Commissioner of Income Tax vs Om Metals and Mineral P. Ltd.

J.K. Ranka, J.—This reference under section 256(1) of the Income-tax Act, 1961 (for short, "the IT Act"), relating to the assessment year 1977-78, is answered on the following question referred to by the Income-tax Appellate Tribunal, Jaipur Bench, Jaipur (for short, "the ITAT") dated March 5, 1993:

"Whether, on the facts and in the circumstances of the case and in law, the Tribunal was justified in holding that the provision on account of contingency was an allowable deduction and, consequently, erred in deleting the disallowance of Rs. 87,224?"

The brief facts, which can be noticed, are that the respondent-assessee is a limited company and was in the business of contract for supply of irrigation gates, job-work and transportation. The assessee made a provision for contingency amounting to Rs. 87,224 on the total amount of Rs. 13,40,070 of work executed at 6 1/2 per cent. It was contended on behalf of the assessee that the work of dam at Right Bank Dam Division, Hidkal Dam had not been completed and, therefore, a provision was made only on the supplies. However, the Assessing Officer (for short, "the AO") was of the view that the said amount is nothing but a provision made for future contingency not ascertained and, accordingly, held that the said amount, relatable to the subsequent year, cannot be allowed and, thus, disallowed the said amount.

The disallowance was assailed by the assessee before the Commissioner of Income-tax (Appeals), (for short, "the CIT(A)"). The Commissioner of Income-tax (Appeals), who in view of an order of the Income-tax Appellate Tribunal in the case of Instrumentation Ltd., allowed the claim.

The Revenue preferred an appeal before the Income-tax Appellate Tribunal and it was argued on behalf of the Revenue that the facts in the case of Instrumentation Ltd. vis-a-vis the present assessee are entirely distinguishable and, thus, the order of the Income-tax Appellate Tribunal in the case of Instrumentation Ltd. cannot be applied. The contention of the Revenue that it is only a contingent liability, as it has been created on an estimated basis, i.e., on a certain percentage of supplies made this year and, thus, cannot be allowed, did not impress the Income-tax Appellate Tribunal and it placed reliance on the order of the Instrumentation Ltd. which was decided on December 17, 1981. The Income-tax Appellate Tribunal further observed that the present matter is being decided on July 30, 1992, and despite of 11 years having been passed since the date of the order of the Income-tax Appellate Tribunal in the case of Instrumentation Ltd., the Revenue was unable to bring on record whether reference was filed in the case of Instrumentation Ltd. or otherwise and, thus, dismissed the appeal of the Revenue.

It is contended by the learned counsel for the Revenue that the Income-tax Appellate Tribunal grossly erred in placing reliance on the judgment of the Income-tax Appellate Tribunal in the case of Instrumentation Ltd. He contended that the matter of Instrumentation Ltd. had come up before this court and on August 8, 1986, this court in the case of Commissioner of Income Tax Vs. Instrumentation Ltd., (1987) 167 ITR 354 : (1987) 1 WLN 580 directed the Income-tax Appellate Tribunal to state the case and refer the question on the same issue for decision of this court within three months. He further contended that subsequently this court in the case of CIT v. Instrumentation Limited vide order dated March 13, 2008, in DB Income Tax Reference No. 30 of 1995 and DB Income Tax Reference No. 87 of 1995, observed that the respondent, namely, Instrumentation Ltd. being a Government company and in the light of the judgment rendered by the hon''ble Supreme Court in the case of Oil and Natural Gas Commission and Another Vs. Collector of Central Excise, (1995) 4 SCC 541 Supp held that if a dispute exists between the Government of India and the public sector undertaking of the Union of India, the same may be resolved amicably by mutual consultation or through good offices of empowered agencies of the Government or arbitration avoiding litigation and this court in the above reference came to the conclusion that the matter of Instrumentation Ltd. has also been referred to a committee constituted by the Government of India and, thus, the reference was disposed of in view of the observations and directions of the Supreme Court. He contended that in so far as the question is concerned, it has not been answered and, thus, is pending and the Income-tax Appellate Tribunal at least ought not to have allowed the claim when the reference was sought by this court in Reference Application No. 170 of 1982 and the Income-tax Appellate Tribunal was aware of the order of this court and further that in DB Income Tax Reference No. 30 of 1995 and DB Income Tax Reference No. 87 of 1995, this very question was forwarded by the Income-tax Appellate Tribunal for decision of this court. Thus, he contended that the question has not yet been decided.

He further contended that it is merely a contingent liability without any assessment or quantification of a future liability and has been created only on estimated basis at 6 1/2 per cent amounting to Rs. 87,224. He contended that by no stretch of imagination, the assessee could have estimated the liability at 6 1/2 per cent and, thus, the assessee was not sure of any ascertained liability. He relied upon the judgment of the hon''ble apex court in the case of Shree Sajjan Mills Ltd. Vs. Commissioner of Income Tax, M.P., Bhopal and Another, AIR 1986 SC 484 : (1986) ECR 276 : (1985) 156 ITR 585 : (1985) 2 SCALE 737 : (1985) 4 SCC 590 : (1985) 3 SCR 593 Supp : Indian Molasses Co. (Private) Ltd. Vs. Commissioner of Income Tax, West Bengal, AIR 1959 SC 1049 : (1959) 37 ITR 66 and the judgment of this court in the case of Rajasthan State Mines and Minerals Ltd. v. CIT [1994] 208 ITR 1010 (Raj). While relying upon the said judgments, he contended that the hon''ble apex court, in the cases (supra) has held that contingent liability do not constitute expenditure and thus is not allowable.

No one appeared on behalf of respondent-assessee despite service.

We have considered the arguments advanced by counsel for the Revenue and, in our view, no interference is required to be made in the order passed by the Income-tax Appellate Tribunal as in our humble view, the Income-tax Appellate Tribunal has come to a correct conclusion that the liability was ascertained and it has been an admitted fact that the work had been completed at the Dam, namely, Right Bank Dam Division, Hidkal Dam and the provision was made only for supplies. Though it may be that the assessee made a provision at the rate of 6 1/2 per cent of the supplies for possible loss due to deduction made by the Government for not keeping the supplies to the satisfaction of the department which, in fact, had been deducted by the Government at 10 per cent. However, to be on the safer side, the assessee made a provision at 6 1/2 per cent. only. It is an admitted fact that the provision, if any made, was to make over the deficiencies, in respect of the work done as per the direction of the Government by which 10 per cent. deduction was made. Admittedly, the entire amount was included by the assessee in the total receipts and once the entire receipt has been shown, the expenditure ought to have been allowed and, therefore, this was an allowable deduction. In our view, the assessee has to ensure an expenditure and if not paid on or before the close of the financial year, it certainly deserves allowance. Admittedly, the system of accounting, followed by the assessee, is mercantile and any expenditure, not paid by the close of the year, is as it is allowable and in fact, even in a mercantile system of accounting, while income is also to be included, which has accrued to the assessee, so also the expenditure is to be allowed in similar fashion.

Though the learned counsel for the Revenue has relied upon the judgments rendered by the hon''ble apex court in the case of Shri Sajjan Mills Ltd. (supra); India Molasses Co. Ltd. (supra) and the judgment rendered by this court in the case of Rajasthan State Mines and Minerals Ltd. (supra) but the hon''ble apex court, in subsequent judgments, rendered in the case of Bharat Earth Movers Vs. Commissioner of Income Tax, Karnataka, AIR 2000 SC 2636 : (2000) 245 ITR 428 : (2000) 8 JT 606 : (2000) 5 SCALE 497 : (2000) 6 SCC 645 : (2000) 2 SCR 295 Supp : (2000) 112 TAXMAN 61 : (2000) AIRSCW 2797 : (2000) 5 Supreme 440 and Rotork Controls India (P) Ltd. Vs. Commissioner of Income Tax, Chennai, (2009) 223 CTR 425 : (2009) 314 ITR 62 : (2009) 6 JT 637 : (2009) 7 SCALE 456 : (2009) 13 SCC 283 : (2009) 8 SCR 1152 : (2009) 180 TAXMAN 422 , has considered the issue again and has distinguished the judgments rendered in the case of Shri Sajjan Mills Ltd. (supra) and India Molasses Co. Ltd. (supra). The hon''ble apex court, after considering the judgment rendered in the case of Metal Box Company of India Ltd. Vs. Their Workmen, AIR 1969 SC 612 : (1969) 39 CompCas 410 : (1969) 18 FLR 336 : (1969) 73 ITR 53 : (1969) 1 LLJ 785 : (1969) 1 SCR 750 culled out following principles for a claim like this ( page 430 of 245 ITR):

"(i) For an assessee maintaining his accounts on mercantile system, a liability already accrued, though to be discharged at a future date, would be a proper deduction while working out the profits and gains of his business, regard being had to the accepted principles of commercial practice and accountancy. It is not as if such deduction is permissible only in case of amounts actually expended or paid;

(ii) Just as receipts, though not actual receipts but accrued due are brought in for the income-tax assessment, so also liabilities accrued due would be taken into account while working out the profits and gains of the business;

(iii) A condition subsequent, the fulfillment 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; and

(iv) A trader computing his taxable profits for a particular year may properly deduct not only the payments actually made to his employees but also the present value of any payments in respect of their services in that year to be made in a subsequent year if it can be satisfactorily estimated."

8.1 After culling out the principles, finally observed as under (page 432 of 245 ITR):

"So is the view taken in Calcutta Company Ltd. Vs. The Commissioner of Income Tax, West Bengal, (1959) 37 ITR 1 : (1960) 1 SCR 185 wherein this court has held that the liability on the assessee having been imported, the liability would be an accrued liability and would not convert into a conditional one merely because the liability was to be discharged at a future date. There may be some difficulty in the estimation thereof but that would not convert the accrued liability into a conditional one; it was always open to the tax authorities concerned to arrive at a proper estimate of the liability having regard to all the circumstances of the case.

Applying the above-said settled principles to the facts of the case at hand, we are satisfied that provision made by the appellant company for meeting the liability incurred by it under the leave encashment scheme proportionate with the entitlement earned by employees of the company, inclusive of the officers and the staff, subject to the ceiling on accumulation as applicable on the relevant date, is entitled to deduction out of the gross receipts for the accounting year during which the provision is made for the liability. The liability is not a contingent liability. The High Court was not right in taking the view to the contrary."

The hon''ble apex court in the case of Rotork Controls India (P.) Ltd. (supra), again distinguished the judgment rendered in the case of Shri Sajjan Mills Ltd. (supra) and allowed the deduction by holding (page 79 of 314 ITR):

"At this stage, we once again reiterate that a liability is a present obligation arising from past events, the settlement of which is expected to result in an outflow of resources and in respect of which a reliable estimate is possible of the amount of obligation. As stated above, the case of Indian Molasses Co. (P.) Ltd. (supra) is different from the present case. As stated above, in the present case we are concerned with an army of items of sophisticated (specialized) goods manufactured and sold by the assessee whereas the case of Indian Molasses Co. Ltd. (supra) was restricted to an individual retiree. On the other hand, the case of Metal Box Co. of India Ltd. (supra) pertained to an army of employees who were due to retire in future. In that case the company had estimated its liability under two gratuity schemes and the amount of liability was deducted from the gross receipts in the profit and loss account. The company had worked out its estimated liability on actuarial valuation. It had made provision for such liability spread over to a number of years. In such a case it was held by this court that the provision made by the assessee-company for meeting the liability incurred by it under the gratuity scheme would be entitled to deduction out of the gross receipts for the accounting year during which the provision is made for the liability. The same principle is laid down in the judgment of this court in the case of Bharat Earth Movers (supra). In that case the assessee-company had formulated leave encashment scheme. It was held, following the judgment in Metal Box Co. of India Ltd.''s case (supra), that the provision made by the assessee for meeting the liability incurred under leave encashment scheme proportionate with the entitlement earned by the employees, was entitled to deduction out of gross receipts for the accounting year during which the provision is made for that liability. The principle which emerges from these decisions is that if the historical trend indicates that large number of sophisticated goods were being manufactured in the past and in the past if the facts established show that defects existed in some of the items manufactured and sold then the provision made for warranty in respect of the army of such sophisticated goods would be entitled to deduction from the gross receipts under section 37 of the 1961 Act."

We may also observe that the judgment rendered by this court in the case of Rajasthan State Mines and Minerals Ltd. (supra), relied upon by counsel for the Revenue, is distinguishable on facts. Both the Commissioner of Income-tax (Appeals) as well as Income-tax Appellate Tribunal have come to a definite finding of fact that the liability existed and was ascertained, therefore, the claim was allowable.

We may also observe that this court in the judgment of Rajasthan State Mines and Mineral (supra) with reference to whether a claim is allowable or not, has observed in paragraph 11 that even the actual liability which is not praesenti is also an expenditure. The only thing, which is required is that it must be the actual liability and not contingent or unascertained.

The hon''ble apex court, in the case of Metal Box Co. of India Ltd. v. Their Workman (supra), had also an occasion to consider as to what is a provision or a reserve and after referring to the settled principle, observed as under (page 67 of 73 ITR):

"The next question is whether the amount so provided is a provision or a reserve. The distinction between a provision and a reserve is in commercial accountancy fairly well known. Provisions made against anticipated losses and contingencies are charges against profits and, therefore, to be taken into account against gross receipts in the profit and loss account and the balance-sheet. On the other hand, reserves are appropriations of profits, the assets by which they are represented being retained to form part of the capital employed in the business. Provisions are usually shown in the balance-sheet by way of deductions from the assets in respect of which they are made whereas general reserves and reserve funds are shown as part of the proprietor''s interest (see Spicer and Pegler''s Book-keeping and Accounts, 15th edition, page 42). An amount set aside out of profits and other surpluses, not designed to meet a liability, contingency, commitment or diminution in value of assets known to exist at the date of the balance-sheet is a reserve but an amount set aside out of profits and other surpluses to provide for any known liability of which the amount cannot be determined with substantial accuracy is a provision"

12.1 After laying down the aforesaid principles, allowed the claim made by the said company with reference to the gratuity.

In view of the concurrent finding of the two appellate authorities, and in the light of the opinion of the hon''ble apex court in the case of Bharat Earth Movers (supra) and Rotork Controls India (P.) Ltd. (supra), and Calcutta Company Ltd. Vs. The Commissioner of Income Tax, West Bengal, (1959) 37 ITR 1 : (1960) 1 SCR 185 in our view, the Income-tax Appellate Tribunal was correct and justified in allowing the amount of Rs. 87,224 which was an ascertained liability on account of the allowable deduction. Accordingly, we answer the question in favour of the assessee and against the revenue. No costs.