NATIONAL AGRICULTURAL COOPERATIVE MARKETING FEDERATION OF INDIA LTD vs. JCIT RANGE-32,

The Hon’ble President of the Income-tax Appellate Tribunal, on a reference made by a Division Bench, has constituted this Special Bench by posting the following question for our consideration and decision:-

The assessee has raised similar grounds in both the captioned appeals against the confirmation of disallowance of interest on damages amounting to Rs.7,92,52,013 and Rs.8,44,34,983 for the A.Ys. 2001-02 and 2002-03 respectively. Since the facts and circumstances of making addition by the Assessing Officer (AO) and then its echoing by the ld. Commissioner of Income-tax (Appeals) [CIT(A)] are similar for both the years, we are espousing the factual matrix relevant to the A.Y. 2001-02 for consideration and decision, which is mutatis mutandis similar to the other year as well.

We have heard the rival submissions and perused the relevant material on record. It is undisputed that the assessee is following mercantile system of accounting and has neither paid such amount of interest nor claimed it as deduction in its books of account. Deduction was claimed directly in the computation of income. The view point of the assessee is that since it is following mercantile system of accounting, the liability to pay interest @ 18% p.a. became due by the order of the ld. Single Judge of the Hon’ble Delhi High Court and accordingly deduction for the same is permissible.

Under the mercantile system of accounting, an assessee gets deduction when liability to pay an expense arises, notwithstanding its actual quantification and discharge taking place subsequently. The relevant criteria for the grant of a deduction is that the incurring of liability must be certain. If the liability itself is uncertain, it assumes the character of a contingent liability and ceases to be deductible. Thus, a deduction can be allowed only when an assessee incurs liability to pay an amount in the nature of an expense. The aspect of incurring a liability needs to be understood in a correct perspective. It is here that a distinction between a contractual and a statutory liability assumes significance. A statutory liability is incurred on a mere issuance of a demand notice against the assessee and becomes deductible at that point of time. The factum of the assessee raising a dispute against such a demand does not ruin the incurring of liability. On the contrary, a contractual liability is not incurred on a mere raising of demand by a claimant. It arises only when such a claim is either acknowledged or in a case of non-acceptance, when 7 a final obligation to pay is fastened coupled with the claimant acquiring a legal right to receive such an amount. Unless the claimant acquires an enforceable right to receive, it cannot be said that the first person has incurred a liability to pay such an amount. To put it simply, in the case of a contractual dispute between the parties, liability of the assessee to pay arises only when the claimant against the assessee acquires some legal right to receive the amount. In the absence of the vesting of any such right in the claimant, neither he earns any income nor the assessee incurs a corresponding liability to pay, entitling him to claim deduction for the same. Crux of the matter is that except for the assessee accepting a contractual claim, his liability to pay does not arise until some legal obligation to pay is fixed on him. A legal obligation to pay is attached on an assessee when a competent court passes order and a suit is decreed against him and not during the pendency of litigation. This difference between a contractual and a statutory liability has been recognized by the Hon’ble Delhi High Court in assessee’s own case since reported as National Agricultural Co-operative Marketing Federation of India Ltd. vs. CIT (2011) 338 ITR 36 (Del). 8

In order to decide the question of deductibility or otherwise of interest by the assessee to Alimenta, we need to have a look at the relevant factual details, which are as under:-

We can summarize the position germane to the issue before us from the above events-chart that the ld. Single Judge of the Hon’ble Delhi High Court vide his judgment and decree dated 28.1.2000 directed, inter alia, the payment of interest to Alimenta at 11.25% up to the date of award as allowed by FOSFA and at 18% from the date of award till the date of realization. It is undisputed that no payment of the principal amount of damages or interest has so far been finally made, except for furnishing bank guarantees etc. to some extent. The assessee filed a letters patent appeal against the judgment and decree of the ld. Single Judge. The Division Bench, during the pendency of such an appeal, vide its interim order dated 28.2.2001 stayed the execution of the judgment of ld. Single Judge. Certain interim orders were passed by the Hon’ble Supreme Court and the Hon’ble Delhi High Court, but the stay on the order and decree of the ld. Single Judge was not disturbed, which continued till the ld. third Judge (on a difference of opinion between the two ld. Judges who heard the appeal) finally decided the appeal of the assessee vide its judgment dated 6.9.2010 holding that a letters patent appeal is not maintainable against the judgment dt. 28.1.2000 of the ld. Single Judge. A consequential judgment was passed in September, 2010. Effect of this judgment is that the stay order of the Division Bench passed on 28.2.2001 got vacated and the judgment and decree of ld. Single Judge dt. 28.1.2000 again came to be revived. On 17.1.2012, the Hon’ble Supreme Court rejected the prayer of the assessee for interim relief and gave liberty to Alimenta to enforce decree dated. 28.1.2000 passed by the ld. Single Judge of the Hon’ble Delhi High Court. This sequence of events transpires that the legally enforceable liability against the assessee to pay interest at the rate of 18% to Alimenta, which was created by the decree of the ld. Single 13 Judge dated 28.1.2000, remained suspended from the date of stay granted by the Division bench of the Hon’ble High Court on 28.2.2001. It is only on the passing of the consequential judgment and decree by the Hon’ble Delhi High Court in September, 2010, subject to certain stays etc. granted against the operation of this judgment, that the assessee incurred a legally enforceable liability to pay such interest to Alimenta.

Now the moot question is whether the assessee is entitled to deduction for interest at the rate of 18% decreed by the ld. Single Judge of the Delhi High Court in the computation of income for the years under consideration. The answer will be in affirmative if the assessee had any legal obligation to pay such interest during the years in question and vice versa. We can do this by ascertaining if any legally enforceable liability existed against the assessee to pay interest in the years under consideration. Per contra, was Alimenta legally entitled to receive such interest income during the years in question? It is patent that the stay order against the judgment and decree of the ld. Single Judge was passed by the Division Bench on 28.2.2001, which is well within the financial year relevant to the assessment year 2001-02 under consideration and remained 14 operative in subsequent years including the immediately succeeding year in appeal. This shows that the assessee did not have any legal obligation to pay interest during these two years. The hitherto obligation which was created by the judgment of the ld. Single judge against the assessee was eclipsed and frustrated by the later judgment of the Division bench and such obligation ceased to exist for the time being.

At this juncture, it will be apposite to consider the judgment dated 3.6.2011 rendered by the Hon’ble Delhi High Court in assessee’s own case for the A.Ys. 1996-97 to 1998-99 as referred to in para 5 of this order supra. The assessee claimed deduction for interest in these three years, which the AO refused to allow. The Tribunal upheld the view of the AO.

This judgment in assessee’s own case has laid down that liability to pay interest arose on the ld. Single Judge passing decree on 28.1.2000 and till then there was no obligation to pay any interest and hence the assessee could not claim deduction of interest in the computation of income for the earlier years. The principle is that deduction becomes available only on coming into existence of a liability to pay and the liability to pay arises when it flows from a legally enforceable order. In such a situation, the period to which the expense originally pertained, loses its relevance. Since the decree in this case was passed by the ld. Single judge on 28.1.2000, which also covered interest for the periods relevant to the A.Ys. 1996-97 to 1998-99, the deduction of interest for such three years was held to be available not in these years but on crystallization of liability on 28.1.2000.

This view of the Hon’ble High Court accords with the one taken by the Hon’ble Supreme Court in CIT vs. A. Gajapathy Naidu (1964) 53 ITR 114 (SC), laying down the law in relation to accrual of income in the following terms : "When an ITO proceeds to include a particular income in the assessment, he should ask himself, inter alia, two questions, namely : (i) what is the system of accountancy adopted by the assessee, and (ii) if it is the mercantile system, subject to the deeming provisions, when has the right to receive accrued ? If he comes to the conclusion that such a right accrued or arose to the assessee in a particular accounting year, he should include the said income in the assessment of the succeeding assessment year. No power is conferred on the ITO under the Act to relate back an income that accrued or arose in a subsequent year to another earlier year, on the ground that that income arose out of an earlier transaction." Applying the same principle to expenses, a deduction can be allowed only in the year in which the liability to pay them finally arises, irrespective of the year to which they actually relate.

Reverting to the point, unless there is a specific contrary provision, deduction for an expense can be allowed in the year in which liability to pay finally arises. Once a person has not voluntarily accepted a contractual obligation and further there subsists no legal obligation to pay qua such contractual claim at a particular time, it cannot be said that the person incurred any liability to pay at that point of time so as to make him eligible for deduction on that count. Notwithstanding the fact that obligation relates to an earlier year, the liability to pay arises only in the later year, when a final enforceable obligation to pay is settled against that person. In our considered opinion, there is no qualitative difference between the two situations, viz., first, in which no enforceable liability to pay is created in the first instance, and second, in which though the enforceable liability was initially created but the same stands wiped out by the stay on the operation of such enforceable liability. In both the situations, claimant remains without any legal right to recover the amount and equally the opposite party without any legal obligation to pay the same. Neither any income accrues to the claimant, nor any deduction is earned by the opposite party. We are instantly confronted with the second type of situation in which the obligation created against the assessee by the judgment of the ld. Single Judge on 28.1.2000 was stayed by the judgment of the Division Bench on 28.2.2001, which position continued till the 19 decree on the judgment dt. 6.9.2010 reviving the judgment of the ld. Single Judge, became enforceable. Even though the crystallization of liability of the assessee to pay interest pursuant to the developments after 6.9.2010 also covers earlier years including the years under consideration, but such liability of the assessee became due only on the acquisition of right by Alimenta to enforce the decree issued on the advent of the judgment dated 6.9.2010. Consequently, the assessee can claim deduction for such interest only at such a later stage and not during the years under consideration.

Our view about non-availability of deduction for the years in question is further fortified by the judgment of the Hon’ble Supreme Court in the case of CIT vs. Hindustan Housing & Land Development Trust Ltd. (1986) 161 ITR 524 (SC). The assessee in that case was dealing in land and maintained its accounts on mercantile basis. Some plots of the assessee were requisitioned by the Government and, subsequently, the land was acquired. Certain sum was awarded as compensation. The assessee preferred appeal before the arbitrator, who made the award fixing higher amount of compensation. The State Government appealed to the High Court and, during the pendency of the appeal, the assessee was permitted to withdraw the amount on furnishing security. The AO brought to tax the difference between the amount paid to the assessee in terms of the award and the amount already paid. This amount was treated as liable to tax on the ground that the income accrued to the assessee on the date of the award. When the matter finally came up before the Hon’ble Apex Court, Their Lordships held that no income accrued to the assessee as there was no absolute right to receive the amount at that stage inasmuch as the arbitrator’s award enhancing compensation for acquisition of the assessee’s land was put in jeopardy by the State Government on filing an appeal against that very right and nothing would be due if the appeal was decided against the assessee. Noticing that there was no absolute right to receive the amount at that stage, the Hon’ble Summit Court held that:

Presently, we are also dealing with an almost similar situation in which Alimenta’s right to receive interest was in serious dispute at the end of the years under consideration because the corresponding liability of the assessee to pay stood stayed by the order of the Division Bench on 28.2.2001. By no standard, the assessee can be said to have incurred any liability for payment of interest to Alimenta at the end of the these two years.

The ld. AR has vehemently relied on the order passed by the Tribunal for the A.Y. 2003-04 in which a view in its favour has been taken. It is the same order, which the succeeding Bench could not agree with and referred the matter for constitution of Special bench. We have gone through this order of the tribunal, a copy of which has been placed in the paper book. It can be observed that the Tribunal, in deciding this issue in favour of the assessee, has been swayed by the fact that the ld. Single Judge passed the order/decree against the assessee on 28.1.2000. There is no reference whatsoever in this order dated 18.7.2008 to the later development, being the order passed by the Division Bench on 28.2.2001 staying the operation of the earlier judgment and decree of the ld. Single Judge. This crucial fact of paramount importance was not brought to the notice of the Tribunal and it is on these half presented facts that the Tribunal allowed deduction of interest.

The ld. AR has relied on certain judgments of the Hon’ble jurisdictional High Court to bolster the deductibility of interest. We find such reliance as completely misplaced. The first judgment is R.C. Gupta vs. CIT (2008) 166 Taxmann 191 (Del). The facts of the case are that the assessee therein made certain purchases from company ‘H’ in the year 1975 and the amount was payable, but, there was dispute on the liability to pay. The assessee claimed deduction for the said amount in its computation of income for the A.Y. 1979-80. The AO disallowed it on the ground that: ‘the said amount did not relate to any purchases made during the previous year relevant to the assessment year in question.’ The Hon’ble High Court eventually allowed deduction for the said amount.

The next case relied by the ld. AR is Jasjeet Films (P) Ltd. Vs. CIT (2007) 165 Taxmann 599 (Del). The assessee in this case constructed a cinema building on a plot of land allotted to it on lease by Delhi Development Authority (DDA). Construction of the said building was completed in August, 1970. On 9.9.1980, the DDA issued a letter to the assessee, wherein demand was raised for ground rent and also towards interest charges for belated payment of such ground rent. The assessee debited the amount in its Profit & Loss Account for the assessment year 1981-82. The AO disallowed the amount of interest pertaining to earlier years on the ground that the said liability could not be construed to have accrued during the relevant previous year. Reversing the view taken by the AO, the Hon’ble High Court held that such amount of interest pertaining to earlier years was deductible in the year in question because the liability to pay such interest accrued on the issuance of letter by the DDA on 9.9.1980. We fail to comprehend as to how this case supports the assessee’s contention. We are dealing with a situation in which the liability to pay interest did not exist at all at the end of the years in question because the judgment and decree of the ld. Single Judge was stayed by the Division Bench of the Hon’ble Delhi High Court vide its order dated 28.1.2001. This judgment rather supports the Revenue’s contention that the deduction can be claimed only when the liability is incurred. Going by the ratio decidendi of the judgement in Jasjeet Films (P) Ltd. (supra), we find that the assessee can claim deduction for interest only when the liability to pay such interest finally got crystallized on the passing of decree by the Hon’ble Delhi High Court in September, 2010, subject to certain stays etc. granted against the operation of this judgment and not the years in question when such liability to pay was absent at the respective year endings.

Similarly, we find that the case of CIT vs. Industrial Finance Corporation of India Ltd. (2009) 185 Taxmann 296 (Del), relied by the ld. AR is not germane to the issue. In that case, the assessee entered into a forward contract for purchase of foreign currency on a future date at a pre- determined rate and the difference between forward contract rate and exchange rate on the date of entering into the contract was recognised as deduction, which the AO refused to allow by treating it as a contingent liability. The Hon’ble Delhi High Court overturned the view taken by the AO and finally held that this is an ascertained and definite liability in terms of contract and, hence, eligible for deduction. In our considered opinion, this judgment has no relevance to the facts under consideration.

We consider it paramount to mention that the assessee has adopted diagonally opposite stands in civil proceedings and income-tax proceedings in so far as the question of interest liability is concerned.

Thus it is palpable that while on one hand the assessee in civil proceedings is seriously contesting its liability to pay interest, on the other hand, when the same question comes up in the income-tax proceedings, it has taken a transversely opposite stand that it has incurred liability towards interest payment and the same be allowed as deduction. 27 There is an absolute mismatch between these two inconsistent stands taken by the assessee in income-tax and civil proceedings. Similar position is prevailing insofar as the assessee’s understanding and reflection of such interest liability in its annual accounts is concerned. It has been brought to our notice by the ld. DR that the assessee in its Annual report for the year 2012-13 has claimed the amount payable to Alimenta as a contingent liability on the ground of the same being sub judice. Similarly, in the Notes and explanatory statements, the assessee has given the reason for not providing this contingent liability in the books of account, on page 79 of its Annual report, that the award is under challenge before the Hon’ble Apex Court and based on expert legal advice, the assessee considers the disputed case likely to be decided in its favour. Though the deductibility or otherwise of an expenditure in the income-tax proceedings depends on the appreciation of the correct legal position under the Act and not what the assessee claims under any proceedings or its treatment as contingent liability in the books of account, the idea behind incorporating these facts in the order is to accentuate the incongruous stand of the assessee on the same issue. 28

Now, we espouse the alternative view point canvassed by the AO for disallowing interest, being the making of claim by the assessee directly in the computation of income without routing it through its Profit and loss account. It is trite that entries in the books of account are not conclusive of accrual of income or deductibility of expenses. If an entry is passed in the books of account for a deduction which is otherwise not available as

We sum up our conclusion on the point that the assessee did not incur any liability for payment of interest to Alimenta as at the end of the years under consideration. Since no legally enforceable liability existed against the assessee, the deduction has been rightly denied.

Now we take up the AO’s alternative point of view that the deduction, if at all permissible, is also hit by the provision of section 40(a)(i). In this regard, we find that this provision with marginal note of - `Amounts not deductible’ - applies to disallow the otherwise allowable deductions in the computation of income of the payer under the head "Profits and gains of business or profession", if any sum chargeable to tax under the Act is payable outside India; or in India to a non-resident, not being a company or to a foreign company, on which tax is deductible at source under Chapter XVII-B and such tax has not been deducted or, after deduction, has not been paid during the previous year, or in the subsequent year before the expiry of the time prescribed under sub-section (1) 30 of section 200. Conversely, if deduction is otherwise not allowable under the head `Profits and gains of business or profession’, then there cannot be any further disallowance in the computation of income for want of deduction of tax at source etc. In view of our decision as to the non- incurring of liability for interest by the assessee and the resultant non- availability of deduction of interest in the computation of income for the years under consideration, section 40(a)(i) of the Act becomes inapplicable, as the underlying condition for its applicability, being the otherwise eligibility of deduction for expense, becomes wanting.

In view of the foregoing reasons, we answer the question posted before this Special bench in negative by holding that in the facts and circumstances of the case, where claim of damages and interest thereon is disputed by the assessee in the court of law, deduction can’t be allowed for the interest claimed on such damages in the computation of business income.

Now the instant appeals are directed to be placed before the Division Bench for disposal having regard to the decision of the special bench on the question raised before it.