Question:
What is the accounting treatment for cessation of a liability? Will the amount on a/c. of cessation of liability be regarded as income?
What will be the tax treatment?
Please answer all the above queries.
Answers:
It depends on how the liability arose in the 1st place and how the liability ceased. Is it because the statute of limitations had run out? (legislative act restricting the time within which legal proceedings may be brought, usually to a fixed period after the occurrence of the events that gave rise to the cause of action. Such statutes are enacted to protect persons against claims made after disputes have become stale, evidence has been lost, memories have faded, or witnesses have disappeared.)
If the original entry was purchases which was deductible for tax previously, now that you're writing the liab back to income, I'd say this income is taxable. On the other had, if the liab was a loan that's no longer payable, I'd fight to say it's not taxable altho' the tax man would say otherwise. But if it's the other way round and you had to write off a loan receivable as a bad debt, the bad debt would not be deductible, so that's why I say I'd fight on this ground to say the write-back of a loan no longer payable should not be taxable.
Very generally, I'd use this as a rule of thumb: if the liability's corresponding entry previously was deductible for tax, now the income is taxable, and if the corresponding entry previously was never claimed as deductible, now the income is not taxable.
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