Why All Written Off Liability Is Not Taxable?

I have been showing certain amount as a liability in my balance sheet since last 6-7 yrs, which was to be paid back as interest to some loan. Loan was paid long back but no correspondence has taken place with the creditor re. the interest over 6-7 years. Now i would like to "Write Back" the amount. Will this reversed amount be subject to tax? Reading Sec. 41 of the I. Tax Act and certain judgements, I feel that unless there is a cessation or remission of a liability, liability, though unenforceable, still exists. Thus even if the liability is written back, the same can not be treated as profits and thus not taxable. Please advise, if i should offer this amt to tax. Swati Raut , Mumbai

Section 41 has five sub-section – 1 to 5 .  Subsection 1 ,4 & 4A starts with the words “ allowance or deduction has been made or allowed ”. Which means that the provisions u/s 1 , 4 or 4A of Section 41 is not applicable if allowance or deduction was not allowed in any assessment year.

Subsection 2,  3 & 5 of section 41 are not related to allowance or deduction , but related to money received on account of capital assets or capital expenditure on scientific research  or business not being in existence .

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, –

……………

 (2) Where any building, machinery, plant or furniture,

(a) which is owned by the assessee;

(b) in respect of which depreciation is claimed under clause (i) of sub-section (1) of section 32; and

(c) which was or has been used for the purposes of business,

is sold, discarded, demolished or destroyed and the moneys payable in respect of such building, machinery, plant or furniture, as the case may be, together with the amount of scrap value, if any, exceeds the written down value, so much of the excess as does not exceed the difference between the actual cost and the written down value shall be chargeable to income-tax as income of the business of the previous year..

(3) Where an asset representing expenditure of a capital nature on scientific research within the meaning of clause (iv) of sub-section (1) , or clause (c) of sub-section (2B) ,  of section 35, read with clause (4) of section 43 , is sold, without having been used for other purposes, and the proceeds of the sale together with the total amount of the deduction made under clause (i) or, as the case may be, the amount of the deduction under clause (ia)  of sub-section (2) ,  or clause (c) of sub-section (2B) ,  of section 35 exceed the amount of the capital expenditure, the excess or the amount of the deductions so made, whichever is the less, shall be chargeable to income-tax as income of the business or profession of the previous year in which the sale took place.

 (4) Where a deduction has been allowed in respect of a bad debt or part of debt …

( 4A ) Where a deduction has been allowed in respect of any special reserve created and maintained ….

(5) Where the business or profession referred to in this section is no longer in existence and there is income chargeable to tax under sub-section (1) ,sub-section (3) or sub-section (4) or sub-section (4A)  in respect of that business or profession, any loss, not being a loss sustained in speculation business omitted , which arose in that business or profession during the previous year in which it ceased to exist and which could not be set off against any other income of that previous year shall, so far as may be, be set off against the income chargeable to tax under the sub-sections aforesaid.

The Supreme Court in the case of Polyflex India (P) Ltd vs CIT [2002] 257 ITR 343 (SC) have made observation that section 41(1) has two limbs and caters to two different situations.

Section 41(1) applies if the following conditions and circumstances are satisfied :

In the assessment for the relevant year an allowance or deduction has been made in respect of any loss, expenditure or trading liability incurred by the assessee. This is the first step.

Coming to the next step the assessee must have subsequently

(i) obtained any amount in respect of such loss or expenditure, or

(ii) obtained any benefit in respect of such trading liability by way of remission or cessation thereof.

In case either of these events happen, the deeming provision enacted in the closing part of sub-section (1) comes into play. Accordingly, the amount obtained by the assessee or the value of benefit accruing to him is deemed to be profits and gains of business or profession and it becomes chargeable to income-tax as the income of that previous year.

Therefore, the facts required to be examined in your case is whether the interest on the loan taken was ever claimed as expenditure by debiting p & L Account . If yes, the provision of section 41  shall be applicable and the written off amounts shall be taxable,  if  not provision u/s 41 will not be applicable .