2013 (9) TMI 403 - AT - Income Tax

Cessation / waiver of interest liability - Deemed income u/s 41(1) - Applicability of section 41(1) of the Income Tax Act when waiver of interest amount treated as capital receipt being related to preoperational period of the company - Assessee-company had raised loans from the Banks to start its business. Subsequently due to heavy losses the company was in trouble and a settlement with the Banks had saved it from a deep crisis. As per this agreement the Banks gave a waiver of interest amount to the company - Banks decided to waive a sum of 22, 74, 85, 511/- during the year under consideration against the overdue interest accumulated over the years including 7, 31, 55, 195/- which pertained to pre-operative period. It was argued that the interest pertaining to pre-operative periods of 7, 31, 55, 195/- was not offered for taxation because the company had neither claimed nor got deduction of this amount - Interest pertaining to pre-operative period was capitalized to the respective assets and deduction of depreciation on such assets had been claimed on the basis of written down value (WDV) of different block of assets Held that - Depreciation claimed on the capital assets are not at all covered under provision of section 41(1) of the Income Tax Act As per requirement of sec. 41(1) it is required that the assessee must have made a claim and it must have been either (i) allowed or (ii) deducted in any previus year. This allowance/deduction must relate to loss expenditure or trading liability incurred by the assessee as the case may be. This benefit obtained must be by way of remission or cessation of such loss expenditure or trading liability Hence it is incorrect to say that amount of interest relating to the pre-operative period became part of trading operation of business and any benefit received on account of waiver of interest is in the nature of profits and gains of business in terms of provisions of section 28(iv) Decided in favor of Assessee.

Summary

Issues Involved:

1. Justification of CIT(A) in determining interest pertaining to the preoperative period at Rs. 524 lacs instead of Rs. 731.55 lacs.
2. Taxability of waiver of interest amounting to Rs. 731.55 lacs under section 41(1) and section 28(iv) of the Income Tax Act, 1961.

Detailed Analysis:

1. Determining Interest Pertaining to Preoperative Period:

The assessee, a Public Ltd Company engaged in manufacturing, had capitalized interest on loans taken for constructing a factory and purchasing machinery. The CIT(A) determined the interest pertaining to the preoperative period at Rs. 524 lacs as opposed to Rs. 731.55 lacs claimed by the assessee. The assessee argued that the interest waiver of Rs. 731.55 lacs, which pertained to the preoperative period, should not be taxed as it was a capital receipt. The Assessing Officer (A.O.) treated the sum of Rs. 731.55 lacs as a revenue receipt and added it to the income of the assessee. However, the Tribunal found that the interest pertaining to the preoperative period was capitalized to the cost of assets and not claimed as a deduction under sections 36(1)(iii) or 37 of the Act. Therefore, the Tribunal concluded that the CIT(A)'s determination was not justified.

2. Taxability of Waiver of Interest under Section 41(1) and Section 28(iv):

The main contention was whether the waiver of interest amounting to Rs. 731.55 lacs should be taxed under section 41(1) or section 28(iv) of the Income Tax Act. The A.O. and CIT(A) held that the waiver should be taxed as it provided a benefit to the assessee. The Tribunal, however, analyzed the provisions of section 41(1), which requires that an allowance or deduction must have been made in respect of loss, expenditure, or trading liability incurred by the assessee. The Tribunal found that the interest pertaining to the preoperative period was capitalized and not claimed as a deduction in any previous year, thus not satisfying the conditions of section 41(1). The Tribunal relied on the decisions in CIT vs. Phool Chand Jiwan Ram and Polyflex (India) (P) Ltd. vs. CIT, which clarified that section 41(1) applies only to trading liabilities and not to capital receipts.

The Tribunal also examined section 28(iv) and concluded that it was not applicable as the waiver of interest did not arise from the business or exercise of a profession but was related to capital assets. The Tribunal found that the waiver of loan amount could not be considered as income since it was capital in nature and not a trading liability.

Conclusion:

The Tribunal allowed the appeal of the assessee, concluding that the waiver of interest amounting to Rs. 731.55 lacs was not taxable under section 41(1) or section 28(iv) of the Income Tax Act, 1961. The interest pertaining to the preoperative period was correctly treated as a capital receipt, and the addition made by the A.O. was unjustified.