Transfer of creditor balances to capital for bank loan facilities was not waiver u/s 41(1)

Transfer of creditor balances to capital account for better bank loan facilities was not waiver of liability u/s 41(1) being without consent form creditors

ABCAUS Case Law Citation:
ABCAUS 2714 (2019) (01) ITAT

Important Case Laws Cited/relied upon:
Commissioner of Income tax Vs Sugauli Sugar Works (P.) Ltd 102 taxman 713

Satpal & Sons (HUF)v. ACIT Circle-38(1), New Delhi 85 taxman.com 283

The instant appeal was filed by the assessee against the order of the Principal Commissioner of Income Tax (Pr.CIT) in invoking his revisonary powers u/s 263 of the Income Tax Act, 1961 (the Act).

The assessee had filed the return of income and the assessment had been completed u/s 143(3)  of the Act.

Subsequently, the Pr.CIT taken up the case for revision u/s 263 and inter alia noticed that the assessee has transferred a huge amount from the trade creditors to the capital accounts of the partners of the firm.

The assessee had explained before the Assessing Officer (AO) that the amounts were transferred for the purpose of bank loans and there was no cessation of liability.

The Pr.CIT was of the view that the contention of the assessee was not substantiated with proper evidence, hence, the Pr.CIT viewed that the creditors were transferred to the capital accounts of the partners and the liability of Firm to the extent ceased to exist and the provisions of section 41(1) were applicable.

The Pr.CIT was of the view that the AO did not verify the application of 41(1), hence the assessment order passed by the AO u/s 143(3) r.w.s. 147 was erroneous and prejudicial to the interest of the revenue. Hence, he issued notice u/s 263 directing the assessee to explain as to why the assessment should not be revised.

In response to the notice issued, the assessee filed detailed explanations and objected for revision.

In respect of trade creditors, the assessee explained that there was no cessation or remission of liability and the trade creditors were transferred to the partners capital account only with an intention to increase the capital base for obtaining the better bank credit facilities and in the subsequent year the balances were retransferred to the respective creditors account thus submitted that there was no benefit obtained by the assessee.

The Pr.CIT was not convinced with the explanation offered by the assessee and held that the assessment made was erroneous and prejudicial to the interest of the revenue and accordingly set aside the assessment and directed the AO to make the addition relating to trade creditors which was transferred to partners capital account u/s 41(1) of the Act and in respect of other issues directed the AO to examine and verify the issues and redo the assessment afresh as per law.

Aggrieved by the order of the Ld.Pr.CIT, the assessee was in appeal before the Tribunal.

The assessee submitted that, the assessment was completed u/s 143(3) originally and during assessment proceedings, the AO had called for all the details relating to the issues raised by the Pr,CIT and examined the same and completed the assessment thus taken a conscious decision not to make the addition and accepted the contentions of the assessee.

It was submitted that the AO had called for the details of transfer of trade creditors to the partners capital account and the assessee explained the same to the Assessing Officer (AO). It was argued that from very reading of the show cause notice issued by Pr.CIT it was established that the issue was verified by the AO.

It was submitted that the AO had called for the full details of purchases, opening stock and other expenses. The AO had called for the details of introduction of capital and its sources which the assessee explained to the AO furnishing the copies of the Partners capital account and explained the transfer of trade creditors balance to the partners capital account.

Subsequently on 1st April, the entire amount was transferred back to the respective trade creditors account and the payment was made by cheque.  It was argued that therefore the entire information was furnished before the AO at the time of assessment which was verified and completed the assessment without making any addition.

It was contended that it was incorrect to say that the AO did not verify the issue at the time of assessment. Since the AO had verified the issue and taken a conscious decision not to make any addition, there is no error in the assessment order which caused prejudice to the assessment and therefore, it was requested the revision order passed u/s 263 be quashed.

The Tribunal observed that It was established by the AO had called for the details during the assessment proceedings and the assessee had explained the reasons for transfer to the partners capital account.

The Tribunal noted that the contention of the assessee was that the amounts were transferred to capital accounts of the partners at the end of the year to increase the capital base for better bank loan facilities.

The Tribunal observed that verification of the balance sheet showed if trade creditors were excluded from the partners capital account, there was a sharp decline in the capital as against the liabilities which showed poor state of financials for bank loan facilities.

The Tribunal opined that in view of the above, the assessee had resorted for window addressing to inflate the capital base to get better facilities from the banks. The explanation offered by the assessee appeared to be reasonable and is a normal practice in the trading community though unethical.

The Tribunal observed that the assessee had retransferred back the creditors balances in the subsequent years to the respective trade creditor which was evident from the ledger accounts and subsequently made purchases and as well as payments were made through bank cheque and there was no cash payment.

The Tribunal pointed out that as upheld by the Hon’ble Supreme court, it is settled law that to tax the trade creditors balances u/s 41(1), the cessation or remission of the liability has to be allowed by the trade creditor but not by the beneficiary assessee and the entries made in the books of accounts are immaterial. There must be consent form the creditor to waive the liability.

The Tribunal held that it was established that the AO had made reasonable and sufficient enquiries during the course of assessment proceedings. Thus, there was no error in the order passed by the AO and the Pr.CIT had incorrectly invoked the jurisdiction u/s 263 of the Act.

Accordingly, the ITAT cancelled the order of the Pr.CIT u/s 263 on this issue and allowed the appeal of the assessee.

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