The ongoing Covid – 19 pandemic has affected the human lives severely. Besides the impact on human lives it has drastically impacted the businesses. As per the data of the National Statistical Office (NSO) India has recorded worst GDP growth rate of -23.90% for quarter 1 of FY 2020-2021. This indicates that the businesses are hampered widely. The negative growth rate has ultimately impacted the financial stability of the businesses. This can hit hardly to the banking sector as many of the loan accounts may become non – performing assets (NPA) and chances of recovery from such account would become remote. For recovery from the NPA accounts, the banks may offer one-time settlement scheme to the loanee, in such a scheme the banks may forgo/waive the loan to certain extent. In this article we are going to understand the taxability of such waiver of loan in the hands of the loanee.
Under section 4 of the Income – tax Act, 1961 [“the Act”], the charging section, the charge of income tax is on the “total income of the previous year”. The term ‘income’ is defined under section 2(24) of the Act. In general, all the receipts of revenue nature, unless specifically exempted are chargeable to tax. Loan taken is not normally a kind of receipt which will be treated as income. However, when a part of that loan is waived by the creditor, some benefit accrues to the assessee. What would be the character of such benefit accrued to the assessee?
In this context, section 28(iv), section 41(1) and section 56(2)(x) of the Act becomes relevant. These provisions have been introduced in the Act to bring certain benefits accrued to the assessee within the sweep of taxation. Since multiple sections are involved, we will deal with each section separately.
I TAXABILITY UNDER SECTION 28(iv) –
1. The section reads as under: –
“28.The following income shall be chargeable to income-tax under the head “Profits and gains of business or profession”,—
(iv) the value of any benefit or perquisite, whether convertible into money or not, arising from business or the exercise of a profession”
2. The above section consists of two components, those are:
i) First part of the section provides that “the value of the benefit or perquisite, whether convertible into money or not”. This means that the benefit or perquisite shall accrue in the form other than the money and
ii) Second part of the section provides that such benefit or perquisite shall arise from business or exercise of a profession.
3. Cumulative reading of both the above components provides that if any benefit or perquisite accrues to the assessee in the form other than money and it has accrued in the course of carrying out business or profession then such benefit or perquisite accrued to the assessee will be taxable under section 28(iv). The Courts have consistently held that the benefit or perquisite arising to the assessee in the form of money would not attract the provisions of section 28(iv). In case of CIT v. Alchemic (P) Ltd. – [(1981) 130 ITR 168 (Guj)], the Court in respect of section 28(iv) has held that the question of including the value of the benefit or perquisite in income would arise only if the benefit or the perquisite is not in cash or money. In other words, only non-monetary benefit or non-monetary perquisite is taxed as income under section 28(iv).
4. Now, a question that arises is whether waiver of loan amounts to monetary benefit or non monetary benefit? This question is very clearly answered by the Apex court in case of CIT v. Mahindra & Mahindra – [(2018) 404 ITR 1 (SC)], the Court has held that waiver of loan by the creditor results receipt in the hands of the debtor / assessee and once ‘waiver of loan’ is treated as ‘receipt’, it can be said that the benefit accrued to the assessee is monetary benefit and it would automatically fall outside the purview of section 28(iv).
5. In consonance with the decision of Apex Court and a recent decision of Bombay High Court in case of Essar Shipping Limited v. CIT – [(2020) 117 taxmann.com 389 (Bom)], it can be concluded that waiver of loan amounts to monetary benefit and therefore it cannot be taxed under section 28(iv).
II TAXABILITY UNDER SECTION 41(1)
1. The relevant portion of the section is reproduced as follows:
“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
2. A bare perusal of the above section would clearly indicate that the section is specifically incorporated in the Act to cover a particular situation. The above section applies where trading liability was allowed as a deduction in earlier years in computing the business income of the assessee and the assessee has obtained a benefit in respect of such trading liability in a later year by way of remission or cessation of the liability. In such a case the section says whatever benefit has arisen to the assessee in the later year by way of remission or cessation of liability will be brought to tax in that year. The principle behind the section is simple. It is a provision intended to ensure that the assessee does not get away with a double benefit once by a deduction in an earlier assessment year and again by not being taxed on the benefit received by him in a later year with reference to the liability earlier allowed as a deduction.
3. To summarise, following are the cumulative conditions to attract the provision of section 41(1)
i) The assessee had incurred a trading liability
ii) Such trading liability has been allowed as deduction in earlier year(s) and;
iii) In subsequent year, the trading liability has been waived or ceased to exist.
4. The main crux of the section is that there should be remission or cessation of ‘trading liability’. A question may arise as to what is ‘trading liability’? Interestingly, the term ‘trading liability is not defined in the Act. The term ‘trading liability’ in general terms can be understood as an obligation of a person (debtor) to pay another person (creditor) for goods purchased or expenditure incurred or any service received related to business. Few examples of ‘trading liability’ are as follows:
i) A creditor for purchase of stock in trade
ii) Sales tax / GST or excise duty collected in course of the business
iii) Unclaimed wages / salary or bonus
iv) Unpaid electricity charges
v) All type of the provisions for expenses.
5. Now, coming to waiver of loan whether taxable under section 41(1) of the Act? Generally, loans are taken either for purchase of capital asset or for a working capital of the business. There was lot of controversies involved in taxability of waiver of loan under section 41(1). Such controversy is settled by the Apex Court in case of CIT v. Mahindra & Mahindra Ltd. (supra)
6. Before going further, it is apposite to go through the facts and ruling of the case CIT v. Mahindra & Mahindra (supra), in this case, the assessee had entered into an agreement with a seller company to purchase the dies, welding equipments and die models. For procurement of the said toolings which were capital assets of the assessee, the seller company agreed to provide a loan to the assessee at the rate of 6% interest, repayable in 10 years installment. The assessee regularly paid interest on such loan but never claimed deduction under section 36(1)(iii). Subsequently, the seller company was taken over by another company, who waived the principal amount of loan given to the assessee. In the return of income for the relevant assessment year the assessee showed the waiver of loan as capital receipt not chargeable to tax. The assessing officer made an addition of the waiver under section 28(iv) of the Act. On appeal before CIT (A), he confirmed the additions by relying on section 41(1) and gave finding that the assessee has received amortisation benefit and therefore the waiver of loan is taxable under section 41(1). First with respect to section 28(iv), the Apex Court held that in order to invoke the provision of section 28(iv), the benefit which is received has to be in some other form rather than in the shape of money. Since, the waiver of loan results in the debtor having extra cash in his hand, it is nothing but the receipt of money in the hands of the debtor. Accordingly, it was held that section 28(iv) will not attract to the facts of the present case. Further with respect to section 41(1), the Court held that section 41(1) is attracted only when an allowance or deduction is claimed by the assessee in any assessment for any year in respect of loss, expenditure or trading liability incurred by the assessee and subsequently, during any previous year, if the creditor remits or waives any such liability, then the assessee is liable to pay tax under section 41. In the assessee’s case the assessee had never claimed purchase cost of toolings as deduction and neither deduction of the interest paid on loan was claimed under section 36(1)(iii). With regard to the amortisation benefit the Court held that it is an accounting term that refers to the process of allocating the cost of an asset over a period of time, hence it is nothing else than depreciation. Depreciation is a reduction in the value of an asset over time, in particular, to wear and tear. Therefore, the deduction claimed by the assessee in previous assessment years was due to the depreciation of the toolings and not on the interest paid by it. Therefore, in the assessee’s case, the waiver of loan amounts to cessation of liability other than trading liability. Whereas section 41(1) particularly deals with the remission of ‘trading liability’. Accordingly, no addition under section 41(1) can be made.
7. Applying the rulings laid down in the above case, it can be concluded that if loan is taken for the purchase of the capital asset and if interest is not claimed as expense under section 36(1)(iii) then in such a case waiver of loan will be capital receipt not chargeable to tax.
8. Now, moving on to the loan taken for the purpose working capital of business. With regard to this there are few decisions prior to the decision of CIT v. Mahindra & Mahindra (supra) which had given the rulings that if loan is taken for the purpose of working capital and interest on such loan is claimed as deduction then waiver of such loan is taxable under section 41(1). Those decision are as follows:
9. Though there are few against decisions, as per author, one may take a stand in view of the Apex Court’s decision in Mahindra & Mahindra, if interest is waived then the portion of interest to the extent claimed as deduction will be taxed under section 41(1) as benefit of deduction is allowed in previous years. With regards to waiver of principal amount of loan it may not be taxable as no deduction is claimed of the principal amount while computing the total income chargeable to tax. As conditions as stated in Para 3 above is not satisfied. The stand may be justified.
10. There are few decisions where interest on loan was not claimed as expense in such case waiver of such loan is treated as capital receipt. Those decisions are as follows:
III TAXABILITY UNDER SECTION 56(2)(x)
1. The Apex Court in case of CIT v. Mahindra & Mahindra (supra) has held that waiver of loan amounts to receipt in the hands of debtor (loanee). Considering this the Department may make an addition under section 56(2)(x). It is apt to reproduce the relevant portion of section as follows:
“56. (2) In particular, and without prejudice to the generality of the provisions of sub-section (1), the following incomes, shall be chargeable to income-tax under the head “Income from other sources”, namely :—
(x) where any person receives, in any previous year, from any person or persons on or after the 1st day of April, 2017,—
(a) any sum of money, without consideration, the aggregate value of which exceeds fifty thousand rupees, the whole of the aggregate value of such sum;
2. The above section is applicable when the assessee receives any sum of money, ‘without consideration’ and aggregate value of which exceeds fifty thousand rupees. In such case such receipt of money is taxable as income in the hands of the assessee.
3. The said section was introduced with the intent to curb the mal – practice being followed by the assessee to bring their own undisclosed income to the economic system through other persons by accepting cash gift without paying due taxes there on. It cannot be said that purpose for which the section was brought to statute book is being attained by taxing waiver of loan by the creditor. Further, going by the provisions of the section, in case of the waiver of loan, whether it can be said that a debtor (loanee) has received such sum of money ‘without consideration’?
4. Undoubtedly, advancement of loan is for a consideration of interest. Therefore advancement of loan cannot be said to be without consideration. However, due to various reasons like losses etc the loan account of the debtor (loanee) may become NPA and chances of recovery from such account becomes remote. To recover whatever amount possible creditor bank offer one time settlement with some terms and conditions and fulfilling such terms and conditions is nothing but the consideration for such waiver. Hence, the amount received by the debtor (loanee) in the form of waiver of loan cannot be said to be without consideration. Therefore, in the authors view, the provisions of section 56(2)(x) is not applicable to waiver of loan.
Disclaimer: The contents of this document are solely for information purpose. It does not constitute professional advice or a formal recommendation.