2025 (7) TMI 900 - HC - Income Tax

Section 41(1) liability cessation provisions inapplicable when creditor suits remain pending without final adjudication

Commissioner of Income Tax, Chennai Versus M/s. Anand Transport

Commissioner of Income Tax, Chennai Versus M/s. Anand Transport - TMI 1. ISSUES PRESENTED and CONSIDEREDThe core legal question considered by the Court was whether the Tribunal was correct in holding that the provision pending in the assessee's books of account for the accounting year 2000-01 relating to claims by SICAL could not be treated as income by virtue of cessation of liability under Section 41(1) of the Income Tax Act, 1961, given that the suit filed by the assessee against SICAL was pending adjudication. In essence, the issue revolved around the applicability of Section 41(1) in taxing provisions made for liabilities that had not been finally settled or crystallized due to ongoing litigation.2. ISSUE-WISE DETAILED ANALYSISIssue: Whether the provision made by the assessee for claims/liabilities relating to FY 2000-01 and earlier years, pending adjudication in a civil suit, can be treated as income under Section 41(1) of the Income Tax Act on the basis that the liability has ceased or been remitted.Relevant Legal Framework and Precedents: Section 41(1) of the Income Tax Act provides that if any trading liability or part thereof, which was allowed as a deduction in any earlier year, has ceased or been extinguished, the amount thereof shall be deemed to be income of the previous year in which such cessation or extinguishment takes place. The key legal principle was reiterated from the Apex Court decision in CIT vs. Sugauli Sugar Works P Ltd [236 ITR 518], which held that the expiry of the limitation period under the Limitation Act does not extinguish the debt but only bars the creditor from enforcing it. Thus, unilateral entries in books of account without any act on the part of the creditor do not amount to cessation of liability for the purposes of Section 41(1).Court's Interpretation and Reasoning: The Court examined the facts that the assessee had made provisions amounting to Rs. 15.04 crores for claims/liabilities raised by SICAL, which were reflected in the books of account but had not been settled due to ongoing disputes. The assessee had filed a civil suit for recovery of dues from SICAL, which was pending adjudication before the High Court. The Court noted that because the suit was sub judice, the liability had neither crystallized nor ceased. The Assessing Officer's approach to treat the provision as contingent and to tax it under Section 41(1) on the ground of cessation of liability was found to be erroneous.Key Evidence and Findings: The assessee's books showed provisions for claims/liabilities pending final settlement. The existence of pending litigation was undisputed and was brought to the notice of the Assessing Officer. The Court found that the Assessing Officer failed to appreciate that the liability was not extinguished but was under judicial consideration. The fact that the assessee had filed suit for recovery of dues and that SICAL had counter-claims offsetting dues was critical to understanding the unsettled nature of the liability.Application of Law to Facts: Applying the principle from the Sugauli Sugar Works case, the Court held that mere unilateral accounting entries without any act of remission or cessation by the creditor cannot be treated as cessation of liability under Section 41(1). Since the liability was sub judice and no amount had been obtained by the assessee by way of remission or cessation, the provisions made could not be taxed as income. The mercantile system of accounting requires recognition of liabilities and provisions, but these do not translate into taxable income unless the liability ceases or is extinguished.Treatment of Competing Arguments: The Revenue argued that since three years had elapsed since the provision was made, and no write-off had been effected, the liability should be considered ceased and taxed accordingly. The Court rejected this on the ground that the mere lapse of time or non-write-off does not amount to cessation of liability. The assessee's argument that the matter was sub judice and no finality had been reached was accepted as it reflected the true state of affairs. The Court also agreed with the CIT (A) and ITAT's findings that the Assessing Officer's characterization of the provision as contingent was misplaced.Conclusions: The Court concluded that the provisions made in the accounts for claims by SICAL could not be treated as income under Section 41(1) since the liability had not ceased or been remitted. The pending litigation prevented any final determination of liability, and thus the Assessing Officer's invocation of Section 41(1) was incorrect.3. SIGNIFICANT HOLDINGSThe Court held: 'When the suits filed were sub judice and the matter was yet to be adjudicated by the Hon'ble High Court, it cannot be inferred that the liability on the part of the assessee in respect of payments to be made to SICAL has ceased or been remitted by SICAL. Therefore, the provision of Section 41(1) of the Act cannot be invoked.'Further, the Court reiterated the principle from the Apex Court ruling: 'The principle that expiry of the period of limitation prescribed by the Limitation Act could not extinguish the debt but it would only prevent the creditor from enforcing the debt has been well settled. Mere entry in the books of account of the debtor made unilaterally without any act on the part of the creditor will not enable the debtor to say that the liability has come to an end. It will also not confer any benefit on the debtor as contemplated by Section 41(1) of the Act.'The final determination was that the appeal filed by the Revenue against the ITAT order was dismissed, affirming that the provisions made in the books of account for pending claims could not be treated as income by way of cessation of liability under Section 41(1) when the matter was sub judice.