Mercantile accounting requires tax liabilities to be deducted on accrual, and a wrong-year allowance can justify revision

Under the mercantile system, sales tax liability is deductible in the year it accrues, not in the year it is later paid or quantified. Because the liability had accrued in earlier assessment years, it could not be shifted to assessment year 1977-78 merely on payment in that year. An allowance in the wrong year was treated as prejudicial to the Revenue, so revision under section 263 of the Income-tax Act, 1961 was justified and the assessment order was set aside.

---

---

Issues: Whether sales tax liability, though relating to earlier assessment years, could be deducted in the year of actual payment by an assessee following the mercantile system of accounting, and whether the Commissioner was justified in exercising revisionary jurisdiction under section 263 of the Income-tax Act, 1961.

Analysis: Under the mercantile system, an expenditure or liability is deductible in the year in which it accrues, not in the year in which it is quantified or paid. The liability to sales tax had accrued during the earlier years relevant to assessment years 1969-70, 1970-71 and 1971-72, and it could not be shifted to assessment year 1977-78 merely because payment was made in that year. The Income-tax Officer's allowance of the deduction was therefore inconsistent with the settled rule of accrual and rendered the assessment order prejudicial to the interests of the Revenue, justifying revision.

Conclusion: The deduction was not allowable in assessment year 1977-78, and the Commissioner was right in invoking section 263 and setting aside the assessment order.

Final Conclusion: The reference was answered in favour of the Revenue, and the Tribunal's order was not sustained.

Ratio Decidendi: For an assessee maintaining mercantile accounts, a tax liability is deductible only when it accrues, and not when it is later paid or quantified; an assessment allowing deduction in the wrong year is prejudicial to the interests of the Revenue and is amenable to revision under section 263.

---