Mercantile system deduction fails where disputed damages and related interest have not crystallised into an enforceable liability.

Under the mercantile system, interest on disputed damages is deductible only when the liability has crystallised into a present, enforceable obligation. Where the assessee continues to contest the damages and the decree awarding them remains stayed, there is no legally enforceable liability in the relevant years and no corresponding right in the claimant to receive interest. On that basis, the interest claimed on the disputed damages was not allowable as a business deduction for the years under consideration. Section 40(a)(i) did not independently assist the assessee once the basic deduction requirement failed.

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Issues: Whether, where the assessee disputes damages and the consequential interest in court, deduction can be allowed for the interest claimed on such damages while computing business income.

Analysis: Under the mercantile system, an expense is deductible only when the liability to pay is certain and has crystallised into an enforceable obligation. A mere contractual claim, when the assessee continues to contest liability and the operative decree is stayed, does not create a present obligation to pay or a corresponding right in the claimant to receive. The liability to pay interest on the disputed damages therefore does not arise merely because an earlier decree had awarded it, when that decree remained under stay during the relevant years. Since no legally enforceable liability existed in the years under consideration, the claim could not be allowed as a business deduction. Once the deduction is otherwise unavailable on this basic principle, section 40(a)(i) does not independently assist the assessee.

Conclusion: Deduction for the interest claimed on the disputed damages cannot be allowed in the years under consideration; the question is answered in the negative and against the assessee.

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