Liability can not be added to income just because they are old or not proved genuine

RELEVANT PARAGRAPH

17. Regarding the addition made u/s 41(1), we are of the view that the Assessing Officer has incorrectly invoked this provision. There is neither any remission nor cessation of the liability. The Assessing Officer has simply added all the credits appearing in the balance sheet which could not be hit by Section 41(1).

The liability to the assessee should cease to exist either due to operation of law or by an order of the court or by limitation i.e for cessation of liability there should be application of some external force. There is no role of the conducting parties in making a liability ceased to exist. They had to abide by the judgment of the court or the provisions of law or rule of limitation. In remission of liability, there has to be conscious act on the part of the creditor to wave or forgo the liability. There should be evidence on record to show that the creditor has either waived the recovery from the assessee or there is some contractual agreement between the assessee and the creditor thereby entire or part of credit standing in the balance sheet of the assessee is written off or waived. To that extent it can be said that liabilities are remitted by the creditors. Another condition common in both cessation and remission by the creditors. Another condition common in both cessation and remission is that such liability must pass through trading account or Profit and Loss Account in some earlier year i.e. it should have been allowed as a deduction. In the present case, the Assessing Officer has not proved that liabilities had passed through Profit and Loss Account/Trading account in earlier years. Presuming it to be so no case is made out that it is a remission or cessation.

21. A careful reading of above authorities and the section, we cull out following Principles;”

21.1 Section 41(1) creates a fiction. Following conditions must be satisfied for invoking this section.

(i) In respect of assessment of an assessee, an allowance or deduction has been made in respect of any loss, expenditure, or trading liability incurred by him

(ii) Any amount is obtained by the assessee in respect of such loss or expenditure or,

(iii) Any benefit is obtained by the assessee in respect of such trading liability by way of remission or cessation thereof.

(iv) Such amount or benefit is obtained in a subsequent year.

21.2 When above conditions are satisfied then-

(i) The amount so obtained by the assessee or the value of benefit so received by him is deemed to be the profits and gains of business or profession which otherwise would not have been his income,

(ii) Such amount or value of benefits would be chargeable as

income of the previous year when such amount was obtained or benefit had accrued to him.

(iii) It is immaterial whether the business or the profession of the assessee was in continuation or not in the year of receipt of benefit by way of remission or cessation.

(iv) Such benefit or amount can be in cash or in kind or by way of book entries,

(v) The deeming fiction cannot be invoked for a receivable

benefit. It should be shown by the revenue that benefit has been actually received,

(vi) Method of accounting is relevant.

21.3 Where an amount of loss or expenditure has not passed through the profit or loss account i.e. it has not been allowed as a deduction and not reduced the chargeable income in any previous year then even if the assessee has obtained any benefit or there has been a remission or cessation, it cannot be taxed in the year of receipt of such benefit.

21.4 Similarly a liability standing in the balance sheet and written off or credited in the P/L account in a subsequent year has to be shown to be a trading liability i.e. it should have been allowed as a deduction in the profit and loss account in an earlier year . It could relate to purchases or to an expenditure charged to profit in an earlier year. Therefore a debt waved in a subsequent year could not be charged to tax unless the assessee is doing business of money lending or banking. Thus Section 41(1) concerns with only trading liability and not with any other type of liability. Every liability standing in the balance sheet cannot be presumed to be a trading liability. The onus benefit accruing to him” related to a trading liability and it has been allowed as a deduction in an earlier year.

21.5 It is for the revenue to show the factum of remission or cessation. In addition, it has to be shown that allowance as deduction and remission or cessation in a later year are correlated. It cannot be presumed. In other words, the facts relating to satisfaction of conditions for legal fiction to spring into action cannot be presumed. They have to be proved by the revenue. However once basic conditions are satisfied, the posterior facts can be assumed and onus will shift to the assessee to prove that he really did not get any benefit or that the creditor has really not remitted the liability.

21.6 As per decision of the Hon’ble Supreme Court in the case of CIT v. Sugauli Sugar Works P. Ltd. 119991 236 ITR 518 the unilateral action of the assessee in writing off his trading liability incurred by him in his books does neither amount to remission nor amount to cessation of such liability or cessation merely because the period of limitation of recovery of such sum by the concerned person has expired. However after insertion of Explanation 1 to section 41(1) vide amendment through the Finance (No. 2) Act of 1996, with effect from April 1, 1997, which made it permissible to add such sum in the income of the assessee in terms of section 41(1), if the assessee has written off such sum in his books of account, as his unilateral act. However, the provision was specifically brought into effect prospectively with effect from April 1, 1997, only and did not have retrospective operation. Therefore the present position is that where the assessee has not written off a trading liability in its books than the A.O. cannot invoke section 41(1) merely because the liabilities standing in the books are old or they could not be proved to be genuine by the assessee.

21.7 A liability could not be treated as a cessation if it was being merely carried forward for years. A non-genuine non- trading liability standing in the balance sheet can be taxed but u/s 68 if it came in the books in the current year. If such non-genuine non trading liability came in the books in an earlier year than same cannot be taxed in the current year even u/s 68. A non-genuine trading liability can be considered in the current year if it is related to current year’s trading/ manufacturing or Profit & loss account but not u/s 41(l) or u/s 68. It can be considered only u/s 28 i.e. it can be considered for disallowance while examining the claim of expenses or outgoings against revenue receipts. Current year’s genuine trading liabilities, form part of trading / manufacturing or P/L account except a note appended to them as disclosure of information.

21.8 The word remission means a positive act on the part of the creditor to wave or forgo his right to recover the debt from the assessee. Some agreement with or letter from the creditor, or some agreement with or letter from the creditor whereby recovery of debt by him is forgone or waived directly or by necessary implication has to be shown.

21.9 The word cessation means the termination by operation of law or by an order of a court, of legal obligation of the assessee to pay to the creditor. A contractual agreement between the parties, approved by a court to wave the debt or terminate the legal obligation of the assessee will also cease the liability to exist.

21.10 Even in a case where a liability ceased to exist due to limitation i.e. the claim of the creditor is barred by limitation under Limitation Act of 1963 but if the liability subsist or has not been written off by the assessee, or the assessee does not absolve himself from the liability, though not legally enforceable, it cannot be taxed U/s 41(1)

22. When, we view the facts of the present case we notice that the A. O. has simply treated all the liabilities of the balance sheet as remission or cessation merely because they were either old or the letters sent to some of them returned back unserved. He did not establish that the liabilities were trading liabilities, they were charged to profit in an earlier year, or that assessee obtained any benefit in respect of them, or there was any remission or cessation thereof. There was no unilateral writing back of these liabilities by the assessee so as to attract the explanation to sec. 41(1) if they were trading liabilities. The assessee has been continuously showing them in its book as his liabilities and there is no material to hold that assessee has no intention to pay back to the creditors. Further there is also no material to hold that basic conditions for invoking deeming fiction are satisfied. Hence the liabilities of the balance sheet cannot be treated as income of the assessee u/s 41 (1).

NF