A proposed amendment in the Finance Bill, 2023, may lead to taxation of loan waivers in the hands of borrowing entities, even if the loan is being utilised for capex purposes.
Such loan waivers could be taxed at 22% plus the applicable surcharge and cess under the new tax rate for domestic companies. This could have far-reaching consequences for stressed assets, in particular IBC transactions, as every such matter invariably involves large haircuts on loans, which will now be taxable. One of the chief incentives for IBC transactions are tax losses that can be offset against income earned by companies.
The Bill seeks to amend Section 28(iv) of the Income Tax Act to provide that the said clause applies to cases where benefit or perquisite provided is in cash or kind or partly in cash and partly in kind. The amendment seems to be planned to align with the provision of Section 194R of the I-T Act, which was inserted by Finance Act, 2022.
This effectively overturns a 2018 ruling by the Supreme Court in the matter of CIT versus Mahindra
“Loan waivers will now be taxable,” said Vaibhav Gupta, partner, Dhruva Advisors. “This is likely to have far-reaching consequences in IBC matters. Even if the target company has tax losses to offset this waiver income, it will reduce valuations offered by bidders, since every bidder would factor the benefit of the available tax losses in their resolution plan. The government should consider carving out an exception for loan waivers pursuant to resolution plans approved by the NCLT.”
There are various instances of stressed assets, where banks take a haircut on the loan provided to the stressed entity, resulting in a write-back of such loan amount waived in the hands of the borrowing stressed entity.
“The loan settlement or waiver by banks for IBC cases should not be treated as taxable income for the stressed entities as taxing the same may make acquisition of such IBC entities unviable,” said Smit Sheth, partner, Price Waterhouse & Co.
He said a specific exclusion should be provided for this in Section 28(iv). “Waiver of loans utilised for capex purposes should be specifically carved out from Section 28(iv) provisions, considering they are in the nature of capital receipts,” Sheth said.
Let’s say a company takes a loan of `100 at 8% per annum, which it uses to buy capital assets. After three years, it pays interest of `24, which is claimed as deduction. Let’s assume that no principal has been repaid so far. At the end of three years, the lender waives `50 and the balance loan continues on the same terms. In this case, the principal component of `50 will become taxable under the amended Section 28(iv). If the lender waives the proportionate interest component as well, the company will have to pay tax on `62 (the principal component plus half of the interest paid).
The benefit or perquisite to be taxable in Section 28(iv) needs to be “arising from business”. “It can be contended that the … loan waiver would be taxable only if the borrowing entity is engaged in money lending or business of obtaining or granting of loans and not otherwise. This, however, could be a matter of intense litigation,” said a tax expert.
Experts believe that the government should bring more clarity on the matter to obviate unnecessary and protracted litigation. The Centre could either exclude applicability of Section 28(iv) in case of stressed assets under IBC or restrict the provision only to trading benefit and perquisite arising from business or exercise of profession, and provide a specific carve out for capital receipts.