Tax consequence of loan waiver

Income-tax law treats loans received by taxpayers with lot of care and caution. Concealed or undisclosed incomes could be brought to regular business use in the guise of loan.

Therefore, provisions of law regulate the method of accepting loans and their repayment.

A taxpayer has to accept loan only by way of account payee crossed cheque or bank draft where the loan is Rs 20,000 or more. Similarly, the repayment must also be in the same mode.

Else, both acceptance and repayment would be liable for penalty. The quantum of penalty is equal to the amount of loan accepted or repaid otherwise than by account payee crossed cheque or bank draft.

In addition to regulating loan acceptance and repayment, the statute also empowers the tax officers to check the genuineness of the loan. The onus is on the taxpayer accepting the loan to prove the worthiness of the lender who is extending such loan. The repealing of Gift-tax Act, 1958 w.e.f. October 1, 1998 resulted in taxpayers taking gifts instead of loan. Then again, the lawmakers had to insert a provision for taxing gifts as deemed income in the hands of recipient vide section 56(2)(v) with tax exemption only for gifts from relatives.

It may so happen that a lender may sympathise with the borrower and waive the loan fully or partly and such waiver may have tax implication. Section 41(1) deals with tax impact of loan waived by the lender in the assessment of borrower.

Sometimes, borrowers may also refuse to repay the loan and pass entries to this effect in their books of account.

The law covers such unilateral write-off of such liability as income chargeable to tax, if it is a trading liability.

Capital loan write off

A loan taken for capital transaction such as acquisition of assets like land, building, machinery or plant when waived by the lender or written off by the borrower (i.e. the assessee) such waiver or write-off could not be subjected to tax, since the loan does not fall in the revenue field.

The courts have consistently held that a loan taken for acquiring capital asset when waived by the lender, either in whole or in part, the amount of waiver cannot be taxed as income since it does not have any semblance of revenue nature. [Refer Mahindra & Mahindra Ltd vs. CIT 261 ITR 501 (Bom); CIT vs. Chetan Chemicals P Ltd 267 ITR 770 (Bom).]

Working capital borrowing

When a borrowing is made for carrying on regular business activity, such borrowing is called as working capital borrowing. It forms part of the trading liability of the borrower. When the lender of such trading facility waives the amount either fully or in part such amount so waived or foregone is chargeable to tax as income as held in Solid Containers Ltd v. Dy.CIT 308 ITR 417 (Bom); Rollatainers Ltd vs. CIT 339 ITR 54 (Del).

In Rollatainers's case, (Supra) the loan amount was borrowed for working capital purposes by way of cash credit limit from bank which was waived subsequently by the bank.

The court upheld the taxation of the amount of working capital loan waived by bank as income in the hands of the assessee on the reasoning that the loan was taken for day to day working capital facility and being a trading liability, its waiver was taxable as income.

Interest

The taxability of interest portion waived by the lender in both working capital loan and term loan would be the same and would be governed by Section 43B of the Act. Since interest on loan on capital account or revenue account from bank and financial institutions is allowable only on actual payment basis, waiver of such interest by the lenders anyway will be outside the tax net. Whether such waiver is prompted by the lender or unilaterally transferred by the borrower, such interest portion will not be chargeable to tax as the amount would not have been allowed as deduction previously.

Impact on actual cost

Where interest free-loan is given originally and subsequently converted into grant for the purpose of purchasing machinery, such grant was held as eligible for reduction from the actual cost of machinery and consequent depreciation claim in Ravi Leathers vs. CIT 240 ITR 702 (Mad).

But a contrary view favouring the taxpayers that part of loan when waived will not reduce the actual cost of machinery could be found in CIT vs. Cochin Co P Ltd 184 ITR 230 (Ker)

(The author is an Erode-based chartered accountant.)

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