2015 (9) TMI 1426 - AT - Income Tax

Addition on account of provisions made for payment of arrears of salary on the basis of revision of pay scales w.e.f. 01.01.2006 - Held that - The provision of the pay revision was made by the assessee as per notification dated 7.1.2009 in view of the minutes of Board meeting held on 18.3.2009. A copy of the extract of the minutes of the Board held on 18.3.2009 was also filed before us. It was very clear from the perusal of this that the arrears of pay revision were to be paid by the assessee in two installments i.e. first installment being 40% of the aggregate arrears during the financial year 2008-09 i.e. relevant assessment year 2009-10 and second installment of 60% of the aggregate arrears in the financial year 2009-10 i.e. 2010- It is quite clear that the liability of payment of 60% of arrears of salary has arisen during the assessment year under consideration and the liability was also discharged at a future date. In this view, the liability is not in the nature of any contingent liability. From these facts, it can be very easily inferred that there was an ascertained liability in the form of payment of arrears of revised pay scales, which partly was booked in an earlier year and the remaining in the present year. Since the assessee is following the mercantile system of accounting and the provision on account of arrears for salary payment was made in the accounts on the accrual basis, the disallowance made by the Assessing Officer was not justified. - Decided in favour of assessee.

Summary

Issues:
1. Disallowance of provision for payment of arrears of salary on the basis of revision of pay scales.
2. Recognition of liability to pay arrears of salary accrued during a specific financial year.
3. Interpretation of provisions under the Income Tax Act regarding accounting standards and liabilities.

Issue 1: Disallowance of provision for payment of arrears of salary:
The case involved an appeal filed by the Revenue against the order of the Commissioner of Income Tax (Appeals) for the assessment year 2010-11. The Assessing Officer disallowed a provision made by the assessee for payment of arrears of salary, amounting to Rs. 2,04,52,413, based on the revision of pay scales. The Revenue contended that the provision was not allowable under the Income Tax Act as no liability had been incurred in that year. However, the CIT (Appeals) reversed this decision, noting that the liability had arisen during the relevant assessment year as per the mercantile system of accounting followed by the assessee.

Issue 2: Recognition of liability for accrued arrears of salary:
The CIT (Appeals) found in favor of the assessee, highlighting that the liability to pay arrears of salary had accrued during the financial year 2009-10. The Board of Directors had passed a resolution to pay arrears of pay scales during the year under consideration. The liability was booked in the accounts based on the mercantile system of accounting, as supported by the State Government notification and board meeting minutes. The CIT (Appeals) emphasized that the liability was ascertained during the accounting period and not a contingent liability, justifying the provision made by the assessee.

Issue 3: Interpretation of Income Tax Act provisions on accounting standards:
The Revenue challenged the CIT (Appeals) order, arguing that the provision for arrears of salary was not allowable under the Income Tax Act and should only be recognized in the year of payment. However, the Tribunal upheld the CIT (Appeals) decision, emphasizing that the assessee, following the mercantile system of accounting, had correctly recognized the liability for arrears of pay scales. The Tribunal cited relevant accounting standards and notifications allowing provisions for known liabilities even when the exact amount cannot be determined with certainty.

In conclusion, the Tribunal dismissed the Revenue's appeal, affirming the CIT (Appeals) decision to allow the provision made by the assessee for payment of arrears of salary. The judgment highlighted the importance of adhering to accounting standards and recognizing liabilities as per the mercantile system of accounting, ultimately supporting the assessee's position in this case.