This has been held in several decisions, the most important being of the Supreme Court in the case of Indian Molasses v CIT (37 ITR 66).

In a recent case of New India Mining Corporation Pvt v CIT (243 ITR 640), the Supreme Court observed that once it is held that no expense was incurred by the assessee, the question of any allowable expense being deducted, in computing the income, from the profits and gains of the assessee did not arise.

The facts in this case were that the Government of Bombay on April 23, 1940, granted to the predecessor of the appellant, leases for a period of 30 years on certain terms and conditions. These were mining leases. Clauses 3 and 17 of the lease agreement laid down that upon the determination of the lease, the lands should be restored to their original condition.

The tribunal held that the expenditure incurred by the appellant for the purpose of restoring the lease land to the original condition was permissible expense under section 37(1) of the Act. This was on the basis of interpretation of the aforesaid two clauses.

However, there was a clear finding that during the relevant years the appellant did not incur any expense to restore the lands to their original condition. The High Court concluded that there was a liability on the assessee to restore the land to its original condition and therefore the estimated liability for restoration charges was deductible.

On appeal to the Supreme Court, it was held that admittedly no expense had been incurred by the appellant. The questions of law, therefore, did not arise. Any question of an allowable deduction could arise only if any expense was so incurred by the assessee.

There are several other situations in which the question of deductibility has been considered. A claim made by a third party against the assessee but not admitted by the assessee, or an amount deposited in Court by the purchaser at a Court sale as security to safeguard the interest of a third party claiming a share in the property, or an unascertained liability to pay damages at a future date, represents merely a contingent liability and cannot be allowed.

The House of Lords laid down in Owen v Southern Railway of Peru Ltd (36 TC 602), that a deduction should be allowed in respect of the liability to pay retiring benefits or deferred remuneration to employees in the future, provided the liability is accurately estimated, eg upon an actuarial valuation.

The aggregate obligation to pay gratuity or other retiring benefits for the services rendered by all the employees in a year can in no real sense be regarded as contingent merely because some employees may forfeit their rights.

Lord Radcliffe observed:
".....where you are dealing with a number of similar obligations that arise from trading, although it may be true to say of each separate one that it may never mature, it is the sum of the obligations that matters to the trader, and experience may show that, while each remains uncertain, the aggregate can be fixed with some precision".

In Calcutta Co Ltd v CIT (37 ITR 1), the Supreme Court held that if a liability has been definitely incurred in the accounting year, eg an unconditional contractual liability, it cannot be regarded as contingent merely because it is to be discharged at a future date and the cost of discharging it is not definite but has to be estimated. In that case, the Court allowed the estimated cost of discharging a contractual liability to undertake a development scheme within reasonable time in the future, as a proper deduction in computing the commercial profits, apart from the express statutory provisions for deductions.

In Standard Mills Co Ltd v CIT (229 ITR 366), the assessee-company was engaged in the business of manufacturing textiles. In the assessment year 1979-80, the assessee claimed deduction of a sum of Rs 46,86,431 on account of excise duty on the basis of show cause-cum-demand notices for the years 1976-77, 1977-78 and 1978-79 received by the assessee during the relevant previous year from the excise authorities.

The assessee replied to the show-cause notice and denied any liability on account of excise duty as alleged in the said notice. No order was passed by the concerned excise authorities rejecting the above claim of the assessee and/or demanding any amount in pursuance of the show-cause notice. Nothing was paid by the assessee in pursuance of the show-cause notice, nor was any provision made for the same in the accounts of the previous year relevant to the assessment year under consideration.

The amount of excise duty mentioned in the show-cause notice was, however, shown by the assessee by way of a note in the balance-sheet and profit and loss account as "contingent liabilities representing the disputed amount of central excise". On the basis of the above, the assessee claimed deduction of the amount mentioned in the show-cause notice. The assessing officer rejected the demand and this was upheld by the tribunal.

On a reference, the Bombay High Court held that there was no actual liability in praesenti. No demand of any amount was raised against the assessee. What was served on the assessee by the collector was merely a show-cause notice. The assessee did not admit any liability and showed cause refuting the allegations made in the show-cause notice. Even according to the assessee, there was no accrued liability.

The assessee itself regarded it as a "contingent liability", which was evident from the fact that the amount of excise duty mentioned in the show-cause notice was shown by the assessee by way of a note in the annual report. Obviously, there was no liability actually existing against the assessee in the year of account. Therefore, the Court concluded that the amount in question did not constitute expenditure for the purposes of income-tax assessment.

In any event, with effect from the assessment year 1984-85 such liability would only be deductible in the year of actual payment under section 43-B.

Hence, where no payment is made pursuant to a show-cause notice, the question of deductibility would not arise at all.

In conclusion, it may be pointed out that expenditure primarily denotes the idea of spending or paying out or away: It is something which is gone irretrievably (Indian Molasses v CIT 37 ITR 66,78).

However, in the circumstances of a case, expenditure may cover an amount of loss which has not gone out of the assessee's pocket, eg discount at which bonds or debentures are issued (MP Financial Corporation v CIT 165 ITR 765).

The settlement of cross-claims may also constitute expenditure (CIT v Nainital Bank 62 ITR 638).

The author is a Supreme Court advocate