Income Tax Appellate Tribunal - Hyderabad
Income-Tax Officer vs Vamet Industries on 19 September, 1990
Equivalent citations: [1991]38ITD504(HYD)
ORDER
R. Rangayya, Accountant Member
1. The assessee is a registered firm carrying on business in manufacture and supply of certain electrical equipment mainly to Andhra Pradesh State Electricity Board (hereinafter referred to as APSEB). They entered into an agreement for supply of 30 transformers on 6-10-1978 at a cost of Rs. 5,43,900. According to Clause 8 of the contract, the time for and the dates of delivery mentioned in the order shall be deemed to be the essence of the contract. In case of delay in delivery of materials, whatever be the reason, the Board (APSEB) had an option to demand and recover from the supplier an amount equivalent to 1/2% of the value of the materials not delivered within the prescribed time limit, for every week of delay or part thereof, subject to a maximum of 5% of the value of the materials that are not supplied as per the guaranteed delivery. This right of the Board was to be without prejudice to its rights under the law including the right to cancel the contract, forfeit the deposit and/or recover damages for breach of contract. The penalty, however, was not supposed to apply for delays proved to be arising out of force majeure conditions beyond reasonable control of the assessee. It was also stipulated as one of the terms of contract that in case the supplier had not adhered to the delivery schedule, the Board reserved the right to purchase the balance quantity from the open market and recover the extra expenditure thus incurred, from the supplier. This was to be in addition to the rights of the Board mentioned in other parts of the contract.
2. The assessee is stated to have failed to supply the contracted material in time with the result that APSEB by its letter dated 21-9-1983 (the accounting year of the assessee being the year ending 30th September 1983) demanded payment of a sum of Rs. 4,53,241.90 arrived at in the following manner :-
Additional expenditure incurred by the Board due to risk purchase Rs. 5,09,229.90 Recoveries already made by way of encashment of bank guarantees Rs. 55,988.00
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Net extra expenditure Rs. 4,53,241.90
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On the ground that the assessee had incurred liability to the extent of Rs. 4,53,241 to APSEB during the year of account, it claimed deduction of the above amount from its profits though such claim was not entered in the books of account. The assessee's claim was based on the letter received by it from APSEB.
3. The Income-tax Officer examined the assessee's contention and held that the above amount cannot be allowed as a deduction while computing the income for the year. According to the Income-tax Officer, the above amount was only a contingent liability. Though APSEB had claimed this amount as early as 21-9-1983, even to date the assessee-firm has not paid the amount as it was not agreeing to such liability. APSEB also has not instituted any civil case for recovery of damages. Thus, it was held that the liability was neither definite nor ascertained. He also held that the decision of the Supreme Court in the case of Kedarnath Jute Mfg. Co. v. CIT [1971] 82 ITR 363 sought to be relied on by the assessee, is not applicable inasmuch as the present claim is not a statutory liability. For the above reasons, the Income-tax Officer disallowed the assessee's claim for deduction of the above sum. On appeal, the Commissioner of Income-tax (Appeals) held that the above sum will have to be allowed as a deduction on the basis of the decision of the Income-tax Appellate Tribunal in the case of ITO v. Radiant Cables (P.) Ltd. [IT Appeal Nos. 679 and 1017 (Hyd.) of 1985, dated 25-2-1986]. Hence the present appeal by the revenue.
4. It is contended by Sri Shyam Sunder, learned departmental representative, that the CIT (Appeals) is not correct in accepting the assessee's claim for deduction of the sum of Rs. 4,53,241 from out of its income. The alleged liability arose on account of non-supply of certain equipment which was contracted to be supplied by an order placed by APSEB in 1978. No doubt it is true that APSEB. had made a claim for payment of damages of Rs. 4,53,241 by its letter dated 21-9-1983, but it is only a claim which was not accepted by the assessee. The assessee had totally denied liability to pay any damages on account of the alleged breach of contract. In fact, till the time of assessment in 1985, the amount was not paid. It was pointed out that from time to time the assessee had been offering to make deliveries and inspection of the equipment manufactured. The assessee had intimated to the Chief Engineer, Electricity Projects, by its letter dated 11-1-1982, the revised programme regarding submission of drawings, commencement of production and when the first unit would be offered for inspection. Thereafter, there were some delays due to technical difficulties with the result that the assessee could not successfully manufacture the required equipment within the time limit. Though it is true that the APSEB by its letter dated 21-9-1983 had demanded the above amount as damages on account of the fact that it had to purchase the equipment by incurring additional expenditure, the assessee by its letter dated 8-11-1983 had clearly denied any liability for the amount claimed by APSEB. It was also claimed by the assessee that the bank guarantee amount was wrongly deducted and should not have been encashed by APSEB.
Once again, by a letter dated 24-7-1985, the assessee disclaimed any liability on account of the alleged damages stated to have been incurred by APSEB. On 25-7-1985, the assessee had also written to APSEB stating that they had entered into a collaboration agreement with another manufacturer and they were prepared to supply the above equipment if they were allowed to supply the same within reasonable time. APSEB by its letter dated 9-4-1986 had agreed to place a fresh purchase order for the same 30 Nos. of 132 KV Current Transformers at a price of Rs. 5,43,900 with the stipulation that if the assessee failed to supply the above mentioned equipment as per the fresh purchase order, the Board will recover from the assessee extra cost of Rs. 5,75,153 incurred earlier in procuring them from BHEL, another manufacturer, at market price. In other words, the original contract was substituted by a new contract and the Board was prepared to reconsider the claim and waive it in case the assessee adhered to the fresh order dated 9-4-1986 for supply of the equipment. This clearly showed that the claim made by APSEB in 1983 was only a tentative one and has not been accepted by the assessee and it was subject to renegotiation from time to time. It is true that the assessee failed to supply the goods as per the fresh contract also and ultimately APSEB recovered this amount due from the assessee in 1990. But, to claim that the sum had become due on the basis of a letter issued by APSEB in 1983 cannot be accepted. At best, it was only a contingent liability which could become a real liability only at the time when it is finally accepted by both the parties. The present claim is not a statutory liability but a contractual liability which becomes final only when it is either accepted by both the parties, or if it is ultimately adjudicated upon by a proper authority. Since the assessee had not accepted the liability claimed by APSEB in 1983, it is contended that it should not be allowed as a deduction from the total income of the assessee for the assessment year 1984-85. The decision relied upon by the CIT(Appeals) is clearly distinguishable in that, that was a case where there was no dispute about the liability between the parties. Since it is well settled that contingent liabilities cannot be allowed as deduction even in a case where the assessee maintains accounts on mercantile basis, it is contended that the CIT (Appeals) is not correct in allowing the deduction of the above sum. The learned departmental representative in this connection relied on the following decisions :-
CIT v. Swadeshi Cotton and Flour Mills (P.) Ltd. [1964] 53 ITR 134 (SC) ; Shree Sajjan Mills Ltd. v. CIT [1985] 156 ITR 585 (SC); CIT v. Phalton Sugar Works Ltd. [1986] 162 ITR 622 (Bom.); Swadeshi Cotton Mill Co. Ltd. v. CIT [1980] 125 ITR 33 (All.); M.S.P. Senthikumara Nadar and Sons v. CIT [1957] 32 ITR 138 (Mad.).
5. Sri G. Satyanarayana, learned representative for the assessee, on the other hand, claims that it is not correct to say that there is no ascertained liability in respect of this amount during the accounting year. The liability arose as soon as there was a breach of contract and the quantum of damage was ascertained and a claim was made by APSEB by its letter dated 21-9-1983 claiming a sum of Rs. 4,53,241. Since this amount was ascertained on the basis of extra expenditure incurred by APSEB for purchase of the contracted equipment from the open market and as the breach of contract had already occurred, he contended that the amount had become an ascertained liability and is allowable as a deduction. The fact that the assessee might have denied its liability without any basis whatsoever does not postpone the accrual of such liability, or the fact that the Board had agreed to permit the assessee to supply the equipment in 1985 does not in any way absolve the assessee from the liability, especially in view of the fact that APSEB had reserved to itself the power to revive this liablity in case of failure on the part of the assessee to adhere to the terms of the new contract. In fact, the assessee could not deliver the goods even as per the new contract and so in 1990 APSEB had recovered the full amount from the assessee by adjustment from the amounts due to it on account of other supplies made. It is accordingly claimed that the first appellate authority is correct in allowing the assessee's claim in this regard. Support is also sought to be drawn from the decision of the Tribunal in ITO v. Radiant Cables (P.) Ltd. [1986] 18 ITD 79 (Hyd.) and the decision of the Allahabad High Court in CIT v. Sugar Dealers [1975] 100 ITR 424.
6. We have heard the rival submissions. In our opinion, the CIT (Appeals) is not correct in accepting the assessee's claim for deduction of the above sum. It is now well settled that a contingent liability cannot be allowed as a deduction even when the assessee is maintaining accounts on mercantile basis. The Supreme Court in the case of Shree Sajjan Mills Ltd. (supra), held that contingent liabilities do not constitute expenditure and cannot be the subject-matter of deduction even under the mercantile system of accounting and that 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. The Madras High Court in the case of M.S.P. Senthikumara Nadar and Sons v. CIT [1957] 32 ITR 138, held that only an ascertained liability justifies an, entry in accounts maintained on the mercantile basis and deductions are not permissible for anticipated losses or contingent liabilities, even if they are inevitable. The Supreme Court, again, in the case of CIT v. Swadeshi Cotton and Flour Mills (P.) Ltd. [1964] 53 ITR 134, while dealing with the claim of the assessee in respect of payment of profit bonus, held that if an employer follows mercantile system of accounting, it has a liability towards profit bonus only when the claim, if made, is settled amicably or by industrial adjudication. In that case, though the bonus related to the calendar year 1947, since the award was made ultimately in 1949, it was held that the liability could be properly attributed to calendar year 1949 and not earlier. The Allahabad High Court in the case of Swadeshi Cotton Mills Co. Ltd. (supra), held that where the liability is based on some contractual obligation, it arises only when it is ascertained. Unless the liability has become an ascertained sum of money, it no doubt exists but proceedings have yet to be taken to determine the exact amount. A vague liability to make a payment cannot be entered in the accounts. The Bombay High Court in the case of Phalton Sugar Works Ltd. (supra) 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.
7. From the above decisions, it will be clear that in respect of contractual obligations, unlike in cases of statutory liabilities, the liability can be allowed as a deduction only after it is ascertained. Before that time it will only be a contingent liability. In case such liability is disputed, deduction can be allowed only when the dispute is finally adjudicated upon or settled and not earlier. A mere claim by one party which is not accepted by the other party cannot make the liability eligible for deduction from the income in order to arrive at taxable income. Mere claims cannot assume the character of ascertained liabilities, especially when the other party has denied such claims. Examined in the light of the above, the position which emerges is as follows :-
In 1978, APSEB had placed an order for supply of 30 Nos. 132 KV Current Transformers. There is no dispute that the assessee could not supply the equipment within the time specified in the contract. By its letter dated 21-9-1983, APSEB had demanded a sum of Rs. 4,53,241 as damages on account of the fact that the Board was forced to purchase the equipment from outsiders at extra cost. This claim for damages was, however, denied by the assessee by its letter dated 8-11-1983. This was once again reiterated by subsequent letter dated 24-7-1985 and other letters. Thereafter, the parties negotiated a further contract. It appears that the assessee pleaded before the Board that it should be given another chance to supply the above equipment. The Board seems to have relented and placed a further order for supply of the equipment. They, however, stipulated that in case the assessee failed to supply the equipment as per the fresh purchase order, APSEB will recover the extra cost of Rs. 5,75,553, part of which amounted to Rs. 4,53,241. Thus, it appears that by negotiations the parties agreed that if the assessee was able to supply the equipment in accordance with the fresh order placed in 1986, the assessee would not have to pay the above amount and the liability would arise only in case of further default even in respect of the new order. As it happened, the assessee once again failed to supply the equipment and ultimately APSEB sought to recover the amount from out of the sums due to the assessee from APSEB. Though this was protested, the matters at present rest there. Thus, it is clear that the liability of Rs. 4,53,241 claimed by APSEB by its letter dated 21-9-1983 has not been accepted by the assessee and the liability was totally denied by it. APSEB was pleased to re-negotiate and enter into a fresh contract and it was stipulated in that contract that the original amount claimed by APSEB will be payable only if the terms of the fresh contract are not adhered to. All these facts clearly show that the liability has not been ascertained and is being disputed and itha4 not become final uptil 1990. Though it is true that the Board was able to recover the above amount from out of the amounts due to the assessee in 1990, it is not known whether the assessee had accepted at that time the liability. Thus, it is clear that during the accounting year relevant to the assessment year 1984-85, the amount claimed by APSEB was only a claim which was disputed by the assessee. It was not ascertained. It has not become final so that it can be said to have accrued as a liability to be allowed as deduction in computing the assessee's income.
8. The decisions sought to be relied upon by the learned representative for the assessee are clearly distinguishable. The decision of the Tribunal in the case of Radiant Cables (P.) Ltd. (supra) is a case where there was no dispute about the liability. Similarly, the decision of the Allahabad High Court in CIT v. Sugar Dealers [1975] 100 ITR 424, is also a case where the claim under consideration was towards a business loss. It was a case of forfeiture of security deposit on account of non-adherence to the terms of the contract which was claimed as a trading loss. The court accepted the assessee's claim for deduction of the amount on the ground that it was a contract entered into with a view to earning profits and forfeiture of security deposited by a businessman for properly carrying out a contract would be a trading loss and the assessee would be entitled to deduct such loss to arrive at the true profits of his business. The above decision, in our opinion, is clearly distinguishable on facts.
9. In view of the above discussion, we are of the opinion that the assessee is not entitled to deduction of the above sum of Rs. 4,53,241 in computing the income for the assessment year 1984-85. The revenue's appeal is allowed and the above sum is restored to the assessment.