1971 (8) TMI 10 - SC - Income Tax

Assessee maintaining his accounts in mercantile system - Assessee was entitled to claim the deduction towards the sales tax liability which it was liable under law to pay during the relevant accounting year - That liability did not cease to be a liability because the assessee had taken proceedings before higher authorities for getting it reduced so long as the assessee's completion did not prevail - assessee's appeal is allowed

Summary

Issues:
- Deductibility of unpaid and disputed sales tax liability as a business expense under Income-tax Act, 1922.
- Validity of claiming deduction under section 10(2)(xv) and section 10(1) for sales tax.
- Impact of accounting method (cash system vs. mercantile system) on the deduction of sales tax.
- Interpretation of "expenditure" under section 10(2)(xv) and its application to sales tax.
- Legal principles governing the deduction of liabilities under the mercantile system of accounting.
- Relevance of maintaining entries in books of accounts for claiming deductions.

Analysis:

The case involved the appeal of a public limited company, engaged in the jute business, regarding the deductibility of unpaid and disputed sales tax liability amounting to Rs. 1,49,776 for the assessment year 1955-56. The core issue revolved around whether such sales tax liability could be claimed as a deduction under the Income-tax Act, 1922. The High Court had ruled that unpaid and disputed sales tax liability cannot be considered a valid deduction for income tax purposes, emphasizing the requirement of actual expenditure laid out exclusively for business purposes.

The appellant contended that sales tax, whether paid or unpaid, should be deductible under section 10(2)(xv) and section 10(1) of the Act. The argument highlighted the distinction between cash system and mercantile system of accounting, stating that under the mercantile system, deductions are permissible in the year to which the liability relates, regardless of the actual payment timing. The term "expenditure" under section 10(2)(xv) was crucial, indicating that sales tax, being an expenditure, should qualify for deduction if incurred for business purposes.

Referring to legal precedents, the appellant argued that under the mercantile system, a liability accrued during the assessment period should be deductible, irrespective of the actual payment date. The judgment cited Commissioner of Income-tax v. Royal Boot House to support the position that a provision for sales tax, even if not paid but accounted for, should be deductible. The obligation to pay sales tax arises upon taxable transactions, regardless of assessment completion, and the liability accrues during the assessment period.

The court rejected the argument that the failure to record a liability in the books of accounts would bar the deduction claim. It emphasized that an assessee's right to claim deductions should be based on legal provisions, not accounting entries. The appellant, maintaining accounts on the mercantile system, was deemed justified in claiming the sales tax liability deduction. Consequently, the appeal was allowed, setting aside the High Court's judgment in favor of the appellant. The appellant was granted costs, and the question of deductibility of sales tax as a business expense was resolved in favor of the assessee against the revenue.