The judgment of the court was delivered by
Anita Sumanth, J.-This appeal comes to us at the instance of the assessee raising the following two substantial questions of law for adjudication in respect of A Y 2000-01.
Whether the circumstances contemplated under section 41(1) of the Income Tax Act, exists so as to enable the income tax authorities to include Rs. 10,77,49,601/- as income in the assessment year 2000-01?
Whether the Tribunal is correct in proceeding on the assumption that WGI had written off the monies in question, when the Appellant Assessees specific plea was that these monies had been converted into equity?
2. The brief facts relevant to the appeal are as follows:
The appellant is a company held, to the extent of 74%, by M/s Transworld Garnet British Columbia, which is in turn wholly held by Western Garnet International Limited, Canada (in short WGI). The appellant company had been set up completely with investment from the parent, WGI. Advances had also been received from WGI towards business needs and the advances were to be adjusted against future supplies of garnet to WGI.
3. The prevailing foreign direct investment policy imposed a cap of 74% in the mining sector. For the balance, individuals were approached. The business of the appellant had not taken off as expected on account of various logistic and administrative reasons and the appellant had been incurring huge losses. The private sources that had been approached for their participation in the equity insisted upon equal investment to be made by the foreign company in order to dilute the losses incurred, as a pre-condition to their investment. Accordingly, WGI directed the appellant to convert the advances made by it into capital. The appellant complied with the direction converting the advances, of an amount of Rs. 10,77,49,601/- as capital and transferring the same to general reserve .
4. At the time of assessment for A Y 2000-01, the assessing officer was of the view that the provisions of section 41(1) of the Act relating to cessation of liability were attracted and that the amount of Rs. 10,77,49,601/- was liable to be brought to tax as income. An assessment was thus completed in terms of section 143(3) read with section 147 of the Income Tax Act, (in short, Act), by order dated 11.3.2004. The officer, without any discussion whatsoever, brought to tax the amount of liability foregone observing that the aforesaid amount ought to have been taken to the profit and loss account instead of to general reserves.
5. In appeal before the Commissioner of Income tax (Appeals) (in short CIT(A)), the appellant submitted that the amount constituted a capital receipt not liable to tax. It was explained that apart from investing in the setting up of the company, WGI had advanced funds for business purposes that were to be adjusted against future sales. As per the extant norms, the investment by a foreign entity was capped at 74% with participation by a resident to the extent of the balance 26%. The resident investor imposed as a condition that the extent of loss that had been incurred be neutralized by further investment by the foreign party. Accordingly WGI had instructed the assessee to convert the advances made by them to capital and credit the same to reserves. The appellant thus claimed that the amount was a capital receipt not liable to tax.
6. The CIT(A), vide order dated 24.11.2004, examined the claim in the light of the provisions of section 41(1) of the Act. The records of the appellant were also examined and a finding recorded to the effect that the conversion of the advances did result in the wiping out of the losses incurred, paving the way for the entry of the Indian participant.
7. The CIT(A) noted that the provisions of section 41(1) of the Act stood attracted only in a situation where the amount in question, in respect of which liability had ceased, had been claimed as an allowance or a reduction in any previous year, which fact had not been established in the present case. He noted that there was no nexus between the allowance/reduction in the previous years and the amount in question to invoke the provisions of section 41(1). He thus concurred with the submission of the assessee that the amount of Rs. 10.77 crores constitued a capital receipt.
8. The matter travelled in appeal to the Income tax Appellate tribunal (in short, tribunal) which, dismissed the ground of appeal relying upon the judgment of the Supreme Court in the case of Commissioner of Income Tax Vs. T.V.Sundaram Iyengar and sons Ltd (222 ITR 344). The tribunal found that the amount was originally received as an advance against supply/export of garnet. Subsequently the claim over the amount was waived and in such circumstances the tribunal was of the view that the amount partook the character of a revenue receipt. Thus, according to the tribunal, the subsequent transfer of the amount to general reserve would constitute only an application that would not change the nature of the taxability of the amount at a stage anterior thereto. The assessee challenges the aforesaid conclusion of the tribunal before us.
9. We have heard the submissions of Mr.R.Venkataraman, learned Senior Counsel for Mr.Srinath Sridevan for the appellant and Mr.Swaminathan, learned counsel on behalf of the Revenue.
10. The provisions of section 41(1) of the Act, the interpretation of which is in issue before us, is extracted below for ease of reference.
Profits chargeable to tax:
41. (1) Where an allowance or deduction has been made in the assessment for any year in respect of loss, expenditure or trading liability incurred by the assessee (hereinafter referred to as the first-mentioned person) and subsequently during any previous year,-
(a) the first-mentioned person has obtained, whether in cash or in any other manner whatsoever, any amount in respect of such loss or expenditure or some benefit in respect of such trading liability by way of remission or cessation thereof, the amount obtained by such person or the value of benefit accruing to him shall be deemed to be profits and gains of business or profession and accordingly chargeable to income-tax as the income of that previous year, whether the business or profession in respect of which the allowance or deduction has been made is in existence in that year or not; or
11. At the outset, we may state that the facts of the matter are not in dispute. The findings of the CIT(A) are based upon the financials as well as all relevant documents. The circumstances in which the infusion of capital was made and the findings relating thereto are also undisputed. Importantly, the CIT(A) finds that there was nothing on record to lead to the conclusion that the advances from WGI had been claimed as an allowance or reduction in any previous year. This finding of fact has not been disturbed by the tribunal in any way.
12. The examination of the legal position is made in the background of the admitted facts as we have noticed in the preceding paragraph. In order for the provisions of Section 41(1) to stand attracted, the benefit obtained by the assessee in the relevant year should have a direct nexus with an allowance or deduction for any previous year as a claim of loss, expenditure, or trading liability which has not been established in the present case. Since the tribunal nonetheless decides the issue against the assessee relying on the judgment of the Supreme Court in the Case of T.V.Sundaram Iyengar, (supra), we advert to the same straightaway.
13. In T.V.Sundaram Iyengar, the Bench notes as a fact, that the amounts received had depleted by adjustments made by the assessee from time to time and the resultant balance had been transferred by the assessee to the profit and loss account. This is not the case in the present matter. The amounts in this case, though no doubt received as advances for supply of garnet, had remained static without depletion of any sort and more importantly, not been claimed in the previous years. This pre-condition to the application of section 41(1) of the Act has not been satisfied in the instant case. The case of T.V.Sundaram Iyengar turned on two facts distinguishable from the present case that the deposits received from the customers had remained unclaimed and become barred by limitation and that TVS itself, treated the money as its own, crediting it to the Profit and Loss account. No reference is made to section 41(1) or the compliance of the condition thereunder.
14. The Supreme Court finds that by virtue of the credits made in the profit and loss account, the assessee has, in effect, become richer to that extent. In the present case, the entire amount of 10.77 crores has been converted to share holding, and consequently, benefit could be said to have accrued to the assessee only in the capital field.
15. The Supreme Court in a later decision, in the case of Chief Commissioner of Income Tax Vs. Kesaria Tea Company (254 ITR 434), decided a matter relating to the write back by an assessee in its accounts, of a provision made for the earlier years towards purchase tax liability. The Bench, after considering the circumstances contemplated by Section 41(1) concluded that the following points are critical in the event the provisions of section 41(1) are to apply and state thus at page 437 of the judgement:
The question is whether the circumstances contemplated by section 41(1) exist so as to enable the Revenue to take back what has been allowed earlier as business expenditure and to include such amount in the income of the relevant assessment year i.e. 1985-86. In order to apply section 41(1) in the context of the facts obtaining in the present case, the following points are to be kept in view: (1) In the course of assessment for an earlier year, allowance or deduction has been made in respect of trading liability incurred by the assessee; (2) Subsequently, a benefit is obtained in respect of such trading liability by way of remission or cessation thereof during the year in which such event occurred; (3) in that situation the value of benefit accruing to the assessee is deemed to be the profit and gains of business which otherwise would not be his income; and (4) such value of benefit is made chargeable to income tax as the income of us.
16. The judgment of the Supreme Court in the case of TVS Iyengar and Sons was distinguished stating that the factual matrix and the provisions considered therein is entirely different.
17. In Polyflex (India) Pvt. Ltd vs. Commissioner of Income Tax (257 ITR 343) the Supreme Court considered the application of section 41(1) of the Act to excise duty refunded to the assessee. The Bench, at page 346 of the report states as follows:
Section 41(1) applies if the following conditions and circumstances are satisfied:
In the assessment for the relevant year an allowance or deduction has been made of any loss, expenditure or trading liability incurred by the assessee. This is the first step. Coming to the next step the assessee must have subsequently (i) obtained any amount in respect of such loss or expenditure or (ii) obtained any benefit in respect of such trading liability by way of remission or cessation thereof. In case either of these events happen, the deeming provision enacted in the closing part of sub-section (1) comes into play. Accordingly, the amount obtained by the assessee or the value of benefit accruing to him is deemed to be profits and gains of business or peofessions and it becomes chargeable to income-tax as the income of that previous year.
18. In view of the above discussion, we find that the judgments of the Supreme Court in the case of Kesaria Tea Company (supra) and Polyflex (India) (supra) would be more relevant to the facts and circumstances of this case.
19. The substantial questions of law are answered in favour of the assessee and the appeal allowed.