Once it is determined that an expense accrues to the taxpayer, it cannot thereafter be regarded as not to accrue merely because the order has been stayed
The Special Bench of the Income-Tax Appellate Tribunal (ITAT) held that the interest expense considered in tax computation based on Delhi High Court’s direction is not allowable as expenditure while computing business income, as the same is not a legally enforceable liability incurred. This was held in the case of National Agricultural Co-operating Marketing Federation of India Ltd vs JCIT. The tribunal held that where an order directing payment of damages and interest is challenged before appellate forum, no expenditure on account of interest arises till the appeal is disposed off.
The taxpayer had breached certain terms of a contract entered into by it with a non-resident. In an arbitration proceeding initiated by the parties, the arbitrator awarded certain costs to be payable by the taxpayer. In the proceeding for enforcement of the award, a single judge of the Delhi High Court directed the taxpayer to pay, in addition to damages, 18% interest from the date of arbitration till realisation date. On appeal by the taxpayer, a division bench of the Delhi High Court stayed the order of the single judge. While a special leave petition against the division bench order was pending before the Supreme Court, the taxpayer claimed deduction for interest cost awarded by the single judge, though the expense was not recorded in the books of accounts of the taxpayer. The tax officer denied the claim on the grounds that the interest liability was only a contingent liability and had not accrued to it in the books of accounts.
The tribunal observed the following while concluding that 18% interest cannot be allowed as expenditure until the same is crystallised.
* Contractual liability is not incurred on mere demand-raising by a claimant, but only when such a claim is either acknowledged or in case of non-acceptance, that a final obligation to pay is fastened coupled with the claimant acquiring legal right to receive such amount.
* Except for the taxpayer accepting a contractual claim, his liability to pay does not arise till the legal obligation to pay is fixed on him. Deduction for such a claim can be allowed only on acceptance of claim by the taxpayer or when a competent court passes an order against the taxpayer.
* The liability that was created by the decree of the single judge dated January 28, 2000, remained suspended from the date of stay granted by the division bench of the high court on February 28, 2001. The obligation created by the judgment of the single judge against the taxpayer was eclipsed and frustrated by a later judgment of the division bench and such obligation ceased to exist for the subject years, being assessment years 2001-02 and 2002-03.
* The Delhi High Court in taxpayer’s own case for AY1998-99 held that, when a claim is under dispute, expenditure cannot be said to have accrued to taxpayer.
* Where the taxpayer has not voluntarily accepted the contractual obligation, it cannot be said that the taxpayer incurred any liability so as to make him eligible for deduction. Notwithstanding that obligation relates to an earlier year, the liability to pay arises only in the later year, when a final enforceable obligation to pay is settled against the taxpayer. This view is supported by the Supreme Court judgment in Hindustan Housing & Land Development Trust which, on the question of year of accrual of income on a disputed liability, held that sums receivable from a transaction that is under dispute would accrue only in the year in which the dispute is settled.
* In the civil dispute before the high court, the taxpayer contended that the decree for payment of interest imposed on it was incorrect. In any case, the taxpayer has only claimed the liability as a contingent liability in its financial statements for the subsequent years.
The special bench order would have a strong impact in a country where every additional claim made under a contract is disputed before the courts for decades. But this order does not seem to have laid down the correct law, insofar as it has sought to apply the principle of accrual of income (where there should exist a right to receive the sum for income to accrue). But for accrual of expenditure (where a provision has to be made for all possible liabilities and losses) and for an expenditure to be deductible, Sec 37 of I-T Act states it shall be laid out or expended…
The tribunal overlooked some facts:
* When the award of an arbitrator is not paid, interest on the decree for the period of delay would be payable, unless a strong case exists for non-payment.
* The dispute in such cases would be limited to the quantum of the interest and the question of whether the interest could exceed the award itself, as was being disputed in the subject case.
* Interest on damages awarded by an arbitrator or a court would never arise from a contract. The special bench misdirected itself on the ground that the interest did not arise out of the contract between the parties and will be allowed only upon final settlement of dispute.
The order of the special bench suggests that the expenditure did accrue on the date when the single judge of the Delhi High Court directed payment of interest, but did not accrue when the order was stayed thereafter. However, once it is determined that an expense accrues to the taxpayer, it cannot thereafter be regarded as not to accrue merely because the order on the basis of which the said expense accrued has been stayed, pending an appeal by the parties.
This judgment might be overruled for the simple fact that interest liability is legally enforceable as the same is binding under a contractual obligation and directed by a court of law. It is rightfully claimed in the tax computation by the taxpayer under business income.
(Assisted by S Sriram, principal associate)
The author is executive partner, Lakshmikumaran & Sridharan, Attorneys. Views are personal