Understanding Prior Period Expenses
Prior period expenses are those relating to earlier accounting periods but recognized in the current year due to late invoices, omissions, or crystallization of liability. They create distinct compliance requirements in both tax audits and income tax return filing.
Section 37(1), Income-tax Act, 1961
Deduction is admissible if the expense:
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is incurred wholly for business purposes,
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is not capital in nature,
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represents a genuine liability, and
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crystallizes during the relevant year.
Judicial Position
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PCIT v. Dishman Pharmaceuticals (Guj. HC) clarified:
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No requirement to match prior period income with prior period expenses.
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If income of earlier years is taxed, corresponding expenditure must be allowed.
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The test is business purpose and crystallization, not timing of origin.
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Principle of Crystallization
Under mercantile accounting, expenses are deductible in the year liability crystallizes, irrespective of the year to which they relate.
Treatment Based on Nature
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Revenue Expenditure: Allowed when crystallized (e.g., rent, utilities, professional fees).
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Employee Costs: Salary arrears, bonus, leave encashment — deductible on crystallization, subject to Section 43B payment conditions.
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Statutory Dues: GST, PF, ESI, taxes — deductible only on actual payment under Section 43B.
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Capital Expenditure: Adjusted through balance sheet, not P&L.
Tax Audit Compliance
Clause 27(b), Form 3CD
All prior period income/expenses recorded in current year must be disclosed:
| Sr. No. | Income/Expenditure | Prior Period Relating To | Amount (₹) | Remarks |
Auditor’s Duties:
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Verify genuineness and crystallization.
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Ensure complete disclosure, irrespective of materiality.
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Report facts only; allowability is a matter of assessment.
ITR Filing Requirements
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Applicable Forms: ITR-3, ITR-5, ITR-6.
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Profit & Loss A/c: Show prior period items separately.
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Notes to Accounts: Disclose nature, year, and reasons for delayed booking.
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ITR Schedules: No dedicated field; include under respective expense heads with explanatory notes.
Section 43B Implications
Deduction restricted to year of actual payment for:
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statutory dues (taxes, cess, duties),
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PF/ESI contributions,
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interest on institutional borrowings,
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payments to MSMEs (w.e.f. FY 2023–24).
Timeline: Payment must be made before the due date for filing return under Section 139(1). Otherwise, deduction shifts to year of payment.
Compliance Considerations
Taxpayers:
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Maintain invoices, approvals, and crystallization evidence.
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Record reasons for late recognition.
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Establish internal approval process.
Tax Auditors:
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Confirm year of crystallization.
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Verify supporting records.
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Ensure exhaustive Clause 27(b) reporting.
Practitioners:
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Guide consistent treatment across years.
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Monitor case law on prior period expenditure.
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Prepare justification files for scrutiny.
Conclusion
Prior period expenses are admissible when crystallized in the current year, subject to Section 43B restrictions. Correct reporting in Form 3CD, transparent presentation in accounts and ITR, and robust documentation are essential to sustain deductions and withstand tax scrutiny.
