2005 (4) TMI 20 - HC - Income Tax

Business Expenditure - It is well settled that if the assessee followed the mercantile system of accounting, deduction has to be claimed when the liability accrued and is not dependent upon the passing of the entries in the books of account as held by the apex court in the case of Kedarnath Jute Mfg. Co. Ltd. v. CIT - Thus, on the finding recorded by the Tribunal that the Government D.O. dated March 31, 1977 and December 27, 1977, issued by the State Government converting the grant into loan was received by the assessee during the assessment year in question, the liability accrued during the assessment year in question and has rightly been allowed - Tribunal was justified in allowing a deduction

Summary

Issues:
- Deduction of Rs. 6,02,125 in the assessment year 1978-79

Analysis:
The case involved a question of law referred by the Income-tax Appellate Tribunal regarding the justification of allowing a deduction of Rs. 6,02,125 in the assessment year 1978-79. The facts revealed that the assessee, a corporation owned by the U.P. Government, received certain amounts for schemes not directly related to its business but where its assistance was sought by the Government. Initially treated as a grant, later converted into a loan by the Government. The dispute arose when the assessee claimed this amount as a deduction in 1978-79 as the debt was repudiated by the Government and became irrecoverable. The Inspecting Assistant Commissioner disallowed the deduction, stating it did not relate to the business activities of that year. The Commissioner of Income-tax (Appeals) also rejected the claim, stating the conversion of grant into a loan did not result in any loss to the assessee's business. However, the Tribunal held that the loss was incidental to the assessee's business during 1978-79 as the grant had been converted into a loan by the Government, justifying the deduction.

The main point of contention was whether the liability accrued in the assessment year 1978-79 or in previous years. The Revenue argued that the liability accrued in 1977-78 or later years based on the passing of necessary entries. However, the Tribunal's finding was that the liability accrued during the assessment year 1978-79 when the Government converted the grant into a loan, which was received by the assessee during that year. The High Court, following the principle that under the mercantile system of accounting, deduction is claimed when the liability accrues, upheld the Tribunal's decision. The Court emphasized that the timing of the liability accrual is crucial, and in this case, it was during the assessment year in question, 1978-79. The Court also noted that the competence or jurisdiction of the State Government in converting the grant into a loan was not challenged before any authorities.

In conclusion, the High Court ruled in favor of the assessee, allowing the deduction of Rs. 6,02,125 for the assessment year 1978-79. The Court highlighted the importance of when the liability accrues, following the mercantile system of accounting principles. The decision was based on the fact that the liability arose during the relevant assessment year, as supported by the Government's actions during that period.