IT APPEAL NO. 1372 (PUNE) OF 2014
[ASSESSMENT YEAR 2007-08]

VIKAS AWASTHY, JUDICIAL MEMBER 
AND PRADIP KUMAR KEDIA, ACCOUNTANT MEMBER

P.I. Patwa for the Appellant. 
P.L. Kureel for the Respondent.

ORDER

Pradip Kumar Kedia, Accountant Member - The captioned appeal filed by the assessee is against the order of CIT(A)-I, Pune dated 03.02.2014 relating to assessment year 2007-08 passed under section 143(3) of the Income-tax Act, 1961 (in short "the Act").

2. In this appeal, the assessee has assailed the action of the CIT(A) in disallowing the whole of finance charges and considering the same as income for the assessment year 2007-08.

3. Briefly stated, the assessee is stated to be an Investment Company investing in shares and securities. The assessee is also stated to be engaged in business of financial intermediary agents and earns income by way of commission and professional fees. The assessee filed its return of income declaring Nil income. During the assessment proceedings, the Assessing Officer observed that the assessee-company had debited a sum of Rs.44,71,126/- as finance charges to the profit and loss account. On being asked about the nature of payment towards finance charges, the assessee submitted that Indian Seamless Steels and Alloys Ltd. (ISSAL) had availed interest free sales-tax Deferral loans (STL) from Government of Maharashtra under Package scheme of incentives-1988 (The scheme). As per the scheme, ISSAL had collected the sales-tax from its customers and retained as an interest free sales-tax loan. It was stated that as per the scheme, the STL is required to be paid in 5 instalments to SICOM being the agency appointed by the Government of Maharashtra. As a part of financing activity, the company took over and accepted sales tax liability (gross) of Rs.864.05 lakhs against discounted receipts of Rs.268.79 lakhs from ISSAL computed Net Present Value (NPV) applying 10% discounting rate. It was further stated that the loan was taken over by way of assignment and it is payable in five equal instalments starting from F.Y. 2011-12 and ending on F.Y.2015-16. In the books of account of the assessee-company, the loan was accounted for at NPV at the time of assignment. It was claimed that the loan liability taken over for a consideration is a part of the business of financing and in the process the company took over not only the liability to the extent of actual consideration received determined at NPV but also even the future liability. It was submitted before the Assessing Officer that the difference between net present value as on 31/03/2007 and 31/03/2006 has been debited as finance charges on accrual basis u/s 145, which is as per the Accounting Standards for prudence and based on matching principle concept. It was argued that the amount though debited as finance charges is not interest within the meaning of section 2(28) of the Act and SICOM is the payee who will receive the instalments of the part payment of loan and not as interest income. It was contented that the difference between consideration (NPV amount on the date of assignments) and actual liability is the expenditure of the business and not interest and therefore no TDS has been deducted from the payment. The Assessing Officer, however, was not impressed with the claim of the assessee towards finance charges. The Assessing Officer was of the opinion that the expenditure is not a revenue expenditure and liability does not exist in praesenti but is a contingent liability. The Assessing Officer, in conclusion, disallowed the claim of finance charges of Rs.44,71,126/- and added to the total income of the assessee.

4. The assessee carried the matter before the CIT(A). The assessee once again reiterated the facts before CIT(A) and submitted that the expenditure in question is neither a contingent liability nor a capital expense and therefore fully deductible as in the earlier years. The CIT(A), however, endorsed the action of the Assessing Officer on the ground that the liability in question is not a present liability but is a contingent in nature. The operative paras from the order of the CIT(A) is reproduced hereunder :—

"4.5 The various contentions raised by the ld. Counsel for the appellant on the admissibility of the expenditure towards finance charges are carefully examined in the light of the material placed on record and the provisions of sec. 37 of the I.T. Act. In the first place it is to be mentioned that admittedly the appellant is an associate concern of Indian Seamless Steels & Alloys Ltd., (ISSAL). As per details furnished by the appellant, ISSAL is manufacturer of steel and in the course of its business; the said company appears to have availed interest free sales-tax deferral Certificate of Entitlement from the Government of Maharashtra under the Package scheme of Incentives, 1988. As per the Package scheme of Incentives, 1988, sales-tax liability of each year is required to be paid by ISSAL to the Sales-Tax Department of Government of Maharashtra in five equal annual instalments upon expiry of ten years from the date of availment i.e. to say the sales tax collected for the financial year 1994-95 would have to be repaid in five equal annual instalments beginning with financial year 2005-06 and so on. As stated in the agreement dated 09.04.2001 claimed to have been entered into by the appellant ISAAL during the period from 01.04.2001 to 31.03.2001, ISSAL had availed of sales-tax deferral of Rs. 835.98 lacs and the repayment schedule of which is as follows:

It is also noticed from Annexure-I of the said agreement that the appellant has agreed to take over liability of the ISSAL for repayment of the said sales-tax deferral amounting to Rs. 835.98 lacs for a consideration of a sum of Rs. 268.79 lacs arrived at @10% NPV based on the repayment schedule as under:

	No. of years from 31/03/01	10	11	12	13	14	Total
	NPV on 31/03/2001 @ 10%
	31.03.2001 (Rs. in lacs)	64.46	58.60	53.27	48.43	44.03	268.79

4.5.1. Thus, by virtue of the said agreement the appellant has taken over the deferred sales-tax liability of Rs. 835.98 lacs of ISSAL payable in five instalments commencing from 30.04.2011 for a consideration of Rs. 268.79 lacs which is stated to be the Net Present Value (NPV) of the deferral liability as on 31.03.2001. This net present liability of 268.79 lacs as on 31.03.2001, which got enhanced to 288.63 lacs as on 31.03.2002 was shown under the head 'unsecured loans' for the first time in the balance sheet of the appellant company as on 31.03.2002. The NPV of liability gets increased every year till the repayment commences in the year 2011-12 and the difference in NPV at the end of a particular financial year and the immediately preceding year is being claimed as expenditure under the head 'finance charges' in the P&L account of that year. As the liability is to be discharged only from F.Y. 2011-12, the differential amount is added to the outstanding NPV and the cumulative liability is being shown in the balance sheet every year till the year 2011-12. Following the same method in this year, the difference in NPV as on 31.03.2007 and as on 31.03.2006 amounting to Rs. 44,71,126/- was debited to the P&L account for the year under consideration as expenditure under the head 'finance charges' and as it was not actually paid, the amount was added to the existing outstanding liability and shown under the head 'unsecured loans'. A copy of the working of the NPV of the liability for seven years from the year ended on 31.03.2001 to the year ended on 31.03.2007 is enclosed to the order as Annexure-A for ready reference. Thus, the difference in NPV between two balance sheet dates is being charged as expenditure, which is stated to be on accrual basis and based on prudence as per Accounting Standard notified under sec. 145. In this background, the crucial points for determination in the present case are whether the liability in question i.e. the difference in NPV of Rs. 44,71,126/- is liability in praesenti as claimed by the appellant. If it is liability in praesenti, whether the same is an allowable deduction u/s 37 of the IT Act.

(i) whether the impugned liability is liability in praesenti:

4.5.2 In the present case, assignor ISAAL was liable to pay sales tax amounts collected from 01.04.2000 to 31.03.2001 to the sales tax department. However, payments were deferred under the Incentive Scheme, 1988 and the amounts were payable after ten years in five equal annual instalments commencing from 30.04.2011, which means that the actual liability arises in future. The claim of the appellant is that it has taken over the said deferral sales-tax liability in the year 2001 and though the liability was payable to the sales tax department after a period of 10 years as per the scheme of incentives, provisions is being made every year based on the difference in NPV at the end of the every year and the expenditure is claimed under the head finance charges. But, the fundamental question that arises is as on 31.03.2007 to whom the appellant was liable to pay the so-called finance charges for which the provision was made in the books of account. The amount was not payable to ISSAL as under the agreement it has assigned the entire liability to the appellant in the year 2001 itself. As on 31.03.2007 the amount was also not payable to the sales-tax department or its agency SICOM. Therefore, the impugned liability for which provision was made in the books of account of the appellant is not a liability in praesenti. The following clauses in the agreement with ISSAL also indicate that the liability is contingent upon certain happenings and it is not a liability in praesenti.

"....The loan amount is subject to assessment by sales-tax authorities and would become final only on completion of assessment.

The Assignee hereby assures that in consideration of Rs. 268.79 lacs NPV the Assignee hereby takes over the said loans of the assignor and agrees to pay' the said loans to sales-tax department as per the payment terms.

In case the liability for payment of sales-tax increases during the assessment, the differential liability would be paid by the assignor on respective due dates. In case such liability reduces during the assessment, the differential liability would be paid by the assignee to the assignor on respective due dates.

In the event of any default by the Assignee, in making the payment on or before due date, the Assignor will make payment of Sales-Tax in which case the Assignee shall be liable to pay the amount thus paid and interest thereon @ 18 p.a. from the date of default and the Assignee shall also be liable to reimburse the penal interest payable on account of delayed payment of Sales tax.

It is expressly agreed between the parties that transfer of Sales Tax liability as aforesaid, shall be subject to the sanction of SICOM Ltd., and Sales-Tax Authorities, if required and the parties shall execute necessary documents, if any to give effect to such sanction as and when received.

It is further expressly agreed between the parties that the transfer of Sales-Tax Liability as aforesaid shall be subject to and take effect from the appointed date of the proposed amalgamation of Indian Seamless Steels & Alloys Ltd., and Jejuri Steels & Alloys Private Ltd.

In the event the proposed amalgamation not taking place for whatsoever reasons, the Assignee would repay to the Assignor all the money received by it under the agreement without any interest."

4.5.3 Further, the appellant has not placed on record any evidence in the present proceedings to show that the sales-tax department has acknowledged or approved the said agreement of ISSAL with the appellant or transfer of the deferred liability to the appellant. Therefore, contention of the appellant that the liability has accrued when it was taken over in the year 2001 though it is to be discharged from the year 2011 is not tenable. Needless to emphasize that there is a distinction between the actual liability in praesenti and a liability de futuro which for the time being is only contingent. In the present case, as on 31.03.2007 there was no liability in praesenti and the appellant has made a provision for a liability de futuro. In such circumstances, the decision of Apex Court in the case of Bharat Earth Movers (112 Taxman 61) and prudence as per AS- 1 read with sec. 145, relied upon by the appellant, do not render any assistance to the case of the appellant.

(ii) If it is liability in praesenti as claimed by the appellant whether the same is otherwise an allowable deduction:

4.5.4 Even presuming for a while that the liability has accrued in the year 2001 and the appellant has made a provision based on NPV of the deferred liability every year, it is now examined whether it is an allowable deduction under the I.T. Act. As clearly spelt out in the said agreement, though the amount is charged to the P&L account under the head 'finance charges', yet it actually represents amount of sales-tax payable to SICOM or the sales tax department from the year 2011. The terms and conditions of the agreement and the Eligibility Certificate clearly show that the amount payable is nothing but sales tax to the sales-tax department after the deferral period of ten years and it is not repayment of loan as claimed by the appellant. When the liability taken over represents the sales-tax payable, whether as part of financing business or otherwise, the same can be allowed as deduction under sec. 43B of the I.T. Act only in the year in which the said sales-tax deferral amount is actually paid to SICOM or sales-tax department. In the present case it is not in dispute that as on 31.03.2007, only a provision was made for the liability and the amount was not actually paid to SICOM or sales-tax department. Therefore, the amount payable, even presuming to be accrued and present liability, cannot be allowed as deduction in view of the express provisions of sec. 43B of the I. T. Act. It may also be mentioned here that the Board circulars cited by the appellant are of relevance to the case of ISAAL and not to the case of the appellant. The other judicial precedents relied upon by the appellant were rendered in a different factual context i.e. early redemption of deep discount bonds and the same cannot be applied to the facts of the present case.

4.5.5 To sum up, the provision for liability towards sales tax payable in future made under head finance charges is not a liability in praesenti and it is liability de futuro which cannot be allowed as deduction in the year under consideration. Even otherwise the liability is hit by provisions of sec. 43B as the sales-tax liability was not discharged during the year and therefore the same cannot be allowed as deduction.

4.5.6 For the foregoing reasons, the Assessing Officer is justified on facts and in law in taking the view that liability in question is not liability in praesenti and disallowing the provision made by the appellant for such liability. Accordingly the addition of Rs. 44,71,126/-made by the Assessing Officer on this ground does not call for any interference and the same is upheld. Grounds of appeal No. 1 to 4 fail."

5. Aggrieved by the order of the CIT(A), the assessee is in appeal before the Tribunal.

6. The ld. Authorized Representative (AR) for the assessee Shri P. I. Patwa submitted at the outset that as per mutual agreement with Indian Seamless Steels and Alloys Ltd. (ISSAL), the assessee had agreed to take over their Differed Sales-Tax Loan of Rs.835.98 lakhs (outflow at a future date) for a consideration (inflow) of a sum of Rs.268.79 lakhs arrived at by applying Net Present Value (NPV) method at the discount rate of 10% based on the repayment schedule. Thus, present value of net inflow of funds received was computed at a discount rate identified at 10%. It was submitted that the loan is returnable in five equal instalments starting from financial year 2011-12 and ending on financial year 2015-16 and in the books of the company, the loan was accounted for at NPV at the time of assignment and as such the loan liability so taken over is an integral part of business of financing for an agreed consideration. It was stated that in the process, the company took over not only the liability to the extent of consideration received but also even the future liability. The difference between the NPV determined as on 31.03.2007 and 31.03.2006 by applying 10% discounting factor has been debited in the Profit & Loss Account as finance charges. The ld. AR for the assessee submitted that the expenditure was booked on 'accrual' basis as per Accounting Standards for prudence and matching principles notified under section 145 of the Act. The liability is to be discharged in favour of SICOM being an agent appointed by the Government of Maharashtra, who will receive the instalment of part payment of loan and not as interest income. The difference between the consideration and the liability determined at NPV is claimed to be accrued expenditure of business. It was contended by the ld. AR that this is not a case of exchange of loan on better repayment terms but a case of receipt of loan at predetermined costs, which cost gets crystallized with the efflux of time and is an actual liability which ought to be allowed as an expenditure regardless of the fact that no actual outgo towards difference in the NPV of this year qua the preceding year has happened. The ld. AR contended that the incremental liability has accrued in the hands of the assessee with the passage of time in terms of agreement and cannot be regarded as contingent liability by any stretch of imagination. The ld. AR drew support from the decision of the Apex Court in the case of Bharat Earth Movers, 112 taxman 61 (SC) and contended that while the liability will be discharged at future date, it has definitely accrued in present time and it does not make a difference if the future date on which the liability has to be discharged is not ascertained. The Ld. AR went on to argue that in the present case, it is certain that the liability has been incurred and is also capable of estimated with reasonable certainty. He submitted that the reliance placed on the various decisions by the Assessing Officer is quite misplaced and cannot be applied to the facts of the present case. He, thereafter, adverted our attention to the notification issued by the CBDT Circular dated 31st March, 2015 forming part of the Paper Book and submitted that the case of the assessee does not fall within the definition of contingent liability as provided in the aforesaid notification. He submitted that the liability is in existence at the end of the previous year and can be determined with reasonable certainty and therefore recognized as per well established accounting practices. He finally contended that the impugned finance charges in question is neither a contingent liability nor a capital expenses and therefore the action of the Revenue in rejecting the claim of the assessee is unwarranted and requires to be set aside.

7. The ld. Departmental Representative (DR) Shri P. L. Kureel, on the other hand, relied upon the order of the CIT(A) and submitted that no actual liability in praesenti has been incurred by the assessee. The liability, if any, will arise in future based on the events which are not certain and therefore the liability is wholly contingent and expenses debited on this count cannot be entertained. He, thus, pleaded that no interference with the order of the CIT(A) is called for.

8. We have carefully considered the rival submissions and orders of the authorities below. The assessee has entered into an assignment agreement with one Indian Seamless Steels and Alloys Ltd. (ISSAL) whereby the liability of the assignor for repayment of the sales-tax deferral loan amounting to Rs.835.98 lakhs as noted above was acquired by the assessee for a consideration of Rs.268.79 lakhs. The liability of the assignor was accepted by the assessee for a sum of Rs.268.79 lakhs received from the assignor stated to be determined by applying discounting factor of 10% as per Net Present Value method based on repayment schedule.

8.1 The relevant extract of the assignment agreement is reproduced hereunder :—

"3. In the course of its business, the Assignor has availed interest-free sales-tax deferral loan from the Government of Maharashtra under the Package Scheme of Incentives, 1988 ('the Scheme'). As per the deferral scheme, the Assignor has, every year beginning with the financial year 1994-95, collected sales-tax from its customers, etc..

4. As per the Scheme, sales-tax liability of each year is required to be paid by the Assignor to the Sales-Tax Department of Government of Maharashtra in five equal annual instalments upon expiry of ten years from the date of availment i.e. to say the sales-tax collected for the financial year 1994-95 would have to be repaid in five equal annual instalments beginning with financial year 2005-06 and so on.

5. Accordingly, during the year from 1st April, 2000 to 31st March, 2001 the Assignor have availed of sales-tax deferral loan of Rs. 835.98 lacs (hereinafter referred to as the said loans) the repayment schedule for which is as per schedule 1 appended herewith. The loan amounts are as they appear in the books of account of the assignor and are subject to confirmation on completion of sales-tax assessments by sales tax authorities.

6. The Assignor is desirous of assigning and the Assignee has agreed to take over liability of the Assignor for repayment of the said sales-tax deferral loans for the period 1st April, 2000 to 31st March, 2001 amounting to Rs.835.98 lacs for a consideration of a sum of Rs.268.79 lacs arrived at @ 10% NPV based on the repayment schedule.

NOW THIS DEED OF ASSIGNMENT WITNESSES THAT
The Assignor hereby declare that he is liable as per his books of account, to make payment of the sales-tax loans of Rs. 835.98 lacs availed during the period from 1st April, 2000 to 31st March, 2001 (hereinafter known as the said liabilities) as per repayment schedule 1 appended herewith. The loan amount is subject to assessment by sales-tax authorities and would become final only on completion of assessment.

The Assignee hereby assures that in consideration of Rs. 268.79 lacs NPV the Assignee hereby takes over the said loans of the assignor and agrees to pay the said loans to sales-tax department as per the payment terms.

In case the liability for payment of sales tax increases during the assessment, the differential liability would be paid by the assignor on respective due dates. In case such liability reduces during the assessment, the differential liability would be paid by the assignee to the assignor on respective due dates.

In the event of any default by the Assignee, in making the payment on or before due date, the Assignor will make payment of Sales Tax in which case the Assignee shall be liable to pay the amount thus paid and interest thereon @ 18% p.a. from the date of default and the Assignee shall also be liable to reimburse the penal interest payable on account of delayed payment of Sales tax."

8.2 It is the case of the assessee that in terms of the agreement, the assessee has debited the difference between NAV of the loan acquired from the assignor at the end of this year vis-à-vis NAV determined at the end of the last year towards finance charges in the Profit & Loss Account. It is the case of the Revenue that the impugned finance charges are contingent in nature and is not a liability in praesenti. Therefore, the pertinent question that arises for our adjudication is whether the additional liability determined at the end of the financial year relevant to the assessment year as per Net Present Value method and consequential finance charges debited to the Profit & Loss Account is an accrued liability or a contingent liability ?

8.3 In terms of section 145 of the Income Tax Act read with section 211 of the Companies Act, a company has to mandatorily prepare its account on 'accrual' basis. The term 'Accrual' has been defined in the Accounting Standard - 1 prescribed by the Institute of Chartered Accountants of India as well as by the Central Government under section 145 of the Income Tax Act as under :—

" 'Accrual' refers to the assumptions that revenues and costs are accrued, that is, recognized as they are earned or incurred (and not as money is received or paid) and recorded in the final statements of the periods to which they relate."
The Accounting Standard further provides that as a matter of prudent accounting policy, provisions should be made for all known liabilities and losses even though the amount cannot be determined with certainty and represents only the best estimate in the light of available information. Under the Mercantile System of Accounting, the expenditure items for which legal liability has been incurred are immediately debited even before the amount in question are actually distributed.

8.4 In terms of section 28 read with section 145 of the Income Tax Act, income chargeable under the head 'profit and gains of business or profession' cannot be determined unless and until the expenses or obligations which have been incurred are set-off against the receipts. Therefore, in order to determine the true profits arising from business, the expenditure actually incurred or liability in respect thereof accrued even though it may have to be discharged at some future date has to be necessarily accounted for. Admittedly, the assessee in the instant case follows the Mercantile System of Accounting and therefore is entitled to deduct such liability which has accrued during the year for which the profits and gains are being computed. On the other hand, if a liability has not accrued during the relevant year, same is actually known as contingent liability. Therefore, the short question is whether the liability towards impugned finance charges is an accrued liability or is a contingent liability in the instant case. Needless to say, an accrued liability is allowable whereas a contingent liability is not allowable deduction for the purposes of determination of taxable income.

8.5 The judicial opinion of the various courts is that a liability depending upon a contingency is not a debt in praesenti or in futuro till the contingency happens. But if it is debt, the fact that the amount has to be ascertained does not make it any the less a debt if the liability is certain and what remains is only a quantification of the amount. A reference in this regard may be made to the decision of the Hon'ble Supreme Court in the case of CITv. Shri Goverdhan Ltd. [1968] 69 ITR 675. The word 'contingent' in contrast, refers to possibility of an obligation or liability to arise on occurrence or non-occurrence of one or more uncertain future events. As per Mercantile System of Accounting, an accrued liability is required to be accounted for in the books of account. In respect of the liability, which has accrued, but quantification for which is still pending, a provision is required to be made in the books of account.

9. In the present case, the assessee by virtue of assignment agreement has received certain amount which is to be replenished and repaid by higher sum computed by applying Net Present Value method at a discounting factor of 10%. The corresponding finance costs debited to Profit & Loss Account during the year represents incremental increase in the liability with the efflux of time where the liability gets accrued as it inches towards maturity. Thus, it is manifest that the incremental liability has accrued to the assessee in praesenti with the efflux of time notwithstanding the fact that increase in the liability is required to be actually discharged on a future date. The gradual increase liability is dependent on the time horizon that has elapsed and therefore not an uncertain event by any stretch of imagination. The Assessing Officer has disallowed the deduction for the liability on the ground that sum will have to be incurred and accordingly in his view the liability has not accrued. We do not find any rationale for holding such view. As noted, the obligation for re payment of enhanced liability corresponding to the financial charges has crystallized with the efflux of time. Thus, the facts of the case clearly indicates that enhanced liability and consequential differential costs i.e. finance charges is accrued indeed. In our considered view, the liability has definitely accrued in praesenti against future outflow of resources which obligation in the present case can be determined with great reliability. Therefore, we find considerable merit in the arguments propounded on behalf of the assessee.

10. In the result, the appeal of the assessee is allowed.