Tax consequence of loan waiver
V.K.Subramani
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V.K.Subramani Income-tax law treats loans received by taxpayers with
lot of care and caution. Concealed or undisclosed incomes could be
brought to regular business use in the guise of loan.
Therefore, provisions of law regulate the method of accepting loans
and their repayment.
A taxpayer has to accept loan only by way of account payee crossed
cheque or bank draft where the loan is Rs 20,000 or more. Similarly,
the repayment must also be in the same mode.
Else, both acceptance and repayment would be liable for penalty. The
quantum of penalty is equal to the amount of loan accepted or repaid
otherwise than by account payee crossed cheque or bank draft.
In addition to regulating loan acceptance and repayment, the statute
also empowers the tax officers to check the genuineness of the loan.
The onus is on the taxpayer accepting the loan to prove the worthiness
of the lender who is extending such loan. The repealing of Gift-tax
Act, 1958 w.e.f. October 1, 1998 resulted in taxpayers taking gifts
instead of loan. Then again, the lawmakers had to insert a provision
for taxing gifts as deemed income in the hands of recipient vide
section 56(2)(v) with tax exemption only for gifts from relatives.
It may so happen that a lender may sympathise with the borrower and
waive the loan fully or partly and such waiver may have tax
implication. Section 41(1) deals with tax impact of loan waived by the
lender in the assessment of borrower.
Sometimes, borrowers may also refuse to repay the loan and pass
entries to this effect in their books of account.
The law covers such unilateral write-off of such liability as income
chargeable to tax, if it is a trading liability.
Capital loan write off
A loan taken for capital transaction such as acquisition of assets
like land, building, machinery or plant when waived by the lender or
written off by the borrower (i.e. the assessee) such waiver or
write-off could not be subjected to tax, since the loan does not fall
in the revenue field.
The courts have consistently held that a loan taken for acquiring
capital asset when waived by the lender, either in whole or in part,
the amount of waiver cannot be taxed as income since it does not have
any semblance of revenue nature. [Refer Mahindra & Mahindra Ltd vs.
CIT 261 ITR 501 (Bom); CIT vs. Chetan Chemicals P Ltd 267 ITR 770
(Bom).]
Working capital borrowing
When a borrowing is made for carrying on regular business activity,
such borrowing is called as working capital borrowing. It forms part
of the trading liability of the borrower. When the lender of such
trading facility waives the amount either fully or in part such amount
so waived or foregone is chargeable to tax as income as held in Solid
Containers Ltd v. Dy.CIT 308 ITR 417 (Bom); Rollatainers Ltd vs. CIT
339 ITR 54 (Del).
In Rollatainers's case, (Supra) the loan amount was borrowed for
working capital purposes by way of cash credit limit from bank which
was waived subsequently by the bank.
The court upheld the taxation of the amount of working capital loan
waived by bank as income in the hands of the assessee on the reasoning
that the loan was taken for day to day working capital facility and
being a trading liability, its waiver was taxable as income.
Interest
The taxability of interest portion waived by the lender in both
working capital loan and term loan would be the same and would be
governed by Section 43B of the Act. Since interest on loan on capital
account or revenue account from bank and financial institutions is
allowable only on actual payment basis, waiver of such interest by the
lenders anyway will be outside the tax net. Whether such waiver is
prompted by the lender or unilaterally transferred by the borrower,
such interest portion will not be chargeable to tax as the amount
would not have been allowed as deduction previously.
Impact on actual cost
Where interest free-loan is given originally and subsequently
converted into grant for the purpose of purchasing machinery, such
grant was held as eligible for reduction from the actual cost of
machinery and consequent depreciation claim in Ravi Leathers vs. CIT
240 ITR 702 (Mad).
But a contrary view favouring the taxpayers that part of loan when
waived will not reduce the actual cost of machinery could be found in
CIT vs. Cochin Co P Ltd 184 ITR 230 (Ker)
----------------------------------------------------------
The courts have held that a loan taken for acquiring capital asset
when waived by the lender, the amount of waiver cannot be taxed as
income since it does not have any semblance of revenue nature.
----------------------------------------------------------
(This article was published in the Business Line print edition dated
December 5, 2011)
V.K.Subramani
Share · print · T+
V.K.Subramani Income-tax law treats loans received by taxpayers with
lot of care and caution. Concealed or undisclosed incomes could be
brought to regular business use in the guise of loan.
Therefore, provisions of law regulate the method of accepting loans
and their repayment.
A taxpayer has to accept loan only by way of account payee crossed
cheque or bank draft where the loan is Rs 20,000 or more. Similarly,
the repayment must also be in the same mode.
Else, both acceptance and repayment would be liable for penalty. The
quantum of penalty is equal to the amount of loan accepted or repaid
otherwise than by account payee crossed cheque or bank draft.
In addition to regulating loan acceptance and repayment, the statute
also empowers the tax officers to check the genuineness of the loan.
The onus is on the taxpayer accepting the loan to prove the worthiness
of the lender who is extending such loan. The repealing of Gift-tax
Act, 1958 w.e.f. October 1, 1998 resulted in taxpayers taking gifts
instead of loan. Then again, the lawmakers had to insert a provision
for taxing gifts as deemed income in the hands of recipient vide
section 56(2)(v) with tax exemption only for gifts from relatives.
It may so happen that a lender may sympathise with the borrower and
waive the loan fully or partly and such waiver may have tax
implication. Section 41(1) deals with tax impact of loan waived by the
lender in the assessment of borrower.
Sometimes, borrowers may also refuse to repay the loan and pass
entries to this effect in their books of account.
The law covers such unilateral write-off of such liability as income
chargeable to tax, if it is a trading liability.
Capital loan write off
A loan taken for capital transaction such as acquisition of assets
like land, building, machinery or plant when waived by the lender or
written off by the borrower (i.e. the assessee) such waiver or
write-off could not be subjected to tax, since the loan does not fall
in the revenue field.
The courts have consistently held that a loan taken for acquiring
capital asset when waived by the lender, either in whole or in part,
the amount of waiver cannot be taxed as income since it does not have
any semblance of revenue nature. [Refer Mahindra & Mahindra Ltd vs.
CIT 261 ITR 501 (Bom); CIT vs. Chetan Chemicals P Ltd 267 ITR 770
(Bom).]
Working capital borrowing
When a borrowing is made for carrying on regular business activity,
such borrowing is called as working capital borrowing. It forms part
of the trading liability of the borrower. When the lender of such
trading facility waives the amount either fully or in part such amount
so waived or foregone is chargeable to tax as income as held in Solid
Containers Ltd v. Dy.CIT 308 ITR 417 (Bom); Rollatainers Ltd vs. CIT
339 ITR 54 (Del).
In Rollatainers's case, (Supra) the loan amount was borrowed for
working capital purposes by way of cash credit limit from bank which
was waived subsequently by the bank.
The court upheld the taxation of the amount of working capital loan
waived by bank as income in the hands of the assessee on the reasoning
that the loan was taken for day to day working capital facility and
being a trading liability, its waiver was taxable as income.
Interest
The taxability of interest portion waived by the lender in both
working capital loan and term loan would be the same and would be
governed by Section 43B of the Act. Since interest on loan on capital
account or revenue account from bank and financial institutions is
allowable only on actual payment basis, waiver of such interest by the
lenders anyway will be outside the tax net. Whether such waiver is
prompted by the lender or unilaterally transferred by the borrower,
such interest portion will not be chargeable to tax as the amount
would not have been allowed as deduction previously.
Impact on actual cost
Where interest free-loan is given originally and subsequently
converted into grant for the purpose of purchasing machinery, such
grant was held as eligible for reduction from the actual cost of
machinery and consequent depreciation claim in Ravi Leathers vs. CIT
240 ITR 702 (Mad).
But a contrary view favouring the taxpayers that part of loan when
waived will not reduce the actual cost of machinery could be found in
CIT vs. Cochin Co P Ltd 184 ITR 230 (Ker)
----------------------------------------------------------
The courts have held that a loan taken for acquiring capital asset
when waived by the lender, the amount of waiver cannot be taxed as
income since it does not have any semblance of revenue nature.
----------------------------------------------------------
(This article was published in the Business Line print edition dated
December 5, 2011)
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