CA Vinamar Gupta
Special Bench presided by ITAT President Mr. DD Sud in the case of National Agriculture Co-operative ITA 1999 & 2000/Del/2008 pronounced on 16-10-2015 has touched and dealt at length the issues of deductibility of expenses in case of Contractual and Statutory liability disputes with the aide of Judicial pronouncements and adumbrated vital principals of law on the subject as under:
1. Where claim of damages and interest thereon is disputed by the assessee in the court of law and decision of paying damages though decided against assessee by Civil Court is stayed by another order during the relevant assessment year, deduction can not be allowed for the interest claimed on such damages while computing business income till the time issue gets finally settled.
2.(a) Under the mercantile system of accounting, an assessee gets deduction when liability to pay an expense arises, notwithstanding its actual quantification and discharge taking place subsequently.[Para 5]
(b) However, If the liability itself is uncertain, it assumes the character of a contingent liability and ceases to be deductible.[para 5]
(c) The aspect of incurring a liability needs to be understood in a correct perspective. It is here that a distinction between a contractual and a statutory liability assumes significance. ( A statutory liability is incurred on a mere issuance of a demand notice against the assessee and becomes deductible at that point of time. The factum of the assessee raising a dispute against such a demand does not ruin the incurring of liability. On the contrary, a contractual liability is not incurred on a mere raising of demand by a claimant. It arises only when such a claim is either acknowledged or in a case of non-acceptance, when a final obligation to pay is fastened coupled with the claimant acquiring a legal right to receive such an amount. Unless the claimant acquires an enforceable right to receive, it cannot be said that the first person has incurred a liability to pay such an amount. To put it simply, in the case of a contractual dispute between the parties, liability of the assessee to pay arises only when the claimant against the assessee acquires some legal right to receive the amount. In the absence of the vesting of any such right in the claimant, neither he earns any income nor the assessee incurs a corresponding liability to pay, entitling him to claim deduction for the same. Crux of the matter is that except for the assessee accepting a contractual claim, his liability to pay does not arise until some legal obligation to pay is fixed on him. A legal obligation to pay is attached on an assessee when a competent court passes order and a suit is decreed against him and not during the pendency of litigation.[Para 5]
(d) In such a situation, the period to which the expense originally pertained, loses its relevance.[Para 10]
3. Hon’ble Supreme Court in CIT vs. A. Gajapathy Naidu (1964) 53 ITR 114 (SC), laying down the law in relation to accrual of income in the following terms :No power is conferred on the ITO under the Act to relate back an income that accrued or arose in a subsequent year to another earlier year, on the ground that that income arose out of an earlier transaction. Applying the same principle to expenses, a deduction can be allowed only in the year in which the liability to pay them finally arises, irrespective of the year to which they actually relate.[para 11]
4. Hon’ble Supreme Court in the case of CIT vs. Hindustan Housing & Land Development Trust Ltd. (1986) 161 ITR 524 (SC) “ The assessee preferred appeal before the arbitrator, who made the award fixing higher amount of compensation. The State Government appealed to the High Court and, during the pendency of the appeal, the assessee was permitted to withdraw the amount on furnishing security. The AO brought to tax the difference between the amount paid to the assessee in terms of the award and the amount already paid. This amount was treated as liable to tax on the ground that the income accrued to the assessee on the date of the award. When the matter finally came up before the Hon’ble Apex Court, Their Lordships held that no income accrued to the assessee as there was no absolute right to receive the amount at that stage inasmuch as the arbitrator’s award enhancing compensation for acquisition of the assessee’s land was put in jeopardy by the State Government on filing an appeal against that very right and nothing would be due if the appeal was decided against the assessee. Noticing that there was no absolute right to receive the amount at that stage, the Hon’ble Summit Court held that: `There is a clear distinction between cases such as the present one, where the right to receive payment is in dispute and it is not a question of merely quantifying the amount to be received, and cases where the right to receive payment is admitted and the quantification only of the amount payable is left to be determined in accordance with settled or accepted principles.”[Para 13]
5. In R.C. Gupta 166 Taxmann 191(Del.), Delhi High Court, it was held that where purchases were made by the assessee but there was dispute regarding liability to pay, the assessee be allowed deduction in the year of purchase. However Special Bench distinguished it saying that in R.C. Gupta(supra) liability was incurred , the only issue was timing of deductibility. However, in present case the disputing is regarding incurring of liability itself [Para 16]
6. Another case quoted was Jasjit Films 165 Taxmann (Del), where in Delhi High Court decided that where demend for ground rent for earlier years also was demanded by DDA, the liability gets crystallized only in the year of demand and can be allowed in the year of demand of liablility, although it contains rent for earlier years aso.
7. In yet another case of CIT vs. Industrial Finance Corporation of India Ltd. (2009) 185 Taxmann 296 (Del), the assessee entered into a forward contract for purchase of foreign currency on a future date at a predetermined rate and the difference between forward contract rate and exchange rate on the date of entering into the contract was recognized as deduction, which the AO refused to allow by treating it as a contingent liability. The Hon’ble Delhi High Court overturned the view taken by the AO and finally held that this is an ascertained and definite liability in terms of contract and, hence, eligible for deduction. [Para 18]
8. The deductibility or otherwise of an expenditure in the income-tax proceedings depends on the appreciation of the correct legal position under the Act and not what the assessee claims under any proceedings or its treatment as contingent liability in the books of account.[Para 20]
9. Entries in the books of accounts are not conclusive of the accrual of Income or deductibility of expenses. Support drawn from Shoorji Vallabhdass (SC) 46 ITR 144 and Smifs Securities 348 ITR 302(SC).
Conclusion: While in case of statutory liability, just issue of demand notice is sufficient of invoke allowability of expense, even if the liability is not admitted by the assessee and an appeal or other judicial proceedings are carried out. But in case of contractual liability, the expense can be claimed only when the dispute is finally settled and claimant against the assessee acquires some legal right to receive the amount.