Section 41(1) — Remission or Cessation of Trading Liability — On settlement of dispute the cost of machinery had reduced by two crore — Depreciation allowed in earlier years on two crore cannot be taxed u/s.41(1) or 41(2).

Section 41(1) — Remission or Cessation of Trading Liability — On settlement of dispute the cost of machinery had reduced by two crore — Depreciation allowed in earlier years on two crore cannot be taxed u/s.41(1) or 41(2).

The assessee company was carrying on the business of manufacturing of steel tubes. In its assessment, the Assessing Officer observed that as per disclosure in the Notes of Accounts, the auditors had stated that by virtue of settlement of dispute with Tata SSL Ltd., the cost of machinery was reduced by Rs.2crore and the excess depreciation that was claimed on these Rs.2 crore in the earlier years had been adjusted in current year’s depreciation.

The Assessing Officer issued a show-cause notice demanding an explanation as to why the depreciation allowed in the earlier years should not be added back u/s.41(1).

 In response to the above notice the assessee furnished an explanation stating that section 41(1) was applicable in respect of trading liabilities. Not satisfied with assessee’s reply, the Assessing Officer treated Rs.2 crore as income u/s.41(1).

On appeal, the Commissioner (Appeals) confirmed the decision of the Assessing Officer. On second appeal, the Tribunal held as follows.

Held:

 It is clear from the reading of section 41(1) that where any allowance or deduction has been made in the assessment year in respect of loss, expenditure or trading liability incurred and subsequently the assessee, during any previous year, has obtained/ recovered such loss, expenditure or trading liability by way of remission or cessation thereof, the amount obtained by him, shall be deemed to be the income of that previous year. However the purpose of having section 41(2) in addition to section 41(1) implies that depreciation is neither loss nor expenditure nor a trading liability as referred to in section 41(1). It is only remission of liability incurred on capital goods. Hence the benefit of depreciation obtained by the assessee cannot be termed as an allowance or expenditure claimed by him and therefore will not be taxed u/s.41(1). The alternate contention of Revenue was that amount in question could be brought to tax u/s.41(2) and the same was also not upheld. (However the depreciation claimed by the assessee on Rs.2 crore was taxed u/s.28(iv) as value of benefit arising from business.)