Accrual of liability under mercantile system: bonus fixed by industrial award deductible, but contingent leave wages are not.
Under the mercantile system, a bonus liability becomes deductible when it is finally settled by agreement or industrial adjudication, because that is when the enforceable liability accrues; the bonus claim for the earlier year was therefore deductible in the accounting year 1949. By contrast, leave wages payable under the Factories Act accrue only when the worker actually takes leave, is discharged, or quits after leave is refused; until then the obligation is contingent, and a reserve or anticipatory debit is not allowable as a deduction. The bonus claim was allowed, while the leave wages claim was disallowed.
Issues: (i) whether the assessee was entitled to deduction of bonus liability of Rs. 4,16,604 for the accounting year 1949 under section 10(2)(xv) of the Indian Income-tax Act, 1922; and (ii) whether the assessee was entitled to deduction of leave wages of Rs. 1,75,246 payable under sections 79 and 80 of the Factories Act, 1948.
Issue (i): whether the assessee was entitled to deduction of bonus liability of Rs. 4,16,604 for the accounting year 1949 under section 10(2)(xv) of the Indian Income-tax Act, 1922.
Analysis: The bonus claim for the earlier year was finally settled by an industrial award in 1949. On the mercantile system, liability is incurred when the claim is settled by agreement or industrial adjudication, and not before. The award created the enforceable liability in 1949, even though payment was made in instalments thereafter.
Conclusion: The deduction was allowable for the accounting year 1949 and the answer was in favour of the assessee.
Issue (ii): whether the assessee was entitled to deduction of leave wages of Rs. 1,75,246 payable under sections 79 and 80 of the Factories Act, 1948.
Analysis: Leave wages under section 79 become payable only when the worker actually takes leave, is discharged, or quits after refusal of leave. Until one of those contingencies occurs, the employer's obligation remains contingent and not an accrued liability. A reserve or debit entry made in anticipation of future leave payments is not a permissible deduction.
Conclusion: The deduction was not allowable and the answer was against the assessee.
Final Conclusion: The reference was answered partly in favour of the assessee and partly against the assessee, with deduction allowed for the bonus liability but disallowed for the leave wages claim.
Ratio Decidendi: Under the mercantile system, an expenditure becomes deductible only when the liability is ascertained and accrued, and a bonus liability fixed by industrial adjudication is incurred in the year of the award, whereas leave wages remain contingent until the statutory conditions for payment arise.