The expenditure might have been paid out and hence refunded or the expenditure is recorded in the books as payable and allowed as a deduction previously — on waiver, would be covered by Section 41(1) of the Act.
The accent of the statute is ‘an allowance or deduction has been made in the assessment for any year in respect of loss, expenditure or trading liability’. The condition for applying Section 41(1) is the allowance of deduction earlier and subjecting it to tax later on its waiver. Explanation 1 to Section 41(1) covers even unilateral transfer of liability by write off in the books of account by the taxpayer.
Solid Containers Case
In the Solid Containers Ltd vs Deputy CIT (2009 308 ITR 417 Bombay) case, the assessee took a loan for business purpose which was written back and credited to reserves account based on the compromise arrived at in a suit proceeding.
The assessing officer (AO) taxed the amount written back as income chargeable to tax under Section 41(1) of the Act.
It may be noted that the loan was never debited to profit and loss (P&L) account as the debit entry would be against the principle of accounting and the loan amount under the Act in any circumstance would not have gone to reduce the taxable income of the borrowing assessee.
The court applied the dictum of the apex court in the CIT vs T.. V. Sundaram Iyengar & Sons Ltd (1996 222 ITR 344 SC) case and held that a sum which initially did not fall within the scope of the taxing provisions might become taxable subsequently when it becomes the assessee’s own money.
Actually in the T. V. Sundaram Iyengar case, the amounts transferred represented the amounts received in the course of trade transactions. The taxpayer transferred the amounts standing in favour of the customers which were time-barred.
The court held that the amounts received were not of income in nature at the time of receipt but by lapse of time and due to time limitation, it attained a different quality viz. a trade surplus. Since the assessee had treated the money as in its own by taking it to P&L account, the taxability as income was justified.
In Mahindra & Mahindra Ltd vs CIT (2003 261 ITR 501 Bombay), the assessee imported capital assets and loan thereon was guaranteed by a foreign company.
Consequent to waiver of loan and interest and as regards taxability under Section 41(1), the court held that in order to apply Section 41(1), the assessee should have obtained a deduction in the assessment for any year in respect of loss, expenditure or trading liability.
Since the assessee has not obtained such allowance or deduction in respect of expenditure or trading liability, Section 41(1) could not be applied and the decision went in favour of the taxpayer.
In CIT vs Aries Advertising (P) Ltd (2002 255 ITR 510 Madras), the time barred deposit of customers transferred to general reserve account was held as chargeable to tax following the T.V..Sundaram Iyengar case (supra).
The decision rendered in the T.V.Sundaram Iyengar case pertains to a trading receipt which was treated as income by the taxpayer by routing it through P&L account. In the Aries Advertising case it was routed through reserve account voluntarily by the assessee and, hence, taxed as income.
In the Mahindra & Mahindra case, it was not the voluntary act of the assessee and since the creditor/lender waived the amount, the amounts were held as not taxable under Section 41(1).
In the Solid Container case also, based on a suit and consent terms arrived with the other party, the assessee got waiver of loan amount. There was no voluntary transfer of write back by the taxpayer. A loan waiver does not fall within the intent or content of the legal provision and, hence, must be outside the purview of Section 41(1) but the court decided otherwise holding that the loan was taken for trading activity and on its waiver it is taxable as income.
If all the loans taken by businessmen upon waiver were to be taxed, then the law must be amended accordingly to tax the same, instead of courts giving conflicting interpretations.