2018 (4) TMI 1949 - AT - Income Tax

Addition u/s 41(1) - cessation of liability by the assessee - CIT-A deleted the addition - HELD THAT - CIT(A) categorically come to the conclusion that the provisions of section 41(1) cannot be invoked at all inasmuch as these liabilities does not cease to exist. CIT(A) had verified the balance sheet of the assessee and had found the assessee had made certain payments to one party in AY 2013-14 and with regard to other parties pursuant to the disputes chose not to pay the dues and had decided to show the balances payable to these parties even as late as on 31.03.2013. Hence there cannot be any case to invoke the provisions of section 41(1) on the ground of cessation of liability by the assessee. None of the factual findings given by the Ld. CIT(A) in his order have been controverted by the revenue before us with material contrary evidences. No justifiable reason to interfere in the order of the Ld. CIT(A) in this regard. Accordingly ground no. 1 raised by the revenue is dismissed. Proportionate disallowance of interest on borrowed funds - CIT-A deleted the addition - HELD THAT - As categorical finding given by the CIT(A) that one partner has allowed his credit balance i.e. own funds to be withdrawn by the another partner of the firm. Hence there cannot be any utilization of borrowed funds for excess withdrawals made by one of the partners and consequentially there cannot be any disallowance of interest on borrowed funds on a proportionate basis. There is no provision in the partnership deed to charge interest on the excess withdrawals made by any of the partners from the firm. While this is so when one partner has accommodated another partner to withdraw the balances which is only internally made between the two partners without disturbing the borrowed funds of the firm. Hence it cannot be categorized as withdrawal of the borrowed funds of the assessee firm so as to warrant disallowance of interest on a proportionate basis. Accordingly CIT(A) had rightly deleted the disallowance of interest - Decided against revenue.

Summary

1. ISSUES PRESENTED and CONSIDERED

The legal judgment considered the following core issues:

a) Whether the Commissioner of Income Tax (Appeals) [CIT(A)] was justified in deleting the addition of Rs. 37,46,658/- made by the Assessing Officer (AO) under Section 41(1) of the Income Tax Act, 1961, on the grounds of cessation of liability.

b) Whether the CIT(A) was justified in deleting the addition of Rs. 4,97,156/- as a proportionate disallowance of interest on borrowed funds, which the AO claimed were diverted for non-business purposes.

2. ISSUE-WISE DETAILED ANALYSIS

a) Deletion of Addition under Section 41(1) of the Act

Relevant Legal Framework and Precedents:

Section 41(1) of the Income Tax Act deals with the cessation or remission of trading liability. The provision is invoked when a liability that was previously allowed as a deduction ceases to exist.

Court's Interpretation and Reasoning:

The CIT(A) observed that the liabilities did not cease to exist as the assessee had acknowledged these liabilities in its audited financial statements, indicating an intention to honor the debts.

Key Evidence and Findings:

The CIT(A) examined the ledger accounts of the assessee and noted that the liabilities were carried forward from previous years and were not settled due to disputes with the creditors. The assessee had also made some payments in subsequent years, further indicating that the liabilities were not extinguished.

Application of Law to Facts:

The CIT(A) concluded that since the liabilities were acknowledged and partially settled later, there was no cessation of liability under Section 41(1). The AO's assumption of cessation was based on incomplete information.

Treatment of Competing Arguments:

The CIT(A) considered the AO's argument that the liabilities ceased to exist due to non-reconciliation but found it unsubstantiated due to the existence of disputes and subsequent payments.

Conclusions:

The CIT(A) rightly deleted the addition as the conditions for invoking Section 41(1) were not met.

b) Deletion of Proportionate Disallowance of Interest

Relevant Legal Framework and Precedents:

The issue revolves around the disallowance of interest on borrowed funds purportedly used for non-business purposes. The principle is that interest on borrowed funds used for business purposes is deductible.

Court's Interpretation and Reasoning:

The CIT(A) found that the funds withdrawn by one partner were from the credit balance of another partner, not from borrowed funds.

Key Evidence and Findings:

The CIT(A) reviewed the partner's capital and current account balances and noted that there was no provision in the partnership deed for charging interest on excess withdrawals.

Application of Law to Facts:

The CIT(A) concluded that since the withdrawals were from the partner's own funds, the borrowed funds were not diverted for non-business purposes, and thus, interest disallowance was unwarranted.

Treatment of Competing Arguments:

The CIT(A) addressed the AO's argument that the withdrawals were from borrowed funds and found it incorrect based on the partner's account balances.

Conclusions:

The CIT(A) correctly deleted the disallowance of interest, as the borrowed funds were not used for non-business purposes.

3. SIGNIFICANT HOLDINGS

Preserve Verbatim Quotes of Crucial Legal Reasoning:

"The provisions of section 41(1) of the Act cannot be invoked at all inasmuch as these liabilities do not cease to exist."

"There cannot be any utilization of borrowed funds for excess withdrawals made by one of the partners and consequentially, there cannot be any disallowance of interest on borrowed funds on a proportionate basis."

Core Principles Established:

The judgment reinforces that liabilities acknowledged in financial statements and partially settled in subsequent years do not qualify for cessation under Section 41(1).

The judgment also clarifies that interest disallowance on borrowed funds is not justified if the funds are not used for non-business purposes.

Final Determinations on Each Issue:

The appeal by the Revenue was dismissed, and the cross objection by the assessee was allowed, affirming the CIT(A)'s decision on both issues.