In a recent judgment, the Shimla High Court had to adjudicate on the conditions prescribed in Section 43-B, IT Act, 1961 for an assessee to claim deductions. The issue related to Section 43-B(f) which envisages deductions to an employer for payments made to employees on encashment of cash leaves.
Facts
For the Assessment Year 2002-03, the assessee inter alia claimed expenses of Rs 45,00,000/-, a sum it paid to LIC on contribution to Credit Leave Encashment Trust. The Assessing Officer disallowed the claim of such expense and added it to the income of the assessee. The assessee was unsuccessful in appeal before the ITAT. The dates are relevant to understand the issue at hand:
The fund was established on 29.10.2002 and contribution of Rs 45,00,000/- to LIC was made on the same date.
Provision for contribution of Rs 45,00,000/- was not made by the assessee after closure of financial year 2001-02, i.e. on 31.03.2002.
The assessee was not following the mercantile system of accounting during the financial year 2001-02.
The liability of payment of Rs 45,00,000/- did not accrue nor was it paid during the financial year 2001-02.
Summary of arguments adopted by the assessee and the Revenue is as follows: the assessee argued that the payment of Rs 45,00,000/- was part of the entire past liability of Rs 1.80 crores assessed by the insurer. The liability was not a contingent liability. And since the liability was met before due date of submission of returns, i.e., 31.10.2002, it was a permissible deduction under Proviso to Section 43-B(f), IT Act, 1961. Revenue, on the other hand, contended that the amount was not deductible under the IT Act, 1961 and even if it was, since it was not ascertained during the relevant financial year could not be a permissible deduction under Proviso to Section 43-B, IT Act, 1961.
Section 43-B, IT Act, 1961
Section 43-B, IT Act, 1961 allows for certain deductions to an assessee only on actual payment. Section 43-B(f) states ‘any sum payable by the assessee as an employer in lieu of any leave at the credit of his employee;’ and the Proviso states:
Provided that nothing contained in this section [[except the provisions of clause(h)]] shall apply in relation to any sum which is actually paid by the assessee on or before the due date applicable in his case for furnishing the return of income under sub-section (1) of section 139 in respect of the previous year in which the liability to pay such sum was incurred as aforesaid and the evidence of such payment is furnished by the assessee along with such return.
Shimla HC Answers Two Questions
The first question that the Shimla High Court decided to answer was whether the contribution made by a corporate employer to a fund for payment of leave encashment to its employees was entitled to deduction. The High Court disagreed with the ITAT and held that it is not accurate to state that such a fund has not been statutorily recognized. The inclusion of Section 43-B(f), as per the High Court, proved otherwise. The High Court cited Exide Industries case to rightly conclude that amount of contribution made by an assessee towards a fund for payment of leave encashment to its employees was a deductible expense.
The second question then was: did the assessee meet requirements of Section 43-B and its Proviso? The High Court answered in the negative. The High Court noted that Proviso allows only allows an assessee to claim a deduction if the sum payable as an employer in lieu of any leave was incurred by the assessee according to the regular method of accounting employed by him and the sum was actually paid in the previous accounting year. The second condition is not a correct interpretation of the Proviso, as it clearly states the payment can be made after the accounting year but before due date of filing returns.
Nonetheless, the Shimla High Court denied the assessee’s claim for deduction on the ground that the liability of Rs 45,00,000/- had already been incurred as a past liability. The assessee’s assertion that the amount was part of a past liability of Rs 1.80 crores determined by the insurer, the High Court noted had not been substantiated. And since the finding of fact is not controverted the High Court denied assessee’s claim for deduction.
Conclusion
The insight this case offers us is that the payment towards a fund for encashment of leave is a permissible deduction under Section 43-B, IT Act, 1961. The payment can be made after the end of accounting year but before the due date to successfully claim deduction. But, the payment must be for satisfaction of a past liability incurred during the previous accounting year and the accounting method adopted by an assessee must reflect the liability. The observation that Section 43-B alongwith Proviso also requires payment before the end of accounting year does not align with a plain reading of the provision and does not hold on scrutiny.