ITAT Mumbai Deletes ₹18.89 Crore Disallowance on Reversal of Earlier-Year Provisions

Sharekhan Limited Vs DCIT (ITAT Mumbai)

Summary: The Income Tax Appellate Tribunal, Mumbai Bench, considered cross-appeals filed by Sharekhan Limited and the Income Tax Department for Assessment Year 2020-21 concerning the tax treatment of reversals of earlier-year provisions, deduction of education cess and disallowance under Section 14A of the Income-tax Act, 1961. The assessee, engaged in stock broking and related activities, had declared total income of ₹1,04,15,37,530. The Assessing Officer assessed its income at ₹1,30,53,39,622 after making additions of ₹17,89,01,092 towards reversal of excess provisions for expenses, ₹1 crore towards reversal of litigation provision, ₹86,66,000 towards education cess and ₹6,62,35,000 under Section 14A. The CIT(A) deleted the Section 14A disallowance because the assessee had earned no exempt income but confirmed the remaining additions. Both parties consequently approached the Tribunal.

Regarding the disallowance of ₹17,89,01,092, the Tribunal examined the assessee’s computations for Assessment Years 2019-20 and 2020-21, expense-wise schedules and ledger reconciliations. It found that the disputed amount had already been added back while computing taxable income for the preceding assessment year. During the subsequent year, the reversal of that provision had reduced the expenditure recorded in the books, and the corresponding adjustment in the income-tax computation was intended to restore the deduction for actual business expenditure. The Tribunal observed that the Assessing Officer had incorrectly treated this adjustment as a fresh claim for contingent expenditure without properly examining its accounting effect. Referring to the principles laid down by the Supreme Court in Bharat Earth Movers v. CIT and Rotork Controls India (P.) Ltd. v. CIT, the Tribunal explained that every estimated provision cannot automatically be regarded as contingent. Since the records supported the year-to-year reconciliation and the Revenue had not established a double deduction or identified expenditure unrelated to the business, the addition of ₹17,89,01,092 was deleted.

The Tribunal similarly deleted the addition of ₹1 crore relating to reversal of a litigation provision. The earlier-year computation disclosed a litigation provision of ₹6,96,21,157 that had not been allowed as a deduction, while the current-year computation separately identified the disputed ₹1 crore as a reversal. The Tribunal held that the Assessing Officer had failed to examine the effect of the earlier-year disallowance and the supporting ledger trail. There was no finding establishing that the same amount had already been deducted, that a taxable benefit had arisen from its reversal or that a duplicate deduction had been claimed. Accordingly, the reversal could not be disallowed merely because it had been adjusted through the computation of income rather than routed through the profit and loss account.

On education cess of ₹86,66,000, the Tribunal upheld the disallowance in view of Explanation 3 to Section 40(a)(ii), inserted retrospectively by the Finance Act, 2022 with effect from 1 April 2005. The provision clarifies that tax includes surcharge or cess levied on business or professional profits. The assessee also acknowledged that the issue stood against it following the Tribunal’s decision in Tech Mahindra Business Services Ltd. Consequently, this ground of the assessee’s appeal was dismissed.

In the Department’s appeal, the Tribunal upheld the CIT(A)’s deletion of the disallowance of ₹6,62,35,000 under Section 14A read with Rule 8D. Although the assessee held investments, it had neither received nor accrued exempt income during the relevant previous year, and the Revenue produced no contrary evidence. The Tribunal held that the mere existence of investments did not justify a disallowance under Section 14A in the circumstances of the case. Interest under Sections 234A, 234B and 234C was directed to be recomputed consequentially, if necessary. The Tribunal also rejected the separate natural justice challenge because the assessee had participated in the assessment proceedings and had not demonstrated any specific denial of opportunity causing prejudice. In the result, the assessee’s appeal was partly allowed and the Department’s appeal was dismissed.

Cases Discussed

• Rotork Controls India (P.) Ltd. v. CIT (Supreme Court) – (2009) 314 ITR 62 (SC). The Supreme Court explained the conditions governing recognition of provisions, including the existence of a present obligation arising from a past event, the probability of an outflow of resources and reliable estimation of the obligation. The Tribunal relied upon these principles to distinguish genuine accrued liabilities from contingent provisions.
• Bharat Earth Movers v. CIT (Supreme Court) – (2000) 245 ITR 428 (SC). The Supreme Court’s principles concerning accrued business liabilities and reliable estimation were considered in determining whether provisions could be treated as contingent merely because their amounts were estimated or supporting invoices were received subsequently.
• Tech Mahindra Business Services Ltd. (ITAT Mumbai) – ITA No. 1256/Mum/2022, order dated 24 July 2023. Relied upon in relation to the disallowance of education cess following the retrospective amendment to Section 40(a)(ii) of the Income-tax Act, 1961.

FULL TEXT OF THE ORDER OF ITAT MUMBAI

These cross appeals for Assessment Year 2020–21 arise from the order passed by the learned CIT(A). The Department’s appeal in ITA No. 4287/Mum/2026 challenges the deletion of the disallowance of ₹6,62,35,000 made under section 14A of the Income-tax Act, 1961 (“the Act”). The assessee’s appeal in ITA No. 1935/Mum/2026 challenges the confirmation of the disallowances relating to reversal of excess provisions for expenses of ₹17,89,01,092, reversal of provision for litigation of ₹1 crore, and claim of education cess of ₹86,66,000. Since the appeals concern the same assessee and assessment year, they were heard together and are being disposed of by this consolidated order.

2. The assessee is engaged in stock broking and related activities. It filed its return of income for the year under consideration declaring total income of ₹1,04,15,37,530. The case was selected for scrutiny, inter alia, on issues concerning expenditure allegedly attributable to exempt income, non-compliance with the Income Computation and Disclosure Standards, deductions claimed in the computation of business income, and provisions for expenses. The assessment was completed under section 143(3) read with section 144B of the Act. The Assessing Officer made a disallowance of ₹6,62,35,000 under section 14A, disallowed ₹86,66,000 claimed as education cess, and made additions of ₹17,89,01,092 and ₹1 crore in respect of reversals of provisions. The total income was assessed at ₹1,30,53,39,622.

3. The learned CIT(A) deleted the disallowance under section 14A on the ground that no exempt income had been earned during the year. The disallowance of education cess and the two provision-related additions were, however, confirmed. The assessee’s appeal before us is directed against the latter findings, while the Department challenges the relief granted by the learned CIT(A) under section 14A.

ITA No.1935/Mum/2026

4. The first substantive issue in the assessee’s appeal concerns the disallowance of ₹17,89,01,092 described as reversal of excess provisions for expenses of earlier years. The assessment order records that, by notice under section 142(1), the assessee was asked to furnish evidence that the expenses represented by the provision had actually been incurred during the year under consideration. The assessee explained that the provision had been made in the preceding year on an estimated basis, that the amount had been added back in computing taxable income for Assessment Year 2019–20, and that the provision was reversed in the books in the succeeding year. In its response to the show-cause notice, the assessee further explained that the reversal credited the expense accounts and thereby reduced the expenses reflected in the books for the year under appeal. The corresponding adjustment in the tax computation was made to ensure that the actual expenditure for the year was not correspondingly understated.

5. The Assessing Officer did not accept this explanation. He treated the amount of ₹17,89,01,092 as a fresh expenditure claim in Assessment Year 2020–21, held that a provision was only a reserve for a future liability and was contingent in nature, and observed that the reversal had been taken directly to the computation of income rather than credited to the profit and loss account. He further held that invoices, bills, vouchers and ledgers had not been furnished to establish that the expenditure had been incurred wholly and exclusively for the purposes of business during the relevant year. The amount was accordingly disallowed under section 37(1) of the Act.

6. The learned CIT(A) affirmed the disallowance. The appellate order reasoned that a reversal entry, by itself, does not establish actual expenditure; that the assessee had not furnished bills, agreements or other evidence of crystallisation; and that ledger entries alone could not establish allowability under section 37(1). The learned CIT(A) also observed that the prior-year provision had not been allowed as a deduction and that the current-year claim could not be permitted in the absence of evidence of actual incurrence. The order records that the assessee did not file new documents during the appellate proceedings. It further records that the Assessing Officer was asked under section 250(4) to furnish a report on the provision issues, but no report was received. The central question before us is whether the amount was correctly treated as a fresh claim for a provision, or whether the orders below failed to examine the accounting and tax treatment of the amount across the two years.

7. The relevant tax computations disclose the following treatment:

The computation for Assessment Year 2019–20 shows ₹17,89,01,092 as a provision for expenses for the year disallowed under section 37. The computation for Assessment Year 2020–21 identifies the same amount as “Excess Provision for Expenses Disallowed Last Year Now Claimed as Deduction.” It separately shows that the provision made for expenses of the year under appeal, amounting to ₹24,97,73,348, was disallowed. These entries are material. They show that the assessee distinguished the earlier-year provision, which had been added back, from the current-year provision, which was separately disallowed. The amount in dispute is thus traceable to the prior-year computation and is not an unexplained amount appearing for the first time in the current-year return.

8. The expense-wise schedule reproduced in the assessment order identifies the heads making up the earlier-year provision. These include service charges, training expenses, employee welfare, sub-brokerage, legal and professional fees, connectivity, rent, lead generation, travel, conveyance, repairs and maintenance, audit fees, rates and taxes, and other operating expenses. The schedule totals ₹17,89,01,092. The ledger and reconciliation material placed before us further explain the provision and the relevant expense and payment entries. By way of illustration, the working concerning legal and professional fees starts with a provision of ₹20,526,461 as per the March 2019 ledger, deducts ₹14,327,346 in respect of tax deducted and paid before the tax audit and return, and identifies the balance of ₹6,199,115 as the ad hoc provision disallowed. That balance corresponds with the legal and professional fees entry in the expense schedule. The material, read as a whole, provides an accounting basis for the amount and for the assessee’s explanation that the provision related to the conduct of its business.

9. The assessee’s written submission explains the accounting effect through an illustration. If actual expenses for a year amount to ₹200 crore and an estimated provision of ₹17 crore is also debited, the profit and loss account would reflect a debit of ₹217 crore. If the provision is added back in computing income for that year, the deduction for that year would remain confined to the actual expenses of ₹200 crore. In the succeeding year, if actual expenses are ₹300 crore and the opening provision of ₹17 crore is reversed by crediting the expense account, the net expense reflected in the books would be ₹283 crore. The assessee’s case is that the corresponding adjustment in the tax computation restores the deduction to the actual expenditure of ₹300 crore. The illustration is explanatory; the claim must ultimately stand on the books and records of the assessee. Its significance is that it shows why the amount of the reversal cannot be treated, without examining its accounting effect, as a separate expense of ₹17 crore incurred in the succeeding year.

10. The accounting principles also require a more considered approach than the one adopted by the Assessing Officer. A provision is not automatically deductible merely because it has been debited in the books. Its recognition depends on the nature of the obligation, its connection with a past event, the likelihood of an outflow and the ability to estimate the amount reliably. Ind AS 37, where applicable to the assessee’s financial statements, distinguishes a present obligation from a reserve for future expenditure. ICDS X, notified under section 145(2) of the Act, similarly addresses provisions, contingent liabilities and contingent assets for the computation of taxable income. It does not follow, however, that every provision is contingent merely because the amount is estimated or the supporting invoice is received later. In the case of services already received or business obligations already incurred, the uncertainty may concern the final measurement of the liability rather than its existence. The principles explained by the Hon’ble Supreme Court in Bharat Earth Movers v. CIT (2000) 245 ITR 428 (SC) and Rotork Controls India (P.) Ltd. v. CIT (2009) 314 ITR 62 (SC) require the nature and accrual of the liability to be examined; they do not permit all provisions to be treated as contingent without considering the underlying facts.

11. On the material before us, the claim is not that the mere reversal of an opening provision, without any corresponding expenditure or accounting consequence, creates a deduction under section 37(1). The assessee’s case is that the provision was disallowed when made; that the reversal credited the expense accounts in the subsequent year; and that the computation adjustment prevented that credit from reducing the amount of actual business expenditure reflected for tax purposes. The earlier-year computation, the current-year computation, the expense-wise schedule and the ledger reconciliation support that explanation. The current-year computation also separately adds back the provision for expenses made for Assessment Year 2020–21. The Revenue has not identified any particular expense in the disputed schedule as capital, personal or unrelated to the assessee’s business, nor has it shown that the amount of ₹17,89,01,092 was allowed as a deduction in Assessment Year 2019–20.

12. The Assessing Officer’s observation that the amount was taken directly to the computation of income and was not credited to the profit and loss account is not, by itself, sufficient to sustain the disallowance. The accounting entry, the computation adjustment and the year-to-year tax treatment have to be read together. The learned CIT(A)’s general observation that ledger entries alone are insufficient does not answer the assessee’s specific reconciliation, particularly when the assessment order itself reproduces the expense-wise schedule and records the earlier-year disallowance. The finding that the current-year claim must fail because the prior-year provision was not allowed also does not address whether the present adjustment merely neutralised the effect of the reversal and allowed the actual business expenditure in the year in which it was recognised or settled. In the facts of this case, the authorities below treated the reversal as a fresh provision claim without first establishing that the assessee had obtained a double deduction or that the amount did not represent business expenditure. The disallowance of ₹17,89,01,092 is accordingly deleted.

13. The next issue concerns the disallowance of ₹1 crore described as reversal of a provision for litigation. The Assessing Officer, by notice under section 142(1), asked the assessee to furnish evidence that the litigation expenditure had been incurred during the year under appeal. The assessee explained that the amount was a reversal of a provision made in the earlier year. The Assessing Officer disallowed it on the grounds that no invoices, agreements, bills or vouchers had been furnished, that the liability had not been shown to have crystallised during the year, and that the reversal was taken directly to the computation of income rather than routed through the profit and loss account. The learned CIT(A) confirmed the disallowance, observing that there was no evidence of a present obligation or reliable estimation and that a reversal entry alone was insufficient. The appellate order also records that the Assessing Officer did not furnish the report called for under section 250(4).

14. The prior-year computation shows a provision for litigation of ₹6,96,21,157 under “Any Other Expenses Not Allowable.” The current-year computation separately records ₹1 crore as “Provision for Litigation (Reversal).” The ledger and reconciliation material, read with these computations and the assessee’s explanation, establish that the disputed ₹1 crore is referable to the earlier-year litigation provision and that the provision was not allowed as a deduction in the earlier year. It is therefore necessary to distinguish the present adjustment from a claim for a fresh, unsubstantiated provision. The Assessing Officer did not identify any deduction allowed in the earlier year in respect of the ₹1 crore, any income or benefit arising to the assessee on its reversal, or any separate deduction of the same amount in the current year. The computation for Assessment Year 2019–20 also records a deposit with SEBI for litigation as a separate allowable deduction; that item is distinct from the ₹1 crore provision reversal in the year under appeal and does not, by itself, establish duplication.

15. A litigation provision must, of course, be tested on its own facts. The mere possibility of litigation does not establish a present liability, and a provision for future legal expenditure cannot be allowed merely because it has been created in the accounts. Here, however, the issue is the treatment of an amount forming part of a provision which was disallowed in the preceding year and is separately identified as a reversal in the year under appeal. The disallowance below rests on the proposition that a reversal not routed through the profit and loss account is necessarily inadmissible. That proposition does not address the tax effect of the earlier-year disallowance or the ledger trail for the amount in the year under appeal. Having regard to the prior-year add-back, the current-year identification of the reversal and the supporting ledger and expenditure material, the disallowance of ₹1 crore is deleted.

16. The assessee has also challenged the disallowance of education cess amounting to ₹86,66,000. Explanation 3 to section 40(a)(ii), inserted by the Finance Act, 2022 with effect from 1 April 2005, clarifies that “tax” includes any surcharge or cess, by whatever name called, levied on the profits or gains of any business or profession. The assessee’s written submission acknowledges that the issue stands against it in view of the retrospective amendment and the decision of the Tribunal in Tech Mahindra Business Services Ltd., ITA No. 1256/Mum/2022, order dated 24 July 2023. The disallowance of ₹86,66,000 is therefore confirmed, and the assessee’s ground on this issue is dismissed.

ITA No.4287/Mum/2026

17. The Department’s appeal challenges the deletion of the disallowance of ₹6,62,35,000 made under section 14A read with Rule 8D. The learned CIT(A) recorded that although the assessee held investments, no income which did not form part of its total income had been received or accrued during the year under consideration. The Assessing Officer did not dispute this factual position. The learned CIT(A), following the applicable jurisdictional position, held that in the absence of exempt income the mere existence of investments did not justify a disallowance under section 14A.

18. The learned counsel supported the order of the learned CIT(A), pointing out that the absence of exempt income is recorded in both the assessment and appellate orders. The learned CIT-DR has not brought any material before us to show that exempt income was earned by the assessee during the relevant previous year. The disallowance was computed by applying Rule 8D to the investments despite the absence of exempt income. In these facts, the learned CIT(A) was justified in deleting the disallowance. The Department’s ground is dismissed.

19. The assessee’s ground relating to interest under sections 234A, 234B and 234C is consequential and shall be recomputed, if necessary, in accordance with the income determined pursuant to this order. The general grounds do not call for separate adjudication. The challenge based on natural justice also does not warrant separate relief: the assessment order records that the assessee responded to the notices, filed replies to the show-cause notices and participated in the video-conference hearing. The assessee has not demonstrated any specific denial of opportunity which caused prejudice in the determination of the issues before us.

20. In the result, the assessee’s appeal is partly allowed, while the Department’s appeal is dismissed.

Order pronounced on 29th September, 2026.