Income Tax Appellate Tribunal - Mumbai
Deputy Commissioner Of Income-Tax vs Esquire Video Film Services (P.) Ltd. on 18 June, 1999
Equivalent citations: [2000]74ITD57(MUM)
ORDER
M. A. Bakshi, JM
1. We find it convenient to dispose of these two appeals of the revenue, for assessment years 1986-87 and 1987-88, by this consolidated order. The common hotly contested issue is relating to the claim payable to two banks, viz. Corporation Bank and Indian Overseas Bank. For assessment year 1986-87 the assessee debited a sum of Rs. 53,40,607 on account of interest payable to the two banks referred to above. Similarly for assessment year 1987-88 the assessee debited a sum of Rs. 54,99,305 as accrued interest payable to the banks referred to above. The amount was not credited to the banks but shown as a liability on account of interest. In the Notes to Accounts the auditors have specifically mentioned that the amount of interest provided in the books of account is a contingent liability in view of the dispute between the assessee and the banks. The Assessing Officer accordingly denied the liability on the ground that the contingent liability is not allowable as a deduction. He has further observed that the assessee will be allowed a deduction as and when the liability is crystallised.
2. On appeal the Commissioner of Income-tax (Appeals) has deleted the additions by holding that there was no logic as to how the assessee could be denied the deductions as the liability had actually accrued and had been debited to the accounts.
3. The revenue is aggrieved. Our attention has been invited to the Auditors Report placed at Page 33 of the Paper Book to point out that the auditors have specifically referred to the liability as contingent liability. Relying upon the decision of the Bombay High Court in the case of CIT v. Phalton Sugar Works Ltd. [1986] 162 ITR 622/24 Taxman 444 it was contended that in the case of contractual liabilities when a dispute is raised the liability accrues only in the year of the settlement of the dispute. Reliance was also placed on the decision of the Supreme Court in the case of Shree Sajjan Mills Ltd. v. CIT [1985] 156 ITR 585/23 Taxman 37 in support of the contention that the contingent liabilities do not constitute expenditure and cannot be allowed even under the mercantile system of accounting. According to the learned Departmental Representative the liability to pay interest to the bank ceases with the filing of the suit against the assessee. The payment of interest from the date of filing of the suit till its decision depended on the discretion of the Court and therefore there was no justification for making a provision in the books of account for the liability which depended on the decision of the Court. Reliance was also placed on the decision of the Supreme Court in the case of Madras Industrial Investment Corpn. Ltd. v. CIT [1997] 225 ITR 802 (SC) where the term 'expenditure' has been explained and it has further been held that a Contingent liability which may have to be discharged in future cannot be considered as expenditure.
14. The learned counsel for the assessee, on the other hand, contended that the assessee was engaged in the manufacture of video cassettes and was maintaining the books of account on mercantile system of accounting. The assessee had borrowed money from the two banks and as per the terms of the agreement the assessee was required to pay interest to the banks. Though there was a dispute between the assessee and the banks, the liability of the assessee to pay interest to the banks did not cease. The assessee had made a provision in the books of account and there was no objection from the auditors for making such a provision. Our attention has also been invited to the suits filed by the banks and the consent terms on the basis of which the dispute has been settled by the Bombay High Court. It has further been pointed out that the assessee has disclosed the difference between the amount claimed as a deduction and the amount ultimately settled as income in assessment year 1989-90 and therefore it would be unreasonable to assess the amount in assessment years 1986-87 and 1987-88. Reliance was placed on the decision of the Bombay High Court in the case of Standard Mills Co. Ltd. v. CIT [1998] 229 ITR 366 (Bom.) and the decision of the Supreme Court in the case of Kedarnath Jute Mfg. Co. Ltd. v. CIT [1971] 82 ITR 363 in support of the contention that the accrued liability is allowable as a deduction under the mercantile system of accounting notwithstanding the fact that the assessee has disputed the liability and that the amount is payable in future.
5. The learned D.R. in counter reply contended that the case law relied upon by the learned counsel for the assessee is relating to the statutory liabilities and not in respect of the contractual liability.
6. We have given our careful consideration to the rival contentions. There is no dispute about the fact that as per the terms and conditions of the agreement between the assessee and the two banks, viz. Corporation Bank and Indian Overseas Bank, the assessee was liable to pay interest at the agreed rate. However, a dispute had arisen between the assessee and the banks and the assessee had refused to pay the principal amount as well as the interest to the banks. When the Assessing Officer asked the assessee to give reasons for making a provision of Rs. 53,40,607 for assessment year 1986-87 vide order sheet entry dated 6-9-1988 the assessee submitted a written reply. The relevant portion is available at Page Nos. 2 & 3 of the assessment order for assessment year 1986-87 and we consider it worthwhile to reproduce the same as under :-
"By virtue of an arrangement with two Banks in question namely Indian Overseas Bank and Corporation Bank we had sufficient working capital to carry on our import and export business in a smooth manner. However, the loan arrangement was upsent by Corporation Bank because of its unilateral action in transfer of cost of capital goods vis-a-vis machinery account to our packing credit account for term loan against which the capital goods were imported. Our cash flow in consequence was disturbed and we were not in a position either to retire import bills nor were we able to import any raw material. In short, our business came to a dead end. In consequence we could not make any payment to the bank and in the meanwhile the Corporation Bank filed a suit numbered 586 of 1984 in the High Court, Bombay. A copy of the plaint filed by the Corporation Bank is enclosed herewith for your information and record. In accord with a prayer contained in the plaint, we have necessarily to make a provision for the interest since we maintain books of account on mercantile system."
7. It is clear from the above reply that the assessee has made a provision for interest in the books of account on the basis of a claim made in the suit filed by the banks in the High Court of Bombay. The assessee had made a provision for interest in the books of account but did not credit the same to the bank account. The amount was separately provided in the Balance Sheet as interest payable. The books of account for the year ended 31st of August, 1985 for assessment year 1986-87 were audited and the Auditors had noted that the liability of the interest provided in the books was a contingent liability. Note No. 2 to Schedule No. 13 being relevant is reproduced hereunder :-
"2. (i) Contingent liabilities for contracts entered into and not executed for Master Taping of Films - Rs. 71,43,400 (last year Rs. 24,40,000).
(ii) Contingent liability for disputed interest payable to Corporation Bank and Indian Overseas Bank amounts to Rs. 83,12,636.
Corporation Bank and Indian Overseas Bank have filed suits against the Company for the recovery of their dues for Rs. 1,62,15,275 and Rs. 1,50,00,000 respectively. The Company has disputed their claims and the matter is sub judice. However the High Court, at the instance of the Corporation Bank, has appointed the Court Receiver who has taken the charge of Master Tapes".
8. From the above facts it becomes evident that the assessee had disputed the contractual liability of interest payable to the banks. The banks had filed a suit for recovery of the principal amount along with interest. As on the close of the previous year the suit was pending in the High Court. The issue before us is as to whether the liability provided in the books of account is an accrued liability or a contingent liability and as to whether it is allowable as a deduction. It is not in dispute that the assessee is following mercantile system of accounting. Before we consider the case law in regard to this issue, it may be pertinent to mention that there is a distinction between a statutory liability and contractual liability. The principles of law applicable in respect of the statutory liabilities differ with the principles of law applicable to contractual liabilities. In the case of statutory liability it is well-settled that the liability that is accrued under the statute is allowable as a deduction notwithstanding the fact that the assessee has disputed the liability either by way of an appeal or otherwise. There are several decisions relating to this issue. Suffice to refer to the decision of the Supreme Court in the case of Kedarnath Jute Mfg. Co. Ltd. (supra). In the case of contractual liability the law is totally different. In the case of Phalton Sugar Works Ltd. (supra) the Bombay High Court held that "where a liability arising out of a contractual obligation is disputed, the assessee is entitled, in the assessment year relevant to the previous year in which the dispute is finally adjudicated upon or settled, to claim a deduction in that behalf". The Bombay High Court has followed the decision of the Supreme Court in the case of CIT v. Swadeshi Cotton & Flour Mills (P.) Ltd. [1964] 53 ITR 134. In the case of Shree Sajjan Mills Ltd. (supra) the Supreme Court held that "the contingent liabilities do not constitute expenditure and cannot be the subject-matter of deduction even under the mercantile system of accounting. Expenditure which is deductible for income-tax purposes is towards a liability actually existing at the time but setting apart money which might become expenditure on the happening of an event is not expenditure".
9. In the case of Madras Industrial Investment Corpn. Ltd. (supra) the Supreme Court held that "there could be no computation of such profits and gains until the expenditure which is necessary for the purpose of earning the receipt is deducted therefrom, whether the expenditure is actually incurred or the liability in respect thereof has accrued even though it may have to be discharged at some future date it was held. Thus, "expenditure" is not necessarily confined to the money which has been actually paid out. It covers a liability which has accrued or which has been incurred although it may have to be discharged at a future date. However, a contingent liability which may have to be discharged in future cannot be considered as expenditure".
10. Considering the principles of law laid down by Bombay High Court and the Supreme Court in the aforementioned cases, it is clear that the assessee is not entitled to deduction in respect of the disputed liabilities of interest accrual of which is contingent on the settlement of the dispute. When the banks filed the suits for recovery of the loan as well as interest, the Court has the discretion to award interest from the date of institution of the suit till the decision of the suit and from the date of the decision of the suit till the recovery of the amount. The accrual of interest from the date of filing of the suit till the decision is contingent and not definite. Therefore, there is no accrual of liability of interest for the year under appeal. The assessee was thus not entitled to deduction on account of interest in the year under appeal.
11. Similarly for assessment year 1987-88 the claim made by the assessee on account of a provision for payment of interest to bank amounting to Rs. 54,99,305 is not allowable in the year under appeal.
12. It may be pertinent to mention that the assessee had reached to a settlement with the bank and agreed to certain terms and conditions described as consent terms. In assessment year 1989-90 the assessee has offered the amount of interest as taxable under section 41. In other words, the assessee has ultimately not been held liable to interest for which a provision was made in the accounts for assessment years 1986-87 and 1987-88. We, therefore, restore the additions of Rs. 53,40,607 and Rs. 54,99,305 for assessment years 1986-87 and 1987-88 respectively. The assessee will be justified in asking the Assessing Officer to delete the amount assessed in assessment year 1989-90 out of the above additions. We hope that the revenue will consider such a request favourably, as it would, in our view, be just and reasonable to do so.
13. For assessment year 1987-88 there are some other grounds of appeal which are dealt with as under :-
Ground No. 1 is relating to the disallowance of Rs. 11,597 on account of foreign travel expenses deleted by the CIT(A). The CIT(A) has recorded a factual finding in Para No. 1 of the order that the expenditure had been incurred by the assessee for purposes of business. The finding of fact recorded by the CIT(A) has not been rebutted by any evidence. We therefore decline to interfere.
Ground No. 2 is relating to the disallowance of Rs. 14,958 on account of telephone expenses for the purpose of computation of perquisite under section 40A(5). The CIT(A) has deleted the addition by recording a finding that there is a separate telephone at the residence of the Managing Director, the expenses of which are not debited to the accounts of the company. It was accordingly held that there was no justification for including part of the telephone expenses of the company for the purposes of computation of perquisite under section 40A(5). We do not find any infirmity in the order of the CIT(A) in this regard. We therefore decline to interfere.
Ground No. 3 is relating to the addition of Rs. 54,99,305 on account of disputed liability of interest. We have restored this addition as per Para Nos. 6 to 12 of this order.
Ground No. 4 is relating to the addition of Rs. 18,78,822 on account of suppression of stocks deleted by the CIT(A). The facts relating to this issue are contained in Para Nos. 6 and 6.1 of the order of the CIT(A). It will be useful to quote the relevant portion from the order as under :-
"6. There is a very elaborated narration on this issue in the assessment order a gist of which is that the income and expenditure account of the immediately preceding year showed a closing stock of Rs. 18,89,300 whereas the accounts of the present year did not show any such closing stock. The Assessing Officer found that as per the statement of assessee-company furnished before him the assessee had at the end of the present accounting year in hand video rights (at cost Rs. 17,57,000 and video rights of English being Rs. 1,21,822) which had not been accounted for in the Profit & Loss account and therefore amounted to suppression of income. The explanation of the assessee is stated to be given in their letter dated 29-7-1989. This explanation as given in the assessment order was that these rights represented unexploited rights and were not includible in the accounts. The Assessing Officer considered this explanation to be incorrect and could not conceive of the profit being correctly arrived at without inclusion of these two amounts of closing stock. The two amounts totalling Rs. 18,78,822 have been accordingly added to the total income agitated by the appellant in this ground of appeal.
6.1 I have gone through the assessee's letter dated 29-7-1989 and feel that this letter is what has caused all the confusion. What has actually happened is that the item of expenditure debited to the accounts under the head 'Material consumed' Rs. 4,05,358 is the net figure of opening stock plus purchases less closing stock. This becomes clear from the statement of cost of sales of materials consumed which is a part of the income and expenditure account. According to this statement the opening stock of video rights is Rs. 17,57,000 included in the entire opening stock for other items at Rs. 1,08,31,649. This opening stock added to purchase of Rs. 10,63,771 is reduced by the closing stock of Rs. 1,08,49,128 to arrive at the cost of sales at Rs. 10,85,247. The break up of this figure is as under :-
Packing charges debited to the P & L A/c Rs. 4,56,768
Stores & Spares debited to P & L A/c Rs. 1,04,056
Recoveries from customers to which extent
expenses written off Rs. 23,665
Blank cassettes taken to current assets Rs. 95,400
Materials consumed debited to P & L A/c Rs. 4,05,358
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Total Rs. 10,85,247
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It will thus be seen that the Profit and Loss account has properly taken into account the entire closing stock of Rs. 1,08,49,128 which includes within these two items considered by the Assessing Officer for addition, viz. Rs. 17,57,000 being video rights and Rs. 1,21,822 being video rights, English. The addition which has been caused by pure confusion to which both the parties have generously contributed is directed to be deleted. There will be a relief of Rs. 18,78,822."
14. The findings recorded by the CIT(A) have not been rebutted before us by any evidence. We therefore find no justification to interfere in the order of the CIT(A) in this regard.
15. In the result, whereas the appeal of the revenue for assessment year 1986-87 is allowed, the appeal for assessment year 1987-88 is partly allowed.