Supreme Court clarifies taxability of loan waivers: Mahindra & Mahindra Ltd. Case (24 April 2018)

LEGAL ISSUE: Whether a loan waiver constitutes taxable income under the Income Tax Act, 1961.

CASE TYPE: Income Tax Law.

Case Name: The Commissioner vs. Mahindra and Mahindra Ltd.

Judgment Date: 24 April 2018

Introduction

Date of the Judgment: 24 April 2018

Citation: (2018) INSC 349

Judges: R.K. Agrawal, J. and Abhay Manohar Sapre, J.

Can a loan waiver be considered as income and therefore be taxed? The Supreme Court of India recently addressed this question in a case involving Mahindra and Mahindra Ltd., clarifying the circumstances under which a loan waiver can be taxed under the Income Tax Act, 1961. This judgment clarifies the scope of Sections 28(iv) and 41(1) of the Income Tax Act, 1961. The bench comprised of Justice R.K. Agrawal and Justice Abhay Manohar Sapre, with the judgment authored by Justice R.K. Agrawal.

Case Background

Mahindra & Mahindra Ltd. (the Respondent), sought to expand its product line by including FC-150 and FC-170 models. On 18 June 1964, it entered into an agreement with Kaiser Jeep Corporation (KJC), an American company, to purchase dies, welding equipment, and die models for $650,000. This price included cost, insurance, and freight (CIF). KJC agreed to provide a loan to the Respondent at a 6% interest rate, repayable in installments after 10 years. The Reserve Bank of India (RBI) and the concerned Ministry approved the loan agreement.

Later, American Motor Corporation (AMC) took over KJC and waived the principal amount of the loan. This waiver was communicated to the Respondent on 17 February 1976. The Respondent, in its return filed on 30 June 1976, showed Rs. 57,74,064 as cessation of liability towards AMC. The Income Tax Officer (ITO) concluded that the waiver of the loan was income and taxable under Section 28 of the Income Tax Act, 1961.

The Commissioner of Income Tax (Appeals) upheld the ITO’s order on 23 March 1981. Subsequently, the Income Tax Appellate Tribunal (the Tribunal) set aside the order of the CIT (Appeals) on 16 August 1982, favoring the Respondent. The High Court of Judicature at Bombay confirmed the Tribunal’s findings on 29 January 2003. The Revenue then appealed to the Supreme Court.

Timeline

Course of Proceedings

The Income Tax Officer (ITO) initially determined that the loan waiver amount was taxable under Section 28 of the Income Tax Act, 1961. The Commissioner of Income Tax (Appeals) upheld this decision with minor modifications. However, the Income Tax Appellate Tribunal (the Tribunal) overturned these decisions, ruling in favor of the Respondent. The High Court of Judicature at Bombay upheld the Tribunal’s decision. Subsequently, the Revenue appealed to the Supreme Court.

Legal Framework

The Supreme Court examined the applicability of Section 28(iv) and Section 41(1) of the Income Tax Act, 1961.

Section 28 of the Income Tax Act, 1961, defines the profits and gains of business or profession that are chargeable to income tax. Specifically, Section 28(iv) states:

“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 profession”,–
x x x
(iv) the value of any benefit or perquisite, whether convertible into money or not, arising from business or the exercise of a profession;
x x x”

Section 41(1) of the Income Tax Act, 1961, deals with profits chargeable to tax, particularly in cases where an allowance or deduction has been claimed earlier. It states:

“41. Profits chargeable to tax .- (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; or
x x x”

Arguments

Revenue’s Arguments:

• The Revenue contended that the loan waiver of Rs. 57,47,064 received by the Respondent from American Motor Corporation, was a benefit that should be treated as income.
• The waiver was a form of compensation for losses, goodwill, and the change in shareholding, and should not be exempt from taxation.
• The Revenue argued that since the amount was waived, it amounted to income for the Respondent, as it was no longer required to be paid.
• The Revenue argued that the case fell under Section 28(iv) or, alternatively, Section 41 of the Income Tax Act, 1961.

Respondent’s Arguments:

• The Respondent argued that the supply of tooling by Kaiser Jeep International Corporation (KJIC) and the loan by Kaiser Jeep Corporation (KJC) were independent transactions.
• The relationship between KJC and the Respondent was that of lender and borrower, not a purchase of goods on credit.
• The amount of $650,000 was a loan on which interest was regularly paid.
• The loan was shown as “Loans-unsecured” in the Respondent’s balance sheet.
• The waiver was a capital receipt and not in the nature of income.
• The Respondent argued that the loan waiver was not a trading liability, and therefore, Section 41(1) of the IT Act did not apply.

Issues Framed by the Supreme Court

The main issue for consideration was:

✓ Whether the sum of Rs. 57,74,064, waived by the lender (American Motor Corporation), constitutes taxable income for the Respondent.

Treatment of the Issue by the Court

Authorities

The Court considered the following legal provisions:

• Section 28(iv) of the Income Tax Act, 1961: This section deals with the taxation of benefits or perquisites arising from business or profession.
• Section 41(1) of the Income Tax Act, 1961: This section deals with the taxation of profits where an allowance or deduction has been claimed earlier and a liability is later remitted.

Judgment

How each authority was viewed by the Court?

✓ Section 28(iv) of the Income Tax Act, 1961: The Court held that this section was not applicable since the receipts of Rs 57,74,064 were in the nature of cash or money.

✓ Section 41(1) of the Income Tax Act, 1961: The Court held that this section was not applicable as the waiver of loan does not amount to cessation of trading liability. It was also noted that the Respondent had not claimed any deduction under Section 36(1)(iii) of the IT Act for the payment of interest.

What weighed in the mind of the Court?

The Supreme Court’s decision was primarily influenced by the nature of the loan waiver, and whether it could be classified as a benefit or perquisite under Section 28(iv) or a remission of trading liability under Section 41(1) of the Income Tax Act, 1961. The Court emphasized that the waiver was a cash receipt, and therefore, not a benefit or perquisite as contemplated under Section 28(iv). Additionally, the Court noted that the loan was not a trading liability and no deduction had been claimed for interest payments, thus Section 41(1) was also inapplicable.

The court’s reasoning was based on the following points:

The Court considered the arguments and legal provisions and concluded that the loan waiver was not taxable under either Section 28(iv) or Section 41(1) of the Income Tax Act, 1961. The court emphasized that the receipt was in the form of cash, not a benefit or perquisite, and that the loan was not a trading liability.

The court stated:

“In the present case, it is a matter of record that the amount of Rs. 57,74,064/- is having received as cash receipt due to the waiver of loan. Therefore, the very first condition of Section 28 (iv) of the IT Act which says any benefit or perquisite arising from the business shall be in the form of benefit or perquisite other than in the shape of money, is not satisfied in the present case.”

The Court further clarified:

“It is undisputed fact that the Respondent had been paying interest at 6 % per annum to the KJC as per the contract but the assessee never claimed deduction for payment of interest under Section 36 (1) (iii) of the IT Act… the deduction claimed by the Respondent in previous assessment years was due to the deprecation of the machine and not on the interest paid by it.”

The Court also noted:

“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 bench was unanimous in its decision.

Key Takeaways

• A loan waiver received in cash is not considered a benefit or perquisite under Section 28(iv) of the Income Tax Act, 1961.
• Section 41(1) of the Income Tax Act, 1961, applies only to the remission of trading liabilities, not other liabilities.
• If no deduction has been claimed for interest payments, the waiver of a loan is not taxable under Section 41(1) of the Income Tax Act, 1961.
• This judgment clarifies the scope of Sections 28(iv) and 41(1) of the Income Tax Act, 1961, providing guidance on the taxability of loan waivers.

Directions

No specific directions were given by the Supreme Court in this case.

Development of Law

The ratio decidendi of this case is that a loan waiver received in cash is not taxable under Section 28(iv) of the Income Tax Act, 1961, and Section 41(1) of the Income Tax Act, 1961, applies only to trading liabilities where a deduction has been claimed. This case clarifies the taxability of loan waivers, providing a clear distinction between capital and trading liabilities.

Conclusion

The Supreme Court dismissed the appeals, holding that the loan waiver received by Mahindra & Mahindra Ltd. was not taxable under Section 28(iv) or Section 41(1) of the Income Tax Act, 1961. The Court clarified that cash receipts from loan waivers do not fall under Section 28(iv), and Section 41(1) applies only to trading liabilities, which this loan was not. This judgment provides important clarity on the tax treatment of loan waivers.