ITAT Mumbai cancels income tax notice over Rs 8 crore compensation to tenants without their consent; rejects I-T department's contingent liability claim

A redevelopment project in Chunabhatti in Mumbai hit a roadblock because the land was occupied by 56 tenants. To clear the land, the builder made a deal with a partnership firm from Veer Nariman Road, which agreed to get the tenants to vacate the land. This firm proposed to offer the tenants compensation for vacating the land.

It's important to note that the firm hired by the builder had already acknowledged a liability of Rs 17 crore for compensating tenants in previous years (Rs 14 crore + Rs 3 crore). During AY 2016-17, this firm recognised an additional liability of Rs 8 crore, taking the total estimated compensation liability in its books to Rs 25 crore. However, this amount hasn't been paid yet, as the final compensation will depend on the outcome of the ongoing negotiations and litigations initiated by the tenants who refused to vacate the land.

To clarify, this article focuses on the Assessment Year AY 2016-17, during which the firm recognised an extra liability of Rs 8 crore for payments to the tenants under the agreement. So the firm recognised this tenant compensation liability and thus it's total taxable income reduced. This is where the firm got into a tax dispute with the tax department.


The Income Tax Department, rejected the firm's claim based on the Rs 8-crore tenant compensation liability. The tax department argued that the liability was only contingent since negotiations with the tenants were still on and the exact compensation payable had not been finalised. So, the tax department said the amount could not be claimed as a business expense until the liability had crystallised.

The dispute between this firm and the Income Tax Department eventually reached the Mumbai Bench G of the Income Tax Appellate Tribunal (ITAT), where the tax tribunal had to decide whether the Rs 8 crore represented an accrued business liability or merely a contingent one.

The Income Tax Assessing Officer from Kautilya Bhawan, BKC, Mumbai, had pointed out in his report that the said amount (Rs 8 crore) remained unpaid as of March 31, 2026 and the matter relating to settlement with occupants/tenants was still under litigation and negotiation.

The Income Tax Assessing Officer therefore held that the liability had not crystallized and represented merely contingent liability. Accordingly, the AO disallowed the claim of Rs 8 crore and added it to the income of the assessee (the firm).

However, ITAT Mumbai disagreed with the Income Tax Department and said that they find considerable merit in the contention of the assessee regarding the applicability of matching principle.

ITAT Mumbai observed that the form hired by the builder had already recognized the compensation received from the builder and offered net business income after considering liability payable towards occupants/tenants.

ITAT Mumbai said: "Once the income arising from the transaction has been recognized, corresponding expenditure attributable thereto has to be necessarily matched in the same accounting period in order to determine true and correct profits of the business."

Also read: Gave up tenancy, got new flat in redeveloped property, then faced income tax notice of STCG of Rs 1.1 crore: How tenant won at ITAT Mumbai

Otherwise, ITAT Mumbai said, the assessee (firm) would be taxed on gross commercial receipts without allowing corresponding business obligations incurred for earning such income, which would result in taxation of hypothetical profits rather than real income.

Thus the builder's hired firm won the case (ITA No. 5850/Mum/2024) on May 12, 2026. The firm recognised Rs 8 crore payment to tenants as compensation if the tenants decided to take the money and vacate the land.

Also read: Tenant wins tax relief on Rs 38.62 lakh sale of landlord’s property, received for surrendering tenancy rights; know why ITAT Mumbai ruled in his favour

Summary of the judgement

Chartered Accountant Suresh Surana explained to ET Wealth Online that in this case, the Mumbai ITAT dealt with the issue of whether an additional liability of Rs 8 crore recognised by the assessee towards compensation payable to occupants / tenants for vacating a property was an allowable business expenditure or merely a contingent liability.

The matter related to AY 2016-17 and arose from the Income Tax Department's appeal against the order of the CIT(A), who had overturned the 'disallowance' made by the Assessing Officer.

The assessee, a partnership firm, engaged in working with builders and developers, had received a compensation of Rs 12.25 crore from the builder in connection with a property situated at Chunabhatti, Mumbai.

That property was occupied by 56 occupants / tenants, and the assessee had undertaken the obligation to get the property vacated by paying off the occupants. During the assessment proceedings, the AO noticed that the assessee had debited Rs. 8 crore towards liability payable to the occupants / tenants.

Since the amount remained unpaid as on March 31, 2016 and the settlement with the occupants was still under litigation and negotiation, the AO had treated the liability as contingent and disallowed the claim.

Before the CIT(A), the assessee explained that the liability was not an arbitrary provision but arose from a business obligation connected with the development transaction. The assessee had acquired the property earlier and was required to provide clear and marketable title.

Since the property was occupied by tenants, the assessee was commercially required to compensate them for vacating the premises. The assessee also pointed out that multiple litigations were pending before various forums and that, due to changes in Development Control Regulations, the compensation demands had substantially increased over time.

The assessee already had earlier recognised liabilities of Rs 14 crore and Rs 3 crore, and during the relevant year, based on correspondence and surrounding circumstances, recognised an additional liability of Rs 8 crore, taking their total liability to Rs 25 crore.

The CIT(A) accepted the assessee's position and held that the liability had crystallised during the year and was allowable as business expenditure. The tax department challenged this, contending that the liability was only a provision as the exact compensation payable to each occupant had not been determined, and the matter was subject to litigation and negotiation. Since the liability lacked finality, it is not allowable under Section 37(1), argued the tax department.

Surana says that the ITAT Mumbai upheld the order of the CIT(A) and dismissed the Revenue's appeal. The tribunal observed that there was no dispute that the assessee had undertaken the obligation to get the property vacated and provide clear and marketable title. This obligation was directly connected with the assessee's business transaction and was an integral part of the property development arrangement.

Surana says: "Therefore, the liability towards compensation payable to occupants / tenants was not an independent or artificial claim, but a genuine business obligation arising from commercial realities."

Also read: Rs 22.94 lakh LTCG for land sale of Rs 92 lakh invited tax notice; Gujarat HC ruled in her favour after 9 years fight; Know why

Why did the firm win the case?

Surana says that the firm won the case because the tax tribunal found that the liability had accrued and crystallised during the relevant year, even though the exact amount payable or the actual payment was to happen in future.

The tribunal relied on the settled principle laid down by the Supreme Court in Bharat Earth Movers v. CIT case, where it was held that if a business liability has definitely arisen during the accounting year, deduction should be allowed, although the liability may be quantified and discharged at a future date.

According to Surana, the tax tribunal also referred to the principles in Rotork Controls India Pvt. Ltd. v. CIT, regarding recognition of provisions where there is a present obligation, probable outflow of resources, and a reasonable basis for estimation.

The tribunal further noted that the assessee's provision was supported by documentary evidence such as correspondence, details of occupants, draft consent terms, pending litigations and surrounding circumstances showing escalation in compensation demands. Therefore, the provision could not be treated as hypothetical, imaginary or ad hoc. The pendency of litigation could affect the timing or final quantification of the payment, but did not erase the existing business obligation that had already arisen.

Also read: Man was denied Section 54F income tax exemption as builder delayed villa construction by 4 years; Telangana HC grants relief, says taxpayer can't suffer for builder's fault

Another important rationale was the application of the matching principle. Surana says that the assessee (firm) had already recognised compensation income of Rs 12.25 crore from the builder. Therefore, the corresponding expenditure / liability incurred for earning that income had to be recognised in the same accounting period to determine the true business profits.

The tax tribunal observed that if the corresponding liability was not allowed, the assessee would effectively be taxed on gross receipts without allowing the related business obligation, which would result in taxation of hypothetical profits rather than real income.

Surana says that while the assessee succeeded on the main issue of allowability of the Rs 8 crore liability, its cross-objection was dismissed. The assessee had argued that the compensation of Rs 12.25 crore received from builder should be treated as a capital receipt and not chargeable to tax.

The Tribunal rejected this argument because the assessee itself had credited the amount to its Profit and Loss Account and claimed corresponding expenditure against it. The Tribunal held that the assessee could not treat the receipt as business income for claiming deduction and then, in appellate proceedings, contend that the same receipt was capital in nature.

In conclusion, the ITAT held that the compensation payable to occupants / tenants was an accrued business liability and not a contingent liability.

Surana says: "The assessee won the principal issue because the liability arose from a binding commercial arrangement, was supported by contemporaneous evidence, had crystallised during the year, and was reasonably estimated."

Surana says: "The ruling reinforces that, under the mercantile system of accounting, a business liability need not be actually paid during the year to be deductible, provided the obligation has arisen, the outflow is reasonably certain, and the estimate is based on reliable material."

Mihir Tanna, associate director, S K Patodia LLP, says that particular income is taxable in the year in which the right to receive arises. Similarly deduction of expenses is allowed in the year in which obligation to pay arises.

Tanna says: "Thus, in many cases year of commercial transaction/year in which transaction appearing in bank is different from year in which the said income is taxable/deduction is allowed for expenses."

According to Tanna, once the year of taxability / deduction is decided, quantification of income/expenses is also important in certain cases as the amount may not be certain in the year in which transactions are carried out.

Tanna says: "Once the amount agreed by both parties and certainty arises; taxability/deduction is decided. Similar provisions are applicable in case of tds on provision of expenses."