The Income Tax Appellate Tribunal Kolkata has clarified a critical principle in mercantile accounting: expenses incurred in prior years but crystallising as liabilities in the current assessment year are deductible if properly substantiated. This ruling provides much-needed doctrinal clarity for businesses facing disallowance of accrued but unrecorded expenditures.
Background & Facts
The Dispute
The assessee, Huldibari Industries and Plantation Company Limited, filed its return for Assessment Year 2022-23 declaring a total income of ₹3,70,090. The Assessing Officer (AO) selected the case for scrutiny under Computer Assisted Scrutiny Selection (CASS) due to high liabilities relative to declared income, and concerns regarding the credibility of creditors, including two entities - Huldibari Tea & Agro (P) Ltd. and Kanisha Petrochem Pvt. Ltd. - whose registrations had been cancelled by the MCA or who showed minimal taxable income.
Key Facts
- The assessee received unsecured loans aggregating ₹6,97,50,000 during the year: ₹5,82,50,000 from Huldibari Tea & Agro (P) Ltd. and ₹1,15,00,000 from Kanisha Petrochem Pvt. Ltd.
- The AO treated these amounts as unexplained cash credits under Section 68 of the Income Tax Act, 1961, and applied the special rate of tax under Section 115BBE.
- The assessee claimed prior period expenses of ₹6,44,442, comprising office rent, audit fees, and professional fees.
- Audit fees of ₹1,00,890 were paid for services rendered from January 2021 to August 2021. The AO allowed only the portion attributable to the five months falling in the current financial year (April - August 2021), disallowing the first three months (January - March 2021).
- The assessee also paid interest of ₹6,61,534 on unsecured loans extended interest-free to related parties, which the AO disallowed under the principle of deemed income.
- The assessee submitted documents including tax audit reports, balance sheets, profit and loss accounts, bank statements, and copies of ITRs of directors.
- The Commissioner of Income Tax (Appeals) [CIT(A)] confirmed the disallowance of prior period expenses except for the proportionate audit fee, upheld the disallowance of interest, and dismissed the challenge to the Section 68 addition.
Procedural History
- 31.03.2022: Due date for filing return of income for AY 2022-23
- 15.07.2023: Notice under Section 142(1) issued by AO
- 20.09.2023: Assessee submitted documents including audit reports and bank statements
- 12.11.2023: AO issued notice under Section 133(6) to creditors; no response received
- 28.02.2024: AO passed assessment order under Section 143(3) adding ₹6,97,50,000 under Section 68, disallowing ₹6,44,442 as prior period expenses, ₹6,61,534 as interest, and ₹1,02,184 as club expenses
- 04.08.2025: CIT(A) passed order partly allowing prior period expenses (only 5/8 of audit fee allowed), disallowing interest, and upholding Section 68 addition
- 25.03.2026: Hearing concluded before ITAT Kolkata
- 08.04.2026: ITAT pronounced order
Relief Sought
The assessee sought deletion of:
- ₹6,44,442 disallowance of prior period expenses
- ₹6,61,534 disallowance of interest on interest-free loans
- ₹6,97,50,000 addition under Section 68
- Application of Section 115BBE
The Revenue sought to uphold the CIT(A)’s order and challenge its jurisdiction to remand the case.
The Legal Issue
The central questions were: (1) Whether prior period expenses that crystallised as liabilities in the current assessment year are deductible under the mercantile system of accounting, and (2) Whether the CIT(A) has the authority to remand a case under Section 250 for fresh evidence to be considered by the AO.
Arguments Presented
For the Appellant
The assessee’s representative, FCA Sanjay Bhattacharaya, argued that under the mercantile system, expenses are deductible in the year the liability crystallises, not necessarily when the invoice is raised. The rent and audit fees were incurred in prior years but became payable and settled in AY 2022-23. The audit bill dated 10.01.2022 covered services rendered up to August 2021, and the liability for the entire period was discharged in the current year. Regarding the interest disallowance, the assessee contended that the interest-free loans were funded from internal accruals, not borrowed funds, and thus no deemed income arose. The documents submitted before the CIT(A) were sufficient and should have been considered by the AO.
For the Respondent
The Department, represented by CIT Pranab Kumar Koley, argued that prior period expenses cannot be claimed in a later year unless specifically permitted under the Act. The audit fees pertained to services rendered in the previous financial year and were therefore not deductible in AY 2022-23. The CIT(A) had no jurisdiction to set aside the assessment order under Section 143(3) and remand it, as per the amendment effective 01.10.2024. The unexplained cash credits under Section 68 were rightly added due to lack of credible evidence from creditors.
The Court's Analysis
The Tribunal examined the nature of mercantile accounting and the legislative intent behind expense recognition. It noted that the mercantile system recognises income and expenditure when the right to receive or obligation to pay arises, irrespective of actual receipt or payment.
"Since the liabilities which related to earlier year but had crystallised during the year, the same were liable to be allowed as a deduction."
The Tribunal held that the CIT(A) erred in disallowing the entire amount of prior period expenses merely because the bills were raised in earlier years. The key test was whether the liability had crystallised in the current year. The assessee was directed to produce evidence of the crystallisation - such as correspondence, settlement records, or accounting entries - and the AO was directed to verify and allow the claim if substantiated.
Regarding the interest disallowance, the Tribunal found the CIT(A)’s reasoning inadequate. The onus was not merely to prove the source of funds but to establish whether the interest-free loans were advanced from the assessee’s own surplus. The Tribunal set aside the order and remanded the issue to the AO for fresh adjudication, granting the assessee an opportunity to submit date-wise fund flow statements.
On the Section 68 addition, the Tribunal rejected the Revenue’s contention that the CIT(A) lacked jurisdiction to remand. It held that the CIT(A) had merely directed the AO to consider documents already filed before him, which was within the scope of Section 250. The AO was directed to re-examine the creditworthiness of the creditors using the documents submitted to the CIT(A).
The Verdict
The appeal by the assessee was partly allowed. The disallowance of prior period expenses of ₹6,44,442 was set aside, and the AO was directed to allow the claim upon verification of crystallisation evidence. The disallowance of interest of ₹6,61,534 was set aside and remanded for fresh adjudication. The addition under Section 68 of ₹6,97,50,000 was also remanded to the AO for fresh consideration using the documents submitted before the CIT(A). The application of Section 115BBE was held in abeyance pending the outcome of the Section 68 review. The cross objections by the Revenue were partly allowed for statistical purposes.
What This Means For Similar Cases
Crystallisation Overrides Invoice Date
- Practitioners must now argue that the timing of liability crystallisation, not invoice issuance, determines deductibility under the mercantile system
- Maintain contemporaneous records showing when obligations became enforceable, payable, or settled
- Submit affidavits or accounting notes linking prior-year invoices to current-year payments
Remand Powers of CIT(A) Are Valid
- The CIT(A) retains authority to direct the AO to re-examine evidence already on record, even post-01.10.2024
- Do not assume remand orders are ultra vires; challenge only if the CIT(A) introduces new evidence or exceeds statutory limits
- Ensure all documents are filed before the CIT(A) to preserve the right to remand
Section 68: Documentary Evidence Trumps Non-Response
- Non-response to Section 133(6) notices does not automatically validate additions
- The burden shifts to the Revenue to prove non-genuineness if the assessee provides credible documents
- Bank statements, annual reports, and ITRs of creditors can rebut presumption of unexplained income
