2008 (1) TMI 386 - HC - Income Tax

Court rules reduction of liabilities profits not taxable as business income under Income-tax Act Sections 28(i) & 28(iv)

ELSCOPE P. LTD. Versus COMMISSIONER OF INCOME-TAX (and vice versa)

The court ruled in favor of the assessee, holding that the profits arising from the reduction of liabilities were not trading profits taxable as business ... Capital or Revenue Expenditure – Going Concern – Payment of guarantee commission can not disallowed – The assessee had acquired four divisions during the year as going concerns along with their assets and liabilities which included amounts payable to four investment companies in five annual equal instalments - The amount due to these investment companies, by mutual agreement, commuted at a discounting rate of 12 per cent. and the difference of Rs. 32,50,557 was credited to the capital reserve of the assessee-company – Assesse contended this amount was not of the character of income or deemed income and that it had nothing to do with the trading activities of the assessee, instead the amount represented capital receipt and was not liable to tax – AO rejected the submissions of the assessee and assessed the amount is taxable income – Held that the profits arising on reduction of liabilities was not trading profits liable to be taxed as business income – amount is not taxable as income. Issues Involved:1. Disallowance of guarantee commission.2. Taxability of profit arising from reduction of liabilities as business income.3. Applicability of Section 28(i) and Section 28(iv) of the Income-tax Act, 1961.Issue-wise Detailed Analysis:1. Disallowance of Guarantee Commission:The primary issue raised by the assessee was whether the Tribunal was justified in confirming the disallowance of guarantee commission amounting to Rs. 3,16,668 for the assessment year 1978-79. The court noted that the matter was concluded by the Supreme Court's decision in Addl. CIT v. Akkamamba Textiles Ltd. [1997] 227 ITR 464, which favored the assessee. Thus, the Tribunal was not justified in confirming the disallowance of the guarantee commission, and the question was answered in the negative, in favor of the assessee and against the Revenue.2. Taxability of Profit Arising from Reduction of Liabilities as Business Income:For the assessment years 1978-79 and 1979-80, the Revenue questioned whether the profit arising from the reduction of liabilities should be taxed as business income. The assessee had acquired four divisions as going concerns, including liabilities payable to investment companies. These liabilities were commuted at a discount rate of 12%, resulting in a difference of Rs. 32,50,557 credited to the capital reserve. The Income-tax Officer considered this amount as trading profit, liable to be taxed as business income or alternatively as short-term capital gain.The Commissioner of Income-tax (Appeals) held that the amount was not chargeable under Section 41(1) as it did not represent a remission of trading liability and was not liable to tax as short-term capital gain. However, he upheld the addition under Section 28, considering it revenue income. The Tribunal, however, found that the commutation charges did not represent business income and deleted the addition.3. Applicability of Section 28(i) and Section 28(iv) of the Income-tax Act, 1961:The Revenue contended that the transaction fell within the provisions of Section 28(i) and Section 28(iv) of the Act, arguing that the surplus should be treated as a benefit arising from the business. The Tribunal rejected this, noting that the business of the assessee was not of acquiring and selling trading concerns but running industrial units. The Tribunal emphasized that the transaction was part of a reorganization scheme within the Sarabhai group and not an adventure in the nature of trade.The Tribunal also found that the commutation of liabilities did not result in any profit under Section 28, as the liabilities were capital in nature and not trading assets. The Tribunal's findings were supported by the decision in Kailash Investments P. Ltd. v. CIT [2006] 281 ITR 92 (Guj), which held that the amount in question was not business income or capital loss.The court upheld the Tribunal's findings, noting that the reduction in liability did not constitute income under Section 28. Additionally, the court found no merit in the Revenue's contention based on Section 28(iv), as the transaction did not arise from the business and lacked the necessary nexus.Conclusion:The Tribunal was justified in holding that the profits arising from the reduction of liabilities were not trading profits liable to be taxed as business income. The questions referred at the instance of the Revenue were answered in the affirmative, in favor of the assessee and against the Revenue. The reference was disposed of with no order as to costs.