Facts of the Case

The assessee, Sivalik Cellulose Ltd., was originally incorporated in 1975 and had established a paper manufacturing plant. Due to continuous losses, rehabilitation proceedings were initiated. Under a rehabilitation scheme dated 15.02.1990, Hindustan Lever Ltd. (HLL) agreed to participate in the management and revival of the company. HLL nominated five directors on the Board, while financial institutions and promoters nominated the remaining directors.

For Assessment Year 2004-05, the assessee claimed:

  1. Deduction of ₹1.52 crores towards salaries and wages allegedly payable to managers and supervisors deputed by HLL during the period 1998-2002.
  2. Non-taxability of ₹24.30 crores claimed from HLL towards alleged short payment of processing charges.

The Assessing Officer (AO) disallowed the salary claim of ₹1.52 crores and also sought to tax ₹24.30 crores on accrual basis under the mercantile system of accounting.

Issues Involved

  1. Whether the assessee was entitled to deduction of ₹1.52 crores claimed towards salaries and wages payable to HLL employees deputed to the assessee company.
  2. Whether ₹24.30 crores claimed by the assessee against HLL as short payment of processing charges had accrued as taxable income.

Petitioner’s Arguments (Revenue)

The Revenue contended that:

  • The Board Resolution dated 04.12.2003 accepting the liability of ₹1.52 crores was passed when HLL controlled the majority of directors on the assessee’s Board.
  • There was no proper basis except a debit note for accepting such a huge liability relating to earlier years.
  • The AO rightly disallowed the expenditure and added the amount back to taxable income.
  • The claim of ₹24.30 crores should have been offered to tax under the mercantile system as income had accrued to the assessee.

Respondent’s Arguments (Assessee)

The assessee argued that:

  • The liability of ₹1.52 crores crystallized only after the Board Resolution dated 04.12.2003 and was therefore allowable.
  • HLL had in fact raised a debit note and the Board had accepted the liability.
  • The ₹24.30 crores represented only a disputed claim pending adjudication before the Company Court.
  • Mere filing of a petition against HLL did not create any enforceable right to receive income.
  • Since the claim was disputed and sub-judice, no real income had accrued to the assessee.

Court Findings / Order

The Delhi High Court partly allowed the appeal filed by the Revenue.

Finding on ₹1.52 Crores Salary Claim

The Court held in favour of the Revenue and against the assessee on this issue. The Court observed that:

  • There was no evidence showing that provisions for such liabilities were made during the relevant earlier years.
  • A substantial portion of the claim was time-barred.
  • HLL later clarified before the Court that only ₹81,22,072/- was actually payable and not ₹1.52 crores.
  • The overwhelming control of HLL over the Board raised serious doubts regarding acceptance of the liability.

Accordingly, the Court held that the ITAT and CIT(A) were not justified in deleting the disallowance.

Finding on ₹24.30 Crores Claim

The Court ruled in favour of the assessee and against the Revenue regarding the ₹24.30 crores claim.

The Court held that:

  • Mere filing of a petition does not create a vested right to receive income.
  • The amount remained disputed and contingent.
  • HLL had denied liability and the matter was pending adjudication before the Company Court.
  • Since no enforceable right accrued to the assessee, the amount could not be taxed under the mercantile system.

The Court therefore upheld deletion of the addition of ₹24.30 crores.

Important Clarification

The judgment reiterates the settled principle that:

  • Mere claims or disputed demands do not constitute accrued income unless there is a legally enforceable right to receive the amount.
  • Prior period liabilities cannot automatically be allowed merely because they are recognized in later years.

Under the mercantile system, only real income that has crystallized can be taxed.

Sections Involved

  • Section 37(1) of the Income Tax Act, 1961 – Allowability of Business Expenditure
  • Principles of Accrual of Income under Mercantile System of Accounting
  • Taxability of Contingent and Disputed Claims 

Link to Download the Order https://delhihighcourt.nic.in/app/case_number_pdf/2015:DHC:1445-DB/RKG12022015ITA5362010.pdf

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