Can unpaid business expenses be claimed as tax deduction? ITAT Mumbai’s ruling explains when you can
A redevelopment firm’s provision of ₹8 crore towards compensation payable to tenants cannot be disallowed merely because the amount had not been paid or finalised, the Income Tax Appellate Tribunal (ITAT), Mumbai, has ruled.
The tribunal held that the liability was an accrued business obligation arising from a redevelopment agreement and not a contingent liability, dismissing the Income Tax Department’s appeal in the case relating to Assessment Year (AY) 2016-17, ET reported.
The dispute stemmed from a redevelopment project in Mumbai’s Chunabhatti, where a partnership firm was engaged by a builder to get 56 occupants to vacate the property. The firm had already recognised liabilities of ₹17 crore towards tenant compensation in earlier years. During AY 2016-17, it recognised an additional liability of ₹8 crore, taking the total estimated compensation payable to ₹25 crore.
The Assessing Officer disallowed the ₹8 crore deduction, arguing that the liability remained contingent because negotiations with the occupants were still underway, some disputes were under litigation and the exact compensation payable had not been finalised. Since the amount remained unpaid, the department held that it had not crystallised and therefore could not be claimed as a business expense.
However, the Commissioner of Income Tax (Appeals) deleted the addition, following which the tax department challenged the order before the ITAT.
Why the tribunal ruled in favour of the firm
Upholding the appellate order, the ITAT observed that there was no dispute that the firm had undertaken the obligation to get the property vacated and provide the builder with a clear and marketable title. The compensation payable to the occupants was therefore directly linked to the firm’s business transaction and formed an integral part of the redevelopment arrangement.
The report noted that the firm had already recognised the compensation received from the builder as business income. Once the income from the transaction had been recognised, the corresponding expenditure attributable to earning that income also had to be recognised in the same accounting period under the matching principle.
According to the ITAT, disallowing the liability would effectively result in taxing gross commercial receipts without allowing the related business obligation, leading to taxation of hypothetical profits instead of real income.
The tribunal further observed that the provision was supported by documentary evidence, including correspondence with occupants, draft consent terms and pending litigation, and therefore could not be regarded as hypothetical or ad hoc. It held that while litigation could affect the timing or final quantification of the payment, it did not erase the existing business obligation that had already arisen.
Supreme Court precedents relied upon
In arriving at its decision, the ITAT relied on the Supreme Court’s rulings in Bharat Earth Movers v. CIT and Rotork Controls India Pvt. Ltd. v. CIT. The tribunal noted that under the mercantile system of accounting, a business liability is allowable as a deduction if the obligation has arisen during the accounting year and can be reasonably estimated, even if the payment is made or finally quantified at a later date.
The tribunal, however, rejected the firm’s cross-objection seeking to treat the ₹12.25 crore received from the builder as a capital receipt. It held that since the assessee had itself recognised the amount as business income while claiming the corresponding expenditure, it could not subsequently contend that the receipt was capital in nature. The ITAT therefore dismissed both the tax department’s appeal and the assessee’s cross-objection.
