2022 (2) TMI 439 - HC - Income Tax

Amortisation of expenditure incurred under voluntary retirement scheme - Disallowance for deduction under the Voluntary Retirement Scheme u/s 35DDA - Whether the allowance for deduction under the Voluntary Retirement Scheme is to be made on the basis of 1/5th of the liability for the payment of Voluntary Retirement Scheme incurred under the mercantile system of accounting or is to be allowed on the basis of 1/5th of the actual payment made during the relevant year? - HELD THAT - Having heard learned counsel for the partiers, this Court is of the view that the ITAT erred in treating the liability under the VRS scheme not as an accrued one but in proceeding on the basis that only the amount actually paid during the AY in question can be allowed. The definition of paid under Section 43(2) of the Act contemplates an accrued liability . There is no dispute that the Appellant follows the accrual method of accounting. There is also no dispute regarding the actual amount that was incurred as liability by the assessee under the VRS scheme. As equally erroneous on the part of the CIT (A) to treat the expenditure towards the aforementioned liability as capital expenditure . There is no warrant for such a conclusion. It was not even the Department s case that liability incurred for settling VRS dues would be capital in nature. It needs to be borne in mind that the Assessee follows the mercantile accounting system and not the cash system and that its income is assessed under the head profits and gains and business of profession. Question framed by this Court is answered in favour of the Assessee and against the Department by holding that allowance and deduction under the VRS scheme are to be based on the entire accrued liability incurred and not just of the amount actually paid during the relevant AY.

Summary

Issues:
Interpretation of Section 35DDA of the Income Tax Act for deduction under Voluntary Retirement Scheme based on accrued liability or actual payment during the relevant year.

Analysis:
The appeal in question stemmed from an order by the Income Tax Appellate Tribunal (ITAT) concerning the Assessment Year 2001-02 and the interpretation of Section 35DDA of the Income Tax Act, 1961. The key query before the court was whether the allowance for deduction under the Voluntary Retirement Scheme (VRS) should be based on 1/5th of the liability for payment incurred under the mercantile system of accounting or on 1/5th of the actual payment made during the relevant year. The Appellant, engaged in manufacturing refractory products, implemented a VRS during the accounting year 2000-01, covering 291 employees with a liability of ?12,83,51,995, which was accrued and accounted for in the books. This liability was amortized over 60 months starting from the accounting year 2000-01.

The court delved into the relevant sections of the Income Tax Act, particularly Section 35DDA and Section 43(2), which define the treatment of expenses incurred under a VRS and the meaning of 'paid' in the context of accounting methods. It was noted that under Section 43(2), 'paid' encompasses amounts actually paid or incurred based on the accounting method used. The court emphasized that even if a liability is incurred and the Assessee follows the accrual system of accounting, the liability should be recognized in the year it was incurred, allowing for subsequent amortization.

The Assessing Officer disallowed a portion of the deduction claimed by the Assessee, treating the balance as a contingent liability, a decision upheld by the Commissioner of Income Tax (Appeals) and the ITAT. However, the court opined that the ITAT erred in considering only the amount actually paid during the year, highlighting that the definition of 'paid' includes accrued liabilities. The court further critiqued the characterization of the expenditure as 'capital expenditure' by the authorities, emphasizing that the Assessee's accounting method and the nature of the liability should guide the treatment.

In conclusion, the court ruled in favor of the Assessee, asserting that the deduction under the VRS scheme should be based on the entire accrued liability incurred, not solely on the amount paid during the relevant year. Consequently, the orders of the CIT (A) and the ITAT, along with the AO's decision, were set aside, and the appeal was allowed with no costs awarded.