ITAT Delhi held In the case of M/s National Agricultural Cooperative Marketing Federation of India Ltd. (NAFED) vs. JCIT that there is no qualitative difference between the two situations, viz., first, in which no enforceable liability to pay is created in the first instance, and second, in which though the enforceable liability was initially created but the same stands wiped out by the stay on the operation of such enforceable liability. In both the situations, claimant remains without any legal right to recover the amount and equally the opposite party without any legal obligation to pay the same. In the given case as the assessee did not incur any liability for payment of interest to Alimenta as at the end of the years under consideration and the arbitration award was also stayed by the court. Since no legally enforceable liability existed against the assessee, the deduction has been rightly denied.
Also in the facts and circumstances of the case, where claim of damages and interest thereon is disputed by the assessee in the court of law, deduction can’t be allowed for the interest claimed on such damages in the computation of business income.
Facts of the Case
The assessee filed its return and the assessment was completed on 27.2.2004 u/s 143(3). During the course of assessment proceedings pertaining to the A.Y. 2003-04, a special audit u/s 142(2A) was carried out which divulged, inter alia, that the assessee had claimed deduction for interest payable to M/s Alimenta SA Switzerland (Alimenta) on account of arbitration award, which was still disputed by it. The AO observed that the assessee claimed deduction of interest amounting to Rs.7.92 crore payable to Alimenta for the A.Y. 2001-02. Such amount of interest was not found to have been debited to the Profit & Loss Account but directly reduced in the computation of total income. He further observed that as per the provisions of section 40(a)(i) of the Act, this amount of interest was deductible only on the deduction of tax at source and payment thereof, which was not done by the assessee. Notice u/s 148 was issued 22.9.2006, which was duly served on the assessee.
Contention of the Assessee
The ld counsel of the assessee relied on certain judgments of the Hon’ble jurisdictional High Court to support the deductibility of interest. The referred judgments are R.C. Gupta vs. CIT (2008) 166 Taxmann 191 (Del), Jasjeet Films (P) Ltd. Vs. CIT (2007) 165 Taxmann 599 (Del) and CIT vs. Industrial Finance Corporation of India Ltd. (2009) 185 Taxmann 296 (Del).
Contention of the Revenue
The ld counsel of the revenues submitted that the assessee in its Annual report for the year 2012-13 has claimed the amount payable to Alimenta as a contingent liability on the ground of the same being sub judice. Similarly, in the Notes and explanatory statements, the assessee has given the reason for not providing this contingent liability in the books of account, on page 79 of its Annual report, that the award is under challenge before the Hon’ble Apex Court and based on expert legal advice, the assessee considers the disputed case likely to be decided in its favour.
Held by CIT (A)
The CIT (A) upheld the AO’s order and disallowances the interest claimed by the assessee. It was held that on identical issue, the assessee preferred appeals before the Tribunal pertaining to assessment years 1996-97 to 1998-99 and the Bench was pleased to hold that the liability for payment of such interest crystallized only in the period relevant to assessment year 2000-01 and hence no deduction was allowable in such years because the claim for interest at the end of such years was not an ascertained liability. He further took note of the view taken by him for the assessment years 2003-04 and 2004-05 in holding that the interest was not deductible.
The assessee’s contention about the finding of the Tribunal for the crystalization of liability on 28.1.2000 pursuant to the passing of the decree by the Hon’ble High Court against NAFED was held by the ld. first appellate authority to be only an obiter dicta i.e. not legally binding.
Held by ITAT
The Division Bench hearing the appeals for the extant years was not convinced with the reasoning given by the Tribunal in its order for the A.Ys. 2003-04 and 2004-05 in deleting the disallowance of interest and, accordingly, made a reference for the constitution of a Special Bench in terms of section 255(3).
It is undisputed that the assessee is following mercantile system of accounting and has neither paid such amount of interest nor claimed it as deduction in its books of account. Deduction was claimed directly in the computation of income. 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. The relevant criteria for the grant of a deduction is that the incurring of liability must be certain. If the liability itself is uncertain, it assumes the character of a contingent liability and ceases to be deductible. Thus, a deduction can be allowed only when an assessee incurs liability to pay an amount in the nature of an expense.
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. This difference between a contractual and a statutory liability has been recognized by the Hon’ble Delhi High Court in assessee’s own case since reported as National Agricultural Co-operative Marketing Federation of India Ltd. vs. CIT (2011) 338 ITR 36 (Del).
It is clear that the ld. Single Judge of the Hon’ble Delhi High Court vide his judgment and decree dated 28.1.2000 directed, inter alia, the payment of interest to Alimenta at 11.25% up to the date of award as allowed by FOSFA and at 18% from the date of award till the date of realization. It is undisputed that no payment of the principal amount of damages or interest has so far been finally made, except for furnishing bank guarantees etc. to some extent. The assessee filed a letters patent appeal against the judgment and decree of the ld. Single Judge which was stayed by the division bench vides order dated 28-02-2001. Certain interim orders were passed by the Hon’ble Supreme Court and the Hon’ble Delhi High Court, but the stay on the order and decree of the ld. Single Judge was not disturbed, which continued till the ld. Third Judge (on a difference of opinion between the two ld. Judges who heard the appeal) finally decided the appeal of the assessee vide its judgment dated 6.9.2010 holding that a letters patent appeal is not maintainable against the judgment dt. 28.1.2000 of the ld. Single Judge. A consequential judgment was passed in September, 2010. Effect of this judgment is that the stay order of the Division Bench passed on 28.2.2001 got vacated and the judgment and decree of ld. Single Judge dt. 28.1.2000 again came to be revived. On 17.1.2012, the Hon’ble Supreme Court rejected the prayer of the assessee for interim relief and gave liberty to Alimenta to enforce decree dated. 28.1.2000 passed by the ld. Single Judge of the Hon’ble Delhi High Court.
This sequence of events transpires that the legally enforceable liability against the assessee to pay interest at the rate of 18% to Alimenta, which was created by the decree of the ld. Single Judge dated 28.1.2000, remained suspended from the date of stay granted by the Division bench of the Hon’ble High Court on 28.2.2001. It is only on the passing of the consequential judgment and decree by the Hon’ble Delhi High Court in September, 2010, subject to certain stays etc. granted against the operation of this judgment, that the assessee incurred a legally enforceable liability to pay such interest to Alimenta.
It is patent that the stay order against the judgment and decree of the ld. Single Judge was passed by the Division Bench on 28.2.2001, which is well within the financial year relevant to the assessment year 2001-02 under consideration and remained operative in subsequent years including the immediately succeeding year in appeal. This shows that the assessee did not have any legal obligation to pay interest during these two years. The hitherto obligation which was created by the judgment of the ld. Single judge against the assessee was eclipsed and frustrated by the later judgment of the Division bench and such obligation ceased to exist for the time being.
This judgment in assessee’s own case has laid down that liability to pay interest arose on the ld. Single Judge passing decree on 28.1.2000 and till then there was no obligation to pay any interest and hence the assessee could not claim deduction of interest in the computation of income for the earlier years. The principle is that deduction becomes available only on coming into existence of a liability to pay and the liability to pay arises when it flows from a legally enforceable order. In such a situation, the period to which the expense originally pertained, loses its relevance. Since the decree in this case was passed by the ld. Single judge on 28.1.2000, which also covered interest for the periods relevant to the A.Ys. 1996-97 to 1998-99, the deduction of interest for such three years was held to be available not in these years but on crystallization of liability on 28.1.2000.
Albeit this judgment has been rendered on 3.6.2011, but the fact that the order and decree dt. 28.1.2000, which created liability to pay interest against the assessee, was stayed on 28.2.2001, appears not to have been brought to the notice of the Hon’ble High Court as it does not find mention anywhere in the judgment. Though this factor is otherwise crucial for our purpose, but does not have any material bearing on the conclusion about the non-deductibility of interest for the three years before the Hon’ble High Court inasmuch as the liability to pay such interest did not crystallize at the end of those three years de hors the stay on the judgment of the ld. Single Judge dated 28.1.2000. Be that as it may, the ratio decidendi of the judgment, which is not marred even by non mentioning by the parties about the stay of the ld. Single Judge’s order, is that deduction for interest can be allowed only when an enforceable liability to pay the same arises irrespective of the consideration that it relates to earlier years.
This view of the Hon’ble High Court accords with the one taken by the 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. Our view about non-availability of deduction for the years in question is further fortified by the judgment of the Hon’ble Supreme Court in the case of CIT vs. Hindustan Housing & Land Development Trust Ltd. (1986) 161 ITR 524 (SC).
It can be observed that the Tribunal, in deciding this issue in favour of the assessee, has been swayed by the fact that the ld. Single Judge passed the order/decree against the assessee on 28.1.2000. There is no reference in this order dated 18.7.2008 to the later development, being the order passed by the Division Bench on 28.2.2001 staying the operation of the earlier judgment and decree of the ld. Single Judge. This crucial fact of paramount importance was not brought to the notice of the Tribunal and it is on these half presented facts that the Tribunal allowed deduction of interest.
We consider it paramount to mention that the assessee has adopted diagonally opposite stands in civil proceedings and income-tax proceedings in so far as the question of interest liability is concerned. While on one hand the assessee in civil proceedings is seriously contesting its liability to pay interest, on the other hand, when the same question comes up in the income-tax proceedings, it has taken a transversely opposite stand that it has incurred liability towards interest payment and the same be allowed as deduction. There is an absolute mismatch between these two inconsistent stands taken by the assessee in income-tax and civil proceedings. Similar position is prevailing insofar as the assessee understands and reflection of such interest liability in its annual accounts is concerned.
Though 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, the idea behind incorporating these facts in the order is to accentuate the incongruous stand of the assessee on the same issue.
In our considered opinion, entries in books are not conclusive of accrual of income or deductibility of expenses. On the contrary, it is the incurring of liability or accrual of income by means of a legally enforceable right, which decides about the deductibility of an expense or earning of income. Our view gets strength from the judgment of the Hon’ble Supreme Court in CIT vs. SMIFS Securities Ltd. (2012) 348 ITR 302 (SC), which reiterates similar view taken in several earlier judgments including CIT vs. Shoorji Vallabhdas & Co. (1962) 46 ITR 144(SC).
Accordingly, question raised before special bench decided against the assessee.