In the current Covid-19 pandemic era, many enterprises due to financial crunch are unable to repay the loan thus on certain occasions owing to negotiations between the parties, loans are waived by the financial creditor/ operational creditor, or they opt for one-time settlement (OTS) with the banks/FIs. Loans are normally acquired for the purpose of acquiring capital assets or to fulfill the working capital requirements of an enterprise. Here in this article, we will be discussing the tax implications on waiver of loans, one-time settlements given by banks.
Taxability of loan waiver has been a matter of debate and the relevant provisions of the Income-tax Act, 1961 (“Act” for short) under normal Income-tax computation provide as under :
• Section 28(iv) of the Act provides, inter alia, that the value of any benefit or perquisite arising from business, whether convertible into money or not, should be taxed as business income.
The main ingredients that can be inferred from the above clause are:-
(i)The assessee should have derived any benefit or perquisite.
(ii)Which arises from business or from the exercise of the profession.
(iii)Then such benefit or perquisite will be income under the head business or profession.
(iv)Irrespective of whether such benefit or perquisite is convertible into money or not.
• Section 41(1) of the Act provides, inter alia, that if an allowance or deduction has been claimed by an assessee in respect of a loss, expenditure, or trading liability and subsequently, obtains some benefit in respect of such trading liability by way of remission or the cessation thereof in cash or in any other manner, such amount is deemed to be the business income of the borrower.
The main ingredients that can be inferred from the above section are:-
(i)Under section 41(1), (a) the loss or expenditure and (b) trading liability has to be considered independently ‘Remission or cessation thereof’ shall apply only to a trading liability and it cannot be applied to loss or expenditure.
(ii)Section 41(1) cannot be invoked on remission of liability in cases where the same has not been allowed as deduction in the earlier years.
(iii) Also note that sub-section (1) of section 41 has been substituted by the Finance Act, 1992 so as to bring to tax the amount or benefit, as the case may be, also in cases where the recipient is a successor in business and is other than the person who was allowed the deduction earlier.”
As waiver of a loan gives a certain kind of benefit to the borrower, Income-tax implications thereof are examined below:
With respect to this section, the issue that arises is whether the words “value of any benefit or perquisite” also cover benefits in cash or money or whether the said words are restricted to any benefit or perquisite in kind, which could be valued. The said issue was settled by the Hon’ble Supreme Court(SC) in the judgment of CIT vs. Mahindra and Mahindra Ltd.  404 ITR 1 (SC) wherein the court categorically held that in order to invoke the provisions of section 28(iv), the benefit which is received has to be in some form other than in the shape of money. As waiver of a loan is a cash receipt, it shall not fall under the purview of section 28(iv).
The main controversy in relation to the taxability of waiver of loans revolves around the provisions of section 41(1). As stated above, section 41(1) is attracted if any benefit arises from remission or cessation of trading liability. The question that arises is whether the loan is a trading liability and waiver thereof will be chargeable to tax under section 41(1) ? In this regard, it is pertinent to note that as per general accounting principles loan is per se a financial, not trading, liability. However, while determining the taxability of loan waivers, various courts have taken divergent views.
The earlier view was that where the loan was availed for acquiring capital assets and the same is waived, then such waiver could not be treated as the value of any benefit or perquisite arising from business or exercise of the profession and hence, section 28(iv) could not be invoked. But where a loan was taken for trading activity and on waiver of that amount, the assessee was able to retain that amount in the business and therefore it becomes its income. However, after the judgment of Hon’ble Apex Court in Mahindra & Mahindra (supra), the distinction between the loan taken on capital account or loan taken on trading account from the bank is no longer applicable because one of the ratios laid down by Hon’ble Apex Court in Mahindra & Mahindra (supra) was that section 28(iv) does not apply in case of benefit received in cash. A similar view was taken by Hon’ble Madras High Court in Iskraemeco Regent Ltd., wherein it was held that the transaction in the nature of a loan transaction has no application with respect to section 28(iv), the same could not be termed as an income within the purview of section 2(24). Therefore, the issue of whether the loan is taken for purchasing capital assets or for meeting working capital requirements is no longer a question as a loan for working capital taken from a bank cannot be equated to a liability of the commercial transaction with a vendor.
Thus, it may be concluded that section 28(iv) will be applicable only in cases of benefit/perquisite derived in kind and arising from business/profession. The benefit/perquisite should have a value though it may not be convertible into money. Waiver of loan is a benefit in cash and therefore, it goes out of section 28(iv). It is immaterial whether the loan was taken for the purchase of capital assets or for meeting working capital requirements (supra). For applying section 41(1) it is necessary for the AO to prove that loss/expenditure or trading liability has been allowed as deduction in an earlier year, in respect of which assessee has derived any benefit whether in cash or in any other manner. Where interest amount waived by the bank/FIs has not been claimed as a deduction by the assessee or not allowed by the AO, such waiver cannot be taxed u/s 41(1). Also, the starting expression u/s 41(1) is “Where an allowance or deduction has been made in the assessment for any year…”. “Has been made in the assessment” means it must have been allowed by the AO in the assessment. If for whatever reason the claim of expenditure (Interest on loan) is disallowed by the AO, then it cannot be said that deduction of expenditure has been made in the assessment. Hence, the same cannot be added u/s 41(1).
In addition, the waiver of the amount of term loan availed by the assessee under OTS will not fall under the purview of income either u/s 28(iv) or u/s 41(1). It is held that Section 28(iv) speaks about the benefit or perquisite received in kind. Such a benefit or perquisite received in kind other than in cash would be an income as defined under section 2(24). In other words, to any transaction which involves cash, section 28(iv) has got no application. Waiver of loan is benefit in cash and not in kind, therefore, section 28(iv) will not be applicable. Further, since a loan is neither a loss nor expenditure nor trading liability allowed in the profit and loss account in an earlier year, section 41(1) will not be applicable.