Whether waiver of loan will amount to a benefit relatable to depreciation expenditure claimed earlier?

ITAT JODHPUR BENCH

Shri Kansara Modular Ltd.

versus

Assistant Commissioner of Income-tax, Jodhpur

IT Appeal No. 196 (Jodh.) of 2011
[ASSESSMENT YEAR 2006-07]

FEBRUARY 11, 2013

ORDER

Hari Om Maratha, Judicial Member

This appeal of the assessee for Assessment year 2006-07 is directed against the order of the ld. CIT(A) dated 21.03.2011.

2. The Appellant has raised the following grounds in its appeal:

1. “That on the basis of facts and circumstances of the case, whether the learned CIT(A) was justified in determining interest pertaining to preoperative period at Rs.524 lacs as against Rs. 731.55 lacs claimed by the appellant.

2. That on the facts and circumstance of the case, whether the learned CIT(A) was justified in holding that waiver of interest amounting Rs.731.55 lacs is taxable under section 41(1)and section 28(iv) of the Income-tax Act, 1961″.

3. The facts leading to this appeal, in brief, are that the assessee is a Public Ltd Company, engaged in the manufacturing of rollers for bearings. For the Assessment year 2006-07, it filed return of income (ROI) through e-filing on 22.11.2006, declaring nil income. The assessee- company maintains its books of accounts in a computer system. But a hard copy of computerized cash-book, Ledger, Journal, Bank-Book and vouchers etc. were produced before A.O. for verification. The assessee- company has properly maintained its stock register. In Assessment Years 2004-05 to 2006-07 g.p. rates of 33.27%, 19.19% and 23.64%, respectively, have been disclosed.

4. Below the computation of income, the assessee has appended a ‘note’ as under :-

“During the year financial institutions waived interest liability of Rs.22,74,85,511/- in favour of the Company. Out of which an amount of Rs. 7,31,55,195/- pertains to pre- operative period and on the basis of legal opinion, same has not been brought to tax being a capital receipt.”

5. During the course of assessment proceedings, the assessee was requested vide letter dated 30/10/2008 to show cause as to why interest related to pre- operative period of Rs. 7,31,55,195/- waived by the Financial Institution, should not be treated as revenue receipt and taxed accordingly. In this connection you are requested to explain/ furnish the following:

(a) A copy of legal opinion.

(b) Basis of working of amount of interest pertains to pre- operative expenses (Asstt. year wise bifurcation of expenses should be furnished).

(c) What treatment was given to interest amount pertaining to pre- operative expenses? Whether capitalized or set off against interest received on FDR’s purchased against letter of credit.

(d) When you have treated the same as capital receipt then why the value of assets was not reduced proportionately.

(e) You are requested to show cause as to why these receipts should not be treated as revenue receipts and assessed to tax accordingly.”

6. In compliance to the above show cause, the assessee filed a written submission on 27/11/2008 explaining as under:-

“You have asked to show cause why interest relating to preoperative period of Rs. 7,31,55,195/- waived by the financial institutions be not treated as revenue receipts and assessed to tax accordingly and another query that why Interest has not been reduced from the cost of assets proportionately. In this regard we have been directed to submit as under: At the very outset, we wish to point out some facts which in our opinion are undisputed:

• Those Loans were advanced by State Bank of Bikaner & Jaipur, Jodhpur and other banks to the assessee company for the construction of factory building, purchasing & installation of plant & machinery and other capital assets.

• That assessee company had capitalized interest to the cost of various assets up to the period they were put to use and subsequent year’s interest was being debited to Profit & Loss Account in respective years as revenue expenditure.

• That the assessee never claimed/got deduction for payment of preoperative interest u/s 36(1)(iii) or under section 37 of the Act

• Due dis allowances/deductions under section 43B have been made in computations of total income in respect of interest claimed as revenue expenditure in various years.

Now let us examine the taxability of waiver of interest which was capitalized to the cost of fixed assets:

Relevant portion of Section 41(1) of the Income Tax Act, 1961 reads as under:

“41(1) Where an allowance or deduction has been made in the assessment for any year in respect of loss, expenditure or trading liability incurred by the assessee (hereinafter referred to as the first mentioned person) and subsequently during any previous year,

(a) The first mentioned person has obtained, whether 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 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 income tax as the income of that previous year, whether the business or profession in respect of which the allowance or deduction has been made is in existence in that year or not; or “

Section 41(1), in a way, enacts statutory fictions. Therefore, the operation of such fictions should be limited to the language of the section. It is, inter alia, where the assessee has incurred a trading liability’, and this trading liability has been allowed deduction in an earlier year, and something has, later on, been recovered in respect of such liability or such liability has either been remitted or has ceased to exist, than section 41(1) comes into operation.

It is contended that in order to attract section 41(1) of the IT Act, the first requisite which ought to be satisfied is that the assessee should have got deduction or benefit of allowance in respect of loss, expenditure or trading liability incurred by the assessee and that subsequently during any previous year the assessee received any amount in respect of such loss, expenditure or trading liability by way of remission or cessation thereof.

In our case, Assessee Company has never got deduction in respect of impugned Rs.7.32 crores under section 36(1)(iii) or section 37, and under the circumstances section 41(1) of the Act is not attracted. In the case of CIT v. Phool Chand Jiwan Ram [1981] 131 ITR 37 (Del), the assessee firm had purchased goods. They had also obtained loans from a party, accounts were settled and the balance was credited to the partner’s account. It was held by the Delhi High Court that the amount referable to loans was not a trading liability. That, the only amounts allowed as deduction in earlier years could be treated as a trading liability. In other words, unless the amounts have been allowed as deduction in earlier years they cannot be treated as trading liability and as such section 41(1) is not applicable.

It will not be out of place to mention here that section 41(1) consists of two main ingredients viz., (a) “loss or expenditure” and (b) “trading liability”. As per the decision of the Honorable Supreme Court decision in the case of Polyflex (India) (P) Ltd. v. CIT [2002] 177 CTR (SC) 93, the two components of section 41(1) of the Act have to be read separately, namely (i) has obtained, whether in cash or in any other manner whatsoever, any amount in respect of such loss or expenditure; (ii) some benefit in respect of such trading liability by way of remission or cessation thereof. Accordingly the Honorable apex Court held that the words “remission or cessation thereof shall apply only to trading liability and it shall not apply to any loss or expenditure.

The next issue which needs to be resolved is whether waiver of interest amount which was capitalized to the cost of assets would amount to trading liability?

In this regard it is submitted that only trading debts, which are allowed as deduction in earlier years, can be treated as trading liability. It is not in dispute that the interest amount which has been waived has not been claimed as deduction in any of the years, on the contrary it also became part of loan amount financed by the bankers as soon as that was capitalized.

Whether or not a liability is a trading liability depends on the facts and circumstances of a particular case. A liability created for purchase of stock-in-trade on credit is certainly a trading liability. Where A purchases his stock-in-trade from B on credit, the liability of A to is a trading liability. But if A borrows money from C in order to pay off his liability to B, ‘s liability to C on such borrowing is not a trading liability. It is thus clear that section 41(1) cannot be invoked if C remits a part or whole of his loans to A [CIT v. Phool Chand Jiwan Ram , [1981] 131 ITR 37 (Del)].

The next issue which needs attention is, whether the waiver of loan will amount to a benefit relatable to depreciation expenditure claimed earlier?

The depreciation u/s 32 is allowed on the “actual cost” of the assets. The term ‘actual cost’ has been defined in section 43(1) according to which, ‘actual cost’ means ‘the actual cost of the assets to the assessee reduced by that portion of the cost thereof, if any, as has been met directly or indirectly by any other person or authority’. So, the only deduction permissible from the actual cost is the amount, which has been met by any other person or authority.

The words “which has been met by any other person or authority” would mean the non-refundable amount given by any other person or authority for the purpose of meeting the cost of the asset. When a person avails a term loan, it has to be repaid along with the interest, if any, in accordance with the terms and conditions prescribed for that purpose. If the term loan is utilized for acquiring any asset, it cannot be termed as ‘meeting of a portion of cost of the asset’. Loan is availed as a source of finance while the depreciation is allowed on the actual user of the asset. So ‘availing of loan’ and ‘claim of depreciation’ are two distinct things, which cannot be clubbed together and, therefore, remission of loan along with interest (on which assessee got no deduction u/s 36(1) (iii) or under section 37 of the Act) will not amount to remission of depreciation.

When the bankers wrote off the liability of the assessee company, it cannot be said in retrospect that the cost to’ the assessee of any part of the capital assets acquired during the years under installation, was met by bankers. It is, therefore, argued that the remission of liability by bankers long after the liability was incurred cannot be relied on to hold that bankers met directly or indirectly, part of the cost of the capital assets installed as early as 1995-96. As per section 43(1) of the Act, if the cost of the asset is met directly or indirectly, at the time of purchase of the machinery, by any other person or authority, to that extent, the actual cost of the assets to the assessee will stand reduced. But it is a far cry to state that though at the time of purchase of the machinery, no person met the cost either directly or indirectly, if, long thereafter a debt incurred in that connection is written off, it could be equated to a position that the financier met part of the cost of the asset to the assessee. We are at loss to accept the proposal that the remission of liability by bankers can, in any way, be said to be one, where the bankers met directly or indirectly the cost of the asset to the assessee.

It is, therefore, submitted that waiver of loan amount cannot be considered as income as it is capital in nature and allowance of depreciation cannot be equated with deduction in respect of “loss, expenditure or trading liability” and, therefore, depreciation allowed cannot be brought back to tax.

Even otherwise, there is no provision in the scheme of block assets to reduce the value of the Assets if the part of interest capitalized is subsequently reduced. The Honorable Kerala High Court in the case of Cochin Co (P) Ltd has specifically held that remission of loan taken to purchase machinery cannot be reduced from the cost of machinery

In the light of foregoing discussions it is submitted that:

• The waiver of principal portion of loan or interest thereon to the extent capitalized to the cost of assets couldn’t be taken as trading liability, as the impugned amount has never been claimed as expenditure or allowance under IT Act.

• And in the absence of any provision for varying the written down value in the year subsequent to the year in which the capital asset was installed, it would be unjustified and unlawful to reduce the written down value as proposed in the notice.”

7. But the A.O. was not convinced from the above explanation of the assessee- company that with a view to tackle its bad financial position, has entered into an agreement with the Banks and the formula suggested by the Bank has been implemented. The A.O. has opined that any such formula will not override or overrule the provisions of the Act and the principles of Accountancy. According to the A.O., the following adjustments are necessitated :-

(i) Whatever assessee has paid, during pre- operative period i.e. debits in Bank Account, were to be first adjusted against the accrued interest;

(ii) Whatever has been charged as interest by the Banks and accounted for against the interest cannot be waived. Waiver, as a prudent meaning refers waiver of amount due. This position is very much supported by the Bank accounts filed by the assessee. For example, assessee’s account in State of Bikaner & Jaipur for the F.Y. 98-99 is reproduced, as it is, as under:-

8. Finally, the A.O. has treated the sum of Rs. 7,31,55,195/- as a revenue receipt and not a capital one. He has, thus, added this entire amount to the income of the assessee. While deciding the appeal of the assessee- company, the ld. CIT(A), has taken the interest on term loan pertaining to pre- operative period at Rs. 524 lacs as against Rs. 731.55 lacs show by the assessee- company. He has also treated this amount of Rs. 731.55 lacs as taxable u/s 41(1) and u/s 28(iv) of the Act. The assessee is in second appeal.

9. We have heard the rival submissions and have carefully perused the relevant material on record. Both parties have reiterated their earlier stand even before us. It was submitted by ld. AR of the appellant Shri R.K. Bothra that the assessee- company had taken loans for the construction of factory-building, for purchasing and installation of plant and machinery and other capital assets, from the State Bank of Bikaner and Jaipur and also from other Banks. It had capitalized interest to the cost of various assets upto the period they were put to use and thereafter it was being debited to the P&L Account in the respective years as revenue expenditure. It was contended that the assessee- company suffered huge losses and did not have funds to repay the over-dues to the Bankers, therefore, the Banks decided to waive a sum of Rs. 22,74,85,511/-, during the year under consideration against the overdue interest accumulated over the years including Rs. 7,31,55,195/- which pertained to pre- operative period. It was argued that the interest pertaining to pre- operative periods of Rs. 7,31,55,195/- was not offered for taxation because the company had neither claimed nor got deduction of this amount. He argued that the A.O. has wrongly taxed this amount by treated it as a revenue receipt with the meaning of sec. 41(1) of the Act on the premise that because the assessee- company, when bought/installed assets, had ‘derived a benefit’ under the head of ‘depreciation’. He disputed the version of the A.O. and also of ld. CIT(A) that technically the depreciation is an expenditure being admissible for deduction u/ss 30 to 44D of the Act. By inviting our attention towards the provisions of section 41(1) of the Act he has submitted that in the facts and the circumstances of the case and in law, this addition is not at all warranted. It was vehemently argued by ld. AR that this amount cannot be treated as income under section 41(1) or under any other provision of the Act and the same deserves to be deleted. It was further contended that the fiction created by sec. 41(1) comes into operation when the assessee incurs a ‘trading liability’ which has been allowed as deduction in any earlier year(s) and something out of the same is recovered in respect of such liability or such liability has either been remitted or has ceased to exist, then the provisions of sec. 41(1) come into operation. In other words to attract this section, requisite conditions are that firstly the assessee should have got deduction or benefit of allowance in respect of loss, expenditure or trading liability incurred by the assessee and secondly during any previous year the assessee had received any amount in respect of such a loss/expenditure or trading liability by way of remission or cessation thereof. As per ld. AR this assessee- company never got deduction in respect of the amount of Rs. 7.32 crores under section 36(1)(iii) or u/s 37, therefore provision of section 41(1) would not apply. In this regard reliance was placed on the decision of CIT v. Phool Chand Jiwan Ram [1981] 131 ITR 37. He has also relied on the decision of the Hon’ble Apex Court rendered in the case of Polyflex (India) (P) Ltd. v. CIT [2002] 257 ITR 343, wherein it has been held that the two components of section 41(1) have to be read separately. It has been held that the words “remission or cessation thereof” shall apply only to the trading liability and it shall not apply to any loss or expenditure. The ld. AR also heavily relied on the ratio of the decision of Honorable Mumbai Bench given in the case of Sulzer India Ltd. v Jt. CIT [2012] 138 ITD 137, wherein it has been held that if a receipt is on capital account then any benefit, if any, obtained is also to be taken on capital account to which section 41(1) will not apply. The ld. AR has further relied on host of other judgments/orders.

10. Per contra, ld. CIT(DR) has heavily relied on A.O.’s and CIT(A)’s orders. He has further submitted that section 41(1) and/or sec 28 (iv) of the Act definitely applies to the facts of this case. The liability which has ceased to exist during the year has to be treated as assessee’s income of the year. He has heavily supported the finding of ld. CIT(A) and has also relied on various decisions apart including those on which the authorities below have relied for arriving at their respective conclusions.

11. We have coolly considered rival stands. We have also gone through the relevant pages of the paper book/written submissions of the parties. We have also carefully perused the relevant provisions of the Act and also the decisions relied before us. The fact of this issue which we have called out are that the assessee- company had raised loans from the Banks to start its business. Subsequently due to heavy losses the company was in trouble and a settlement with the Banks had saved it from a deep crisis. As per this agreement the Banks gave a waiver of interest amount to the company. Whatever was given as a waiver out of interest amount has been treated by the company as a capital receipt being related to pre operational period. As per revenue this is to be treated as a revenue receipt taxable either u/s 41(1) or u/s 28(iv). Given the above facts of this case, let us examine the legal position on this issue.

Section 41(1) of the Act reads as under :-

“1.(1) Where an allowance or deduction has been made in the assessment for any year in respect of loss, expenditure or trading liability incurred by the assessee (hereinafter referred to as the first-mentioned person) and subsequently during any previous year, –

(a) the first-mentioned person has obtained, whether 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 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 income-tax as the income of that previous year, whether the business or profession in respect of which the allowance or deduction has been made is in existence in that year or not; or

(b) the successor in business has obtained, whether in cash or in any other manner whatsoever, any amount in respect of which loss or expenditure was incurred by the first-mentioned person or some benefit in respect of the trading liability referred to in clause (a) by way of remission or cessation thereof, the amount obtained by the successor in business or the value of benefit accruing to the successor in business shall be deemed to be profits and gains of the business or profession, and accordingly chargeable to income-tax as the income of that previous year.

[Explanation 1.- For the purposes of this sub-section, the expression “loss or expenditure or some benefit in respect of any such trading liability by way of remission or cessation thereof” shall include the remission or cessation of any liability by a unilateral act by the first mentioned person under clause (a) or the successor in business under clause (b) of that sub-section by way of writing off such liability in his accounts.]

[Explanation 2].- For the purposes of this sub-section, “successor in business” means,-

(i) where there has been an amalgamation of a company with another company, the amalgamated company;

(ii) where the first-mentioned person is succeeded by any other person in that business or profession, the other person;

(iii) where a firm carrying on a business or profession is succeeded by another firm, the other firm;]

[(iv) where there has been a demerger, the resulting company .]”

12. Sub section (1) of section 41 was substituted by the Finance Act, 19902 w.e.f. 1-4-1993. The pre- requisite conditions to apply sub-section (1) of section 41 are mainly two-fold :

(i) that an allowance or deduction must have been made in the assessment for any year in respect of loss, expenditure or trading liability incurred by the assessee, and

(ii) during any previous year the assessee has obtained any amount in respect of such loss or expenditure, or any benefit in respect of such trading liability by way of remission or cessation thereof, the amount so received shall be deemed to be the profit or gain of assessee’s business chargeable to tax as the income of that previous year.

13. Let us now examine if the above two conditions are fulfilled in the given case or not. In case these conditions are satisfied, the interest on loan waiver receipt has to be taxed in this assessment year, otherwise not.

14. The obtaining facts of assessee’s case are that it got benefit of waiver of total interest of Rs. 22.75 crores which included a sum of Rs. 732 lacs pertaining to the pre- operative period. The ld. CIT(A) has taken this figure at Rs. 524 lacs and this is the subject matter of grounds no. (1) of assessee’s appeal. We will deal with that aspect later. The interest pertaining to pre- operative period was capitalized to the respective assets and deduction of depreciation on such assets had been claimed on the basis of written down value (WDV) of different block of assets. According to the ld. AR first condition of section 41(1) is not satisfied from the facts of this case. According to ld. DR the assessee has got benefit by way of waiver of interest on term loan shown under pre- operative expenditure in accounting year relevant to A.Y. 2005-06 and has capitalized to the assets, therefore, total deduction of depreciation in term of section 32 which can be treated as claim of expenditure by the assessee and as such waiver of this interest amount has to be taxed in this year. The contention of ld. AR is that this ‘expenditure’ to which ld. DR is referring to, has to be incurred in respect of ‘trading-liability’ and not in respect of capital liability. According to him even “depreciation allowed” can not be considered as claim of expenditure as it is on the capital side.

15. We have carefully analyzed the provisions of section 41(1) of the Act. We are of the considered opinion that the ‘depreciation’ claimed on the capital assets are not at all covered under this provision. What are actually covered in section 41(1) are ‘profits’ (as the heading suggests derived in respect of loss or expenditure or some benefit in respect of trading liability by way of remission or cessation thereof. From the bare reading of this section it becomes manifest that there are three situations to one of which such ‘benefit obtained’ must relate to. These situations are as under:

(i) loss claimed or

(ii) expenditure claimed or

(iii) liability incurred by the assessee.

16. To further elaborate and simplify the above to fit in the requirement of sec. 41(1) it is required that the assessee must have made a claim and it must have been either (i) allowed or (ii) deducted in any previous year. This allowance/deduction must relate to loss, expenditure or trading liability, incurred by the assessee as the case may be. This ‘benefit obtained must be by way of ‘remission’ or ‘cessation’ of such loss, expenditure or trading liability. In our opinion the assessee has not obtained any ‘allowance’ or ‘deduction’ in respect of any loss or in respect of any expenditure or in respect of any trading liability. In fact the expressions expenditure and trading liability take their color from each other and clearly suggest that they are talking about ‘business’ and not about ‘assets’. All these ‘terms’ refer to ‘revenue-side’ and not to ‘capital-side’ of a business of any assessee.

17. Therefore, we find force in the contention of ld. AR. The operation of this statutory fiction created by section 41(1) has to be limited to the language of this section. When the assessee has incurred a trading liability and it has been allowed as deduction otherwise in a earlier year; and something has been recovered in respect of such liability even by way of remission or cessation than only this section comes into play. In our opinion from the facts of this case, this important ingredient is missing, as we have already discussed. The assessee- company has never got deduction in respect of this Rs. 732 lakh u/s 36(1)(ii) or under section 37 of the Act. Therefore, section 41(1) is not at all relevant to tax this benefit qua the pre- operational stage interest-wavier. In this regard the decision of the Honorable Delhi High Court rendered in the case of Phool Chand Jiwan Ram (supra) is relevant. In this case it has been held thus:

“The point that is urged on behalf of the department before us, as was also urged before the Tribunal, was slightly different. It was pointed out that for the period from November 12, 1947, to October 30, 1948, the assessed-firm had purchased cloth worth Rs. 3,75,120 from a firm in Bombay styled as M/s. Narsinghdass Banarsidass. On the last day of the accounting year, i.e., October 30, 1948, this account had been debited with a sum of Rs. 1,80,000 representing the amount paid to that firm by M/s. Janki Dass Banarsi Dass on behalf of the assessed-firm. The argument is that to the extent the account of M/s. Janki Dass Banarsi Dass reflects a credit of Rs. 1,80,000 on account of this cash payment it should also be treated as a payment to M/s. Janki Dass Banarsi Dass for the purchase of cloth from the Bombay firm and, therefore, is in effect representing a trading liability of the assessed-firm. We agree with the Tribunal that this construction of the transaction is far-fetched. The purchase of cloth between November 12, 1947, and October 30, 1948, was effected by the assessee from the Bombay firm. The debt owed by the assessee to the Bombay firm was a trading debt and that was no doubt allowed for the purpose of income-tax. However, so far as the account of M/s. Janki Dass Banarsi Dass is concerned, the liability of the assessee to this party arose because the above party had paid a sum of Rs. 1,80,000 to the Bombay firm on the assessee’s account. In other words, vis-a-vis the assessee and M/s. Janki Dass Banarsi Dass, this was not a payment made for the purchase of stock-in-trade; it was a credit in respect of an amount borrowed by the assessed from M/s. Janki Dass Banarsi Dass in order to discharge its liability to the Bombay firm. The sum of Rs. 1,80,000 which is reflected in the account of M/s. Janki Dass Banarsi Dass could not, therefore, be described as a liability on trading account. As rightly pointed out by the Tribunal, s. 10(2A) enacts a statutory fiction. The operation of this fiction should be limited to the language of the section. It is only where the assessed has incurred a trading liability and this trading liability has been allowed in earlier years that s. 10(2A) is attracted on the occasion when the trading liability is either remitted or ceased to exist. In our opinion, the Tribunal was right in coming to the conclusion that the sum of Rs. 1,80,000 did not represent a trading liability owned by the assessee to M/s. Janki Dass Banarsi Dass, nor had this amount of liability been allowed as a deduction in earlier assessments.

8. For the above reasons, we agree with the view taken by the Tribunal and answer the question referred to us in the affirmative and against the applicant. There will be no order as to costs.”

18. Further, The Hon’ble Apex Court in the case of Polyflex (India) (P) Ltd. (supra) has held that section 41(1) consist of two main ingredients viz (i) loss or expenditure and (ii) ‘trading liability’. These two components of section 41(1) have to be read separately. The assessee must have – one – obtained, whether in cash or in any other manner whatsoever, any amount in respect of such loss or expenditure; and two – some benefit in respect of such ‘trading liability’ by way of remission or re cessation thereof. The Honorable Supreme Court has held that the terms “remission or cessation thereof” shall apply only to trading liability and it shall not apply to ‘any loss’ or ‘expenditure’. Accordingly, In our considered opinion, the facts of the given case are different and therefore, this section will not apply to assessee’s case.

19. The Assessee Company has never got deduction in respect of impugned Rs. 7.32 crores under section 36(1) (iii) or section 37, and under the circumstances section 41(1) of the Act are not attracted. In the case of Phool Chand Jiwan Ram (supra), the assessee firm had purchased goods. They had also obtained loans from a party, accounts were settled and the balance was credited to the partner’s account. It was held by the Delhi High Court that the amount referable to loans was not a trading liability. Thus, the only amounts allowed as deduction in earlier years could be treated as a trading liability. In other words, unless the amounts have been allowed as deduction in earlier years they cannot be treated as trading liability and as such section 41(1) is not applicable. It will not be out of place to mention here that section 41(1) consists of two main ingredients viz., (a) “loss or expenditure” and (b) “trading liability”. As per the decision of the Honorable Supreme Court decision in the case of Polyflex (India) (P) Ltd. (supra), the two components of section 41(1) of the Act have to be read separately, namely (i) has obtained, whether in cash or in any other manner whatsoever, any amount in respect of such loss or expenditure; (ii) some benefit in respect of such trading liability by way of remission or cessation thereof. Accordingly the Honorable apex Court held that the words “remission or cessation thereof shall apply only to trading liability and it shall nor apply to any loss or expenditure.”

20. The ld. A.R. has further submitted that only trading debts, which are allowed as deduction in earlier years, can be treated as trading liability. It is not in dispute that the interest amount which has been waived has not been claimed as deduction in any of the years, on the contrary it also became part of loan amount financed by the bankers as soon as that was capitalized. The pre- operative interest capitalized to the cost of machines & other assets being in the nature of capital receipt in origin would not change its character to revenue receipt on being waived by the bankers. Merely name of accounting head does not define its nature. Actually deciding factor about its character/taxability is the accounting treatment which has been given to respective transaction. In this case, preoperative interest was capitalized to the cost of fixed assets and was reflected in the balance sheet, not in Profit & Loss Account and also the remission of amount so obtained from Bankers had not been claimed as expenditure or trading liability in any of the earlier previous years. Whether or not a liability is a trading liability depends on the facts and circumstances of a particular case. A liability created for purchase of stock-in-trade on credit is certainly a trading liability. Where A purchases his stock-in-trade from B on credit, the liability of A to B is a trading liability. But if A borrows money from C in order to pay off his liability to B, A’s liability to C on such borrowing is not a trading liability. It is thus clear that section 41(1) cannot be invoked if C remits a part or whole of his loans to A. Phool Chand Jiwan Ram’s case (supra).

21. AO in his assessment order himself has said that “the judgments relied upon by the assessee are related to trading liabilities which has no relevance in the case of the assessee”, then how he can make the addition by invoking section 41(1) of the Act?

22. The next issue which needs attention is, whether the waiver of loan will amount to a benefit relatable to depreciation expenditure claimed earlier? The depreciation u/s 32 is allowed on the “actual cost” of the assets. The term ‘actual cost’ has been defined in section 43(1) according to which, ‘actual cost’ means ‘the actual cost of the assets to the assessee reduced by that portion of the cost thereof, if any, as has been met directly or indirectly by any other person or authority’. So, the only deduction permissible from the actual cost is the amount, which has been met by any other person or authority. The words “which has been met by any other person or authority” would mean the non-refundable amount given by any other person or authority for the purpose of meeting the cost of the asset. When a person avails a term loan, it has to be repaid along with the interest, if any, in accordance with the terms and conditions prescribed for that purpose. If the term loan is utilized for acquiring any asset, it cannot be termed as ‘meeting of a portion of cost of the asset’. Loan is availed as a source of finance while the depreciation is allowed on the actual user of the asset. So ‘availing of loan’ and ‘claim of depreciation’ are two distinct things, which cannot be clubbed together and, therefore, remission of loan along with interest (on which assessee got no deduction u/s 36(1) (iii) or under section 37 of the Act) will not amount to remission of depreciation. When the bankers wrote off the liability of the assessee company, it cannot be said in retrospect that the cost to the assessee of any part of the capital assets acquired during the years under installation, was met by bankers. The remission of liability by bankers long after the liability was incurred cannot be relied on to hold that bankers met directly or indirectly, part of the cost of the capital assets installed as early as 1995-96. As per section 43(1) of the Act, if the cost of the asset is met directly or indirectly, at the time of purchase of the machinery, by any other person or authority, to that extent, the actual cost of the assets to the assessee will stand reduced. But it is a far cry to state that though at the time of purchase of the machinery, no person met the cost either directly or indirectly, if, long thereafter a debt incurred in that connection is written off, it could be equated to a position that the financier met part of the cost of the asset to the assessee. We are at loss to accept the proposal that the remission of liability by bankers can, in any way, be said to be one, where the bankers met directly or indirectly the cost of the asset to the assessee. Therefore, this waiver of loan amount cannot be considered as income as it is capital in nature and allowance of depreciation cannot be equated with deduction in respect of “loss, expenditure or trading liability” and, therefore, depreciation allowed cannot be brought back to tax.

23. As regards the decisions relied by the ld. CIT(A) of Bombay High Court in the case of Solid Containers Ltd. v. Dy. CIT [2009] 308 ITR 417 and Hon’ble Supreme Court in the case of CIT v. T V Sundaram Iyengar & Sons Ltd [1996] 222 ITR 344, their facts are entirely different in as much as there was a amount which was taken for trading activity and ultimately, upon waiver the amount was retained in business by the assessee.

24. We would like to refer para 3 of the order of Bombay High Court in the case of Solid Containers Ltd. (supra) which clearly establishes that this case is not at all applicable to the facts of this case. Para 3 of the order is reproduced here below for your ready reference:

“The present appellant can hardly derive any advantage from the case of Mahindra & Mahindra Ltd. (supra). As in that case, a clear finding was recorded that the assessee continued to pay interest at the rate of 6% for a period of 10 years and the agreement for purchase of toolings was entered into much prior to the approval of loan arrangement given by the Reserve Bank of India. Therefore, the loan agreement, in its entirety, was not obliterated by such waiver. Secondly, the purchase consideration related to capital assets. The toolings were in the nature of dies and the assessee was a manufacturer of heavy vehicles. The import was that of plant and machinery and the waiver could not constitute business. The facts of the present case are entirely different in as much as it was a loan taken for trading activity and ultimately, upon waiver the amount was retained in business by the assessee. Thus, the principle stated by the Supreme Court in the case of T V Sundaram Ayengar & Sons Ltd (supra) would be squarely applicable to the facts of the present case. The amount which initially did not fall within the scope of the provisions rendering it liable to tax subsequently have become the assessee’s income being part of the trading of the assessee “

25. Same is in the case of T V Sundaram Iyengar & Sons Ltd. (supra). The Hon’ble Supreme Court in this case found that the sums were stated to be credit balances standing in favour of the ‘customers’ of the company. Since these balances were not claimed by the customers, the amounts were transferred by the assessee to the profit & loss account. It held that if a commonsense view of the matter were taken, the assessee, because of the ‘trading operation’, had become richer by the amount which it transferred to its profit and loss account. The money had arisen out of ordinary trading transactions. Although the amounts received originally were not of income nature, the amounts remained with the assessee for a long period unclaimed by the trade parties. By lapse of time, the claim of the deposit became time-barred and the amount attained a totally different quality. It became a definite trade surplus. The assessee itself had treated the money as its own money and taken the amount to its profit and loss account. The amounts were asses sable in the hand of the assessee. But, in the case of this assessee, amount was borrowed for acquiring capital assets.

26. Next the ld. CIT(A) also considered the application of section 28.

This section reads as under :-

“28. The following income shall be chargeable to income-tax under the head “Profits and gains of business or profession”, – (i) The profits and gains of any business or profession which was carried on by the assessee at any time during the previous year;

(ii) Any compensation or other payment due to or received by, – (a) Any person, by whatever name called, managing the whole or substantially the whole of the affairs of an Indian company, at or in connection with the termination of his management or the modification of the terms and conditions relating thereto;

(b) Any person, by whatever name called, managing the whole or substantially the whole of the affairs in India of any other company, at or in connection with the termination of his office or the modification of the terms and conditions relating thereto;

(c) Any person, by whatever name called, holding an agency in India for any part of the activities relating to the business of any other person, at or in connection with the termination of the agency or the modification of the terms and conditions relating thereto;

(d) Any person, for or in connection with the vesting in the Government, or in any corporation owned or controlled by the Government, under any law for the time being in force, of the management of any property or business; (iii) Income derived by a trade, professional or similar association from specific services performed for its members;

(iiia) Profits on sale of a license granted under the Imports (Control) Order, 1955, made under the Imports and Exports (Control) Act, 1947 (18 of 1947);

(iiib) Cash assistance (by whatever name called) received or receivable by any person against exports under any scheme of the Government of India;

(iiic) Any duty of customs or excise re-paid or re-payable as drawback to any person against exports under the Customs and Central Excise Duties Drawback Rules, 1971;

(iv) The value of any benefit or perquisite, whether convertible into money or not, arising from business or the exercise of a profession ;

(v) Any interest, salary, bonus, commission or remuneration, by whatever name called, due to, or received by, a partner of a firm from such firm :

Provided that where any interest, salary, bonus, commission or remuneration, by whatever name called, or any part thereof has not been allowed to be deducted under clause

(b) Of section 40, the income under this clause shall be adjusted to the extent of the amount not so allowed to be deducted;

(vi) Any sum received under a Key man insurance policy including the sum allocated by way of bonus on such policy.

27. We have examined the provisions of section 28 (iv), as extracted above and have found that this section is not at all applicable to the facts of this case. It is incorrect finding of ld. CIT(A) that the amount of interest relating to the pre- operative period became part of trading operation of business and any benefit received on account of waiver of interest is in the nature of profits and gains of business in terms of provisions of section 28(iv).

28. Accordingly, in view of our foregoing discussions, we allow the appeals of the assessee.

29. In the result, the appeal of the assessee is allowed.