expenditure to be incurred in future in respect of a liability that accrued during the related accounting would be eligible for a deduction.
in order to claim deduction of business expenditure, it is not necessary that the amount has been actually paid or expended during the relevant accounting year itself. It is sufficient that the liability for payment had incurred or accrued during the relevant accounting year. The actual payment of amount or discharge of liability may occur in future. What is crucial is the accrual of liability for payment or expenditure during the relevant accounting year. But, a contingent liability that may arise in future, cannot be treated as expenditure.
In the instant case, the revenue has no case that the sale deed executed in respect of the building did not provide that the assessee was liable to complete the construction of the building. The Tribunal was right in confirming the finding of the appellate authority that, the expenditure incurred by the assessee company during the financial years subsequent to the sale of the building, is eligible for deduction in computation of taxable income.
FULL TEXT OF THE HIGH COURT ORDER / JUDGEMENT
Is expenditure to be incurred in future in respect of a liability that accrued during the accounting year eligible for deduction in the computation of taxable business income? This is the substantial question of law to be considered in this appeal filed by the revenue.
2. The respondent/assessee is a company engaged in the business of construction and sale of residential and commercial building complexes. During the assessment year 2009-10, the assessee sold a portion of the mall building constructed by it. The construction of the building was not completed at that time. In the revised return of income filed on 06.04.2011, deduction of the expenses incurred during the financial years 2009-10 and 2010-11 for completing the construction of the building was claimed by the assessee. The assessing authority disallowed the aforesaid deduction claimed and completed the assessment.
3. The assessee took up the matter in appeal before the Commissioner of Income Tax (Appeals). The appellate authority allowed the appeal by observing as follows:
“In this case, during the course of assessment proceedings, the construction of Mall was completed and therefore, the appellant could find out the actual cost of construction per sq.ft by dividing the total expenditure on construction by the total saleable area. In a situation where at the time of assessment the building remains incomplete, estimated future expenditure to be incurred is also considered along with the expenditure already incurred and is taken as cost relatable to the total saleable area ie. saleable area already built and the saleable area to be built in future, for arriving at the estimated cost of construction per sq ft. It is not a case of mere sale of commercial space but the appellant was required to provide amenities like escalators, lifts, parking, common toilet etc also. Therefore the contentions of the appellant are accepted and it is held that the AO was not justified in not taking the value of building work in progress during the FY 2009-10 and 2010-11 for working out the cost per square ft. It is therefore, directed that the cost per sq.ft shall be taken as total expenditure incurred in construction divided by total saleable area for the purpose of working out the profit from sale of commercial area.”
4. The revenue challenged the order of the appellate authority before the Income Tax Appellate Tribunal. The Tribunal agreed with the view taken by the appellate authority and dismissed the appeal. The aforesaid order of the Tribunal is under challenge in this appeal filed by the revenue.
5. We have heard learned counsel for the department and also the learned counsel for the respondent.
6. Learned counsel for the department contended that the claim for deduction of future expenses made by the assessee cannot be allowed. Learned counsel contended that there is a distinction between amount spent to pay off an actual liability and a liability that would be incurred in future which is only contingent. It is contended that the former is deductible but not the latter.
7. Per contra, learned counsel for the respondent contended that the amount claimed as deduction was expenditure to be incurred to meet an accrued liability and not a contingent liability. Learned counsel also contended that the deduction was claimed in this case after incurring the expenditure since the construction of the building was completed when the assessment proceedings were pending.
8. At the outset, we may state that the dispute raised by the revenue is only with regard to the deduction claimed by the assessee in respect of the expenses incurred in future, that is, after the sale of the building, during the subsequent financial years, and not in respect of the expenses incurred by it during the relevant financial year.
9. Section 37 of the Income tax Act, 1961 (hereinafter referred to as “the Act”) is a residuary section for allowability of business expenditure. Section 37(1) of the Act reads as follows:
“37 (1).– Any expenditure (not being expenditure of the nature described in sections 30 to 36 and not being in the nature of capital expenditure or personal expenses of the assessee), laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head “Profits and gains of business or profession”.
10. The expression “profits and gains” has to be understood in its commercial sense and there can be no computation of such profits and gains until the expenditure which is necessary for the purpose of earning the receipts is deducted therefrom – whether the expenditure is actually incurred or the liability in respect thereof has accrued even though it may have to be discharged at some future date. The profit of a trade or business is the surplus by which the receipts from the trade or business exceed the expenditure necessary for the purpose of earning those receipts. It is the meaning of the word “profits” in relation to any trade or business. Whether there be such a thing as profit or gain can only be ascertained by setting against the receipts the expenditure or obligations to which they have given rise (See Calcutta Company Limited v. Commissioner of Income Tax, West Bengal : AIR 1959 SC 1165)
11. In Calcutta Company Limited (supra), the assessee was a company conducting the business of developing land fit for building purposes and selling it in plots at a profit. The procedure followed was that when a plot was sold, the purchaser would pay about 25 per cent of the purchase price in cash and would undertake to pay the balance with interest at a certain rate in instalments which he secures by creating a charge on the land purchased. The assessee, in its turn, would undertake to carry out the developments within six months from the date of the sale. The assessee claimed deduction of the amount to be spent for development in the computation of the profits and gains of its business. The Income Tax Officer disallowed that claim on the ground that the expenses had not been actually incurred in the year of account and also on the ground that the estimate had not been proved to be based on a consideration of the real expenses which the company would have to incur for the purpose. When the matter ultimately reached the Apex Court, after dealing with the provisions contained in Sections 10(1) and 10(2) of the Income Tax Act, 1922, it was held as follows:
“The question which really arises for our determination in this appeal is whether having regard to the fact that the appellant’s method of accounting, viz., the mercantile method was accepted by the Income Tax Officer and the receipts appearing in the books of account included the unpaid balance of the sale price of the plots in question, the amount of liability undertaken by the appellant to earn those receipts was to be deducted even if there had not been actual disbursement made by it during the accounting year. Inasmuch as the liability which had thus accrued during the accounting year was to be discharged at a future date the amount to be expended in the discharge of that liability would have to be estimated in order that under the mercantile system of accounting the amount could be debited before it was actually disbursed. The appellant here is being assessed in respect of the profits and gains of its business and the profits and gains of the business cannot be determined unless and until the expenses or the obligations which have been incurred are set off against the receipts. …. We are definitely of opinion that the sum of Rs. 24,809 represented the estimated amount which would have to be expended by the appellant in the course of carrying on its business and was incidental to the same and having regard to the accepted commercial practice and trading principles was a deduction which, if there was no specific provision for it under Section 10(2) of the Act was certainly allowable deduction, in arriving at the profits and gains of the business of the appellant under Section 10(1) of the Act, there being no prohibition against it, express or implied in the Act”.
12. “Expenditure” is not necessarily confined to the money which has been actually paid out. It covers a liability which has accrued or which has been incurred although it may have to be discharged at a future date. However, a contingent liability which may have to be discharged in future cannot be considered as expenditure. It also covers a liability which the assessee has incurred in praesenti although it is payable in futuro (See Madras Industrial Investment Corporation Limited v. Commissioner of Income Tax : AIR 1997 SC 2063).
13. In Bharat Earth Movers v. Commissioner of Income Tax : AIR 2000 SC 2636, the Supreme Court has held as follows:
“The law is settled: if a business liability has definitely arisen in the accounting year, the deduction should be allowed although the liability may have to be quantified and discharged at a future date. What should be certain is the incurring of the liability. It should also be capable of being estimated with reasonable certainty though the actual quantification may not be possible. If these requirements are satisfied the liability is not a contingent one. The liability is in praesenti though it will be discharged at a future date. It does not make any difference if the future date on which the liability shall have to be discharged is not certain”.
14. It is discernible from the decisions referred to above that, in order to claim deduction of business expenditure, it is not necessary that the amount has been actually paid or expended during the relevant accounting year itself. It is sufficient that the liability for payment had incurred or accrued during the relevant accounting year. The actual payment of amount or discharge of liability may occur in future. What is crucial is the accrual of liability for payment or expenditure during the relevant accounting year. But, a contingent liability that may arise in future, cannot be treated as expenditure. Thus, the substantial question of law is answered in favour of the assessee and against the revenue.
15. In the instant case, the revenue has no case that the sale deed executed in respect of the building did not provide that the assessee was liable to complete the construction of the building. The Tribunal was right in confirming the finding of the appellate authority that, the expenditure incurred by the assessee company during the financial years subsequent to the sale of the building, is eligible for deduction in computation of taxable income.
Consequently, the appeal is dismissed. No costs.