Section 41(1) of Income Tax Act doesn’t apply till liability is not written off in the books

ITO Vs Simu Sonthalia (ITAT Gauhati)

ITAT Gauhati held that provisions of section 41(1) of the Income Tax Act cannot apply since the liability is still ‘payable’ to sundry creditor and had not been written off in the books of account and there is no evidence to indicate that said liabilities had ceased to exist.

Facts-

During the course of assessment proceedings AO called for details of purchases and the confirmation of sundry creditors. The assessee neither filed any detail of purchases nor any confirmation was filed. AO, thereafter, issued notice u/s. 133(6) of the Act to Shree Balaji Udyog, sundry creditor. Notice u/s 131(1) of the Act in the case of sundry creditor, Dip Sarma (Prop. Anurag Packaging & Maa Kamakhya Packaging was duly served. But neither the sundry creditor(s) appeared nor filed any details.

Therefore, AO made the addition u/s. 41(1) of the Act at Rs. 1,04,24,883/- & Rs.93,43,452/- for cessation of liability in the name of M/s. Anurag Packaging & Maa Kamakhya Packaging. Similar addition was also made u/s. 41(1) of the Act at Rs. 93,89,186/- for outstanding liability in the name of Shree Balaji Udyog.

Aggrieved, the assessee preferred an appeal before the ld. CIT(A) challenging the additions made u/s. 41(1) of the Act at Rs.2,91,57,521/- and succeeded.
Aggrieved, the revenue is now in appeal before this Tribunal.

Conclusion-

Held that the appellant/assessee continued to reflect or record liabilities standing in books of account ‘payable’ to the creditors and had not written them off in the books of account and there is no evidence to indicate that said liabilities had ceased to exist.

Invoking of Section 41(1) arises on various counts including remission and cessation of liability. If in a case there is cessation of liability, it means that though there is a liability standing in the books, but if it is fictious in nature and in real terms the assessee has not to pay such liability and liability cease to exist, then in such case section 41(1) of the Act needs to be invoked and creditors/credit liabilities should be treated as income chargeable to tax.

FULL TEXT OF THE ORDER OF ITAT GAUHATI

The present appeal has been preferred by the revenue against the order dated 29-08-2018 of the Ld. Commissioner of Income-tax (Appeals), [hereinafter referred to as ‘CIT(A)’], Guwahati-1, Guwahati for the assessment year 2015-16.

2. The revenue has raised the following grounds:-

(i) For that on the facts and circumstances of the case the Ld. CIT(A) is not justified in facts as well as in law in deleting the addition of Rs.29,1 5,73,211­ without appreciating the fact that the assessee had failed to produce details of purchases made during the F.Y. 2014­15 relevant to A.Y. 2015­16.

(ii) For that on the facts and circumstances of the case the Ld. CIT(A) is not justified in facts as well as in law in ignoring the enquiry conducted by the AO in respect of sundry creditors namely Mr. Dip Sharma [ Prop. Anurag Packaging & Maa Kamakhya Packaging]. and Mr. Alok Sonthalia, [Prop. Shree Balajee Packaging ]. The Ld. CIT(A’) has failed to appreciate that these creditors failed to comply with the provisions u/s 131 of the LT. Act, 1961.

(iii) On the facts and circumstances of the case the Ld. CIT(A) is not justified in facts as well as in law that, the sundry creditor namely Mr. Dip Sharma [ Pro Anurag Packaging & Maa Kamkhya Pakaging ] did not file his ITR except for A.Y. 201 ­12. Even in the A.Y. in which he had filed his return of income i.e A.Y. 2011­12 he has not shown any details of his sundry debtors.

(iv) The appellant craves leave to add, alter or amend any or all of the appeal before or during the course of appeal.

3. Brief facts of the case as culled out from records are that the assessee is engaged in carrying on business in manufacturing of BOPP Self Adhesive Tapes, Paper Core etc. Income at Rs. 19,320/- in return filed on 30.09. 2015 declared after claiming deduction under chapter VI of Rs. 10,73,120/-. Case selected for limited scrutiny followed by serving of notices u/s. 143(2) & 142(1) of the Act. During the course of assessment proceedings the ld.AO called for details of purchases and the confirmation of sundry creditors. The assessee neither filed any detail of purchases nor any confirmation was filed. The ld. AO, thereafter, issued notice u/s. 133(6) of the Act to Shree Balaji Udyog, sundry creditor. Notice u/s 131(1) of the Act in the case of sundry creditor, Dip Sarma (Prop. Anurag Packaging & Maa Kamakhya Packaging was duly served. But neither the sundry creditor(s) appeared nor filed any details. Therefore, the ld. AO made the addition u/s. 41(1) of the Act at Rs. 1,04,24,883/- & Rs.93,43,452/- for cessation of liability in the name of M/s. Anurag Packaging & Maa Kamakhya Packaging respectively. Similar addition was also made u/s. 41(1) of the Act at Rs. 93,89,186/- for outstanding liability in the name of Shree Balaji Udyog (Prop. Alok Santhalia [ husband of the assessee].

4. Aggrieved, the assessee preferred an appeal before the ld. CIT(A) challenging the additions made u/s. 41(1) of the Act at Rs.2,91,57,521/- and succeeded as the ld. CIT(A) was of the view that the ld. AO had gone beyond the powers u/s. 41(1) of the Act, more so, when the appellant/assessee continued to reflect or record liabilities still ‘payable’ to the creditors and had not written them off in the books of account and moreover, there was no evidence to indicate that said liabilities had ceased to exist.

5. Aggrieved, the revenue is now in appeal before this Tribunal raising the aforementioned grounds of appeal.

6. The Ld. Departmental Representative vehemently argued referring to the detailed finding of the ld. AO and further submitted that spot enquiry was conducted by the inspector regarding the creditworthiness of sundry creditor, Dip Sarma and found that Shri Dip Sarma is an auto van driver, who has no business premises or any office and he has not maintained any books of account. Further, it was submitted that the assessee was given sufficient opportunity to produce the required documents, but the assessee deliberately did not comply with the same issued u/s. 131(1) of the Act and awaited for submissions of document, The ld. DR asserted that finding of the ld. AO may please be restored.

7. Per contra, Ld. Counsel for the assessee vehemently argued supporting the finding of the ld. CIT(A) also referring to various judgments stating that provisions of section u/s. 41(1) of the Act are not applicable in the present case as the assessee has shown the creditors as liabilities in the books and the transactions are being carried out. Reference also made to the paper book containing 79 pages, which includes copies of ledger confirmations, tax audit report and the decisions relied on by the assessee.

8. We have heard the rival contentions and perused the material placed before us. The main grievance of the revenue is that the ld. CIT(A) erred in deleting the addition of Rs.2,91,57,521/- made by the ld. AO u/s. 41(1) of the Act under the fact that after conducting necessary enquiry the alleged sundry creditors failed to comply of the notice u/s. 131(1) of the Act and the sundry creditors, M/s. Anurag Packaging & M/s. Maa Kamakhya had not filed I.T Returns.

9. We notice that alleged additions of Rs. 2,91,57,321/- made in respect of following sundry creditors:-

10. The provisions of section 41(1) of the Act, invoked by the ld. AO reads as follow:-

Section 41(1):

41.(1) 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 first­mentioned person) and subsequently during any previous year,­

(a) the first­mentioned 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 gains of business or profession and accordingly chargeable to income­tax 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 first­mentioned person or some benefit in respect of the trading liability referred to in clause (a) way of remission or cessation thereof”, the amount obtained by the successor in business or the value of benefit accruing to successor in business shall be deemed to be profits and gains of the business or profession, and accordingly chargeable to income­tax as the income of that previous year.

Explanation 1.­For the purposes of this sub­section, the expression “loss or expenditure or some benefit in respect of any such trading liability by way of remission or cessation thereof” shall include the remission or cessation of any liability by a unilateral act by the first­mentioned person under clause (a) or thesuccessor in business under clause (b) of that sub­section by writing off such liability in his accounts. Explanation 2.­For the purposes of this sub­section, “successor in business means,­

(l) where there has been an amalgamation of a company with another company, the amalgamated company;

(il) where the first­mentioned person is succeeded by in that business or profession, the other person;

(iii) where a firm carrying on a business or profession is succeeded by another firm, the other firm

iv) where there has been a demerger, the resulting company.”

11. Now as far as the case of the assessee is concerned, we find the ld. AO made the addition by observing that the liability of alleged sundry creditors had ceased to exist in the case of assessee. There is a cessation of liability in case of outstanding of above sundry creditors. The assessee has relied on the judgment of the Hon’ble Supreme Court in the case of CIT Vs. Sugrauli Works (P) Ltd (1999) 236 ITR 518/152 CTR 46 (SC), The Hon’ble Court held:

“11. In our opinion, for considering the taxability of amount coming within the mischief of S. 41(1) of the Act, the system of accounting followed by the assessee is of no relevance or consequence. We have to go by the language used in s. 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.

12. We fully agree with the view taken by the Division Bench in C.I.T. v. Rashmi Trading (1977) Tax IR 520 Gujarat (Supra) that the only meaning that can be attached to 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 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 of the 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”. As rightly observed by the Division Bench in the context in which these words occur, no other meaning is possible.” we are in agreement with the said reasoning.

12. The ld. CIT(A) also referred to the above judgment along with other decisions holding that provisions of section 41(1) of the Act cannot apply since the liability is still ‘payable’ to sundry creditor and had not been written off in the books of account..

13. Now as per finding of the ld. CIT(A) we find that basis of giving relief is that the appellant/assessee continued to reflect or record liabilities standing in books of account ‘payable’ to the creditors and had not written them off in the books of account and there is no evidence to indicate that said liabilities had ceased to exist. In our humble understanding if the liability is written off by a person in the books of account, there is no need to apply section 41(1) of the Act as the person at his own had written off and necessary entries will be made in the books of account to show the income arising out of writing off the liability. Invoking of Section 41(1) arises on various counts including remission and cessation of liability. If in a case there is cessation of liability, it means that though there is a liability standing in the books, but if it is fictious in nature and in real terms the assessee has not to pay such liability and liability cease to exist, then in such case section 41(1) of the Act needs to be invoked and creditors/credit liabilities should be treated as income chargeable to tax.

14. In view of our above observations let us examine the alleged sundry creditors. As far as addition of Rs. 93,89,186/- in name Mr. Alok Sonthalia (husband of the assessee) is concerned, we find that Mr. Alok Sonthalia is husband of the assessee. There is an opening balance of Rs.94,92,586.87 and almost monthly payment of Rs.9,400/- is made and the liability is payable to him. Alok Sonthalia being genuine sundry creditor/loan, which the ledger account suggests, we find that no addition was called for u/s. 41(1) of the Act for the credit balance appearing in the name of Alok Sonthalia and to this extent, the finding of the ld. CIT(A) is confirmed.

15. As regards the other two creditors namely, M/s. Maa Kamakhya Packaging & M/s. Anurag Packaging (Prop.Dip Sarma) are concerned, we find that there is a credit balance of Rs.93,43,452/- and Rs.1,04,24,883/-respectively. Certain observations are made by the ld. AO that both the concerns are bogus and the proprietor has no creditworthiness to deal with this transaction. As per the inspector’s report, who was sent for spot enquiry by the ld. AO, Dip Sarma is proprietor of both the concerns having total turnover of at least Rs. 2 crores and above. He also observed that Dip Sharma is an auto van driver, who has no business premise/ office and at the address on record is his residence. Inquiry was made in case of Shri Dip Sharma with wife Smt. Torali Sharma and sister, Smt. Mamoni Sharma. Shri Dip Sharma stated that he has not maintained any books of account. The report along with photograph evidence and the I.T Return filed for the AY 2011-12 revealed that financial condition of Shri Dip Sharma is not at all commensurate with the outstanding amount due in assessee’s books. In the course of hearing before the ld. AO no details whatsoever in the form of I.T.R or balance sheets of both these concerns i.e. M/s. Maa Kamakhya Packaging & M/s. Anurag Packaging (Prop.Dip Sharma) were filed. Before us only confirmation letter has been filed. The ledger accounts of both these concerns namely, Maa Kamakhya Packaging & M/s. Anurag Packaging are same. Neither any bank statement nor any other details have been filed to prove the genuineness of the transaction.

15 (a). On perusal of ledger account of M/s. Anurag Packaging for the FY 2014-15(1.4.2014 to 31.3.2015), we notice that there is opening balance of Rs. 63,71,547/-. During the year there are further entries of purchase and only payment of Rs.97,183/- was made. It is also surprising to note that on the credit side of ledger account the assessee has received transfer from bank at Rs.24,576/-, Rs.2,30,201/-, Rs.15,000/-, Rs.28,811/- Rs. 6000/- and Rs. 18,600/-. It is surprisingly to note that the person who is a creditor for selling goods has also made some payments to the assessee for the reason best known to the assessee. Similarly in case of M/s. Maa Kamakshya Packaging against the total credit balance of Rs. 98,51,634/- the assessee has only paid 51,000/- and remaining amount is outstanding. It is hard to believe that a person who is physically verified to be an Auto Van Driver has been able to procure goods worth crores and given then on credit to assessee and total outstanding at the year end is Rs. 1, 97,68,335/-.

16. Looking to these facts and spot enquiry in respect of Shri Dip Sharma, who is said to be proprietor of M/s.Anurag Packaging & M/s. Maa Kamakhya Packaging and the observations made hereinabove, we are of the considered view that the said creditors are not real sundry creditor. In actual sense no such amount is payable and the outstanding amount are merely book entries. The liability which is appearing in the books of account for which the assessee has claimed purchases in the P & L account is bogus and both the sundry creditors, M/s.Anurag Packaging & M/s. Maa Kamakhya Packaging, in our considered view are fictious creditors and in real term there is no liability to pay.

17. Therefore the given facts and circumstances suggests that the liability to pay the creditors, M/s.Anurag Packaging & M/s. Maa Kamakhya Packaging, had ceased to exist being bogus in nature as there is no real business concern selling/purchasing of goods and these are merely paper adjustment entry and since the liability in books ceased to exist, provisions of section 41(1) of the Act are attracted. Thus, we confirm the addition of Rs.1,04,24,883/- made in the case of M/s.Anurag Packaging & Rs.93,43,452/-made in the case of M/s. Maa Kamakhya Packaging totaling to Rs.1,97,68,335/- by ld. AO made u/s. 41(1) of the Act treating it as cessation of liability. Ground nos. (i) to (iii) are partly allowed.

18. Ground no. (iv) is general in nature, which needs no adjudication.

19. In the result, the appeal of the revenue is partly allowed.

Order pronounced in open court on 19-09-2022