Mercantile accrual and hospitality expense principles kept bonus deduction and customer refreshments outside disallowance

Under the mercantile system, a statutory bonus liability under the Payment of Bonus Act accrues in the accounting year even if the exact amount is quantified after year-end, so the excess later determined remained deductible in that year because it did not exceed the statutory ceiling. Expenditure on food and drinks supplied to customers was treated as hospitality, not entertainment, and was therefore outside the disallowance under section 37(2A) of the Income-tax Act, particularly since the amended provision applied only from 1 April 1976. Both issues were resolved in favour of the assessee.

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Issues: (i) Whether bonus paid under the Payment of Bonus Act, 1965, but quantified after the close of the accounting year, was deductible in the relevant year of account by an assessee maintaining mercantile accounts; and (ii) whether expenditure on food and drinks supplied to customers, being hospitality expenditure and not entertainment expenditure, was hit by the disallowance under section 37(2A) of the Income-tax Act, 1961.

Issue (i): Whether bonus paid under the Payment of Bonus Act, 1965, but quantified after the close of the accounting year, was deductible in the relevant year of account by an assessee maintaining mercantile accounts.

Analysis: The liability to pay bonus under the Payment of Bonus Act, 1965 is a statutory obligation. The Act fixes minimum and maximum bonus, prescribes the time for payment, and makes non-payment punishable. Where the assessee follows the mercantile system, the obligation to pay bonus accrues in the accounting year and only the precise amount is quantified later. A settlement reached after the year-end merely determines the amount payable; it does not convert the statutory liability into a non-statutory one. Since the amount paid did not exceed the statutory ceiling, the excess over the provision made in the accounts remained relatable to the relevant accounting year.

Conclusion: The deduction was allowable in the relevant year of account and the issue was decided in favour of the assessee.

Issue (ii): Whether expenditure on food and drinks supplied to customers, being hospitality expenditure and not entertainment expenditure, was hit by the disallowance under section 37(2A) of the Income-tax Act, 1961.

Analysis: The expenditure related to hospitality and not entertainment. The amended disallowance provision under section 37(2A) had come into force only from 1 April 1976 and was therefore not applicable to the assessment years in question. On the facts found, the expenditure did not fall within the prohibited category of entertainment expenditure.

Conclusion: The expenditure was not disallowable and the issue was decided in favour of the assessee.

Final Conclusion: Both questions were answered against the Revenue, and the assessee succeeded on the deduction of bonus as well as on the hospitality expenditure claim.

Ratio Decidendi: Under the mercantile system, a statutory liability that accrues in the accounting year remains deductible for that year even if its exact amount is quantified later, and expenditure on hospitality is not disallowable as entertainment expenditure unless it falls within the statutory prohibition.

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