Leave Encashment Payment Made After Financial Year not Deductible under Income Tax Act Without Accrued Liability: Himachal Pradesh HC [Read Order]

The High Court of Himachal Pradesh,ruled that leave encashment payments made after the end of the financial year cannot be claimed as a deduction under the Income Tax Act,1961 unless the liability had actually accrued during that year.

Stay Updated with the Latest Audit Report Formats & Audit Trials Requirements! Click here

H.P. State Civil Supplies Corporation Ltd.,petitioner-assessee,filed an appeal against the Income Tax Appellate Tribunal(ITAT)’s order that upheld the disallowance of ₹45,00,000 claimed as a deduction. The amount was paid to LIC for setting up a leave encashment trust, but the payment was made after the end of the relevant financial year.

The Assessing Officer(AO), Commissioner of Income Tax (Appeals)[CIT(A)], and ITAT all held that the liability had not arisen during the year, the trust was created later, and there was no specific provision under Section 36 to allow such a deduction. It was also noted that the appellant followed the cash system of accounting, and the conditions under Section 43-B were not met.

The division bench comprising of Tarlok Singh Chauhan(Judge) and Satyen Vaidya(Judge) observed that the fund was created on 29.10.2002 and the ₹45,00,000 contribution was made to LIC on the same day. No provision was made in the books for this payment in the financial year 2001–02, and the liability for leave encashment had neither accrued nor been paid during that year. The assessee had also not followed the mercantile system of accounting.

Stay Updated with the Latest Audit Report Formats & Audit Trials Requirements! Click here

Both the CIT(A) and ITAT had held that the contribution was not deductible under the Act, and that Section 43-B(f) allowed deduction only if the liability was incurred and paid within the same financial year.

The Court disagreed with this narrow interpretation. Referring to the Supreme Court’s decision in Exide Industries, it noted that Section 43-B(f) was introduced to prevent misuse, where employers could claim deductions without actually paying employees. The Court held that the provision aimed to protect employees and prevent tax avoidance, and should be interpreted accordingly.

The Kerala High Court earlier held that insurance premium paid to keep a policy valid was a business expense allowed under Section 37 of the Act.

In this case, the assessee claimed a deduction of ₹45,00,000 paid to LIC for leave encashment by relying on the proviso to Section 43B, stating the payment was made on 29.10.2002—before the return filing due date of 31.10.2002.

Income Tax Bill 2025: What’s New, What’s Gone, and What You Must Know! Click Here

However, the Court rejected this claim. It noted that the deduction under Section 43B(f) was allowed only if the liability was both incurred and paid in the same financial year. The assessee had not shown that the liability existed in the books before the payment. In fact, the fund itself was created only on 29.10.2002.

Though the assessee referred to an earlier estimate of ₹1.80 crores as past liability, this was not backed by any records or accepted by tax authorities. Both lower authorities found that leave encashment payments were actually made between 2004 and 2016, not in 2001–02.

Read More: Bombay HC Quashes Income Tax Reassessment Over Change of Opinion and No Failure to Disclose Facts

The assessee also relied on Supreme Court rulings in Bharat Earth Movers and Textools. But the Court held that those decisions did not apply here. Section 43B(f), which was added from 1.4.2002, changed the position. It allowed deduction only when actual payment was made, regardless of accounting method.

The Court concluded that the deduction was rightly disallowed since the liability was not incurred in the relevant year and Section 43B(f) had to be followed.

In short,the appeal was dismissed.

To Read the full text of the Order CLICK HERE

Support our journalism by subscribing to Taxscan premium. Follow us on Telegram for quick updates