Accrued liability under mercantile accounting permits deduction of estimated development costs as necessary business expenditure.

Under the mercantile system of accounting, an unconditional covenant in conveyance deeds to complete roads, drains, filling and lighting creates an accrued legal liability at the date of sale rather than a mere contingent liability; consequently the estimated cost to discharge that liability may be debited before payment and treated as an allowable deduction in computing profits and gains under income tax law, while tax authorities retain the power to examine and fix an appropriate monetary estimate.

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Issues: Whether the assessee-company was entitled to deduct Rs. 24,809 in computing the profits and gains for the assessment year 1948-49 being the estimated cost of development works which it had undertaken under sale deeds but had not actually disbursed during the accounting year.

Analysis: The Court examined (i) the mercantile system of accounting under which receipts due and receivable are credited and expenditures for legal liabilities incurred may be debited before actual payment; (ii) whether the undertaking in the conveyance deeds to complete roads, drains, filling and lighting within six months (time not being of the essence) created an accrued legal liability as distinct from a mere contingent liability; and (iii) the scope of allowable deductions under section 10(1) read with the enumerations in section 10(2)(xv) of the Income-tax Act. Applying commercial principles and precedents on accrued versus contingent liabilities, the Court found the covenant in the deeds to be an absolute, unconditional undertaking thereby producing an accrued liability at the date of sale though discharge was to occur later. The estimated expenditure to discharge that accrued liability could properly be debited under the mercantile system and, being necessary for earning the receipts, was deductible in computing profits and gains under section 10(1); the income-tax authorities retain power to scrutinise and fix an appropriate monetary estimate.

Conclusion: The sum of Rs. 24,809 is an allowable deduction from the profits and gains for the assessment year and the referred question is answered in the affirmative; appeal allowed in favour of the assessee.

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