2026 (1) TMI 1544 - AT - Income Tax

Provision for gratuity and leave encashment under section 11 treated as applied income; Tribunal allows accounting provisions as application.

Assessment of whether provisions for gratuity and leave encashment qualify as application of income under section 11 for a registered charitable trust. ... Assessment of trust - exemption u/s 11 - allowability of provision for gratuity and leave encashment as application of income in the hands of a charitable trust registered u/s 12A and claiming exemption under section 11 HELD THAT:- The co-ordinate Bench [2021 (8) TMI 287 - ITAT MUMBAI] while adjudicating the issue in the assessee’s own case, has categorically observed that such provisions are mandated by law, that the liability has already crystallized as on the balance sheet date, and that without making such provisions the books of account would not present a true and fair view of the state of affairs. The Tribunal has further drawn a clear and cogent analogy with depreciation, observing that although depreciation is also a book entry without actual flow of funds, it is nonetheless required to be provided for to reflect the correct profits of the entity. It has been held that in the context of section 11, the expression “applied” cannot be construed in a narrow sense as “actually spent” alone, but must be understood in its commercial sense to include necessary statutory provisions representing accrued and crystallized liabilities incurred in the course of carrying out the objects of the trust. In that view of the matter, the Tribunal had directed the Assessing Officer to allow the provision for gratuity and leave encashment as application of income for the objects of the trust and had dismissed the grounds raised by the Revenue. Issues: (i) Whether provision for gratuity and leave encashment made on actuarial valuation constitutes application of income of a charitable trust under section 11; (ii) Whether excess of expenditure (deficit) for the year can be carried forward and set off against income of subsequent years as application of income for charitable purposes.Issue (i): Whether provision for gratuity and leave encashment made on actuarial valuation constitutes application of income of a charitable trust under section 11.Analysis: The issue was examined in light of consistent accounting practice, Accounting Standard 15, statutory employment obligations including the Payment of Gratuity Act, 1972, and earlier co-ordinate Bench decisions in the assessee's own case. The provisions were found to represent accrued and crystallized liabilities as on the balance sheet date and were necessary to present a true and fair view of accounts. An analogy with depreciation was applied to illustrate that book entries which do not involve immediate cash outflow may nevertheless be necessary deductions or applications of income when mandated by law and accounting principles. The Tribunal relied on binding precedents of co-ordinate Benches rendered on identical facts and found no distinguishing feature in the present assessment year.Conclusion: The provision for gratuity and leave encashment is allowable as application of income under section 11 and the ground raised by the Revenue is dismissed (in favour of the assessee).Issue (ii): Whether excess of expenditure for the year can be carried forward and set off against income of subsequent years as application of income for charitable purposes.Analysis: The issue was considered with reference to the Bombay High Court decision in CIT v. Institute of Banking Personnel Selection and related precedents, holding that commercial principles permit adjustment of earlier year deficits against subsequent year income where such adjustment reflects application of income for charitable purposes. The facts were found identical and the binding precedents, including dismissal of related SLPs, were followed. Quantification was adjusted to reflect deletion of disallowance, and the Assessing Officer was directed to allow carry forward of the revised deficit.Conclusion: The carry forward of the deficit to subsequent assessment years is allowed (in favour of the assessee).Final Conclusion: The Tribunal, following binding co-ordinate Bench and High Court precedents and applying accounting and statutory principles, affirms the deletion of disallowance of provisions for gratuity and leave encashment and allows carry forward of the revised deficit; the Revenue's appeal is dismissed.Ratio Decidendi: Provisions for gratuity and leave encashment made on the basis of actuarial valuation in compliance with Accounting Standard 15 and statutory/employment obligations constitute accrued and crystallized liabilities that amount to application of income under section 11 and are allowable for a registered charitable trust.