Accrued liability under mercantile accounting: unconditional development obligations are deductible when incurred, even if later quantified.

An unconditional contractual undertaking to carry out development work, such as roads, drains and lighting, created an accrued liability under the mercantile system even though performance and exact quantification were deferred. The estimated cost was deductible in the accounting year because the obligation had already arisen and its valuation difficulty did not make it contingent. The same expenditure was also allowable in computing business profits, since taxable profits are to reflect the true commercial balance after giving effect to obligations incurred to earn the sale receipts. The principle is that an accrued business liability need not be paid or precisely quantified before deduction if it has definitely arisen.

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Issues: (i) whether the estimated expenditure for development work undertaken under the deeds of sale was an accrued liability deductible in the year of account under the mercantile system of accounting; (ii) whether the amount was allowable in computing business profits under the charging and deduction provisions of the Income-tax Act.

Issue (i): whether the estimated expenditure for development work undertaken under the deeds of sale was an accrued liability deductible in the year of account under the mercantile system of accounting

Analysis: The undertaking to lay roads, drains, lighting and allied facilities was incorporated in the sale deeds and was unconditional. Time for performance was not of the essence, so the obligation was not contingent on any future event. Under the mercantile system, expenditure may be debited when a legal liability has accrued, even if payment is deferred and the exact amount must be estimated. The difficulty of valuation did not change the character of the liability.

Conclusion: The liability had accrued and the estimated expenditure was deductible in the accounting year.

Issue (ii): whether the amount was allowable in computing business profits under the charging and deduction provisions of the Income-tax Act

Analysis: Business profits must be computed on a commercial basis by setting receipts against the expenditure or obligations incurred to earn them. Section 10(1) embraces the true balance of profits, and section 10(2) is not exhaustive of all allowable deductions. The estimated development cost was incidental to the business and necessary to earn the sale proceeds, so it formed part of the computation of taxable profits.

Conclusion: The amount was allowable as a deduction in computing the business profits of the assessee.

Final Conclusion: The referred question was answered in the affirmative and the deduction claimed by the assessee was held allowable.

Ratio Decidendi: Where a trader follows the mercantile system, an unconditional contractual liability incurred to earn business receipts is deductible when it accrues, even if discharge and exact quantification occur later, because taxable profits must reflect the true commercial balance after allowing necessary expenditure or obligations.

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