High Court Rejects Tax Addition on Old Sundry Creditors, Citing Lack of Liability Cessation

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Case Name:

Principal Commissioner of Income Tax Vs Matruprasad C. Pandey (High Court of Gujarat)

Tax Appeal No. 192 of 2015

Key Takeaways:

1. Additions under Section 41(1) require proof of remission or cessation of liability during the relevant assessment year.

2. Long-standing sundry creditors cannot be automatically assumed as ceased liabilities for tax purposes.

3. The court emphasized the importance of following proper procedures in verifying the genuineness of creditors.

Issue:

Can the Income Tax Department add back old sundry creditors to taxable income under Section 41(1) of the Income Tax Act without proving remission or cessation of liability?

Facts:

1. The assessee's balance sheet showed sundry creditors amounting to Rs.1,97,72,289/-.

2. The Assessing Officer found 10 sundry creditors with outstanding liabilities that were very old, some dating back to 2001-2002.

3. The assessee failed to provide details such as address, PAN number, and confirmation for these creditors when asked.

4. The Assessing Officer treated Rs.56,51,645/- as no longer payable and added it to the total income under Section 41(1) of the Act.

Arguments:

1. Revenue's Argument:

The assessee's failure to furnish complete identity and creditworthiness of the creditors justifies the addition under Section 41(1).

2. Assessee's Argument:

The sundry creditors have been shown in the balance sheet for several years, and there was no remission or cessation of liability during the relevant assessment year.

Key Legal Precedents:

1. CIT Vs. Nitin S. Garg (22 Taxman 59 (Guj))

2. CIT Vs. Bhogilal Ramjibhai Atara (Tax Appeal No. 588/2013)

These cases established that Section 41(1) applies only when there is a remission or cessation of liability during the relevant assessment year.

Judgement:

1. The High Court dismissed the appeal by the Income Tax Department.

2. The court held that the addition under Section 41(1) cannot be made unless there is proof of remission or cessation of liability during the relevant assessment year.

3. The court agreed with the ITAT's decision to delete the addition of Rs. 56,96,645/- made under Section 41(1).

4. The court also upheld the ITAT's decision to remand the issue of unexplained labor charges to the CIT(A) for fresh consideration.

FAQs:

Q1: What is Section 41(1) of the Income Tax Act?

A1: Section 41(1) deals with the taxation of remission or cessation of trading liabilities.

Q2: Can old sundry creditors be automatically added to taxable income?

A2: No, the court clarified that merely because liabilities are outstanding for many years, it cannot be inferred that they have ceased to exist.

Q3: What proof is required for an addition under Section 41(1)?

A3: The tax authorities must prove that there has been a remission or cessation of liability during the relevant assessment year.

Q4: What happens if the creditors themselves are found to be non-genuine?

A4: The court noted that even if the debt is found to be non-genuine from the beginning, Section 41(1) may not apply if there's no proof of cessation or remission in the relevant year.

Q5: What was the outcome for the other additions made by the Assessing Officer?

A5: The court upheld the ITAT's decision to remand the issue of unexplained labor charges to the CIT(A) for fresh consideration.

[1.0] As common question of law and facts arise in both these Tax Appeals they are disposed by this common order.

[2.0] Feeling aggrieved and dissatisfied with the impugned judgment and order passed by the learned Income Tax Appellate Tribunal, Ahmedabad “D” Bench (hereinafter referred to as “the Tribunal”) dated 17/10/2014 in ITA No.190/Ahd/2011 for the Assessment Year 2007-08, the revenue has preferred Tax Appeal No.192/2015 with the following substantial questions of law;

(A) Whether in the facts and circumstances of the case, the learned ITAT has erred in law in deleting the addition of Rs.56,96,645/- made by the Assessing Officer as confirmed by CIT(A) under Section 41(1) of the Income Tax Act?

(B) Whether in the facts and circumstances of the case, the learned ITAT has erred in law and on facts in restoring the ground relating to giving the benefit of telescoping effect to the addition of Rs.56,96,641/- made under Section 41(1) and Rs.11,01,381/- under Section 68 of the Act against the addition of unexplained labour charges of Rs.25,65,634/-?

(C) Whether in the facts and circumstances of the case, the learned ITAT has erred in law and on facts by restoring the grounds raised by assessee to the file of CIT(A) for deciding afresh on the issues of-

(i) The addition of Rs.25,65,634/- being 15% of the labour charges legitimately incurred and debited to the profit and loss account and confirmed by the CIT(A);

(ii) The CIT(A) giving the benefit of telescoping of the additions of Rs.56,96,645/- and Rs.11,01,381/- against the addition of Rs.25,65,634/-?

[3.0] Feeling aggrieved and dissatisfied with the impugned judgment and order dated 17/10/2014 passed by the learned Tribunal in ITA No.362/Ahd/2011 for the Assessment Year 2007-08, the revenue has preferred Tax Appeal No.193/2015 with the following proposed substantial questions of law;

(A) Whether in the facts and circumstances of the case, the learned ITAT has erred in law in restoring the ground raised by the Revenue to file of CIT(A) for deciding afresh on issue of deleting the addition of Rs.25,65,634/- made by the Assessing Officer under Section 41(1) and under Section 68 of the Act?

(B) Whether in the facts and circumstances of the case, the learned ITAT has erred in law in not allowing the appeal of the department against the order of CIT(A) directing to give telescoping effect to additions made under Sections 41(1) and 68 of the Act against the addition of unexplained labour charges of Rs.25,65,634/-?

[4.0] The assessee filed the return of income for the Assessment Year 2007-08 showing the total income of Rs.3,95,580/-. The return was duly processed under Section 143(1) of the Income Tax Act (hereinafter referred to as “the Act”). The case was selected for scrutiny and notice under Section 143(2) of the Act was issued. Thereafter, notice under Section 142(1) of the Act alongwith a detailed questionnaire was issued and duly served upon the assessee. On verification of the balance sheet, it was noticed that the assessee had shown sundry creditors amounting to Rs.1,97,72,289/-. The assessee was required to furnish copy of the ledger account of the last three years of the persons against whom sundry creditors were appearing in the balance sheet alongwith complete name, address, PAN and conformation thereof. The assessee failed to produce the breakup of the amounts appearing in the balance sheet. The assessee did not furnish the details asked for and, therefore, show cause notice came to be issued on 20/11/2009 as under;

“Vide point No.3 of this office show cause notice dated 03/11/2009, you were required to furnish confirmation, name, address and PAN of the persons against whom sundry creditors of Rs.1,97,72,289/- were reflected in your balance sheet as on 31/03/2007. Thereafter, your A.R. Shri Omkar Mishra attended before the undersigned on 03/11/2009, 12/11/2009 and 17/11/2009 but failed to produce the details as called for. Please note that if you failed to produce the details as called for on the next date of hearing, the credit of Rs.1,97,72,289/- appearing in the balance sheet will be added to your total income as unexplained credit.”

[4.1] It was found by the Assessing Officer that in the case of 10 sundry creditors the outstanding liability of the sundry creditors was very old. The particulars of the same are under;

LIST OF SUNDRY CREDITORS 2006-2007 No. Name Year since pending /payable

Amount

1. H.R. Enterprise 02-03 644282

2. Jay Construction 02-03 45213

3. Rane Builders 02-03 63808

4. Rent received in advance Not furnished 217350

5. Sharddha Construction 04-05 1297477

6. Sigma Electricals 05-06 836805

7. S J Communication 02-03 255509

8. S J Communication 02-03 1324825

9. Torrent Communication 01-02 110277

10. Deversh Associates 01-02 856099

TOTAL 5651645

The assessee was asked to furnish complete identity, creditworthiness of the creditors. However, the assessee failed to furnish any details regarding the above. The Assessing Officer found that some of the balances were pending from F.Y. 2001-2002 and 2002-2003. As the assessee failed to produce the address, PAN number and conformation of the aforesaid parties, the Assessing Officer found that the aforesaid amount of Rs.56,51,645/- was no longer payable and the payment has reached at cessation stage and, therefore, longstanding sundry creditors amounting to Rs.56,51,645/- was treated as no longer payable / cessation of liability under Section 41(1) of the Act and the same was added to the total income. During the course of the assessment it was noticed by the Assessing Officer that the assessee had debited the amount of Rs.1,71,04,226/-, being the labour charges. The assessee was called upon to produce the evidences in support of the expenditure debited in the Profit & Loss Account, which the assessee failed to produce. The Assessing Officer disallowed 15% of the labour charges of Rs.1,71,04,766/- by observing that it is quite possible that the assessee had not executed the major portion of the alleged work but it was only as accommodating contract entity for inflation of the expenses of one of the main contractor and consequently added Rs.25,65,634/- to the total income of the assessee.

[4.2] Feeling aggrieved and dissatisfied with the order passed by the Assessing Officer in making the addition of Rs.56,96,645/- under Section41(1) of the Income Tax Act and the addition of Rs.25,65,634/-, being 15% of the labour charges as unexplained expenditure, the assessee preferred appeal before the learned CIT(A) and the learned CIT(A) partly allowed the appeal, however confirming the action of the Assessing Officer in making the addition of Rs.56,96,645/- by invoking Section 41(1) of the Act and also confirming the action of the Assessing Officer in making the addition of Rs.11,01,381/- under Section 68 of the Income Tax Act in respect of capital account from sale of mango orchard affected by an independent partnership firm in which the assessee was one of the partner. The learned CIT(A) has also confirmed the action of the Assessing Officer in making the addition of Rs.25,65,634/-, being 15% of the labour charges, which comes to Rs.1,71,04,226/-, however, the learned CIT(A) deleted the addition of Rs.25,65,634/- made by the Assessing Officer under Section 41(1) and 68 of the Act.

[4.3] Feeling aggrieved and dissatisfied with the order passed by the learned CIT(A), both the revenue as well as the assessee preferred appeals before the learned Tribunal. By the impugned judgment and order, the learned Tribunal has partly allowed the appeal of the assessee by deleting the addition of Rs.56,96,645/- in respect of outstanding credit balances of certain parties brought forward from earlier years by invoking Section41(1) of the Act. So far as the order passed by the learned CIT(A) confirming the action of the Assessing Officer in making the addition of Rs.25,65,634/-, being 15% of the labour charges is concerned, the learned Tribunal restored the issue to the file of the learned CIT(A) with a direction to decide the same afresh in accordance with law and after providing reasonable opportunity of hearing to the assessee. Consequently, the learned Tribunal also disposed of the appeal preferred by the revenue / allowed the appeal preferred by the revenue for statistical purpose.

[4.4] Feeling aggrieved and dissatisfied with the impugned common judgment and order passed by the learned Tribunal in ITA No.190/Ahd/2011 and ITA No.362/Ahd/2011 for the Assessment Year 2007-08, the revenue has preferred the present Tax Appeals with the aforesaid proposed substantial questions of law.

[5.0] Shri Varun Patel, learned advocate appearing on behalf of the revenue has vehemently submitted that the learned Tribunal has materially erred in deleting the addition of Rs.56,96,645/- made by the Assessing Officer confirmed by the learned CIT(A) under Section 41(1) of the Act.

[5.1] It is submitted that in the present case during the course of the assessment proceedings, the Assessing Officer observed certain liabilities (sundry creditors) amounting to Rs.56,96,645/- in the balance sheet of the assessee, which were very old. It is submitted that though the assessee was given an opportunity to furnish complete identity, creditworthiness of the creditors etc. by the Assessing Officer and the CIT(A), the assessee had failed to do so. It is submitted that even the assessee also failed to produce the address, PAN number and conformation of the said sundry creditors. It is submitted that under the circumstances when the Assessing Officer made the addition of Rs.56,96,645/- under Section 41(1) of the Act, the learned Tribunal is not justified in deleting such addition.

[5.2] It is submitted that the learned Tribunal has materially erred in relying upon the decision of this Court in the case of CIT Vs. Nitin S. Garg rendered in 22 Taxman 59 (Guj) as well as the decision dated 04/02/2014 in the case of CIT Vs. Bhogilal Ramjibhai Atara in Tax Appeal No.588/2013 since the facts and circumstances of the present case are completely different than that of the aforesaid cases. It is submitted that as such there is no absolute proposition of law in the aforesaid decision. The addition under Section 41(1) of the Act cannot be made if the assessee had written off the credit balance of the party brought forward from the earlier years. It is submitted that therefore the impugned judgment and order passed by the learned Tribunal is erroneous and untenable in law.

[5.3] It is further submitted by Shri Patel, learned advocate appearing on behalf of the revenue that in the facts and circumstances of the case, the learned Tribunal has erred in law and on facts in restoring the ground relating to giving benefit of telescopic effect to the addition of Rs.56,96,645/- made under Section 41(1) of the Act and Rs.11,01,381/- under Section 68 of the Act against the addition of unexplained labour charges of Rs.25,65,634/-. It is submitted that as such the learned Tribunal has failed to give independent reasons for restoring the same to the file of the CIT(A) with a direction to decide the same afresh in accordance with law. Making the above submissions, it is requested to admit / allow the present Tax Appeals.

[6.0] Heard Shri Varun Patel, learned advocate appearing on behalf of the revenue at length. We have perused and considered the assessment order, the order passed by the learned CIT(A) as well as the impugned judgment and order passed the learned Tribunal.

[6.1] At the outset, it is required to be noted that the Assessing Officer made the addition of Rs.56,96,645/- invoking Section 41(1) of the Income Tax Act by doubting certain sundry creditors amounting to Rs.56,96,645/- appearing in the balance sheet of the assessee since past several years. However, it is required to be noted that as such those sundry creditors mentioned in the balance sheet of the assessee were shown as sundry creditors since past several years from the relevant assessment year and at no point of time earlier the Assessing Officer doubted the creditworthiness and / or identity. In any case the addition on the aforesaid ground under Section 41(1) of the Act cannot be made unless and until it is found that there was remission and / or cessation of the liability that too during the previous year, relevant to the assessment year in question, there cannot be any addition invoking the provision of Section 41(1) of the Act. Identical question came to be considered by the Division Bench of this Court in the case of Nitin S. Garg (Supra) and in the similar set of facts and circumstances of the case when the addition was made invoking Section 41(1) of the Act by doubting the creditworthiness and / or identity of the sundry creditors mentioned in the balance sheet and it was found that those sundry creditors were very old and no interest had been paid on those loans, the Division Bench has deleted such addition made under Section 41(1) of the Act. In paragraph 15 the Division Bench has observed and held as under;

“15. In the case before us, it is not been established that the assessee has written off the outstanding liabilities in the books of account. The Appellate Tribunal is justified in taking the view that as assessee had continued to show the admitted amounts as liabilities in its balance sheet the same cannot be treated as assessment of liabilities. Merely because the liabilities are outstanding for last many years, it cannot be inferred that the said liabilities have seized to exist. The Appellate Tribunal has rightly observed that the Assessing Officer shall have to prove that the assessee has obtained the benefits in respect of such trading liabilities by way of remission or cessation thereof which is not the case before us. Merely because the assessee obtained benefit of reduction in the earlier years and balance is carried forward in the subsequent year, it would not prove that the trading liabilities the assessee have become non existent.

[6.2] The aforesaid decision of the Division Bench in the case of Nitin S. Garg (Supra) has been considered and followed by the Division Bench of this Court in the case of Bhogilal Ramjibhai Atara (Supra) and the addition made under Section 41(1) of the Act in the similar facts and circumstances of the case is ordered to be deleted. In paragraph 8 the Division Bench has observed and held as under;

“We are in agreement with the view of the Tribunal. Section 41(1) of the Act as discussed in the above three decisions would apply in a case where there has been remission or cessation of liability during the year under consideration subject to the conditions contained in the statute being fulfilled. Additionally, such cessation or remission has to be during the previous year relevant to the assessment year under consideration. In the present case, both elements are missing. There was nothing on record to suggest there was remission or cessation of liability that too during the previous year relevant to the assessment year 2007-08 which was the year under consideration. It is undoubtedly a curious case. Even the liability itself seems under serious doubt. The Assessing Officer undertook the exercise to verify the records of the so called creditors. Many of them were not found at all in the given address. Some of them stated that they had no dealing with the assessee. In one or two cases, the response was that they had no dealing with the assessee nor did they know him. Of course, these inquiries were made ex parte and in that view of the matter, the assessee would be allowed to contest such findings. Nevertheless, even if such facts were established through bi-parte inquiries, the liability as it stands perhaps holds that there was no cessation or remission of liability and that therefore, the amount in question cannot be added back as a deemed income under section 41(c) f the Act. This is one of the strange cases where even if the debt itself is found to be non- genuine from the very inception, at least in terms of section 41(1) of the Act there is no cure for it. Be that as it may, insofar as the orders of the Revenue authorities are concerned, the Tribunal not having made any error, this Tax Appeal is dismissed.”

In the present case there was no remission and / or cessation of the liability during the previous year relevant to the assessment year under consideration. As such, there is no remission and / or cessation of the liability during the year under consideration subject to the conditions contained in the statute being fulfilled. In the present case, both the aforesaid elements are missing.

[7.0] Under the circumstances, as such, no error has been committed by the learned Tribunal in deleting the additions made under Section 41(1) of the Act. The proposed substantial questions of law (A) and (B) with respect to deleting the addition made under Section 41(1) of the Act are answered against the revenue.

[8.0] Now so far as the other two questions in restoring the grounds raised by the learned Tribunal with respect to the additions made under Section 68 of the Act of unexplained labour charges of Rs.25,65,634/- is concerned, it is required to be noted that as such the entire issue is remanded by the learned Tribunal to the file of the learned CIT(A) and the matter is remanded to the learned CIT(A). Under the circumstances, with respect to the above, no interference of this Court is called for, as the entire issue with respect to the same would be at large before the learned CIT(A).

[9.0] In view of the above and for the reasons stated hereinabove, both the Appeals fail and they deserve to be dismissed and are accordingly dismissed.

(M.R. SHAH, J.)

(S.H. VORA, J.)