Income Tax Implications under Insolvency & Bankruptcy Code, 2016

WAIVER OF LOANS

Pursuant to approval of Resolution Plan by the Adjudicating Authority under Insolvency & Bankruptcy Code, 2016, has presuppose waiver of ‘Loans & Other Liabilities’ which includes financial and operational liabilities of the Corporate Debtor.

The aforesaid Loans & Other Liabilities can be sub-divided on the basis of type of loan & end user as under:

1. Revenue Loans (such as Working Capital Loans);
2. Capital Loans (such as utilized for capital purpose)

It is pertinent to note that the Income Tax implications will depend on the type and utilization of loan. The potential tax implications may arise under Section 28(iv), Section 41(1) and Section 194R of the Income Tax Act, 1961.

With effect from 01.04.2024 vide Finance Act, 2023, Section 28(iv) reads as under-

Section 28 Profits and Gains of Business or Profession

(iv) the value of any benefit or perquisite arising from business or the exercise of a profession, whether––

(a) convertible into money or not; or

(b) in cash or in kind or partly in cash and partly in kind;

Implication before Amendment: In terms of Section 28(iv) of the Income Tax Act, 1961 pertaining to profits and gains of business of profession, “the value of any benefit or perquisite, whether convertible into money or not, arising from business or the exercise of a profession”, will be chargeable to income tax under the head “Profits and gains of business or profession”.

Implication before Amendment: In order to ensure that no income is left from taxability, benefit or perquisite arising in cash also brought into the scope of Section 28(iv) of the Act. Post this amendment, rulings in case of Mahendra & Mahendra do not much relevance now.

However, although it might now provide for taxability for benefits in cash, it is important to examine whether waiver of loan can be considered as “arising from business or exercise of profession”

Effect of waiver in terms of Section 41(1):

Extracts of Section 41(1) reads as under-

“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— 

• 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

• 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.”

In view of this section, it is to be considered that the taxability may arise if the loan was taken for the purpose of business or trading activity and was claimed as an expense in any of the assessments.

Also, in case of Logitronics (P.) Ltd. v. CIT, Hon’ble Delhi HC held that, “Whether taxability of waiver of loan by bank would depend upon purpose for which said loan was taken – Held, yes – Whether if loan was taken for acquiring capital asset, waiver thereof would not amount to any income eligible to tax, but, on other hand, if loan was taken for trading purpose and was treated as such from very beginning in books of account, waiver thereof may result in income, more so when it was transferred to profit and loss account – Held, yes”.

Hence, here it arises the importance to check for the type and purpose of loan, in addition to if “arising from business or exercise of profession”.

Effects of Section 194R read with Circular No. 12 of 2022:

In the said Circular, it was mentioned that provisions of Section 194R would be applicable to perquisite or benefit in cash as well. It was further mentioned that principal amount of loan waived, being a benefit to the borrower, would also be covered under section 194R of the Act. Hence, subject to the taxability, applicability of Section 194R is required to be taken into consideration.

Applicability in cases of loan waiver arising out of Resolution Plans under Insolvency and Bankruptcy Code, 2016

The approved resolution plans likely to provide for extinguishment of liabilities and different tax statutes including waiver of loans.

The position of law as regards the claims up to the initiation of the corporate insolvency resolution process, including the income tax liability is clear that if the plan is approved by the NCLT, claims covered in the resolution plan and treatment of such claims will be governed by the provisions of the approved resolution plan and the same will bind all the parties i.e. corporate debtor, its members, creditors, etc., as well as central government, state government or any other local authorities and no person will be entitled to initiate or continue any proceedings regarding the claim which did not form part of the approved resolution plan.

That having said, aspects that we have discussed here does not be take care of by above stated legal position as what we have examined is whether, by virtue of waiver of the loan, any tax liability arises under Section 28(iv) or Section 41(1).

Conclusion:

Though the matter is a litigative issue to conclude a final verdict, but given the law and legal precedents as mentioned above, following assertions may be made-

CARRY FORWARD AND SET-OFF OF LOSSES IN CASE OF CERTAIN COMPANIES

Section 79(1) of Income Tax Act provides certain restrictions on carry forward and set off of losses if there is a change in the shareholding of a company (not being a company where the public is substantially interested) during the previous year, it restricts the company’s ability to carry forward and set off losses incurred in prior years.

This restriction applies unless a specific condition is met, i.e., on the last day of the previous year, at least 51% of the voting power in the company is held by the same persons who held at least 51% of the voting power on the last day of the year(s) when the losses were incurred.

However, it is pertinent to note that restriction of Section 79 is applicable only in case of loss and is not applicable in case of adjustment of unabsorbed depreciation.

Since in case of Insolvency there is likely to be changes in shareholding pattern, the provisions of Section 79(1) may not get complied.

However, Section 79(2)(c) specifically exempts companies that have undergone a corporate insolvency resolution process under the Insolvency and Bankruptcy Code, 2016 (IBC). But the conditions for exemptions are:

• There must have been a change in shareholding during the previous year due to the approved resolution plan.
• The jurisdictional Principal Commissioner or Commissioner of Income Tax must have been given a reasonable opportunity to be heard during the resolution process.

The Provisions of Section 79(2) (c) reads as follows:

Section 79(1) is not applicable to a company where a change in the shareholding takes place in a previous year pursuant to a resolution plan approved under the Insolvency and Bankruptcy Code, 2016 (31 of 2016), after affording a reasonable opportunity of being heard to the jurisdictional Principal Commissioner or Commissioner;

Hence, this provision allows such companies to carry forward and set off their past losses, even if there has been a significant change in their ownership structure.

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Disclaimer: This article provides informational content and should not be construed as solicitation for any purpose. For professional advice, consult a qualified expert. For specific inquiries or further assistance, contact the author at advshipradudeja@gmail.com or 85270 73808.