Taxability of benefit of waiver of loans and unpaid interest for borrower

Court : Delhi Income Tax Appellate Tribunal

Citation: Addl. CIT Vs. Rollatainers Ltd. [2010- TIOL-379-ITAT-DEL]

Brief :The ITAT ruled that waiver of unpaid interest, which was not allowed as deduction in the past, is not liable to tax under the specific provisions of Indian Tax Laws (ITL) which provide for taxation of remission of trading liability. The ITAT also ruled that waiver of term loans used for acquiring capital assets is not liable to tax under the specific provisions of the ITL which provide for taxation of benefit or perquisite arising from business. The ITAT further held that waiver of cash credit facility used for trading operations is liable to tax since the benefit bears revenue character and, therefore, in the nature of benefit or perquisite arising from business.

Background and facts

• · In terms of specific provisions of the ITL, a benefit obtained by a taxpayer by way of remission or cessation of a trading liability, loss or expenditure allowed as deduction in the past is chargeable as business income in the year of remission or cessation.
• · In terms of another specific provision in the ITL, the value of any benefit or perquisite, whether or not convertible into money, arising from business (business perquisite) is treated as business income.
• · The Taxpayer had availed term loans and cash credit facilities from financial institutions. The terms loans were utilized for acquiring machinery. The cash credit facilities were used for working capital requirements.
• · The Taxpayer ran into financial difficulties and was unable to repay the terms loans, cash credit facilities and interest thereon. It was referred to the Board for Industrial & Financial Reconstruction as a ‘sick company’. Under a Corporate Debt Restructuring scheme, the financial institutions waived part of the term loans, cash credit facilities and unpaid interest. The Taxpayer credited the amounts waived to Profit & Loss Account (P&L).
• · The Taxpayer claimed that none of the three items were chargeable to tax. The Tax Authority, however, rejected the contention and added the waived term loans, cash credit facilities and interest amount to the Taxpayer’s income.
• · The first appellate authority upheld the Taxpayer’s claim and held that none of the items were liable to tax. Aggrieved, the Tax Authority appealed to the ITAT.

Taxpayer’s contentions

• · As regards unpaid interest, the Taxpayer had not claimed deduction in the past since, in terms of the ITL, interest payable to financial institutions is allowable as deduction only upon actual payment. Since the unpaid interest was not allowed as deduction, the waiver thereof is not liable to tax.
• · As regards the principal amount of term loans and cash credit facilities, the waiver is on capital account and not liable to tax. The principal amounts were not allowed as deduction in the past and, hence, they cannot be brought to tax as remission of trading liability. The waiver of loan is also not in the nature of business perquisite.

Tax Authority’s contentions

• · The waiver of all the three items viz. unpaid interest, term loans and cash credit facilities are liable to tax. The waiver of unpaid interest represents remission of trading liability. The waiver of term loans and cash credit facilities represents business perquisite.
• · In the present case, the Taxpayer credited the waived amounts to P&L which reflects that the Taxpayer itself treated these items as its income. Reliance was placed on the Supreme Court (SC) ruling in the case of CIT v. T. V. Sundaram Iyengar [222 ITR 344] (Sundaram ruling) where it was held that although the security deposits received in the course of taxpayer’s business are, at the time of receipt, capital in nature, their character changed when the amounts were credited to P&L by the taxpayer. The taxpayer became richer by this amount by treating it as its own money and, hence, such waiver represented business perquisite.

ITAT’s ruling

• · As regards waiver of unpaid interest, the ITAT upheld the Taxpayer’s claim and ruled that this item was not chargeable to tax as remission of trading liability since the interest was never allowed as deduction in the past in view of the provisions of the ITL, which permit deduction of interest payable to financial institutions only upon actual payment.
• · As regards waiver of term loans also, the ITAT upheld the Taxpayer’s claim and ruled that this item was not chargeable to tax. The term loans were used for acquiring machinery i.e. for capital purposes and the monies did not come into the Taxpayer’s hands in the course of any trading transaction. Hence, the waiver thereof is a benefit which bears capital character. It does not represent either remission of trading liability or business perquisite.
• · However, as regards waiver of cash credit facilities, the ITAT upheld the Tax Authority’s contention and held that this item was liable to tax as business perquisite.
• · The ITAT distinguished the ruling by the High Court (HC) of Delhi, in the case of CIT Vs. Phool Chand Jiwan Ram [131 ITR 37] (Phool Chand ruling), relied upon by the Taxpayer. In this case, the taxpayer had taken loan to pay off its trade creditors. The Delhi HC held that the loan liability was not a trading liability and waiver thereof by the loan creditor does not give rise to taxable income in the hands of the taxpayer.
• · The ITAT held that the Phool Chand ruling did not represent good law in view of the subsequent Sundaram ruling of the SC. The Sundaram ruling unsettles some of the earlier decisions to the effect that the character of a receipt is once and for all decided at the time it was obtained. In this ruling, the SC held that the character may change subsequently when the amount is credited to P&L, more so when it is a benefit received in the course of carrying on the business. The benefit obtained on waiver of cash credit facility bears revenue character as the monies were borrowed for day-to-day operations or circulating capital and not for purchase of capital assets.
• · The ITAT held that a subsequent Bombay HC ruling in the case of Solid Containers Vs. DCIT [308 ITR 417], where waiver of loan used for trading purpose was held liable to tax after considering Sundaram ruling, was more closer to the Taxpayer’s facts.

Comments:- In the absence of specific provisions in the ITL dealing with tax treatment of waiver of loans, the issue of tax ability of the benefit obtained on remission of loan liability has been a subject matter of high litigation between the taxpayers and the Tax Authority. The issue has spawned multiple conflicting judicial precedents. The present ITAT ruling indicates the recent trend of judicial thinking viz. that waiver of loan used for capital purposes bear’s capital character, whereas the one used for trading purposes bears revenue character.

NF