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Supreme Court Ruling on Loan Waivers Likely to Benefit Insolvent Companies

A bench comprising of Justice R.K. Agrawal and Justice Abhay Manohar Sapre in The Commissioner vs. Mahindra and Mahindra Ltd. in Civil Appeal Nos. 6949-6950 of 2004 have confirmed the decision of the Bombay High Court in the case of Mahindra & Mahindra Limited, deciding the matter in favour of the company.

The Supreme Court on 24th April, 2018 decided in holding that the waiver of loan is not income in the hands of the borrower could not have come at a more opportune time, given the large number of cases under the Insolvency and Bankruptcy Code, 2016 (IBC) where such waivers are being sought and granted. The Supreme Court in its decision in the case of Mahindra & Mahindra Limited has dismissed the income-tax department's appeal in a batch of 23 cases, and has held that the waiver of a loan cannot be subject to income tax in the hands of the borrower. A bench comprising of Justice R.K. Agrawal and Justice Abhay Manohar Sapre have confirmed the decision of the Bombay High Court in the case of Mahindra & Mahindra Limited, deciding the matter in favour of the company.

Mahindra & Mahindra Limited, in the present case, had borrowed funds from the supplier for the purpose of acquiring certain capital assets. The loan agreement was approved by Reserve Bank of India and the concerned ministry of the government. The company had regularly paid interest on the loan. Subsequently, for various commercial reasons, the lender agreed to waive off the principal amount of the loan granted to the company. The loan amount, even though written back, was not offered to tax as income by the company, with the company treating it as capital receipt. The income-tax authorities taxed the loan write-back, alleging that on the waiver of the loan, the company stood benefited and the same constituted income under section 28(iv) of the Income-Tax (IT) Act. Section 28(iv) seeks to tax value of any benefit or perquisite arising from business or profession.

The tax authorities had also claimed that the remission of loan liability was even taxable as per provisions of section 41(1) of the IT Act. Section 41(1) brings to tax any benefit received in respect of loss or expenditure, or by way of remission or cessation of trading liability, where an allowance or deduction in respect of such loss, or expenditure, or trading liability, has been made. The Supreme Court noted that the term loan generally refers to borrowing something, especially cash, that is to be paid back along with the interest as mutually decided. Any waiver by the lender results in the borrower having extra cash in his hand. The first issue that the Supreme Court examined was the taxability of such a waiver as income under section 28(iv).

The court held that in order to consider the waiver of a loan as business income under section 28(iv), it should arise from ‘business or profession’ and that the benefit should be in some form, other than the form of money. As the loan waiver constituted benefit in the form of money, the Supreme Court held that it cannot be taxed as income under section 28(iv). The next issue examined by the Supreme Court was whether the waiver was taxable as income under section 41(1). It held that for section 41(1) to apply, the remission should be of a trading liability and that the waiver of a loan amounts to cessation of a liability, other than that of a trading liability.

Further, it also highlighted that as no deduction was claimed in respect of interest (a specific fact of the given case), therefore the claim of the income-tax department to tax the same under section 41(1) was incorrect. The facts in respect of the other 22 cases have not been specifically discussed in the judgement. One of the connected appeals was against the decision of the Delhi High Court, which had held that a waiver of working capital facilities was taxable under section 41(1). The decision of the Delhi high Court is accordingly reversed and thereby a waiver of working capital facilities will implicitly not be taxable.

This is an important ruling bringing to rest the long-standing debate over the taxability of write-backs of loan. The ruling will also have a positive impact on the cases under the IBC. Debt waiver is an integral part of the resolution process under the IBC. The debt waiver sought and granted under the IBC may cover waivers or haircuts in respect of term loans, working capital facilities, and also current liabilities for goods and services. The tax implications on such waivers / haircuts are a matter of concern for prospective bidders and / or the entities against whom the IBC proceedings have been initiated and are suitably factored in at the time of making bids.

The decision does not deal with the issue of taxability of loan write backs under the Minimum Alternate Tax (MAT) provisions. The implications of such waivers / haircuts under MAT provisions in the cases of companies adopting Ind AS is quite complicated and may require a separate discussion altogether. The government must consider clarifying this aspect as it would facilitate the smoother and faster revival of insolvent companies, and would contribute at large to the success of the IBC.

NCLT Advises IBBI on the Need to Review the Insolvency and Bankruptcy Code to Protect Interest of Operational Creditors

The Hon'ble NCLT, Kolkata on 02nd May, 2018 vide application number CA(IB)No.201/KB/2018,CA(IB)No.234/KB/2018 and CA(IB)No.245/KB/2018 suggested to Insolvency and Bankruptcy Board of India that there is a need to review the insolvency code regulations to ensure that they are not "misused or misinterpreted".

It also said that the resolution professional should be competent and independent so that there are no interruptions in the process which lead to delays in disposal of insolvency cases. Besides, it has said the claims of operational creditors are neglected or ignored as the Committee of Creditors has supremacy of the financial creditors (banks and financial institutions) who have control over the entire process.

Nobody is taking care of operational creditors' claim, said the NCLT Kolkata Bench in its order passed last week on the Binani Cement matter. "It is time to recognise their voice also in the committee of creditors," it said, suggesting changes to the IBBI.

In the 60-page order, the tribunal has also raised concern about the functioning of RPs, saying it has been receiving several pleas from stakeholders on issues such as transparency, arbitrariness and delays in the process. The adjudicating authority is facing too much interruption from various stakeholders. Till date we have never come across any frivolous application. All come with a genuine grievance. All challenge the independence of the resolution professional and lack of transparency, competency and arbitrariness in the matter of resolution process.

While citing Binani Cement case, the tribunal said: "In the case in hand, 12 applicants came forward ...for not following the process mandated under the code by the resolution process. The arbitrary way of dealing with the cases has always led to interruptions and also caused delay in disposal of cases."

According to NCLT, while there is a need for reforming the regulations of the insolvency code to ensure that it is not misused or misinterpreted, there can not be any question that independence and competency of RPs are essential for preserving the objective of the code in a transparent manner leaving no room for interruption from any corner. The NCLT Bench of Member-Judicial Madan B Gosavi and Jinan K R said: "Hopefully, we believe that IBBI take note of all the above observations and do the needful review of the code and regulation."

Referring to the Binani Cement case, NCLT said here the RP is a chartered accountant by profession and he failed to take business decisions to run the corporate debtor on his own. He managed to run the company by appointing about 22 representatives, who are from his own partnership. A resolution professional, like the RP in a case of this nature, needs some basic training for handling the resolution independently, efficiently and tackle the multiple questions from different stakeholders, said NCLT order, passed on May 2.

"Whenever a question arises, even if answerable by the RP independently or with advice from his advisors, he comes to adjudicating authority... He shifts that burden too to the adjudicating authority," the bench said.

11 May 2018
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