Should Refund Of Duties Paid Earlier Be Taxed On Receipt or Due Basis ?

We are into imports of wood and there’s a duty of 5 % (basic) and 4% (SAD) on our imports. WEF 14/09/2007 the government has decided to issue refund of the SAD (4%) component of the duty. To file a claim for duty refund we have to show in our accounts that this is a refund expected. This will be treated as income. Question is : Do we have to pay income tax on this in the first installment or is income tax only liable after we receive the refund. The refund might or might not come through. So if we pay income tax on it now and it doesn’t come through, then what ? Sameer Chhapra, Mumbai

There is express provision under section 41 of the I T Act to  treat any expense or trading liability , which was earlier deducted against the business income , but which  is recovered either in cash or by any other methods as income .n case of Polyflex (India) (P.) Ltd. v. CIT [2002] 257 ITR 343 (SC)., Supreme Court held that where the statutory levy in respect of goods dealt in by the assessee is discharged and subsequently the amount paid is refunded, it is the first clause in section 41(1) that more appropriately applies, viz. ‘obtained any amount in respect of such loss or expenditure’. The  exact wording of section 41(1) is as under:

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….

As  per sec. 41(1) , such recovery or receipt of expenditure deems to be  income of the assessee in the financial year in which it is obtained.I

Such income is taxed on due basis or cash i.e receipt basis?

The  issue  which vexed every one is the timing of taxation. Many time , as in your case , the refund of such duties  are declared in principle, but  actual receipt is much later than the year in which it was declared. Therefore , a business entity following the mercantile system gets confused whether it should show the  income , (refund of duties) in the year of declaration following mercantile system or in the year of actual receipt.

The Courts have however cleared certain confusions on issues related to section 41(1) like

1. it held that the system of accounting is  not relevant for  treatment of income u/s 41(1)
   
2. The  income  is taxed in the year when it is actually received.

In CIT v. Bharat Iron & Steel Industries [1993] 199 ITR 67 (Guj.) (FB).. Gujarat High Court held as under 

After having carefully considered the decisions of this court in CIT v. Rashmi Trading [1976] 103 ITR 312 and Motilal Ambaidas v. CIT [1977] 108 ITR 136, we are inclined to agree with the view taken by this court in CIT v. Rashmi Trading [1976] 103 ITR 312. Section 41(1) introduces a fiction by which an allowance or deduction which 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 the business or profession and accordingly chargeable to income-tax as 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. The fiction is an indivisible one. It cannot be enlarged by importing another fiction, namely, that if the amount was obtainable or receivable during the previous year, it must be deemed to have been obtained or received during that year.

…………

In our opinion, for considering the taxability of amount coming within the mischief of section 41(1) of the Act, the system of accounting followed by the assessee is of no relevance or consequence. We have to go by the language used in section 41(1) to find out whether or not the amount was obtained by the assessee or whether or not some benefit in respect of trading liability by way of remission or cessation thereof was obtained by the assessee and it is in the previous year in which the amount or benefit, as the case may be, has been obtained that the amount or the value of the benefit would become chargeable to income-tax as income of that previous year.

We fully agree with the view taken by the Division Bench in CIT v. Rashmi Trading [1976] 103 ITR 312 (Guj), that the only meaning that can be attached to the words “obtained, whether in cash or in any other manner whatsoever, any amount in respect of such loss or expenditure” incurred in any previous year clearly refer to the actual receiving of the cash of that amount. The amount may be actually received or it may be adjusted by way of an adjustment entry or a credit note or in any other form when the cash or the equivalent of the cash can be said to have been received by the assessee. But it must be the obtaining of the actual amount which is contemplated by the Legislature when it used the words “has obtained, whether in cash or in any other manner whatsoever, any amount in respect of such loss or expenditure in the past”. As rightly observed by the Division Bench, in the context in which these words occur, no other meaning is possible.

 Whether provision u/s 41(1)  apply if claim is pending in appeal?

The  Courts have held that if any duty or any other payments which was earlier claimed as deduction from business income  becomes payable i.e refundable to assessee and department appeals to higher judicial authority against such refunds , the provision u/s 41(1) under which such refund has to be taxed , remains in suspension till the finality of the appeal.

It was held by Allahabad High Court in J.K. Synthetics Ltd. v. O.S. Bajpai, ITO [1976] 105 ITR 864 (All.) which approved by Supreme Court [199 ITR 14 (SC)] that the assessee was not liable to pay tax on duty which was earlier allowed as deduction  but which was held refundable by the High Court . The reason of the All habad High Court was that  since  the department went in appeal to the Supreme Court, the deduction already allowed could not be brought to tax under section 41(1), because the appeal by the department had destroyed the finality of the High Court’s decision .

In Visnagar Taluka Audyogik Sahakari Mandli Ltd. v. CIT [2000] 242 ITR 627 (Guj.), Gujarat High Court held that where refund of excise duty was paid to an assessee pursuant to an order of the High Court as a measure of interim relief, but the department filed an appeal to the Supreme Court, the refund cannot be brought to tax under section 41(1) in the year of receipt till the matter is finally decided by the Supreme Court. Even if the refund was received during the pendency of proceedings, section 41(1) cannot be invoked as there is no final decision on the question whether or not the assessee is entitled to claim the refund of duty. The fact that the assessee was maintaining cash system of accounting would be of no relevance .