Contingent liabilities cannot be added to income merely on the basis of tax audit report

Contingent liabilities not debited to profit and loss account cannot be added merely on the basis of disclosure in the tax audit report – ITAT 

In a recent judgment, ITAT Ahmedabad deleted adjustment made by CPC u/s 143(1)(a) holding that contingent liabilities which are not debited to the profit and loss account cannot be added merely on the basis of disclosure in the audit report.

ABCAUS Case Law Citation:
4608 (2025) (06) abcaus.in ITAT

In the instant case, the Revenue had challenged the order passed by the Commissioner of Income Tax (Appeals), National Faceless Appeal Centre (NFAC) in deleting addition towards contingent liability and late deposit of EPF.

The assessee was a HUF and proprietor. His return was processed under section 143(1) by the CPC, Bengaluru, vide intimation u/s 143(1)(a) wherein the total income was enhanced and demand was raised. The increase in income was due to two adjustments made in the intimation were

(a) Addition treating the contingent liability debited to the Profit and Loss Account based on disclosure of contingent liability under clause 21(g) of the tax audit report. (b) Disallowance on account of late payment of employees’ contribution to PF, which according to the assessee was added twice – once by himself and again by CPC.

Before the CIT(A), the assessee contended that the first addition was not a real expenditure but a contingent liability merely disclosed in the tax audit report under clause 21(g) for disclosure purposes and was never debited to the profit and loss account. To support its contention, the assessee filed the revised Tax Audit Report, Auditor’s certificate clarifying the inadvertent mention and Copies of audited financial statements. As regards the second disallowance, the assessee submitted that the same was already disallowed suo motu in the return of income, and the CPC made a duplicate disallowance under two different heads in the intimation. The assessee also placed reliance on some judicial precedents.

The CIT(A), after examining the profit and loss account and revised tax audit report, concluded that no actual amount was debited towards contingent liability. The disclosure under clause 21(g) was found to be for informational purposes only and not part of income computation. With regard to second disallowance, the CIT(A) accepted that the assessee had already disallowed the amount in the return, and the CPC disallowance resulted in duplication. As a result, the CIT(A) deleted both additions and allowed the appeal.

Before ITAT the Revenue admitted that the additions were made primarily on the basis of disclosures in the tax audit report and not on any real entries in the books of account or profit and loss account.

The Tribunal observed that undisputed fact was that the first addition was made solely on the basis of disclosure under clause 21(g) of the tax audit report, without there being any corresponding debit in the profit and loss account. This fact was corroborated by the financial statements and the revised audit report. The copy of the Auditor’s certificate indicating the facts that the amount was inadvertently reported in the original tax audit report and the same is rectified in the revised form 3CD – annexure to the tax audit report in form 3CB.

The Tribunal further observed that the coordinate benches had held that contingent liabilities which are not debited to the profit and loss account cannot be added merely on the basis of disclosure in the audit report.

Further, under section 143(1)(a), the scope of adjustment was limited to arithmetical errors, incorrect claims apparent from any information in the return, or disallowance of loss claimed without required return. The adjustment made in the instant case did not fall under any of the said categories, as it required verification beyond the return itself.

Regarding the second disallowance for employees’ PF, the assessee had already disallowed the same by adding it to the total income by the assessee as disallowable u/s 36 of the Act.  The CPC’s duplication of the same disallowance was clearly apparent from the intimation.

The Tribunal upheld the order passed by the CIT(A) holding that adjustments made by the CPC under section 143(1)(a) were erroneous and rightly deleted by the first appellate authority.

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