Call Deduction u/s 57 allowed for following mercantile system consistently
Under mercantile system of accounting which is also called as accrual system of accounting, incomes and expenses are recorded in the books of accounts as and when they are earned or incurred. This is regardless of the fact that whether they are actually received or paid. The system adheres to the matching principle, which requires that expenses be matched to the revenues they help to generate.
While calculating the total tax liability for a year, various deductions of expenditure made are claimed against certain incomes from other sources. This provision is explained in section 57 of the income tax act.
Kolkata Bench of ITAT has dealt with such an appeal where assessing officer disallowed deduction of interest expenditure against the interest income of assessee.
Issues involved:
Assessee Bal Krishna Mundhra had declared an interest income in the Income tax return and claimed deduction of interest expenditure under section 57. Since assessee was following mercantile system of accounting, he reported accrued income and accrued expenditure in the ITR. Assessing Officer disallowed a portion of the expenditure saying it was not actually incurred. He then added the difference amount total income of the assessee.
Facts of the case explained:
Issue under consideration here pertains to AY 2020-21 where assessee had declared a total income of Rs.2,81,829/-. On brief examination it was revealed that he had shown an interest income of Rs.1,32,22,133 and he had claimed interest expenditure of Rs.1,29,23,294. This expenditure was claimed under section 57 of the income tax act. Assessee had actually paid interest of only Rs.95,00,000/-. AO hence disallowed the balance expenditure ofRs.34,23,294/- and made addition to the income.
Appeal to the ld. CIT(Appeals) did not bring any relief to the assessee. Assessee then appealed to the Tribunal. Where representative of the assessee stated that the interest expenditure was claimed on the grounds of accrual basis and remaining portion of the expenditure was paid in the subsequent year. The payment on 14.09.2020 of Rs.70,00,000/- do include Rs.34,23,294/-, which is the component of interest. The total amount of interest income was also not received completely by the assessee still he had reported entire interest income. Similarly, the assessee has recognized the interest expenditure on accrual basis out of the total amount accrued to it. It has actually paid Rs.95,00,000/- and the balance was paid on 14th September in the next year. Revenue on the other hand raised the issue of 26AS, where the interest expenditure was not reflected and hence it stated that the same could not be allowed. The bench held that There is no dispute with regard to the fact that the assessee has been consistently following mercantile system of accounting. It has accounted its interest income on mercantile system and not on receipt basis. This stand of the assessee was not disputed by the ld. Assessing Officer. To conclude the same ITAT stated, that if AO excluded the interest income shown by the assessee to the extent, it was not received in this year by following cash system of accounting.
Similarly, he cannot disallow the expenditure worked out by the assessee on mercantile system of accountancy. The appeal of the assessee was allowed and disallowance was deleted.
Conclusion:
Since there was consistency in following of accounting method by assessee, where he had followed mercantile system, his expenditure under section 57 were allowed by ITAT. This system provides a more accurate picture of financial position of assessee over a specific period of time, as it matches income and expenses to the periods in which they are incurred. These provisions would have been scrutinised more by Hon’ble Bench had the assessee made defaults in following the system of accounting consistently.
About Author:
CA Chinmay Shirish Agate
Chinmay Agate is a Practicing Chartered Accountant having 4+ years of experience and expertise in the field of Direct Taxation and Auditing compliances. In the past, he worked in various CA firms and comes with wide industry experience from services, retail to manufacturing to trading where he has handled various complex assignments. He has keen interest in Forex and Derivative knowledge as well as fundamental analysis.