Loans are taken by any person in order to fulfill their financial requirements. Such loans are used for the purpose of acquiring capital assets as well as working capital requirements of any enterprise. Though loans obtained are obviously required to be repaid but on certain occasions due to some financial crunch or on account of some negotiations between the parties, loans are waived by the financial creditor/operational creditor. Here in this Article, I will be discussing the accounting treatment of write back of waiver of loans and tax implications thereupon.
Accounting treatment of write-back of loan amount waived
In India, the accounting principles are governed by Indian GAAP, Accounting Standards (“AS”) and Indian Accounting Standards (“IND AS”). The ICAI has also issued Guidance Notes on some topics for providing more clarity w.r.t. accounting. Moreover, ICAI has set-up an Expert Advisory Committee which provides its opinions on various accounting issues. On the basis of the said material which forms the basis of accounting in India, there are two possible accounting treatments which are discussed hereunder:
i) Write-back of the loan amount waived to Statement of Profit and Loss
It is worthwhile to mention here that AS-30, Financial Instruments and Derivatives deals with the ‘derecognition of a financial liability’. As per the said AS, derecognition of any financial liability shall be routed through Statement of P&L. Further, IND AS 109, ‘Financial Instruments’ also provides the same treatment as provided in AS 30 i.e. derecognition of any financial liability shall be routed through Statement of P&L. Also, the Expert Advisory Committee of the ICAI in its various opinions regarding waiver of loans has stated that waiver of loan should be credited to Statement of P&L.
Thus, in light of the above discussion, one of the possible accounting treatment is that the write-back of loan amount on account of waiver is to be credited to the Statement of Profit and Loss.
ii) Write-back of the loan amount waived to Capital Reserve
Another possible accounting treatment for write-back of loan waived is to credit the same to Capital Reserve. In the ‘Guidance Note on Terms Used in Financial Statements’, Capital Reserve has been defined as a reserve of a corporate enterprise which is not available for distribution as dividend. Though as a reserve created from derecognition of a financial liability (waiver of loan) is not available for distribution of dividend but no special backing is available which prescribes that a loan which has been waived should be written back to capital reserve.
In the author’s view, although AS 30 and IND AS 109 discussed above provide for writing back the loan waiver to Statement of P&L but logically as a loan is a balance sheet item i.e. a financial liability of a person, the benefit arising on account of reduction in the said liability is a kind of capital profit and not a revenue profit. Also, it is important to mention here that AS 30 was withdrawn by ICAI on 15.11.2016 and IND AS 109 is only applicable to certain categories of companies. Further, the opinion/view given by the Expert Advisory Committee of ICAI is recommendatory in nature and is only applicable on the specific entity who has raised the query. Therefore, for persons (other than companies on which IND AS is applicable), it is not mandatory to credit the loan amount waived to the Statement of P&L and accordingly, the same being capital in nature can be credited to Capital Reserve as a Balance Sheet item.
Tax Implications as per the provisions of Income-tax Law
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.
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 trading liability and subsequently, obtains some benefit in respect of such trading liability by way of remission or cessation thereof in cash or in any other manner, such amount is deemed to be business income of the borrower.
Section 56(2)(x)(a) of the Act, inter alia, provides that where any person receives, in any previous year, any sum of money without consideration, the aggregate of such sum shall be chargeable to tax as income from other sources if such sum exceeds Rs. 50,000/-.
As the waiver of a loan gives certain kind of a benefit to the borrower, income tax implications under the aforesaid provisions may arise on the same which are examined hereunder:
Section 28(iv)
With respect to the said section, the question arises that whether the words ‘value of any benefit or perquisite’ also cover benefits in cash or money or whether the said words shall be restricted to any benefit or perquisite in kind which could be valued. The said issue was discussed by the Gujarat High Court in the case of CIT v. Alchemic (P.) Ltd. [1981] 130 ITR 168 wherein it was held that section 28(iv) does not apply to benefits in cash or money. Further, the said issue has been also settled by the Hon’ble Supreme Court (SC) in the recent judgment of Commissioner vs. Mahindra & Mahindra Ltd. [2018] 93 taxmann.com 32 wherein it was categorically held that in order to invoke the provision of section 28(iv), the benefit which is received has to be in some other form rather than in the shape of money. As waiver of loan is a cash receipt, Section 28(iv) does not come into picture.
Section 41(1)
The main controversy in relation to 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 a trading liability. The question that arises for consideration is that whether loan is a trading liability and waiver of the same will be chargeable to tax under the provisions of Section 41(1)? In this regard, it is pertinent to note that as per general accounting principles loan per se is a financial liability and not a trading liability. However, while determining the taxability of waiver of loans, various courts have taken divergent views. So, it is imperative to take reference from the said judicial precedents, the relevant extract of which is reproduced herein below for ready reference-
The Hon’ble High Court of Bombay in the case of Mahindra & Mahindra Ltd. v. CIT [2003] 261 ITR 501 (Bombay) has held that as Toolings constituted capital asset and not stock-in-trade, section 41(1) was not applicable. The said principle laid down by the Bombay HC that loans received/or taken for purchase of capital assets does not constitute trading liability was upheld by the Hon’ble SC in Commissioner v. Mahindra And Mahindra Ltd. [2018] 302 CTR 213 by observing that waiver of loans taken for capital assets amounts to cessation of liability other than trading liability.
In Logitronics (P.) Ltd. v. CIT [2011] 333 ITR 386, the Hon’ble Delhi HC held that waiver definitely gives some benefit to the assessee. Whether it is to be treated as capital receipt or income chargeable to tax would depend upon the purpose for which the said loan was taken. If the loan was taken for acquiring a capital asset, waiver thereof would not amount to any income exigible to tax, but on the other hand, if the loan was taken for trading purpose and was treated as such from the very beginning in the books of account, the waiver thereof may result in the income, more so when it was transferred to the P&L account.
In case of Rollatainers Ltd. v. CIT [2011] 339 ITR 54, the Delhi High Court by referring to the judgment of the Bombay HC in case of Mahindra & Mahindra (supra) held that waiver of term loans given by financial institutions cannot be treated as income in the hands of the assessee. It is only the writing off loans on cash credit account which was received for carrying out the day to day operations of the assessee which is to be treated as “income” in the hands of the assessee.
From the analysis of the aforesaid judicial precedents, it is apparent that law is settled in case of waiver of loans obtained for purchase of capital asset by the recent judgment of the Hon’ble SC in case of Mahindra & Mahindra (supra) and accordingly, no tax implications shall arise if loan amount waived was obtained and/or utilized for purchase of capital assets by an assessee.
However, as far as the issue in relation to waiver of working capital loans is concerned, it is worthwhile to note that on micro examination of the above judicial precedents, it can be observed that High Courts in the cases of Logitronics (P.) Ltd. (supra) and Rollatainers Ltd. (supra) have apparently drawn an incorrect inference from the judgement of the Bombay HC in the case of Mahindra & Mahindra Ltd. (supra) as a loan per se is a financial liability and not a trading liability. The Delhi HC in the said judgments has laid down an altogether different principle of purpose test i.e. the purpose of obtaining the loan is to be considered for determining whether the respective loan is a trading liability or not. The same test was also applied by Hon’ble High Court of Bombay in its subsequent decision in the case of Solid Containers Ltd. v. DCIT (2009) 308 ITR 417. In author’s view, loan is a financial liability and not a trading liability, however, the aforesaid judgments have given a principle of purpose test in order to tax the remission of a loan which has been incorrectly inferred from the judgment of the Bombay HC in case of Mahindra & Mahindra (supra). Accordingly, until and unless the issue that whether a loan per se is a financial liability or a trading liability travels to the SC or is otherwise clarified, the taxability of waiver of loans taken to meet working capital requirements would remain a debatable issue and is subject to litigation.
After discussing the applicability of Section 28(iv) and Section 41(1) of the Act in case of waiver of loan, it is also important to analyse some of the recent judgments of the Hon’ble Courts/Tribunals wherein by following the judgment of Mahindra & Mahindra Ltd. (supra) in some cases, decisions have been given in favour of the assessee by holding that no income shall be taxable under Section 28(iv) or Section 41(1) of the Act in case of waiver of loans. The said judgments are as under:
In the case of Jai Pal Gaba v. Income Tax Officer, Ward-III, Ludhiana (2019) 178 ITD 357, Chandigarh Tribunal held that where assessee took loan from bank for the purpose of business but not in course of business i.e. loan sourced was not linked to trading receipts then subsequent waiver of loan amount under one time settlement could not be said to be benefit or perquisite arising from business to assessee taxable under Section 28(iv). Also, it was held that waiver of loan amount would not amount to cessation of trading liability so as to attract Section 41(1) of the Income Tax Act,1961.
In the case of PCIT v. Vibhadeep Investment & Trading Ltd. (2019) Income Tax Appeal No. 843 of 2017, Hon’ble Bombay High Court held that waiver of loan being waived off by the lender on account of one time settlement of loan cannot be termed as revenue receipt. Therefore, on such waiver of loan taken on capital account, neither the Section 41(1) of the Act nor Section 28(iv) of the Act, are applicable.
In the case of Principal Commissioner of Income Tax v. SICOM Ltd. (2020) IT APPEAL NO. 1692 OF 2017, Hon’ble Bombay High Court held that the very first condition of Section 28(iv) of the IT Act which says 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, is not satisfied in the present case. Also, Section 41(1) will not apply to waiver of loan as waiver of loan does not amount to cessation of trading liability.
Section 56(2)(x)(a)
To charge any sum to tax under the said section, the following two conditions must be satisfied:
i) A person receives any sum of money exceeding Rs. 50,000/- from any person in the previous year; and
ii) Such sum of money received must be without consideration.
It is pertinent to mention here that whether Section 56(2)(x)(a) can be invoked in case of waiver of loans has not been an issue for adjudication before any Courts or Tribunals yet as the same has been recently introduced in the Act. However, as per the author’s view, the said section cannot be invoked in case of waiver of loans on account of the below-mentioned grounds:
In the previous year in which the amount of loan was received, the said loan was not received without consideration. The borrower had to incur interest expenditure on the said loan.
In the previous year in which waiver of loan takes place, the borrower has not actually received any sum of money. The sum of money was actually received in the year in which loan was taken.
Therefore, though on the basis of above-mentioned grounds, Section 56(2)(x)(a) of the Act cannot be invoked but as the SC in Mahindra & Mahindra (supra) while dealing with the issue of Section 28(iv) has mentioned that waiver of loan is a cash receipt, the Assessing Officers by placing reliance on the said judgment can invoke the provisions of Section 56(2)(x)(a) of the Act.