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Commissioner Of Income-Tax v. Pranlal P. Doshi.

Gujarat High Court
Jul 29, 1992
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Structured Summary of the Opinion — Reference on Section 41(1), Income-tax Act, 1961

Factual and Procedural Background

This reference was made at the instance of the Revenue. The core question referred was whether the Income-tax Appellate Tribunal (the Tribunal), by applying section 41(1) of the Income-tax Act, 1961, was justified in holding that the assessee's business (processing cotton seeds and running a solvent extraction plant) was deemed to have been carried on during the accounting period relevant to assessment year 1970-71 and consequently whether the assessee was entitled to an allowance of loss of Rs. 31,452.

Relevant factual and procedural points drawn from the opinion:

  • The respondent-assessee is an individual whose financial year ended on 31 March 1970; the assessment year in question is 1970-71.
  • The assessee formerly operated a cotton-seed processing and solvent-extraction business at Veraval; the business had been wound up since 1967 after failure to pay dues to a financial corporation, assets were sold under section 31 of the State Financial Corporations Act, and only some raw materials remained on the books.
  • For the assessment year in question the assessee declared a loss of Rs. 31,452 and also showed receipts of Rs. 18,048 from sale of five items; there was a claimed interest provision of Rs. 49,500 (disallowed by the Income-tax Officer).
  • The Income-tax Officer disallowed the loss, concluding the assessee had not actually run the business in the relevant year and that the business was closed; receipts of Rs. 18,048 were questioned for lack of details of sale/disposal/purchase.
  • The Appellate Assistant Commissioner reversed part of the Income-tax Officer's view and held that the Rs. 18,048 realised from sale of five items were connected with the business (stores and ancillary items purchased in earlier years) and that the business was in continuation for the relevant year.
  • The Revenue appealed to the Tribunal. The Tribunal did not accept that the business factually continued, but nevertheless confirmed the allowance of the loss by invoking section 41(1) of the Income-tax Act and treating the sale receipts (Rs. 18,048) under the legal fiction created by that provision.
  • The present reference arises from the Revenue's challenge to the Tribunal's reliance on section 41(1).

Legal Issues Presented

  1. Whether, on the facts and in the circumstances of the case, applying the provision of section 41(1) of the Income-tax Act, 1961, the Income-tax Appellate Tribunal was justified in law in holding that the business of the assessee in processing cotton seeds and running a solvent-extraction plant was deemed to have been carried on during the accounting period relevant to the assessment year in question and, consequently, whether the assessee was entitled to the allowance of loss of Rs. 31,452 as claimed by it.

Arguments of the Parties

Revenue's Arguments (as presented in the opinion)

  • The Tribunal erred in law by invoking the legal fiction under section 41(1) of the Income-tax Act when the necessary factual conditions precedent to the applicability of that provision were not established on the record.
  • Specifically, the Revenue contended that the Tribunal had not found the required antecedent facts (that relevant deductions/allowances had been made in prior assessments in respect of the expenditure on the sold items) and therefore could not legitimately treat the realised amount under section 41(1).

Appellate Assistant Commissioner's / Assessee's Position (as reflected in the record)

  • The Appellate Assistant Commissioner found that the Rs. 18,048 realised from sale of five items were connected with the business and were stores/ancillary items purchased in earlier years, hence they could not be treated as income from other sources.
  • On that basis the Appellate Assistant Commissioner concluded that the business was in continuation during the relevant assessment year and that the loss claimed should be allowable.

The opinion records that the assessee (or its representatives) did not appear to support the Appellate Assistant Commissioner's factual finding before the Tribunal, and that on the facts the business had been wound up earlier and many assets sold under court order.

Table of Precedents Cited

Precedent Rule or Principle Cited For Application by the Court
CIT v. Rampur Timber and Turnkey Co. Ltd., Allahabad High Court [1973] 89 ITR 150 Illustrates operation of section 41(1) where the anterior factual preconditions (that certain expenditure was allowed as deduction in earlier assessments and subsequently a sum was recovered) were established on record; once those preconditions exist the legal fiction under section 41(1) can operate and posterior facts may be presumed. The court held the Tribunal's reliance on this decision was misplaced here because in Rampur the preconditions for invoking section 41(1) were proved on the record, whereas in the present case those anterior facts were not established by evidence; accordingly Rampur did not aid the assessee.
CIT v. Deepak Textile Industries Ltd., (this Court) [1987] 168 ITR 773 Discusses scope and ambit of legal fictions (in that context section 32(2)), noting that when construing a legal fiction it is proper and necessary to assume those facts on which alone the fiction can operate — a principle applicable to posterior facts once the fiction has validly arisen. The court observed that the principle is sound but not helpful to the assessee in the present case because the necessary antecedent facts to make the fiction operate were absent on the record here.

Court's Reasoning and Analysis

The court examined the text of section 41(1) and identified the factual conditions that must exist before its deeming fiction will apply:

  1. An allowance or deduction must have been made in the assessment for some year in respect of loss, expenditure or trading liability incurred by the assessee (i.e., the expenditure must earlier have been claimed and allowed as a deduction in assessment).
  2. Subsequently, during any previous year relevant to the inquiry, the assessee must have obtained (in cash or otherwise) any amount in respect of such loss or expenditure or some benefit in respect of such trading liability by way of remission or cessation thereof.

The court's step-by-step analysis:

  • The Tribunal did not make factual findings establishing the two conditions precedent required by section 41(1). Instead, the Tribunal made assumptions and conjectures that the items sold (total Rs. 18,048) were articles used in the business previously and that deductions for them had been claimed and allowed earlier.
  • The Tribunal's own statement was quoted: it assumed the assessee had been running the solvent extraction plant and thus must have possessed the articles and must have claimed deductions in the past; therefore the sale proceeds would fall under section 41(1).
  • The court identified three distinct assumptions implicit in the Tribunal's reasoning: (i) the entire Rs. 18,048 comprised articles used in the business earlier; (ii) expenditure on those articles had been claimed by the assessee as business expenditure when acquired; and (iii) such allowance/deduction was actually made / permitted by the assessing authority in earlier assessments.
  • The court emphasised that these anterior pre-conditions are factual matters which cannot be presumed merely on conjecture. The correct approach is that these antecedent facts must be established on evidence before the legal fiction may be activated; only after the fiction validly arises may posterior facts be presumed to give effect to it.
  • Consequently, because the Tribunal had presumed not only posterior facts but also the essential anterior facts (the very preconditions), the court found that the Tribunal's invocation of section 41(1) rested on unsupported conjecture and was legally impermissible.
  • The court distinguished the Rampur Timber decision relied upon by the Tribunal: in Rampur the antecedent facts were proved and undisputed, so the legal fiction properly operated there; that is not the situation here. The court also noted the Deepak Textile decision's observations about assuming facts for a fiction, but held those observations did not assist the present factual posture because the basic preconditions were absent in the record before the Tribunal.

Holding and Implications

Holding:

The question is answered in the negative: the Tribunal was in error in invoking section 41(1) on the facts of the present case; the result is in favour of the Revenue and against the assessee.

Implications (direct and limited to the present matter):

  • The Tribunal's reliance on the legal fiction created by section 41(1) is set aside in this case because the necessary antecedent factual conditions were not proved on the record.
  • As a direct consequence, the deeming under section 41(1) could not be invoked to treat the receipts or to justify treating the business as having continued for the relevant assessment year on the basis asserted by the Tribunal.
  • The court did not indicate that it was establishing a new or broader precedent beyond applying established principles about when legal fictions may operate; rather, it applied those principles to the facts and found the Tribunal's use of conjecture impermissible. The opinion concludes with the formal disposition in favour of the Revenue and against the assessee and records: "No order as to costs."
Show all summary ...

1. In this reference, at the instance of the Revenue, the following question is referred for our opinion :

"Whether, on the facts and in the circumstances of the case, applying the provision of section 41(1) of the Income-tax Act, 1961, the Income-tax Appellate Tribunal was justified in law in holding that the business of the assessee in processing cotton seeds and running a solvent extraction plant was deemed to have been carried on during the accounting period relevant to the assessment year in question and, consequently, the assessee was entitled to the allowance of loss of Rs. 31,452 as claimed by it ?"

2. In order to appreciate the scope and ambit of this question, certain background facts become necessary to be noted at this stage. The respondent-assessee is an individual. The relevant assessment year is 1970-71. The financial year ended on March 31, 1970. The assessee formerly was having business at Veraval in cotton seed processing and an oil extraction plant. For the assessment year in question, the assessee had declared a loss of Rs. 31,452 as under :

Rs.

3. The Income-tax Officer, amongst other items with which we are not concerned, disallowed the aforesaid loss on the ground that it was not shown that the assessee, during the relevant assessment year in question, had actually run the business. According to the Income-tax Officer, it cannot be said that the assessee was engaged in any business in the year in question and, therefore, it had to be held that the business was closed. Consequently, the assessee's claims in respect of interest provision of Rs. 49,500 could not be allowed.

4. So far as the receipt of Rs. 18,048 was concerned the Income-tax Officer took the view that the assessee had not furnished any details as to how he sold the goods, disposed of them and how he had purchased them.

5. The assessee carried the matter in appeal. The Appellate Assistant Commissioner of Income-tax, disagreeing with the Income-tax Officer, took the view that Rs. 18,048 realised from sale of the following five items, viz. :

Rs.

could not be treated as income from other sources. It was found by the Appellate Assistant Commissioner that it is very much connected with business hitherto carried on by the assessee. It was on record for the earlier year that the items sold were nothing but the required stores and ancillary items required for the industry and they were purchased in the earlier years for which details were filed. Consequently, it was held that the business was in continuation during the relevant assessment year.

6. The Revenue carried the matter in second appeal before the Tribunal. Before the Tribunal no attempt appears to have been made by the respondent to support the finding of the Appellate Assistant Commissioner on facts, presumably because the facts on record started one in the face, viz., the assessee's business was wound up since 1967 as the assessee had failed to pay up the dues of the G. S. F. C. and under the order of the learned District judge, the assets of the business were sold under section 31 of the State Financial Corporations Act and only some raw materials were left. Consequently, factually, it would have been impossible to take the view that the business of the assessee had continued during the relevant assessment year. In fact, the Tribunal had not confirmed the aforesaid conclusion reached by the Appellate Assistant Commissioner. However, the Tribunal confirmed the order of the Appellate Assistant Commissioner on an entirely different ground, viz., by falling back upon section 41(1) of the Act, a legal fiction had arisen to the effect that the assessee's business could be presumed to have continued by raising the fiction only because some of the assets of the business, viz., articles employed in the business earlier worth Rs. 18,048 would have earned requisite deductions in the earlier years and, therefore, once they were realised in the current year, income from their sale during the relevant assessment year would give rise to the aforesaid legal fiction. By raising such a legal fiction, the Tribunal reached the conclusion that, for the purpose of the present assessment year, the assessee's business can be treated to have been continued and hence loss can be deducted as suggested by the assessee.

7. Mr. Shelat, for the Revenue, in support of this reference vehemently contended that the Tribunal had patently erred in law in raising the legal fiction about continuance of the assessee's business during the relevant assessment year resorting to section 41(1) of the Act when the very condition precedent to the applicability of the provision was not established on the facts of the present case. In order to appreciate this contention, we have to look at section 41(1) of the Act which reads as under :

"Where an allowance or deduction has been made in the assessment for any year in respect of loss, expenditure or 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, any amount in respect of such loss or expenditure or 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."

8. A bare perusal of the above provision shows that before any amount accruing to the assessee during a given financial year is deemed to be profits and gains of business even when such business or profession had actually ceased to exist in the relevant year, the following conditions must be factually fulfilled : (i) any allowance or deduction should have been made in the assessment for any assessment year in respect of such expenditure incurred by the assessee during the course of business. (ii) Subsequently, during any previous year relevant to the inquiry, the assessee must have obtained whether in cash or any other manner whatsoever, any amount in respect of such expenditure by way of remission or cessation thereof. If these conditions are factually found to be established, then only the legal fiction contemplated by the second part of section 41(1) would spring into action, meaning thereby that once these conditions are established, then during the relevant assessment year, the question whether the business of the assessee is actually in existence or not would pale into insignificance and the said expenditure would be treated as profits or gains of business and accordingly chargeable to income-tax as the income of that previous year would be non-existent. When we turn to the order of the Tribunal, we find that for fulfilling the said two conditions precedent for raising the deeming fiction under section 41(1), no finding of fact has been reached by the Tribunal. What has been stated by the Tribunal in this connection is worth noting as under :

"It is not disputed that the assessee was running a solvent extraction plant and also processing cotton seeds. The solvent extraction plant was a big unit of about Rs. 25 lakhs. The assessee's turnover was also quite substantial. It is, therefore, not difficult to believe that the assessee was in possession of articles worth Rs. 18,048 which were sold in the year under appeal. Details of these articles are mentioned in the order of the learned Appellant Assistant Commissioner. Having regard to the articles it would appear that the assessee must have claimed deduction in respect of expenditure incurred in connection with the purchase of these articles in the past. Therefore, the said amount of Rs. 18,048 would fall under section 41(1) of the Income-tax Act, 1961."

9. The aforesaid conclusion of the Tribunal for raising the legal fiction under section 41(1) proceeds on three assumptions : (i) that the entire amount of Rs. 18,048 realised from the sale of concerned listed five articles wholly comprised of articles which were required to be utilised in the course of the assessee's business during the earlier years; (ii) expenditure on these articles must have been claimed by the assessee as business expenditure during the relevant year when these articles were acquired for the purposes of the business and (iii) that such allowance or deduction was actually made in the relevant assessment years, meaning thereby, that even the Department would have permitted such deduction/allowance to be made so that the assessee's taxable income from profits and gains from the business during the relevant assessment year would have been computed after permitting such deductions from the business income returned during the concerned years when these items were acquired. The Tribunal has not arrived at any such factual finding on record. It has presumed that the assessee must have acquired these articles during the earlier years for the purpose of his business and he must have claimed deduction in respect of the expenditure incurred in connection with purchase of these articles in the past. With respect, this finding is based on pure conjecture and is not borne out from the record. On such conjecture and surmise, the factual conditions precedent for raising the legal fiction under section 41(1) cannot be established. It is easy to visualise that if the Legislature permitted legal fiction to be drawn on the basis of certain basic facts, these basic facts have to be established first as a condition precedent and once they are established, then only the legal fiction would spring into action and once such legal fiction spring into action, all necessary facts for efficacious running of such fiction can be presumed. In other words, the facts necessary to be established by way of condition precedent for raising of the fiction have to be established first and they can be established only on the basis of evidence on record. But once these facts are established and the legal fiction spring into action, then immagination cannot be permitted to get boggled and such legal fiction which has started operating has to be carried to its logical end and, in the process, all posterior facts necessary for operation of such fiction can also be presumed. Here, unfortunately, the Tribunal on the basis of legal fiction under section 41(1) has presumed not only posterior facts after the fiction validly arises but even anterior pre-conditional facts. Such anterior facts establishing condition precedent could not have been presumed. They have to be proved as any other fact from the evidence on record. that was unfortunately not done by the Tribunal. Consequently, the legal fiction which, according to the Tribunal, arose under section 41(1) did not at all click or arise in the present case. Hence, section 41(1), on the facts of the present case, was not at all attracted as wrongly assumed by the Tribunal. Reliance placed by the Tribunal on the decision of the Allahabad High Court in CIT v. Rampur Timber and Turnkey Co. Ltd. [1973] 89 ITR 150, is also misplaced. The Allahabad High court, in that matter, was not concerned with any other facts by way of pre-condition for raising the legal fiction under section 41(1). Such anterior facts by way of pre-condition were actually established on record and they were not in dispute. Once that happened, the legal fiction under section 41(1) operated and then all consequential posterior facts could be validly presumed as held by the Allahabad High Court. In the case before the Allahabad High Court, the assessee had claimed that though his business had come to end during the relevant previous year, he had received refund of Rs. 6,982 from the electricity department out of the electricity charges already paid by the assessee in the earlier when the assessee was carrying on the business which had been allowed to the assessee as an expenditure of the business in those assessments. During the assessment for the assessment year 1962-63, the Income-tax Officer included the aforesaid amount of Rs. 6,982 as business income of the assessee in view of the provisions of section 41(1). The Tribunal held that the profit of Rs. 6,982 could be set off against the unabsorbed depreciation allowance of Rs. 46,003 determined for the assessment years 1951-52 to 1954-55. The question was whether, under section 41(1), it could be presumed that, during the assessment year 1962-63, even though there was no business carried on by the assessee, such profit could be treated as having arisen on the assumption that Rs. 6,982 were deemed profits of the business which was carried on earlier. Answering this question in favour of the assessee, it was held that the sum of Rs. 6,982 assessed as the business income of the assessee for the relevant previous year was liable to be set off against the unabsorbed depreciation of Rs. 46,003 carried forward from 1954-55. The benefit of unabsorbed depreciation could be availed of by an assessee in any subsequent year without satisfaction of the pre-conditions attaching to sub-section (1) of section 32 of the Act and it was not necessary that in such subsequent year, the assessee actually carried on the business and the asset in question was used for the purpose of the assessee's business. It is the aforesaid decision of the Allahabad High court which had weighed heavily with the Tribunal in the present case. We fail to appreciate how the said decision can be of any avail to the assessee. In the aforesaid case, the electricity charges paid by the assessee during the relevant year during the course of business were in fact allowed by the Department as permissible business expenditure while making assessment for the earlier years. Thus, the basic facts which are required for raising the legal fiction under section 41(1) were proved as a matter of fact on record and then only the legal fiction comtemplated by section 41(1) arose. In the present case, there is no such attempt on the part of the assessee to prove the existence of anterior facts which are by way of preconditions as noted earlier. Consequently, the applicability of section 41(1) which rightly arose on the facts of the case before the Allahabad High Court was not capable of being pressed into service by the assessee on the facts of the present case. In fairness, our attention was also invited by the learned advocate for the Revenue to the decision of this court in CIT v. Deepak Textile Industries Ltd. [1987] 168 ITR 773, which had relied upon the aforesaid Allahabad decision. This court, while considering the scope and ambit of the legal fiction under section 32(2) has held that, in construing the scope of a legal fiction, it would be proper and even necessary to assume all those facts on which alone the fiction can operate. These observation would obviously apply to posterior facts after the fiction is found to have legally arisen. As discussed earlier, the facts of the present case are entirely different. The basic facts for raising the legal fiction are non-existent on record or at least they are not found to be proved as aforesaid and, with respect, have been wrongly assumed by the Tribunal to have existed.

10. As a result of the aforesaid discussion, it must be held that the Tribunal was in error invoking section 41(1) on the facts of the present case. The question referred for our opinion must be answered in the negative, that is, in favour of the Revenue and Against the assessee. No order as to costs.