2. Section 41 (1) – Omission on part of the assessee
to pay off a trading liability – can be construed as an unilateral act on part
of assessee as not to pay – cessation of liability may be said to result
–addition of unpaid trade liability justified u\s 41 (1).
Decision of Delhi High Court in the case of CIT vs. Chipsoft Technology (P) Ltd – 26 taxmann.com 109 (Delhi)
2.1. The assessment year involved in this case is A.Y. 2006-07. The facts of the case are that the assessee had shown in its accounts unpaid liability on account of its employees’s dues. Out of this, a part pertained to
salary for the year 2005-06 and the balance pertained to the previous years, some extending to as far back in period as 2000-01. The Assessing Officer held that there was a cessation of assessee’s liability and added the amount invoking the provisions of section 41(1). The assessee succeeded in the appeals before Commissioner (Appeals) and the Tribunal.
2.2. In the appeal filed by the Income Tax Department, the following question of law was posed before the Delhi High Court:-
"Did the Tribunal fall into error of law, in its impugned judgment in setting aside the disallowance of Rs. 32, 28,724/- towards unpaid liability claimed in respect of salaries of the assessee for the assessment year 2006-07?"
2.3. Before the High Court, it was contended that there was cessation of the liability by operation of law and that therefore, there was no case for making an addition u\s 41 (1).
The High Court has however rejected the assessee’s arguments and upheld the addition made by the Assessing Officer with the following findings:-
“Two aspects are to be noticed in this context. The first is the view that liability does not cease as long as it is reflected in the books, and that mere lapse of the time given to the creditor or the workman, to recover the amounts due, does not efface the liability, though it bars the remedy. This view is an abstract and theoretical one, and does not ground itself in reality.
Interpretation of laws, particularly fiscal and commercial legislation is increasingly based on pragmatic realities, which means that even though the law permits the debtor to take all defences, and successfully avoid liability, for abstract juristic purposes, he would be shown as a debtor. In other words, 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.
The second reason why the assessee’s contention is unacceptable is because with effect from 1-4-1997 by virtue of the Finance Act, 1996 (No.2), an Explanation was added to section 41 which spells out that ‘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 first mentioned person under clause’. The expression ‘include’ is significant; Parliament did not use the expression ‘means’. Necessarily, even omission to pay, over a period of time, and the resultant benefit derived by the employer/assessee would therefore qualify as a cessation of liability, albeit by operation of law.
The submission of the assessee that no period of limitation is provided for under the Industrial Disputes Act, as a result of which it is exposed to liability at any time, is insubstantial and unpersuasive”.
2.4. The decision has come indeed come as a shocker to all. Generally, cessation of liability was understood to be an outcome of an operation of law. Also, when the assessee writes back the trading liability in his books, his conduct would draw a presumption of cessation of liability against him. But, this is the first case where an alleged omission to pay over a period of time has be construed as resulting in cessation of liability.
I am not commenting on the correctness of this decision. One should expect the Income Tax Department to take recourse to this decision to make additions u\s 41 (1) in several cases in the future.
2.5. But, the point I wish to put forward to the Readers is on a different lines. In order to invoke the provisions of section 41 (1), it is not enough that the Income Tax Department shows that that the trade liability has ceased. It is further essential that that the cessation is proved to be in the year under assessment only. Since it is the Income Tax Department who is alleging the cessation, the onus lies on it to specifically show that the event of cessation has taken place in the year under assessment. Merely because in the course of assessment, a long outstanding liability is found unpaid, it does mean that that the cessation has taken place in that year itself. It could be in any prior year as matter of fact. While the issue of cessation of trade liability frequently appears in litigations, the issue of the year of cessation rarely figures.
Even in the Delhi High Court decision, the question of year of cessation was not before the High Court and what was involved in question was only whether there was a cessation or not. Therefore, even based on this decision, if an act of omission to pay a trade liability is inferred on assessee in assessment, there still remains on the Income Tax Department the burden of further showing that the alleged act had taken place in the year under assessment only in order to successfully support its addition u\s 41 (1). It may be noted that a decision of a High Court is a precedent only on the question answered by it and not on an issue which was not before it for consideration.
Decision of Delhi High Court in the case of CIT vs. Chipsoft Technology (P) Ltd – 26 taxmann.com 109 (Delhi)
2.1. The assessment year involved in this case is A.Y. 2006-07. The facts of the case are that the assessee had shown in its accounts unpaid liability on account of its employees’s dues. Out of this, a part pertained to
salary for the year 2005-06 and the balance pertained to the previous years, some extending to as far back in period as 2000-01. The Assessing Officer held that there was a cessation of assessee’s liability and added the amount invoking the provisions of section 41(1). The assessee succeeded in the appeals before Commissioner (Appeals) and the Tribunal.
2.2. In the appeal filed by the Income Tax Department, the following question of law was posed before the Delhi High Court:-
"Did the Tribunal fall into error of law, in its impugned judgment in setting aside the disallowance of Rs. 32, 28,724/- towards unpaid liability claimed in respect of salaries of the assessee for the assessment year 2006-07?"
2.3. Before the High Court, it was contended that there was cessation of the liability by operation of law and that therefore, there was no case for making an addition u\s 41 (1).
The High Court has however rejected the assessee’s arguments and upheld the addition made by the Assessing Officer with the following findings:-
“Two aspects are to be noticed in this context. The first is the view that liability does not cease as long as it is reflected in the books, and that mere lapse of the time given to the creditor or the workman, to recover the amounts due, does not efface the liability, though it bars the remedy. This view is an abstract and theoretical one, and does not ground itself in reality.
Interpretation of laws, particularly fiscal and commercial legislation is increasingly based on pragmatic realities, which means that even though the law permits the debtor to take all defences, and successfully avoid liability, for abstract juristic purposes, he would be shown as a debtor. In other words, 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.
The second reason why the assessee’s contention is unacceptable is because with effect from 1-4-1997 by virtue of the Finance Act, 1996 (No.2), an Explanation was added to section 41 which spells out that ‘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 first mentioned person under clause’. The expression ‘include’ is significant; Parliament did not use the expression ‘means’. Necessarily, even omission to pay, over a period of time, and the resultant benefit derived by the employer/assessee would therefore qualify as a cessation of liability, albeit by operation of law.
The submission of the assessee that no period of limitation is provided for under the Industrial Disputes Act, as a result of which it is exposed to liability at any time, is insubstantial and unpersuasive”.
2.4. The decision has come indeed come as a shocker to all. Generally, cessation of liability was understood to be an outcome of an operation of law. Also, when the assessee writes back the trading liability in his books, his conduct would draw a presumption of cessation of liability against him. But, this is the first case where an alleged omission to pay over a period of time has be construed as resulting in cessation of liability.
I am not commenting on the correctness of this decision. One should expect the Income Tax Department to take recourse to this decision to make additions u\s 41 (1) in several cases in the future.
2.5. But, the point I wish to put forward to the Readers is on a different lines. In order to invoke the provisions of section 41 (1), it is not enough that the Income Tax Department shows that that the trade liability has ceased. It is further essential that that the cessation is proved to be in the year under assessment only. Since it is the Income Tax Department who is alleging the cessation, the onus lies on it to specifically show that the event of cessation has taken place in the year under assessment. Merely because in the course of assessment, a long outstanding liability is found unpaid, it does mean that that the cessation has taken place in that year itself. It could be in any prior year as matter of fact. While the issue of cessation of trade liability frequently appears in litigations, the issue of the year of cessation rarely figures.
Even in the Delhi High Court decision, the question of year of cessation was not before the High Court and what was involved in question was only whether there was a cessation or not. Therefore, even based on this decision, if an act of omission to pay a trade liability is inferred on assessee in assessment, there still remains on the Income Tax Department the burden of further showing that the alleged act had taken place in the year under assessment only in order to successfully support its addition u\s 41 (1). It may be noted that a decision of a High Court is a precedent only on the question answered by it and not on an issue which was not before it for consideration.
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