Mercantile accounting allows deduction of accrued purchase tax liability despite dispute and reserve classification, with later remission taxed separately.

Under the mercantile system, purchase tax liability is deductible in the year it accrues, even if the amount is placed in a reserve account and the liability is disputed. The tax liability arose on the relevant transactions and had already been assessed under the U.P. Sales-tax Act, so actual payment was not required for deduction. The accounting entry adopted by the assessee did not determine the tax character of the expenditure. Any later remission or cessation of the liability would be dealt with under section 41 of the Income-tax Act, 1961.

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Issues: Whether the assessee, following the mercantile system of accounting, was entitled to claim deduction of the purchase tax liability that had accrued during the relevant previous year, notwithstanding that the amount was kept in a reserve account and the liability was under dispute.

Analysis: The liability to purchase tax arose when the relevant transactions took place and an assessment under the U.P. Sales-tax Act had already been made against the assessee. Under mercantile accounting, a deduction is allowable when liability accrues, and actual payment is not a prerequisite. The manner in which the assessee recorded the amount in its books does not control the tax treatment of the expenditure. The possibility of later relief in the sales-tax proceedings was held to be covered by the statutory scheme of section 41 of the Income-tax Act, 1961, which brings any subsequent remission or cessation of the liability to tax.

Conclusion: The assessee was entitled to the deduction of the purchase tax liability in the relevant assessment year.

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