The Hindu : Business : Forfeited advance may be taxable

Online edition of India's National Newspaper
Monday, Apr 18, 2005

Business

Business

Forfeited advance may be taxable

Advance by itself does not constitute income

Ten years back I received an advance equivalent to Rs. 15 lakhs for export of garments to Australia. The buyer cancelled the order, before I could process it. Subsequently I refused to refund the advance. The amount is still remaining unpaid in my books. If I write it off now, will it be treated as my income?

Advance by itself does not constitute income. Where a business advance is forfeited for breach of a business contract, it accrues as income in the year in which breach occurs, because that is the year in which the right to forfeit the advance arises.

It appears that though the assessee refused refund on the ground that he was not liable to repay the amount, he continues to treat the amount as a liability to return the advance in his books.

This is a contradiction. In such cases of damages for breach of contract, it is taxable in the year in which the liability is agreed by the opposite party or decreed by a competent court or otherwise settled as pointed to in N. Sundareswaran v CIT (1997) 226 ITR 142 (Ker).

If the assessee now proposes to write off the advance, he has either to square it up by crediting it to the profit and loss account or to the account of the proprietor/ partners. If he does so, it may well be taken as the years in which the transaction has become final and be taxed in that year.

If he carries forward indefinitely, the assessing officer may tax it in the year in which he infers that it accrues to him probably taking into consideration, the treatment given in the accounts of the opposite party. Liability itself cannot be avoided in respect of such gains arising in respect of a trading contract in the course of business as was pointed out in S. Kempadevamma v CIT (2001) 251 ITR 871 (Mad).

In fact, in the facts as stated by the reader, he cannot avoid liability even after he chose to refute liability in writing to return the advance. He may be expected to return the income, once he finds that he is no longer obliged to return the advance. If the advance has been received by a person, who is not a trader, the inference may well be different. Where a property owner holding it as investments receives earnest money, which he forfeits, because the agreement holder had not honoured his commitment, such advance will be a capital receipt, but ultimately taxed at the time of sale of property, because Sec. 51 of the Income-tax Act provides that such advance will be deducted from the cost of the asset in computing the cost of acquisition for reckoning taxable capital gains.

S. Rajaratnam

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