2005 (1) TMI 59 - HC - Income Tax

Amount of Rs. 7,85,725 kept as a provision for future scheme loss - Whether the Tribunal is correct in finding that the amount of Rs. 7,85,725 provided by the assessee as an accrued liability is contingent liability and hence not an allowable deduction? - Tribunal has rightly come to the conclusion that no liability had accrued in the previous year relevant to the assessment year in question and as no liability has accrued, the same is a contingent liability. It is not a case where the liability has accrued and the payment is postponed. - Accordingly, we answer the question posed as above, in the affirmative, in favour of the Revenue and against the assessee.

Summary

Issues:
Whether the amount provided by the assessee as an accrued liability is a contingent liability and not an allowable deduction for the assessment year 1988-89.

Analysis:
The case involved a reference by the assessee regarding the treatment of an amount of Rs. 7,85,725 kept as a provision for future scheme loss for the assessment year 1988-89. The assessee, a registered firm conducting vehicle schemes, claimed this amount as a scheme loss, which was disallowed by the assessing authority. The assessing authority and the Commissioner of Income-tax (Appeals) held that the provision for future loss is not an allowable deduction as the liability accrues only after the scheme is completed. The assessee contended that the liability to pay the extra or bonus amount to unsuccessful subscribers accrues when the contract is signed, making it an accrued liability under the mercantile system of accounting.

The Income-tax Appellate Tribunal (ITAT) differentiated between contingent liability and a payment depending on a contingency. The ITAT held that no liability accrued to the assessee until the unsuccessful member paid the final instalment, making the liability contingent. The Tribunal observed that the liability undertaken by the assessee at the contract's inception was conditional on the member paying all 40 instalments without default. As there was no guarantee on the number of remaining subscribers till the end, the liability was deemed contingent.

The High Court agreed with the ITAT's findings, concluding that no liability had accrued in the relevant previous year for the assessment year in question. As no liability had accrued, the court deemed it a contingent liability, not an accrued one where payment is postponed. Therefore, the court answered the question in the affirmative, in favor of the Revenue and against the assessee. The reference was answered accordingly.

This judgment clarifies the distinction between accrued and contingent liabilities in the context of scheme losses under the mercantile system of accounting. It underscores the importance of when a liability truly accrues and the conditions that determine its nature, impacting the deductibility of provisions for future losses in financial reporting.