Section 115JB – Amendment required and clarification sought in respect of taxability of waiver of Principal amount by banks/ NBFC
Presently, there is increased focus on resolution of large NPAs faced by banking sector. The Government and RBI are vigorously pursuing several measures to reduce NPAs through different debt-restructuring schemes. Extreme measure of initiating insolvency proceedings against large borrowers through newly enacted Insolvency and Bankruptcy Code 2016 is also being pursued. The Sick Industrial Companies (Special Provisions) Act, 1985 (for which necessary benefit is given under existing section 115JB) is repealed in December, 2016.
The outcome of compromise or debt restructuring measures is likely to result in a situation where substantial part of debt owed by the borrower company may be waived by the lenders. The borrowing companies may consequently write back such liabilities in their books by credit to Profit & Loss statement as required by applicable Accounting Principles.
The loan waiver (which may include outstanding principal and interest) is not likely to adversely impact companies in normal tax computation having regard to following:-
i. Waiver of outstanding interest which has not been allowed as deduction in view of limitation of section 43B (which permits deduction only on actual payment) is not taxable u/s 41(1). This includes interest which is capitalised to asset cost as required by proviso to section 36(1)(iii) read with ICDS IX and/or ICAI’s AS16. Section 41(1) being a claw back provision captures only those items which have earlier been allowed as deduction in normal tax computation.
ii. Waiver of principal amount of loan which has been used for capital purposes, as per preponderant judicial view, is not taxable as ‘income’ under normal computation. It is not taxable u/s 41(1) since the loan was not allowed as deduction in the past. The waiver represents a capital receipt which is outside the scope of charging provisions of section 4 and 5 of the Income-tax Act, 1961. However, on waiver of principal amount of loan used for working capital purposes, taxpayers are facing difficulty in view of court rulings which have held such waiver to be taxable as business income
Due to the waiver of loan and interest which will be credited to profit and loss account, borrower
companies will have to consider Minimum Alternate Tax provisions of section 115JB which seeks to levy minimum tax @ 18.5% of ‘book profit’. The ‘book profit’ is computed by adopting net profit as per Profit and loss A/c and subjecting it to upward and downward adjustments prescribed in section 115JB.
To the extent, waiver of outstanding interest which was debited to Profit and loss in earlier years is included in ‘book profit’ of current year and taxed under MAT, it would be fair to treat the amount as income being identical to taxation under normal computation u/s 41(1).
Under MAT provisions, the taxation of principal amount of loan waiver used for capital purposes and/or interest which was capitalised to asset cost under AS 16 by including the same in ‘book profit’ creates onerous burden on borrower companies for following reasons :-
i. It is well settled that waiver of said amounts are not liable to tax under normal computation. This results in mismatch between normal computation and MAT based on ‘book profit’.
ii. The waiver amounts are likely to be substantial resulting in huge MAT liability at effective MAT rate of 18.5% on waived amounts.
iii. The exclusion provided in MAT computation for profits of sick industrial companies till net worth of such companies becomes NIL or positive is not effective since Sick Industrial Companies (Special Provisions) Act, 1985 is now repealed and all such companies will now have to file the application under Insolvency and Bankruptcy Code. Further, even under existing provision, exclusion does not apply if waiver is granted when net worth of the company is positive.
iv. The provisions for set-off of brought forward book loss/unabsorbed depreciation in MAT computation are very restrictive. Set off is available for lower of the two figures and no set off is available if one of the twofigures is NIL. Hence, company is not able to effectively absorb past book losses in its MAT computation.
v. A company which isalready reeling under high debt and losses and is attempting to recover through debt restructuring scheme will face substantial cash flow burden due to MAT liability with no visibility on whether it will be able to utilise the MAT credit over next 15 years. Companies which get liquidated pursuant to insolvency proceedings will never be able to utilise the MAT credit.
vi. Bankers will also be reluctant to waive off their secured debt if they realise that substantial part of debt waived off in the interests of reviving the company will get locked up in MAT payment. Besides it is also unfair to tax the principal amount of loan waiver under MAT for following reasons:-
i. MAT was introduced to make companies which declared high profits and paid dividends to shareholders but paid very little or low taxes by availing different tax incentives, pay a minimum amount of tax.
ii. It is an alternate basis of taxation in lieu of normal computation. MAT cannot overreach the charging provisions of section 4 and 5 and seek to levy tax on capital receipts which are not liable to tax under normal computation. It is well settled that every receipt is not income.
iii. Principal amount of loan waiver as a capital receipt stands on a different footing as compared to other capital receipts like exempt capital gains which, but for specific exemption under normal computation, are otherwise within the scope of definition of ‘income’ and charging provisions of section 4 and 5.
iv. It is unfair to exempt revenue incomes like dividend from companies or mutual funds but tax
capital receipts in the form of loan waiver under MAT.
Unfortunately the subject is highly controversial and there are conflicting judicial precedents – some in favour of taxpayer and others favouring the Tax Authority. The Government is very keen for implementation of Insolvency and Bankruptcy Code for reducing the NPAs and to provide support to companies for revival / restructuring their operation in the best possible manner. To attain this objective it is suggested that necessary amendment may be made in section 115JB of the Income-tax Act to align with the Government’s objective for proper implementation of IBC Code.
In view of aforesaid, it is suggested that:
1. (i) The provisions of section 115JB of the Income-tax Act,1961 may be suitably amended to provide for specific exclusion for:
a) principal amount of loan waiver credited to the statement of Profit and loss and
b) interest waiver credited to the statement of Profit and loss to the extent it was not debited to the statement of Profit and loss in earlier years where the waiver is granted by banks or public financial institutions or NBFC pursuant to any scheme framed under RBI guidelines or proceedings under Insolvency and Bankruptcy Code 2016.
(ii) The existing provisions which provides for reduction of lower of loss or depreciation for the purpose of computation of book profit may be amended to remove the condition of depreciation and thereby the entire unabsorbed losses (including unabsorbed depreciation) as per books of accounts should be allowed to be reduced for the purpose of calculation of book profit.
2. There are disputes about taxability of waiver of principal amount in respect of working capital loans from Banks/ NBFC. As explained, waiver of principal amount in Resolution Plan under Insolvency and Bankruptcy Code will help to revive the company. On principles, there is no difference between loan used for acquiring capital asset or for working capital. The loan raised is not allowed as business deduction to trigger section 41(1) on waiver. Also, waiver of loan cannot be regarded as business perquisite u/s. 28(iv) which can apply only to benefits received in regular course of business (like freebies or gifts) Hence it is requested to clarify that any waiver of principal amount by banks/ NBFC will not be taxable under normal provisions of the Act.