By C. N. Vaze
Shailes h Kamdar
Jagdis h T. Punjabi
Bhadres h Doshi
Section
37(1) – Where assessee, a financial intermediary agent, enters into an
assignment agreement whereby liability of assignor is acquired by assessee at
its NPV, then difference between NPV of the said liability as at end of
relevant financial year and as at end of preceding financial year, till the
repayment of the liability commences, is allowed as finance charges.
FACTS
The assessee-company was engaged in business
of financial intermediary agents and earned income by way of commission and
professional fees and followed mercantile system of accounting.
During the assessment proceedings, the AO
inquired about the nature of payment of Rs.44,71,126/-that the assessee had
debited as finance charges in its profit and loss account.
In response to the same, the assessee
submitted that Indian Seamless Steels and Alloys Ltd. (ISSAL) had availed
interest free sales-tax deferral Certificate of Entitlement from the Government
of Maharashtra under the Package scheme of Incentives,1988. As per the said
scheme, sales-tax liability of each year was required to be paid by ISSAL to
the Sales-Tax Department of Government of Maharashtra in five equal annual
instalments upon expiry of ten years from the date of availment i.e. to say the
sales tax collected for the financial year 1994-95 was required to be repaid in
five equal annual instalments beginning with financial year 2005-06 and so on.
As a part of financing activity, the
assessee vide agreement dated 9th April 2001, took over
liability of the ISSAL for repayment of sales-tax deferral amounting to Rs.
835.98 lakh (collected by ISAAL for the period 1st April 2000 to 31st
March 2001) for a consideration of Rs.
268.79 lakh arrived at @10% NPV based on the repayment schedule. The said loan
was repayable by the assessee to Government in five equal instalments starting from
F.Y. 2011-12 and ending on F.Y.2015-16.
This NPV of liability amounting to Rs.
268.79 lakh as on 31.03.2001, got enhanced to 288.63 lakh as on 31.03.2002 and
the same was shown under the head ‘unsecured loans’ for the first time in the
balance sheet of the assessee as on 31.03.2002. The NPV of liability thus got
increased every year till the repayment would commence in the F.Y. 2011-12 and
the difference in NPV at the end of a particular financial year and the
immediately preceding year was claimed as expenditure under the head ‘finance
charges’ in the P&L account of that year.
Following the same method in this year, the
difference in NPV as on 31.03.2007 and as on 31.03.2006 amounting to Rs.
44,71,126/- was debited to the P&L account for the year under consideration
as expenditure under the head ‘finance charges’ and as it was not actually
paid, the said amount was also added to the existing outstanding liability and
shown under the head ‘unsecured loans’.
The AO was of the view that the amount so
debited was not a revenue expenditure as liability did not exist in praesenti
but was a contingent liability. He thus disallowed the claim of finance
charges.
The Commissioner (Appeals), endorsed the
action of the Assessing Officer.
On appeal before the Tribunal:
HELD
The judicial opinion of the various courts
is that a liability depending upon a contingency is not a debt in praesenti
or in futuro till the contingency happens. But if it is debt, the fact
that the amount has to be ascertained does not make it any less a debt if the
liability is certain and what remains is only a quantification of the amount.
The word ‘contingent’ in contrast, refers to possibility of an obligation or
liability to arise on occurrence or non-occurrence of one or more uncertain
future events.
An accrued
liability is an allowable deduction whereas a contingent liability is not an
allowable deduction for the purposes of determination of taxable income.
Therefore the pertinent question that arises for adjudication is whether,
difference in NPV of the liability at the end of a particular financial year
and the immediately preceding year claimed as expenditure under the head
‘finance charges’ in the P&L account of that year (i.e. Rs. 44,71,126/-
debited to P&L for relevant assessment year under consideration), is an
accrued liability or a contingent liability.
In terms of section 145 of the Income-tax
Act, 1961 read with section 211 of the Companies Act, 1956 – a company has to
mandatorily prepare its account on ‘accrual’ basis. The term ‘Accrual’ has been
defined by the Accounting Standard-1 and by section 145 of the Income-tax Act,
1961 as follows -.
‘Accrual’ refers to the assumptions that
revenues and costs are accrued, that is, recognized as they are earned or
incurred (and not as money is received or paid) and recorded in the final
statements of the periods to which they relate.
The Accounting Standard-1 further provides
that as a matter of prudent accounting policy, provisions should be made for
all known liabilities and losses even though the amount cannot be determined
with certainty and represents only the best estimate in the light of available
information. Under the Mercantile System of Accounting, the expenditure items
for which legal liability has been incurred are immediately debited even before
the amount in question is actually distributed.
In terms of section 28 read with section 145
of the Income Tax Act,1961 income chargeable under the head ‘profit and gains
of business or profession’ cannot be determined unless and until the expenses
or obligations which have been incurred are set-off against the receipts.
Therefore, in order to determine the true profits arising from business, the
expenditure actually incurred or liability in respect thereof accrued even
though it may have to be discharged at some future date has to be necessarily
accounted for.
In the present case, the assessee by virtue
of assignment agreement received certain amount which was to be replenished and
repaid by higher sum computed by applying Net Present Value method at a
discounting factor of 10%. The corresponding finance costs debited to profit
& loss account during the year represents incremental increase in the
liability with the efflux of time where the liability gets accrued as it inches
towards maturity. Thus, it was manifest that the incremental liability had
accrued to the assessee in praesenti with the efflux of time notwithstanding
the fact that increase in the liability was required to be actually discharged
on a future date. The gradual increase in liability is dependent on the time
horizon that has elapsed and therefore not an uncertain event by any stretch of
imagination. The liability has definitely accrued in praesenti against
future outflow of resources and the said liability can be determined with great
reliability.
In result, the appeal of the assessee is
allowed.
