TAXABILITY OF LOAN WAIVER POST SC DECISION IN CASE OF MAHINDRA & MAHINDRA

Introduction 

The decision
of the Supreme Court (SC) in the case of Commissioner vs. Mahindra &
Mahindra Ltd.¹
(Mahindra’s case) is a landmark ruling in the context of tax treatment
of loan waiver benefit obtained by a tax payer. The SC held that such waiver is
neither taxable as business perquisite u/s. 28(iv)²  of the Income-tax Act 1961 (ITA), nor taxable
as remission of trading liability u/s. 41(1)³ of the ITA.

The SC delivered the judgement after hearing a
batch of connected appeals with the lead case being that of Mahindra. In most
cases before the SC, the loan was utilised by the assessee for acquiring capital
assets (including in Mahindra’s case). But, there were also cases where the
loan was utilised by the assessee for working capital purposes. The SC has
delivered the judgment by analysing the fact pattern of Mahindra’s case as the
lead case.

To understand
the controversy in greater detail, it is worthwhile to revisit the history of
judicial development on this aspect.

OLD ENGLISH RULING ON NON – TAXABILITY OF REMISSION OF LIABILITY

As far back
as 1932, the House of Lords in the British Mexican Petroleum Company Limited
vs. The Commissioners of Inland Revenue⁴ (British case) dealt
with a case where the tax payer used to purchase raw material from a supplier
who was also the promoter of the company. At a later date, there was remission
or waiver of indebtedness (including indebtedness which arose due to supplies
effected during the year of remission). The release from liability was not
regarded as a ‘trading receipt’. The Court held “how on earth the
forgiveness in that year of a past indebtedness can add to those profits, I
cannot understand”.

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1   [2018]
404 ITR 1

2   Section
28(iv) of the ITA provides for taxation under the head ‘Profits and gains from
Business or Profession’ of value of any benefit or perquisite whether
convertible into money or not arising from business or profession

3   Section
41(1) of the ITA provides for business taxation of any loss, expenditure or
trading liability which is claimed in past years in the year of remission or
cessation of such loss, expenditure or trading liability.

4   (16
Tax Cases 570) (HL)

BRITISH CASE FOLLOWED BY INDIAN JUDICIARY

In the case
of Mohsin Rehman Penkar vs. CIT⁵ before the Bombay High Court
(HC), there was waiver of loan (including waiver of interest expense
component).Following the ratio of the British case, the Bombay HC held “it
is impossible to see how a mere remission which leads to the discharge of the
liability of the debtor can ever become income for the purposes of taxation”.

The ratio of these decisions was followed in the
following illustrative cases dealing with (a) waiver of a trading liability,
e.g. payable towards trading goods, or interest expense, allowed as deduction
from income, (b) waiver of a loan used for working capital purposes, and (c)
waiver of loan used for fixed capital.

Illustratively,
the following cases dealt with waiver of trading liability:

Further,
the  following cases dealt with waiver of
loan used for trading purposes:

Further, the
following cases dealt with waiver of loan used for fixed capital purposes:

5     [1948] 16 ITR
183

STATUTORY INTERVENTION TO OVERCOME THE RATIO OF BRITISH CASE RESTRICTED TO REMISSION OF TRADING LIABILITY

To overcome
the ratio of British case, a new s/s. (2A) was added in section 10 of the
Indian Income-tax Act 1922 (erstwhile ITA), whereby waiver of trading liability
was expressly made liable to tax by treating the waiver or remission as profits
and gains of business chargeable to tax as such.

Section 41(1)
of ITA is successor to section 10(2A) of the erstwhile ITA. Section 41(1)
fictionally treats any amount or benefit received by way of remission or
cessation in respect of loss, expenditure or trading liability allowed in any
past year as profits and gains of business or profession. The fiction is
attracted regardless of discontinuance of business in respect of which the
allowance or deduction was originally made.

The question
whether section 41(1) is wide enough to overrule decisions like Phool Chand (supra)
dealing with non-taxability of loan used for working capital became the subject
matter of debate which is discussed a little later in
this article.

JUDICIAL DEVELOPMENTS FAVOURING NON TAXABILITY OF WAIVER OF FIXED CAPITAL LOAN

The judicial
development in context of non-taxability of waiver of loan utilised for fixed
capital like plant and machinery has been quite consistent. The Courts
consistently held that such waiver is neither taxable u/s. 28(iv) of the ITA as
a business perquisite nor taxable u/s. 41(1) of the ITA. Refer, the following
illustrative cases:

An aberration
to this trend was the Madras HC ruling in the case of CIT vs. Ramaniyam
Homes⁶  which after
considering the earlier rulings including its own decision in the case of
Iskraemeco Regent (supra) held that waiver of loan has ‘monetary value’
and is, therefore, taxable u/s. 28(iv) of the ITA.

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6     [2016] 384 ITR 530 (A.Y. 2006-07)

JUDICIAL DEVELOPMENTS FAVOURING NON TAXABILITY OF WAIVER OF WORKING CAPITAL LOAN

The Bangalore
Income-tax Appellate Tribunal (ITAT) in the case of Comfund Financial
Services (I) Ltd vs. DCIT⁷  held
that section 41(1) of the ITA does not capture remission of a loan liability
used for working capital purposes.

In that case,
Deutsche Bank (DB) was one of the promoters of the tax payer company. It also
acted as banker to the tax payer company. DB had extended huge overdraft
facilities to the tax payer company. During the year under reference (A.Y.
1983-84), the outstanding on account of principal amount was Rs. 44.70 crore
and the outstanding on account of interest was Rs. 2.60 crore.

On account of huge losses suffered by the tax
payer company, DB decided to write off the above outstanding. In the assessment
of the tax payer, there was no dispute as regards taxability of write-back of
interest amount of Rs. 2.60 crore which was offered to tax u/s. 41(1) of the
ITA. The write-back of principal amount of Rs. 44.70 crore was not offered by
the tax payer to tax on the ground that section 41(1) of the ITA did not apply
to such write-back. However, the Tax Department’s contention was that the
overdraft facility was used to buy securities on trading account, and the cost
of security was allowed as deduction.

The ITAT did
not accept the contentions of the Tax Department and held that neither section
41(1) nor section 28(iv) of the ITA was applicable to the facts of the case.
The ITAT, drawing distinction between trading transactions of the tax payer
comprising of purchase of securities and the loan transactions with DB, held that
the remission of loan does not constitute revenue income in the hands of the
tax payer.

JUDICIAL DEVELOPMENTS FAVOURING TAXABILITY OF WAIVER OF WORKING CAPITAL LOAN

However, the
tide turned against the tax payer with the Bombay HC ruling in the case of Solid
Containers Ltd vs. DCIT⁸ which held that waiver of working
capital loan is taxable as income. The Bombay HC distinguished its earlier
ruling in the case of Mahindra & Mahindra Ltd. (supra) where waiver
of loan used for acquiring capital assets was held to be non-taxable u/s. 41(1)
or section 28(iv) of the ITA. The Bombay HC ruling was followed by the Delhi HC
in the case of Rollatainers Ltd. vs. CIT⁹  and Logitronics (P.) Ltd. vs. CIT¹⁰  where the Delhi HC distinguished between
waiver of loan used for acquiring fixed assets and loan used for working
capital purposes. The Delhi HC held that waiver of loan used for acquiring
fixed assets is not taxable, whereas waiver of loan used for working capital
purposes is taxable as income. While in the case of Solid Containers and
Rollatainers (supras), the taxability was confirmed u/s. 28(iv) of the
ITA, in the case of Logitronics (supra) it is not clear whether the
taxability was confirmed u/s. 41(1) or section 28(iv) of the ITA. None of the
decisions considered the amount to be a chargeable receipt w.r.t section 28(i)
of the ITA, and, with respect, correctly so.

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7   [1998]
67 ITD 304 (A.Y. 1983-84)

8   [2009]
308 ITR 417

While
sustaining taxability, the Bombay and Delhi HCs relied on SC decisions in the
cases of CIT vs. T.V. Sundaram Iyengar & Sons Ltd.¹¹ and CIT
vs. Karamchand Thapar¹² for their conclusion on taxability of
waiver of working capital loan. Hence, it is necessary to understand the
purport of these SC rulings.

The SC in
Sundaram’s case (supra) held that if the amount is received as 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
tax payer’s own money because of limitation or by any other statutory or
contractual right. 

In the case
of Karamchand (supra), the tax payer was acting as a delcredre agent of
collieries and also as an agent for purchase of coal. Excess collections from
the customers for payment of railways remained unclaimed with the tax payer and
the Tax authority sought to tax the same as revenue income. In this case, the
SC upheld taxability on the reasoning that the initial receipt from the
customers was on trading account as a part of trading transaction. Excess
remaining with the tax payer was a normal feature of the regular business of
the tax payer. The SC held that “we do not see the case as a case of
transaction on capital account; it is a simple case where trading receipts were
more than expenditure”.

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9 [2011] 339 ITR 54

10 [2011] 333 ITR 386

11 [1996] 222 ITR 344

12[1996] 222 ITR 112

Having regard
to the context before the SC in the above rulings, with utmost respect, the
authors believe that reliance on these SC cases was not apt. These SC cases are
distinguishable from loan waiver case inasmuch as the SC in Sundaram’s case (supra)
and tax payer’s case was dealing with a receipt which always represented a
trading transaction, at point of receipt. The ratio, with respect, could not
have been extended to waiver of a loan receipt which was never, to begin with,
a trading receipt forming part of the regular trade transaction.

BUNCH OF APPEALS BEFORE SC IN MAHINDRA’S CASE INVOLVES BOTH WAIVER OF FIXED CAPITAL AND WORKING CAPITAL LOANS

The Tax
Department appealed to the SC against HC rulings holding that waiver of loan
used for acquiring fixed assets is on capital account and not taxable. The tax
payer in Rollatainer’s case (supra) appealed against the Delhi HC ruling
to the extent it held that waiver of loan used for working capital purposes is
taxable as revenue income¹³. The tax payer in Ramaniyam Homes (supra)
also appealed to the SC against the Madras HC ruling holding that remission of
loan is taxable as ‘monetary benefit’ u/s. 28(iv) of the ITA. The SC heard all
the appeals together in Mahindra’s case and disposed them under a common judgement.

AS A LEAD CASE, SC DECIDED MAHINDRA’S CASE, INVOLVING WAIVER OF FIXED CAPITAL LOAN, IN FAVOUR OF THE TAX PAYER

The SC explicitly dismissed the Tax Department’s
appeal in Mahindra’s case making it clear that waiver of loan used for
acquiring capital assets is neither taxable u/s. 28(iv) of the ITA nor taxable
u/s. 41(1) of the ITA. The SC held that the scope of section 28(iv) of the ITA
is restricted to non-monetary benefits received during the course of business,
whereas waiver of loan is akin to receipt of money.

Further, since the loan when borrowed
was not allowed as deduction, waiver thereof is not taxable as remission of
trading liability u/s. 41(1) of the ITA.

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13    Civil Appeal No. 1214 of 2012

 
SC ‘disposed’ off
other appeals involving both fixed capital and working capital loan cases

While
concluding and dealing with other appeals including tax payer’s appeal in
Rollatainer’s case (supra), the SC observed as follows:

“17. To
sum up, we are not inclined to interfere with the judgment and order passed by
the High Court in view of the following reasons:

(a) Section
28(iv) of the IT Act does not apply on the present case since the receipts of
Rs 57,74,064/- are in the nature of cash or money.

(b) Section
41(1) of the IT Act does not apply since waiver of loan does not amount to
cessation of trading liability. It is a matter of record that the respondent
has not claimed any deduction under section 36 (1) (iii) of the IT Act qua the
payment of interest in any previous year.

18. In
view of above discussion, we are of the considered view that these appeals are
devoid of merits and deserve to be dismissed. Accordingly, the appeals are
dismissed. All the other connected appeals are disposed off accordingly,
leaving parties to bear their own cost.”

Unfortunately,
the SC did not expressly comment on the aspect of distinction between loan used
for acquiring fixed assets and a loan used for working capital purposes.

SC RULING ARGUABLY SETTLES WAIVER OF WORKING CAPITAL LOAN CONTROVERSY

In the view
of the authors, the reasoning adopted by the SC at para 17 of the judgment for
upholding non-taxability was that: (a) section 28(iv) of the ITA does not apply
to a benefit in the nature of cash; and (b) section 41(1) of the ITA does not
apply since waiver of loan is not cessation of trading liability for which
respondent has claimed deduction. These reasonings are as applicable to a loan
for working capital as to a term loan. In fact, the basis on which some of the
decisions turned against the tax payer stands demolished by the SC conclusion
that section 28(iv) of the ITA is inapplicable to a case of loan receipt which
was received in the form of cash or money.

Further, it is also arguable that the SC used the
term ‘disposed’ while dealing with other connected appeals as distinguished
from ‘dismissed’ or ‘allowed’ since it was concerned with both the Tax
Department’s and the tax payer’s appeals.

Hence, the
authors believe that the ratio of the SC ruling in Mahindra’s case is equally
applicable to waiver of working capital loan.

WHETHER WAIVER OF LOAN CAN BE TAXED U/S. 56(2)(x) OF THE ITA?

In Mahindra’s
case, while dealing with non-applicability of section 28(iv) of the ITA to
waiver of loan, the SC observed, “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.” This observation raises concern whether a waiver of
loan granted by lender can be taxed as ‘Income from other sources’ u/s. 56(2)(x)
of the ITA.

Section
56(2)(x)¹⁴  of the ITA is an
‘anti-abuse’ provision. Section 56(2)(x) of the ITA provides that where any
person receives, in any previous year any sum of money, without
consideration, the aggregate value of which exceeds fifty thousand rupees,
the whole of the aggregate value of such sum shall be regarded as income
chargeable to tax. The provision has certain exceptions (like gifts from
relatives) which are not relevant for the purposes of current discussion.

The authors
believe that the context and language of section 56(2)(x) of the ITA would not
permit such interpretation. Firstly, in context, on a strict construction
basis, the section could apply only in a case where there is physical instead
of a hypothetical receipt, and the chargeability is examined at the stage of
receipt. Secondly, when the amount was received, it was not without
consideration. Thirdly, more often than not, the creditor will grant waiver in
lieu of some condition to be fulfilled by the borrower. For example, the banker
may grant waiver of a part of the amount, provided the balance part is agreed
to be paid within a given time frame. In any such scenario, the waiver is
backed up by consideration and cannot be said to be a grant ‘without
consideration’. Fourthly, in case of a distressed or insolvent company, it
would be a case of inability to recover rather than an intent to place cash in
the hands of the company. All in all, the context of a provision should be
limited to cases which tap the abuse for which the provision is introduced, and
is, arguably, very unlikely to extend to a case of waiver of loan.

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14    As also its predecessor provisions of s.
56(2)(v) / (vi) / (vii) / (viia) of the ITA

MINIMUM ALTERNATE TAX (MAT) LIABILITY IS GOVERNED BY BOOK TREATMENT

The entire
discussion in the earlier part of this article is in the  context of computation under normal
provisions of the ITA. In contrast, section 115JB levies a MAT on ‘book profit’
of the company. The ‘book profit’ is largely governed by accounting treatment
adopted for recognition of gains and losses in Profit & Loss account
(P&L) as per applicable accounting standards. It is well settled by a
series of SC rulings starting with Apollo Tyres Ltd. vs. CIT¹⁵  that MAT requires strict construction and the
Tax Authority is not permitted to tinker with net profit shown in P&L
beyond what is expressly permitted by MAT provision itself.

Incidentally, the Expert Advisory Committee (EAC)
of the Institute of Chartered Accountants of India has opined that waiver of
loan should be credited to P&L¹⁶. Hence, if gain on account of
waiver of loan is credited to P&L, an issue arises whether such gain is
liable to MAT. This is a controversial issue which is not resolved by Mahindra’s
case since Mahindra’s case was concerned with normal tax treatment.

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15  [2002]
255 ITR 273

16  Refer
EAC Opinion dated 24^th December 1998

Mahindra’s
case is helpful to the extent it holds that the benefit of waiver of loan is
not in the nature of ‘income’. The debate which arises is whether a benefit
which does not fall within the scope of charging provisions of sections 4 and 5
of the ITA can be taxed under MAT merely because it is credited to P&L.
This is a highly debatable issue on which there is sharp difference of opinion
within the judiciary, but this part of the controversy is best discussed as an
independent subject.

CONCLUSION

Since the
introduction of Insolvency and Bankruptcy Code, the waiver or re-calibration of
banking loans has been a matter of regular recurrence. The sacrifice made by
financial institutions plays a vital role in the rehabilitation of ailing
enterprises. The stamp of non-taxability on such waiver amount is perceived by
the tax payers as a substantial relief. The SC judgement is consistent with the
understanding that, but for a fictional provision in law, an income can only
accrue provided it originates from a source of income; the grace from a lender
is not reckoned to be a source from which income is expected to accrue to a man
in business. While the authors believe that the judgement is authentic enough
to urge for non-taxability of waiver of working capital loans, a clarification
to that effect from tax administration will go a long way in controlling
litigation in the years to follow.