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September 7, 2020

You got loan waiver in Covid19? Is it taxable in Income Tax?

by shivam jaiswal in Income Tax

You got loan waiver in Covid19? Is it taxable in Income Tax?

Loan basically refers to a type of credit in which a sum of money is lent to another party in exchange for future repayment of the value or principal amount. In many cases, the lender also adds interest and/or finance charges to the principal value which the borrower must repay in addition to the principal balance. Loans come in many different forms including secured, unsecured, commercial, and personal loans.

The economic impact of the 2020 coronavirus pandemic in India has been largely disruptive. The lockdown though necessary has led to a disastrous impact on the economy.

The Government of India announced a variety of measures to tackle the situation, from food security and extra funds for healthcare and for the states, to sector related incentives and tax deadline extensions. The Reserve Bank of India (RBI) announced an extension of the moratorium on term loan EMIs.

The Supreme Court continues hearing petitions seeking an extension of the moratorium period on repayment of loans and to waive off the interest on interest on the loan amount in view of the COVID-19 pandemic. 

However, if such waiver is granted will the same be taxable under income tax? Is waiver of loan (principal or interest) taxable under Income Tax?

What do you mean by waiver of loan?

A loan waiver is the waiving or surrender of the real or potential liability of the person or party who has taken out a loan by the person or party who has made or given the loan.

For instance, one of your friends borrowed a sum of Rs.10000 from you, but he was unable to repay because of some financial difficulties. You have realized the situation of your friend that the repayment of loan is beyond his control; so you forgave the loan amount given to him and informed him that you have absolved him from the debt. Here you have voluntarily cancelled the loan amount receivable from your friend. This is called waiver of loan.

Is waiver of loan taxable under Section 28(iv) of the Income Tax Act?

Section 28 of the Income Tax Actstates theincomes that shall be chargeable to income-tax under the head “Profits and gains of business or profession”. According to Section 28(iv), the value of any benefit or perquisite, whether convertible into money or not, arising from business or the exercise of a profession is chargeable to income-tax under the head “Profits and gains of business or profession”.

In simple words it means that the benefit or perquisite accruing in the form other than money, arising from business or a profession, is chargeable to income-tax under the head “Profits and gains of business or profession”.

The Courts have held many times that the benefit or perquisite arising to the assessee in the form of money would not attract the provisions of section 28(iv).

In ITO Vs Tini Pharma Ltd, ITAT Hyderabad held that, waiver of principal amount would not constitute income falling u/s 28(iv) of the Act. Referring to the provisions of section 28(iv), it was submitted that the amount was received as cash receipt due to the waiver of loan. Therefore, the very first condition in the section itself was not satisfied for applicability of section 28(iv) of the Act.

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In CIT Vs. Mahindra and Mahindra Ltd [2018], Supreme Court observed that the assessee had not received any benefit or perquisite in kind which could be valued and in any event such benefit should be in the nature of income.

The Division Bench noted that the loan was advanced to the assessee Mahindra and Mahindra, the assessee paid interest at 6% per annum for ten years being the period of contract, and it never got deductions for payment of interest under Section 36(1)(iii) or under Section 37 of the Act. 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).

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).

Is waiver of loan taxable under Section 41(1) of the Income Tax Act?

In business there are circumstances where a person might have incurred a liability but later on he need not have to pay it for one or other reason. The Income Tax Act brings to tax such liabilities which are no more payable under Section 41(1).

Section 41(1) states that any allowance or deduction made in the assessment for any year in respect of loss, expenditure or trading liability incurred by the assessee and subsequently it is waived off or remission is granted by the lender, it shall be deemed to be the income chargeable to tax under the head ‘Profits and gains of business or profession’.

The section brings in to its ambit benefit in cash or in kind obtained by a person by remission or cessation of liability. The only condition is that the person must have obtained a deduction or allowance in his computation of income for the said liability in any previous years.

To compute the same one has to consider the following points:

  • There has to be a remission or cessation of a liability
  • There has to be recovery of any loss or
  • There has to be recovery of any expenditure
  • The liability must be a trading liability and not on capital account
  • The person is allowed deduction or allowance for the same in any previous year

The term ‘trading liability’ became subject matter of discussion in Rollatainers Ltd. v. CIT [2011] (Delhi). The assessee took cash credit facility from a bank and it was meant for carrying on business. The waiver of such cash credit amount subsequently was held as cessation of trading liability and, thus, falling in the revenue field.

It was held that the money was borrowed by way of cash credit for day-to-day affairs of the business and was not meant for purchase of machinery. When the loan forming part of circulating capital of the assessee is waived, off it is chargeable to tax under section 41(1). The Court held that such waiver, even though would not fall in section 28(iv), it is covered by section 41(1) and, hence, liable to be taxed as an income.

With regard to waiver of ‘term loan’ or any other loan in contrast to ‘working capital loan’ it was held as not chargeable to tax under section 41(1) in Mahindra & Mahindra Ltd. v. CIT [2003].  With regards to applicability of section 41(1), SC held that there must have been an allowance or deduction which was claimed by the assessee earlier and subsequently the creditor waived off such liability.

The objective of the provision was to ensure that the assessee did not get double benefit (deduction in the earlier year and remission in the subsequent year). The loan was obtained for the purpose of acquisition of plant, machinery and tooling equipments. The said purchases were not debited to trading account and profit and loss account.

Hence, the waiver of loan given earlier for acquisition of assets would not result in taxation of income. It held that section 41(1) dealt with remission of trading liability. When the term loan or machinery loan was waived off, it was not a cessation of trading liability to trigger section 41(1).  

Applying the rulings laid down in the Mahindra 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.

Is waiver of loan taxable under Section 56(2)(x) of the Income Tax Act?

Section 56(2)(x) of the Income-tax Act, 1961 provides that where any person receives in any previous year, from any person or persons, any sum of money, without consideration, the aggregate value of which exceeds fifty thousand rupees, the whole of the aggregate value of such sum shall be taxable under the head ‘Income from Other Sources’.

In this context, a question arises whether Section 56(2)(x) of the Act would apply to a waiver of loan. Basically, Section 56(2)(x) 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.

However, advancement of loan is for a consideration of interest. Therefore advancement of loan cannot be said to be without consideration. Hence, the amount received by the debtor (loanee) in the form of waiver of loan cannot be said to be without consideration.

Therefore in short, Section 28(iv) of the IT Act does not apply in the waiver of loan since the receipts are in the nature of cash or money. Section 41(1) of the IT Act also does not apply since waiver of loan does not amount to cessation of trading liability. Therefore waiver of loan is generally not taxable under Income Tax.

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