Remission of Unsecured Loan
Case for Taxability u/s 41(1) vis-à-vis 28(iv)
Brief facts for issue in discussion are as under-
ABC Pvt. Ltd had taken unsecured loan from various parties. For the first 2 years the company paid interest regularly and thereafter it did not pay any interest on the said unsecured loans. After 4 years the said lenders entered into an agreement with the company and they agreed for receiving 10% of the total loan amount against the full discharge of loan. The company credited the balance amount into capital reserves.
The question now arises about the taxability of the amount credited to the reserves and surplus?
The AO has treated the aforesaid remission of loans as a benefit accruing to the company during the course of its business activity and brought to tax the same by invoking provisions of s. 28(iv) of the Act.
To fully appreciate the issue, following two section are reproduced, which are applicable in the instant case Section 28(iv) and 41(1)
Section 28 (iv) reads as under
"28- Profits and gains of business or profession.
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....”
Section 41(1) reads as under-
"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 the assessee has obtained, whether in cash or in any other manner whatsoever, any amount is 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 him 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 of profession in respect of which the allowance or deduction has been made is in existence in that year or not."
The discussion for the issue under consideration therefore revolves, around two provisions mentioned above.
As far as interest is concerned, which in case, if debited to profit & loss account, the remission thereof is fully taxable u/s 41(1) as because it has been claimed as deduction in the profit & loss account for arriving at the profit for the year.
But in case of the principal amount, this is not the case. The assessee has never claimed any benefit of the said amount in so far as it never claimed any debit in profit & loss a/c of the said loan amount.
As far as section 28(iv) is concerned, what is taxable is value of any benefit, whether convertible into money or not, arising from business & profession.
Cash benefit/ perquisite is not covered under this section. Only non monetary benefit are covered by this section [CIT v Alchemic Pvt. Ltd. (1981)130 1TR 168 (Guj)]
The decision in the case of CIT vs. Chetan Chemicals (P) Ltd. [(2004) 267 ITR 770 (Guj)], is relevant. Facts in brief are as under-
The assessee is a private limited company. The company maintained its accounts as per mercantile system of accounting. In the course of carrying on its business, the company had obtained unsecured loans from various creditors, and in the light of the financial difficulties faced by the company, the creditors approached the High Court by filing various company petitions. During the course of those proceedings, it transpires that a compromise was reached between the assessee-company and its creditors wherein, as per the terms of the compromise, certain creditors remitted unsecured loans amounting to Rs. 1,77,052/-. At the same time, interest which had accrued in favour of the creditors amounting to Rs. 2,96,171/- was also remitted. Such remitted interest was declared by the assessee as income liable to tax under s. 41(1) of the IT Act, while filing its return of income, but the remission of loans amounting to Rs. 1,77,052/- was not returned as income liable to tax.
While deciding the issue the Hon'ble High Court held as under-
Sec. 28 of the Act deals with profits and gains of business or profession and cl. (iv) thereof says that the value of any benefit or perquisite, whether convertible into money or not, arising from business or the exercise of a profession shall be chargeable as income under the head profits and gains of business or profession. In the facts of the present case, it cannot be said that the assessee-company was carrying on business of obtaining loans and that the remission of such loans by the creditors of the company was a benefit arising from such business.
Further on applicability of section 41 (1) the Hon'ble Gujrat HC have observed as under-
On a reading of the provisions, it is apparent that before the section can be invoked, it is necessary that an allowance or a deduction has been granted during the course of assessment for any year in respect of loss, expenditure or trading liability which is incurred by the assessee, and subsequently during any previous year the assessee obtains, whether in cash or in any other manner, any amount in respect of such trading liability by way of remission or cessation of such liability. In that case, either the amount obtained by the assessee or the value of the benefit accruing to the assessee can be deemed to be the profits and gains of a business or profession and can be brought to tax as income of the previous year in which such amount or benefit is obtained. In the facts of the case on hand, without entering into the aspect as to whether the liability to repay the loans would be a trading liability or not, it is an admitted position that there had been no allowance or deduction in any of the preceding years and hence, there is no question of applying the provision as such.
Accordingly it held that Assessee-company not carrying on business of obtaining loans, remission of loans by the creditors of the company was not a benefit taxable under s. 28(iv).
In the case of Mahindra & Mahindra Ltd. vs CIT [(2003) 261 ITR 501 (Bom)], the assessee purchased tooling from one KJC of America for which purpose KJC advanced a loan to the assessee for 10 years bearing 6 per cent interest. Later on KJC was taken over by AMC and the latter agreed to waive the principal amount of loan but not interest. Assessee continued to pay interest over the period of 10 years. It was held that Sec. 28(iv) did not apply to the waiver of principal amount of loan (not interest) which was advanced to the assessee by the supplier of capital assets.
As regards the taxability u/s 41 (1) the court held that since no allowance or deduction having been allowed in respect of loan taken by assessee for purchase of capital assets, s. 41(1) was not attracted to remission of principal amount of loan
But in the case of Protos Engineer Co. Pvt. Ltd. vs. CIT [(1995) 211 ITR 919 (Bom)] the Hon'ble Bombay High Court took a different view. The facts of the case, in brief, are as under -
The assessee is a private limited company. During the previous year, the assessee credited to its P&L a/c a sum of Rs. 63,379/-. This amount comprised of various unclaimed sum such as deposit by customer for purchase, excess commission received from parties and the like. Thus the sum of Rs. 63,379/- representing the above amounts was appropriated by the assessee to its P&L a/c as it was of the opinion that this amount was no longer required to be returned to the third parties.
Before the ITO, the assessee contended that this amount, though credited to the P&L a/c, should not be included in its assessable income in as much as no deduction having been allowed in respect of the same in computation of its income in any if the earlier years and as such sec 41(1) of the Act had no application.
The ITO, however, held that the amount of Rs. 63,379/- represented the value of benefit received by the assessee in the ordinary course of business carried on by it and hence it was trading receipt includible in the computation of the income of the assessee.
The Hon'ble High Court while adjucating the appeal observed as under-
“6….. The benefit that has arisen to the assessee in the instant case by appropriation of the excess commission or advance receipts against supplies, etc. received in earlier years and not credited to P&L a/c in those years, has a close and direct nexus with the business of the assessee. This condition therefore, is satisfied.
7. Appropriation of the amount received by way of excess commission, advances against supplies, etc. received in earlier years and credited to the P&L a/c in the year under consideration definitely amounts to a benefit to the assessee. There can be no dispute about it. This has the result of not only reducing the trade liabilities of the assessee and enhancing its profits of business during the year but also increasing its capital.
8. The only aspect that remains to be considered is whether it is a benefit arising to the assessee in the form of money or it is a benefit which is convertible into money. There is no dispute about the fact that none of these amounts were received by the assessee in the year under consideration. It represented unclaimed old credit balances which were not claimed by the creditors as according to them they were not due to them. The amounts therefore represented amounts payable to the assessee for the services rendered by it to the creditors in course of business or reimbursement of expenses incurred by it in the past on their account in course of business which was not appropriated to the P&L a/c in the year of receipt for one reason of the other. The assessee had appropriated these amounts, which were appearing in its account as amounts due to others, to its own account as profit by crediting the same to its P&L a/c. No benefit in cash as such had arisen to the assessee during the year under consideration. The benefit received by the assessee by appropriation of this amount to its P&L a/c is definitely a benefit convertible into money. Sec. 28(iv) of the Act will squarely apply to such benefit. The controversy whether benefit arising in cash will fall within the purview of s. 28(iv) or not is thus academic so far as the present case is concerned. In that view of the matter, we need not decide the same.
And therefore the Court held as under
"We are, therefore, of the opinion that in the instant case the amount of Rs. 63,379/-represented the benefit arising to the assessee from its business which was convertible into money. In that view of the matter, we are of the opinion that s. 28(iv) in clearly attracted and the Tribunal was right in confirming the inclusion of the name in the income of the assessee chargeable to income-tax."
This judgment has not covered the issue of whether the benefit/perquisite involved was received in cash or not. In case these are deemed to be received in cash then the said section is not applicable and therefore the said amounts are not taxable. Further all these receipts were held to be trading in nature and were also credited to P & L A/c and therefore treated as business income u/s 28(iv)
Similarly in the case of CIT v Aries Advertising (P) Ltd. [(2002) 255 ITR 520 (Mad)] the Hon’ble High Court held as under-
“The assessee here has not treated the amount as a liability and more particularly a continuing liability. On the other hand, the assessee has transferred this amount to general reserve. It is trite law that any amount transferred to the general reserve would be out of profits alone. Once the assessee transferred this amount to the general reserves, it is the same as the profits. The amount represents the various credits deposits during the trading with a firm. They remained for a long time to be recovered (even before the limitation period) and this remained unclaimed. The amounts were then transferred by the assessee company to the general reserve obviously treating them to be the profits. In the view the amount has to be treated as income of the assessee chargeable to income tax.”
In this case also it seems that since the amounts were received from the customers, therefore it was held that the said receipts were received during the trading operations of the assessee and therefore were treated as income of the assessee.
The remission of unsecured loans therefore, which are neither trading receipts and nor credited to P & L A/c, it seems that, are not includible in business u/s 28(iv) or u/s 41(1) of the Income Tax Act.
Recently in the case of Prism Cements Ltd v JCIT [(2006) 101 ITD 103 (Mum)] Tribunal held that if earnest money or advance amount received on account of issuance of debentures, were forfeited on account of non payment of call money, the loan liability would only convert into a capital receipt. It would not assume the character of a revenue receipt or business receipt because the debentures were not issued in the course of regular business of the assessee.
It therefore appears, from the above discussion, there exists conflicting decisions but it seems to tilts towards the view that the remission of unsecured loans will be outside the purview of the section 28(iv) and 41(1) of the Income Tax Act. Any other views/clarifications, of the readers are invited.