2013 (4) TMI 285 - HC - Income Tax

Dis-allowance of prior year expenses as the assessee has been following mercantile system of accounting - Held that - Merely because an expense relates to a transaction of an earlier year it does not become a liability payable in the earlier year unless it can be said that the liability was determined and crystallized in the year in question on the basis of maintaining accounts on the mercantile basis. In each case where the accounts are maintained on the mercantile basis it has to be found in respect of any claim, whether such liability was crystallized and quantified during there previous year so as to be required to be adjusted in the books of account of that previous year. There is no finding as to why the liability for the expenses accrued to the appellant by any of the authorities. It is the case of the appellant that liability for expenses for which claim was made in the profit and loss account of the year under consideration had crystallized only during the year and as such, no claim towards the same was made in the account of the earlier years. There is also no finding as to why the claim of the appellant for prior years for the reasons aforesaid was not allowable. Under these circumstances, the matter remitted back to the Tribunal for recording a finding of fact as to whether the expenditure which has been claimed by the assessee in the revised computation of income has actually been crystallized during the assessment year under consideration, after giving opportunity of hearing to the parties concerned.

Summary

Issues:
Assessment of income under mercantile system of accounting, validity of revised computation of income, disallowance of prior year expenses, interpretation of Section 139(1) and Section 143(3) of the Income Tax Act.

Analysis:
The case involved the assessment of income by a Corporation owned by the government engaged in construction activities for the assessment year 2006-07, following the mercantile system of accounting. The Corporation filed a revised computation of income during the assessment proceedings, which was not accepted by the Assessing Authority as no valid revised return was filed. The Assessing Authority held that once income is declared under Section 139(1) of the Income Tax Act, it cannot be changed based on revised final accounts. Additionally, the Authority disallowed prior year expenses under the assessment year, citing the adoption of the mercantile system of accounting.

The assessee appealed the decision, but both the first and second appeals were rejected, including the additional ground regarding the disallowance of prior year expenses. The High Court observed that the authorities had not considered whether the claimed expenses had crystallized during the assessment year under consideration. The Court emphasized that expenses related to an earlier year do not become payable unless they are determined and crystallized in the current year based on maintaining accounts on a mercantile basis.

The Court highlighted that under the mercantile system, liabilities must be crystallized and quantified in the previous year to be adjusted in the books of account. If a liability depends on demand and acceptance by the assessee and is claimed and paid in later years, it cannot be disallowed as a deduction solely based on the mercantile system. The Court stressed that true profits and gains must be computed based on actual receipt and accrual of income. The High Court found no justification for the disallowance of claimed expenses and remitted the matter back to the Tribunal to determine whether the expenses had actually crystallized during the assessment year, allowing an opportunity for all concerned parties to present their case.

In conclusion, the High Court directed the Tribunal to record a finding on the crystallization of expenses claimed by the assessee during the assessment year and submit the same within three months. The appeal was listed for further proceedings in July 2013.