2025 (1) TMI 287 - HC - Income Tax

Contribution made by a corporate employer towards fund for payment of leave encashment to its employees disallowed as deduction from profit and loss account under the Act - HELD THAT - The amount of contribution made by the assessee towards the fund for payment of leave encashment to its employees qualifies to be deductible as expenses, subject, however, to the conditions imposed under Section 43-B of the Act. The proviso to Section 43-B of the Act deals with any sum which is actually paid by the assessee on or before the due date applicable in his case for furnishing the return of income under sub-Section (1) of Section 139 of the Act, in respect of the previous year in which, the liability to pay such sum was incurred and instance of such payment is furnished by the assessee along with such return. The argument raised on behalf of the assessee deserves to be rejected for the reason that the proviso to Section 43-B relates only to that liability as was incurred by actual payment of the sum in the previous accounting year, which in the instant case is 2001-02. Thus, exception carved out by the aforesaid proviso only derives the limitation from end of accounting year to the date of submission of return as per Section 139 (1). As per Section 43-B only that sum payable by the assessee as an employer in lieu of any leave at the credit of his employees shall be allowed as deduction where firstly the liability to pay such sum was incurred by the assessee according to method of accounting regularly employed by him and secondly the sum was actually paid by the employer in the previous accounting year. Whether the assessee in the instant case had incurred the liability to pay a sum to its employees for the previous year in which such sum is actually paid ? - In Excide Industry Ltd 2020 (4) TMI 792 - SUPREME COURT had the occasion to adjudicate the constitutional validity of Section 43-B (f) of the Act and one of the grounds of such challenge was that the proviso had been incorporated to undo the effect of judgment passed by the Hon ble Supreme Court in Bhart Earth Movers 2000 (8) TMI 4 - SUPREME COURT While rejecting the challenge on said ground it has been held that the judgment in Bharat Earth Movers was rendered keeping in view the then applicable statutory regime. Adhering to the constitutional validity of Section 43-B (f), the Hon ble Supreme Court held that the said provision will apply prospectively meaning thereby that the period prior to period of enactment of Section 43-B (f), would be governed by the law laid down in Bharat Earth Movers. In view of such exposition, the assessee cannot derive any benefit from the verdict in Bhart Earth Movers, as he has to independently tackle the obstacles raised by incorporation of Section 43-B (f) w.e.f. 1.4.2002. It will also be gainful to reproduce Excide Industries Ltd case 2020 (4) TMI 792 - SUPREME COURT to support our view that the liability incurred by the assessee did not qualify the requirement of Section 43-B(f) of the Act and hence were rightly disallowed by the revenue.

Summary

1. ISSUES PRESENTED and CONSIDERED

The judgment addresses several core legal questions related to the admissibility of deductions for leave encashment under the Income Tax Act, 1961. The issues considered include:

• Whether the provision for meeting the liability for encashment of saved leave by employees is an admissible deduction.
• Whether leave encashment is a present or future liability for the purposes of Section 37 of the Income Tax Act, 1961.
• Whether leave encashment is a current or contingent liability in light of the Supreme Court's decision in Bharat Earth Movers.
• Whether the provision for leave encashment is a defined benefit entitled to deduction when made in books of accounts according to Accounting Standard 15.
• Whether the expense of leave encashment deduction was rightly claimed in view of the Bharat Earth Movers judgment.
• Whether the liability towards leave encashment was ascertained during the assessment period for future payment in accordance with the Central Civil Services Leave Rules.
• Whether the procedure for ascertaining leave encashment liability per Accounting Standard-15 was correct and the expense is deductible under the Income Tax Act.
• Whether expenses towards contributions to a leave encashment trust are allowable under Section 37(1) of the Income Tax Act.
• Whether the Tribunal was justified in enhancing income by adding deductions not agitated by either party.
• Whether the Tribunal was justified in holding a certain amount payable to the State Government as income of the appellant corporation.
• Whether the Tribunal was justified in stating there was no change in the accounting system despite evidence to the contrary.

2. ISSUE-WISE DETAILED ANALYSIS

Issue i) to viii): Leave Encashment as Deductible Expense

• Legal Framework and Precedents: The judgment examines the applicability of Section 37 and Section 43-B of the Income Tax Act, along with Accounting Standard 15 and relevant case law, including Bharat Earth Movers and Excide Industries Ltd.
• Court's Interpretation and Reasoning: The court analyzed whether the liability for leave encashment is a present liability and whether it can be deducted under the Income Tax Act. The court referenced the Supreme Court's decision in Excide Industries, which clarified the nature of leave encashment as a present liability but subject to payment for deduction.
• Key Evidence and Findings: The court found that the liability was not incurred in the relevant financial year, and the payment was made post the accounting year closure. The appellate authorities consistently held that the liability was not ascertained during the relevant year.
• Application of Law to Facts: The court applied Section 43-B(f), which mandates actual payment for deduction, and found that the liability was not incurred during the relevant year, thus disallowing the deduction.
• Treatment of Competing Arguments: The court rejected the appellant's reliance on Bharat Earth Movers, noting that the statutory framework had changed with the introduction of Section 43-B(f).
• Conclusions: The court concluded that the contribution to the leave encashment fund was not deductible as it did not meet the requirements of Section 43-B(f).

Issue ix) and xi): Tribunal's Justifications

• Legal Framework and Precedents: The court considered whether the Tribunal exceeded its jurisdiction by addressing issues not raised by the parties.
• Court's Interpretation and Reasoning: The court noted that the Tribunal's findings were based on the evidence and submissions presented.
• Key Evidence and Findings: The court found no merit in the appellant's claims regarding the Tribunal's actions.
• Conclusions: The court upheld the Tribunal's decisions, finding no procedural or substantive errors.

3. SIGNIFICANT HOLDINGS

• Verbatim Quotes: "The liability of leave encashment continues to be a present liability as per the mercantile system of accounting. Further, the insertion of clause (f) has not extinguished the autonomy of the assessee to follow the mercantile system. It merely defers the benefit of deduction to be availed by the assessee for the purpose of computing his taxable income and links it to the date of actual payment thereof to the employee concerned."
• Core Principles Established: The judgment reinforces the principle that deductions for leave encashment under Section 43-B(f) require actual payment within the relevant financial year.
• Final Determinations: The court dismissed the appeals, affirming the disallowance of deductions for leave encashment as the liability was not incurred during the relevant financial year.