2025 (6) TMI 481 - AT - Income Tax

Trust wins on liability cessation and notional rent issues in tax dispute

Centre For The Study Of Social Change Versus Income Tax Officer Exemption Ward 1 (2), Maharashtra

The ITAT Mumbai ruled in favor of a trust on two key issues. First, regarding a Rs. 4.80 crore liability shown as deposit, the tribunal held that ... Assessment of trust - Cessation of liability - treatment of a large liability of Rs. 4.80 crores shown as a deposit received by the trust - HELD THAT:- Since 2013 till the financial year ending 2023, Kamath hotel never intended to give up its claim of the advance. Note 15.1 is very clear that, adjustments if any to the existing provision will be made on the disposal or conclusion of the matter which is pending arbitration. This Tribunal called upon the Ld.AR to submit the statement of claim and counterclaims filed by Kamat Hotels and assessee before the Ld. Arbitrator. It is noted that, these documents were never reviewed by the authorities below and based on the reply filed by Kamat Hotels, a presumption is drawn regarding the liability of the assessee having ceased. The issue is still pending before the arbitrator. It is also noted that, both parties continue to assert their respective claims to be valid in this litigation. It is a basic accounting principle that when the loan be an impairment, the land, can a provision to indicate the risk also with the advance to non-recoverability. We also note that waiting a provision is an accounting measure, that allows the lender to clean their balance sheet but it does not relieve the borrower of their debt. The lender can take legal action, use collateral, or pursue other recovery methods. In our view, the authorities' observation below lacks any basis and is unsupported by any provisions of the Act. Under these circumstances, Kamat Hotels' decision to write off the alleged advance does not ipso facto imply that the liability has ceased in the hands of the assessee. In our view the quantification of the liability depends on the award passed by the Ld. Arbitrator. We therefore do not find any force in the addition made in the hands of the assessee during the year under consideration, and the same deserves to be deleted. Notional rent calculated for the trust property used by LIHS without any consideration - It is an admitted fact that, the property held by the assessee was given to LIHS for its use without any consideration. The structure used by LIHS was constructed by the assessee out of its investments. Further the Ld.AO observed that, nature of activities of LIHS and assessee are not common. We find that that the object clause No.1 reproduced herein above supports the activities of LIHS. The objection of the Ld.AO is thus rejected. AO computed Notional rent in the hands of the assessee as the premise was given to LIHS without any consideration. Under these admitted facts, we are of the opinion that, if notional income is calculated on the basis of accrual under the mercantile system of accounting, it would be conceived as income for the purposes under section 11(1)(a) of the Act. Further it must not be forgotten that, such notional income can never be actually applied or accumulated or set apart for the purposes of the trust, and the assessee while being liable to pay income-tax on accrual basis, will not be able to derive any benefit on such notional income conferred by the said provision. We therefore do not agree with the view of Ld.AO to compute notional rent in the hands of the assessee. Be that as it may, we note that no rent was admittedly charged by the assessee nor was it recorded in the books of account. Based on the above discussions, we do not find any merit in the findings of the authorities below in computing notional rent. We therefore direct the Ld.AO to delete the addition on account of notional rent. In the event any violation is found as specified under section 13(1)(c) r.w.s. 13(1)(b) of the Act, the denial of benefit u/s 11 must be restricted only to the extent such income diverted or utilised in violation of section 13(1)(c) r.w.s. 13(1)(b) of the Act. The core legal questions considered in this appeal revolve around the tax treatment of a large liability of Rs. 4.80 crores shown as a deposit received by the trust, the applicability of cessation of liability as income, the legitimacy of addition of notional rent for premises given without consideration to a related charitable trust, and the correct application of relevant provisions of the Income Tax Act governing charitable trusts.First, the Tribunal examined whether the sum of Rs. 4.80 crores, shown as a liability in the trust's books and received as a security deposit from a third party, should be treated as income on the ground of cessation of liability. The key legal framework involves provisions related to cessation of liability and income recognition, notably section 41 of the Income Tax Act (which deals with deemed income on cessation of liability), and sections 11 to 13, which govern taxation of charitable trusts. The assessing officer initially treated the amount as income due to cessation of liability, relying mistakenly on section 41. However, the Tribunal noted that section 41 is inapplicable to charitable trusts, as the heads of income do not apply in the same manner to them. The Tribunal referred to authoritative precedents confirming that cessation of liability does not automatically result in income for a charitable trust under sections 11 to 13. The trust continued to show the amount as a liability, and the third party had only made a provision for doubtful recovery rather than writing off the amount, with ongoing arbitration proceedings pending. The Tribunal emphasized that a provision for doubtful debts is an accounting measure and does not extinguish the liability or create income for the trust. The legal principle established is that cessation of liability must be clear and absolute to trigger income recognition, which was not the case here. The Tribunal accordingly held that the addition of Rs. 4.80 crores as income on cessation of liability was untenable and deleted the addition.Second, the Tribunal addressed the issue of the timing of any alleged cessation of liability and consequent income recognition. The assessing officer's case was that the cessation occurred in an earlier year (2013-14), yet the addition was made in the assessment year under appeal (2016-17). The Tribunal observed that even if cessation were to be considered, income could only be assessed in the year in which cessation occurred, supporting this with reference to relevant provisions on the previous year and assessment year. Since the cessation had not occurred in the year under consideration, the addition was misplaced.Third, the Tribunal considered the addition of notional rent of Rs. 18,61,409/- on premises given without consideration to another charitable trust (LIHS). The assessing officer treated this as income from other sources, invoking section 56. The Tribunal analyzed the provisions relating to charitable trusts, particularly sections 11 to 13, which provide a special regime for income and application of income. It noted that income for trusts is not computed under the general heads of income under section 14 but under the special provisions of section 11. The Tribunal found that section 56 does not contemplate addition of notional income; it applies only to real income received or accrued. The Tribunal also rejected the applicability of sections 13(2)(b) and 13(3), which deal with application of income for the benefit of specified persons, as there was no direct or indirect benefit to any individual or disqualifying person. The Tribunal further held that the use of premises by LIHS, whose activities fall within the ambit of the trust's objects, did not amount to diversion of income or property. The Tribunal emphasized that no rent was charged or recorded, and that no notional income should be computed on an accrual basis for such use. The addition of notional rent was therefore deleted.The Tribunal also clarified that in the event of any violation of section 13(1)(c) read with 13(1)(b), denial of exemption under section 11 should be restricted only to the extent of income or property diverted or misapplied, not by adding notional income.Lastly, the Tribunal addressed the consequential ground relating to set-off of deficits. The assessee claimed entitlement to carry forward and set off a deficit of Rs. 7.83 crores. The Tribunal allowed this ground partly for statistical purposes, pending final determination of income.In summary, the Tribunal's significant holdings include the following:'Section 41 of the Income Tax Act does not apply to charitable trusts, and cessation of liability does not ipso facto result in income for such trusts under sections 11 to 13.''A provision for doubtful debts or write-off in the books of the creditor does not amount to cessation of liability or income in the hands of the debtor trust.''Income of a charitable trust is governed by the special provisions contained in sections 11 to 13 and not by the general heads of income under section 14 or provisions like section 56 relating to income from other sources.''Notional rent cannot be added as income in the hands of a charitable trust for premises given without consideration to another charitable trust, where there is no diversion or misapplication of income or property.''Denial of exemption under section 11 on account of application of income for the benefit of disqualifying persons under section 13 should be limited to the extent of such misapplication and not by addition of notional income.''Income attributable to cessation of liability, if any, must be assessed in the year in which cessation occurs, not in a subsequent year.'Accordingly, the Tribunal allowed the appeal on the grounds relating to the addition of Rs. 4.80 crores on cessation of liability and the addition of notional rent, and partly allowed the ground relating to set-off of deficit.