(2000) 245 ITR 428 (SC)
General conditions — revenue expenditure laid out wholly and exclusively for business
Yes. A liability that has definitely arisen in the year is deductible even though it will be discharged in future and its quantification requires estimation. Only a contingent liability is excluded.
Is a provision for the liability to pay leave encashment to employees deductible, when the actual payment will fall due only in future years and its amount is not precisely known?
The assessee operated a leave scheme under which employees accumulated leave and were entitled to encash it, either during service or on retirement. In accordance with actuarial estimates it created a provision in its accounts for the liability accruing in respect of leave earned during the year, and claimed the provision as a deduction. The Revenue disallowed it, taking the view that no liability to pay had yet arisen, that the payment might never be made if an employee left in circumstances that forfeited the entitlement, and that the amount was in any event an estimate.
The disallowance was confirmed through the appellate stages and by the High Court, which regarded the liability as contingent. The assessee appealed to the Supreme Court.
For the assessee
The entitlement to encash leave arises as the leave is earned during the year of service; the employer's obligation is therefore present, though its discharge lies in the future. Difficulty in quantifying a liability does not make it contingent, and the estimate had been made on an actuarial basis.
For the Revenue
Whether any payment will be made, to whom and in what amount depends on future events — continued service, the manner of cessation, and the employee's choices. A liability of that character is contingent, and a provision for it is not an expenditure incurred.
The Court restated the distinction between an accrued liability and a contingent one. A liability is accrued where the obligation has definitely arisen in the year, even though it is to be discharged at a future date; it is contingent only where the very existence of the obligation depends on an event that may or may not happen. Applying that test, the Court held that the employer's obligation to pay leave encashment arises as and when the employee renders service and earns leave, because it is that service that creates the entitlement. The obligation is therefore present, and what lies in the future is only its discharge. The Court held that the need to estimate the amount does not convert an accrued liability into a contingent one: if the liability can be quantified with reasonable certainty, a provision made on a proper basis is deductible. It added that the possibility of some employees forfeiting the benefit affects the estimate rather than the existence of the liability, and can be built into the actuarial calculation.
Applied under Section 34 of the IT Act 2025 and central to the treatment of provisions generally — leave encashment, warranty, and other estimated obligations. Note the important qualification: Parliament subsequently introduced a provision requiring leave encashment specifically to be allowed only on actual payment, so for that item the statutory rule now displaces the general principle. The reasoning continues to govern other provisions, as Rotork Controls illustrates.