1.1. Impact of Covid-19 pandemic may affect a number of Assessees and their businesses. A large number of Assessees may not be able to repay their loan or interest or both. Most of the Assessees may approach the banks or other financial institutions for waiver of loans and interest. What will be the consequence of waiver of loan and the interest thereon, from the tax angle, though seemingly settled by the recent judgement of the Apex Court in the case of Mahindra & Mahindra, various rulings of other high courts by following or referring to another decision of Supreme Court in the case of TVS Sundaram Iyengar makes it a debatable issue. Recently, however, the Honourable Bombay High Court, in a land mark judgement, in Essar Shipping Ltd v. CIT (Bom) (HC) www.itatonline.org dt. 5/March/2020, held that waiver of loan cannot be assessed as benefit or perquisite. Considering the importance of the subject I am revising my earlier article on the subject “The law on taxability of loan waiver“ (Posted on May 2018) www.itatonline.org for the benefit of readers.
1.2. Tax is essentially levied on the income actually earned by any ‘person’ defined u/s. 2(31) of the Income tax Act, 1961. The legislature, in it’s wisdom, felt that in order to bring to tax certain benefits which are otherwise not covered under the scheme of taxation there is a need to introduce certain deeming provisions. Let me take readers through two such provisions which were considered by various forums and decided in favour of assessees by holding that such remission would not lead to taxation in the hands of the beneficiary, but interpreted logically from a different angle in subsequent decisions of various high courts.
1.3. Provisions of s.28(iv) deal with taxability of any benefit or perquisite received by an Assessee in the course of business whereas provisions of s.41(1) refers to any amount treated as profit of an Assessee, subject to conditions being fulfilled, and aims at imposing tax on an amount which is not in the form of money and which also arises in the course of business. The purpose of both the sections, in the opinion of the Revenue, was to bring to tax any benefit arising to an assessee in the event of remission or otherwise by the other party and it has to be brought to tax either u/s 28 or u/s 41 whereas from the perspective of an assessee the transaction, at the initial stage, was of capital nature and upon remission, due to specific circumstances, it would not change its character to be roped in u/s 28 or 41 and there is, even otherwise, no benefit in cash to the assessee to treat such an event as a taxable event. The dissension between the Assessees and the tax department with respect to whether any benefit arises to the Assessee in case of waiver of loan, and if the postulate that a benefit arises is agreed to, whether such a benefit should be taxable in the hands of the Assessee, apart from the year of taxability, has been examined in a periscopic view by different courts. The Supreme Court, in the cases of Mahindra & Mahindra (2018) 404 ITR 1 (SC) and CIT v. Compaq Electric Ltd (2019) 261 Taxman 71 (SC), have held that s.28(iv) and s.41(1) are not applicable in the case of waiver of loans and hence no tax can be levied in such situations.
1.4. Recently the Bombay High Court, in the case of Essar Shipping Limited v. CIT ITA (IT) NO.201 OF 2002 (Bom.) (HC) www.itatonline.org, dealt with the issue of loan granted by Government of Karnataka and its subsequent waiver. The Supreme Court decision in the case of Mahindra & Mahindra(supra) has been followed.
Brief analysis of Essar Shipping case:
The Tribunal, in the above case had taken a view that writing off of the loan was inseparably connected with the business of the Assessee and therefore this benefit had arisen out of the business of the Assessee. Amount written off was nothing but an incentive for the business of the Assessee. It was held that the benefit was received by the Assessee in the form of writing off of the liability to the extent of the loan. Therefore, it could not be said that the Assessee received cash benefit u/s 28(iv).
The Bombay High Court followed the decision in Mahindra & Mahindra (supra) wherein a loan of ₹ 2.52 cores was given by the Karnataka Government to the Assessee which was subsequently waived. Therefore, such amount was construed to be cash benefit in the hands of the Assessee, falling outside the ambit of s.28(iv).
Taxability of waiver of loans: Judicial analysis
In the case of British Mexican Petroleum Co.  16 Tax Case 570, the House of Lords had rejected the contention of the Revenue that waiver of loan is taxable in the year of waiver, by observing as under;
“I cannot see how the extent to which a debt is forgiven can become a credit item in the trading account for the period within which the concession is made.”
It is important to bear in mind that the issue of taxability of such benefit came up for consideration before Bombay high court also – see Mohsin Rehman Penkar v. CIT  16 ITR 183 (Bom.), Orient Corpn. v. CIT  18 ITR 28 (Bom),- and presumably to identify some specific nature of remmissions which needs to be taxed, which are otherwise not taxable under 1922 Act, in the light of the above judgements, sections 28(iv) and 41(1) came to be enacted.
In the case of CIT v. Phool Chand Jiwan Ram  131 ITR 37 (Delhi), it was held that unless the amounts have been allowed as deduction in earlier years they cannot be treated as trading liability.
Thereafter, there have been several cases, both for and against this concept of taxability of waiver of loan. When the position of taxability came up before the Bombay High Court in the year 2002 in the case of Mahindra & Mahindra Ltd. v. CIT (2003), 261 ITR 501 (Bom) (HC), it held that when no deduction was claimed by the assessee in earlier years and the utilisation of loan went into acquiring capital assets, s.28(iv) or s.41(1) cannot be made applicable. Emphasis was also made on non-claiming of deduction u/s 36(1)(iii) of the interest component which shows that irrespective of whether the loan has been utilised for acquiring capital goods or otherwise, as long as no deduction was claimed, s.28(iv) or 41(1) would not be applicable. However in the case of Solid Containers Ltd v. DCIT (2009) 308 ITR 417 (Bom) (HC), the Hon’ble court deviated from the earlier decision and held that application of the funds would decide the nature of treatment to be given to the remission of liabilities. The court held that if the loans were utilised for trading purposes, remission of such liabilities would be in the nature of income, whereas if the loans were utilised for capital purposes, remission of loan could not be treated as income. Court further observed that a receipt, which is capital in nature in the earlier year, by efflux of time, can change its character as revenue receipt.
The Hon’ble Madras High Court, in the case of Iskraemeco Regent Ltd. v. CIT (2011) 331 ITR 317 (Mad) (HC) held that remission of liability does not give rise to liability to tax under the Act and reference was made to the decision of the Bombay High Court in Mahindra & Mahindra Ltd. v. CIT (2003) 261 ITR 501 (Bom) (HC) and Solid Containers Ltd. v. DCIT (2009) 308 ITR 417. The court has also considered the decision of the Hon’ble Supreme Court in the case of CIT v. T. V. Sundaram Iyengar & Sons Ltd. (1996), 222 ITR 344 (SC) and held that waiver of loan could not be treated as income under s. 28(iv) of the Act.
However, in a later judgement, the Hon’ble Madras High Court (in the case of CIT v. Ramaniyam Homes (P.) Ltd.  384 ITR 530 (Madras)), after considering Iskraemeco Regent Ltd. (supra), Solid Containers (supra) and Mahindra & Mahindra (supra), differed from the views taken in the aforementioned judgments and held that waiver of loan was a benefit in the hands of Assessee and not ‘receipt of money’. The relevant observation is reproduced here;
“the waiver of a portion of the loan would certainly tantamount to the value of a benefit. This benefit may not arise from “the business” of the assessee. But, it certainly arises from “business”. The absence of the prefix “the” to the word “business” makes a world of difference.”
Further the distinction sought to be made between the waiver of a portion of the loan taken for the purpose of acquiring capital assets on the one hand and the waiver of a portion of the loan taken for the purpose of trading activities on the other hand, has also been dealt with in the judgment and after considering all the aforementioned judgments, decided in favour of the revenue i.e. waiver of loan is taxable in the hands of the Assessee.
However, the controversy was put to rest to a certain extent by the Supreme Court in the case of Mahindra and Mahindra Ltd.  404 ITR 1 (SC) where it had interpreted that the provisions of section 28(iv) and 41(1) are not applicable in the event of waiver of loan. Though the Madras high court did not follow the line of reasoning adopted by Honble Bombay high court, having regard to the fact that the decision of the Bombay high court in the case of Mahindra & Mahindra was approved by Apex court (supra), the view taken by Madras High Court in the case of Ramaniyam can be said to be no longer relevant. The Bombay High Court as well as the benches of Tribunal have followed the Apex Court’s decision in several judgments in varying circumstances.
Taxability of benefit, if any, arising out of waiver of loan, falls for consideration, in the opinion of the Revenue, either u/s 28(iv) or s.41(1)and hence section wise analysis is made hereunder;
3.1. Taxability u/s 28(iv) :
The relevant portion of the section is reproduced here:
‘28. The following income shall be chargeable to income-tax under the head “Profits and gains of business or profession”,—
(iv) the value of any benefit or perquisite, whether convertible into money or not, arising from business or the exercise of a profession …’
This sub-section speaks of two components i.e., (i). the benefit or perquisite may or may not be convertible into money and hence it has to be other than money and, (ii). It should arise from business or exercise of a profession.
With respect to taxability u/s 28(iv), the courts have been clear about the fact that the benefit arising to the assessee should be anything but cash.
In the case of CIT v. Alchemic (P) Ltd  130 ITR 168 (Guj.) (HC), court observed that taxability u/s 28(iv) would arise only if the benefit or perquisite is not in cash/ money.
In the case of Ravinder Singh v. CIT  205 ITR 353 (Del.) (HC), it held that, “s.28(iv) can be invoked only where the benefit or perquisite is other than cash. If what was received either by way of benefit or perquisite was money, there would be no question of considering the value of such monetary benefit or perquisite under clause (iv) of s.28”.
The Apex court, in the case of Mahindra & Mahindra (supra), has held that “ ‘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.”
And once, ‘waiver of loan’ is treated as ‘cash receipt’, it would automatically fall outside the purview of s.28(iv).In other words the expression “benefit or perquisite” does not cover loans in which event, upon waiver of such loan, s.28(iv) is not attracted even if the loan is connected to business or profession.
Similar view was expressed in the following judgements;
PCIT v. SICOM Ltd.  116 taxmann.com 410 (Bombay) (HC)
PCIT v. Vibhadeep Investment & Trading Ltd. ITA No. 843 of 2017 dt. 11/09/2019, A.Y. 2008-09 (Bom.)(HC)
CIT v. Santogen Silk Mills Ltd.  231 Taxman 525 (Bombay) (HC)
Iskraemeco Regent Ltd. v. CIT  331 ITR 317 (Madras) (HC)
PCIT v. M/s. Colour Roof (India) Ltd. ITA 896 of 2017, dt. 25.9.2019, www.itatonline.org
Another aspect which may have to be considered is the ‘Purpose’ for which the loan had been taken. Even though Mahindra & Mahindra (supra) has not considered this aspect of the nature for which the loan has been taken, emphasis on the same has been made by several High Courts and the Supreme Court in the case of Sunderam Iyengar (1996) 222 ITR 344 (SC).
When a loan is taken for purchase of capital assets, majority of the decisions concluded that section 28 comes into play only when receipt or subsequent benefit is of revenue character and it cannot be invoked when loan was taken for capital investment and not for it’s day to day business; upon remission also it does not change it’s character.
3.2. Taxability u/s 41(1) :
The relevant portion of the section is reproduced here:
‘41. [(1) Where an allowance or deduction has been made in the assessment for any year in respect of loss, expenditure or trading liability incurred by the assessee (hereinafter referred to as the first-mentioned person) and subsequently during any previous year,—
(a) the first-mentioned person has obtained, whether in cash or in any other manner whatsoever, any amount in respect of such loss or expenditure or some benefit in respect of such trading liability by way of remission or cessation thereof, the amount obtained by such person or the value of benefit accruing to him shall be deemed to be profits and gains of business or profession and accordingly chargeable to income-tax as the income of that previous year, whether the business or profession in respect of which the allowance or deduction has been made is in existence in that year or not…..;’
S.41(1) may be divided into the following parts:
(i) An allowance or deduction should have been claimed in any earlier year preceding the year of remission;
(ii) Such allowance or deduction should relate to any expenditure or loss;
(iii) The liability generated from the expenditure or loss should be in the nature of a ‘Trading Liability’ and;
(iv) In any later year, the trading liability in respect of such expenditure is waived off.
The Supreme Court in CCIT v. Kesaria Tea Co.  254 ITR 434 (SC) held that the following points are to be kept in view:
“1) In the course of assessment for an earlier year, allowance or deduction has been made in respect of trading liability incurred by the assessee;
2) Subsequently, a benefit is obtained in respect of such trading liability by way of remission or cessation thereof during the year in which such event occurred;
3) In that situation the value of benefit accruing to the assessee is deemed to be the profits or gains of business which otherwise would not be his income; and
4) Such value of benefit is made chargeable to income-tax as the income of the previous year wherein such benefit was obtained.”
The Karnataka High Court in the case of CIT v. Compaq Electric Ltd  249 CTR 214 (Karn.) (HC) [SLP by department dismissed –  261 Taxman 71 (SC)], held that for the application of s. 41(1), the condition precedent is that there should be an allowance or deduction in the assessment for any year in respect of loss, expenditure or trading liability incurred by the assessee. Then, subsequently, during any previous year, if the creditor remits or waives any such liability, then the assessee is liable to pay tax u/s 41 and not otherwise.
The Apex court, in the case of Mahindra & Mahindra (supra), observed that if loan is obtained for the purpose of purchasing machinery i.e. capital assets and loan was an independent transaction, such liability was not a trading liability and hence, would not come under the purview of s.41(1). Further, emphasis was also made on the fact that the interest amount was not claimed as deduction u/s 36(1)(iii).
Similar view was taken in the following cases:
PCIT v. SICOM Ltd.  116 taxmann.com 410 (Bombay) (HC)
CIT v. V. S. Dempo & Co. Ltd  233 Taxman 417 (Bombay) (HC)
CIT v. Xylon Holdings (P.) Ltd.  211 Taxman 108 (Bombay)(Mag.)
CIT v. Gujarat State Fertilizers & Chemicals Ltd.  217 Taxman 343 (Gujarat)
CIT v. Dholgiri Industries (P) Ltd.  266 CTR 111 (Madhya Pradesh) (HC)
PCIT v. M/s. Colour Roof (India) Ltd. ITA 896 of 2017, dt. 25.9.2019, www.itatonline.org
A question could arise as to what is a ‘trading liability’?
Trading Liability in general terms can be understood as an obligation of a person (Debtor) to pay another person (Creditor) for goods purchased or value received from that other person in the course of business. A genuine Trading Liability incurred in the course of business or Profession is a permissible expenditure under the Income-tax Act.
The expression “trading liability” has not been defined in the Income-tax Act but a liability created for purchase of stock-in-trade on credit or a current trading transaction or a liability, which is awaiting adjustment by way of supply of goods or services, or a trade debt is certainly a trading liability which is quite different from a mere loan on capital account. This difference is generally overlooked by the A.Os. As per the accounting parlance and legal parlance a “trading liability” would mean the following –
a) Liability created for purchase of stock-in-trade on credit or a trade debt;
b) A liability, which is awaiting adjustment by way of supply of goods or services;
c) Borrowings for working capital
d) Sales tax collected in the course of business;
e) Receipt of compensation for loss of stock-in-trade;
f) Recoupment of debt / loss allowed as bad debts u/s 41(4) / business loss;
g) Remission / cessation of liability in respect of a trading transaction;
h) Remission in respect of unclaimed wages or bonus claimed in the return of income;
i) Unclaimed insurance premium;
j) Unclaimed excise duty liability, sales tax or purchase tax liability;
k) Refund of excise duty and sales tax;
l) Refund of electricity charges as grant / concession in power rates
m) Sums obtained as rebates;
n) Write back of excess provision;
o) Amounts earlier allowed as bad debts and later realised;
p) Unclaimed deposits received from customers in the course of trading operations credited to profit and loss account;
q) Monies kept for disbursement to meet business expenses;
r) Amounts received in the course of carrying on trading; etc
Trading liability-waiver of loan, when not taxable
In the following cases trading liability, upon waiver, was held to be not taxable:
5.1. In the case of Mohsin Rehman Penkar v. CIT  16 ITR 183 (Bom.) (HC), it was held that “once the Income-tax department accepts the mercantile system of accounts keeping and taxes an assessee on the accrual and not on the payment basis the department is not concerned as to how the liability incurred by the assessee is in fact discharged. He may discharge that liability by actual payment or he may discharge it by getting a remission from his creditor. But that is a question entirely for the debtor to determine. 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.”
Further, Honourable Justice Chagla, CJ of Bombay High Court, referred to the decision of the decision in the case of British Mexican Petroleum Co.  16 Tax Case 570 in great detail which is reproduced herein;
“There the appellant company entered into a contract with an oil producing company for the purchase of petroleum for a minimum period of twenty years. The appellant company came into difficulties and the accounts of the company’s business were made up for the year ended 30th of June, 1921, and for eighteen months i.e upto 31st of December, 1922. On the 30th of June, 1921, the amount which the appellant company owed to the oil producing company was £1,073,281 and on the 31st of December, 1922, £1,270,232. The appellant company paid to the oil producing company £ 325,000 and was released by the oil producing company from its liability to pay the balance, viz., £945,232. The amount so released was carried direct to the appellant company’s balance sheet and was shown as a separate item under the head “Reserve” on the 31st of December, 1922.
The contention of the Crown was that the amount released should be brought into account in computing the appellant company’s profits for the purposes of income-tax either in the account for eighteen months up to the 31st of December, 1922, or alternatively for the year ending on 30th of June, 1921, that account being reopened for that purpose. Both those contentions were rejected by the Court.
The House of Lords took the view that the account having been once settled as on 30th of June, 1921, and the liability of the appellant company fixed, that could not be re-opened merely because a creditor had remitted a part of the debt. With regard to the other contention that the remission should be looked upon as a trading receipt Lord Thankerton at p. 592 stated as follows:—
“I am unable to see how a release from a liability, which liability has been finally dealt with in the preceding account, can form a trading receipt in the account for the year in which it is granted.”
Lord Macmillan at p. 593 is equally emphatic as to what he thought about it. This is what the learned Law Lord says :—
“I say so for the short and simple reason that the appellant company did not, in those eighteen months, either receive payment of that sum or acquire any right to receive payment of it. I cannot see how the extent to which a debt is forgiven can become a credit item in the trading account for the period within which the concession is made.”
5.2. In the case of CIT v. Dholgiri Industries (P) Ltd.  266 CTR 111 (MP.) (HC), it was held that where principal amount of loan being never claimed by assessee as its expenditure, its waiver would not amount to income of assessee.
Cases where cessation of trading liability was held to be taxable
6.1. In the case of CIT v. T.V. Sundaram Iyengar & Sons Ltd.  222 ITR 344 (SC), the court observed that the moneys had arisen out of ordinary trading transactions. The assessee had received certain deposits from customers in the course of carrying on his business, which were originally treated as capital receipts. Since these credit balances, standing in favour of assessee’s customers, were not claimed by the customers, the assessee transferred such amounts to its profit and loss account. The assessee did not include such amounts in its total income.
The Court held that although the amounts received originally were not of income nature, the amounts remained with the assessee for a long period unclaimed by the trade parties. By lapse of time, the claim of the deposit became time barred and the amount attained a totally different quality. It became a definite trade surplus. Although it was treated as deposit and was of capital nature at the point of time it was received, by efflux of time the money has become the assessee’s own money. What remains after adjustment of the deposits has not been claimed by the customers. The claims of the customers have become barred by limitation.
Here we see the concept of ‘changing of character of receipt by efflux of time’ and the action of the assessee of crediting it to profit & loss account which shows that the assessee treats it as revenue.
6.2. In the case of Solid Containers Ltd. v. DCIT  308 ITR 417 (Bom.) (HC), after considering the Bombay High Court decision of Mahindra and Mahindra Ltd. v. CIT  261 ITR 501 (Bom.)(HC), the Hon’ble High Court observed that in the case of Mahindra & Mahindra purchase consideration related to capital assets; the toolings were in the nature of dies and the assessee was a manufacturer of heavy vehicles & the import was that of plant and machinery in which event waiver was held to be not a business activity. However the facts in the case of Solid Containers are entirely different inasmuch as it was a loan taken for trading activity and ultimately upon waiver, the amount was retained in business by the assessee, due to which the amount of deposit liability, which was waived off, was treated as income in the hands of the Assessee.
6.3. The Bombay High Court in the case of Protos Engineer Co. (P.) Ltd. v. CIT  211 ITR 919 (Bom.) (HC) held that cessation of a trading liability is not receipt of money, but receipt in kind u/s 28(iv) and hence taxable. In the above case, there were trade advances i.e. amount received in advance for purchase of goods and such advances were never claimed by the customers. The Court held such receipt of money as trade receipts in the course of business. The second point to be decided was whether such receipts, which were not received during the year under consideration, but were received at an earlier date, could not be treated as receipt of cash in the year under consideration. The court held that such benefit was a receipt of benefit in kind and hence covered u/s 28(iv).
[Note : Considered by Essar Shipping Limited v. CIT ITA (IT) NO.201 OF 2002 (Bom.) (HC) and held that this judgment no longer holds the field.]
Law laid down by Mahindra and Mahindra Ltd.  404 ITR 1 (SC)
7.1. The Bombay high court in the case of Mahindra and Mahindra (supra) (HC) mentions that waiver of loan, where loan is taken for a capital asset, would not constitute a capital receipt at the time of waiver of such loan and hence not taxable in the hands of the assessee. The Bombay high court in the case of Solid Containers(Supra) states that the loan was taken for trading activity and ultimately, upon waiver the amount was retained in business by the assessee and hence the case of Mahindra & Mahindra (HC) (Supra) would not be applicable and the waiver of trading liability in question would be taxable in the hands of the assessee.
7.2. The Supreme Court approved the view of the Bombay High court in the case of Mahindra and Mahindra Ltd  404 ITR 1 (SC) by observing that s.41(1) would not be applicable since firstly there should be an allowance or deduction claimed by the assessee in any assessment year in respect of loss, expenditure or trading liability incurred by the assessee. The objective behind this Section is simple, i.e. it is made to ensure that the assessee does not get away with a double benefit once by way of deduction and another by not being taxed on the benefit received by him in the later year with reference to deduction allowed earlier in case of remission of such liability.
Facts of Mahindra & Mahindra Case
An agreement was entered into by the assessee with the seller company to purchase dies, welding equipment and die models. However, for the procurement of the said equipment, a loan was taken from the seller at the rate of 6% interest repayable after 10 years in instalments. Later on, the seller company was taken over by another company, who had then waived the loan taken by the assessee. The Apex Court held that neither of the sections i.e. 41(1) and 28(iv) would be applicable due to the following reasons:
Section 28(iv) requires that the value of any benefit or perquisite, whether convertible into money or not, arising from business or the exercise of a profession. In this regard Hon’ble Court observed as under:
“It is a well-settled principle that creditor or his successor may exercise their “Right of Waiver” unilaterally to absolve the debtor from his liability to repay. After such exercise, the debtor is deemed to be absolved from the liability of repayment of loan subject to the conditions of waiver. The waiver may be a partly waiver i.e., waiver of part of the principal or interest repayable, or a complete waiver of both the loan as well as interest amounts. 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”
The section clearly mentions that such benefit can be in any form, which can also be convertible into money. However, it should not be money. The Apex court has now clarified that ‘waiver of loan’ should be treated as ‘receipt of money’ and hence such receipt of money would fall outside the purview of s.28(iv) and accordingly cannot be taxable.
Section 41(1) requires that where an allowance or deduction has been made in the assessment for any year in respect of loss, expenditure or trading liability incurred by the assessee and subsequently during any previous year, any benefit arises due to the cessation of such trading liability, shall be chargeable to income-tax as the income of that previous year. It has observed as under;
“It is evident that it is sine qua non that there should be an allowance or deduction claimed by the assessee in any assessment for any year in respect of loss, expenditure or trading liability incurred by the assessee. Then, subsequently, during any previous year, if the creditor remits or waives any such liability, then the assessee is liable to pay tax under Section 41 of the IT Act.”
The Apex Court has held that for ‘waiver of loan’ to be considered for taxability through the lens of S.41(1), the first and foremost condition is the claim of the amount of loan received, as an expenditure or loss or trading liability i.e. it has passed through the Profit and Loss account(previously not accounted in taxable profits).
The second condition to be fulfilled was for the loan to be a trading liability. The Court held as under;
“It is important to note that the said purchase amount had not been debited to the trading account or to the profit or loss account in any of the assessment years. Here, we deem it proper to mention that there is difference between ‘trading liability’ and ‘other liability’. Section 41 (1) of the IT Act particularly deals with the remission of trading liability. Whereas in the instant case, waiver of loan amounts to cessation of liability other than trading liability.”
The Apex Court thus concluded that waiver of loan would not come within the purview of s.41(1).
A particular reference may be made to the case of CIT v. Sun Engineering Works (1992) 198 ITR 297 (SC) where the Supreme Court held:
“It is neither desirable nor permissible to pick out a word or a sentence from the judgment of this court, divorced from the context of the question under consideration and treat it to be the complete ‘law’ declared by this court. The Judgment must be read as a whole and the observations from the judgment have to be considered in the light of the questions before the court. A decision of this court takes colour from the questions involved in the case in which it is rendered and, while applying the decision to a later case, the Courts must carefully try to ascertain the true principle laid down by the decision of this court and not to pick out words or sentences from the judgment, divorced from the context of the questions under consideration by this court, to support their reasoning.”
In a nutshell the Apex Court, in the case of Mahindra & Mahindra, considered the gamut of cases relevant under sections 28(iv) & 41(1) as well as the facts and ratio laid down in all the leading decisions on this aspect and hence the issue is no longer res integra. In the case of Sun Engineering (supra) the court rightly observed that a view taken by any court by picking one word from a piece of legislation (known as cherry picking), divorced from it’s context, need not be followed. Entire judgment and the facts of each case would have to be read and understood to come to a conclusion as to whether any of the decisions, holding a view contrary to the apex court’s decision, are applicable in the given facts and not based on cherry picking method, as against a well-reasoned judgment in the case of Mahindra (supra).
Treatment of waiver of loan in case of deduction being claimed u/s 36(1)(iii)
Whether in a case where a deduction would have been claimed of the interest amount u/s 36(1)(iii), would the entire amount of principal also get taxed?
One of the methods to determine the purpose of the loan to be revenue is to check how the interest payment has been treated in the books of the Assessee.
An immediate question which should now come to the minds of the professionals is what would be the quantum of such principal which would get taxed? Would it be to the extent of the proportion of interest claimed u/s 36(1)(iii) or to that of the principal amount or whether it would be the entire principal amount along with interest component?
The Court in the case of Solid Containers(supra) has tried to infuse the concept of ‘trading and non-trading purpose’. It mentions that, once it is established that the loan was taken in the course of business or for utilising it for trading activities, the nature of the loan changes from a capital receipt to a revenue receipt.
If we have a glance at s.36(1)(iii), it states that “the amount of the interest paid in respect of capital borrowed for the purposes of the business or profession:”, such an amount would be allowed as a deduction under this section.
Hence, from the above, an inference can be drawn that, once deduction is claimed, it could be deemed to be used for the purposes of business, due to which the loan amount could be treated as borrowed for trading activity, which was upheld by the Court in the case of Solid Containers which states that in such an event(as mentioned above), such waiver of loan becomes taxable.
Once the purpose of the loan is taken towards capital, the proportion of claim of deduction may not be looked into since the entire amount waived would fall outside the purview of the aforementioned provisions.
The Apex Court in the case of Mahindra & Mahindra(supra) laid emphasis on the fact the no deduction u/s 36(1)(iii) has been claimed by the assessee.
In a situation where such a deduction is claimed, the author is of the view that only to the extent of the deduction claimed would be taxable in the hands of the Assessee, in light of the Mahindra judgment.
Situation where Loan is taken for one purpose but utilised for another purpose
In a situation where the loan is obtained for capital purposes but utilised for trading purposes or vice versa, the concept of substance over form may be considered i.e. the ultimate utilisation of the fund should be considered for the purposes of taxability under the Income-tax Act and not the form in which the loan was procured.
Interplay between s.41(1), s.28(iv) and s.56(2)(x)
Since the Hon’ble Courts have held that waiver of loan is nothing but ‘receipt of cash’ in the year when the loan gets waived, whether the newly introduced provisions of s.56(2)(x) applicable?
s.56(2)(x) of the Act states as under :
‘where any person receives, in any previous year, from any person or persons on or after the 1st day of April, 2017,—
(a) any sum of money, without consideration, the aggregate value of which exceeds fifty thousand rupees, the whole of the aggregate value of such sum; ……….’
Under s.56(2)(x), the provision mandates the ‘receipt of money’ in any previous year. Now, because of the law laid down by the Apex court, the understanding of ‘receipt of money’ would incorporate in it, even ‘waiver of loan’. The event of loan being waived off, would now be treated as the year in which the money is received.
But, s.56(2)(x) clearly states that such receipt of money should be without any consideration. The next question which would arise is, whether there is any consideration involved in receiving the benefit of loan waiver?
Two situations may arise here i.e.
(a) When the creditor or the giver of the loan chooses to forgo or forsake his/her right to receive the loan back.
(b) In a case where the Assessee is not in a position to pay back the loan or becomes bankrupt and thereby requests the other party to forsake his right to receive.
The first scenario is similar to the case of Mahindra & Mahindra (supra) where the reason for waiver of loan was given as a measure of compensation for certain losses including goodwill, the benefit of association, and also for sudden change to another company. However, the interest had been undisputedly paid i.e. there was no waiver of interest in the case of Mahindra & Mahindra.
Since the section mandates consideration, even though it may not be adequate, can it be now said that the consideration for the waiver of loan has already been received by the other party either in the form of continued interest (as in the case of Mahindra) or in the form of receiving part of the amount at an earlier date or in any other indirect form in the course of business?
A similar point has been considered by the Chandigarh Tribunal in the case of Jai Pal Gaba v. ITO  178 ITD 357 (Chandigarh – Trib.) in respect of waiver of loan and its taxability u/s 56(2)(vi) where it held that there is adequate consideration involved. The following observation was made;
“the terms and conditions were settled and as per the terms and conditions, in the event of the loanee paying an amount of ₹ 140 lacs immediately, out of which ₹ 125 lacs to be deposited in third party account, which would be acceptable on the approval of the one-time settlement and execution of ‘compromise agreement’ at the cost of the loanee, the remaining of the loan was agreed to be waived/sacrificed by the bank. It was not a simple case of waiver without consideration, rather, the consideration of the waiver was the condition of depositing immediately the remaining part of the loan i.e. ₹ 140 lacs and performance of certain other formalities as per the agreement. It is not just a case where the bank has simply waived or remitted the loan amount, rather the bank to secure payment of ₹ 140 lacs, which otherwise the bank was feeling difficult to recover, was the consideration for settlement of the loan account. Hence, the amount received by the assessee as waiver or remission of loan amount cannot be said to be without consideration. Hence, in our view, the provisions of section 56(2)(vi) are not applicable to the case in hand.”
Even in the case of Mahindra & Mahindra it was observed that the loan was waived because of certain losses including goodwill, the benefit of association, and also for sudden change another company as a shareholder. Hence there is adequate consideration involved in this case as well.
Whether consideration other than in the form of money can be considered as consideration for the purposes of s.56(2)(x).
However, we may not be able to apply such a theory to every act of waiver of loan. The reasons for waiver may have to be looked into. But more often than not, we may be able to see some strong reason behind any person to forsake a right to receive.
Dealing with the second scenario i.e. in a case where the Assessee is not in a position to pay back the loan or becomes bankrupt and thereby requests the other party to forsake his right to receive. Revenue may raise an issue that apparently there is no consideration or it is inadequate, but in business or real life scenario nobody is expected to waste good money after bad and keep fighting the litigation with a near certain conclusion that even the litigation expenditure adds to the existing loss and in such an event it can be argued that purchasing mental peace and averting further expenditure is a consideration.
In fact, such a scenario is likely to raise in the current covid-19 pandemic where many business may run into losses and they may not be able to repay the banks either due to bankruptcy or some other reason.
Before we come to a superficial conclusion that in such cases waiver of loans has to be taxed, let us look at the motive behind implementation of these provisions.
The Finance bill 2017  391 ITR 40 (st.) introduced the provision of s. 56(2)(x) to expand the scope of the provisions of the said section to all categories of assessees so that the assets received without or inadequate consideration may be brought to tax. The Memorandum explaining the Finance bill stated as under:
“In order to prevent the practice of receiving the sum of money or the property without consideration or for inadequate consideration, it is proposed to insert a new clause (x) in sub-section (2) of section 56 so as to provide that receipt of the sum of money or the property by any person without consideration or for inadequate consideration in excess of
₹ 50,000 shall be chargeable to tax in the hands of the recipient under the head “Income from other sources”.
The provision of s.56(2)(x) has borrowed most of its content from its erstwhile s.56(2)(vii) & (viia) which were inserted in the years 2009 & 2010 respectively. Since the provision of s.56(2)(x) was intended to merely expand the scope of the provision, not may changes have been made.
In the Memorandum explaining Finance Bill 2010  321 ITR 110(st.), under the heading ‘Taxation of certain transactions without consideration or for inadequate consideration’ it has been mentioned that, “These are anti-abuse provisions which are currently applicable only if an individual or an HUF is the recipient”.
Since the Memorandum explaining the Finance bill 2010 shows that these are ‘anti-abusive provisions’, genuine transactions will go out of the sweep of these provisions.
The intention of the legislature in inserting those provisions was to bring to book those Assessees who have made a real profit, which can be gleaned from the Memorandum to the Finance Act 2010 wherein it was mentioned that it was mainly incorporated as an ‘Anti-abuse’ measure, and hence the situation as explained above, may not come within the purview of s.56(2)(x).
12.1. Depreciation and its effect
What happens when the loan is utilised for purchase of plant and machinery, etc? Whether the benefit of depreciation already claimed would have any effect?
A loan received having been utilised for the purpose of infusing capital into the business in the form of purchasing plant/machinery, the subsequent waiver of loan would not convert such loan into a revenue item so as to fall for taxation either u/s 28(iv) or u/s 41(1).
S.41(1) states that no claim of deduction or loss should have been made in earlier years. It essentially refers to claim of deduction of the loan repayment or interest repayment whereas depreciation is not a repayment and its essentially a mere charge to the profit and loss account since the value of the asset gets depleted on the basis of the user. Therefore, in my humble opinion, it may not fall within the ken of section of 41(1) of the Act, so as to call for taxation of the amount waived. There are catena of decisions explaining the nature of depreciation and even in a case of estimate of income by rejecting the book results, courts have taken a view that depreciation being a statutory deduction, it has to be independently considered.
However, there is a contrary decision of the ITAT Hyd bench in the case of Binjrajka Steel Tubes Ltd. v. ACIT  130 ITD 46 (Hyd.), though it can be distinguished on the ground that in the event of waiver of loan, the value of the asset gets reduced proportionately in which event there is no double tax benefit to the assessee and in the event of sale of such asset, the profit or loss if any would be determined on the basis of the net asset value.
In the case of Binjrajka Steel Tubes Ltd. v. ACIT  130 ITD 46 (Hyd.), the court observed as under:
“However, assessee-company had obtained the benefit of depreciation in the earlier years even on this amount of ₹ 2 crores. Hence, when it was written off later, the assessee obviously was not entitled for the depreciation benefit which was granted earlier. It is an undisputed fact that the assessee-company had claimed the depreciation on the entire amount of ₹ 6 crores from the year of acquisition of the asset and it was already allowed by the Department. Now that we have held hereinabove that ₹ 2 crores liability written off by the TATA SSL on the supplies of plant and machinery is not liable to be taxed as deemed income under section 41 of the Act, depreciation allowed on that amount earlier has to be withdrawn and added back in this year, as otherwise, the assessee-company will get double benefit which is not justified. In this view of the matter, considering the totality of facts and the circumstances of the case, we hold that the depreciation claimed by the assessee on ₹ 2 crores in the earlier years, which the assessee-firm is not entitled, need to be brought back to tax under section 28(iv) of the Act, as the value of benefit arising from business of the firm. After reducing the said amount of depreciation granted earlier from the amount of ₹ 2 crores, balance amount is to be reduced from the closing written down value of the block of assets. Hence, we direct the Assessing Officer to bring back to tax, the amount of depreciation granted to the assessee in the earlier years on the alleged amount of ₹ 2 crores under section 28(iv) of the Act and re-determine the closing written down value of the block of assets in the year under consideration, as discussed above.”
However, the Bangalore bench in the case of Akzo Nobel Coatings India (P.) Ltd. v. DCIT  139 ITD 612 (Bangalore) observed that allowing depreciation from year to year on a capital asset would not change the character of loan and unless remission falls within the specific letter of law i.e. u/s 41(1) mere double benefit, if any, should not be the criterion for invoking the provisions of s.41(1). The relevant portion of the paragraph has been reproduced as under:
“….there is a lacuna in the law and it is for the legislature to provide appropriate safeguards in this regard. It is true that the Assessee on the one hand gets the waiver of monies payable on purchase of machinery and claims such receipt as not taxable because it is capital receipt. On the other hand the Assessee claims depreciation on the value of the machinery for which it did not incur any cost. Thus the Assessees stand to benefit both ways. As per the law as it prevails as on date, we are of the view that the revenue is without any remedy. The only way that the revenue can remedy the situation is that it has to reopen the assessment for the year in which the asset was acquired and fall back on the provisions of Sec. 43(1) of the Act which says that actual cost means the actual cost of the assets to the assessee. Even this can be done only when after the waiver of the loan which was used to acquire machinery. By that time if the assessments for that AY gets barred by time, the revenue is without any remedy. Even the provisions of Sec. 155 do not provide for any remedy to the revenue in this regard.”
In the light of the conflicting interpretations on this issue, it can safely be contended that a view in favour of the Assessee be taken in the light of the principle laid down by the Apex Court in the case of CIT v. Vegetable Products Ltd.  88 ITR 192 (SC). The Hyderabad bench decision is based on several independent assumptions which were probably not even conceived by the legislators while enacting the provisions of s.28(iv) or 41(1). Law evolves and becomes stronger when all the facets of the issue are properly put forth in a given case and the author wishes to borrow the words of Lord Denning, “A judge must not alter the material of which it is woven but he can and should iron out the creases”. If it can be shown that in the event of reducing the amount waived from the capital asset, there would be reduction in the future depreciation and eventually, in the long run, there is no double benefit, it can always be pleaded that neither s.28(iv) nor s.41(1) can be roped in.
However, when there are two views possible, the law is settled that a view which is in favour of the Assessee has to be adopted. This principle has also been propounded in the case of CIT v. Vegetable Products Ltd.  88 ITR 192 (SC) which states that the rule of beneficial construction of the provisions shall be of eminence. And when there are multiple or conflicting decisions of co-ordinate benches, then that judgment which appears to state the law more elaborately and accurately must be followed [Amar Singh Yadav And Anr. v. Shanti Devi And Ors. AIR 1987 Pat 191 – Para 24]. In fact, a few courts have also held that the later decision should be followed i.e. the decision delivered later in time.
12.2. MAT provisions
A question may arise as to how waiver of other liabilities/trading liabilities be treated under MAT provisions. When a Loan is waived, it may be recorded as an extraordinary item in the books of the Assessee i.e. as a capital receipt. Further, if such loan had been utilised for the purpose of acquiring equipment of capital nature, then, as per the interpretation of the Courts, as discussed till now, waiver of loan would become a capital receipt. Since only the ‘working results’ are required to be considered for the purpose of computing the book profit under the provisions of section 115JB, waiver of loan may not be imported under the framework of MAT provisions.
The purpose and legislative intent behind introduction of provisions of section 115J/115JA/115JB was to take care of the phenomenon of prosperous zero tax companies which had continued but were paying no income tax even though they had profits and were declaring dividends. It was, therefore, sought that minimum corporate tax should be paid by these prosperous companies and accordingly, MAT was introduced. It was never the intention of the legislature that any receipts which is not taxable per se within the income tax provision or not reckoned as part of net profit as per the profit & loss account as per Companies Act can be brought to tax as a book profit.
The Hon’ble Supreme Court in the case of Indo Rama Synthetics (I) Ltd. v. CIT (2011) 330 ITR 363 (SC) held that object of the MAT provision is to bring out the ‘real profits’ of the companies and the main thrust is to find out the working result of the company. And for the purpose of achieving the real working result of a company, capital receipt has to be excluded. This proposition has also been considered by the Bangalore tribunal in the case if JSW Steel mentioned below.
In the case of M/s. JSW Steel Limited v. ACIT ITA No.923/Bang/2009, A.Y. 2004-05, the Tribunal observed as under:
“if an assessee company is in receipt of a ‘capital receipt’ which is not chargeable to tax at all, that is, it does not fall within any of the charging section or can be classified under any heads of income under the Income Tax Act, then same cannot be treated as part of net profit as per Profit & Loss account or reckoned as ‘working result’ of the company of the relevant previous year and consequently, cannot be held to be taxable as ‘book profit’ under MAT in terms of section 115JB. Accordingly, our conclusion remains the same that, the capital surplus on account of waiver of dues is neither taxable nor can be included in computation of book profit u/s 115JB.”
In summary, the law as it stands today, vis-à-vis the provisions of s.28(iv) and 41(1), needs to be cautiously approached, depending on the facts of each case and certainly not in a case where amount of loan initially received was on capital account, apart from other factors considered by the Apex Court in the case of Mahindra & Mahindra (supra).
In cases where waiver of loan/remission of liability, the Assessee may keep the following in mind:
Check whether the principal amount and interest amount are seperately given effect to in the books of the Assessee.
Find out the treatment given by the bank in its books of accounts w.r.t. the loan.
In case the Assessee is unable to procure such information from the Bank, a letter may be written stating the treatment given by the Assessee.
Once the principal amount and interest amount is determined, check the purpose for which the loan has been utilised.
Check whether any amount has been claimed as deduction, either principal amount or the interest amount.
Accordingly the taxability can be determined w.r.t. the waiver of the liability, in light of the judgments mentioned in the article above.