Landmark Cases on Business Income and Deductions

Under the mercantile system of accounting, interest income accrues and is taxable in the year it arises, even for "sticky" or doubtful loans, as the right to receive the income is paramount, not its actual receipt, provided there is an agreement for payment.

No substantial question of law arises regarding a subsidy granted for setting up a new industrial unit in a backward area for employment generation, as held by the Bombay High Court. This decision was subsequently set aside by the Supreme Court.

Employees' contribution to provident fund and ESI, if paid by the assessee before the due date for filing the return of income under section 139(1), is an allowable deduction under section 43B. No distinction is drawn between employer's and employee's contributions for the purpose of section 43B.

Income from shares and securities held by banks as stock-in-trade constitutes business income, hence Section 14A disallowance is not attracted. Further, any disallowance under Section 14A cannot exceed the actual amount of exempt income earned by the assessee during the year.

When making an addition for unaccounted receipts, on-money, or non-genuine purchases/sales, the addition should be restricted to the estimated profit element embedded in such transactions, rather than the entire gross amount, particularly when evidence of corresponding expenditure is incomplete. This estimation often involves applying a net profit rate.

The employees' contribution to provident fund (PF) and Employee State Insurance (ESI), if remitted before the due date for filing the income tax return, is an allowable deduction under section 36(1)(va), especially when considering the prospective amendment introduced by the Finance Act, 2021.

Disallowances made under various sections, such as for PF/ESIC contributions, result in an increase in business profits, and these enhanced profits are eligible for deduction under Sections 10A and 10AA. Similarly, gains from foreign exchange fluctuations directly linked to export sales are also eligible for deduction under Section 10A.

Employees' contribution towards Provident Fund (PF) and Employees' State Insurance Corporation (ESIC) is allowable as a deduction under Section 36(1)(va) read with Section 43B if deposited before the due date of filing the income tax return, even if deposited after the expiry of the statutory time period specified in the applicable fund's statute.

The Completed Contract Method (CCM) is an accepted method of accounting for recognizing revenue from real estate contracts, allowing income recognition to be deferred until the contract's completion. The Supreme Court approved the use of CCM, having considered both CCM and the Percentage of Completion Method (POCM) under the framework of Section 145.

A liability recognized in accordance with the Accounting Standards prescribed by the Institute of Chartered Accountants of India (ICAI) is an allowable expense for income tax purposes.

When purchases are found to be entirely bogus and based on fictitious invoices from non-existent or unconfirmed suppliers, the entire amount of such purchases is liable to be added back as unexplained expenditure, not merely a percentage thereof.

The Assessing Officer has a duty to examine whether an assessee's books of account truly disclose the correct income and is not bound to accept the accounting system regularly employed by the assessee or methods followed in earlier years. Each assessment year is a distinct and self-contained unit for tax purposes.

For the purpose of Section 41(1) of the Income-tax Act, a liability is considered to have ceased only when the creditor actively releases or writes off the amount, or when the liability ceases to exist in the assessee's books; mere expiry of the limitation period for recovery does not constitute cessation of liability.

Expenditure is defined as money paid out or away, which is gone irretrievably. To be deductible under Section 37(1), expenditure must be wholly and exclusively for business, not capital or personal, and not fall under specific provisions of Sections 30 to 36, often justifiable on grounds of commercial expediency.

The expression "for the purpose of business" is wider in scope than "for the purpose of earning profits" and encompasses expenditures made for commercial expediency, business preservation, administration, and modernization.

Income accrues and becomes taxable only when there is a reasonable certainty of its realization. A mere possibility or expectation of income, particularly when subject to ongoing disputes, is not enough for it to be considered accrued.

If approval from the Department of Scientific and Industrial Research (DSIR) for an in-house R&D centre is granted during the previous year, the assessee is entitled to claim weighted deduction under section 35(2AB) for the entire expenditure incurred during that year.

The Supreme Court determines the eligibility of subsidies for deduction under industrial incentive sections, specifically 80IB and 80IC of the Income-tax Act, 1961.

Exemption provisions under Chapter III, such as Section 10B(8), must be interpreted strictly, and any claim for such exemptions must be made in the return of income. The principles governing Chapter III (incomes not forming part of total income) differ from those for Chapter VIA (deductions in computing total income).

The Supreme Court approves the mixed fund theory, holding that no interest disallowance is warranted under section 36(1)(iii) if investments or advances are made from the assessee's own non-interest bearing funds, even when mixed funds are available. This presumption applies when non-interest bearing funds are sufficient to meet the investments.

Employee contributions to provident fund and ESI, if deposited before the due date for filing the return of income under section 139(1), are allowable deductions under section 36(1)(va) and cannot be disallowed. Such an adjustment is also not permissible summarily under section 143(1).

Cash receipts from customers against genuine delivery of goods or services cannot be added as unexplained cash credits under Section 68. The case also provides guidance on non-disallowance under Section 40A(3) for business payments made in specific contexts like agricultural markets.

For a limited company, expenses cannot be disallowed merely on the grounds of presumed personal use of assets by directors or by treating the expenditure as a non-business purpose. Percentage disallowances of expenses in such cases are not sustainable.

A loss incurred by a businessman, such as money lost or advances written off, if it arises in the ordinary course of business, is a deductible trading loss. Such a loss is allowable as it is inherent or incidental to the business operations.

Disallowance under Section 14A of the Income-tax Act applies even if no exempt income is actually earned during the relevant previous year, provided investments capable of yielding exempt income exist.

Employee contributions to provident fund or ESI are deductible if deposited with the authorities before the due date for filing the income tax return under Section 139(1), even if deposited after the due date prescribed by the respective fund's Act.

Employee contributions towards ESI and PF are allowable as a deduction if paid by the due date for filing the income tax return, even if paid after the statutory due dates prescribed under the respective ESI/PF Acts.

The Supreme Court established the foundational test for distinguishing between capital and revenue expenditure, holding that the aim and object of the expenditure and whether it brings into existence an asset or an advantage of an enduring nature determines its character, irrespective of the payment method. An advantage lasting five years or more can be considered enduring.

When calculating deductions under sections like 10A or 10AA, any expenses or items reduced from 'export turnover' in the numerator must also be reduced from 'total turnover' in the denominator to ensure consistent application of the deduction formula.

Before the insertion of Explanation 2 to Section 36(1)(va), there was ambiguity regarding the due date for payment of employees' contribution to provident fund and ESI. The intended purpose of a tax amendment is to remove hardship for the assessee, not the Department.

Disallowance under Section 14A of the Income-tax Act is made only if exempt income is actually earned, and the disallowance cannot exceed the amount of exempt income earned.

Interest, sales tax, and purchase tax subsidies received by an assessee are generally considered capital receipts, not revenue income, for income tax purposes.

An amendment clarifying the disallowance of employee contributions under sections 36(1)(va) and 43B is prospective. Therefore, before such amendment, employee contributions paid before the due date for filing the income tax return are deductible.

Amounts collected by an assessee as an agent or for a predefined purpose are diverted by an overriding title and do not form part of the assessee's income. Such amounts, even if refundable on contingencies, are not considered uncertain and create a ripening obligation.

This case establishes principles for the timing of income or loss recognition, particularly concerning the classification and treatment of Non-Performing Assets (NPAs) for tax purposes under the mercantile system of accounting.

A new industrial undertaking is not considered a reconstruction of an existing business for tax deduction purposes if it is a separate, independent production unit manufacturing commercially tangible products that can operate without losing its identity in the old business. The transfer and substantial use of assets and manpower from an old business to a new one may indicate reconstruction.

The onus lies on the assessee to demonstrate that interest-bearing funds were advanced or utilized for genuine business purposes and commercial expediency to claim interest expenditure as a deduction.

Once a claim for deduction under section 80-IA or 80-IB is allowed in the initial assessment year and is not subsequently withdrawn, the revenue is estopped from denying the deduction for subsequent years on the same grounds.

The word 'production' has a wider connotation than 'manufacture'; every manufacture is production, but not every production amounts to manufacture. 'Production' includes bringing into existence new goods, by-products, or inter-products through a process, which may or may not be manufacture.

The waiver of a loan taken for acquiring capital assets is considered a capital receipt and is not taxable as income under Section 28(iv) of the Income Tax Act. The ruling distinguishes between the waiver of trading liabilities and capital liabilities for tax purposes.

Section 43B of the Income-tax Act applies to both employer and employee contributions to welfare funds, allowing deductions for these contributions only upon actual payment.

Excise duty and sales tax must be excluded from 'total turnover' when calculating deductions under Chapter VI-A, such as Section 80HHC or 80IA, to ensure that the export turnover and total turnover are on a comparable basis.

If an assessee possesses interest-free funds exceeding investments in tax-free securities, it is presumed that investments are made from these own funds, precluding disallowance of interest expenditure under Section 14A read with Rule 8D(2)(ii). Additionally, weighted deduction under Section 35(2AB) is computed on the gross expenditure incurred, not net expenditure after reducing income earned.

The Bombay High Court holds that employees' contributions to provident fund and ESIC, though paid beyond the due dates specified in the respective welfare legislations, are allowable as a deduction under section 36(1)(va) if they are paid before the due date for furnishing the return of income under section 139(1) of the Income-tax Act.

If an assessee possesses sufficient interest-free own funds to cover investments yielding exempt income, it is presumed that such investments are made from these own funds, precluding any disallowance of interest expenditure under Section 14A, even when borrowed funds are also available.

Expenditure incurred for increasing a company's share capital, such as expenses related to issuing shares or an initial public offering (IPO), is capital expenditure. Such expenses are not allowable as a revenue deduction under Section 37, even if they incidentally benefit the business, because they result in an increase in capital.

The income derived from letting out assets, such as coal mining leases, constitutes "profits and gains of business or profession" if the primary object and activity of the assessee company are to acquire, develop, and sub-lease such assets. This classification holds even if the income arises from letting, provided the letting itself constitutes the assessee's business.

The Income Tax Officer (ITO), even when accepting the assessee's method of accounting, is not bound by the profit figures shown in the accounts and can still determine the correct profits.

Compulsory product registration fees essential for making sales constitute revenue expenditure and are allowable as a deduction under Section 37 of the Income Tax Act, rather than capital expenditure.