2015 (10) TMI 1901 - AT - Income Tax

Deduction allowed for the interest claimed on damages while computing business income - Accrual of interest expenditure - Held that - It is trite that entries in the books of account are not conclusive of accrual of income or deductibility of expenses. If an entry is passed in the books of account for a deduction which is otherwise not available as per law, it does not make the claim per se deductible. In the like manner, if a claim is otherwise deductible, but no entry has been passed in the books of account, then there can be no denial of such a claim. Essence of the matter is the deductibility or otherwise as per law and not the passing of entries in the books of account. In our considered opinion, entries in books are not conclusive of accrual of income or deductibility of expenses. On the contrary, it is the incurring of liability or accrual of income by means of a legally enforceable right, which decides about the deductibility of an expense or earning of income. Our view gets strength from the judgment of the Hon ble Supreme Court in CIT vs. SMIFS Securities Ltd. (2012 (8) TMI 713 - SUPREME COURT) which reiterates similar view taken in several earlier judgments includingCIT vs. Shoorji Vallabhdas & Co. (1962 (3) TMI 6 - SUPREME Court) . As such, we jettison this contention advanced on behalf of the Revenue as a reason for sustaining the disallowance of interest. We sum up our conclusion on the point that the assessee did not incur any liability for payment of interest to Alimenta as at the end of the years under consideration. Since no legally enforceable liability existed against the assessee, the deduction has been rightly denied. Applicability of provision of section 40(a)(i) - Held that - In this regard, we find that this provision with marginal note of - Amounts not deductible - applies to disallow the otherwise allowable deductions in the computation of income of the payer under the head Profits and gains of business or profession , if any sum chargeable to tax under the Act is payable outside India; or in India to a non-resident, not being a company or to a foreign company, on which tax is deductible at source under Chapter XVII-B and such tax has not been deducted or, after deduction, has not been paid during the previous year, or in the subsequent year before the expiry of the time prescribed under sub-section (1) of section 200. Conversely, if deduction is otherwise not allowable under the head Profits and gains of business or profession , then there cannot be any further disallowance in the computation of income for want of deduction of tax at source etc. In view of our decision as to the non-incurring of liability for interest by the assessee and the resultant nonavailability of deduction of interest in the computation of income for the years under consideration, section 40(a)(i) of the Act becomes inapplicable, as the underlying condition for its applicability, being the otherwise eligibility of deduction for expense, becomes wanting. In view of the foregoing reasons, we answer the question posted before this Special bench in negative by holding that in the facts and circumstances of the case, where claim of damages and interest thereon is disputed by the assessee in the court of law, deduction can t be allowed for the interest claimed on such damages in the computation of business income. Now the instant appeals are directed to be placed before the Division Bench for disposal having regard to the decision of the special bench on the question raised before it.

Summary

Issues Involved:
1. Deduction of interest on damages disputed by the assessee in court.
2. Applicability of Section 40(a)(i) of the Income-tax Act, 1961.

Issue-wise Detailed Analysis:

1. Deduction of Interest on Damages Disputed by the Assessee in Court:

The primary issue revolves around whether the assessee can claim a deduction for interest on damages, which is still under litigation. The assessee had claimed deductions for interest payable to Alimenta SA Switzerland based on an arbitration award, which was disputed in court. The Assessing Officer (AO) disallowed this deduction, arguing that the liability was not acknowledged due to ongoing litigation and no tax was deducted at source as required by Section 40(a)(i) of the Income-tax Act, 1961. The Commissioner of Income-tax (Appeals) [CIT(A)] upheld this view, noting that the liability for such interest crystallized only in the period relevant to the assessment year 2000-01 following the decree by the Hon'ble Delhi High Court.

The Tribunal examined whether the liability to pay interest was certain and enforceable during the years in question. Under the mercantile system of accounting, a deduction is allowed when the liability to pay an expense arises. However, if the liability is uncertain, it is considered contingent and not deductible. The Tribunal distinguished between contractual and statutory liabilities, stating that a contractual liability arises only when a final obligation to pay is established by a competent court's order, not during the pendency of litigation. In this case, the liability to pay interest was suspended by the Division Bench of the Hon'ble Delhi High Court's stay order dated 28.2.2001, which continued until the decree was enforceable again in September 2010. Therefore, the assessee did not have a legally enforceable liability to pay interest during the years under consideration.

The Tribunal's view was further supported by the Hon'ble Delhi High Court's judgment in the assessee's case for the assessment years 1996-97 to 1998-99, which held that the liability to pay interest arose only on the decree passed on 28.1.2000. The Hon'ble Supreme Court's judgment in CIT vs. Hindustan Housing & Land Development Trust Ltd. (1986) 161 ITR 524 (SC) also reinforced that no income accrues, and no deduction is allowed when the right to receive payment is in dispute.

2. Applicability of Section 40(a)(i) of the Income-tax Act, 1961:

The AO's alternative argument was that the deduction was also hit by Section 40(a)(i) due to the non-deduction of tax at source. However, the Tribunal clarified that Section 40(a)(i) applies only if the deduction is otherwise allowable under the head "Profits and gains of business or profession." Since the liability to pay interest did not exist during the years in question, the deduction was not allowable, rendering Section 40(a)(i) inapplicable.

Conclusion:

The Tribunal concluded that the assessee did not incur any liability for payment of interest to Alimenta as at the end of the years under consideration. Consequently, the deduction was rightly denied. The Tribunal answered the question in the negative, holding that in the facts and circumstances of the case, where the claim of damages and interest thereon is disputed by the assessee in court, deduction cannot be allowed for the interest claimed on such damages in the computation of business income. The appeals were directed to be placed before the Division Bench for disposal in light of the Special Bench's decision.