There is no deeming fiction u/s 28(va) to tax amount on receipt basis – ITAT

There is no deeming fiction u/s 28(va) to tax amount on receipt basis where sum accrued earlier following mercantile system of accounting

ABCAUS Case Law Citation:
ABCAUS 2918 (2019) (05) ITAT

Important Case Laws Cited/relied upon by the parties
The Morvi Industries Pvt. Ltd. v. CIT (82 ITR 835) (SC)
CIT v. Excel Industries Ltd. (358 ITR 295) (SC).
CIT v. Amco Power Systems Ltd (379 ITR 375) (Kar.)

The appeal of the assessee was directed against the order of the Commissioner of Income-tax (Appeals). The only issue was whether the amount could be brought to tax on receipt basis u/s 28(va) of Income Tax Act, 1961 (the Act)?

The assessee was a company engaged in the business of software. For the relevant assessment year, the return of income was filed disclosing a loss.

The assessee (the business group) had entered into a Business Co-operative Agreement (BCA) whereby the current business, the staff and software development facility of the assessee was to be handed over to another company.

Further, the assessee had undertaken not to carry on same or similar business during the subsistence of the BCA. In view of the undertaking not to carry on same or similar business, the assessee was to be compensated. During the relevant assessment year, the assessee had received the said compensation for discontinuance of business.

The Assessing Officer (AO) issued notice u/s 148 of the Act to bring to tax the amount of compensation received. The assessee objected to the proposed addition stating that entire amount payable as per the BCA had accrued to the assessee at the time of entering into the agreement in way back. It was submitted that it was due to this fact that the assessee had credited the full amount to the capital reserve account. It was further submitted that the compensation paid was capitalized in the books of account of the payee as an intangible asset and depreciation was claimed on the same. It was contended that merely because the liability was to be paid in installment does not mean that the income accrued from year to year.

The AO however rejected the contentions / objections of the assessee and brought to tax the sum received.

The CIT(A) also rejected the contentions raised by the assessee.

Before the Tribunal, the assessee made the submission that the amount was accrued in the earlier assessment year and could not be brought to tax u/s 28(va) of the Act on receipt basis in the current assessment year.

The Tribunal observed that when an Assessing Officer proceeds to include a particular income in the assessment, two questions arise namely:

(i) what is the system of accountancy adopted by the assessee? and

(ii) if it is the mercantile system of accountancy, subject to the deeming provisions, when has the right to receive that amount accrued?

If the AO comes to the conclusion that such a right accrued or arose to the assessee in a particular accounting year, he shall include the said income in the assessment of the succeeding assessment year. If, on the other hand, the assessee follows the cash system of accounting, the income would be includible in the assessment year next following the accounting year in which it was actually received, no matter when it did accrue.

The Tribunal further opined that following the principles of mercantile accounting system, the  income which had already accrued cannot be sought to be taxed in a subsequent year for the reason that it escaped assessment in its year of accrual even if such escapement be due to a fault or device of the assessee. The proper remedy for the department in such a case would be to reopen the assessment of the earlier year, if possible.

The Tribunal noted that the amount had accrued on the basis of agreement entered. It was due to these facts the assessee had credited the full amount to the capital reserve account. The compensation paid by the payer was capitalized in their books of account as an intangible asset and depreciation was claimed on the same. Therefore the Tribunal opined that it was clear from the terms / clauses of the BCA that the liability though paid in installments, had accrued when the agreement was entered.

The Tribunal observed that the provision of Section 28(va) of the Act does not speak of any deeming fiction whereby the amount received can be brought to tax on receipt basis. On the contrary, the amount received or receivable can be brought to tax, depending the system of accounting adopted by the assessee.

The Tribunal opined that in the instant case since the assessee had adopted mercantile system of accounting and the amount had accrued earlier, the same could not be brought to tax in the current assessment year.

Accordingly, the appeal filed by the assessee is allowed

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