Deemed income under
Income Tax Act, 1961
CA MEHUL THAKKER
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Let’s consider the provisions of section 41 (1)
Section 41(1) is applicable if the following
conditions are satisfied—
Condition one - In any of the earlier years a
deduction was allowed to the taxpayer in respect
of loss,
expenditure or trading liability incurred
by the assessee.
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Condition two - During the current previous year, the
taxpayer—
a. has obtained a refund of such trading liability (it
may be in cash or any other manner);
Or
b. has obtained some benefit in respect of such
trading liability by way of remission or cessation
thereof (“remission or cessation” for this purpose
includes unilateral act of the assessee by way of
writing off of such liability in his books of account).
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If the above two conditions are satisfied,
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 tax as the
income of that previous year.
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Considering the above, Hon’ble Supreme Court in
case of Polyfex India (P.) Ltd. v. CIT [2002] 124
Taxman 373 held that where expenditure is actually
incurred by reason of payment of duty on goods and
the deduction or allowance has been given in the
assessment for earlier period, the assessee is liable
to disgorge that benefit as and when he obtains
refund of the amount so paid. The consideration
whether there is a possibility of the refund being
set at naught on a future date will not be relevant
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consideration. Once the assessee gets back the
amount which was claimed and allowed as business
expenditure during the earlier year, the deeming
provision in section 41(1) comes into play and it is
not necessary that the Revenue should await the
verdict of higher court or the Tribunal. If the court
or the Tribunal upholds the levy at a later date, the
assessee will not be without remedy to get back the
relief (the amount so paid will be allowed as
deduction under section 43B on “payment” basis).
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Section 41 (1) creates a liability to pay tax only in
those cases where an allowance had been actually
granted, and not where the income had been
estimated. Once income has been estimated, the
deduction cannot be said to have been actually
allowed. –Tirunelveli Motor Bus Serive Co. (P) Ltd
vs. CIT [1970] 78 ITR 55 (SC), CIT vs. Bhawan Va
Path Nirman Bohra [2002] 258 ITR 440 (Raj).
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As regards trading liabilities, section 41(1) can be
applied only upon “remission or cessation”. When a
liability becomes barred by the law of limitation,
there is neither remission or cessation of the liability.
In such cases the liability is not extinguished, only the
creditor’s remedy becomes barred. Therefore, if the
amount of a trading liability which has become
barred by limitation cannot be taxed in the year in
which it has become time-barred. - CIT vs. Sugauli
Sugar Works (P) Ltd. [1999] 236 ITR 518 (SC) .
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In the case of CIT v. T.V. Sundaram lyengar & Sons Ltd.
[1996]88 Taxman 429, the Supreme Court has held that
such amounts are to be treated as income of assesse.
The amount representing unclaimed credit balances will
be liable to be taxed during the assessment year relevant
to the previous year in which such amount is written
back to Profit and Loss account by the assesse.
Further, in view of the amendment with effect from A.Y.
1997-98, unilateral act of writing off any liability is also
covered by section 41(1).
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This issue came up before the Delhi High Court in
Rollatainers Ltd. v. CIT (2011) 339 ITR 54.
Waiver of term loan (Principal)
The High Court observed that, as regards term loans, the
same were taken for the purchase of capital assets from
time to time. Therefore, since the money did not come
into the possession of the assessee on account of any
trading transaction, the receipts were capital in nature,
being loan repayable over a period of time along with
interest. The liability in question,
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i.e. the term loan for purchase of capital assets, is
not a trading liability. Therefore, the provisions of
section 41(1) are not attracted in this case since
the waiver is in respect of a term loan taken for a
capital asset and hence, cannot be treated as
remission or cessation of a trading liability. Thus,
the waiver of such term loans cannot be treated as
income of the assessee.
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Waiver of working capital loan (Principal)
In a case where loan is written off in the cash credit
account, the benefit is in the revenue field as the
money had been borrowed for day-to-day affairs
and not for the purchase of capital asset. These
loans were for circulating capital and not fixed
capital. They were received for carrying out the
day-to-day operations of the assessee.
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Therefore, the writing off of these loans on the
cash credit account amounted to remission of a
trading liability and hence, has to be treated as
income in the hands of the assessee by virtue of
section 41(1).
As far as waiver of interest is concerned, the same
cannot be brought to tax by invoking the provisions
of section 41(1), whether it be interest on term
loan or working capital loan, since such interest
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would not have been allowed as deduction in any
earlier previous year due to the provisions of
section 43B requiring actual payment for claiming
deduction of interest. Therefore, since no
deduction would have been allowed in any earlier
previous year on account of non-payment of such
interest, there is no question of taxability of
interest in the year of waiver.
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Section 59 (1) provides that the provisions of subsection (1) of section 41 shall apply, so far as may
be, in computing the income of an assessee under
section 56, as they apply in computing the income
of an assessee under the head "Profits and gains of
business or profession".
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Hon’ble Calcutta High Court while answering the
above issue in case of CIT V. India Automobiles Ltd.
251 ITR 117 (2001) held that there is no deeming
provisions under the head “Income from house
property” like section 41(1) under the head “Profits
and gains from business or profession” or section 59
under the head “Income from other sources”. And
therefore, in the absence of such provision under
the statute, refund of municipal tax can never be
taxed.
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(i) Recently, in Amiantit International Holding
Ltd., [2010] 189 Taxman 149 (AAR-New Delhi),
Dana Corporation, [2010] 186 Taxman 187 (AARNew Delhi) and Goodyear Tire & Rubber Co.,
[2011] 199Taxman 121 (AAR-New Delhi), it was
held that where consideration for which capital
asset has been transferred, is not ascertainable
then gain cannot be measured (means calculation
machinery fails), therefore gain arising from
transfer of such asset shall not be taxed.
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(ii) Consequently, a new section 50D has been
inserted by the Finance Act, 2012 providing that, in
case where the consideration received or accruing
as a result of the transfer of a capital asset by an
assessee is not ascertainable or cannot be
determined, then, for the purpose of computing
income chargeable to tax as capital gains, the fair
market value of the said asset on the date of
transfer shall be deemed to be the full value of
consideration received or accruing as a result of such
transfer.
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(iii) Considering the above amended provision,
contention of Mrs. A is not acceptable and Rs.
12,00,000 shall be deemed to be the sale
consideration while computing capital gain in her
hands.
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The Amritsar Bench in the case of ACIT V. Citizen
Urban Co-Operative Bank Ltd. [2009] 314 ITR 91
held that public deposits accepted by bank are not
covered u/s 68 as the bank is not obliged to
question the source of deposit of customers where
depositors have been properly introduced.
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The Madhya Pradesh High Court in the case of CIT
v. Nevendram Ahuja [2007] 290 ITR 453 held that
the landlord is only to prove the identity of the
tenant and the genuineness of transaction under
which deposit was made. There is no necessity to
prove capacity of tenant to make deposit. Section
68 does not apply in such a case.
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(i) Section 68 brings to tax any sum found credited
in the books of an assessee, in respect of which the
assessee does not offer any explanation about the
nature and source of money so credited or the
explanation offered by the assessee is not found to
be satisfactory by the Assessing Officer.
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(ii) A proviso has been inserted in section 68 by
Finance Act, 2012 as under:
 any explanation offered by a closely held
company in respect of any sum credited as share
application money, share capital, share
premium or such amount, by whatever name
called, in the accounts of such company shall be
deemed to be not satisfactory
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

- unless the person, being a resident, in whose
name such credit is recorded in the books of such
company also explains, to the satisfaction of the
Assessing Officer, the source of sum so credited
as share application money, share capital, etc. in
his hands.
- Otherwise, the explanation offered by the
assessee-company shall be deemed as not
satisfactory, consequent to which the sum shall
be treated as income of the company.
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However, this proviso shall not apply if the
person in whose name such sum is recorded in
the books of the closely held company is a VCF
or a VCC registered with SEBI.
Thus, amended proviso shall apply only when
resident shareholder brings share capital, share
premium…… and not when non-resident brings the
money. Considering this, Rs. 1,00,000 (being
amount received from Mr. Rajnikant) shall be taxed
in the hands of company.
(iii)
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
Company in which public are substantially
interested: - Relevant clause of Section 2 (18)
reads as under:-
(b) if it is a company which is not a private
company as defined in the Companies Act,
1956 (1 of 1956), and the conditions
specified either in item (A) or in item (B) are
fulfilled, namely :—
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
(A) shares in the company (not being shares entitled to a
fixed rate of dividend whether with or without a further right
to participate in profits) were, as on the last day of the
relevant previous year, listed in a recognised stock exchange
in India in accordance with the Securities Contracts
(Regulation) Act, 1956 (42 of 1956), and any rules made
thereunder ;

Considering the above definition, ABC tutorials Ltd is the
“company in which public are substantially interested” and
therefore, proviso to section 68 shall not apply, hence,
nothing shall be taxed in the hands of ABC tutorials Ltd.
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

Explanation 5A to Section 271 reads as under:In the course of search assesse is found to be the
owner of
a) Assets
b) Income based on entry in Books of Accounts and
documents
and he claims that such assets or entry in books
of accounts or documents represents his income
for the “specified previous year”.
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
If above conditions are satisfied then Explanation
5A provides that taxpayer deemed to have
concealed particulars of income and liable for
penalty under section 271 (1) (c) even if such
income is declared by a taxpayer in any return of
income furnished on or after date of search.
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
a)
b)
c)
Here specified previous year means
previous year which has ended before date of
search and
due date for filling return of income for such
year has expired
and assesse has not submitted return.
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
Considering above explanation, previous year
2010-11 squarely falls under Explanation 5A.
Hence, A.O. is justified for invoking penalty u/s.
271 (1) (c) on Rs. 6,00,000 even though same has
been recorded in books of account before search.
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
Section 271AAB is applicable if search is initiated
on or after July 1, 2012, there is some
“undisclosed income” and it pertains to a
“specified previous year”. In such a case, the
assessee shall be liable for penalty under section
271AAB in addition to tax as follows:-
1. If undisclosed income is admitted during the
course of search, the taxpayer will be liable for
penalty at the rate of 10 per cent of undisclosed
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income provided the following conditions are
satisfied—
a) The assessee in the course of the search, in a
statement under section 132(4) admits the
undisclosed income and specifies the manner in
which such income has been derived;
b) he substantiates the manner in which the
undisclosed income was derived;
c) he pays the tax, together with interest, if any, in
respect of the undisclosed income; and

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

d) he furnishes the return of income for the
specified previous year declaring such
undisclosed income therein.
2. If undisclosed income is not admitted during
the course of search but he satisfies conditions
(c) and (d) (above), he will be liable for penalty at
the rate of 20 per cent of undisclosed income.
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
3. In a case not covered under (1) and (2) above
,the taxpayer will be liable for penalty at the rate
ranging from 30 percent to 90 percent of
undisclosed income.

Meaning of Specified previous year for the
purpose of section 271AAB- “Specified previous
year” means -
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i.
ii.
the previous year in which search is conducted.
the previous year
a. which has ended before the date of search but
b. the due date of furnishing return of income
under section 139(1) has not expired before the
date of search and
c. the assessee has not furnished his return of
income for the previous year.
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Meaning of undisclosed income, for the purpose
of this section, means:
(1) any income of the specified previous year
represented, either wholly or partly, by any
money, bullion, jewellery or other valuable article
or thing or any entry in the books of account or
other documents or transactions found in the
course of a search under section 132, which has
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a)
not been recorded on or before the date of
search in the books of account or other
documents maintained in the normal course
relating to such previous year; or
b)
otherwise not been disclosed to the Chief
Commissioner or Commissioner before the date
of search; or
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(2) any income of the specified previous year
represented, either wholly or partly, by any entry
in respect of an expense recorded in the books
of account or other documents maintained in the
normal course relating to the specified previous
year which is found to be false and would not
have been found to be so had the search not
been conducted.
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
Considering above, previous year 2011-12
squarely falls under section 271 AAB. Hence, A.O.
is not justified for invoking penalty u/s. 271 (1)
(c). But A.O. may impose penalty under section
271 AAB on undisclosed income (i.e. Jewellery Rs.
5,00,000 ) ranging from 10% to 90% of such
income.
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
Considering the definition of specified previous
year and second limb of definition of
“Undisclosed income”, A.O. may impose penalty
under section 271 AAB on undisclosed income
(i.e. unaccounted marriage expenditure Rs.
9,00,000 ) ranging from 10% to 90% of such
income.
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