Commissioner Of Income-Tax v. Pre-Stressed Concrete Co. (S.I) P. Ltd.

1. The assessee-company carried on the business of consulting engineers. In the assessment for the year 1970–71, corresponding to the previous year ending with March 31, 1970, the assessee returned a loss of Rs. 2,25,815. This sum included a sum of Rs. 2,09,993 which was shown as royalty outstanding and payable to a foreign company. The total amount of royalty which was payable at the end of the accounting year 1963–64 was Rs. 4,74,918 out of which a sum of Rs. 2,64,926 had been paid. The last payment was made on April 24, 1964, in the sum of Rs. 30,000. Subsequent to the accounting year 1963–64, no royalty was payable by the assessee, as there was no manufacture of cones which was the product for which royalty was to be paid. The foreign company had also neither asked nor taken any steps to recover the balance of royalty which was shown as due to the foreign company. The Income-tax Officer taking the view that the outstanding liability had, for all intents and purposes, ceased, added this amount and completed the assessment.

2. On appeal, the Appellate Assistant Commissioner took the view that the royalty was payable to the foreign collaborator, which was a French company, and there was no evidence of any remission or cessation of a trading liability and accordingly deleted the addition.

3. The Revenue took the matter in appeal to the Tribunal. The Tribunal took the view that there was no evidence to show as to why it should be considered as a remission or cessation in the assessment year in question and that the acknowledgment of the liability in the balance-sheet would suffice to stamp it with the character of a liability and, therefore, the amount representing that liability could not be added back under section 41(1) of the Income-tax Act, 1961. The Tribunal having dismissed the appeal of the Revenue, the following two questions have been referred to this court for its opinion at the instance of the Revenue:

“1. Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that the sum of Rs. 2,09,993 being the unpaid royalties to the foreign collaborator should not be brought to tax under section 41(1) of the Income-tax Act, 1961?

2. Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that there was no cessation of liabilities to the extent of Rs. 2,09,993 to the assessee in view of the bar of limitation and the benefit accrued to the assessee as a result of such cessation was not liable to be taxed under section 41(1) of the Income-tax Act, 1961, for the assessment year 1970–71?”

4. The decision of both the questions depends on whether the sum of Rs. 2,09,993 could be treated as an amount in respect of which the liability had ceased within the meaning of section 41(1) of the Income-tax Act. Both the questions can, therefore, be dealt with together.

5. Learned counsel appearing on behalf of the Revenue has relied on a decision of the Gujarat High Court in CIT v. Hides & Leather Products Pvt. Ltd., 101 ITR 61, in support of the proposition that no steps having been taken by the foreign company for the recovery of the amount, which was shown as due on account of the royalty, the liability shown in the balance-sheet must be treated as having ceased. Learned counsel contended that once there is a cessation of liability and this cessation must be inferred from the fact that the foreign company has not taken any steps to recover the amount of royalty, the trading liability must be held to have ceased and the amount of royalty has to be added back as income under section 41(1) of the Income-tax Act, 1961. The relevant part of section 41(1) of the Income-tax Act, 1961, in so far as the facts of the present case are concerned, will read as follows:

“41. (1) Where an allowance or deduction has been made in the assessment for any year in respect of…………………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…………………………some benefit in respect of such trading liability by way of remission or cessation thereof, the amount obtained by him or the value of benefit accruing to him, shall be deemed to be profits and gains of business or profession and accordingly chargeable to income-tax as the income of that previous year, whether the business or profession in respect of which the allowance or deduction has been made is in existence in that year or not.”

6. A reading of section 41(1) of the Income-tax Act, 1961, will show that certain conditions must be fulfilled before the Revenue can resort to section 41(1) of the Act. These conditions are:

(1) in the assessment of an assessee an allowance or deduction has been made in respect of any loss, expenditure or trading liability incurred by him;

(2) any amount is obtained in respect of such loss or expenditure or any benefit is obtained in respect of such trading liability by way of remission or cessation thereof;

(3) the amount or benefit must be obtained by the assessee; and

(4) the amount or benefit is obtained in a subsequent year.

7. The principal condition which has to be satisfied before section 41(1) of the Act is invoked by the Revenue, in so far as the instant case is concerned, is that it must be established that the assessee has obtained a benefit in respect of the trading liability of Rs. 2,09,993 by way of remission or cessation of a trading liability. It is not the case of the Revenue that there is any remission by the foreign company in respect of the trading liability. The case of the Revenue which was canvassed before the Tribunal and which is also canvassed in this court, is that there is a cessation of the trading liability. As a matter of fact, the inference of cessation of the trading liability is sought to be drawn only on the mere fact that the foreign company has not taken any steps to recover the amount which is shown in the balance-sheet as due to the foreign company. It is clear that unless it is established that there is a cessation of the trading liability or, in other words, the trading liability by way of payment of royalty to the foreign company has ceased, there will be no question of the assessee obtaining any benefit as contemplated by section 41(1) of the Act. The only circumstance on which the liability is said to have ceased and an inference of cessation of the trading liability is sought to be drawn is that the foreign company has not taken any steps to recover the amount of royalty. The Income-tax Officer remained satisfied by merely observing that the foreign company had not asked for any further remittance towards royalties and, therefore, the excess provision of Rs. 2,09,993 which was being carried forward from year to year as an outstanding liability, even though for all intents and purposes the liability had ceased, would enable him to add back the said amount. Now, strictly speaking, there is no material whatsoever to come to the conclusion that the liability had for all intents and purposes ceased. The only basis for the inference of cessation of the liability is that between the last payment made on April 24, 1964, and the end of the relevant accounting year, that is, March 31, 1970, either the amount has not been paid or no payment has been made to the foreign company. It is difficult to see how on this circumstance alone, an inference of cessation of liability can be drawn. The assessee has been treating the royalty amount as a liability outstanding against it and this is reflected in the balance-sheet. Merely because the period of limitation of three years provided under the Indian law for the recovery of an amount due has passed, the indebtedness does not cease as pointed out by the Supreme Court in Bombay Dyeing & Manufacturing Co. Ltd. v. State of Bombay, AIR 1958 SC 328, in which it was held that the expiry of the limitation period only deprives the creditor of his remedy to institute a suit in a court of law to recover the debt, but the indebtedness nevertheless continues. In J.K Chemicals Ltd. v. Commissioner Of Income-Tax, Bombay City Ii., [1966] 62 ITR 34, the Bombay High Court dealing with remission or cessation of the liability under section 10(2A) of the Indian Income-tax Act, 1922, pointed out that the mere fact that more than three years had elapsed since the accrual of the liability and that the debts had become unenforceable against the assessee under the general law does not constitute cessation of the trading liability within the meaning of section 10(2A) of the Indian Income-tax Act, 1922.

8. In CIT v. Sadabhakti Prakashan Printing Press (P.) Ltd., [1980] 125 ITR 326 (Bom), it has been held by the Bombay High Court that even the transfer of an entry in the books of account which is only a unilateral act does not bring about the cessation of the liability of the debtor.

9. The decision in CIT v. Hides and Leather Products Pvt. Ltd., [1975] 101 ITR 61 (Guj), relied upon by learned counsel for the Revenue, undoubtedly takes the view that where a liability of a foreign supplier was at one time shown in the books of account and the balance-sheet of the assessee and that amount was written back and debited to the account of the foreign supplier and credited in the capital reserve account, an inference of cessation of liability could be drawn. We have, however, to remember that the question relevant in that case was with reference to the actual cost of machinery for the purpose of a claim for depreciation. The assessee had purchased machinery from a foreign firm in 1955. The assessee maintained its accounts on the mercantile system and though the price was not paid to the foreign firm, because according to the assessee, there was some defect in the machinery, the liability of the foreign supplier was shown in the books of account and the balance-sheet till the year 1960. In 1960, however, the assessee, by making appropriate entries in the account books, wrote back the said amount, debited the amount in the account of the foreign supplier and credited the amount in the capital reserve account. The question was whether the assessee was entitled to depreciation on the actual cost computed at Rs. 30,572 which was the amount said to be due to the foreign supplier and was written back. All that the Gujarat High Court held was that the foreign supplier had not recovered the amount of Rs. 30,572 and no legal steps had been taken towards its recovery for so long a time and it was, therefore, not unreasonable to infer that the foreign supplier had treated the liability of the assessee to itself as having ceased and in fact and in substance, there had been a cessation of the liability. A careful reading of the Gujarat High Court's decision will show that what seems to have weighed with the learned judges was the length of the period for which the amount was not claimed by the foreign supplier. The transaction in that case was one of 1955 and five-year period was considered by the tax authorities as being sufficiently long to give rise to an inference that there was a cessation of liability. The question as to whether on given facts at a given point of time, the liability can be said to have ceased was undoubtedly a mixed question of fact and law. If the Tribunal, on the facts of the case, has taken the view that notwithstanding the non-payment by the assessee and by virtue of the liability continuing to be shown as a liability in the books of account in the balance-sheet, an inference of cessation of liability cannot be drawn, in our view, that being an inference which was quite permissible, it would not be proper for us to interfere with that view. Accordingly, we must hold that the Tribunal was justified in taking the View that there was no cessation of liability and the amount of Rs. 2,09,993 could not be brought to tax under section 41(1) of the Income-tax Act, 1961. Accordingly, both the questions can be answered by giving one answer, that is, in the affirmative and in favour of the assessee.

10. The questions are, therefore, answered in the affirmative and in favour of the assessee. The assessee will get the costs of this reference from the Revenue. Counsel's fee Rs. 500.