2011 (2) TMI 12 - HC - Income Tax

Waiver of loan and interest - one time settlement with the bank (OTS) - Deemed income u/s 41(1) - Held that - Answer would depend upon the purpose for which the said loan was taken. If the loan was taken for acquiring the capital asset, waiver thereof would not amount to any income exigible to tax. On the other hand, if this loan was for trading purpose and was treated as such from the very beginning in the books of account, as per Sundaram Iyengar (T.V.) and Sons Ltd. (1996 -TMI - 5532 - SUPREME Court), the waiver thereof may result in the income moreso when it was transferred to Profit and Loss account. It is clearly admitted that the borrowed funds were not used for long term investment contrary to contention made in submissions filed before me. All along it has been admitted by the appellant that borrowing was made for financing business. However, after the assessment order was passed & the AO added this amount treating it as part of circulating capital, the appellant has come up with the plea that the funds were borrowed for long term investment. This is nothing but change of stand. Income u/s 28(iv) - perquisites - a subsequent event has the effect of changing the nature and character of loan, a capital receipt into a trading receipt - Tribunal has reached a finding of fact that the amount of loan was not used in financing business. - Decided in favor of revenue

Issues Involved:
1. Taxability of waiver of loan.
2. Applicability of Section 28(iv) and Section 41(1) of the Income Tax Act, 1961.
3. Characterization of loan waiver as capital or trading receipt.
4. Judicial precedents and their applicability to the current case.

Detailed Analysis:

Issue 1: Taxability of Waiver of Loan
The primary issue is whether the waiver of the principal amount of loan by the State Bank of India (SBI) should be treated as taxable income. The appellant, engaged in manufacturing electronic products, had a loan from SBI which was categorized as a Non-Performing Asset (NPA). Upon settlement, SBI waived a substantial portion of the loan. The Assessing Officer (AO) treated the waiver of the principal amount as taxable income, arguing that the waiver constituted a gain for the appellant. The AO's reasoning included the assertion that the waiver provided a benefit or perquisite arising from business, thus falling within the definition of "income" under Section 2(24) of the Income Tax Act, 1961.

Issue 2: Applicability of Section 28(iv) and Section 41(1) of the Income Tax Act, 1961
Section 28(iv) and Section 41(1) were scrutinized to determine their applicability to the waiver of the loan. Section 28(iv) covers the value of any benefit or perquisite arising from business, while Section 41(1) deals with profits chargeable to tax in cases where an allowance or deduction has been made in respect of loss, expenditure, or trading liability, and subsequently, any benefit is obtained by way of remission or cessation of such liability.

The Tribunal, reversing the CIT (A)'s decision, relied on the Supreme Court's judgment in T.V. Sundaram Iyengar and Sons Ltd., which held that amounts initially not received as trading receipts could eventually be regarded as business income due to subsequent events. The Tribunal concluded that the waiver of the loan taken for business purposes should be treated as income.

Issue 3: Characterization of Loan Waiver as Capital or Trading Receipt
The characterization of the loan waiver as either a capital or trading receipt was crucial. The Tribunal noted that if the loan was used for acquiring capital assets, the waiver would not constitute income. However, if the loan was used for business or trading activities, the waiver would be treated as income. This distinction was supported by various judicial precedents, including the Bombay High Court's decision in Mahindra & Mahindra Ltd., which differentiated between loans used for capital assets and those used for business purposes.

Issue 4: Judicial Precedents and Their Applicability
The judgment extensively discussed relevant case laws, including:
- T.V. Sundaram Iyengar and Sons Ltd.: The Supreme Court held that the nature of a receipt could change over time and become taxable as income if it becomes the assessee's own money due to limitation or other statutory or contractual rights.
- Tosha International Ltd.: This Court held that the waiver of the principal amount of a loan did not amount to income under Section 41(1) or Section 28(iv) if the loan was not claimed as expenditure or trading liability.
- Mahindra & Mahindra Ltd.: The Bombay High Court held that the waiver of a loan used for acquiring capital assets did not constitute income under Section 28(iv) or Section 41(1).

The Tribunal restored the case to the AO for fresh adjudication, directing the assessee to provide details about the purpose for which the loan was utilized. If the loan was used for acquiring capital assets, the waiver would not be taxable. However, if used for business purposes, the waiver would be treated as income.

Separate Judgment in ITA No.503 of 2010
In a separate but related case, the assessee, an investment company, had a loan waiver of Rs. 25,00,000, which was added to its taxable income by the AO. The Tribunal, following the judgment in Tosha International Ltd., deleted the addition, holding that Section 41(1) was not applicable as the loan was not claimed as a deduction. The Tribunal found that the loan was used for long-term investment in shares, not for the financing business, thus not constituting a trading receipt.

Conclusion
The High Court upheld the Tribunal's findings, emphasizing that the taxability of loan waiver depends on the purpose for which the loan was taken. If used for acquiring capital assets, the waiver does not constitute income. However, if used for business purposes, the waiver becomes taxable income. The appeals were dismissed, with costs imposed on the assessee in the first case, and the Tribunal's decision was affirmed in the second case.

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