Why income tax levy when Loans are waived and Payables are ceased

Every business has Loans and Liabilities and everyone wants to pay it on time. Sometime situation arises where we are not able to repay it. So non-payment of loans and liabilities brings liability of Income Tax because Income Tax act treated it as your income.

Let’s take a brief look, how income tax is levy on cession of liabilities:

A Section 41 of income tax states that:

  • If deduction has been claimed as an expense in earlier year and
  • Liabilities is trading in nature, and
  • There are cessation of liabilities

Then above cessation may invite income tax.

There are hundreds of case laws on this section of which 2 transactions which generally taxed are given below:

  1. Working capital loan, that is subsequently waived
  2. Liabilities which have been on books for a very long time with little change

In CIT vs Chipsoft Technology Pvt Ltd, it was held that where the assessee has just continued the entry in his books of accounts without any intention to pay back the same, it should be added to his income u/s 41(1).

In CIT vs Vardhaman Overseas Ltd., it was held that unconfirmed creditor balance as per balance sheet cannot be taxed u/s 41(1) – Creditors’ balances remaining outstanding for over 4 years not taxable u/s 41(1), even if no balance confirmation available; Disclosure of creditors’ balance in balance sheet amounts to acknowledgment of debt and fresh limitation period applicable under the Limitation Act ; Specific provision u/s 41(1) to prevail over general provision u/s 28(iv).

In Income tax act, Each and every transaction has its own implication, So companies needs to give due consideration to the waivers.

Section 41(1) of Income Tax Act:

Profits chargeable to tax.

41. (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

(b)  the successor in business has obtained, whether in cash or in any other manner whatsoever, any amount in respect of which loss or expenditure was incurred by the first-mentioned person or some benefit in respect of the trading liability referred to in clause (a) by way of remission or cessation thereof, the amount obtained by the successor in business or the value of benefit accruing to the successor in business shall be deemed to be profits and gains of the business or profession, and accordingly chargeable to income-tax as the income of that previous year.

Explanation 1.—For the purposes of this sub-section, the expression “loss or expenditure or some benefit in respect of any such trading liability by way of remission or cessation thereof” shall include the remission or cessation of any liability by a unilateral act by the first-mentioned person under clause (a) or the successor in business under clause (b) of that sub-section by way of writing off such liability in his accounts.

Explanation 2.—For the purposes of this sub-section, “successor in business” means,—

 (i)  where there has been an amalgamation of a company with another company, the amalgamated company;

(ii)  where the first-mentioned person is succeeded by any other person in that business or profession, the other person;

(iii) where a firm carrying on a business or profession is succeeded by another firm, the other firm;

(iv) where there has been a demerger, the resulting company.

 

 

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