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December 9, 2020

Waiver of loan cannot be assessed as business income – SC

by CA Shivam Jaiswal in Income Tax

Waiver of loan cannot be assessed as business income – SC

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 Act states the incomes 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”

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

Let us refer to the case of The Commissioner vs Mahindra and Mahindra Ltd was whether sum due which later on waived off by the lender constitute taxable income or not?

Facts of the Case:

  • The appellant was the Department of Income Tax (Revenue) and the respondent was Mahindra & Mahindra Ltd, a company registered under the Companies Act, 1956.
  • The Respondent, way back, decided to expand its jeep product line.
  • For this purpose, it entered into an agreement with Kaiser Jeep Corporation (KJC) based in America wherein KJC agreed to sell the dies, welding equipment’s and die models to the assessee.
  • The final price of the tooling and other equipment’s was agreed at $6,50,000 including cost, insurance and freight (CIF).
  • Meanwhile, the Respondent took all the requisite approvals from the concerned Government Departments.
  • The said tooling’s and other equipment’s were supplied by the Kaiser Jeep Corporation through its subsidiary Kaiser Jeep International Corporation (KJIC).
  • However, for the procurement of the said tooling’s and other equipment’s, KJC agreed to provide loan to the Respondent at the rate of 6% interest repayable after 10 years in instalments.
  • For this purpose, the Respondent addressed a letter to the RBI for the approval of the said loan agreement. The RBI and the concerned Ministry approved the said loan agreement.
  • Later on, it was informed to the Respondent that the American Motor Corporation (AMC) had taken over the KJC and also agreed to waive the principal amount of loan advanced by the KJC to the Respondent and to cancel the promissory notes as and when they got matured.
  • The same was communicated to the Respondent.
  • The Respondent filed its return and showed Rs. 57,74,064 as cessation of its liability towards the American Motor Corporation.
  • After perusal of the return, the Income Tax Officer (ITO) concluded that with the waiver of the loan amount, the credit represented income and not a liability.
  • Accordingly, the ITO, held that the sum was taxable under Section 28 of the Income Tax Act.

Proceedings of Appellate Authorities and High Court (HC)

  • Being dissatisfied, the Respondent preferred an appeal before the Commissioner of Income Tax (Appeals) [CIT(A)].
  • After perusal of the matter, CIT (A) dismissed the appeal and upheld the order of the ITO with certain modifications
  • Being aggrieved, the Respondent as well as the Revenue preferred appeals before the Tribunal.
  • The Tribunal, set aside the order passed by CIT (A) and decided the case in favour of the Respondent
  • Being aggrieved, the Revenue filed a Reference before the High Court.
  • In that Reference, three applications were filed, one by the assessee and rest two by the Revenue.
  • The High Court confirmed certain findings of the Tribunal in favour of the Respondent.
  • Hence, the Revenue filed an appeal before the Supreme Court (SC)

Observations of the SC on the issue of the present case

  • The term “loan” generally refers to borrowing something, especially a sum of cash that is to be paid back along with the interest decided mutually by the parties.
  • In other terms, the debtor is under a liability to pay back the principal amount along with the agreed rate of interest within a stipulated time.
  • It is a well-settled principle that creditor or his successor may exercise their “Right of Waiver” unilaterally to absolve the debtor from his liability to repay.
  • After such exercise, the debtor is deemed to be absolved from the liability of repayment of loan subject to the conditions of waiver.
  • The waiver may be a partly waiver i.e., waiver of part of the principal or interest repayable, or a complete waiver of both the loan as well as interest amounts.
  • Hence, waiver of loan by the creditor results in the debtor having extra cash in his hand.
  • It is receipt in the hands of the debtor/assessee.
  • The issue in the instant case arose whether waiver of loan by the creditor is taxable as a perquisite under Section 28 (iv) or taxable as a remission of liability under Section 41 (1) of the IT Act.

Observations of the SC on the applicability of Section 28(iv) of the IT Act

  • On a plain reading of Section 28(iv), prima facie, it appeared that for the applicability of the said provision, the income which can be taxed shall arise from the business or profession.
  • Also, in order to invoke the provision of Section 28 (iv), the benefit which was received had to be in some other form rather than in the shape of money.
  • In the present case, the amount was received as cash receipt due to the waiver of loan.
  • Therefore, the very first condition of Section 28 (iv) which stated that any benefit or perquisite arising from the business shall be in the form of benefit or perquisite other than in the shape of money, was not satisfied in the present case.
  • Hence, according to the SC, in no circumstances, it could be said that the amount could be taxed under the provisions of Section 28(iv).

Observations of the SC on the applicability of the Section 41(1) of the IT Act.

  • On a perusal of the said provision, it was evident that it was an essential condition that there should be an allowance or deduction claimed by the assessee in any assessment for any year in respect of loss, expenditure or trading liability incurred by the assessee.
  • Then, subsequently, during any previous year, if the creditor remitted or waived any such liability, then the assessee was liable to pay tax under Section 41.
  • The objective behind this Section was to ensure that the assessee did not get away with a double benefit once by way of deduction and another by not being taxed on the benefit received by him in the later year with reference to deduction allowed earlier in case of remission of such liability.
  • It was an undisputed fact that the Respondent was paying interest at 6% p.a to the KJC as per the contract but the assessee never claimed deduction for payment of interest under Section 36 (1)(iii).
  • In the case at hand, CIT (A) relied upon Section 41(1) and held that the Respondent had received amortization benefit.
  • Amortization is an accounting term that referred to the process of allocating the cost of an asset over a period of time, hence, it was nothing else than depreciation.
  • Depreciation was a reduction in the value of an asset over time, in particular, to wear and tear.
  • Therefore, the deduction claimed by the Respondent in previous assessment years was due to the deprecation of the machine and not on the interest paid by it.
  • Moreover, the purchase effected from the Kaiser Jeep Corporation was in respect of plant, machinery and tooling equipment’s which were capital assets of the Respondent.
  • It was important to note that the said purchase amount was not been debited to the trading account or to the profit or loss account in any of the assessment years.
  • Here, SC deemed it proper to mention that there was difference between ‘trading liability’ and ‘other liability’.
  • Section 41(1) particularly dealt with the remission of trading liability.
  • Whereas in the instant case, waiver of loan amounted to cessation of liability other than trading liability.
  • Hence, SC found no force in the argument of the Revenue that the case of the Respondent would fall under Section 41(1).

Conclusion by SC

SC did not interfere with the judgment and order passed by the HC in view of the following reasons:

  • Section 28(iv) did not apply on the present case since the receipts were in the nature of cash or money.
  • Section 41(1) did not apply since waiver of loan does not amount to cessation of trading liability.
  • It was a matter of record that the Respondent had not claimed any deduction under Section 36 (1) (iii) for the payment of interest in any previous year.

Therefore, SC was of the view that the appeals were devoid of merits and deserve to be dismissed.

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