2011 (3) TMI 847 - AT - Income Tax

Accrual of expenditure - actual or contingent - mercantile basis of accounting - Expenditure on performance incentives and sales incentives - held that - Without making provisions for performance incentive and sales incentive the true picture of the company cannot be ascertained. Since in the instant case, the assessee has made provisions, a part of which has admittedly been paid subsequently and the unpaid part has already been offered to tax in the impugned assessment year itself; therefore, the bonafide of the assessee in making the provision, should not have been doubted. In this view of the matter, set aside the order of the CIT(A) on this issue and direct the Assessing Officer to delete the disallowance - Decided in favour of assessee. Inflated expenditure - Provision for excessive expenditure - Advertisement and sales promotion expenses - held that - The assessee could have made the claim in the subsequent year when such bill is received. - Merely because the assessee has reversed the entry in the subsequent year; the same is not the proper accounting method - If the system is allowed then any person, who earns huge income in a particular year can inflate the provisions for expenses and in the subsequent year when there is less income or loss, can reverse the entry - This, cannot be permitted - Therefore, do not find any infirmity in the order of the ld CIT(A)upholding the addition - The ground raised by the assessee is accordingly dismissed.

Summary

Issues:
1. Disallowance of expenditure on performance incentives and sales incentives.
2. Disallowance of expenditure on advertisement and sales promotion expenses.
3. Tax treatment of reversed provision for advertisement and sales promotion expenses.

Issue 1: Disallowance of expenditure on performance incentives and sales incentives:

The appellant, engaged in marketing and sales of vaccines, made provisions for sales and performance incentives, which the Assessing Officer disallowed as contingent liabilities not crystallized during the relevant year. The appellant argued that the liabilities accrued as per the employees' appointment letters and appraisal processes. However, both the Assessing Officer and the CIT(A) found the liabilities contingent upon achieving targets, not quantified during the financial year. The CIT(A) upheld the disallowance, stating lack of crystallization of liabilities. The appellant contended that a significant portion of the provisions had been paid or offered for taxation. The ITAT held in favor of the appellant, recognizing the accrual basis of accounting followed, allowing the deduction for the provisions made, part of which was paid, and the balance offered for tax in the same assessment year.

Issue 2: Disallowance of expenditure on advertisement and sales promotion expenses:

The appellant had made provisions for bills yet to be received, but the actual bills received were lower, resulting in an excess provision. The Assessing Officer disallowed the excess provision as the liability did not crystallize during the year. The CIT(A) upheld the disallowance, emphasizing that liabilities cannot be claimed until bills are received for the relevant year. The ITAT concurred, stating that reversing entries in subsequent years to manipulate profits is improper accounting practice. The ITAT dismissed the appellant's appeal, upholding the addition made by the Assessing Officer.

Issue 3: Tax treatment of reversed provision for advertisement and sales promotion expenses:

The appellant sought deduction for the amount credited to the profit and loss account on reversing the excess provision for advertisement and sales promotion expenses disallowed in the previous year. The Assessing Officer did not address this issue, and the CIT(A) upheld the disallowance due to non-deduction of tax at source. The ITAT directed the issue to be reconsidered by the Assessing Officer to determine if any double disallowance had occurred. The ITAT allowed the appellant's ground for statistical purposes, restoring the matter to the Assessing Officer for further examination.

In conclusion, the ITAT partially allowed the appeal for statistical purposes, addressing the issues of disallowance of expenditure on incentives and advertisement expenses, while directing a reevaluation of the tax treatment of the reversed provision for advertisement and sales promotion expenses.