Business expenditure deduction allowed for arbitration compensation where contractual liability crystallised on failure to perform agreed development obligation.

Compensation paid under an arbitration award for failure to deliver agreed built-up area was treated as deductible business expenditure because the transaction formed part of the assessee's regular real-estate business and the contractual liability arose from the agreement itself. Objections based on absence of registered ownership and the agreement being in the managing partner's name were rejected, as the dispute concerned joint development rights and the firm's accounts reflected the transaction. The liability was held to have crystallised when non-performance became evident; the later arbitration award only quantified an existing obligation. Applying mercantile accounting and prudence, the deduction was allowed in the year of crystallisation.

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Issues: Whether compensation of Rs. 64.74 crores paid pursuant to the arbitration award for failure to deliver the agreed built-up area was deductible as business expenditure in the assessment year under consideration, and whether the liability had crystallised during that year.

Analysis: The agreement identified the properties and contemplated transfer of built-up area to the buyer against advance consideration. The assessee had recorded the transaction in its books and had consistently treated similar real-estate dealings as part of its regular business. The objection that the assessee was not the registered owner of the properties was rejected because the dispute related to rights in constructed area under joint development arrangements, not to title in the underlying land. The objection that the agreement was entered into in the name of the managing partner was also rejected because the transaction stood reflected in the firm's accounts and was part of the firm's business pattern. On the question of timing, the liability to compensate arose from the contractual obligation itself and became ascertainable when the assessee realised it could not perform within the agreed period. The subsequent arbitration award only quantified an existing obligation. Applying the principle of prudence and the accounting treatment mandated under mercantile accounting, the loss was held allowable in the year in which the failure to perform had become evident, even though quantification occurred later.

Conclusion: The compensation liability was held to have crystallised for the relevant year and the deduction was allowed.

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