We have to make provision for various expenses based on the estimates at
the year end as we are following the accrual system of accounting. But
the income tax department was disallowing the same on the ground that
same being contingent in nature and hence not allowable. Here are some
of the case study and opinion in this respect. Please go through the
same and send your valuable feedback at
mr_manish_ca@yahoo.com
1.The assessee company would like to refer the Honble
Supreme Court decision in the case of Calcutta Co. Limited v CIT (
37 ITR 1).
2.The summary of the facts & decisions of the aforesaid case
is given below.
Section 28(i) , read with section 145 of the Income-tax Act,
1961 (Corresponding to section 10(1), read with section 13 of the
Indian Income-tax Act, 1922) - Business deductions - Allowable as -
Assessment year 1948-49 - Asessee dealt in land and property and
carried on land developing business - It maintained its accounts in
mercantile method - In relevant accounting period it sold certain
plots and even though assessee received only a portion of sale
price, it entered in credit side of its account books whole of sale
price of plots - Under terms of side deeds assessee undertook to
carryout developments within six months from date of sale -
Accordingly, it estimated a sum as expenditure for developments to
be carried out in respect of plots sold out during relevant year and
debited said sum in its books of account as accrued liability -
Department did not take any exception to said estimated expenditure
in regard to quantum but disallowed assessee's claim for deduction
of that sum by relying upon provisions of section 10(2) of 1922 Act
- Whether estimated expenditure which had to be incurred by assessee
in discharging a liability which it had already undertaken under
terms of sale-deeds of lands in question was an accrued liability
which according to mercantile system of accounting assessee was
entitled to debit in its books of account for accounting year as
against receipts which represented sale proceeds of said lands -
Held, yes
3.The same was also confirmed in the case of F.F.E. Minerals
India (P) Limited v JCIT (142 Taxmann 110). The summary of the facts
& decisions of the aforesaid case is given below.
Section 28(i) of the Income-tax Act, 1961 - Business
loss/deduction - Allowable as - Assessment years 1997-98 and 1998-99
- Assessee-company claimed deduction for damages in computing its
income as soon as delay in supply was noticed and case of
under-performance remained at end of respective previous years -
Claims in books were based on terms of contract between parties -
Tribunal confirmed disallowance of claims as made by authorities
below - Whether since in view of decision of Supreme Court in case
of Calcutta Co. Ltd. v. CIT [1959] 37 ITR 1, liability arising out
of contract should be allowed as and when it arises and should not
be postponed to a later date, deduction claimed by assessee was
allowable - Held, yes.
4.The assessee company would like also to quote the recent
decision of Jharkhand High Court in the case of TRF Limited v CIT
(TAX APPEAL NOS. 42 TO 46 OF 2001).
5. The summary of the facts & decisions of the aforesaid case
is given below.
Section 37(1), read with section 145, of the Income-tax Act,
1961 - Business expenditure - Year in which deductible - Assessment
years 1991-92 to 1995-96 - Assessee-company was awarded a contract
by Rourkela Steel Plant for modernization of coal handling plant,
work related to structural fabrication, erection, dismantling and
modification - It had given work to PECO on sub-contract basis -
After commencement of work, PECO found sub-contract not profitable
and expressed inability to work - In order to retain PECO to
complete work, assessee agreed to enhance stipulated rates and to
provide additional facilities such as labour payment, supply of
consumables, etc., value of which was to be adjusted against revised
rates - Accordingly, assessee, from time-to-time, made payments
towards aforesaid facilities on actual basis of work completed -
Assessee raised bills on Rourkela Steel Plant for work done during
each year, value of which was duly credited to profit and loss
account of that year in accordance with mercantile system of
accounting followed by it - Accordingly, it made a provision in each
year for additional liability based on extra payments made to PECO
for work done and claimed deduction thereof - Revenue authorities
disallowed deduction on ground that additional payment made by
assessee was only an advance payment and same became liability only
on final settlement arrived at between parties on 28-7-1997 - On
appeal, Tribunal upheld disallowance - Whether since as per
mercantile system of accounting, income from Rourkela Steel Plant
was duly included in profit and loss account in respective years
according to work done, expenditure incurred for earning such income
was deductable even on estimated basis for arriving at true income -
Held, yes - Whether assessee's claim was to be upheld - Held, yes.
6.The facts & decisions of CIT v Triveni Engineering &
Industries Limited (196 Taxmann 94) case is given below.
Section 37(1) of the Income-tax Act, 1961 - Business
expenditure - Year in which deductible - Assessment year 2000-01 -
Assessee was following revenue recognition accounting policy
consistently as per which profit on its project related activities
was recognized on completion or on substantial completion of project
- During relevant assessment year, assessee credited profit and loss
account by income in respect of projects completed/substantially
completed during year - It also made provision for expenses to be
incurred up to stage of completion - Assessing Officer held that
such a liability, to be incurred on a future date, was a contingent
liability and, therefore, could not be allowed under section 37(1) -
On appeal, Tribunal allowed assessees claim - Whether when
admittedly, expenditure incurred by assessee on project was
admissible deduction and only dispute was regarding year of
allowability of expenditure, considering that assessee was a company
assessed at uniform rate of tax, entire exercise of seeking to
disturb year of allowability of expenditure would, in any case, be
revenue neutral - Held, yes - Whether therefore, no substantial
question of law arose in instant case and appeal was to be dismissed
- Held, yes.
7.With respect to the above case, the assessee company
humbly submits that in case provision for aforesaid expenses not
allowed in one year, they are going to be allowed in another year
and hence the effect of same is neutral.
8.Further, Provision for Warranty is allowable expenditure
based on the following judgments.
Himalaya Machinery (P) Limited v DCIT 334 ITR 64
CIT vs. Luk India P. Ltd. 52 DTR 117.
Siemens Public communication Networks Limited v CIT
Rotork Controls India P. Ltd. (2009) 314 ITR 62 (SC).
CIT v Indian Transformer Limited. 270 ITR 259
9. Also, Provision for foreign exchange loss is allowable
expenditure based on the following judgments.
DCIT v Bank of Baharain & Kuwait
Woodword Governor 294 DTR 451
Diamonds R US v DCIT 9 Taxmann.com 67.
LG Electronics India (P) Limited 309 ITR 265.
Oil & Natural Gas Corporation Limited v CIT. Civil
Appeal No. 7223 of 2008 dated March 15, 2010.
10.At last, Section 145 of the Income Tax Act, 1961
prescribes the method of accounting to be followed by the assessee
for computing income chargeable under the head Profits and gains of
business or profession. Section 145(1) states that the computation
would be in accordance with either cash or mercantile system of
accounting regularly employed by the assessee. Section 145(2)
further states that the Central Government may notify from time to
time accounting standards to be followed by any class of assessees
or in respect of any class of income. The mercantile system, as
distinguished from the cash system brings in the concept of accrual
of liability or income in the relevant previous year which is the
subject-matter of the assessment. The liability is reflected even
where there is no actual expenditure; likewise the income is
reflected even where there is no actual receipt of money. Moreover,
section 209(3) of the Companies Act, 1956 makes it mandatory for
companies to keep accounts on accrual basis only.
11.Finally, the accounting standards issued by the ICAI
require that accounting policies must be governed by the principle
of prudence. In other words, Provisions should be made for all
known liabilities and losses even though the amount cannot be
determined with certainty and represents only the basic estimate in
the light of available information. Para 6 of Accounting Standard 1
defines accrual as the assumption 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 financial
statements of the periods to which they relate. What is required,
therefore, is that all anticipated liabilities and foreseeable
losses have to be provided for, while caution is to be exercised
against accounting for unearned gains. Ultimately the emphasis is on
presenting a true and correct state of affairs of the company as a
going concern. This explains why, for instance, the valuation of
closing stock as on the date of the balance sheet, is done at cost
or market value, whichever is lower. Where the market value is lower
than the cost, valuation at market value reflects the anticipated
loss. On the other hand, where the market value is higher than the
cost, the unrealized gains are not accounted for.
CAclubindia
