When assessee reverses a unilateral write back of dues payable to a vendor to its P & L account, the liability is to be treated as contingent liability

Echjay Forgings P. Ltd. Vs. ITO (ITAT Mumbai)- The assessee has merely reversed a unilateral write back of dues payable to vendor. As a matter of fact, as later developments showed, the very decision of writing off amount payable to Is pat Profiles Limited was premature and based on too optimistic an appraisal of vendor’s willingness of forego the claim.

All that the assessee has done in the present year to reverse the action of write off. There is no dispute, as evident from the legal proceedings initiated by the vendor and as evident from the fact that ultimately assessee had to pay off this liability- though at a lesser amount, that the liability to pay to Ispat Profiles Limited did exist in the relevant previous year, even as it did not reflect in the assessee’s account. Under these circumstances, disallowing the liability debited to profit and loss account, on the ground that it is a contingent liability, was clearly erroneous. The profits of the assessee are to be computed on the basis of normal accountancy practices, and it is only elementary that all known liabilities are to be provided for while computing business profits. There was thus no infirmity in assessee’s claim for deduction of liability of ~ 1,07,83,402 payable to Ispat Profiles Limited. The stand of the authorities below that liability accrued as a result of memorandum of understanding dated 1^st September, 2004 is wholly incorrect, inasmuch as liability came into existence as a result of purchase of raw materials from Ispat Profiles Limited, and the MOU only resulted in part remission of the same to the extent claim was forgone by the vendor. The same has been offered to tax in the relevant assessment year and Assessing Officer has accepted the same. As observed by Hon’ble Supreme Court, in the case of Chainrup Sampatram vs CIT, 24 ITR 481, “while anticipated loss is thus taken into account, anticipated profits…is not brought into account, as no prudent trader would care to show increased profit before it’s actual realisation”. The underlying principle is the theory of conservation in accounting which has the sanction of Honourable Courts above. In view of these discussions, as also bearing in mind the entirety of the case, we deem it fit and proper to direct the Assessing Officer to delete the impugned dis-allowance of t. 1,07,83,402 The assessee gets relief accordingly.

Echjay Forgings P. Ltd. Vs. Income Tax officer

ITAT Mumbai

I.T.A. No. 922/ Mum/2009

Assessment year: 2004- 05

 O R D E R

Per Pramod Kumar:

3. In ground No. 3, the assessee is aggrieved that the CIT(A) erred in sustaining dis-allowance of Rs. 1,07,83,402 on account of contingent liability.

4. The relevant material facts are like this. The assesee is engaged in the business of manufacturing of steel forgings and automobile parts. The assessee was supplying railway tyres to Indian Railways and the raw material for producing these railway tyres was purchased from Ispat Profiles Limited. During the financial year 1997-98, the assessee received complaints about quality of railway tyres. In the opinion of assessee, the defects pointed out in railway tyres were on account of defective raw material supplied by Ispect Profiles Limited. It was in this backdrop that the assessee decided not to pay outstanding bills payable to Is pat Profiles Limited, and unilaterally write back these dues to the credit of his profits and loss account. In effect thus the amount payable to Is pat Profiles Limited was adjusted as damages claimed on account of poor quality of raw material supplied, and offered to tax. This claim for damages, however, was repudiated by Is pat Profiles Limited. Not only that Ispat Profiles Limited refused to take into account the debit note issued by the assessee, Ispat Profiles Limited even filed a suit for recovery of it’s dues. On 9th January, 2004, Is pat Profiles Limited served a winding up notice on the assessee. Realising that Ispat Profiles Limited will not give up it’s claim and that unilateral write off by the assessee was perhaps premature, the assessee wrote back the amount which was earlier offered to tax. In effect thus liability of Rs. 1,07,83,402 was brought back to accounts- a liability for payment of outstanding dues to Ispat Profiles Limited. The Assessing Officer disallowed the same. He was of the view that it was a contingent liability. The Assessing Officer further noted that the liability to Ispat Profiles Limited was finally settled for Rs. 65,00,000 vide memorandum of understanding dated 1^st September, 2004, and that the actual liability can at best be claimed in the relevant assessment year i.e. 2005-06. He was of the view that the liability was ascertained and crystallised only on 1.9.2004 i.e. previous year relevant to the assessment year 2005-06. Accordingly, claim of deduction for Rs. 1,07,83,402 was disallowed. Aggrieved, assessee carried the matter in appeal before the CIT (A) but without any success. While confirming the action of the AO, CIT(A) observed as follows:

“I have considered the facts in the instant case. The original liability to pay M/s. Ispat Profiles Ltd., accrued during the F.Y. 1998-99 and the same was accordingly allowed under section 37(1). Subsequently, in the A.Y. 2001- 02, the appellant suo-moto wrote back the liability and offered the same for taxation u/s.41(1). The appellant has now reclaimed the same amount in the A.Y. 2004-05 by reversing the entries made in the FY 2000- 2001. In my opinion if the AO was to allow this, it would amount to a double deduction u/s.37(1) as this amount has already been allowed in the A.Y. 1999-2000. It is only by virtue of a legal fiction, created by section 41(1) ,that this amount was brought to tax in the A.Y. 2001-02. There is no legal fiction, of a similar nature, in the statute whereby a reversal of an amount written back to the P&L account can be claimed as a deduction. Therefore, there is no question of allowing the same u/s. 37(1)/28, once again. Even otherwise, I find that the AO has rightly held that, during the F.Y. 2003- 04, the liability to pay M/s. Is pat Profiles Limited had not accrued. It was only in the FY 2 004-05 that a settlement was reached by virtue of which an amount of Rs. 65 lakhs was paid to M/s. Is pat Profile Ltd. A simply legal notice u/s.433/434 of the Companies Act could not create a liability to pay the disputed amount. Therefore, by reversing the entry of Rs. 1,07,83,402 all the assessee did was to create a contingent liability which has rightly been disallowed by the AO. This ground of appeal is therefore, dismissed.”

5. The assessee is not satisfied and is in appeal before us.

6. We have heard the rival contentions, perused the material on record and duly considered the factual matrix of the case as also the applicable legal position.

7.  We find that in the relevant previous year, the assessee has merely reversed a unilateral write back of dues payable to vendor. As a matter of fact, as later developments showed, the very decision of writing off amount payable to Is pat Profiles Limited was premature and based on too optimistic an appraisal of vendor’s willingness of forego the claim. All that the assessee has done in the present year to reverse the action of write off. There is no dispute, as evident from the legal proceedings initiated by the vendor and as evident from the fact that ultimately assessee had to pay off this liability- though at a lesser amount, that the liability to pay to Is pat Profiles Limited did exist in the relevant previous year, even as it did not reflect in the assessee’s account. Under these circumstances, disallowing the liability debited to profit and loss account, on the ground that it is a contingent liability, was clearly erroneous. The profits of the assessee are to be computed on the basis of normal accountancy practices, and it is only elementary that all known liabilities are to be provided for while computing business profits. There was thus no infirmity in assessee’s claim for deduction of liability of ~ 1,07,83,402 payable to Ispat Profiles Limited. The stand of the authorities below that liability accrued as a result of memorandum of understanding dated 1^st September, 2004 is wholly incorrect, inasmuch as liability came into existence as a result of purchase of raw materials from Ispat Profiles Limited, and the MOU only resulted in part remission of the same to the extent claim was forgone by the vendor. The same has been offered to tax in the relevant assessment year and Assessing Officer has accepted the same. As observed by Hon’ble Supreme Court, in the case of Chainrup Sampatram vs CIT, 24 ITR 481, “while anticipated loss is thus taken into account, anticipated profits…is not brought into account, as no prudent trader would care to show increased profit before it’s actual realisation”. The underlying principle is the theory of conservation in accounting which has the sanction of Honourable Courts above. In view of these discussions, as also bearing in mind the entirety of the case, we deem it fit and proper to direct the Assessing Officer to delete the impugned dis-allowance of t. 1,07,83,402 The assessee gets relief accordingly.

8. Ground No. 3 is thus allowed.

9. Ground No. 4 was not pressed by the assessee and is dismissed as such.

10. In ground Nos. 5, 6 and 7, the assessee has challenged levy of interest u/s. 234A, B & C. however, having noted that the CIT (A) has dismissed the grievances as consequential and without dealing with the matter on merits, we deem it fit and proper to remit the matter to the file of the CIT(A) for fresh adjudication, by way of a speaking order and after giving an opportunity of hearing to the assessee, in accordance with law. To this extent, ground Nos. 5,6 & 7 are allowed for statistical purposes.