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Synopsis
Section 41(1) applies when an assessee gets a remission or benefit in respect of trading liability cessation thereof,or by a unilateral act by the assessee by way of writing back of such liability in his accounts.
The question that arises is if any benefit has been obtained in respect trading liability by remission or cessation, when a creditor’s balance has remained unpaid for a long period of time, though it has not been written back to the profit and loss account, particularly if the recovery of such amount is barred by the law of limitation.
Issue for Consideration
Section 41(1) of the Income Tax Act, 1961 provides that 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 and subsequently during any previous year, the assessee 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.
The provisions of this section, therefore, come into play only when the assessee has “obtained any amount in respect of such loss or expenditure or some benefit in respect of such trading liability by way of remission or cessation of such liability”.
Explanation 1 to this section, inserted with effect from Assessment Year 1997-98, further provides that 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 assessee by way of writing off such liability in his accounts.
The question has arisen before the courts as to whether any benefit has been obtained in respect of trading liability by way of remission or cessation when a creditor’s balance has remained unpaid and outstanding for a long period of time, though it has not been written back to the profit and loss account, particularly if the recovery of such amount is barred by the law of limitation.
The Delhi High Court has taken two different views of the matter, one in the case of sundry creditors, and the other in the case of unpaid dues of employees. In one case, it has held that the amount is not taxable u/s. 41(1), while in the other, it is held that such outstanding amount of liability is taxable.
Shri Vardhman Overseas’ Case
The issue first came up before the Delhi High Court in the case of CIT vs. Shri Vardhman Overseas Ltd. 343 ITR 408.
In this case, relating to the Assessment Year 2002- 03, the assessee was a company engaged in the manufacture of rice from paddy. It also sold rice after purchasing it from the local market. The Assessing Officer, while verifying the sales and sundry debtors, decided to verify the sundry creditors shown in the books of account. He asked the assessee to submit confirmation letters from the sundry creditors. The assessee did not submit the confirmation letters, on the ground that it was not aware of the present whereabouts of the creditors after a lapse of 4 years, and whatever addresses were available had been given by the suppliers at the time that the purchases were made from them. The assessing officer added the amount of sundry creditors to the assessee’s income.
On appeal, the Commissioner (Appeals) held that the assessee’s conduct clearly showed that the liability shown in the sundry creditors account in its books did not exist. He, therefore, held that the liabilities had ceased to exist, and therefore, the addition made by the assessing officer was held to be justified, but confirmed as taxable u/s. 41(1).
The Tribunal held that since the amounts payable to the sundry creditors were not credited to the profit and loss account for the year but continued to be shown as outstanding as at the end of the year, the tribunal held that the provisions of section 41(1) were not attracted, in the light of the decision of the Supreme Court in the case of CIT v Sugauli Sugar Works (P) Ltd. 236 ITR 518. According to the Tribunal, this decision of the Supreme Court applied with greater force since, in that decision, the assessee had credited the profit and loss account with the amount standing to the credit of the sundry creditors, whereas in the case before the Tribunal, the amounts payable to the sundry creditors were not credited to the profit and loss account for the year and were still shown as outstanding as at the end of the year. The Tribunal, therefore, deleted the addition made by the assessing officer.
Before the Delhi High Court, on behalf of the revenue, attention was drawn to the fact that the assessee itself had admitted that the amount was outstanding for more than 4 years, and therefore, the assessee had obtained a benefit in the course of its business, which was assessable u/s. 41(1). It was argued that it would make no difference that the liabilities were not written back to the profit and loss account for the year under consideration, because what was to be seen was whether the assessee had obtained a benefit in a practical sense. It was claimed that since the amounts remained unpaid for 4 years, there was a reasonable inference that the assessee was no longer liable to pay those parties. According to the revenue, the benefit arose on account of the fact that the debts were more than 3 years old, and were, therefore, not recoverable from the assessee in view of the law of limitation.
It was argued that Explanation 1 to section 41(1) was not relied upon by the revenue, but the writing back of the accounts of the sundry creditors in the profit and loss account was only one of the many unilateral acts which could be done by the assessee, and even in the absence of such a write back, there could be remission or cessation of the trading liability which resulted in a benefit to the assessee.
The Delhi High Court agreed that the Explanation 1 was not applicable, but observed that it must be established that the assessee had obtained some benefit in respect of the trading liability which had earlier been allowed as a deduction. It noted that there was no dispute that the amounts due to the sundry creditors have been allowed in the earlier assessment years as purchases in computing the business income of the assessee. The question was whether by not paying them for a period of 4 years and above, the assessee had obtained some benefit in respect of the trading liability allowed in earlier years. It observed that the revenue’s argument that, non-payment or non-discharge of liability resulted in some benefit in respect of such trading liability in a practical sense or common sense overlooked the words “by way of remission or cessation thereof”. It observed that it was not enough that the assessee should derive some benefit in respect of such trading liability, but it was also essential that such benefit should arise by way of remission or cessation of the liability.
Analysing the meaning of the terms “remission” and “cessation”, the Delhi High Court noted the decision of the Supreme Court in the case of Bombay Dyeing and Manufacturing Company Ltd. vs. State of Bombay AIR 1958 SC 328, where the Supreme Court held that when a debt becomes time-barred, it does not become extinguished, but only unenforceable in a court of law. The Supreme Court had also held that modes in which an obligation under contract becomes discharged were well-defined, and the bar of limitation was not one of them. This was the view also taken by the Supreme Court in the case of Sugauli Sugar Works (supra), which was a case where the credits were outstanding for almost 20 years and were written back by credit to the profit and loss account. The Delhi High Court noted that in the Sugauli Sugar Works case, a contention was advanced before the Supreme Court on behalf of the revenue that since the liability remained unpaid for more than 20 years, there was practically a cessation of the debt, which resulted in a benefit to the assessee, which should be brought to tax u/s. 41(1). This argument was not accepted by the Supreme Court in that case.
The Delhi High Court, therefore, held that, as there was no write back of the accounts of the sundry creditors to the profit and loss account, the amount of outstanding liabilities was not taxable u/s. 41(1).
This decision was followed by the Delhi High Court on the same date in the case of CIT vs. Hotline Electronics Ltd. 205 Taxman 245, taking an identical view.
Chipsoft Technology’s Case
The issue again came up before the Delhi High Court in the case of CIT vs. Chipsoft Technology (P) Ltd. 210 Taxman 173 (Del)(Mag). In this case, relating to assessment year 2006-07, the assessee had outstanding liabilities on account of employee dues, some of which pertained to salary for the Assessment Year 2005-06, and the balance related to earlier years, extending to as far back as Assessment Year 2000-01.
The Assessing Officer called for confirmations from the employees. The assessee was able to furnish confirmations from only 3 employees out of 170 employees whose dues were outstanding. The Assessing Officer held that there was a cessation of the assessee’s liabilities and that he had obtained benefit in respect of these amounts, and he, therefore, added these amounts to the assessee’s income u/s. 41(1).
The Commissioner (Appeals) allowed the assessee’s appeal, holding that the liability was outstanding in the books of account, and that it did not, therefore, amount to cessation of liability. The Tribunal upheld the Commissioner(Appeals) order.
Before the Delhi High Court, on behalf of the Revenue, it was argued that the amount due to 170 employees remained unchanged and static for about 6 or 7 years and no payment was made during the intervening period. It was pointed out that the assessee did not claim that the employees were actively pursuing their claims and had taken any steps to recover their dues. No correspondence with the employees was filed to substantiate its argument that the amount was still outstanding, and even in the assessment proceedings it was unable to furnish full particulars about its employees. It was, therefore, argued that the liability had ceased. It is further argued that even if it was assumed that at some point the liability existed, the lapse of time and the resultant defence available to the assessee under the Limitation Act justified inclusion of these amounts as the income of the assessee on the ground of cessation of liability. It was claimed that the tribunal had not appreciated that the benefit had accrued to the assessee by virtue of the wage liability becoming time-barred.
The Delhi High Court noted the decisions cited on behalf of the revenue in the case of Kesoram Industries and Cotton Mills Ltd vs. CIT 196 ITR 845 (Cal), and in the case of CIT vs. Agarpara Co. Ltd. 158 ITR 78, where the Calcutta High Court had held, in the context of bonus payable to workmen which had remained outstanding for several years, that once bonus had been offered by the employer, but remained undrawn, it cannot be said that the liability subsisted even after the expiry of the time prescribed by the statute, particularly when there was no dispute pending regarding the payment of bonus. The Calcutta High Court had observed that under these circumstances, it may be inferred that unclaimed or unpaid bonus was in excess of the requirement of the assessee, and therefore, to that extent, the liability had ceased.
The Delhi High Court observed that the view that the liability did not cease as long as it is reflected in the books and that mere lapse of the time given to the creditor or the workmen to recover the amount due did not efface the liability though it barred the remedy, was an abstract and theoretical one and did not ground itself in reality. According to the Delhi High Court, interpretation of laws, particularly fiscal and commercial legislation, was increasingly based on pragmatic realities, which meant that even though the law permitted the debtor to take all defences and successfully avoid liability, for abstract dualistic purposes, he would be shown as a debtor. According to the Delhi High Court, it would be illogical to say that the debtor or an employer holding
onto unpaid dues should be given the benefit of his showing the amount as a liability, even though he would be entitled in law to say that the claim for its recovery was time-barred, and continue to enjoy the amount.
The Delhi High Court also observed that Explanation 1 to section 41(1) used the term “shall include” and not the term “means”, which meant that there could be other means of deriving benefits by way of cessation or remission of liability. According to the Delhi High Court, even omission to pay over a period of time and the resultant benefit derived by the employer/assessee would qualify as a cessation of liability, though by operation of law. The Delhi High Court rejected the assessee’s argument that no period of limitation was provided for under the Industrial Disputes Act, by referring to the Supreme Court decision in the case of Nedungadi Bank Ltd. vs. K. P. Madhavankutty AIR 2000 SC 839, when the Supreme Court held that even though no period of limitation had been prescribed under that Act, a stale dispute where the employee approached the forum under the said Act after an inordinate delay could not be entertained, or adjudicated.
The Delhi High Court, therefore, held that there was a benefit derived by the employer by cessation or remission of liability and that the amount of outstanding workmen dues was taxable u/s. 41(1).
Observations
Section 3 of the Limitation Act, 1963 provides that every suit instituted, appeal preferred, and application made after the prescribed period shall be dismissed, although limitation has not been set up as a defence. Section 18(1) of that Act provides that where, before the expiration of the prescribed period for a suit or application in respect of any property or right, an acknowledgment of liability in respect of such property or right has been made in writing signed by the party against whom such property or right is claimed, or by any person through whom he derives his title or liability, a fresh period
of limitation shall be computed from the time when the acknowledgment was so signed.
Therefore, the law of limitation merely bars filing of a suit for recovery of debts beyond the period of limitation. It does not bar payment of such amounts, where the debtor is willing to pay the liability.
As rightly observed by the Delhi High Court in Vardhaman Overseas’ case, as well as by other Courts, including the Supreme Court, the mere fact that recovery of a liability has been barred by limitation does not mean that the liability has ceased to exist. The assessee may still have the intention of paying off the liability, as and when demanded. Under such circumstances, taxing such liability would not be justified. Further, if such liability is subsequently paid off, the assessee would not be able to claim a deduction in the year of payment. Therefore, taxation of such outstanding amount, which is not written back, does not seem to be justified.
The Delhi High Court, in Chipsoft’s case, did not consider various other decisions of its own High Court, where the High Court had observed that disclosure of a liability in its Balance Sheet has the effect of extending the period of limitation, since it amounts to an acknowledgement of debt by the company for the purposes of section 18 of the Limitation Act. Further, it’s attention was also not drawn to its own earlier decisions in the case of Vardhaman Overseas and Hotline Electronics, where it had held that such amounts, suits for recovery of which may be barred by limitation, did not result in a benefit due to cessation or remission of liability.
Given the express observations of the Supreme Court in Bombay Dyeing’s and Sugauli Sugar Works’ cases, to the effect that a remission of a liability can only be granted by a creditor, and a cessation of the liability can only occur either by reason of operation of law, or by the debtor unequivocally declaring his intention not to honour his liability
when payment is demanded by the creditor, or by a contract between the parties or by discharge of the debt, the Delhi High Court does not seem justified in preferring to follow decisions of another High Court in preference to the decisions of the Supreme Court.
In Chipsoft’s case, the Delhi High Court relied to a great extent on the decisions of the Calcutta High Court in Agarpara’s and Kesoram’s cases. If one looks at the logic behind Agarpara’s case, it proceeds on the footing that the unpaid provision for bonus was an excess provision than that required under the law, and that it was, therefore, no longer
payable. Kesoram’s case dealt with unpaid wages, which were written back to the Profit & Loss Account. Following Agarpara’s case, the Calcutta High Court in Kesoram’s case held that considering the facts that the employer himself came to the conclusion that the unpaid amount of wages would not be claimed by the concerned employees, that it proceeded to forfeit such amount and wrote it back to the credit of the Profit & Loss Account, the reasonable inference that would follow from these facts and circumstances and the conduct of the assessee was that the amount which was provided for was not necessary and was an excess provision.
These facts were not present in Chipsoft’s case, as neither the employer had credited the amounts to the Profit & Loss Account nor were there any actions of the assessee to indicate that such amounts were no longer payable. In Chipsoft’s case, it was not proved by the revenue that such provision was an excess provision. Therefore, the application of the ratio of Agarpara’s and Kesoram’s cases to Chipsoft’s case does not seem to have been justified.
The decision of the Bombay High Court in the case of Kohinoor Mills Ltd. vs. CIT 49 ITR 578, which was also a case dealing with unpaid wages, though these were written back to the Profit & Loss Account, was not brought to the attention of the Delhi High Court. The Bombay High Court, in that case, held:
“Where wages are payable but they are unclaimed and their recovery is barred by limitation, the position in law is that the debt subsists, notwithstanding that its recovery is barred by limitation. There is in such a case no ‘cessation of trading liability’ within the meaning of section 10(2A) and the amount of such wages cannot be added to the income.”
This view had been also confirmed by the Bombay High Court in the case of J. K. Chemicals Ltd. vs. CIT 62 ITR 34.
It also needs to be kept in mind that Explanation 1 to section 41(1) was inserted to expressly cover amounts written back by credit to the Profit & Loss Account. If the intention was to cover all liabilities outstanding beyond the period of limitation or beyond a particular period of time, whether written back or not, the explanation would have read differently. It would have provided for the specific year in which such debt, barred by limitation, is deemed to be income.
The view taken by the Delhi High Court in Vardhaman Overseas’ case, that such long outstanding amounts continuing as liabilities in the accounts, cannot be taxed u/s. 41(1), therefore, seems to be the better view of the matter.
