Section 37(1) – If a claim of damages and interest thereon is
disputed by the assessee in the court of law, deduction cannot be
allowed for the interest claimed on such damages. Deduction can be
allowed only when an enforceable liability to pay the same arises
irrespective of the fact that it relates to earlier years.
Facts
For
assessment year 2001-02, the assessee filed its return of income and
the assessment was completed on 27.2.2004 u/s. 143(3) of the Act. During
the course of assessment proceedings for AY 2003-04, a special audit
u/s. 142(2A) was carried out which divulged interalia that the assessee
had claimed deduction for interest payable to M/s Alimenta SA
Switzerland (`Alimenta’) on account of arbitration award, which was
disputed by the assessee. The Assessing Officer (AO) observed that the
assessee claimed deduction of interest amounting to Rs. 7.92 crore
payable to Alimenta for AY 2001-02. Such interest was not debited to P
& L Account, but was directly reduced in the computation of total
income. He also observed that since tax was not deducted at source,
amount was not allowable u/s. 40(a)(i) as well. Notice u/s. 148 was
issued and duly served on the assessee.
In the course of
assessment proceedings, the AO noticed that the claim for deduction was
not backed by any corresponding liability to pay; the liability claimed
by the assessee as deduction was not acknowledged due to ongoing
litigation and proceedings for compromise. He also noticed that the
assessee had not deducted tax and therefore in view of provisions of
section 40(a)(i), as well, the amount was not allowable. He rejected the
assessee’s contention that there was a breach of contract on its part
for which the Delhi High Court held it liable for loss incurred by
Alimenta and also interest @ 18% per annum from the date of award till
the date of realisation; the judgment delivered by Delhi High Court was
binding, the liability was determined and ascertained because of the
decree of the Delhi High Court notwithstanding the assessee filing an
appeal against it.
The AO disallowed the assessee’s claim.
Aggrieved, by the additions made, the assessee preferred an appeal to the CIT(A) who confirmed the action of the AO.
Aggrieved,
by the order passed by CIT(A), the assessee preferred an appeal to the
Tribunal. Similar issue was decided in favor of the assessee, by the
Tribunal, for assessment years 2003-04 and 2004-05. The Division Bench
was not convinced with the reasoning given by the Tribunal in its order
for AY s 2003-004 and 2004- 05 in deleting the disallowance of interest
and made a reference for constitution of a Special Bench.
The President posted the following question for consideration of the Special Bench-
“Whether
on 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 be allowed for the interest claimed on such damages while
computing business income?”
Held
(i) 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. 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. The 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. This difference between a contractual and a
statutory liability has been recognised 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).
(ii) On facts, 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.
(iii)
Now the moot question is, whether the assessee is entitled to deduction
for interest at the rate of 18% decreed by the ld. Single Judge of the
Delhi High Court in the computation of income for the years under
consideration. The answer will be in affirmative if the assessee had any
legal obligation to pay such interest during the years in question and
vice versa. We can do this by ascertaining if any legally enforceable
liability existed against the assessee to pay interest in the years
under consideration. Per contra, was Alimenta legally entitled to
receive such interest income during the years in question? It is
pertinent 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.
iv) Unless there is a specific contrary provision, deduction for an expense can be allowed in the year in which liability to pay finally arises. Once a person has not voluntarily accepted a contractual obligation and further there subsists no legal obligation to pay qua such contractual claim at a particular time, it cannot be said that the person incurred any liability to pay at that point of time so as to make him eligible for deduction on that count. Not withstanding the fact that obligation relates to an earlier year, the liability to pay arises only in the later year, when a final enforceable obligation to pay is settled against that person. In our considered opinion, 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. neither any income accrues to the claimant, nor any deduction is earned by the opposite party. We are instantly confronted with the second type of situation in which the obligation created against the assessee by the judgment of the ld. Single judge on 28.1.2000 was stayed by the judgment of the division Bench on 28.2.2001, which position continued till the decree on the judgment dt. 6.9.2010 reviving the judgment of the ld. Single judge, became enforceable. even though the crystallization of liability of the assessee to pay interest pursuant to the developments after 6.9.2010 also covers earlier years including the years under consideration, but such liability of the assessee became due only on the acquisition of right by alimenta to enforce the decree issued on the advent of the judgment dated 6.9.2010. Consequently, the assessee can claim deduction for such interest only at such a later stage and not during the years under consideration.
(v) The Special Bench answered the question posted before it in negative by holding that 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.
