Business expenditure – Section 37(1) of ITA, 1961 – Where assessee company, engaged in business of construction and sale of residential and commercial building complexes, sold a building which was under construction at time of sale and incurred expenditure for completing its construction during financial year subsequent to sale of building, such expenditure was liable for deduction u/s 37(1)

Business expenditure – Section 37(1) of ITA, 1961 – Where assessee company, engaged in business of construction and sale of residential and commercial building complexes, sold a building which was under construction at time of sale and incurred expenditure for completing its construction during financial year subsequent to sale of building, such expenditure was liable for deduction u/s 37(1)

The assessee was a company engaged in the business of construction and sale of residential and commercial building complexes. During the A.Y. 2009-10 the assessee sold a portion of the mall building being constructed by it. The construction of the building was not complete at that time. The assessee incurred expenditure during the financial years 2009-10 and 2010-11 for completing the construction and claimed it as deduction. The AO disallowed the same.

The Commissioner (Appeals) held that in a situation where at the time of assessment the building remains incomplete, estimated future expenditure to be incurred was also considered along with the expenditure already incurred and was taken as cost relatable to the total saleable area, i.e., saleable area already built and the saleable area to be built in future, for arriving at the estimated cost of construction per square foot (sq. ft.). Therefore, the contentions of the assessee were accepted and it was held that the AO was not justified in not taking the value of building work-in-progress during the financial years 2009-10 and 2010-11 for working out the cost per sq. ft.

It was directed that the cost per sq. ft. would be taken as total expenditure incurred in construction, divided by the total saleable area, for the purpose of working out the profit from the sale of commercial area. The Tribunal upheld the decision of the Commissioner (Appeals).

The Revenue filed an appeal before the High Court and contended that the claim for deduction of future expenses made by the assessee could not be allowed. It contended that there was a distinction between the amount spent to pay off an actual liability and a liability that would be incurred in future which was only contingent. It was contended that the former was deductible but not the latter.

The Kerala High Court upheld the decision of the Tribunal and held as under:

‘(i) The dispute raised by the Revenue is only with regard to the deduction claimed by the assessee in respect of the expenses incurred in future, that is, after the sale of the building, during the subsequent financial years, and not in respect of the expenses incurred by it during the relevant financial year. Section 37 is a residuary section for allowability of business expenditure.

(ii)    The expression “profits and gains” has to be understood in its commercial sense and there can be no computation of such profits and gains until the expenditure which is necessary for the purpose of earning the receipts is deducted therefrom –whether the expenditure is actually incurred or the liability in respect thereof has accrued even though it may have to be discharged at some future date. The profit of a trade or business is the surplus by which the receipts from the trade or business exceed the expenditure necessary for the purpose of earning those receipts. It is the meaning of the word “profits” in relation to any trade or business. Whether there be such a thing as profit or gain can only be ascertained by setting against the receipts the expenditure or obligations to which they have given rise.

(iii)    “Expenditure” is not necessarily confined to the money which has been actually paid out and it covers a liability which has accrued or which has been incurred although it may have to be discharged at a future date. However, a contingent liability which may have to be discharged in future cannot be considered as expenditure. It also covers a liability which the assessee has incurred in praesenti although it is payable in futuro.

(iv)    In order to claim deduction of business expenditure, it is not necessary that the amount has been actually paid or expended during the relevant accounting year itself and it is sufficient that the liability for payment had incurred or accrued during the relevant accounting year and the actual payment of amount or discharge of liability may occur in future and what is crucial is the accrual of liability for payment or expenditure during the relevant accounting year. But a contingent liability that may arise in future cannot be treated as expenditure. Thus, the substantial question of law is answered in favour of the assessee and against the Revenue.’