Under the mercantile system of accounting, a liability becomes admissible when it is created, regardless of the actual payment, and therefore, the payment made in discharge of liability accrued during earlier years is not a permissible deduction during the accounting period.

1. The Income-tax Appellate Tribunal, Cochin Bench has referred the following question for decision of this Court under S.256 (1) of the Income-tax Act.

"Whether on the facts and circumstances of the case, Rs. 17,092/- being the amount paid by the assessee by way of arrears of tax under the Kerala Motor Vehicles (Taxation of Passengers & Goods) Act, 1963, relating to earlier years is to be allowed as a deduction in computing the assessee's income for the assessment year 1975-76?"

2. The Assessee is a firm carrying on business of passenger transport. The firm was constituted as per a deed of partnership dated 1-11-1959. Clause.11 of the partnership-deed provides for the accounts of the firm to be maintained on mercantile basis and its accounts are maintained accordingly.

3. The firm filed a return for the assessment year 1975-76 disclosing an income of Rs. 77,930.00. It had claimed deduction of Rs. 33,672.00 being the tax paid under the Kerala Motor Vehicles (Taxation of Passengers and Goods) Act 1963. The Income-tax Officer noticed that out of Rs. 33,672.00 paid during the accounting period a sum of Rs. 17, 091.72 related to tax payable during the earlier years. Accordingly the income assessable to tax was determined, without permitting deduction of the amount of tax under the T.P.G. Act relating to earlier years paid during the previous year. In appeal at the instance of the assessee, the Appellate Assistant Commissioner allowed deduction of the entire tax paid during the accounting period even though part of the payment related to tax accrued during earlier years. The decision of the Appellate Assistant Commissioner is confirmed by the Income-tax Appellate Tribunal based on its earlier decision in I.T.G.No.35 (Coch)/ 75-76 dated 29-12-1979. The Appellate Tribunal in its order observed that even though the liability for payment of tax under the T P.G. Act bad accrued during earlier years the liability was not in force during the pendency of the proceedings before this. Court and the Supreme Court, challenging the validity of the Act and after the pronouncement of the Supreme Court upholding its validity, the State Government had agreed to receive payment of the arrears of tax under the Act, in instalments. The sum of Rs 17,091.72 paid during the accounting period relates to the instalment that had fallen due with respect to the arrears of tax accrued during earlier years.

4. On the facts found by the statutory authorities, it cannot be disputed that the assessee is following the mercantile system of accounting. The assessee has no case that it has no liability to pay the tax due under the T.P.G.Act, during the earlier years in respect of which it was discharging the arrears of tax due in instalments. There is also no dispute that the deduction of Rs. 17,091.72 disallowed by the Income-tax Officer relates to payment made by the assessee in discharge of its liability pertaining to periods prior to the accounting period. When the assessee is following the mercantile system of accounting, it should have made provision for the liability accrued during each accounting period and claimed deduction in respect of the same in the relevant assessment years. It is not the actual payment in discharge of an earlier liability that will qualify for a deduction during the accounting period.

5. The Supreme Court in the decision in State Bank of Travancore v. C.I.T. (1986 (24) Taxman 337) observed at page 365:

"9. In this country, by and large, two systems of account keeping are followed one is the cash and the other, mercantile. Plainly speaking, the cash system postulates actual receipt of money; and for exigibility of income-tax, such receipt from business, profession or vocation or from other sources has to be actual in the relevant year of account. The mercantile system, on the other band, is one where accounts are maintained on the basis of entitlement to credit and/or debit. A sum of money, as soon as it becomes payable, is taken i