THE ITO, CORPORATE WD-2(4), KOCHI vs. M/S.TEAM FRONT LINE LTD, KOCHI

Per CHANDRA POOJARI, AM:

The appeal filed by the Revenue is directed against the order of the CIT(A)-I,

Kochi dated 31/07/2018 and pertain to the assessment year 2015-16.

I.T.A. No.502/Coch/2018 with the issue as to whether the waiver of principal portion of loan which was taken for purchase of capital assets is taxable in the hands of the borrower and is not applicable to the facts of the present case.

limited Company on 13.6.1996 and converted to public limited Company on

11.2.200S. The Company was initially incorporated by Mr S.R.Nair, Mrs.Saleena Nair

and Mr. Venkitachalam. Mr. Venkitachalam left the Company in few years. The other

two promoters were holding 50% of shares of the Company. The Company was

dealing in sales and services of computers and computer relating systems,

networking, integration and implantation of software. Since computer business

industry was not doing well, the Directors sold their shares in the company to three

of its employees. Accordingly, they entered into an agreement and all the assets

and liabilities were taken over by the outgoing shareholders, including bank loan

and personal loan of the Directors. The writing off of the unsecured loan of

Rs.1,59,25,662/-, is a nomenclature error, it is only the taking over of certain loans,

loss, assets, debtors and creditors from the company by the outgoing partners,

I.T.A. No.502/Coch/2018 since incoming partners don't want to take the liability of such items which is

doubtful or not realizable. .

3.1 On going through the agreement dated 28.2.2015 made between the outgoing

partners and incoming shareholders, the Assessing Officer found that the outgoing

shareholders had taken over some of the assets and liabilities of the company to

effect the takeover of the Company by the existing Directors. After the above

adjustments, outgoing shareholders, Shri S.R.Nair and Smt. Saleena Nair agreed to

set off the accumulated loss of the company against their loan outstanding with the

assessee company which was Rs.31,08,832/-and 1,14,87,737/- respectively. The

third outgoing shareholder M/s.Peso Infrastructures P Ltd agreed to waive the loan

of Rs. 15,37,304/- which was given by them to the assessee company. The total

amount set off/waived came to Rs. 1,61,33,873/-. However, the amount added to

the Reserve and Surplus during the year as waiver of loan was only

Rs.1,59,25,662/-. By adjusting the above amount of Rs. 1,59,25,662/-, the

accumulated loss as per the Reserve and Surplus of the company reduced to Rs.

19,04,681/- from the loss of Rs.1,78,30,343/- as shown below :

Opening balance as on 1.4.2015 9599464(-) Add: current year profit Profit as per P&L 3387396(-) Stock written off due to taken over 4843483 8230879(-)

17830343 Add : Loan written of by the shareholders 15925662(+) Reserve & Surplus as on 31/03/2015 19,04,681(-)

I.T.A. No.502/Coch/2018 3.2 The Assessing Officer noticed that the amount credited to the reserves

becomes a part of shareholder's fund and these balances together with the capital

constitute the net worth of the Company. Accordingly, it was noticed that by

reducing the loss, the company had gained that much money. According to the

Assessing Officer, the assessee could not prove the source of credit of Rs.20 lakhs

on 11.11.2014 as loan from Smt. Saleena Nair. The assesses failed to substantiate

the amount of Rs.90 lakhs credited to Shaleena's account on 6.11.2014, which was

transferred to assessee's account on 7.11.2014 accounted as loan. So, the entire

amount of Rs.11000000/- brought into assessee's business as loan from Smt.

Shaleena Nair was treated as assessee's own money and whatever liability was

outstanding as on 1.4.2014, apart from Director's loan, it was met by the assessee's

own money. Hence, the Assessing Officer assessed the amount of Rs. 15925662/-

added to the Reserve & Surplus during the year as loan waiver as income of the

assessee.

Srnt.Shleena Nair and M/s Peso Infrastructure Pvt Ltd waived the loan given to the

assessee company of Rs.31,08,832/-, Rs.1,14,87,737/- and Rs.15,37,304/-

respectively totalling to Rs.1,61,33,873/-, However, total amount added to the

Reserve & Surplus during he year as waiver of loan was Rs.1,59,25,662/- only,

which the Assessing decided to add to the total income of the assessee company.

Because of this waiver of loan, the accumulated loss of the assessee company got

reduced to Rs.10,19,04,681/- from the loss of Rs.1,78,30,343/-. Before the CIT(A),

I.T.A. No.502/Coch/2018 the Ld. AR contended that loan from Director was on the capital account and was

not claimed as expenses and it was not a trade or revenue liability which was

waived and therefore the same cannot be added u/s. 41(1) for cessation of liability

to the total income of the assessee. The Ld. AR contended that benefit from a loan

liability is not covered u/s 41(1) of the Act and to support his contention, he placed

reliance on the decision of Hon'ble Bombay High Court in the case of Mahindra &

Mahindra Ltd Vs CIT (261 ITR 501), which has been recently confirmed by

Supreme Court in May, 2018.

“Capital asset loan waiver neither perquisite u/s 28(jv) nor cessation of trading liability. “

4.1 The CIT(A) agreed with the contention of the assessee and held that the

waiver of loan by a Director of the Company cannot be treated as income of the

assessee as waiver was on capital account and the same had never been claimed

as expenditure and therefore, under these circumstances, provisions under section

41(1) cannot be invoked. Thus, the CIT(A) deleted the addition of Rs. 1,59,25,662/-

submitted that the loans taken from the shareholders were towards funding the

working capital requirements of the assessee company and upon waiver, the

amount of loan was retained in the business by the assessee and therefore, it is to

be treated as taxable income of the assessee company. He further submitted that

the assessee had become richer by this amount in the course of carrying on its

business and, therefore, in the light of the decision of Apex Court in the case of CIT 5

I.T.A. No.502/Coch/2018 vs T.V. Sundaram Iyengar & Sons Ltd, 220 ITR 344 (SC), this amount is liable to be

included as income of the assessee, notwithstanding the fact that this amount was

not includible in the income at the time when it was received.

company had written back the loan from directors amounting to Rs.1,59,25,662/-

which the assessing officer had added stating that cessation of liability is taxable.

The CIT(A) after considering the facts in detail allowed the claim of the assessee

based on the latest decision of the Apex Court in Mahindra & Mahindra (404 ITR 1).

Regarding the contention of the revenue that loan waived which was not taken for

purchase of capital asset would constitute income, as per judgment of the Apex

Court in the case of CIT Vs T V Sundaram lyengar and Sons Ltd. (222 ITR 344),

deposit received during the course of business which was no longer repayable was

assessed as income. In the assessee’s case the waiver was loan from directors and

not deposit received in the course of business.

6.1 The Ld. AR submitted that the issues in the case relied on by the CIT (A) are

different and, therefore, not applicable in the present case .In this case, the Apex

Court had considered the applicability of section 28(iv) in relation to loan waived.

With regard to the question of application of section 28 (iv) in relation to waiver of

loan, the Apex Court had held in the case of Mahindra and Mahindra (supra) that

section 28 (iv) of the IT Act cannot be applied in the case considered since the

receipts are in the nature of cash or money. It was submitted that in the case of

I.T.A. No.502/Coch/2018 Mahindra and Mahindra loan received from one Kaiser Jeep Corporation which was

used for acquiring capital asset was waived by the lender and the assessing officer

assessed the waived amount as income u/s 28 (iv) of the Act. On appeal by the

Revenue against High Court order, the Apex Court had declined to interfere with the

judgment of the High court in view of the reasons that section 28 (iv) of the Act did

not apply if the receipts are in the nature of cash or money and held that the

utilisation of loan (whether for purchase of asset or for working capital purpose ..

etc.) is irrelevant to decide the applicability of section 28 (iv) in respect of receipt in

the nature of cash or money. It was submitted that in the present case, loan from

directors was received in cash and on waiver of loan the assessee became owner of

money received as loan. Moreover, according to the Ld. AR, the receipt of loan in

the form of cash is not in dispute at any stage of assessment proceedings. Hence, it

was submitted that the amount of Rs. 1,59,25,662/- cannot be chargeable to

income-tax u/s 28 (iv) of the Act.

assessee company was started as private limited company on 13.6.1996 and

converted to public limited Company on 11.2.2005. On incorporation, the directors

were Shri S.R.Nair, Smt.Saleena Nair and Shri Venkitachalam. Shri Venkitachalam

left the Company in few years. The other two promoters were holding 50% of

shares of the Company. In the meanwhile, the directors sold their shares in the

Company and they entered into an agreement and all the assets and liabilities were

taken over by the outgoing shareholders, including bank loan and personal loan of

I.T.A. No.502/Coch/2018 the Directors. The agreement was entered into on 28/02/2015 and the accumulated

loss of the Company was set off against the loan outstanding with the outgoing

Directors, namely Shri S.R Nair and Smt. Saleena Nair at Rs. 31,08,832/- and

1,14,87,737/- respectively. The third outgoing shareholder, M/s. Peso

Infrastructures P. Ltd. waived the loan of Rs.15,37,304/- and the total amount

waived comes to Rs.1,61,33,873/-. However, the amount of Rs.1,59,25,662/- as

waived loan was taxed the hands of the assessee. Now the question that arises is

whether the waiver of this amount which is credited to the Reserve and Surplus

account is income chargeable to tax under the Act. According to the Assessing

Officer the assessee derived benefit by way of waiver of loans in the course of

running of its business activities and therefore, the amount to that extent waived by

the Directors is includible in the hands of the assessee as business income. In our

opinion, there cannot be any dispute with regard to the contention of the assessee

that the waiver of this amount of loan is not hit by Section 41(1) of the Act. In other

words, no dispute has been raised by the AO with regard to the applicability of the

provisions of section 41(1) of the Act. In this situation, now the question arises as

whether the waiver of the above loan can be treated as business income in view of

the principles laid down in the case of T.V. Sundaram Iyengar & Sons (222 ITR

344). In the present case, in order to decide the question as to whether the

decision of Supreme Court in the case of T.V. Sundaram Iyengar & Sons (supra) is

applicable to the present case, we deem it necessary on our part to dwell upon the

facts of the present case, particularly to find out the nature and purpose for which

the loan was taken and utilized. The outgoing shareholders, Shri S.R.Nair and Smt.

I.T.A. No.502/Coch/2018 Saleena Nair agreed to set off the accumulated loss of the company against their

loan outstanding with the assessee company which was Rs.31,08,832/-and

1,14,87,737/- respectively. The third outgoing shareholder M/s.Peso Infrastructures

P Ltd agreed to waive the loan of Rs. 15,37,304/- which was given by them to the

assessee company. The total amount set off/waived came to Rs. 1,61,33,873/-.

7.1. The decision of Hon’ble Supreme Court in the case of CIT vs. T.V. Sundaram

Iyengar & Sons (supra) and Hon’ble Bombay High Court in the case of Mahindra &

Mahindra Ltd. vs CIT (supra) had been referred to by the CIT(A). Assessee claimed

that the said impugned loan was the capital receipt and has not been claimed as

deduction from the taxable income as expenses and, therefore, did not come u/s

41(1) of the Act. The credit balance written back was treated by the AO to be the

income of the assessee u/s 28 of the Act in view of the fact that the credit balance

was directly arising out of the business activity. The assessee, relying upon the

judgment of Supreme Court in the case of Mahindra & Mahindra Ltd. (supra)

contended that in relation to the transaction in question, Section 28(iv) was not

attracted and even provisions of Section 41(1) of the Act could not be applied to

treat the same as business income of the assessee liable to tax.

7.2 On an appeal, CIT(A) reversed AO’s action by placing reliance on the judgment

in the case of Mahindra and Mahindra (supra). However, we find that the Supreme

Court in the case of CIT vs. T.V. Sundaram Iyengar (supra) held that if the amount

I.T.A. No.502/Coch/2018 is received in the course of trading transactions, even though it is not taxable in the

year of receipt, as being of capital character, the amount changes its character

when the amount becomes assessee’s own money because of limitation or by any

other statutory or contractual right. Where the assessee received deposits in the

course of trading transactions, the amount of such credit balances, which were

barred by limitation and which were returned back by the assessee to the profit and

loss account, were to be assessed as the assessee’s income. In our opinion, the

principle stated by the Supreme Court in the case of T.V. Sundaram Iyengar & Sons

(supra) would be squarely applicable to the facts of that case and, therefore, the

amount, which was initially did not fall within the scope of the provisions rendering

it liable to tax, subsequently have become the assessee’s income being part of the

trading of the assessee. Further, the assessee because of this transaction became

richer by the amount, which had been transferred and/or retained in the Reserve

and Surplus account of the assessee. The following observation of Hon’ble Apex

Court in T.V. Sundaram Iyengar & Sons Ltd.’s case has been noted by Hon’ble

Bombay High Court in the case of Solid Containers Ltd. vs DCIT (308 ITR 417):

“22. The principle laid down by Atkinson J. applies in full force to the facts of this case. If a common sense view of the matter is taken, the assessee because of the trading operation had become richer by the amount, which is transferred to its profit and loss account. The moneys had arisen out of ordinary trading transactions. Although the amounts received originally were not of income nature, the amounts remained with the assessee for a long period unclaimed by the trade parties. By lapse of time, the claim of deposit became time barred and the amount attained a totally different quality. It became a definite trade surplus, Atkinson J. pointed out that in Morley’s case (supra) no trading asset was created. Mere change of method of book- keeping had taken place. But, where a new asset came into being automatically by operation of law, common sense demanded that the 10

I.T.A. No.502/Coch/2018 amount should be entered in the profit and loss account for the year and be treated as taxable income. In other words, the principle appears to be that if an amount is received in course of a trading transaction, even though it is not taxable in the year of receipt as being of revenue character, the amount changes its character when the amount becomes if assesee’s own money because of limitation or by any other statutory or contractual right. When such a thing happens, common sense demands that the amount should be treated as income of the assessee.

7.3 The operative portion of decision in the case of Solid Containers Ltd. vs. DCIT

(supra) is as under:

“3. The present appellant can hardly drive any advantage from the case of Mahindra & Mahindra Ltd. (upra). As in that case, a clear finding was recorded that the assessee continued to pay interest at the rate of 6 per cent for a period of 10 years and the agreement for purchase of toolings was entered into much prior to the approval of loan arrangement given by the Reserve Bank of India. Therefore, the loan agreement, in its entirely, was not obliterated by such waiver. Secondly, the purchase consideration related to capital assets. The toolings were in the nature of dies and the assessee was a manufacturer of heavy vehicles. The import was that of plant and machinery and the waiver could not constitute business. The facts of the present case are entirely different inasmuch as it was a loan taken for trading activity and ultimately, upon waiver the amount was retained in business by the assessee. Thus, the principle stated by the Supreme Court in the case of T.V. Sundaram Iyengar & Sons ltd. (supra) would be squarely applicable to the facts of the present case. The amount which initially did not fall within the scope of the provisions rendering it liable to tax subsequently have become the assessee’s income being part of the trading of the assessee. Similar view was also taken by a Bench of Madras High Court in the case of CIT vs Aries Advertising (P) Ltd. (2002) 255 ITR 510. The court took the view that the assessee because of trading operation became richer by the amount which 11

I.T.A. No.502/Coch/2018 had been transferred and or retained in the Profit and Loss Account of the assessee.”

7.4 In the case of CIT vs Aries Advertising P. Ltd., 255 ITR 510 (Mad), an amount

of Rs.1,77,886/-, being the balance due to Printers; Block Makers and Souvenir

publishers by the erstwhile firm of an outstanding more than three years had been

transferred to general reserve since these amounts had remained unclaimed for a

long period of time. It was held by the Hon’ble High Court that in the case of

unclaimed balance written back, if a common sense view of the matter is taken, the

assessee, because of the trading operation, becomes richer by the amount, which it

has transferred to its general reserve account. The money had arisen out of

ordinary trading transactions. Although the amounts received originally were not of

income nature, but subsequently, it becomes the assessee’s income when the

amount was written off in the accounts. In this case, the Hon’ble Madras High Court

has also observed that once the assessee transferred any amount to the general

reserve, it treated the same as the profit. In this connection, reference was made to

the decision of Hon’ble apex court in the case of Wazir Sultan Tobacco Ltd. (1981)

132 ITR 559, where it has been held that a reserve is appropriation of profits.

7.5 In the light of the discussion made above, and following the decision of

Bombay High Court in the case of Solid Containers Ltd. vs. DCIT (supra) where the

principle enunciated by the Supreme Court in the case of CIT vs T.V. Sundaram

Iyengar & Sons Ltd. (supra) has been applied, we held that the principal amount of

loan, which is taken for the purpose of business or trading activity, on its waiver by

I.T.A. No.502/Coch/2018 the creditor, would constitute income chargeable to tax under the Act. However, if

the loan is utilized for the purpose of acquiring any capital asset, the same, on its

waiver, would not constitute income chargeable to tax as held by Hon’ble Bombay

High Court in the case of Mahindra & Mahindra Ltd. vs CIT (supra) and Hon’ble

Delhi High Court in the case of CIT vs. Tosha International Ltd. 176 taxmann 187

either under section 41(1) or 28(iv) or 2(24) of the Act.

7.6. In the instant case, it would be the duty of the assessee to prove and

establish that the amount of loan taken from the Directors/shareholders was utilized

for the purpose of business. If on an enquiry and verification, it transpires that the

assessee had utilized the loan for the purpose of its business activity or trading

activity, the amount of loan to the extent it has been waived by the

Directors/shareholders shall be deemed to be the assessee’s income chargeable to

tax as per the decision of Hon’ble Bombay High Court in the case of Solid Containers

Ltd. vs DCIT (supra), where the principle laid down by the Supreme Court in the

case of CIT vs. T.V. Sundaram Iyengar & Sons Ltd. (supra) has been applied and

followed. In the present case, the total amount swaived was Rs.161,33,873/-.

However, the amount added to the Reserve and Surplus during the year as waiver

of loan was only Rs.1,59,25,662/-. It was found that there was no details furnished

by the assessee as to how the loan amount was utilized or applied or for the

purpose for which the loan was raised. Hence, we remit this issue to the file of the

Assessing Officer for fresh consideration.

I.T.A. No.502/Coch/2018 8. In the result, this appeal filed by the revenue is treated to be allowed

for statistical purposes. Order pronounced in the open Court on this 22nd March, 2019

sd/- sd/- (GEORGE GEORGE K.) (CHANDRA POOJARI) JUDICIAL MEMBER ACCOUNTANT MEMBER

Place: Kochi Dated: 22nd March, 2019 GJ Copy to: 1. M/s. Team Front Line Ltd., 63/642A, Prasanth Bhavan, Opp. Girinagar Fire Station, Kochi-682 017. 2. The Income Tax Officer, Corporate Ward-2(4), Kochi. 3. The Commissioner of Income-tax(Appeals)-I, Kochi. 4. the Pr. Commissioner of Income-tax, Kochi 5. D.R., I.T.A.T., Cochin Bench, Cochin. 6. Guard File. By Order

(ASSISTANT REGISTRAR) I.T.A.T., Cochin