Facts of the Case

The appellant, a Public Sector Undertaking (HUDCO), filed its return for AY 2007–08 declaring income, later revised downward. The case was scrutinized and assessed under Section 143(3).

Subsequently, the Commissioner invoked Section 263, directing reassessment on two major grounds:

  1. Non-disallowance of provision for salary amounting to ₹1.60 crore.
  2. Non-addition of ₹1.28 crore arising from change in accounting policy regarding fee recognition.

The Assessing Officer disallowed the salary provision and added ₹1.28 crore due to accounting policy change. CIT(A) and ITAT upheld these findings, leading to appeal before the Delhi High Court.

Issues Involved

  1. Whether provision for salary based on anticipated pay revision constitutes an accrued liability or a contingent liability.
  2. Whether change in accounting policy for revenue recognition (from accrual to realization basis) is permissible under the Income Tax Act.

Petitioner’s Arguments (HUDCO)

  • The salary provision was based on recommendations of the Pay Revision Committee and past experience, making it a reasonably certain liability, not contingent.
  • Pay revision was due from 1 January 2007; hence liability accrued during the relevant year.
  • Relied on judicial precedents including:
    • Bharat Heavy Electricals Ltd.
    • Bharat Earth Movers vs. CIT
  • Regarding accounting policy change:
    • Recognition of income should follow AS-9, which requires certainty of realization.
    • The change was made to comply with CAG observations and was revenue-neutral.

Respondent’s Arguments (Revenue)

  • Salary provision was merely an ad hoc and unascertained liability, as pay revision was not finalized during the year.
  • Deduction is allowable only when liability crystallizes.
  • Change in accounting policy violated Section 145, as mixed accounting system is not permissible.
  • The assessee failed to adjust income computation under the Income Tax Act after changing accounting method.

Court Findings / Judgment

On Salary Provision (₹1.60 Crore)

  • The Court held that liability had accrued since pay revision was certain, though quantification was pending.
  • It relied on Bharat Earth Movers principle that liability is deductible if:
    • It has arisen in the accounting year, and
    • It can be estimated with reasonable certainty.
  • The Court observed that pay revision was inevitable and based on scientific estimation.
  • Held: Disallowance by ITAT and CIT(A) was incorrect. Deduction allowed.

On Accounting Policy Change (₹1.28 Crore)

  • The Court upheld the addition made by tax authorities.
  • It ruled that:
    • Assessee cannot adopt selective cash system while otherwise following mercantile system.
    • Even if accounting policy is changed for compliance (e.g., CAG), Income Tax Act provisions prevail.
  • Income had accrued earlier; therefore, change leading to deferment was not permissible without adjustment.
  • Held: Addition of ₹1.28 crore justified.

Important Clarifications

  • A provision is allowable if it represents a present obligation based on reasonable certainty, even if final quantification is pending.
  • Contingent liability vs. accrued liability is determined by certainty of obligation, not timing of payment.
  • Assessees must maintain consistency in accounting method; hybrid systems are not permitted under Section 145.
  • Accounting standards cannot override statutory provisions of the Income Tax Act.

Link to download the order -https://delhihighcourt.nic.in/app/case_number_pdf/2020:DHC:851-DB/SVN06022020ITA5412019_123910.pdf

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