2007 (10) TMI 146 - HC - Income Tax

High Court allows interest deduction as contractual liability under Income Tax Act for AY 1981-82

The High Court ruled in favor of the Assessee, allowing the deduction of interest payment claimed as a contractual liability under the Income Tax Act for ... Disputed liability for interest on arrears of ground rent – mercantile system of accounting – held that, impugned liability was incurred for first time in 1980 when DDA quantified the interest so deduction can’t be disallowed merely because liability was discharged much later i.e. in 2007 Issues:Interpretation of contractual liability for interest payment under Income Tax Act, 1961 for Assessment Year 1981-82.Analysis:1. The case involved a dispute regarding the liability to pay interest as a contractual obligation between the Assessee and the Delhi Development Authority (DDA) for a plot of land allotted for constructing a cinema building.2. The Assessee raised concerns about the payment of ground rent, alleging non-provision of facilities by DDA and encroachment on the land.3. Legal actions were taken by the Assessee, including a Civil Writ Petition and a subsequent suit, challenging the demands made by DDA.4. The Assessing Officer disallowed a sum of Rs.79,220 claimed by the Assessee as interest payable to DDA for an earlier period, stating it did not accrue during the relevant previous year.5. The Tribunal upheld the AO's decision, considering the demand for interest in a letter dated 9th September, 1980, as a mere reminder and not a fresh demand.6. The Assessee contended that under the mercantile system of accounting, the liability to pay interest arises when demanded, as in the case of the letter dated 9th September, 1980.7. The High Court analyzed the letter and applied the principles laid down by the Supreme Court in Bharat Earth Movers case, emphasizing that an accrued liability, even if discharged later, should be allowed as a deduction.8. The Court distinguished the Allahabad High Court's decision and the Swadeshi Cotton and Flour Mills case, asserting that the liability to pay interest crystallized when demanded in 1980, irrespective of the actual payment date in 2007.9. Ultimately, the Court ruled in favor of the Assessee, stating that the interest liability accrued in 1980 and should be allowed as a deduction, concluding the reference under Section 256(1) of the Income Tax Act, 1961.This detailed analysis of the judgment highlights the contractual nature of the liability, the timing of its accrual, and the application of accounting principles in determining the deductibility of interest payments under the Income Tax Act for the relevant Assessment Year.