Taxability of Loan Waivers: Amount not taxable on receipt changes colour when it becomes assessee’s own money

Two questions of taxability arise when a loan is waived off –

1. Whether the interest waived off is revenue receipt or capital receipt
2. Whether the principal waived off is revenue receipt or capital receipt

The principle laid down by The Hon’ble Supreme Court in this regard in the case of CIT Vs. TV Sundaram Iyengar & Sons Ltd - 1996 (9) TMI 1 - SUPREME COURT was that in case an amount is received for working capital purpose, even though it is not taxable in the year of receipt as being of revenue character, the amount changes its character when the amount becomes the assessee's own money because of limitation or by any other statutory or contractual right. However, the Hon'ble Supreme Court in the case of CIT vs. Mahindra & Mahindra (2018 (5) TMI 358 - SUPREME COURT) has held that wherein it has been held that in a case of a term loan barrowed for acquisition of capital assets, any interest or principal waiver relating to the principal amount cannot be brought to tax either u/s. 28(iv) of the Act, or u/s. 41(1) of the Act.

Now again the definition of “income” as per Section 2(24)(viii) includes –

“Assistance in the form of a subsidy or grant or cash incentive or duty drawback or waiver or concession or reimbursement (by whatever name called) by the Central Government or a State Government or any authority or body or agency in cash or kind to the assessee other than, -

1. the subsidy or grant or reimbursement which is taken into account for determination of the actual cost of the asset in accordance with the provisions of Explanation 10 to clause (1) of section 43; or
2. the subsidy or grant by the Central Government for the purpose of the corpus of a trust or institution established by the Central Government or a State Government, as the case may be;];”

Again Section 28(iv) requires that 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 arising from business or the exercise of a profession, whether—

1. convertible into money or not; or
2. in cash or in kind or partly in cash and partly in kind;]

Further while clarifying on TDS u/s 194R vide Circular 18/2022, dated 13 September 2022, The CBDT laid down that TDS u/s 194R was not applicable in case of loan waiver by specified institutions. However, it made it very clear that this clarification is only for the purposes of section 194R of the Act. The treatment of such settlement/waiver in the hands of the person who had got benefitted by such waiver would not be impacted by this clarification. Taxability of such settlement/waiver in the hands of the beneficiary will be governed by the relevant provisions of the Act.

Therefore, to answer the questions framed above, we refer squarely to the decision of The Hon’ble ITAT in the case of SHARE MICROFIN LTD Vs DY. C. I. T. CIRCLE 3(1) HYDERABAD [2023 (6) TMI 1209 - ITAT HYDERABAD] and frame our answers as follows –

1. Interest on a loan which is earlier debited to P/L A/c will be added to the income in the year of waiver of repayment. However, the interest which was earlier capitalised, and in the year of waiver the same is written off from the value of the asset, would be treated as a capital receipt.
2. The purpose test has to be applied on the principal loan amount. In case the principal was taken for working capital purposes, then the loan waiver would be taxed as a revenue receipt. In case the principal was taken on capital account, then the loan waiver would be taxed as a capital receipt.

Hence the “purpose” for which the loan is taken is material (capital expenditure or revenue expenditure). In case the loan is taken to run day to day operations, then its waiver is a ‘revenue receipt’ and in case it is for expansion of an undertaking then it is ‘capital receipt’.