Commissioner of Income Tax vs Pranlal P. Doshi

Majmudar, J.—In this reference, at the instance of the revenue, the following question is referred for our opinion:

"Whether, on the facts and in the circumstances of the case, applying the provisions of section 41(1) of the income tax Act, 1961, the Appellate Tribunal was justified in law in holding that the business of the assessee of processing cotton seeds and running a solvent extraction plant was deemed to have been carried on during the accounting period relevant to the assessment year in question and, consequently, the assessee was entitled to the allowance of loss of Rs. 31,452 as claimed by it ?"

In order to appreciate the scope and ambit of this question, certain background facts become necessary to be noted at this stage. The respondent-assessee is an individual. Relevant assessment year is 1970- 71. The financial year ended on 31-3-1970. The assessee formerly was having business at Veraval in cotton seed processing and oil extraction plant. For the assessment year in question, the assessee had declared loss of Rs. 31,452 as under:

Rs.

Interest provision made in the suspense account

49,500

Less : Receipt from sales of stores

18,048

31,452

The ITO, amongst other items, with which we are not concerned, disallowed the aforesaid loss on the ground that it was not shown that the assessee during the relevant assessment year in question, had actually run the business. According to the ITO, it cannot be said that the assessee was engaged in any business in the year in question and, therefore, it had to be held that business was closed. Consequently, the assessee''s claim in respect of interest provision of Rs. 49,500 could not be allowed.

So far as receipt of Rs. 18,048 was concerned, the ITO took the view that assessee had not furnished any details as to how he sold the goods, he disposed them of and how he had purchased them.

The assessee carried the matter in appeal. The AAC disagreeing with the ITO took the view that Rs. 18,048 realised from sale of the following five items, viz. :

Rs.

Building materials

5,040

Industrial by-products, lint cotton products

6,768

Factory consumable stores lagging com. thermometers, bolts, nuts, welding rods, points, etc.

3,100

Spare parts of 3 Mercedes trucks and one Studebaker car

2,040

Machinery, platform scale Avery and Kundla scales

1,100

18,048

could not be treated as income from other sources. It was found by the AAC that it is very much connected with business hitherto carried on by the assessee. It was on record of the earlier year that the items sold were nothing but the required stores and ancillary items for the industry and they were purchased in earlier years for which the details were filed. Consequently, it was held that the business was in continuation during the relevant assessment year.

The revenue carried the matter in second appeal before the Tribunal. Before the Tribunal, no attempt appears to have been made by the respondent to support the finding of the AAC on facts, presumably because the facts on record stared in the face, viz., the assessee''s business was wound up since 1967 as the assessee had failed to pay up the dues of GSFC and under the orders of the learned District Judge, the assets of the business were sold u/s 31 of the State Finance Corporations Act and only some raw material was left. Consequently, factually, it would have been impossible to take the view that the business of the assessee had continued during the relevant assessment year. In fact, the Tribunal had not confirmed the aforesaid conclusion reached by the AAC. However, the Tribunal confirmed the order of the AAC on entirely a different ground, viz., by falling back upon section 41(1) of the income tax Act, 1961 (''the Act'') a legal fiction had arisen to the effect that the assessee''s business could have presumed to have continued by raising the fiction only because some of the assets of business, viz., articles employed in the business earlier worth Rs. 18,048 would have earned requisite deductions in the earlier years and, therefore, once they were realised in the current year, income from their sale during the relevant assessment year would give rise to the aforesaid legal fiction. By raising such legal fiction, the Tribunal reached the conclusion that for the purpose of the present assessment year, the assessee''s business can be treated to have been continued and, hence, loss can be deducted as suggested by the assessee.

Mr. Shelat for the revenue, in support of this reference, vehemently contended that the Tribunal had patently erred in law in raising the legal fiction about continuance of the assessee''s business during the relevant assessment year by taking resort to section 41(1) when the very condition precedent to the applicability of the said provision was not established on the facts of the present case. In order to appreciate this contention, we have to look at section 41(1) which reads as under:

" Profits chargeable to tax. -(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, and subsequently during any previous year the assessee 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 him 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."

A bare perusal of the above provision shows that before any amount accruing to the assessee during a given financial year is deemed to be profit or gains of business even when such business or profession had actually ceased to exist in that relevant year, the following conditions must be factually fulfilled : (i) any allowance or deduction should have been made in the assessment for any assessment year in respect of such expenditure incurred by the assessee during the course of business, (ii) subsequently, during any previous year relevant for the inquiry, the assessee must have obtained whether in cash or in other manner whatsoever, any amount in respect of such expenditure by way of remission or cessation thereof. If these two conditions are factually found to be established, then only, legal fiction contemplated by the second part of section 41(1) would spring into action, meaning thereby, once these conditions are established, then during the relevant assessment year, the question whether business of the assessee is actually in existence or not would pale into insignificance and the said expenditure would be treated to be profit or gains of business and accordingly chargeable to income tax as the income of the previous year, even de hors the fact that business during that relevant previous year would be non-existent. When we turn to the order of the Tribunal, we find that for fulfilling the said two conditions precedent for raising the deeming fiction u/s 41(1), no finding of fact has been reached by the Tribunal. What has been stated by the Tribunal in this connection is worth noting as under:

"It is not disputed that the assessee was running a solvent extraction plant and also processing cotton seeds. The solvent extraction plant was a big unit of about Rs. 25 lakhs. The assessee''s turnover was also quite substantial. It is, therefore, not difficult to believe that the assessee was in possession of articles worth Rs. 18,048 which were sold in the year under appeal. Details of these articles are mentioned in the order of the learned AAC. Having regard to the articles it would appear that assessee must have claimed deduction in respect of expenditure incurred in connection with the purchase of these articles in the past. Therefore, the said amount of Rs. 18,048 would fall u/s 41(1) of the income tax Act, 1961."

The aforesaid conclusion of the Tribunal for raising legal fiction u/s 41(1) proceeds on three assumptions: (i) that the entire amount of Rs. 18,048 realised from the sale of concerned listed five articles wholly comprised of articles which were required to be utilised in the course of the assessee''s business during the earlier years; and (ii) expenditure on these articles must have been claimed by the assessee as business expenditure during the relevant year when these articles were acquired for the purpose of the business; and (iii) that such allowance or deduction was actually made in the relevant assessment years, meaning thereby, even the department would have permitted such deduction/allowance to be made so that the assessee''s taxable income from profit or gains from the business during the relevant assessment year would have been computed after permitting such deductions from the business income returned during the concerned years when these items were acquired. The Tribunal has not arrived at any such factual findings on record. It has presumed that the assessee must have acquired these articles during the earlier years for the purpose of his business and he must have claimed deduction in respect of the expenditure incurred in connection with purchase of these articles in past. With respect, this finding is based on pure conjecture and is not borne out from the record. On such conjecture and surmise, the factual conditions precedent for raising the legal fiction u/s 41(1) cannot be established. It is easy to visualise that if the Legislature permitted legal fiction to be drawn on the basis of certain basic facts, these basic facts have to be established first as a condition precedent and once they are established, then only, legal fiction would spring into action and once such legal fiction springs into action, all necessary facts for efficacious running of such fiction can be presumed. In other words, facts necessary to be established by way of condition precedent for raising of fiction have to be established first and they can be established only on the basis of evidence on record. But once these facts are established and legal fiction springs into action, then imagination cannot be permitted to get boggled and such legal fiction which has started operating has to be carried to its logical end and, in the process, all posterior facts necessary for operation of such fiction can also be presumed. Here, unfortunately, the Tribunal on the basis of legal fiction u/s 41(1) has presumed not only posterior facts after the fiction validly arises but even anterior pre-conditional facts. Such anterior facts establishing condition precedent could not have been presumed. They have to be proved as any other fact from the evidence on record. That was unfortunately not done by the Tribunal. Consequently, the legal fiction which, according to the Tribunal, arose u/s 41(1) did not at all click or arise in the present case. Hence, section 41(1) on the facts of the present case was not at all attracted as wrongly assumed by the Tribunal.

Reliance placed by the Tribunal on the decision of the Allahabad High Court in the case of Commissioner of Income Tax Vs. Rampur Timber and Turnery Co. Ltd., is also misplaced. The Allahabad High Court in that matter was not concerned with any anterior facts by way of pre-condition for raising legal fiction u/s 41(1). Such anterior facts by way of pre-condition were actually established on record and they were not in dispute. Once that happened, legal fiction u/s 41(1) operated and then all consequential posterior facts could be validly presumed as held by the Allahabad High Court. In the case before the Allahabad High Court, the assessee had claimed that though his business during the relevant previous year had come to end, he had received refund of Rs. 6,982 from the electricity department out of the electricity charges already paid by the assessee in the earlier years when the assessee was carrying on the business which had been allowed to the assessee as an expenditure of the business in those assessments. During the assessment for the assessment year 1962-63, the ITO included the aforesaid amount of Rs. 6,982 as the business income of the assessee in view of the provisions of section 41(1). The Tribunal held that profit of Rs. 6,982 could be set off against the unabsorbed depreciation allowance of Rs. 46,003 determined for the assessment years 1951-52 to 1954-55. The question was whether u/s 41(1) it could be presumed that during the assessment year 1962-63, even though there was no business of the assessee, such profit could be treated to have arisen on the assumption that Rs. 6,982 were deemed profits of the business which was earlier carried on. Answering this question in favour of the assessee, it was held that sum of Rs. 6,982 assessed as the business income of the assessee for the relevant previous year was liable to be set off against the unabsorbed depreciation of Rs. 46,003 carried forward from 1954-55. The benefit of unabsorbed depreciation could be availed of by an assessee in any subsequent year without satisfaction of the pre-conditions attaching to sub-section (1) of section 32 of the Act and it was not necessary that in such subsequent year, the assessee actually carried on the business and the asset in question was used for the purpose of the assessee''s business. It is the aforesaid decision of the Allahabad High Court which had weighed heavily with the Tribunal in the present case. We fail to appreciate how the said decision can be of any avail to the assessee. In the aforesaid case, the electricity charges paid by the assessee during the course of business were in fact allowed by the department as permissible business expenditure while making assessment for the earlier years. Thus, basic facts which are required for raising legal fiction u/s 41(1) were proved as a matter of fact on record and then only legal fiction contemplated by section 41(1) arose. In the present case, there is no such attempt on the part of the assessee to prove the existence of anterior facts which are by way of pre-conditions as noted earlier. Consequently, applicability of section 41(1) which rightly arose on the facts of the case before the Allahabad High Court was not capable of being pressed in service by the assessee on the facts of the present case. In fairness, our attention was also invited by the learned advocate of the revenue to the decision of this Court in the case of Commissioner of Income Tax Vs. Deepak Textile Industries Ltd., which had relied upon the aforesaid Allahabad High Court decision. This Court, while considering the scope and ambit of legal fiction u/s 32(2), has held that in construing the scope of a legal fiction, it would be proper and even necessary to assume all those facts on which alone the fiction can operate. These observations would obviously apply to posterior facts after the fiction is found to have legally arisen. As discussed earlier, the facts of the present case are entirely different. The basic facts for raising legal fiction are non-existent on record or at least they are not found to be proved as aforesaid and, with respect, wrongly assumed by the Tribunal to have existed.

As a result of the aforesaid discussion, it must be held that the Tribunal was in error in invoking section 41(1) on the facts of the present case. The question referred for our opinion must be answered in the negative, that is, in favour of the revenue and against the assessee. No order as to costs.