2006 (3) TMI 204 - AT - Income Tax

Cessation of liability - Chargeable to tax - earnest money or an advance - NCDs were issued in order to borrow the funds to raise the capital - capital nature or a revenue receipt - HELD THAT - We have examined the judgment of the Hon ble Gujarat High Court in the case of Chetan Chemicals (P.) Ltd. 2001 (10) TMI 12 - GUJARAT HIGH COURT in which Their Lordships have held that on a reading of section 41(1) of the Income-tax Act 1961 it is apparent that before the section can be invoked an allowance or a deduction has been granted during the course of assessment for any year in respect of loss expenditure or trading liability which is incurred by the assessee and subsequently during any previous year the assessee obtains whether in cash or in any other manner any amount in respect of such trading liability by way of remission or cessation of such liability. In that case either the amount obtained by the assessee or the value of the benefit accruing to the assessee can be deemed to be the profits and gains of business or profession and can be brought to tax as income of the previous year in which such amount or benefit is obtained. We find that the NCDs were issued to raise a capital of the assessee before commencement of the business and whatever earnest money or advance was received on account of issuance of NCDs was kept in separate account and was shown as loan liability upon the assessee and this liability was never debited to the profit and loss account nor was its deduction claimed in the relevant assessment year. Since the NCDs were issued in order to borrow the funds to raise the capital the amount received in lieu thereof has assumed the character of capital receipt if at all not treated to be a loan liability inasmuch as issuance of NCDs was not a business of the assessee. Thus the earnest money or an advance amount received on account issuance of NCDs if forfeited on account of nonpayment of call money the loan liability would only convert into a capital receipt. It would not assume a character of revenue receipt or business receipt because NCDs were not issued in the course of regular business of the assessee as evident from the facts of the case. Assessee s main business is of cement and it was in the process of set up of cement manufacturing plant at Satna during the impugned assessment year. In these circumstances we are constrained to hold that the amount received by the assessee in lieu of issuance of NCDs which were forfeited later on account of non-payment of call money assumes a character of capital receipt which earlier was shown as a loan liability in the books of account of the assessee. If we consider this receipt to be a business receipts even then it would not be taxable to tax under the provisions of section 41(1) of the Act inasmuch as there was no allowance or deduction of this liability in the earlier years. We also do not find any provision in this Act according to which this type of receipts are chargeable to tax. We therefore are of the considered view that the revenue was not justified in treating this receipt as revenue receipt. We therefore set aside the order of CIT(A) and delete the addition. In the result the appeal of the assessee is allowed.

Issues Involved:
1. Treatment of the amount written back on forfeiture of debentures as income exigible to tax.
2. Applicability of the provisions of sections 4 and 5 of the Income-tax Act.
3. Applicability of section 41(1) of the Income-tax Act.
4. Character of the receipt from issuance of non-convertible debentures (NCDs) as capital or revenue.

Detailed Analysis:

1. Treatment of the Amount Written Back on Forfeiture of Debentures as Income Exigible to Tax:
The Assessing Officer (AO) treated the amount written back on forfeiture of debentures as income exigible to tax, adding Rs. 14,19,000 to the total income of the assessee. The AO argued that the forfeited amount, derived from the business setup process, retains the character of income and is taxable as "income from other sources," following the precedent set by the Hon'ble Apex Court in CIT v. T.V. Sundaram Iyengar & Sons Ltd. [1996] 222 ITR 344.

2. Applicability of the Provisions of Sections 4 and 5 of the Income-tax Act:
The assessee contended that under sections 4 and 5, the general liability to tax is imposed upon income, but not all receipts are income chargeable to tax. The burden lies on the department to prove that a receipt falls within the taxing provisions. The assessee argued that the forfeited amount, initially received as a loan through debentures, does not change its character to income upon forfeiture due to non-payment of call money. The assessee cited Parimmisetti Seetharamamma v. CIT [1965] 57 ITR 532 to support this contention.

3. Applicability of Section 41(1) of the Income-tax Act:
The assessee argued that section 41(1) applies only if the liability was debited to the profit and loss account in earlier years as a loss, expenditure, or trading liability. Since the liability was not debited or allowed as a deduction in earlier years, it cannot be treated as income upon cessation. The assessee referenced the judgments in Mahindra and Mahindra Ltd. v. CIT [2003] 261 ITR 501 (Bom.) and Chetan Chemicals (P.) Ltd. v. CIT [2004] 267 ITR 770 (Guj.) to support this argument.

4. Character of the Receipt from Issuance of NCDs as Capital or Revenue:
The assessee issued NCDs to raise capital, and the amount received was credited to the capital account as a loan or advance. The assessee argued that the forfeited amount retains its capital nature and does not become taxable income. The Tribunal examined various judgments, including T.V. Sundaram Iyengar & Sons Ltd., Lakshmi Vilas Bank Ltd., and Comfund Financial Services (I) Ltd., to determine the nature of the receipt. The Tribunal concluded that the borrowed funds through NCDs were of a capital nature, and their character does not change upon forfeiture.

Conclusion:
The Tribunal held that the amount received from the issuance of NCDs, forfeited due to non-payment of call money, retains its character as a capital receipt and is not taxable as income. The provisions of section 41(1) do not apply since the liability was not debited to the profit and loss account in earlier years. The revenue's treatment of the forfeited amount as a revenue receipt was unjustified. The Tribunal set aside the CIT(A)'s order and deleted the addition, allowing the assessee's appeal.

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