In the recent judgment of UOI v. Exide Industries Limited and Ors [2020] (SC) decided on 24.04.2020, a three-judge bench of the apex Court upheld the constitutional validity of section 43B(f) of the Income Tax Act, 1961.
Clause (f) of Section 43B, inserted by Finance Act, 2001 w.e.f
01.04.2002, allows deduction of leave encashment on actual payment irrespective
of the regular method of accounting employed by the assessee. In other words,
even if the assessee follows the mercantile basis of accounting, the deduction
would be provided in the assessment year when leave encashment is actually paid
and not in the year when the expenditure is incurred.
This takes us back to the case where the apex Court
first laid out conclusively the
nature of leave
encashment and its allowability. In the year 2000, the long-standing
dispute on the nature of
leave encashment was put to rest
by the apex Court in the case of Bharat Earth Movers v. Commissioner of Income Tax, Karnataka [2000] [TS-5116-SC-2000-O] (SC) when the Court held
that leave encashment is a certain
liability eligible for deduction in the year it accrued.
In this case, the assessee-company launched two beneficial welfare schemes
for its employees for encashment of leave. The officers of the company were
entitled to a paid leave 2.5 days per 30 days and the staff were entitled to
vacation leave of 1.5 days per month. Both were permitted to accumulate leave
up to 240/126 days maximum. Once they accumulated leave, the employee in the
subsequent year could either avail the leave or encash it. Any leave earned
beyond the ceiling limit of 240/126 days could not be availed or encashed and
would lapse. The assessee made yearly provision for the liability and claimed
that provision as deduction.
The Assessing Officer
disallowed such a provision citing
it to be a contingent liability. Tribunal allowed
such a deduction. The High
Court, reasoned that the liability would arise only in the event of an employee
encashing the leave instead of going on leave. It therefore held that the provision for accrued leave salary
was a contingent liability and, therefore not a permissible deduction.
The apex Court while allowing such a deduction
observed in para 4 of the judgment as follows:
“The law is settled: if a business liability
has definitely arisen in the accounting year, the deduction should be allowed
although the liability may have to be quantified and discharged at a future
date. What should be certain is the incurring of the liability. It should also
be capable of being estimated with reasonable certainty though the actual
quantification may not be possible. If these requirements are satisfied, the
liability is not a contingent one. The liability is in praesenti though it will
be discharged at a future date. It does not make any difference if the future
date on which the liability shall have to be discharged is not certain.”
After this judgment, Clause (f) of Section 43B was inserted by Finance
Act, 2001 w.e.f 01.04.2002. Thus the only effect of insertion of clause (f) is
to regulate the stated deduction by putting it in a special provision.
Whether the dictum of Bharat earth movers still
relevant?
What is crucial is the accrual of liability for
payment or expenditure during the relevant accounting year.
The Bharat Earth
Movers judgment dealt
with more than
just the allowability of leave encashment. It laid out legal principles for appreciating
the accrual or mercantile basis of accounting in allowing deduction for
liabilities. It laid out principles for distinguishing a certain liability from a contingent liability. It held that if a business liability has definitely arisen in the accounting year, the deduction should be allowed
although the
liability may have to be quantified and discharged
at a future date.
The arguments advanced in both the Exide Industries Case and the Bharat
Earth Movers Case are different. In Bharat Earth, the allowability of the
deduction of leave encashment was on the anvil. In Exide Industries, the issue
was regarding the timing of deduction and not the nature of liability.
Therefore, in effect, neither the amendment to Section 43B, nor the
judgment of Exide Industries erodes the foundation of the Bharat Earth Movers
judgment.
This is evident from the post 43B(f) era judgments of various courts,
relying on Bharat Earth Movers to test the nature of liability and its
consequent allowability.
In Taparia Tools Ltd. v. JCIT Special Range
- I [2015]
[TS-5013-SC-2015-O] (SC), quoting Bharat Earth,
the apex Court upheld the upfront deduction of interest on debentures in the
first year itself.
Similarly, in the recent judgment of Housing and Urban Development
Corporation Ltd. V. ACIT [2020] [TS- 5085-HC-2020(DELHI)-O] (Delhi), the Court relying on Bharat Earth amongst
other judgements, held that for
allowing deduction of arrears on account of pay revision, the effective date
of commencement of
wage revision after which the liability accrues is relevant.
In CIT v. Oberon Edifices &
Estates (P.) Ltd, [2019] [TS-5634-HC-2019(KERALA)-O] (Kerala), Bharat Earth Movers was followed by the Court to
allow deduction of post-sale business
expenditure incurred in
subsequent financial years, for the completion of construction of an under-construction building.
In Grace Shelter v. Assistant
Commissioner of Income-tax, Range - 21(2), [2019] [TS-5284-HC- 2019(BOMBAY)-O] (Bombay), Bharat Earth was distinguished and
certain expenditure incurred
by the assessee
for slum rehabilitation was disallowed since the same was contingent upon the
Slum Rehabilitation Authority handing over the vacant possession of a part of land where such construction would be carried
out.
Thus, the principles enumerated in Bharat Earth movers can still be used
to resolve disputes wherein the nature of a liability is to be determined.
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