REMISSION OR CESSATION OF THE TRADING LIABILITY UNDER SECTION 41(1) OF INCOME TAX ACT, 1961.

[Mr. M. GOVINDARAJAN]

                        Section 41 of the Income Tax Act, 1961 (‘Act’ for short) deals with the profits chargeable to tax.  Section 41(1) of the Act provides that where an allowance or deduction has been made in the assessment for any year in respect of loss, expenditure or trading liability incurred by the assessee (hereinafter referred to as the first mentioned person) and subsequently during any previous year-

a)      the first mentioned person has obtained, whether in cash or in any other manner whatsoever, any amount in respect of such loss or expenditure or some benefit in respect of such trading liability by way of remission or cessation thereof, the amount obtained by such person or the value of benefit accruing to him shall be deemed to be profits and gins of business or profession and accordingly chargeable to income tax as the income of that previous year, whether the business or profession in respect of which the allowance or deduction has been made is in existence in that year or not; or

b)      the successor in business has obtained, whether in cash or in any other manner whatsoever, any amount in respect of which loss or expenditure was incurred by the first mentioned person or some benefit in respect of the trading liability referred to in clause (a) by way of remission or cessation thereof, the amount obtained by the successor in business or the value of benefit accruing to the successor in business shall be deemed to be profits and gains of the business or profession, and accordingly chargeable to income tax as the income of that previous year.

In order to apply the provisions of Section 41(1) the following points are to be kept in view:

• In the course of assessment year for an earlier year, allowance or deduction has been made in respect of trading liability incurred by the assessee;
• Subsequently, a benefit is obtained in respect of such trading liability by way of remission or cessation thereof during the year in which such event occurred;
• In that situation the value of benefit accruing to the assessee is deemed to be the profit and gains of business which otherwise would not be his income;
• Such value of benefit is made chargeable to income tax as the income of the previous year wherein such benefit as obtained.

The words ‘obtained, whether in cash or in any other manner whatsoever, any amount in respect of such loss or expenditure’ incurred in any previous year, according to the Division Bench in ‘Commissioner of Income Tax V. Rashmi Trading’ – 1975 -TMI - 39417 – (GUJARAT High Court), clearly refer to the actual receiving of the cash of that amount.   The amount may be actually received or it may be adjusted by way of an adjustment entry or a credit note or in any other form when the cash or the equivalent cash can be said to have been received by the assessee.   But it must be the obtaining of the actual amount which is contemplated by the Legislature when it used the words ‘has obtained; whether in cash or in any other manner whatsoever, any amount in respect of such loss or expenditure in the past.

                        For considering the taxability of amount coming within the mischief of Section 41(1), the Gujarat High Court in ‘Commissioner of Income Tax V. Bharat Iron and Steel Industries’ – 1992 -TMI - 21339 – (GUJARAT High Court) held that the system of accounting followed by the assessee is of no relevance or consequence.  We have to go by the language used in Section 41(1) to find out whether or not the amount was obtained by the assessee or whether or not some benefit in respect of trading liability by way of remission or cessation thereof was obtained by the assessee and it is in the previous year in which the amount or benefit, as the case may be, has been obtained that the amount or the value of the benefit would become chargeable to income tax as income of that previous year.

                        The Supreme Court in ‘Chief Commissioner of Income Tax V. Kesaria Tea Co. Limited’ – 2002 -TMI - 6065 – (SUPREME Court) held that the resort to Section 41(1) could arise only with the liability of the assessee can be said have ceased finally without the possibility of reviving it.  In this case the purchase tax liability had not ceased finally during the year in question.  The Department contended that the assessee itself took steps to write off the liability on account of purchase tax by making necessary adjustments in the books which itself is indicative of the fact that the liability ceased for all practical purposes and, therefore, the addition of amount of Rs.3,20,758 deeming the same as income of the year 1985-96 under Section 41(1) is well justified of the Act.   But it was held that what the assessee has done is not conclusive.   An unilateral action on the part of the assessee by way of writing off the liability in its accounts does not necessarily mean that the liability ceased in the eye of law.

                        The Supreme Court in ‘Commissioner of Income Tax V. Sugauli
Sugar Works P Limited’ – 1999 -TMI - 5715 – (SUPREME Court) had the occasion to consider the effect of Section 41 of the Act. It was held that the mere fact that the assessee has made an entry of transfer in his accounts unilaterally will not enable the department to say that Section 41 would apply and the amount should be included in the total income of the assessee.   It could not be said that the liability had come to an end as period of more than 20 years ha elapsed and the creditor had not taken any steps to recover the amount.   The expiry of the limitation did not extinguish the debit but only prevented the creditor from enforcing the debt.

                        In ‘Goodricke Group Limited V. Commissioner of Income Tax (No.2)’ – 2011 -TMI - 204456 – (CALCUTTA HIGH COURT) the assessee carries on business of growing and manufacturing tea.   During the previous year ending 31.03.1995 the assessee credited to its P&L account a sum of Rs.5,02,646/- as liabilities no longer required to be written back since the cheques for the said amount issued to the creditors were not presented within the validity period.   The assessee claimed the said amount was liable to be excluded from the profit as per the P&L account and could not be subject to tax under Section 41(1) of the Act since the action of the assessee in writing off the said amount was an unilateral act and there was no remission or cessation of the trading liability nor had the assessee obtained any cash or any amount in respect of such expenditure or any benefit within the meaning of the said section.  The Assessing Officer treated the said amount as the assessee’s income under Section 41(1) of the Act.  The Commissioner (appeals) upheld the order of the assessing officer.   The Tribunal also dismissed the appeal.  The Tribunal held that writing off the said amount in the books of account was not an unilateral act of the assessee but had resulted out of the creditors’ conduct in not presenting the cheques to the bank for encashment within the limitation period and the assessee had also not shown any desire to pay the said amount to the creditors.

                        The appellant submitted the following before the High Court in the appeal filed:

• The assessee maintain the mercantile system of accounting and there is no dispute that the cheques for the said amount were duly given to the creditors who, however, did not encash the cheq8es;
• Merely because the creditors did not encash the cheques, does not imply that those debts have been either extinguished or become barred under the law of limitation;
• Even if it is assumed for the sake of argument that the period of limitation for filing a suit for recovery of that amount has become barred, the debit of his client to the aforesaid extent has not been extinguished;

The Department contended that the Tribunal has rightly held that Section 41(1) of the Act was applicable from the materials on record.   The High Court held that it has not been established that for non encashment of the cheques in question, the money involved has become the money of the assessee because of limitation or by any other statutory or contractual right.   The question whether the liability is actually barred by limitation is not a matter which can be decided by considering the assessee’s case alone but has to be decided only if the creditor is before the concerned authority.   In the absence of the creditor, it is not possible for the authority to come to a conclusion which may enable the creditor to come with a proceeding for enforcement of the debt even after expiry of the normal period of limitation as provided in the limitation act.  The High Court allowed the appeal.