S. 41(1): Liability outstanding for long period of time is assessable as income (despite no write-back in A/cs) if assessee is unable to prove genuineness of liability

ITO vs. Shailesh D. Shah/ Yusuf R Tanwar vs. ITO (ITAT Mumbai)

The assessee, engaged in the business of civil construction and labour contractor, had an amount of Rs. 86.25 lakhs shown as outstanding labour charges in his balance sheet that had remained unpaid for more than three years. The AO held that the fact that the amount was outstanding for so many years was abnormal. As the assessee was unable to give the addresses and labour bills of the labourers, he held that the assessee had failed to prove the genuineness of the liability and that it had ceased to exist. He therefore assessed the said sum as income u/s 41(1). On appeal, the CIT(A) reversed the AO on the ground that the fact that the amount was outstanding for a long period and that the assessee was unable to furnish confirmations did not mean that there was a remission or cessation of liability during the assessment year so as to attract s. 41(1). On appeal by the department to the Tribunal HELD allowing the appeal:

It is very improbable that payments to labour can remain outstanding for more than three years. The assessee has not been able to produce the records relating to the name, addresses and bills of the labour etc to prove that the liability continues to exist. It is accordingly a case of cessation of liability. The assessee has just continued the entry of the same in his books of account without any intention to pay back the same. The view that such sums shown as liability is assessable to tax is sanctioned byChipsoft Technology 210 Taxman 173 (Del) (attached) where the view was taken that it would be illogical to say that a debtor or an employer, holding on to 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 a claim for its recovery is time barred, and continue to enjoy the amount. This view is not contrary to the view taken in Vardhaman Overseas Ltd 343 ITR 408 (Del) where the law was laid down that s. 41(1) does not apply if the amount of liability is not written back in the accounts. If both judgements are read in harmony, it can be observed that the assessee cannot be allowed to show an amount as a liability even though he has no intention to pay it back but to enjoy the same for an unlimited period without being added to his income only on the excuse that he has not written off the same in his books of accounts. However, if the facts of the case establish that the liability has been genuinely shown by the assessee and his subsequent conduct shows that he has paid back the said credits and his intention was not to enjoy the amount for unlimited period without any intention to pay back the same, then it cannot be said to be a case of cessation of liability. On facts, not only is the existence of outstanding liability of labour charges for so many years improbable in the normal course of business but the assessee has also failed to give any evidence regarding the identity & genuineness of the creditors. Accordingly it is a case of cessation of liability and s. 41(1) applies (Yusuf R. Tanwar vs. ITOfollowed (attached)).

Note: The view in Chipsoft Technology that an outstanding liability can be assessed as income u/s 41(1) is contrary to Vardhaman Overseas Ltd where it was held (after considering Sugauli Sugar Works 236 ITR 518 (SC)) that s. 41(1) does not apply in the absence of a write-back of the liability (one of the judges (Easwar J.) is common). Also, the view taken in Chipsoft is contrary (as noted in that judgement itself) to the law laid down in J.K. Chemicals Ltd 62 ITR 34 (Bom),Sadabhakti Prakashan 125 ITR 326 (Bom), etc, that the mere fact that an amount is outstanding for a long time does not mean that there is a remission or cessation of liability. Also, it is not clear how the amount is assessable in the present AY given that there is no event of the year.