By TIOL News Service

NEW DELHI, OCT 17, 2015: THE bone of contention before the Special Bench is - Whether deduction for interest on damages can be claimed as contractual liability even as the appeal against such a liability continues to be sub-judice. NO is the verdict.

Facts of the case

The assessee is an agricultural cooperative marketing federation. The assessee filed its return and the assessment was completed. During the course of assessment, a special audit u/s 142(2A) was carried out which divulged that the assessee had claimed deduction for interest payable to M/s Alimenta SA Switzerland ('Alimenta') on account of arbitration award, which was still disputed by it. The AO observed that the assessee claimed deduction of interest amounting to Rs.7.92 crore payable to Alimenta for the A.Y. 2001-02. Such amount of interest was not found to have been debited to the Profit & Loss Account but directly reduced in the computation of total income. He further observed that as per the provisions of section 40(a)(i) of the Act, this amount of interest was deductible only on the deduction of tax at source and payment thereof, which was not done by the assessee. In a nutshell, the AO opined that such interest was not deductible. Notice u/s 148 was served on the assessee.

The CIT(A) observed that on identical issue, the assessee preferred appeals before the Tribunal pertaining to assessment years 1996-97 to 1998-99 and the Bench was pleased to hold that the liability for payment of such interest crystalised only in the period relevant to assessment year 2000-01 and hence no deduction was allowable in such years because the claim for interest at the end of such years was not an ascertained liability. He further took note of the view taken by him for the assessment years 2003-04 and 2004-05 in holding that the interest was not deductible. The assessee's contention about the finding of the Tribunal for the crystalization of liability on 28.1.2000 pursuant to the passing of the decree by the High Court against NAFED, was held by the first appellate authority to be only an obiter dicta. He, therefore, upheld the view taken by the AO in making disallowance of interest amounting for both the years.

On appeal, the Tribunal had allowed deduction of interest, the same view be followed for the two A.Ys. under consideration. The Division Bench hearing the appeals for the extant years was not convinced with the reasoning given by the Tribunal in its order for the A.Ys. 2003-04 and 2004-05 in deleting the disallowance of interest and, accordingly, made a reference for the constitution of a Special Bench in terms of section 255(3) of the Act. That is how, the instant proceedings have come up before us for consideration and decision.

Held 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 Single Judge of the 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. 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 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. 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 Delhi High Court in assessee's own case 2011-TIOL-384-HC-DEL-IT;

++ the Single Judge of the Delhi High Court had 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 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 Single Judge. Certain interim orders were passed by the Supreme Court and the Delhi High Court, but the stay on the order and decree of the Single Judge was not disturbed, which continued till the third Judge (on a difference of opinion between the two 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 Single Judge. A consequential judgment was passed in September, 2010. Effect of this judgment is that the stay order of the Division Bench got vacated and the judgment and decree of Single Judge again came to be revived. On 17.1.2012, the Supreme Court rejected the prayer of the assessee for interim relief and gave liberty to Alimenta to enforce decree passed by the Single Judge. 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 Single Judge dated 28.1.2000, remained suspended from the date of stay granted by the Division bench of the High Court on 28.2.2001. It is only on the passing of the consequential judgment and decree by the 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;

++ 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 Single Judge. 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;

++ 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. 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 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;

++ 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.

(See 2015-TIOL-1658-ITAT-DEL-SB)