KPMG Flash News 24 March 2011

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1 KPMG IN INDIA KPMG Flash News 24 March 2011 TAX Delhi High Court rules that taxability in the context of waiver of loan amount would depend upon the purpose for which the loan was taken Recently, the Delhi High Court (High Court) in the case of Logitronics Pvt. Ltd. and Jubilant Securities Pvt. Ltd. 1 held that in the context of waiver of loan amount, taxability would depend upon the purpose for which the loan was taken. Waiver of loan taken for acquiring a capital asset would not result in income exigible to tax. However, waiver of loan availed for trading purpose, results in the income taxable under the Income-tax Act, 1961(the Act). Logitronics Pvt. Ltd. Facts of the case The taxpayer was a company engaged in the business of manufacturing of electronic products and had availed a loan from State Bank of India (SBI). Since the taxpayer could not discharge its liability for specific time, the SBI categorized this loan as Non- Performing Asset (NPA). The taxpayer entered into a settlement with the SBI, pursuant to the entire amount of interest and part of principal amount outstanding was waived. While the taxpayer offered the interest waived to tax, the principal amount waived was directly taken to balance sheet under the head capital reserve and was not offered to tax relying upon the decision of the Delhi High Court in the case of Tosha International Ltd 2. 1 Logitronics Pvt. Ltd v. CIT (ITA no of 2010) & CIT v. Jubilant Securities Pvt. Ltd. (ITA No. 503 of 2010) (Judgement date: 18 February 2011) 2 CIT v. Tosha International Ltd. [2009] 176 Taxman 187 (Del) 1

2 The Assessing Officer (AO) held that even waiver of principal amount of loan was taxable. The Income-tax Appellate Tribunal (the Tribunal) restored the matter back to the AO for ascertaining the purpose for which the loan was used. Tax department s contentions When the taxpayer ceases to be liable to pay something that he was legally bound to pay, then he gains the amount that he was bound to pay. Therefore, principal amount of loan written off was gain/income in the hands of the taxpayer. The claim of the bank was alive prior to settlement, and since income accrued pursuant to the waiver of loan, it must be recognized in the period during which settlement took place. Judgment in the case of Tosha International Ltd. was distinguishable because it held that principal amount written off was not taxable under Section 41(1) of the Act. However, it was not held that such income was exempt from tax. Income was taxable under the head profit and gains of business and profession because loan was taken for the purpose of business and one time settlement was an integral part of the business. Jubilant Securities Pvt. Ltd. Facts of the case The taxpayer was an investment company engaged in the business of sale/purchase of shares and business of taking loans and further providing it to the parties. The taxpayer had taken loan from Sail Holdings Pvt. Ltd. more than 10 years ago. Since there was no communication from the party and no claim was made for so many years the loan was written back. The taxpayer had credited a sum of INR 2.5 million to its Profit and Loss Account on account of remission of liability with respect of certain unsecured loans. It was treated as capital receipt and was reduced from taxable income in the computation of assessable income for the assessment year in question. AO was of the view that the taxpayer had treated such write back as capital in nature without explaining as to how and in what manner such cash credited was transferred to the Profit and Loss Account. Accordingly, the AO held that the amount of INR 2.5 million as written off liability was the income of the taxpayer. 2

3 High Court ruling The High Court relied on the Supreme Court decision in the case of T.V. Sundaram Iyengar and Sons Ltd. 3 where the taxpayer in the course of trading transactions had collected deposits from customers. Since the customers did not claim the amounts standing to their credit, the taxpayer had transferred the unclaimed deposits to the profit and loss account. Accordingly the Supreme Court had held that even though the deposits were of capital in nature at the point of time of receipts they had changed their character change by afflux of time had attained the character of trading receipts. The Supreme Court in the case of T.V. Sundaram Iyengar referred to the decision in the case of Tattersall 4 wherein it was held that that the taxability of a receipt was fixed with reference to its character at the moment it was received and could not be altered subsequently. However, the Supreme Court noted that in the case of Jay s The Jewellers Ltd. 5 it was held that an amount received in course of trading transaction, even though not taxable in the year of receipt as being of revenue character, changes its character when the amount becomes the taxpayer s own money because of limitation or by any other statutory or contractual right and therefore the amount should be treated as income of the taxpayer. The Supreme Court in the case of Karam Chand Thapar 6 held that amounts which were not received initially as trading receipts could eventually be regarded as business income by reason of subsequent events. The Supreme Court in the case of The Travencore Rubber & Tea Co. Ltd. 7 held that the principle referred above in the case of Karam Chand Thapar would apply only if the subsequent event is such that a different quality is imprinted on the receipt otherwise the receipts would bear the same character. In the case of The Travencore Rubber & Tea Co. Ltd. the taxpayer entered in agreement for sale of rubber trees and benefited from forfeiture of advance (earnest) money. The Supreme Court held that the amounts forfeited referred only to capital asset of the taxpayer and therefore were capital receipts. The High Court referred to the decision of the Madras High Court in the case of Iskraemeco Regent Ltd. 8 wherein loan taken from bank for the purpose of capital asset was waived off and was held to be capital in nature. The Madras High Court further held that such a benefit can neither be treated as remission or cessation of trading liability nor can it be taxed as benefit arising from business. 3 CIT v. T.V. Sundaram Iyengar [1966] 222 ITR 344 (SC) 4 Morley (Inspector of Taxes) v. Tattersall [1939] 7 ITR 316 (CA) 5 Jay s The Jewellers Ltd. v. IRC (1947) 29 TC 247 (KB) 6 CIT v. Karam Chand Thapar [1996] 222 ITR 112 (SC) 7 The Travencore Rubber & Tea Co. Ltd. v. CIT [2000] 243 ITR 158 (SC) 8 Iskraemeco Regent Ltd.v. CIT [2011] 196 Taxman 103 (Mad) 3

4 Referring to above mentioned decisions, the High Court concluded that in the context of waiver of loan amount, taxability would depend upon the purpose for which the said loan was taken. If the loan was taken for acquiring the capital asset, waiver 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, the waiver may result in the income particularly when it was transferred to Profit and Loss account. Accordingly, the High Court in the case of Logitronics Pvt. Ltd. held that the Tribunal was right in remanding the matter back to AO for determining whether the loan was used for business trading or capital purpose. The High Court in the case of Jubilant Securities Pvt. Ltd. relying on Tribunal s finding held that the loan obtained by the taxpayer was not used in financing business but was rather used for long term investments in shares, held that the write back was not liable to tax. The High Court also noted that borrowed funds are source of funds and it can never be taxpayer s business to borrow or advance loans. Our Comments This is a welcome ruling by the Delhi High Court which states that in the context of waiver of loan amount, taxability would depend upon the purpose for which the loan was taken. If the loan was taken for acquiring the capital asset, waiver would not amount to any income exigible to tax. However, if loan was for trading purpose, the waiver results in the income taxable under the Act. It can also be inferred that the different accounting treatment adopted in the above cases would not be determinative of taxability of waiver of loans in the hands of the taxpayers. The High Court has considered a spectrum of decisions of various courts while arriving at the above conclusion. It is interesting to note that as per Direct Taxes Code, 2010 which is proposed to be operative from 1 April 2012, the amount of remission or cessation of any liability by way of loan, deposit, advance or credit has to be has included while calculating Gross Earnings for the purpose of computing profits from any business. 4

5 Bangalore Maruthi Infotech Centre, 11-12/1 Inner Ring Road Koramangala, Bangalore Phone: Fax: Chennai KPMG House No.10, Mahatma Gandhi Road, Nungambakkam High Road, Chennai Phone: Fax: Chandigarh SCO st Floor, Sector 8 C Madhya Marg Chandigarh Tel: Fax: Mumbai Lodha Excelus, Apollo mills compound, NM Joshi Marg, Mahalaxmi, Mumbai India Phone: Fax: Pune 703, 7th Floor Godrej Castlemaine, Next to Ruby Hall Clinic, Bund Garden Road, Pune Phone: /65 Fax: Kochi 4/F, Palal Towers, M. G. Road, Ravipuram, Kochi Phone: +91 (484) Fax: +91 (484) Delhi DLF Cyber City, Building no. 10, Block B, Phase II Gurgaon, Haryana Phone: Fax: Hyderabad KPMG, /2 Reliance Humsafar, 4th Floor Road No.11, Banjara Hills Hyderabad Phone: Fax: Kolkata KPMG Infinity Benchmark Plot No. G-1, 10th floor Block - EP & GP, Sector V, Salt Lake City Kolkata Phone: The information contained herein is of a general nature and is not intended to address the circumstances of 2011 KPMG, an Indian Partnership and a member firm any particular individual or entity. Although we endeavour to provide accurate and timely information, there of the KPMG network of independent member firms can be no guarantee 2011 that KPMG, such information an Indian Partnership is accurate as and of the a member date it is firm received of the or that KPMG it will network continue of to independent affiliated member with KPMG firms International affiliated with Cooperative ( KPMG be accurate in KPMG the future. International No one should Cooperative act on such ( KPMG information International ), without appropriate a Swiss professional entity. All rights advice reserved. International ), a Swiss entity. All rights reserved. after a thorough examination of the particular situation. 1

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