By TIOL News Service:

CHENNAI, APRIL 26, 2016: THE ISSUE IS - Whether the amount representing the principal loan amount waived by the bank under one time settlement scheme which the assessee received during course of its business, constitutes income u/s 28(iv) in the hands of assessee and hence, liable to tax under I-T Act. YES, is the answer.

Facts of the case:

The assessee had filed its return for the AY 2006-07 admitting a total loss of Rs.2,42,20,780/-. The case was selected for scrutiny and a notice u/s 143(2) and 142(1) was issued, wherein it was found by the AO that the assessee was indebted to the Indian Bank. By a letter, the Indian Bank mooted a proposal for a one time settlement at Rs.10.50 Crores and the amount had to be paid on or before 30.4.2006. The assessee however paid only a sum of Rs.93,89,000/-. During assessment, the AO was of the view that since the assessee accepted the one time settlement scheme, they should have shown the entire interest waived by the bank as income u/s 41(1) on accrual basis. The AO found that the total amount waived was Rs.10.50 Crores and that as per the assessee's accounts, the total interest and principal waived worked out to Rs.9,29,32,594/-, which left a difference of Rs.1,20,67,406/-. Therefore, this difference was directed to be treated as income u/s 28(iv). On appeal, the CIT(A) found that the one time settlement scheme was accepted by the assessee in the F.Y 2005-06, but the assessee paid only Rs.17.21 lakhs as against Rs.10.50 Crores required to be paid. Therefore, the One Time Settlement sanctioned, lapsed. However, in the F.Y 2006-07, the assessee complied with the terms of One Time Settlement and obtained a No Due Certificate from the bank. Under such circumstances, the CIT(A) held that the merer acceptance of the conditional offer of the Indian Bank under the One Time Settlement Scheme, without complying with the substantive part of the terms and conditions, would not give a vested right of waiver. Therefore, the CIT(A) held that the interest waived to the extent of Rs.1.68 Crores was eligible to tax u/s 41(1). On the issue of interest not paid u/s 43-B, the CIT(A) held that it was wrong on the part of the AO to conclude that the payment of Rs.93,89,844/- was just a book entry. On the issue of addition of Rs.4,79,45,628/- u/s 28(iv), the CIT(A) held that Section 28(iv) had no application to cases involving waiver of principal amounts of loans. On further appeal, on the only issue namely the deletion of the principal portion of the term loan waived by the bank, the Tribunal held that the term loan had admittedly been used by the assessee for acquiring capital assets, hence was not exigible to tax.

After hearing the parties, the High Court had held:

1. It is seen that a distinction is sought to be made between the waiver of a portion of the loan taken for the purpose of acquiring capital assets on the one hand and the the waiver of a portion of the loan taken for the purpose of trading activities on the other hand. It appears that in so far as accounting practices are concerned, no such distinction exists. Irrespective of the purpose for which, a loan is availed by an assessee, the amount of loan is always treated as a liability and it gets reflected in the balance sheet as such. When a repayment is made in monthly, quarterly, half yearly or yearly instalments, the instalment is divided into two components, one relating to interest and another relating to a portion of the principal. To the extent of the principal repaid, the liability as reflected in the balance sheet gets reduced. The interest paid on the principal amount of loan, will be allowed as deduction, in computing the income under the head "profits and gains of business or profession", as per the provisions of the Act. But, Section 36(1)(iii) makes a distinction. The amount of interest paid in respect of capital borrowed for the purpose of business or profession is allowed as deduction u/s 36(1)(iii), in computing the income referred to u/s 28. But, the proviso thereunder states that any amount of interest paid in respect of capital borrowed for acquisition of an asset for extension of existing business or profession, whether capitalised in the books of account or not for any period beginning from the date on which the capital was borrowed for the acquisition of the asset, till the date on which such asset was put to use, shall not be allowed as deduction.

2. It is clear that the moment the asset is put to use, the interest paid in respect of the capital borrowed for acquiring the asset, could be allowed as deduction. When the loan amount borrowed for acquiring an asset gets wiped off by repayment, two entries are made in the books of account, one in the profit and loss account where payments are entered and another in the balance sheet where the amount of unrepaid loan is reflected on the side of the liability. But, when a portion of the loan is reduced, not by repayment, but by the lender writing it off, only one entry gets into the books, as a natural entry. A double entry system of accounting will not permit of one entry. Therefore, when a portion of the loan is waived, the total amount of loan shown on the liabilities side of the balance sheet is reduced and the amount shown as Capital Reserves, is increased to the extent of waiver. Alternatively, the amount representing the waived portion of the loan is shown as a capital receipt in the profit and loss account itself.

(See 2016-TIOL-830-HC-MAD-IT)