Assessees are aware that in computing business income a deduction is available under Section 37 of the Income-Tax Act (Act) for revenue expenditure which is incurred wholly and exclusively for the business during the year. The position all along has been that contingent liabilities do not constitute allowable expenditure and are not deductible even under the mercantile system of accounting, though what is contingent and what is not would depend on the facts of each case.
Apex court rulings
Thus, as held by the Supreme Court in CIT vs Swadeshi Cotton and Flour Mills P. Ltd. (53 ITR 134), a claim made by a third party against an assessee in respect of a contractual liability which is not admitted by the assessee but is disputed by him would be deductible only on finality, viz. on an award or a decree being passed or when the dispute is finally settled.
However, as laid down by the Supreme Court in Kedarnath Jute Mfg. Co. Ltd vs CIT (82 ITR 363), a statutory liability is always allowable even if disputed by the assessee, subject to the provisions of Section 43B of the Act.
A different view
In a recent decision, the Delhi High Court expressed a different view in connection with deduction for a disputed contractual liability. In the R. C. Gupta vs CIT (298 ITR 161) case, the assessee claimed a deduction for the liability towards purchases of raw material.
The amount claimed represented disputed liability for purchases made in the earlier years but claimed as a deduction in the current year since a suit for recovery had been filed by the supplier during the current year.
The Tribunal disallowed the claim of the assessee on the settled principle that as long as the dispute continued and the assessee kept resisting the liability it would not be able to claim deduction even under the mercantile system of accounting.
On further appeal, the claim for deduction was allowed by the High Court. The court referred to the Supreme Court decision in the Bharat Earth Movers vs CIT (245 ITR 428) case, in which it was held that if a liability had definitely arisen in the accounting year, the deduction should be allowed although the liability may have to be quantified and discharged at a later date, though what should be certain is the incurring of the liability.
The liability should be capable of being estimated with reasonable certainty, though actual quantification may not be possible. The Supreme Court held that if these requirements were satisfied then the liability would not be a contingent one and it would not make any difference if the future date on which the liability would have to be discharged is not certain.
The court further held that a condition subsequent the fulfilment of which may result in the reduction or even extinction of the liability would not have the effect of converting that liability into a contingent liability.
Estimating the liability
The Delhi High Court, relying upon the aforesaid decision of the Supreme Court, held that the liability in the case was capable of being estimated with reasonable certainty when a recovery suit was filed by the supplier against the assessee during the year.
(The author is a Senior Manager with Deloitte Haskins & Sells, Mumbai.)
Merely because the liability was not a statutory one it could not be said that the liability was unascertained and contingent. Accordingly, the liability was held to be deductible during the year although it was disputed by the assessee.
The High Court, in arriving at its decision in this case, had considered the earlier principles laid down in Swadeshi Cotton and Flour Mills case, relied by the department in the course of the appeal. The court however relied upon the Supreme Court decision in the Bharat Earth Movers case.
However, it may be noted that the Supreme Court in this decision had emphasised that what should be certain is the incurring of the liability. The court in this case was not concerned with the issue of allowability of a disputed contractual liability but was concerned with deduction for provision for encashment of accrued leave salary which was not capable of actual quantification.
In the facts of the case, the Supreme Court had held that the liability was certain and not contingent. The Delhi High Court in its decision appears to have proceeded on the basis that a liability had definitely arisen on the basis of the claims made, though disputed by the assessee.
It, therefore, appears that in the aforesaid decision there has been a departure from the earlier settled principle that a disputed contractual liability is deductible only when the dispute is finally settled. A subsequent Supreme Court ruling may provide more clarity and certainty on this issue.