2000 (8) TMI 4 - SC - Income Tax

Provision for earned leave encashment deductible when liability is incurred if certain and reasonably estimable, not contingent

Bharat Earth Movers Versus Commissioner of Income-Tax

SC allowed the appeal, holding that a company's provision for encashment of earned leave (subject to the applicable accumulation ceiling) is an allowable ... Deduction - Liability for encashment of earned leave by the employee - accumulate earned/vacation leave subject to the ceiling limit of 240/126 days - HELD THAT:- The law is settled : if a business liability has definitely arisen in the accounting year, the deduction should be allowed although the liability may have to be quantified and discharged at a future date. What should be certain is the incurring of the liability. It should also be capable of being estimated with reasonable certainty though the actual quantification may not be possible. If these requirements are satisfied the liability is not a contingent one. The liability is in praesenti though it will be discharged at a future date. It does not make any difference if the future date on which the liability shall have to be discharged is not certain. We are satisfied that the provision made by the appellant-company for meeting the liability incurred by it under the leave encashment scheme proportionate with the entitlement earned by employees of the company, inclusive of the officers and the staff, subject to the ceiling on accumulation as applicable on the relevant date, is entitled to deduction out of the gross receipts for the accounting year during which the provision is made for the liability. The liability is not a contingent liability. The High Court was not right in taking the view to the contrary. The appeal is allowed. The judgment under appeal is set aside. The question referred by the Tribunal to the High Court is answered in the affirmative, i.e., in favour of the assessee and against the Revenue. Issues:1. Deductibility of provision for encashment of accrued leave for assessment year 1978-79.Analysis:The Supreme Court addressed the issue of whether the provision for meeting the liability for encashment of earned leave by the employee is an admissible deduction for the appellant-company for the assessment year 1978-79. The company had two sets of employees, officers, and staff, with different entitlements for earned and vacation leave. The company created a fund by making a provision for meeting its liability arising from the accumulated earned/vacation leave. The High Court had held that the provision for accrued leave salary was a contingent liability and therefore not a permissible deduction. However, the Supreme Court disagreed with this view. The appellant argued that the liability is certain as it is made to the extent of entitlement of the employees to accumulate earned/vacation leave, subject to the ceiling limit. The Court held that if a business liability has definitely arisen in the accounting year and is capable of being estimated with reasonable certainty, the deduction should be allowed, even if the liability will be discharged at a future date.The Court referred to the Metal Box Company case, where it was established that for an assessee maintaining accounts on the mercantile system, a liability already accrued, though to be discharged at a future date, should be a proper deduction. The liability should be certain and capable of being estimated with reasonable certainty. The Court also cited the Calcutta Co. Ltd. case, emphasizing that the liability being imported would be an accrued liability and not a conditional one merely because it is to be discharged in the future. Applying these principles to the case at hand, the Court concluded that the provision made by the appellant-company for meeting the liability under the leave encashment scheme is entitled to deduction out of the gross receipts for the accounting year during which the provision is made, as the liability is not contingent but certain.The Court allowed the appeal, set aside the judgment under appeal, and answered the question in favor of the assessee and against the Revenue. Additionally, the Court expressed dissatisfaction with the failure of the Tribunal to comply with directions for a supplementary statement of case and emphasized the importance of authorities acting in aid of the Supreme Court. The Court observed that the necessary facts related to the leave encashment scheme were not disputed before the Tribunal or the Court, as stated in the statement of facts filed by the appellant before the Income-tax Appellate Tribunal.