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Issues: Whether disallowance under section 40(a)(ia) could be sustained in the assessment year where the impugned expenditure had been capitalised to work-in-progress and not claimed in the profit and loss account, and whether the Revenue could insist on a direct addition instead of adjustment to work-in-progress.
Analysis: The core pre-condition for disallowance under section 40(a)(ia) is that the expenditure must be claimed as a deduction in computing business income. Where an amount is not claimed in the profit and loss account and remains embedded in work-in-progress, there is no deduction in the relevant year to which the disallowance can attach. The accounting method, whether percentage completion or completed contract, does not by itself determine the issue; what matters is whether the expenditure has actually entered the computation of income for the year. The record also showed that substantial portions of the impugned expenditure were retained in closing work-in-progress and only a part was charged to the year, and the subsequent verification accepted this allocation. In such a situation, the proper course is adjustment of work-in-progress to the extent the expenditure is not allowable, rather than a direct addition to total income in the year.
Conclusion: The disallowance under section 40(a)(ia) was not warranted for the portion of expenditure not claimed in the year, and the direction to verify and adjust work-in-progress was sustained in favour of the assessee.
Final Conclusion: The Revenue's challenge failed because the impugned expenditure, to the extent it remained in work-in-progress, did not give rise to a disallowance in the year under appeal, and the order of the first appellate authority was upheld.
Ratio Decidendi: Section 40(a)(ia) applies only to expenditure claimed in the computation of income for the relevant year, and where the amount is capitalised to work-in-progress, the correct treatment is adjustment of work-in-progress rather than a direct addition to income.
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