2016 (1) TMI 790 - HC - Income Tax

Court rules license fee liability deductible under mercantile accounting system

The court held that the Income Tax Appellate Tribunal (ITAT) erred in confirming the disallowance of the amount on account of liability of license fee and ... Disallowance of liability of licence fee and on account of interest on arrears of licence fee payable to N.D.M.C. for running the business at Chanakya Cinema - Ascertained or accrued liability - Held that:- There was no question of there being no liability on the Assessee whatsoever for the renewal of the licence. Merely because the Assessee had chosen to challenge in Court the enhancement of the licence fee, which was permissible to be raised by it in accordance with law, did not preclude the Assessee, which was following the mercantile system of accounting, from claiming it as a liability during the AYs in question. The Court, therefore, does not, in view of the averments made by the Assessee in the pleadings in the suit filed by it against the NDMC, as a reason to preclude the Assessee from claiming the licence fee, the head office fee and the interest on arrears payable to the NDMC in terms of the renewed licence deed as a liability for the AYs concerned. The ITAT also appears to have drawn a distinction between a statutory liability and a contractual liability and opined that a deduction in respect of the contractual liability would be permissible “only when the disputes are settled.” This is contrary to the legal position as explained in the above decisions of the Courts. Even where a challenge is laid to a liability arising under a contract, by a challenger initiating legal proceedings, such challenger can still for the purposes of its accounts and for the purposes of computation of its income tax liability claim the entire amount under challenge as an accrued liability as long as such amount is ascertainable. Corresponding adjustments would be made in the year in which the suit is finally decided or the disputes settled. That, however, would not preclude the Assessee from claiming it as an ascertained liability. The ground urged on behalf of the Assessee as regards consistency also merits acceptance. There is indeed a demonstrable inconsistency in the Revenue’s stand in the matter. While the Assessee consistently claimed liability towards licence fee, the Revenue appears to have accepted it in its entirety some years and not in some others. In AYs 1982-83 to 1986-87, the AO fully allowed the amount as claimed in respect of the licence fee as well as interest by the Assessee in terms of the Agreement dated 23rd September, 1980. ITAT was in error in declining the plea of the Assessee for the AYs in question with regard to the full claim of the payment towards licence fee and interest on the arrears of licence fee. The question framed is answered in the negative, i.e., in favour of the Assessee and against the Revenue. Issues Involved:1. Whether the Income Tax Appellate Tribunal (ITAT) was correct in law in reversing the order of the Commissioner of Income Tax (Appeals) [CIT(A)] and confirming the disallowance of the amount on account of liability of license fee and interest on arrears of license fee payable to NDMC for running the business at Chanakya Cinema.Detailed Analysis:Background Facts:The Assessee was engaged in running a cinema hall named Chanakya Cinema at Yashwant Place, owned by NDMC, under a license agreement dated 16th September 1970. The license was initially for ten years with an option for renewal. The renewal was granted on 23rd September 1980 with an increased annual license fee. The Assessee paid the license fee under protest and initiated litigation challenging the increase.Various Rounds of Litigation:The Assessee filed multiple suits and writ petitions challenging the increase in license fee and sought interim reliefs, which were granted by various courts. The litigation history includes multiple appeals and revisions, with interim orders allowing the Assessee to continue operations under modified terms until the final disposal of the suits.Proceedings under the Income Tax Act:The Assessee claimed deductions for license fees and interest on arrears for various assessment years. Initially, the Assessing Officer (AO) allowed these deductions, but for later years, disallowed the amounts not actually paid. The CIT(A) reversed the AO's disallowance, but the ITAT upheld the AO's decision, leading to these appeals.Submissions of Senior Counsel for the Assessee:The Assessee's counsel argued that the AO erred in disallowing the license fee and interest, emphasizing that the Assessee followed the mercantile system of accounting, which allows deduction of accrued liabilities. The liability was ascertained, and the dispute was only regarding the enhancement of the fee, not the liability itself. The counsel cited several precedents supporting the claim for deduction of accrued liabilities.Submissions of Counsel for the Revenue:The Revenue's counsel contended that the Assessee could not claim the liability as ascertained while simultaneously disputing it in court. They argued that the liability was not crystallized until the dispute was resolved. They also distinguished between statutory and contractual liabilities, asserting that a contractual liability under dispute could not be claimed as a deduction until settled.Ascertained or Accrued Liability:The court reviewed precedents on ascertained liabilities, including statutory and contractual obligations. It noted that under the mercantile system, liabilities that are reasonably certain and capable of estimation can be claimed as deductions even if disputed. The court emphasized that the dispute in this case was about the reasonableness of the enhanced fee, not the existence of the liability itself.The Rule of Consistency:The court highlighted the inconsistency in the Revenue's treatment of the Assessee's claims over different assessment years. It referred to the principle that fundamental aspects settled in earlier years should not be disturbed unless there is a significant change in circumstances. The court criticized the Revenue for changing its stance without justification.Conclusion:The court concluded that the ITAT erred in upholding the AO's disallowance of the license fee and interest. It held that the Assessee's liability was ascertained and deductible under the mercantile system of accounting. The court also ruled in favor of the Assessee on the grounds of consistency, setting aside the ITAT's orders and allowing the appeals without costs.