Entries in the books of account cannot decide whether expenses are allowable as deduction or not – SC
The Income-tax Act, 1961 brings to tax ‘Profits and Gains’ of a business or profession of a taxpayer. The profits and gains to be brought to tax are the real profits and they have to be ascertained on ordinary principles of commercial trading and commercial accounting. While computing the profit and gains from business or profession, there are certain expenditures which are disallowed. This means that the income tax department does not allow the benefit of such expenditures and the assesses are required to pay taxes on such expenditures by adding it back to the net profits. There are two primary reasons for disallowance of any expenditure:
- The tax amount required to be deducted on certain expenditures are not deducted while making the payment.
- The expenditure does not implicitly relate to the conduct of such business or profession;
However, could deduction of an expense be disallowed to an assessee on the ground that such deduction was in fact not claimed in the books of account?
Let us refer to the case of Kedarnath Jute Manufacturing Co Ltd v. CIT (1971), where the issue under consideration was whether a deduction could be claimed by an assessee where liability to pay the expense had accrued during the year of assessment even though it had to be discharged at a future date?
Facts of the Case:
- The appellant was a public limited company doing the business of jute and manufacturing of jute goods.
- It followed the mercantile system of accounting.
- Before the Income-tax Officer (ITO), the appellant claimed a deduction on account of assessed sales-tax.
- The demand of sales-tax was contested by the appellant before the higher sales-tax authorities but before the matter was finalised the ITO completed the assessment.
- He disallowed appellant’s claim for deduction of sales tax on the ground that the liability, to pay sales tax was not highlighted by the appellant and no provision was made in its books with regard to payment of the assessed amount.
- The authorities under the Act dismissed the appeals.
- The High Court (HC) in reference was of the opinion that unpaid and disputed sales tax liability could not form the basis of a claim for deduction.
- Aggrieved with the order of the HC, appellant appealed before the Supreme Court (SC)
Observations of the SC
- If an assessee followed mercantile system of accounting, deduction of an expense was allowed in the year in which the liability to pay arose even though the payment was to be made in subsequent year.
- This was the very essence of mercantile system of accounting, that the chargeability of any income and allowability of any expense was not contingent upon the actual receipt or payment.
- This view was consistently taken by SC.
- Further, in case of sales tax, once the order of the assessing authority was received, it crystallised the liability and an assessee could claim deduction of such amount of tax on the ground that the same had accrued though he had not accepted the liability and had filed an appeal against the same.
- Further, allowability of an expense and taxability of any income was not contingent upon the entries made in the books of account. The same is governed by the provisions of the Act.
- Thus, even if there was no entry in the books of account making provision for any expenses, the same could be claimed as a deduction if otherwise the liability to pay had accrued in the assessment year under consideration.
- SC held that an assessee who followed the mercantile system of accounting was entitled to deduct from the profits of the business such liability which had accrued during the period for which the profits and gains were being computed.
SC held that the liability for payment of sales tax had accrued during the assessment year even though it had to be discharged at a future date. If an assessee under some misapprehension or mistake fails to make an entry in the books of account and although, under the law, a deduction must be allowed by the Officer. The assessee would not lose the right of claiming or would not be debarred from being allowed that deduction. Whether the assessee was entitled to a particular deduction or not would depend on the provision of law relating thereto and not on the view which the assessee might take of his rights nor can the existence or absence of entries in the books of account be decisive or conclusive in the matter.