Accrual of income fails where recovery is restrained; actual payment governs deduction of business expenses and leave encashment.

Interest on deposits with a bank under RBI restraint did not accrue as taxable income merely because the assessee followed the mercantile system, since recovery remained uncertain until the restriction ceased. Ex gratia payment above Payment of Bonus Act limits was allowable as business expenditure if actually paid and incurred wholly for business purposes, subject to verification of payment. Leave encashment actually paid during the year was deductible because it was not a mere provision. The additions were not sustained and the Revenue's appeal failed.

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Issues: (i) Whether sticky advances and interest on deposits placed with a bank under RBI restraint could be assessed as income on accrual basis; (ii) whether ex gratia payment in excess of the Bonus Act limits was allowable as business expenditure only on actual payment; (iii) whether leave encashment actually paid during the year was deductible.

Issue (i): Whether sticky advances and interest on deposits placed with a bank under RBI restraint could be assessed as income on accrual basis.

Analysis: The interest on the relevant deposits had not been credited to the profit and loss account, and the debtor bank was under RBI restrictions under section 35A of the Reserve Bank of India Act, 1934, preventing normal banking operations including repayment of deposits. In these circumstances, the income could not be treated as having really accrued merely because the assessee followed the mercantile system. The receipt was liable to tax only when the restriction ceased and recovery became possible.

Conclusion: The issue was decided in favour of the assessee and against the Revenue.

Issue (ii): Whether ex gratia payment in excess of the Bonus Act limits was allowable as business expenditure only on actual payment.

Analysis: Ex gratia paid wholly and exclusively for business purposes is allowable as an expenditure, even if it exceeds the limits under the Payment of Bonus Act, 1965, but deduction depends on actual payment and not merely on a provision. Since the factual verification of payment was necessary, the disallowance was not sustained and the matter was left to verification by the Assessing Officer.

Conclusion: The issue was decided in favour of the assessee, subject to verification of actual payment.

Issue (iii): Whether leave encashment actually paid during the year was deductible.

Analysis: The record showed that the leave encashment amount had in fact been paid during the year and was not a mere provision for an anticipated liability. Once actual payment was established, the expenditure could not be disallowed on the footing of a prior-period provision.

Conclusion: The issue was decided in favour of the assessee and against the Revenue.

Final Conclusion: The additions made by the Assessing Officer were not sustained and the Revenue's appeal failed; the cross objection also did not survive independently.

Ratio Decidendi: Income does not accrue for taxation purposes where the right to receive is effectively restrained and recovery is uncertain, and business expenditure is deductible when it is shown to have been actually incurred or paid in accordance with the applicable legal test.

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