2020 (12) TMI 1181 - AT - Income Tax

Disallowance on account of prior period expenses - HELD THAT - In the present case all the expenses claimed by the assessee under the head prior period expenses do not represent the expenses. As such the 2 items namely interest income and rental income represent the income which was offered to tax in the earlier years and written off in the year under consideration as claimed by the assessee which in our considered view represent the bad debts - assessee cannot be allowed deduction for these items as prior period expenses. But the same can be claimed as bad debts under the provisions of section 36(1)(vii). On perusal of the documents filed by the assessee it is not decipherable whether the impugned amount of bad debts were offered to tax in the earlier years and the same were written off in the books of accounts in the current year as on 31-3-2006 as contended by the assessee. Similarly, it is also not clear that the assessee has not claimed such interest as bad debt along with the bad debts of the debtors as apprehended by the learned CIT(A) in his order dated 4th June 2015. On perusal of the financial statements prepared under the companies Act for 11 months, the assessee has shown prior period adjustments - where the assessee has adopted a different period under the companies Act than the previous year defined under the Income Tax Act, it is to file separate financial statements under the Income Tax Act. But we note that the assessee has not filed such financial statements prepared under the Income Tax Act. Thus in the absence of sufficient documentary evidence by the assessee even in the set-aside proceedings, we are not inclined to disturb the finding of the authorities below. Reversal of the rental income - Assessee has justified its claim based on the documentary evidence that it has reversed the entry in respect of accounts of the rental income which was offered to tax. Accordingly, we find that the conditions as specified under section 36(1)(vii) of the Act have been duly satisfied. Accordingly, we reverse the finding of the learned CIT(A) and direct the AO to delete the addition made by him. Advance given to the sales representative - Though it is not a prior period expenses/adjustment, but represent the loss which has been incurred in the course of the business. Once the assessee has written of any loss in the books of accounts which was incurred in the course of the business, we are of the view that such loss is eligible for deduction. Accordingly, we reverse the finding of the learned CIT(A) and direct the AO to delete the addition made by him. Thus the ground of appeal of the assessee is partly allowed.

Issues Involved:
1. Disallowance of ? 23,27,520/- on account of prior period expenses.
2. Classification and treatment of prior period expenses under the Income Tax Act versus the Companies Act.
3. Verification of the reversal of entries in the books of accounts.
4. Allowability of bad debts under Section 36(1)(vii) of the Income Tax Act.

Detailed Analysis:

1. Disallowance of ? 23,27,520/- on account of prior period expenses:
The assessee, a limited company engaged in the manufacturing of pharmaceuticals, claimed a deduction of ? 23,27,520/- for prior period expenses in the assessment year 2006-07. The prior period expenses included sales promotion expenses, interest on debtors, and cost recovery related to earlier periods. The Assessing Officer (AO) disallowed these expenses, stating that there was no evidence to justify that these expenses were crystallized in the year under consideration. The AO also noted the absence of bills and vouchers supporting these expenses and pointed out that the auditor had classified these as prior period expenses.

2. Classification and treatment of prior period expenses under the Income Tax Act versus the Companies Act:
The assessee argued that the financial year under the Companies Act was extended to 13 months (up to 30 April 2005), whereas the assessment year under the Income Tax Act was 12 months (April to March). Therefore, the expenses recorded in April 2005 should not be considered as prior period expenses under the Income Tax Act. The CIT(A) and the AO, however, upheld the classification of these expenses as prior period expenses based on the auditor's report and the lack of supporting evidence.

3. Verification of the reversal of entries in the books of accounts:
The ITAT had previously remanded the case to the CIT(A) for fresh adjudication with directions to verify the assessee’s claim regarding the reversal of entries. The assessee submitted that the interest reversal on debtors and rental income reversal were recorded in the books of accounts within the same financial year and thus should not be considered as prior period expenses. However, the CIT(A) found that the assessee failed to provide sufficient evidence, such as ledger accounts, to support the claim of reversal of entries.

4. Allowability of bad debts under Section 36(1)(vii) of the Income Tax Act:
The tribunal analyzed whether the disallowed expenses could be claimed as bad debts under Section 36(1)(vii) of the Income Tax Act. The tribunal noted that for bad debts to be deductible, they must be written off as irrecoverable in the books of accounts. The assessee failed to provide clear evidence that the bad debts were offered to tax in earlier years and written off in the current year. However, the tribunal found that the reversal of rental income of ? 2,50,000/- was justified based on documentary evidence and directed the AO to delete the addition. Similarly, the tribunal allowed the deduction of ? 35,927/- given as an advance to a sales representative as a business loss, reversing the CIT(A)'s decision.

Conclusion:
The tribunal partly allowed the appeal, granting deductions for the reversal of rental income and the advance given to the sales representative, while disallowing the other prior period expenses due to lack of sufficient evidence. The order was pronounced in open court on 10/07/2020.

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