Instances of Loan default & settlement, loan waiver, one Time Settlement (OTS) by banks, financial institutes, lender etc are on the rise. With this emerges the question of its taxation. Whether the amount borrowed & its settlement at a subsequent date will give rise to “Income” liable for taxation?
Let us consider a case of M/s. X Ltd who has availed a loan of Rs. 5 Cr from a bank which consists of Rs. 4 Cr term loan for purchase of capital assets and Rs. 1 Crore as working capital limit for stock & book debts. X Ltd has repaid the amount of Rs. 75 Lakh in the term loan A/c & Rs. 25 Lakh in working capital limit A/c. The principal outstanding now consists of tem loan of Rs. 3.25 Cr & working capital limit of Rs. 75 Lakh. [For ease of convenience and understanding, the interest component is ignored]. Under OTS scheme, the bank settled the claim @ 60% to Rs. 2.40 Crore. Whether the difference or waiver of Rs. 1.60 Cr would be taxable in the hands of X Ltd?
There are three important provisions in the Income Tax Act- 1961 which are applicable in such situation and one needs to understand it for knowing the tax implications.
- Section 28(iv):
Section 28(iv) provides that “the value of any benefit or perquisite, whether convertible in to money or not, arising from business or exercise of a profession “is taxable under the head as “Income from Business & Profession”.
- Section 41(1):
Where an allowance or deduction has been made in earlier years by creating a liability and such liability ceased to exists because of remission or waiver then the value of benefit accruing to the assessee shall be deemed to be profits and gains of business or profession & is chargeable to income-tax as income. What is taxable u/s 41(1) is an allowance or deduction which is claimed by the assessee in earlier as a loss or expenditure.
- Section 56(2)(x):
Section 56(2)(x) provides that any person who receives any sum of money, without consideration [or for a consideration which is less than its fair market value (FMV) and the difference exceed Rs. 50,000/-] then the amount (or difference) would be liable to tax under the head “Income from Other Source”.
The tax implications of loan waiver is covered in three different situations:
I. Waiver of Term Loan taken for acquiring the capital assets in the business like Plant & Machinery, Factory sheds, office equipment etc.
- Waiver of Term Loan taken for non business purpose like housing loan, education loan, personal loan, etc.
III. Working capital or C.C. Loan taken for trading or regular business purpose i.e., for stock, book debts, processing, etc.
- Waiver of Term Loan waiver wherein loan is taken for acquiring capital assets for Business purpose:
In respect of waiver of term loan taken for acquiring business assets is of capital nature, Hon’ble Supreme court in the case of CIT Vs. Mahindra & Mahindra (2018) 404 ITR 0001 (SC) has made following observation:
1. Taxation u/s 28:
For taxation of any amount as business income u/s 28, it should arise from business or profession. In order to invoke provision of Section 28 (iv), benefit should be in some other form & not in the shape of direct money. In the present case, amount was received as “cash” receipt due to waiver of loan. Therefore, very first condition of Section 28 (iv) which says “any benefit or perquisite, whether convertible in to money or not, arising from business or exercise of a profession “is not satisfied. Accordingly, such loan waiver is outside the tax net of section 28.
- Taxation u/s 41:
For applicability of section 41(1), there should be an allowance or deduction claimed by assessee in any assessment year as a result of which the “trading liability” is created in the books of the assessee. Subsequently, if creditor remits or waives any such liability, then assessee is liable to pay tax u/s 41. In the present case, waiver of loan amounted to cessation of liability other than trading liability. Waiver of a loan liability on the capital account is not in the nature of income. There is no force in argument of Revenue that case of assessee would fall u/s 41 (1) & so revenue’s appeal was dismissed.
- Taxation u/s 56:
It may be noted that the issue of taxation u/s 56(2)(x) was not discussed in above case as the section 56(2)(x) was recently introduced in the Act and was not applicable to above case. In my view, section 56(2)(x) is applicable if the amount is received “without consideration”. In case of bank loan, the amount is taken by the borrower against a consideration of “Interest” & “Promise to repay”. Further, the settlement is also against a “consideration” of paying certain fixed amount to the bank & compliance with the terms and condition of OTS. In short, there is a consideration involved and so in my considered opinion, the provision of section 56(2)(x) will not be applicable in such case. Resultantly, the amount waived may not be taxable as “Income from Other source” in case of term loan waiver. Further, invoking of provisions of section 56(2)(vi) is not proper considering the fact that this section as inserted by Taxation Laws (Amendment) Act, 2006 w.e.f 01.04.2007 was introduced to tax the gift transactions without consideration with a limit of Rs. 50,000/-.
In short, Waiver of loan of capital nature is neither taxable as a perquisite u/s Section 28 (iv) nor taxable as a remission of liability u/s 41 (1) nor taxable u/s 56(2)(x).
- Waiver of Term Loan wherein loan is taken for non business purpose like housing loan, car loan, education loan:
In such cases, the taxation u/s 28 & 41 will not arise as the said provisions are applicable only for taxing the business transactions. Further, the amount waived will not be taxable u/s 56 as the discussions above apply mutatis mutandis in this case also.
III. Waiver of working Capital Limit:
- The prima facie view is that the working capital limit is in revenue in nature and so the ratio laid down in the case of CIT Vs. Mahindra & Mahindra (2018) 404 ITR 0001 (SC) may not be relevant in such cases.
- Working Capital limit for stock & book debts will be in the nature of trading liability & may squarely fall within the ambit of section 28 or section 41(1). Interest waived to the extent allowed in the computation of assessable income in earlier years is taxable under Sec. 41(1) of the Act in the year of waiver.
- As far as waiver of principal portion of working capital limit is concerned, it may be noted that
a) Bombay High court in the case of Solid Containers Ltd Vs. DCIT (2009) 308 ITR 0417has held that Cash credit loan is utilized for trading purposes & hence provisions of section 28 (iv) of the Act is applicable as the same is in the nature of Revenue receipt. The court relied on Madras High Court in the case of CIT Vs. Aries Advertising Pvt Ltd (2002) 255 ITR 510 wherein it was held that assessee because of the trading operation became richer by the amount which has been transferred and / or retained in the P & L A/c of the assessee.
b) Supreme court in CIT vs. T.V. Sundaram Iyengar & Sons Ltd: (1996) 222 ITR 344 (SC) has held as under:
“If the amount is received in the course of trading transactions, even though it is not taxable in the year of receipt as being of capital character, the amount changes its character when the amount becomes the assessee’s own money because of limitation or by any other statutory or contractual right. Where the assessee received deposits in the course of trading transactions, the amount of such credit balances which were barred by limitations and which were written back by the assessee to the P&L a/c were to be assessed as the assessee’s income”.
- In short, Bombay High Court as well as Apex court has held in favor of Income Tax Department to tax the amount of working capital limit.
- However, there is an interesting finding by the Chandigarh bench of ITAT in the case of Jai Pal Gaba (Prop: M/s Mack Hosiery) Vs.ITO [ITA No. 244/CHD/2018, (2019) 178 ITD 0357), as under:
a] In this case, assessee owed Rs. 3,78,93,001/-, split into term loan of Rs. 84,83,001/- and cash credit limit of Rs. 2,94,10,000/- as on 31.12.2006 which had become non-performing assets (NPA). Accumulated interest for the period of NPA i.e. from 1.4.2003 to 31.12.2006 of Rs. 1,93,64,729/- was neither booked by the bank as its income nor claimed by the assessee as its expenditure. Apart from that, there were certain other liabilities such as legal expenditure and valuation charges for the NPA period amounting to Rs. 1,47,857/- which were also not claimed as expenditure by the assessee. The total liability to the bank of the assessee was Rs. 5,74,05,687/-. The bank in One time settlement programme settled the whole debt at of Rs. 1,40,00,000/-, thus, waiving principal amount of loan of Rs. 2,38,93,001/-and interest along with legal and valuation expenses amounting to Rs. 1,95,12,686/-, total waiver of Rs. 4,34,05,687/-.
b] Assessing officer by invoking the provisions of section 28 (iv), 41(1), 56(2) of the Income-tax Act, 1961 added the whole amount of waiver of Rs. 4,34,05,687/- to the taxable income of the assessee. On first appeal, CIT(Appeal) confirmed the addition done by AO with respect to waiver of Principal amount of Rs. 2,83,93,001/-. With respect to addition on account of waiver of interest and legal/valuation charges of Rs. 1,95,12,686/-, CIT(A) directed the Assessing officer to verify whether such interest and other expenses were claimed by the assessee in earlier years or not, and if it would be found that no interest was claimed as expense in respect of aforesaid amount of interest waived by the bank, provisions of section 41(1) of the Act would not be applicable and addition would stand deleted. However, if it is found that assessee has claimed the expenditure, addition would be sustained.
c] On appeal, ITAT, Chandigarh has made following categorical observation:
4. On Taxation u/s 28(iv):
Language of the section 28(iv) is very much clear & provide for taxing of any benefit or perquisite arising from business or profession. Taking of loans is not regular business of the assessee. Except in money lending business, such waiver of loan cannot be treated as income arising from business U/s 28.
5. On Taxation u/s 41(1):
The one-time settlement was not done as part of the business activity of the assessee, rather, the transaction of the loan and waiver was a separate transaction. Under the circumstances, the waiver of part of the loan amount cannot be said to be a benefit or perquisite arising from business or profession to the assessee u/s 41.
Hon’ble ITAT quoted that
“The loan in question though was taken by the assessee for the purpose of business/trading activity, however, in our view, the same was not out of the trading activity of the assessee. The liability of loan was not created or incurred in the course of business, rather, it was an independent loan transaction of the assessee with the bank and the assessee was not involved in any business activity with the bank. As submitted by the Ld. Counsel for the assessee, the assessee was not in a business of taking/ lending of the loan and, hence, the amount of loan received by the assessee for the business of hosiery was not part of the trading activity of the assessee. Though, grant of loan on interest may be the part of banking business of the Lender Bank, but to take loan is not the business activity of the assessee.”
6. On Taxation u/s 56(2)(x):
The loan was advanced by the banker for a consideration of interest. Advancement of loan cannot be said to be without consideration. Hence the amount waived cannot be said to be the amount without consideration, it will not be taxable u/s 56.
7. Under the circumstances, though the assessee has got some benefit by way of waiver of the principal amount but the same cannot be termed as “Income” of the assessee exigible to tax. However, it is made clear that above observations are made in the peculiar facts and circumstances of this case and cannot be simply applied in each and every type of waiver of the loan amount.
Waiver of working capital limit is taxable in the hands of the assessee in view of the pronouncement by Bombay High Court in Solid Containers Ltd Vs. DCIT (2009) 308 ITR 0417 and Supreme court in CIT vs. T.V. Sundaram Iyengar & Sons Ltd: (1996) 222 ITR 344 (SC). The pronouncements by Chandigarh ITAT in the case of Gaba (Prop: M/s Mack Hosiery) Vs.ITO need to further pass the test of higher judiciary.