DEDUCTIBILITY OF ADVANCE PAYMENTS – Section 43B

This section, which was inserted with effect from assessment year 1984-85, to the extent relevant for our discussion, reads as under:

43B. Notwithstanding anything contained in any other provision of this Act, a deduction otherwise allowable under this Act in respect of—

(a) any sum payable by the assessee by way of tax, duty, cess or fee, by whatever name called, under any law for the time being in force, or

(b) any sum payable by the assessee as an employer by way of contribution to any provident fund or superannuation fund or gratuity fund or any other fund for the welfare of employees, or

(c) any sum referred to in clause (ii) of sub-section (1) of section 36, or

(d) any sum payable by the assessee as interest on any loan or borrowing from any public financial institution or a State financial corporation or a State industrial investment corporation, in accordance with the terms and conditions of the agreement governing such loan or borrowing, or

(e) any sum payable by the assessee as interest on any loan or advances from a scheduled bank in accordance with the terms and conditions of the agreement governing such loan or advances, or

(f) any sum payable by the assessee as an employer in lieu of any leave at the credit of his employee,

shall be allowed (irrespective of the previous year in which the liability to pay such sum was incurred by the assessee according to the method of accounting regularly employed by him) only in computing the income referred to in section 28 of that previous year in which such sum is actually paid by him :

Provided that nothing contained in this section shall apply in relation to any sum which is actually paid by the assessee on or before the due date applicable in his case for furnishing the return of income under sub-section (1) of section 139 in respect of the previous year in which the liability to pay such sum was incurred as aforesaid and the evidence of such payment is furnished by the assessee along with such return.

Explanation 2 to section 43B provides that for the purposes of clause (a), “any sum payable” means a sum for which the assessee incurred liability in the previous year, even though such sum may not have been payable within that year under the relevant law.

Therefore, in respect of the specified sums , even if the liability has been incurred, but payment has not been made, the deduction would not be allowable in the year in which the liability is incurred, but would be allowable in the year of payment.

The section begins with a non-obstante clause that has the effect of overriding the provisions of the Act . It further states that a deduction otherwise allowable in respect of the specified sums will be allowed in the year of actual payment.

A controversy has arisen in respect of a converse type of situation where the payment has been made, but liability to pay has not yet been incurred, particularly in respect of taxes which are covered by clause (a). While the Kerala High Court has taken the view that the deduction would not be allowable in the year of payment if the liability has not been incurred as per the method of accounting, the Calcutta, Punjab & Haryana and Delhi High Courts have taken a contrary view to the effect that the deduction would be allowable u/s 43B in the year of payment, even if the liability to pay tax or duty was incurred in the next year under the mercantile system of accounting followed by the assessee. A related controversy has also arisen for allowance of deduction, in the year of payment, though the liability to pay the same may not have arisen under the relevant statute governing the expenditure in the year of payment. The special bench of the ITAT favours the grant of allowance in the year of actual payment.

Kerala solvent extractions’ case
The issue arose before the Kerala High Court in the case of CIT v. Kerala Solvent Extractions, 306 ITR 54.

In this case, pertaining to assessment year 1994-95, the assessee which was following the mercantile method of accounting, made an additional payment of Rs. 23 lakhs towards sales tax payable for April 1994. This amount was claimed as a deduction for the year ended 31st March 1994. The Assessing Officer disallowed the claim u/s 143(1)(a), since it was specifically stated in the accounts accompanying the return that the amount paid was towards sales tax for April 1994.

The assessee’s appeal against the disallowance was allowed by the Commissioner(Appeals), who held that the disallowance of the amount paid towards advance sales tax was a debatable point. The Tribunal confirmed the order of the Commissioner(Appeals).

Before the Kerala High Court, it was argued on behalf of the Revenue that sales tax liability payable in April 1994 was not an allowable deduction u/s 37(1) r.w.s 145. It was argued that the claim was not allowable as the assessee had not incurred expenditure, and that unless the amount paid was the liability of the assessee for the previous year, it could not be allowed, no matter whether the assessee had paid it or not. On behalf of the assessee, it was contended that the tax having been paid in the previous year, though not a liability of the year, was an allowable deduction under clause (a) of section 43B read with explanation 2.

The Kerala High Court observed that it was not in dispute that the sales tax liability of the assessee was an allowable deduction in the computation of income from business by virtue of section 29 r.w.s 37(1), that income chargeable under the head “Profits and Gains of Business or Profession” was to be computed in accordance with either cash or mercantile system of accounting regularly employed by the assessee, that the assessee was following the mercantile system of accounting and that like any other liability, sales tax liability should be claimed and allowed on mercantile basis. It was also undisputed that the sales tax liability of Rs. 23 lakh pertained to April 1994, which fell in the next financial year, and that u/s 145, the assessee was not entitled to deduction of this amount in the earlier year of payment.

According to the Kerala High Court, the issue was whether section 43B entitled the assessee to deduction of liability of the next financial year merely because the amount was paid by the assessee during the previous year relevant to the assessment year. The Kerala High Court observed that words of section 43B showed that the section dealt with deductions otherwise allowable under the provisions of the Act, and that the section only laid down the conditions for eligibility for deduction of certain al-lowances which were otherwise admissible under the Act. According to the Kerala High Court, the scheme of section 43B was to allow the deductions referred to in clauses (a) to (f) only on payment basis, even though the assessee was following the mercantile method of accounting. In other words, section 43B was an exception to section 145, inas-much as even if the claim was allowable deduction based on the system of accounting, it would still be inadmissible u/s 43B if it was not paid on or before the end of the relevant previous year, or at least before the date of filing of the return. The Kerala High Court therefore held that section 43B was only supplementary to section 145 and was only an additional condition for allowance of deductions otherwise allowable under the other provisions of the Act.

The Kerala High Court, on examination of the scheme of the sales tax, noted that under the scheme, the liability for payment of sales tax arose on the due date of filing of the monthly returns and the final return and the liability therefore arose only on due date of filing of the return. Under this scheme, if the assessee remitted any amount in the financial year towards tax payable for any month of the next financial year, this amount did not constitute tax liability of the assessee for that previous year, but would be carried as an amount of tax paid in advance for the next year, and would be adjusted towards tax liability for that year. If the assessee discontinued business, it was entitled to get refund of the tax paid in the earlier year.

According to the Kerala High Court, explanation 2 to section 43B did not justify the claim of the assessee for deduction because even under that provision, only liability incurred by the assessee during the previous year was allowable on payment basis. What the explanation contemplated was incurring of liability by the assessee in the previous year, though the amount was not payable during the previous year under the relevant law. The Kerala High Court noted that so far as sales tax was concerned, it was a tax on sale or purchase of a commodity. Since the liability arose under the statute and the payment was not towards tax due for the previous year or payable in that year, the assessee was not entitled to claim deduction u/s 29 r.w.s 37(1) and 145.

The Kerala High Court therefore held that the asses-see was not entitled to the deduction in the year of payment, and further confirmed that the payment of sales tax was prima facie disallowable, and hence upheld the disallowance u/s 143(1).

Paharpur cooling towers’ case

The issue again came up recently before the Calcutta High Court in the case of Paharpur Cooling Towers Ltd v. CIT, 244 CTR 502.

In this case, for assessment year 1996 -97, the assessee paid a sum of Rs. 3.22 crore on account of excise duty, the liability for payment of which was incurred in the previous year relevant to assessment year 1997- 98. The assessee claimed deduction in respect of the amount actually paid by it during the previous year ended 31st March 1996 in the assessment for assessment year 1996-97, u/s 43B.

The assessing officer disallowed the assessee’s claim for deduction of the excise duty paid on the ground that the liability for such excise duty was not incurred during the previous year relevant to assessment year 1996-97. The Commissioner(Appeals) allowed the appellant’s claim for deduction of excise duty. The tribunal allowed the appeal of the revenue against the order of the Commissioner(Appeals), upholding the disallowance of such advanced payment of excise duty.

The Calcutta High Court observed that the requirement of section 43B(a) was that the assessee must have actually paid the amount, as well as incurred liability in the previous year for the payment, even though such sum may not have been payable within that year under the relevant law. The court noted that the assessee had undoubtedly paid the duty in the previous year and such payment was made consequent upon the liability incurred in the very year, but in view of the fact that it followed the mercantile system of accounting, the amount was legally payable in the next year. According to the High Court, the amount therefore was clearly covered by section 43B read with explanation 2.

The High Court further noted that the position would have been different if the amount was not paid in the previous year, in which case the assessee would not have been eligible to get the benefit. The object of the legislature was to give the benefit of deduction of tax, duty, etc. only on payment of such amount, liability of which the assessee had incurred and not otherwise. Even if the tax or duty was payable in the next year in view of the system of accounting followed by the assessee, according to the Calcutta High Court, if the liability was ascertained in the previous year and the tax was also paid in that same year, there was no scope of depriving the assessee of the benefit of deduction of such amount.

The Calcutta High Court, after analysing the reasons for introduction of section 43B, stated that it was never the intention of the legislature to deprive the assessee of the benefit of deduction of tax, duty, etc, actually paid by him during the previous year, although in advance, according to the method of accounting followed by him. The Calcutta High Court observed that, if the reasoning given by the tribunal were accepted, an advance payer of tax, duty, etc payable in accordance with the method of accounting followed by him would not be entitled to get the benefit even in the next year when liability to pay would accrue in accordance with the method of accounting followed by him, because the benefit of section 43B was given on the basis of actual payment made in the previous year.

The Calcutta High Court therefore held that the advance excise duty paid was allowable as a deduction in the year of payment, though the liability to pay such duty arose in the subsequent year as per the method of accounting employed by the assessee.

A similar view was taken by the Delhi High Court in the case of CIT v. Modipon Ltd (No 2) 334 ITR 106, as well as by the Punjab and Haryana High Court in the case of CIT v Raj and San Deeps Ltd 293 ITR 12, again in the context of excise duty paid in advance.

Observations

The dispute is two fold. In claiming deduction based on actual payment while computing the total income of the year payment, whether it is necessary that the liability to pay the specified sum has arisen (a) under the respective statute governing the expenditure and(b) under the method of accounting employed by the assessee. The Revenue’s case is that for an allowance of deduction, it is essential that three conditions are satisfied; liability under the governing statute, liability under the method of accounting and the actual payment. It is only on compliance of all the three conditions that an assessee shall be entitled to a valid claim of deduction. In contrast, the assesses are of the view that the only condition necessary for a valid deduction is the actual payment and once that is proved the claim cannot be frustrated.

The purpose behind the introduction of section 43B, and the reasons for introduction of Explanation 2 are narrated by the Explanatory Memorandum reported in 176 ITR (St) 123. It states that the objective of section 43B is to provide for a tax disincentive by denying deduction in respect of a statutory liability which is not paid in time. The first proviso to section 43B was introduced to rule out the hardship caused to certain taxpayers who had represented that since the sales tax for the last quarter cannot be paid within the previous year, the original provisions of section 43B would unnecessarily involve disallowance of the payment for the last quarter. The Memorandum further states that certain courts had interpreted the words “any sum payable” to the effect that the amount payable in a particular year should also be statutorily payable under the relevant statute in the same year. This was against the legislative intent and it was therefore being proposed, by way of a clarificatory amendment and for removal of doubts, that the words “any sum payable” be defined to mean any sum, liability for which had been incurred by the taxpayer during the previous year, irrespective of the date by which such sum was statutorily payable.

The language of the provision specifically provides for overriding or ignoring the method of accounting. Once that is done, there is no enabling provision found in the section that requires looking back to the method of accounting for ascertaining the eligibility of the deduction, otherwise. The only requirement is to ascertain the fact of the actual payment. If the payment is made , the deduction is allowed and should be allowed instead of denying the same.

The actual payment of the specified sum, under the provision, is the key consideration for allowance of the deduction. It emerges nowhere that a person should satisfy the twin conditions of the liability and of the actual payment as well, before a lawful deduction is claimed and allowed. To read the condition of the incurring of the liability in the section amounts to doing a serious violence to the provision and should be avoided. The use of the words ‘irrespective of the previous year in which the liability to pay such sum was incurred’ clearly puts to rest any doubts about the intention of the legislature, which is to allow the deduction in the year of payment, irrespective of the year in which liability was incurred.

Further, nothing is gained by denying a lawful deduction based on actual payment, as the payment is the conclusive proof of the intention of the payer. It may be that in some stray cases, the person making the payment in advance is refunded the sum paid. In such cases, the law has enough provisions to tax the refund in his hands including under the provisions of s.41(1) of the Act.

It is nobody’s case that a deduction should be allowed on payment in respect of an expenditure that is otherwise not allowable under the Act. The deduction should surely be for an expenditure that is allowable in computing the income under the provisions of the Act. In view of this position, any attempt to frustrate a deduction by relying on the opening part of the section which uses the term ‘a deduction otherwise allowable’ should be nipped in the bud. The said term simply means that the claim should be of an expenditure that is otherwise allowable under the Act and not necessarily w.r.t. the method of accounting. If the intention were to first determine the allowability on the basis of the method of accounting , it would have been provided there and then, by stating that ‘ a deduc-tion otherwise allowable on accrual’ or ‘as per the method of accounting’. On the contrary, the latter part simply advises one to ignore the method of accounting.

The next difficulty is about the need for accrual of liability under the relevant statute that provides for the expenditure and its relation to the Explanation 2. The scope of the said Explanation 2 is restricted to only those payments which are covered by clause(a) of s. 43B of the Act. This again emphasizes the fact that the scheme of the deduction is based on one and only condition and that is that of the actual payment, at least as far as the deduction under clauses(b) to(f) are concerned and if that is so, there is nothing that permits assigning of a different treat-ment for clause(a) payments. With great respect to the Calcutta High Court, it seems that the court’s observation that in order for a valid deduction, it was necessary that the liability for such payment should have been incurred under the relevant law in the same year in which the amount was paid, though it might not have become payable under the method of accounting employed by the assessee, does not seem justified. Kindly note that the said Explanation 2 itself supports the claim for the deduction in the year of payment, irrespective of the liability to pay, when it states ‘even though such sum might not have been payable within that year under that law’. If that is so, undue importance is not required to be given, for the purposes of deduction under the Income tax Act, to accrual of liability and the time thereof, under the relevant laws governing the payment of the expenditure. The Delhi High Court seems to support this position when it stated that the purpose of s. 43B is ‘subserved by the payment of the duty to the Department concerned’.

The Special Bench of the Income Tax Appellate Tribunal also had occasion to consider this issue, though again in the context of excise duty, in the case of DCIT v. Glaxo Smith Kline Consumer Health-care Limited, 299 ITR (AT) 1 (Chd)(SB). Some of the observations of the members of the special bench are interesting and throw considerable light on how section 43B is to be viewed in the case of advance payments, and are reproduced below:

(i)    There is no reference to any condition to establish “accrual of liability” for the claim of deduction. Only actual payment is insisted upon. The whole idea of enactment of section 43B is to change the system and replace the condition of allowability of deduction from incurring of the liability to actual payment. Having in mind the provision of section 43(2) and the purpose of section 43B, there is no question of asking the assessee to prove actual payment as well as incurring of a liability.

(ii)    It is not necessary that the assessee must prove incurring of a specific liability under any statute referred to in the different clauses of section

43B. It must be an expenditure connected and related to the assessee’s business deductible u/s 28 of the Act. It should not be a prohibited item totally unrelated to the business of the assessee. The expression “a deduction otherwise allowable” only means statutory liabilities mentioned in section 43B. The expression “a deduction otherwise allowable” reflects deduction on account of general liability fastened to the assessee’s business on account of duties, taxes, cess or fees by whatever name called, arising in the course of the carrying on of the business. The expression does not mean any specific liability which is required to be incurred.

(iii)    There is no justification to examine the previous year in which liability to pay the sum was incurred, when the mandate is “irrespective of the previous year in which liability was incurred” and the claim is to be allowed on the basis of actual payment. To do otherwise would be in violation of the words “irrespective of the previous year” in which the liability was incurred and disregard the mandate of the section.

(iv)    Section 43B brought in a change in the normal rule of deduction of expense based on the accounting method followed by an assessee. The rule of deduction u/s 43B is actual payment of the liability. When the payments are understood as actual payments, those payments even if mentioned as advance payments, need to be allowed as deduction u/s 43B.

(v)    Section 43B provides for the deduction of sums payable mentioned in clauses (a) to (f), only if actually paid ; but they shall be allowed irrespective of the previous year in which the liability to pay such sum was incurred by the assessee. The expression “irrespective of the previous year” means the deduction has to be allowed regardless of the previous year. Any reference to the time of incurring or accruing of the liability is dispensed with by the statute while concentration is made on the point of actual payment of the sum to the Treasury of the Government.

(vi)    It is highly improbable to presume that an assessee would indulge in tax avoidance by actually paying money towards duties and taxes. Any such benefit arising to an assessee is only incidental.

(vii)    The section does not lay down any rule that the liability to pay the duty must be incurred first and only thereafter the payment of such duty made, so as to claim the deduction under section 43B. The expression “otherwise allowable” refers to a declaration that payments which are available as deductions u/s 43B, are those expenses which are usually allowed by the Income-tax Act for the purpose of computing income. The expression “any sum payable” does not mean “payment outstanding”.

On a combined reading of the provisions together with the Explanatory Memorandum and of the intention and the history behind the provisions, amended form time to time, it is clear that section 43B completely overrides the method of accounting and therefore section 145, and that even advance payments of tax are allowable as deduction, in the year of actual payment, even if the liability to pay the tax did not arise during the previous year, but in a subsequent year.

The view taken by the high courts in favour of the allowance of deduction on payment is , in our respectful opinion, a better view of the matter.

Further, the view that the deduction is allowed under the Income tax Act in the year of payment , as held by the special bench of the ITAT, irrespective of its year of accrual under the relevant statute providing for liability to the expenditure, once the actual payment is made, is a far better view.