Mere Lien over payment due to pending dispute does not result in cessation of trading liability u/s 41(1)

Brief about the case

The assessee is an individual and prop. of M/s R.S International which is engaged in manufacturing & trading of carpets. He filed his return of total income of Rs. 3,62,880/- on 30/09/2009. The AO completed the assessment vide order dated 30/12/2011 by rejecting the books under section 145(3) and made a total addition of Rs.4512594 composed of Rs. 3745366 being on account of suppressed production and Rs. 703498 being on account of low drawings for household expenses. Aggrieved from the order of ld AO, the assessee filed first appeal challenging rejection of books of accounts u/s 145(3) and additions on merits.

The ld CIT(A) by detailed observations held the action of rejection of books to be unjustified relying upon the decision of St. Teresa’s Oil Mills vs. State of Kerala (76 ITR 365) wherein Hon’ble Kerala High Court held that accounts regularly maintained in the course of business had to be taken as correct unless there was a strong and sufficient reason to indicate that they were unreliable. However, revenue did not raise any ground against the order of ld. CIT(A) for upholding the books of accounts, thus the Revenue’s grounds in appeal are only on the merits of additions.

The ITAT held that the production of the assessee was supported by bills of job workers. Moreover, no other independent material or inquiry was brought on record to prove suppression of production. Thereby it was contended that ld CIT(A) rightly appreciated the facts and by detailed observations held that there was no cessation of liability and deleted the addition.

Facts of the case:

• The assessee is an individual and prop. of M/s R.S International which is engaged in manufacturing & trading of carpets.
• The AO assessed the income of the assessee and passed the order making the following additions:

a) Suppressed production Rs. 37,45,366/-

b) U/s 41(1) of Income Tax Act, 1961 Rs. 7,03,498/-

c) Low House hold withdraw Rs. 63,730/-

Total Additions Rs. 45,12,594/-

• Aggrieved from the order of ld AO, the assessee filed first appeal challenging rejection of books of accounts u/s 145(3) and additions on merits.
• The ld CIT(A) by detailed observations held the action of rejection of books to be unjustified and deleted all the above additions.
• Aggrieved from the order of ld. CIT(A) the revenue knocked the door of ITAT.
• The revenue appealed against 2 grounds; first being the deletion of addition on account of suppressed production wherein there wasa an excess of 7282.1 sq.ft. carpet which have been washed during the year without there being any opening stock or production during the year; and second being the deletion of addition on account of impugned income u/s 41(1) wherein the assessee failed to prove that the amount was actually payable to said party as on 31-03-2009.
• The ITAT held that the allegation of suppressed production was no incriminating evidence whatsoever was either detected or indicated by ld. AO. Mere alleged discrepancy in the washing of the carpet is presumed to be basis of addition for suppressed production and sale. Moreover the production of the assessee being supported by bills of job workers proves no suppression of production.
• Further with regard to the second issue, the assesse contends that the amount in question represents commission payable to M/s Laxmi Carpet Enterprises for arranging exports to a foreign party M/s Hassan Carpet Pvt Ltd. The sales and corresponding commission were entered in the books for FY 2006-07 and was payable on receipt of sale proceeds. Due to some disputes assessee was not able to recover the sale proceeds from said M/s Hassan Carpet Pvt Ltd since last 5 years, consequently payment of commission to M/s Laxmi Carpet was withheld pending realization of sale proceeds which lead to strained relationship; the party refused to give confirmation. Ld. AO without appreciating these simple commercial transactions and the fact the assesse had a lien over the payment due to pending dispute; arbitrarily held that assessee has failed to prove that the amount was actually payable to M/s Laxmi Carpet Enterprises as on 31.03.2009;
• Jaipur ITAT in assessee’s own case for the assessment year 2007-08 and on similar facts in respect of another party has deleted the similar type of addition u/s 41(1) of the Act. Besides the judgement in the case of CIT vs. Sugauli Sugar Works (P) Ltd. (SC) is also applicable to the facts of the assessee case.
• Thereby both the additions were deleted and the order of CIT(A) was upheld by the Jaipur ITAT.

Contention of the Revenue

• CIT(A), Jaipur has erred in deleting the addition of Rs. 37,45,366/- made by the AO on account of suppressed production without appreciating the fact that the assessee had not been able to explain the discrepancy of exces 7282.1 sq. ft carpet which have been washed during the year without there being any opening stock or production during the year.
• CIT(A), Jaipur has erred in deleting the addition of Rs. 7,03,798/- on account of impugned income u/s 41(1) of the I.T. Act, 1961 without appreciating the fact that the assessee had not provided the confirmation or the present address of the party i.e. M/s. Laxmi Carpet Enterprises and assessee failed to prove that the amount was actually payable to said party as on 31-03-2009.

Contention of the Assessee

• The assessee contended that :
  • There was no difference in quantity of 9×9 unwashed carpet.
  • The production and stock of carpet was reconciled from washing charges paid by the assessee.
  • The mistake in a column of inventory of 9×9 carpet was due to computer misprint which was properly reconciled by the assessee.
  • Adverting to Ground No. 2, the export of carpet to M/s. Hasan Carpet (P)Ltd. was arranged through M/s. Laxmi Carpet Enterprises for which commission of Rs. 7,03,498/- claimed in F.Y. 2006-07 remained outstanding due to non-payment of sale proceeds by M/s. Hasan Carpet (P) Ltd. These facts clearly emerge from the record and therefore section 41(1) should not be implied.

Held by ITAT (Jaipur)

• In the entirety of the facts and circumstances of the case, we find no infirmity in the order of the ld. CIT(A) deleting the addition on merits after duly appreciating the factual aspects and relying on the decision of Hon’ble Supreme Court in the case of Dhakeshwari Cotton Mills Ltd. vs. CIT, 26 ITR 775 (supra) and other cases mentioned above. Thus Ground No. 1 of the Revenue is dismissed.
• Once, there is an impending dispute between assessee and M/s. Laxmi Carpet Enterprises then it cannot be assumed that liability for payment has ceased, consequently the provisions of Section 41(1) cannot be invoked against the assessee in view of these facts. Jaipur ITAT in assessee’s own case for the assessment year 2007-08 and on similar facts in respect of another party has deleted the similar type of addition u/s 41(1) of the Act. Besides the judgement in the case of CIT vs. Sugauli Sugar Works (P) Ltd. (SC) is also applicable to the facts of the assessee case. In view of these facts and circumstances and respectfully following the judicial precedents cited above, we uphold the order of the ld. CIT(A) on this issue also. Thus Ground No. 2 of the Revenue is dismissed.