Commissioner of Income Tax vs Veekanardt (P.) Ltd.

B.P. Saraf, J.—By this reference u/s 256(1) of the income tax Act, 1961, ''the Act'', made at the instance of the revenue, the Tribunal,

Bombay has referred the following questions of law to this court for opinion:

Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that the provisions of section 40A(8) of the

I.T. Act, 1961 were not applicable in respect of interest payments of Rs. 1,73,002, Rs. 2,87,000 and Rs. 1,49,127 on the ground that the interest

payments were not interest payments on deposits received?

Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that an amount of Rs. 8,56,440 credited to

the Capital Reserve Account by the assessee-company in respect of provisions for contractual liability taken over by the assessee-company was

not chargeable to tax u/s 41(1), 176(3A) or 23(iv) of the I.T. Act, 1961?

The assessee is a private limited company. It was incorporated in the year 1973. Its business is that of manufacture of Pharmaceuticals. Its

accounts are closed every year on 31st December. This reference pertains to the assessment year 1977-78, the corresponding previous year being

calendar year 1976. The assessee became a partner in the firm of Wockardt Pharmaceuticals on and from 1-1-1975. On 31-12-1975, by an

agreement between the partners, all the other partners of the said firm retired and the assessee became the sole proprietor of the business carried

on by it. Under the said agreement the assessee-company took over the partnership business as a running concern on and from 1-1-1976. In

terms of the agreement, all liabilities of the said firm including liability an account of all deposits received by the erstwhile firm as well as the amounts

standing to the credit of the outgoing partners in their capital accounts (both fixed capital account and current account), were taken over by the

assessee. In terms of the dissolution deed, some shares of the assessee-company were allotted to the outgoing partners and on the balance amount

standing to the credit of the partners, the assessee paid interest. Some of these partners, in the meantime had also become directors of the

assessee-company and others were shareholders. In course of its assessment for the assessment year 1976-77, the assessee-company claimed

that out of the total interest paid by it, a sum of Rs. 1,73,002 was not on deposits received by it but represented interest on the liabilities of the old

firm taken over with effect from 1-1-1976, on its becoming the sole proprietor of the business of the dissolved firm. The claim of the assessee was

negatived by the authorities below. However, on appeal, the Tribunal accepted the contention of the assessee and held that payment of interest

amounting to Rs. 1,73,002 on the liabilities of the business of the erstwhile firm which had been taken over by the assessee, could not be held to be

''expenditure by way of interest in respect of deposits received by it'' and, hence, section 40A(8) of the Act was not applicable. According to the

Tribunal, this expenditure was on account of interest in respect of legal obligations to pay certain amounts to the partners concerned in terms of the

agreement. From the above order of the Tribunal, the revenue sought for reference u/s 256(1) of the Act. The Tribunal has, accordingly, referred

to us question No. 1.

The facts relating to the second question are as follows: The ITO included in the income of the assessee a sum of Rs. 8,56,440 u/s 41(1) of the

Act. This amount is made of two sums : (i) Rs. 8,43,460 being the provision for excise duty in respect of which a demand had been raised by the

Excise Authorities against the predecessor of the assessee. The above provision had been made by the said firm in its books of account and

deduction was claimed and allowed in respect thereof in computation of its income of the relevant assessment year. The liability in respect thereof

appeared in the balance-sheet of the said firm as on 31-12-1975 under the head ''Current liabilities and Provisions''. The above provision had been

taken over by the assessee-company on 1-1-1976. This liability became unenforceable against the assessee-company during the calendar year

1976 relevant to the assessment year under consideration by virtue of a decision of the High Court rendered during the said year; and (ii) Rs.

23,980 representing the amount due by the erstwhile firm to Wockardt Chemicals Works Pvt. Ltd., on account of unpaid rent, the liability in

respect of which appeared in the balance sheet of the said firm as on 31-12-1975. In terms of a consent decree, Wockardt Chemicals Works Pvt.

Ltd. agreed not to enforce its demand for Rs. 23,980 against the assessee-company.

Both the above provisions and liability were included in the liabilities taken over by the assessee-company. The liabilities in respect of these two

amounts, thus, having ceased, the assessee-company transferred the above amounts, in all amounting to Rs. 8,56,440, initially to the profit and loss

account and thereafter to its capital reserve account. The ITO applied the provisions of section 41(1) and included the said amounts in the income

of the assessee. This order was confirmed on appeal. However, on further appeal, the Tribunal reversed the above finding of the authorities below

and held that these amounts were not chargeable to tax in the hands of the assessee-company u/s 41(1). Aggrieved by the above decision, the

revenue sought for reference of question of law arising therefrom to this Court which the Tribunal did by referring to us question No. 2.

We have heard at length Mr. G.S. Jetly, the learned counsel for the revenue. So far as the controversy in the first question is concerned, it is

clear from the facts of the case that after the business of the erstwhile partnership firm was taken over by the assessee-company as a running

concern with all its assets and liabilities including the amounts standing to the credit of the outgoing partners of the said firm, the amounts belonging

to the partners no more retained the character of ''capital'' but assumed the character of debt due. The former partners became the creditors of the

assessee-company in respect of the amounts in question. The assessee-company also paid interest on the said amounts.

Section 40A(8) refers to expenditure by way of interest in respect of any deposit received by a company and provides for disallowance of 15

per cent of such interest. ''Deposit'' has been defined in Explanation (a) to mean any deposit of money with the company, including any money

borrowed by it. The only exclusion is on account of amounts received by the company which fall under any of the clauses thereof. The admitted

position in the present case is that these amounts do not fall in any of the exclusionary clauses. In such a situation, the amounts in question, lying in

deposit with the assessee-company on which interest had been paid by it, evidently fall within the meaning of section 40A(8) and, hence, interest

paid thereon would fall within the purview of section 40A(8). The method or manner in which the amounts came to be received by the assessee, in

our opinion, has no relevance for the purpose of deciding whether the particular amounts belonging to others and lying with the assessee on which

interest was also paid by the assessee, would fall within the expression ''deposit''. We have dealt with this aspect in income tax Reference No. 57

of 1984 decided on 30-11-1994, wherein also we have taken identical view in the matter.

5.A For the reasons set out above, the Tribunal was not justified in holding that the interest payments in question were not in respect of any deposit

received by the assessee but were in respect of obligations which the assessee had taken over from the firm as a going concern while taking over

its business. Obligation to pay the money to the partners to whom it belonged is always there in all such cases. We fail to understand why such

obligations would not qualify as ''deposits'' when they have all the ingredients of a deposit. In the premises, we answer question No. 1 in the

negative and in favour of the revenue.

So far as the second question is concerned, the admitted position is that the partnership firm, the business of which had been taken over by the

assessee, had claimed deduction in respect of the two amounts in question in computation of its income as a trading liability which was allowed by

the income tax Officer. The amounts appeared in its books of account as a trading liability. All liabilities including the liability in respect of the

amounts in question, had been taken over by the assessee-company. There is no controversy about the fact that during the previous year relevant

to the assessment year under consideration, by virtue of the decision of the High Court, the liability of the assessee-company to pay excise duty

ceased to exist and so far as the liability to pay the sum of Rs. 23,980. Wockardt Chemicals Works Pvt. Ltd. is concerned, again the admitted

factual position is that this liability came to an end during the relevant previous year as a result of consent decree passed by the Court.

That being so, in our opinion, section 41(1) is clearly attracted. Section 41(1) provides:

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,

In the instant case, from the facts set out above, it is obvious that all the conditions of section 41(1) were fulfilled in respect of the trading liabilities

in question and the assessee-company obtained a benefit in respect thereof by way of cessation/remission of the same. The value of such benefit so

accruing to him, therefore, has to be deemed to be profit and gains of the assessee and chargeable to income tax as his income of the assessment

year under consideration.

The only question that, possibly, could have arisen in this case is whether the deduction in respect of such expenditure or trading liability having

been made in the assessment of the erstwhile partnership firm, provisions of section 41(1) would be applicable to the assessee-company which

took over the business of said firm as a going concern. That, question, however, has become academic in view of the specific provision contained

in sub-section (3A) of section 176 of the Act which was inserted by the Taxation Laws (Amendment) Act, 1975 with effect from 1-4-1976. It

reads:

(3A) Where any business is discontinued in any year, any sum received after the discontinuance shall be deemed to be the income of the recipient

and charged to tax accordingly in the year of receipt, if such sum would have been included in the total income of the person who carried on the

business had such sum been received before such discontinuance.

This sub-section, thus, provides that any sum received after discontinuance of a business is to be treated as income of the recipient in the year of

receipt, as if it would have been included in the total income of the person who carried on the business, had it been received before such

discontinuance.

In the premises, we are of the clear opinion that the Tribunal was not right in holding that section 41(1) was not applicable to the amounts in

question. Hence, the second question is also answered in the negative and in favour of the revenue.

In the result, both the questions are answered in the negative and in favour of the revenue. On the facts and circumstances of the case, there shall

be no order as to costs.