Cessation of liability principle bars tax on reserve-bound lapsed drafts and gift cheques retained for future claims.

Amounts representing lapsed demand drafts and gift cheques credited to the profit and loss account were held not to be taxable income where RBI instructions required the sums to be transferred to general reserve for meeting future claims. Because the assessee remained liable to honour future claims and the liability had not ceased, the receipts could not be treated as freely available income or as dividend. On that basis, the revisionary direction under section 263 directing inclusion in income was unsustainable and was set aside.

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Issues: Whether the amounts representing lapsed demand drafts and gift cheques credited to the profit and loss account were taxable in the hands of the assessee, and whether the revisionary order under section 263 directing their inclusion in income was sustainable.

Analysis: The amounts were credited to the profit and loss account pursuant to binding instructions issued by the Reserve Bank of India under section 35A of the Banking Regulation Act, 1949, and were required to be transferred to general reserve for meeting future claims. The assessee remained under an obligation to honour future claims, the amounts could not be treated as freely available income or distributed as dividend, and there was no cessation of liability. On these facts, the principle relating to cessation of liability and taxable receipts did not justify treating the amount as income, and the revisionary direction to disallow the deduction could not stand.

Conclusion: The amount was not taxable as income in the hands of the assessee, and the order under section 263 was rightly set aside.

Final Conclusion: The substantial questions of law were answered against the revenue, and the appeal failed.

Ratio Decidendi: Where amounts credited through the profit and loss account are statutorily required to be retained in reserve for future claims and the liability has not ceased, such amounts do not acquire the character of taxable income.

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