SECTION 43B OF THE INCOME TAX ACT 1961 – OVERVIEW FROM A TAX AUDIT PERSPECTIVE

A. Scope of Section 43B under the Income Tax Act 1961 (‘the Act’)

a) Section 43B provides that certain expenditure/ payments which are otherwise eligible for deduction under the Act shall be allowed as a deduction only in the year of actual payment irrespective of the year of accrual of such expenditure.

b) However, the section shall not apply to any sum which is paid on or before the due date of filing of return of income as stipulated under Section 139(1) of the Act.

c) If the liability to pay the specified sum pre-existed on the first day of the previous year, (i.e. outstanding liabilities) deduction will be allowed only if the payment is made on or before the end of the previous year.

d) In other words, the due date for filing the return deadline applies to the sums for which the liability was incurred during the previous year and not to pre-existing liabilities.

Nature of expenses covered under Section 43B –

a) Any tax, duty, cess or fee under any law;

b) Contribution made by employer to any provident fund or superannuation fund or gratuity fund or any other fund for the welfare of employees;

c) Bonus or commission to employees;

d) Interest on any loan or borrowing from any public financial institution or a State financial corporation or a State Industrial Investment corporation;

e) Interest on any loan or advances from a Scheduled bank;

f) Sum payable by the assesse as an employer by way of leave encashment.

Section 43B begins with non obstante clause and hence over rides all other sections in the Act. Even where a deduction is admissible under any other section, it may still not be allowable unless the amount is paid in respect of items covered by this section. Further, the provisions of this Section is relevant only for assessees following mercantile system of accounting.

B. Issues for consideration

From the Assessment Year 2013-14, amongst other reports the tax audit report is also required to be filed electronically even though it does not support the facility of attaching any annexures/supporting documents. Clause 26 of Form 3CD deals with sums covered by Section 43B of the Act. In the ensuing paras, some key issues (with relevant case laws) and an audit checklist has been discussed that may be borne in mind while conducting a tax audit -

1. Actual Payment – Whether it includes constructive / advance payments/ book adjustments/ set -offs

Advance payments -

On a plain reading of the Section it appears that where the admissible expenditure is made in advance it can be allowed as a deduction in the year of payment though under normal circumstances, the amount is deductible in the year in which it has accrued. This view is supported by the following case laws –

- CIT Vs. Gupta and Sons (C.L.) - [TS-6019-HC-2002(ALLAHABAD)-O]

- CIT Vs. Modipon Ltd.- [TS-5061-HC-2011(Delhi)-O]

- Paharpur Cooling Towers Ltd. Vs. CIT – [TS-361-HC-2011(CAL)-O]

However, the Hon’ble Courts in the following cases have held that the Section may not be understood as authorizing payment which have not become due:

- Gopi Krishna Granites India Ltd. Vs. DCIT – [TS-5527-HC-2001(Andhra pradesh)-O]

- DCIT Vs. CWC Wines (P) Ltd. – [TS-5576-ITAT-2003(HYDERABAD)-O]

- DCIT Vs. Amforge Industries Ltd. – [TS-5031-ITAT-2000(MUMBAI)-O]

The Hon’ble Supreme Court in the case of Berger Paints India Ltd. [TS-5005-SC-2004-O] held that the entire excise duty/customs duty which was paid by the assessee in a particular accounting year was an allowable deduction in respect of that year, irrespective of the amount of excise duty/customs duty included in the valuation of the closing stock of the assessee’s closing stock at the end of the accounting year.

Constructive Payments -  

Sales tax deferment - If the sales tax (‘ST’) law provides that where deferred ST/ST is deemed to have been converted into loan it is to be treated as actual payment, the same will be treated as paid.

- Mahalaxmi Bricks Mfg. Mldg & Fab Ind. (P.) Ltd. [TS-5769-HC-2004(PUNJAB)-O]

- Circular No. 496, dated 25-9-1987, 196 ITR, St 53. and Circular No. 674, dated 29-12-1993, 205 ITR ST 119

Interest payable converted into loan – The aforesaid mentioned Circular No. 674 is not applicable, where with the consent of the lender, interest payable is converted into loan, i.e., it will not be considered as actual payment –

-Kalpana Lamps and Components Ltd. v. DCIT [TS-15-HC-2001(MAD)-O]

Set off -  The Hon’ble Kolkata High Court in the case of CIT Vs. National Standard Duncan Ltd [TS-5033-HC-2003(CALCUTTA)-O] held that where the Bombay Sales Tax Act 1959 and the rules  thereunder allows  the assessee  to set-off sales tax paid on the purchase of raw material used for the finished products, then such assessee would be entitled to set off or adjustment of its liability to pay sales tax payable on the sale of such finished products, availing such set-off by the assessee should be treated as actual payment of sales tax liability for Section 43B purposes.

Book adjustments - The Hon’ble Jharkhand High Court held that book adjustments constitute "actual payment" for Section 43B - CIT Vs. Shakti Spring Industries (P) Ltd. [TS-4-HC-2013(JHAR)-O]

1. Audit checklist & other issues vis-a vis clause 26 of Form 3CD

General- Issues

a) Deduction of expense admissible even if not charged to Profit & Loss Account – Chemicals & Plastics (I) Ltd. v. CIT – [TS-5740-HC-2002(MADRAS)-O]

b) Section 43B is attracted only when the expense is charged to Profit & Loss account – Jet Lite (India) Ltd. Vs. CIT – [TS-5546-HC-2015(DELHI)-O],

c) Section 43B provisions are not applicable to income computed under Section 11 of the Act – ITO Vs. Mother Theresa Educational Society – [TS-5443-ITAT-2016(VISAKHAPATNAM)-O]

d) Provisions of Section 43B applicable to presumptive taxation – Good Luck Kinetic Vs. Income Tax Officer [TS-356-ITAT-2015(PAN)-O]

e) Furnishing of bank guarantee cannot be equated with actual payment for the purpose of Section 43B – CIT Vs. McDowell and Co. Ltd. – [TS-94-SC-2009-O]

Clause wise – Checklist & issues

Tax, duty, cess or fee [Sec.43B (a)]

a) Verify whether any sales tax, customs duty, excise duty, service tax or any other indirect tax, cess, levy, etc. is debited to profit and loss account. If so, report the amounts so debited to profit and loss account.

b) If the assessee credits sales tax, excise duty etc. to a separate account and treats the amounts collected as a liability, the tax or duty collected but not paid should be indicated by way of a suitable note.

c) Actual payment also includes payment of indirect taxes by using input credits (i.e. VAT credit/ CENVAT credit) / Book adjustments/ set -offs permissible under law.

d) Section 43B is applicable to interest payable on tax, duty, cess or fee – CIT Vs. Andhra Sugars Ltd. [TS-5524-HC-2014(ANDHRA PRADESH)-O], Mewar Motors Vs. CIT [TS-5780-HC-2002(RAJASTHAN)-O]

e) Section 43B does not cover VAT included in purchase price of raw materials paid by the assessee – ACIT Kochi Vs. Plant Lipids (P) Ltd. [TS-5129-ITAT-2016(COCHIN)-O]

f) Unutilized Cenvat credit / VAT credit balances are not to be regarded as amounts paid. DCIT Vs. Glaxo Smith Kline Consumer Healthcare Ltd. [TS-5387-ITAT-2007(CHANDIGARH)-O],

g) Electricity Duty/Charges are not fees - Sarvaraya Textiles Ltd. [TS-5339-ITAT-1994(HYDERABAD)-O], CIT Vs. Andhra Ferro Alloys (P) Ltd. [TS-790-ITAT-2011(MUM)-O].

h) Pre-deposit of excise duty demanded for hearing of appeal is payment of duty and not merely a deposit- CIT vs Dharampal Satyapal Sons (P) Ltd, [TS-5845-HC-2010(Delhi)-O].

i) Excise duty paid under protest would qualify for deduction under Section 43B in the year of payment – Maruti Suzuki India Ltd Vs. Addl.CIT [TS-5593-ITAT-2015(DELHI)-O]

j) Sales tax collected and credited to liability account but not claimed as expenses in the P&L account, section 43B is still held applicable - Associated Pigments Ltd. [TS-5376-HC-1993(CALCUTTA)-O]

k) The question of applicability of section 43B arises only if the amounts collected are considered as trading receipts. Thus, when assessee does not have absolute right over the amount collected and the same were lying with him on account of uncertainty (as challenged over judicial authorities) over the extent of liability owed in respect of turnover tax payable to SEBI, provision of section 43B is not applicable - Ellenbarrie Industrial Gases Ltd. [TS-5336-HC-1993(CALCUTTA)-O]

l) If the assessee collected deposit for sales tax or want of proper sales tax forms/declaration, it is not trading receipt, 43B does not apply - Ellenbarrie Industrial Gases Ltd. [TS-5336-HC-1993(CALCUTTA)-O]

Employer's contribution to Provident fund, superannuation fund etc. [Sec. 43B(b)]

a) Verify that the provisions of section 40(a)(iv) are complied with in respect of provident fund or other fund established for the benefit of the employees. In case of any violations under Section 40(a)(iv) of the Act, then the payments will have to be reported under clause 21(b)(vii) of Form 3CD.

b) Verify the dates of payment from the books and documents.

c) Section 43B is not restricted to employers’ contribution to PF and other funds, it also includes employees’ contribution - CIT Vs. Gujarat State Road Transport Corporation [TS-681-HC-2013(GUJ)-O], CIT Vs. Hemla Embroidery Mills (P) Ltd. [TS-5669-HC-2012(PUNJAB)-O], CIT Vs. Ghatge Patil Transports Ltd. [TS-5905-HC-2014(BOMBAY)-O], CIT Vs. Spectrum Consultants India (P) Ltd. [TS-684-HC-2013(KAR)-O]

Bonus or Commission to employees [Sec. 43B(c)]

a) Ascertain that the provision/payments in respect of bonus or commission to employees are in reality bonus or commission and not dividends payable to them as shareholders but shown as bonus/Commission. If the payments are in the nature of dividends, it requires reporting under clause 20(a) to Form 3CD.

b) Verify the dates of payment from records.

c) Depositing of bonus payable to employees into a separate bank account does not amount to actual payment – Thanjavur Textiles Ltd. Vs. JCIT [TS-5485-HC-2012(MADRAS)-O]

Interest payable to public financial institution/State Financial Corporation/State Industrial Investment Corporation [Sec.  43B(d)] Interest payable to a scheduled bank in respect of any loan or advance [Sec. 43B(e)]

a) Verify the loan agreement with the public financial institution/ Scheduled Bank etc.

b) Mere conversion of interest into a loan or borrowing (i.e. funded loan) is not regarded as payment as per Explanation 3C to Section 43B. Therefore, verify the certificates of payment from the institutions.

c) Verify the dates of payment of interest payable from books and records.

d) Verify whether amount of any interest debited to profit and loss account is inadmissible under proviso to section 36(1)(iii). If so, the same should be reported against clause 21(i) to Form 3CD.

e) Conversion of interest into shares to be treated as extinguishment of liability for the purpose of Section 43B – CIT Vs. Rati Graphics Technologies Ltd. [TS-5416-HC-2015(DELHI)-O]. Against – ITO Vs. Glittek Granites Ltd. - [TS-6155-ITAT-2012(Kolkata)-O]

Leave encashment [Section 43(f)]

a) Verify the dates of payment from books and records.

b) The Hon’ble Calcutta High Court in the case of Exide Industries Ltd v. UOI [TS-5524-HC-2007(CALCUTTA)-O] held that amendment to Section 43B(f) was not constitutionally valid and accordingly struck down Section 43B(f). The Calcutta High Court referring to the decision of Bharat Earth Movers v. CIT [TS-4-SC-2000-O] held the provision to be arbitrary and vulnerable, because there was no disclosure of reasons for the amendment. However, the Hon'ble Supreme Court has stayed the operation of the judgment of the Calcutta High Court and held that during the pendency of this Civil Appeal, the assessee would pay tax as if Sec. 43B(f) is on the statute book.

While there are still quite a few controversial issues as far as when Section 43B will be applicable, the aforesaid mentioned instances would be something we would all like to remember at least for the month of September!