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Remission or cessation of trading liability


Under the Income- tax Act an amount becomes taxable under section 41( 1) of the IT Act if there is a remission or cessation of trading liability.

However, the scope of section 41 has to be examined properly. Merely because the liability to some creditors is outstanding for more than four years and the liability shown in the accounts of the assesseecompany, the amount cannot be assessable as income under section 41( 1) of the IT Act. This is a judgment which was given by the Delhi High Court in the case of CIT v. Shri Vardhman Overseas Ltd. ( 2012) 343 ITR 408.

As this is an important judgment, the facts and the judgment in this case are analysed below.

In the course of assessment proceedings for 2002- 03, the Assessing Officer discovered certain credits.

He held that the creditors were not genuine and there was no genuine outstanding in their accounts. He accordingly added Rs.

1,25,46,534 which represented the credit balances in the accounts of nine parties.

The Assessing Officer specifically noted that the amounts were being treated as unexplained credits in the books of account under section 68 of the IT Act since the liabilities were not proved by the assessee. The matter was taken to the CIT ( Appeals) who held that the liabilities had ceased to exist and, therefore, the addition of Rs. 1,25,46,534 made by the Assessing Officer was justified. He confirmed

it under section 41( 1). The matter was taken to the Tribunal.

The Income- tax Appellate Tribunal held that the applicability of section 68 of the IT Act was ruled out since no fresh amounts were credited in the accounts of the creditors under consideration during the relevant accounting year. It was also held that there was no cessation of liability and hence section 41( 1) of the IT Act was not applicable. The Revenue appealed to the High Court.

The High Court dismissed the appeal holding that the assessee had not unilaterally written back the accounts of the sundry creditors in its profit and loss account.

The liability was shown in the balance- sheet as on 31.3.2002. The assessee being a limited liability company, this amounted to acknowledging the debt in favour of the creditors for purposes of section 18 of the Limitation Act, 1963.

Thus, the assessees liability to the creditors subsisted and did not cease nor was it remitted by the creditors.

The liability was enforceable in a court of law.

Hence, the Delhi High Court held that the amount was not assessable under section 41( 1) of the IT Act.

The assessee was a company engaged in the manufacture of rice from paddy and also selling rice after purchasing the same from the local market. The total sales shown by the assessee to these parties amounted to Rs. 3,40,12,459. While verifying the sales and the sundry debtors shown by the assessee in its books of account as on 31.3.2002, which was the last day of the accounting year, the Assessing Officer also wanted to verify the sundry creditors shown in the books of account as on the said date.

This was because he took the view that if the consignment sales were not genuine, the purchases shown to have been made by the assessee on credit basis could not be treated as genuine.

He, therefore, called upon the assessee to submit consignment letters from the sundry creditors which were 10 in number. The total amount due to these 10 sundry creditors on account of purchase of paddy was Rs. 1,31,17,230. The assessee did not submit the confirmation letters, but wrote to the Assessing Officer on 18.1.2005, that it was not aware of the present whereabouts of the creditors after a lapse of four years and whatever addresses were available with the assessee had been given by the suppliers at the time when the assessee purchased paddy from them.

The assessee was, however, able to file the confirmation letter from Shri VRI Pvt.

Ltd. in whose account the assessee showed a credit balance of Rs. 5,70,696.

In the aforesaid background, the Assessing Officer was of the view that the assessee was not interested in proving the genuineness of the creditors by filing confirmation letters or by giving the necessary information.

In this view he held that the creditors were not genuine and there was no genuine outstanding in their accounts. Accordingly, he added Rs. 1,25,46,534

SEC 41( 1) applies when a trading liability was allowed as a deduction in an earlier year in computing the business income of the assessee and the assessee has obtained a benefit by way of remission or cessation of the liability

which represented the credit balances in the accounts of nine parties, excluding Shri VRI Pvt. Ltd. who had filed confirmation letter.

As regards the assessees request made to him that he may issue summons to the creditors, the CIT ( Appeals) stated that such a request was made by the assessee knowing fully well that no summons could be issued to the creditors by the Departmental authorities due to the lack of details. He further held that the conduct of the assessee clearly showed that the liabilities shown in the sundry creditors account in its books does not exist. In this view of the matter, he held that the liabilities/ credits have ceased to exist and, therefore, the addition of Rs. 1,25,46, 534 made by the Assessing Officer was justified. He confirmed the same under section 41( 1) of the IT Act. The asssessee took the matter in further appeal before the Income- tax Appellate Tribunal.

As regards the applicability

applicability of section 41( 1) of the IT Act, the Tribunal held that the assessee was a limited company whose accounts were accessible to general public and that the balances in the accounts of the sundry creditors were only brought forward balances.

The standing counsel for the Income- tax Department drew the attention of the Delhi High Court to the fact that the assessee itself had admitted that the amounts were outstanding for more than four years and contended that, therefore, the assessee obtained a benefit in the course of its business which was assessable under section 41( 1) of the IT Act.

The High Court opined that in this, the assessee had not transferred the said amount from the creditors account to its profit and loss account. The liability was shown in the balance sheet as on 31.3.2002. The assessee being a limited company, this amounted to acknowledging the debts in favour of the creditors.

The Delhi High Court also noted that another distinguishing feature of this case was the sundry creditors continued to be shown in the balance- sheet of the assessee as on 31.3.2002. The standing counsel also referred to section 28( iv) of the IT Act according to which ” the value of any benefit or perquisite, whether convertible into money or not, arising from business or the exercise of a profession” would be chargeable to income- tax under the head ” Profits and gains of business or profession”. It was submitted by the standing counsel that since the amounts remained unpaid to the sundry creditors for a period of four years or more, the monies were available to the assessee in its business which amounted to a benefit arising from the business carried on by the assessee. The court was of the view that this contention seemed attractive at first blush but could not bear scrutiny. This is because the provisions of section 41( 1) of the IT Act have been specifically incorporated in the Act to cover a particular fact situation.

The section applies where a trading liability was allowed as a deduction in an earlier year in computing the business income of the assessee and the assessee has obtained a benefit in respect of such trading liability in a later year by way of remission or cessation of the liability. In such a case the section says that whatever benefit has arisen to the assessee in the later year by way of remission or cessation of the liability would be brought to tax in that year. It was further clarified by the High Court that they were concerned mainly on the applicability of section 41( 1)( a) of the IT Act and as to what would constitute remission or cessation of a trading liability.

In this case, the assessee did not unilaterally write back the accounts of the sundry creditors in its profit and loss account. Hence, the High Court answered the question of law in the negative and in favour of the assessee.

The appeal of the Revenue was accordingly dismissed.

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