A debt is not considered “taxable income” simply because it has been outstanding for a long time or is time-barred under the Limitation Act.

By | April 4, 2026
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A debt is not considered “taxable income” simply because it has been outstanding for a long time or is time-barred under the Limitation Act.

The Dispute

  • The Situation: The assessee had a liability of ₹2.05 crores payable to a creditor (Rockfort Gulf FZE) since FY 2011-12.

  • The AO’s Logic: The Assessing Officer (AO) noted that the assessee had substantial income in subsequent years but made no attempt to pay this creditor. The AO inferred that the liability had “ceased to exist” and added the amount to the assessee’s income as Deemed Business Income under Section 41(1).

  • The CIT(A)’s View: The CIT(A) upheld the addition, suspecting the debt was disputed and that the assessee never intended to pay it.

The Judicial Verdict

The Court ruled in favour of the Assessee, establishing that:

  • Accounting Reality: As long as the liability is still reflected in the assessee’s Balance Sheet, the assessee is acknowledging the debt.

  • Limitation Act vs. Income Tax: The fact that a creditor might be legally barred from suing for recovery (due to the 3-year limitation period) does not mean the debt has been “remitted” or “ceased.”

  • Requirement for Addition: For Section 41(1) to apply, there must be a specific act of remission (creditor waiving the debt) or cessation (debt physically ending). Mere silence or non-payment is not enough to trigger tax.

II. Business Expenditure: Ad Hoc Disallowances (Section 37(1))

The Department cannot disallow a percentage of expenses (like 50%) based on guesswork; disallowances must be supported by specific evidence of non-business use.

The Dispute

  • The Facts: The assessee claimed ₹6.04 lakhs for hotel and travel expenses incurred for their energy and mining business.

  • The Decision: The AO disallowed the entire amount. On appeal, the CIT(A) “split the difference” and disallowed ₹3.02 lakhs (50%) on an ad hoc basis, essentially guessing that half the expenses might be personal.

The Judicial Verdict

The Court ruled in favour of the Assessee, stating:

  • Evidence Required: If an expenditure is supported by vouchers and is related to the business, the AO must prove it is personal or non-business related before disallowing it.

  • No “Middle Ground”: Ad hoc disallowances (e.g., “let’s disallow 20% to be safe”) have no place in tax law. An expense is either deductible or it isn’t. Without a specific finding of “personal use,” the entire amount must be allowed.

Key Takeaways for Taxpayers

  • Keep Creditors in the Books: If you still owe money to someone, keep showing it in your Sundry Creditors. Do not “write it back” to your P&L unless you are prepared to pay tax on it. As long as it sits in the Balance Sheet, it is generally safe from Section 41(1).

  • Maintain Travel Logs: To fight ad hoc disallowances, maintain basic documentation like boarding passes, hotel bills, and a brief “purpose of visit” note. If the Department tries to cut 50% of your expenses, you can challenge it on the grounds that “ad hocism” is not legally permissible.

  • Consistency in Wealth: The Court noted that having “substantial income” doesn’t force a person to pay a specific debt; the choice of when to settle a business liability remains with the entrepreneur, not the Tax Department.

Crux Title (10-15 words):

High Court: Long-standing Debts are Not Taxable Income; Ad Hoc Expense Cuts are Legally Invalid.

Would you like to know how to handle “untraceable creditors” to avoid a Section 41(1) scrutiny?

IN THE ITAT MUMBAI BENCH ‘G’
Girish Raghavan
v.
ACIT*
C.V.Bhadang (Retd), President
and ARUN KHODPIA, Accountant Member
IT Appeal No.6955 (MUM) OF 2025
[Assessment year 2014-15]
MARCH  4, 2026
Devendra Jain for the Appellant. Swapnil Choudhary for the Respondent.
ORDER
C.V. Bhadang, President. – By this appeal, the appellant-assessee is challenging the order dated 14.08.2025 passed by NFAC, Delhi (‘CIT(A)’ short), which in turn arose out of assessment order dated 26.12.2016 passed by the Assessing Officer (‘AO’ for short). The appeal relates to assessment year 2014-15.
2. The appellant is a resident individual. The appellant, inter alia, engages in the business of energy and fuel management, mining and acquisition. The assessee’s business includes evaluation of market, target potential clients, assisting the client to avail credit facility, planning of shipment of coal etc. During the relevant year, the appellant filed his Return of Income (RoI) for the assessment year in question on 30.11.2014 declaring a total income of Rs.93,82,420/-. The case was selected for scrutiny by issuing notice under Section 143(2) of the Income Tax Act, 1961 (‘Act’ for short) on 10.09.2015. Subsequently, a notice under Section 142(1) of the Act came to be issued alongwith questionnaire on 01.06.2016 calling for various details. The AO has noticed that Schedule-F of the Balance Sheet annexed to the RoI showed an amount of Rs.2,04,71,565/- under the head ‘Current Liabilities’. The appellant was asked to furnish complete details in this regard. On 02.12.2016, the appellant filed a submission before the AO as under:
“Due to boost in the business operations during the financial year 2011-12, it became essential for the assessee to take professional assistance from Rockfort Gulf FZE (‘a company’). Rockfort is into various businesses like trading of cement to UAE, Qatar etc, providing assistance for arrangement of funds, providing consultation on supply coal etc. Assessee took professional assistance of Rockfort for his business as well. Thus Rockfort Gulf FZE raised an invoice for INR 20,471,565 as payable by the assessee.”
3. The AO has noticed that an amount of Rs.2,04,71,565/- shown as payable under the head ‘Sundry Creditors’ was outstanding since assessment year 2012-13. In such circumstances, the appellant was asked to furnish the details of the transaction entered with the said entity in assessment year 2012-13 and as to how the same is accounted for in the books of the appellant and the justification for still showing the amount as payable since financial year 2011-12 (assessment year 2012-13). The appellant filed his response on 16.12.2016. The relevant portion of the same is reproduced as under: –
“Due to boost in the business operations during the financial year 2011-12, it became essential for the Assessee enable professional assistance on letters ofcredit from Rockfort Gulf FZE (‘a company’). Rockfort is into various businesses like trading of cement and cement raw materials to Shri. Girish Raghavan-AY 2014-15 UAE, Qatar etc, providing assistance for arrangement of funds, providing consultation on supply coal etc. Assessee took professional assistance of Rockfort for his business as well. Thus, Rockfort Gulf FZE raised an invoice for INR 20,471,565 as payable by the assessee.”
ParticularsAmount
Business Expenses18,090,073.00
Office Expenses2,381,492.00
Total20,471,565.00

 

The overall market conditions for energy and fuel industry have been difficult from past 3 to 4 years because of which contracts are not fulfilled by performance both (by Seller and Buyer) Therefore this payment is yet to made and hence it remains outstanding.”
Along with his submission, copy of confirmation letter dated 01.04.2012 of M/s. Rockfort Gulf FZE was also enclosed.”
4. The AO has noticed that inspite of assessee having substantial income during the assessment years 2012-13, 2013-14, 2014-15 and 2015-16, no payment was made to Rockfort Gulf FZE and the liability remained as it is although the expenses were booked in financial year 2011-12 (assessment year 2012-13). In such circumstances, the AO vide a show cause notice dated 15.12.2016 under Section 142(1) of the Act required the appellant to explain as to why the said liability should not be treated as ‘cessation of liability’ in accordance with Section 41(1) of the Act.
5. The assessee, in response, submitted as under :-
“That the assessee continued to acknowledge these liabilities in its books of accounts.
(i)That even if more than 4 years have passed, then at the best these liabilities may be termed as not enforceable in the court of law, butthat alone would notfinally exonerate the assessee from these liabilities.
(ii)Thatthe decision to pay or notto pay a liability can be taken by the businessmen alone.
(iii)That so long as, the liabilities are acknowledged in the books ofaccount, no presumption should be drawn that the liability ceased to exist that too merely on the basis of their age.
(iv)That there is nothing to show that the creditors had discharged the assessee from payments of these liabilities.
(v)that for the application of provisions of section 41(1), an assessee must get some benefit in real terms by way of remission or cessation of the liabilities.”
6. The AO found that in assessment year 2012-13 the deduction was allowed towards the amount payable to Rockfort Gulf FZE, which is in respect of a trading liability. The AO has found that the said liability has ceased to exist, which should be treated as deemed profit and gains of business for the assessment year in question in this appeal. It is in these circumstances that the AO has made the disallowance under Section 41(1) of the Act of Rs.2,04,71,565/-.
7. The second disallowance is towards hotel charges and travel expenses of Rs.6,04,043/- under Section 37(1) of the Act.
8. In appeal, the First Appellate Authority has found that the appellant has not established that the said amount has been paid and has not furnished any confirmation from the creditor Rockfort Gulf FZE indicating that the liability still exists. The First Appellate Authority has observed that the appellant has not claimed that the said amount was paid and, thus, it is subject matter of certain dispute and the appellant did not intend to pay the same. The learned CIT(A) has, therefore, confirmed the disallowance under Section 41(1) of the Act.
9. So far as the hotel and travel expenses are concerned, an ad hoc disallowance has been made restricting the amount to Rs.3,02,022/-.
10. It is this order which is the subject matter of challenge in this appeal.
11. We have heard the learned AR for the appellant and the learned DR representing the Revenue. With their assistance, we have gone through the record.
12. The learned AR has submitted that merely because the liability was shown as subsisting from assessment year 2012-13, the disallowance cannot be made during assessment year 2014-15. It is submitted that during the assessment year in question, only two years had elapsed from the date on which the expense was first booked in assessment year 2012-13. It is submitted that even assuming that as on the date of assessment order four years had elapsed, still then merely on account of the fact that the remedy to recover the amount was barred, the right itself was not lost. Reliance is placed on the decision of Supreme Court in Bombay Dyeing & Manufacturing Co. Ltd. v. State of Bombay [1958] SCR 1122 in order to submit that the limitation only bars the remedy and not the right. The learned AR has placed reliance on the decision of Bombay High Court in Kohinoor Mills Co. Ltd. v. CIT [1963] 49 ITR 578 (Bombay) in which the High Court placing reliance on the decision of Supreme Court in Bombay Dyeing & Manufacturing Co. Ltd (supra) has refused to permit the disallowance under Section 10(2A) of the Act towards unclaimed wages. He, therefore, submitted that the disallowance could not have been made.
13. Insofar as the disallowance under Section 37(1) of the Act is concerned, it is submitted that no such ad hoc disallowance could be made for which reliance is placed on the following decisions:
i.ACIT v. Arthur Anderson & Co. [2006] 5 SOT 393 (Mumbai)Smt. Gurmitkaur Amarjit Singh Bhasin v. ITO [IT Appeal No. 559(Mum) of 2014 , dated 3-7-2015]
ii.Asstt. CIT v. Ganpati Enterprises Ltd. ITD 118 (Delhi – Trib.)
iii.ITO v. Lake Palace Hotels & Motels (P.) Ltd [1982] 13 TTJ 216 (Jaipur)
iv.Tripat Kaur v. ACIT v. ACIT [IT Appeal No. 3244 (Delhi) of 2012 , dated 7-9-2012]
v.Sunita Mine Chem Ind. v. ITO [2008] 23 SOT 39 (Jodhpur)(URO)
vi.Simbhaoli Sugar Mills Ltd. v. ACIT [2007] 17 SOT 90 (Delhi)
vii.Continental Seeds & Chemicals Ltd. v. ACIT [2003] 1 SOT 393 (Delhi)
14. The learned DR has supported the impugned order. It is submitted that the burden to establish that the trading liability still subsists is on the assessee which has not been discharged in this case. It is submitted that merely because the liability is shown subsisting in the books of account is not sufficient, particularly when at the time, the assessment order was passed, the limitation to enforce recovery of the liability had expired. It is thus, submitted that the authorities below were justified in making the disallowance on account of cessation of liability.
15. In respect of the hotel expenses and travelling expenses, it is submitted that the CIT(A), in the circumstances of the case, had reduced the disallowance made by the Assessing Officer and restricted it to Rs.3,02,022/-
16. We have considered the submissions made. The disallowance u/s. 41(1) of the Act on account of alleged cessation of liability, in our opinion, cannot be sustained. It is necessary to note that the liability was incurred by the appellant towards Rockfort Gulf FZE in F.Y. 2011-12 relevant to A.Y. 2012-13. The impugned disallowance has been made for A.Y. 2014-15. Although on the date of the passing of the assessment order i.e. on 26.12.2016 more than three years had elapsed, the fact remains that the disallowance pertains to A.Y. 2014-15 which cannot be said to be beyond three years from A.Y. 2012-13, in which the liability is said to be incurred. That apart, it is now well-settled that the expiry of limitation only bars the remedy and not the right [see the decision of Supreme Court in Bombay Dyeing & Manufacturing Co. Ltd. (supra)]. Thus, even assuming for the sake of argument that the date of the assessment order would be relevant, the mere fact that the period of limitation for enforcing recovery of the liability had expired, cannot ipso facto lead to the conclusion, that there is cessation of liability within the meaning of sub-section (1) of section 41 of the Act. A bare perusal of clause (a) of sub-section (1) of section 41 [which applies in this case] would indicate that the said clause can be invoked only when the assessee (first-mentioned person) has obtained, either 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 learned AR pointed out that there is a confirmation letter dated 01.04.2012 from M/s. Rockfort Gulf FZE, which was produced before the AO.
17. A useful reference in this regard can be made to the decision of Bombay High Court in the case of Kohinoor Mills Co. Ltd. (supra). In that case certain amount towards wages due to the labourers and workmen was not paid by the assessee as none of the labourers and workmen had turned up to receive them. The AO had made the impugned addition of the amount payable to said labourers and workmen on account cessation of liability u/s. 10(2A) of the Income tax Act 1922 which is in pari materia to section 41(1) of the Act. The Bombay High Court placing reliance on the decision of the Supreme Court in Bombay Dyeing & Manufacturing Co. Ltd. (supra) held that the fact that by reason of expiry of three years [as liability was incurred in 1952 and the addition was made in relation to year 1955] and that the remedy of the labourers and workmen to recover the amount was barred, cannot lead to the conclusion that there was cessation of liability. In that view of the matter, we find that the impugned addition made u/s. 41(1) of the Act cannot be sustained.
18. In so far as the disallowance made on account of Hotel expenses and Travelling expenses are concerned, various decisions of co-ordinate Benches referred in para 13 above have held that adhoc disallowances in such case cannot be made. It is not necessary to multiply authorities on the point. Thus, the said disallowance also cannot be sustained.
19. In the result, the appeal is allowed. The impugned additions stand deleted.