One of the fundamental goals of any tax legislation is to gather resources to fund various socio-economic projects and welfare measures. Except for a very few number of countries, the income tax levied by the government on the taxable income of individuals or companies, is the major resource base for the governments to achieve economic development.
At the micro-level, a small businessman or householder may borrow loan for business purpose or personal use. Taxable income is the amount of income used to calculate how much tax an individual or a company owes to the government in a given tax year. It is generally described as adjusted gross income minus any deductions or exemptions allowed in that tax year. Taxable income includes wages, salaries, bonuses, and tips, as well as investment income and unearned income.
Taxability of Waiver of Loan under the Income Tax Act (ITA)
Section 28(iv) and Section 41(1) of the ITA: Section 28 of the ITA distinguishes the incomes which may 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”. It means that the benefit or perquisite accruing in any 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”
Section 41(1) of the ITA 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.
The Bombay High Court in the case of Essar Shipping Limited v. Commissioner of Income-tax shed light on the issue whether a loan waiver can be considered as a taxable business income under the provisions of Section 28(iv) of the Act?
Facts and Procedural background of the Case:
- The assessee, Essar Shipping Limited, had filed for a revised return of income. An amount of Rs. 2,52,00,000/- was claimed as a deduction amount for the loan given to the company by the Government of Karnataka. This loan was subsequently written off as the said amount had become irrecoverable.
- This claim made was rejected by the Assessing Officer who observed that the appellant had benefitted by carrying on its business from the waiver of loan and as per Section 28 of the ITA, the said benefit constituted as total income of the assessee.
- In an appeal against this order, the Commissioner of Income Tax considered the requirements of Section 28(iv) of ITA and held that waiver of loan cannot partake the character of income to be included for assessment.
- The matter was carried forward through another appeal before ITAT which held that the loan which written off was inseparably connected with the business of the assessee and therefore benefitted their business. This benefit received was in the form of writing off a liability and was not a cash benefit. The tribunal restored the order of the Assessing Officer.
- The appellant contended that for an income to be chargeable to income tax under the head “profits and gains of business and profession”, the value of any benefit or perquisite must arise from the business solely or the exercise of a profession and it should not be in cash.
- The defendant contended that after a loan is waived it partakes the character of a subsidy. It was argued that the action of the Government in writing off of the loan provided was an act of providing ‘operational subsidy’ to the assesse thus extending a helping hand to the assessee to salvage its losses thereby benefiting the assessee to the extent of the loan waived.
Findings of the Bombay High Court on the Issues raised:
Section 28 of the ITA deals with profits and gains of business or profession. It states that an income will be chargeable to income tax under the head “profits and gains of business or profession”. Clause (iv) of the section refers to the value of any benefit or perquisite whether convertible into money or not arising from business or the exercise of a profession.
1. Whether the loan waived off by the government can be taxed under Section 28(iv) of ITA?
The amount of loan which was waived off by the Karnataka Government must construed to be a cash receipt in the hands of the assessee and hence cannot be taxed under Section 28(iv).
2. Right of waiver:
It is a well-settled principle in law that a creditor or their successor may exercise their “right of waiver” unilaterally to absolve the debtor from their 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.
3. Difference between “loan” and “subsidy”
There is a fundamental difference between “loan” and “subsidy” and the two concepts cannot be equated. While “loan” is a borrowing of money required to the repaid back with interest; “subsidy” is not required to be repaid back being a grant. Such grant is given as part of a public policy by the state in furtherance of public interest. Therefore, even if a “loan” is written off or waived, which can be for various reasons, it cannot partake the character of a “subsidy”.
Reliance on Supreme Court’s Judgment in ‘CIT v. Mahindra & Mahindra Limited’:
1. The Supreme Court in this case was examining whether the amount waived off by the lender would constitute as the taxable income of the company (the assessee) or not?
- The Court discussed the purview of Section 28(iv) of the ITA and held that for applicability of this section, the income should arise from the business or profession and the benefit which is received must be in some other form ‘rather than in the shape of money’.
2. The Court discussed the meaning of the term “loan” and also the right of the creditor to exercise its right of waiver.
- It was held that 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.
3. Having discussed the above, Supreme Court posed a question as to whether waiver of loan by the creditor is taxable as perquisite under Section 28(iv) of the ITA or not?
- Supreme Court held that for the applicability of this provision, the income which can be taxed must arise from a business or profession. Further, in order to invoke the provisions of section 28(iv), the benefit which is received has to be in some other form rather than in the shape of money.
The taxability of a loan or advance waived off has been a subject of discussions before various courts and there have been contradictory judgments. For instance, the Madras High Court in one of its judgment had held that an amount representing principal loan amount waived by a bank under the one-time settlement scheme would constitute as income under Section 28(iv) of the Act.
However, the Supreme Court in this case gave the judgment in the favour of the taxpayer and established that Section 28(iv) and Section 41(1) are not applicable in the present case since waiver of loan does not amount to cessation of trading liability and because the amount waived is ‘receipt’ in the nature of cash/ money.
Currently, a waiver of loan by a creditor would result in receipt in the hands of the assessee and once this waiver is treated as a receipt, then 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). Consequently, it can be concluded that waiver of loan amounts to a monetary benefit and therefore it cannot be taxed under section 28(iv).
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