2007 (5) TMI 218 - HC - Income Tax

Court rules on liability, accounting change, and disallowance under Income-tax Act

COMMISSIONER OF INCOME-TAX Versus WILLARD INDIA LTD.

The court ruled in favor of the assessee on the issue of cessation of liability under section 41(1) of the Income-tax Act, stating that the liability ... Perquisite to employee cannot be disallowed in hands of employer in terms of rule 3 - unilateral entry on part of assessee to write back the amount on ground of limitation does not amount to cessation of liability, so not chargeable u/s 41 - Additions towards cessation/remission of liability are not justified - even if there was change of accounting system from cash to mercantile, payment of bonus to employees are allowed to deduction in A.Y. in question – revenue’s appeal dismissed Issues Involved:1. Cessation of liability under section 41(1) of the Income-tax Act.2. Disallowance under section 40A(5) of the Income-tax Act.3. Change in the method of accounting from cash to mercantile for bonus payments.Detailed Analysis:Issue 1: Cessation of Liability under Section 41(1) of the Income-tax ActThe primary issue was whether the sum of Rs. 2,99,287, written back by the assessee and lying unclaimed for three years, constituted a cessation of liability under section 41(1) of the Act. The Tribunal held that the liability of the assessee to pay these amounts to the creditors did not cease merely because the amounts were written back. It emphasized that the liability continues as long as the limitation period for the creditors to claim these amounts is not expired. The Tribunal found no evidence from the Assessing Officer that the debts were not genuine or that the creditors were bogus. Consequently, the addition was not justified.The court referred to previous judgments, including *Bhagwat Prasad and Co. v. CIT* and *CIT v. Iswari Khetan Sugar Mills Ltd.*, which established that a liability does not cease merely because it is time-barred or written back unilaterally by the debtor. The Supreme Court's decision in *CIT v. Sugauli Sugar Works P. Ltd.* was also cited, which held that an entry in the debtor's books does not amount to cessation of liability. Therefore, the court concluded that the provisions of section 41(1) were not attracted, and the question was answered in favor of the assessee.Issue 2: Disallowance under Section 40A(5) of the Income-tax ActThe second issue concerned the disallowance under section 40A(5) of the Act for the assessment years 1984-85 to 1987-88. The Tribunal had directed the Assessing Officer to work out the disallowance in terms of rule 3(c)(ii) of the Income-tax Rules, 1962. However, the court referred to the Supreme Court's decision in *CIT v. British Bank of Middle East*, which clarified that section 40A(5) and rule 3 deal with different situations and different sets of assessees-one dealing with employer-assessee and the other with employee-assessee. Consequently, section 40A(5) cannot be controlled by rule 3. Therefore, this issue was answered in the negative, in favor of the Revenue.Issue 3: Change in Method of Accounting for Bonus PaymentsThe third issue involved the change in the method of accounting for bonus payments from cash to mercantile system during the assessment year 1985-86. The assessee claimed a deduction of Rs. 3,67,872, which pertained to the previous accounting year but was paid during the year in question. The Tribunal found the change in the method of accounting to be bona fide and allowed the deduction, stating that adjustments are necessary when there is a change in the accounting method to reflect true profit and loss.The court upheld the Tribunal's decision, noting that the law permits a bona fide change in the method of accounting. It recognized that such a change might require adjustments to account for liabilities accrued in previous years but paid in the current year. Thus, the Tribunal's deletion of the addition of Rs. 3,67,872 was justified, and this issue was answered in favor of the assessee.ConclusionThe court concluded by addressing the issues as follows:- The first issue regarding the cessation of liability was answered in the affirmative, in favor of the assessee.- The second issue concerning the disallowance under section 40A(5) was answered in the negative, in favor of the Revenue.- The third issue about the change in the method of accounting for bonus payments was answered in the affirmative, in favor of the assessee.In view of the divided success, the parties were left to bear their own costs.