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Quiz for the week (04 Nov 2024): Dhyaneshwar (P) Ltd is engaged in manufacturing activity. It has huge production capacity but has insufficient working capital and therefore it could not achieve economies of largescale purchase of raw materials and allowance of extended credit period to its customers. This has dented its profit margin. The directors of the company decided to give interest-free loan to the company and accordingly, it was resolved that the company would accept the said loans. Some of the directors borrowed money in their personal capacity from banks and gave loan to the company and a few gave out of their own sources. Are the loans received by the company or the notional interest on such loans, liable to tax under section 56(2)(x) of the Income-tax Act? Best Answer : Section 56(2)(x) says that-where any person receives, in any previous year, from any person or persons on or after the 1st day of April, 2017- (a) any sum of money, without consideration, the aggregate value of which exceeds Rs.50,000, the whole of the aggregate value of such sum – is taxable as income; Section 56(2)(x) is worded to cover receipt of money without consideration. If there is consideration, then the provision will not apply. Receipt of interest free loan is only a benefit which is not covered in section 56(2)(x). A benefit or concession in the course of business is not covered by section 56(2)(x). When a director gives loan, it is for the company to do business more efficiently / profitably or at least to get over the financial difficulty. If such advancing of money is taken as benefit liable to tax, then to charge an income therefrom, there must be a specific legal provision. A hypothetical income is always not taxable. The section is intended to tax receipt of money and not the receipt of such loan with or without interest. One may gainfully refer to the observation of Delhi High Court in the case of CIT v. Mridu Hari Dalmia (1982) 133 ITR 550 (Del) where the court observed "a transaction of a loan implies an agreement to repay the money i.e. borrowed. Shri Harihar Lal cited a definition of loan from Corpus Juris Secundum (Vol.54 p.654). According to this passage a loan of money is defined as "a contract by which one delivers a sum of money to another and the later agrees to return at a future time a sum equivalent to that which he borrows"; and again as "the delivery by one party and the receipt by the other party of a given sum of money on an agreement, express or implied, to repay the sum lent with or without interest". These definitions can be accepted as succinctly summarising or analysing the ingredients of a loan. They are in line with the definitions enunciated by our Supreme Court (vide K.M.S.Lakshmanier and Sons v. CIT (1953) 23 ITR 202 (SC); Badridas Daga v. CIT (1958) 34 ITR 10 (SC) and other cases). They make it clear that a loan involves an enforceable agreement between two parties, one of whom is the lender and the other the borrower. The former lends moneys to the latter. The latter receives the sum and promises to repay it by an equivalent amount at a future date with or without interest. The essence of a loan is a contract". [Emphasis supplied]. One may refer to the decision in the case of ITO v. Paramveer Abhay Sancheti (2018) 95 taxmann.com 258 (Nagpur-Trib) where the Assessing Officer taxed the receipt of loan as income on the ground that there was no legally enforceable repayment agreement with the lender. Hence, the amount borrowed was taxed under section 56(2). It was held by ITAT that the borrower had treated the amount received as loan in the books of account and therefore a contrary stand could not be taken by the Assessing Officer. Also refer Nilesh Janardhan Thakur v. ITO (2017) 88 taxmann.com 166 (Mumbai-Trib). Therefore, receipt of loan from directors cannot be taxed as income of the borrowing company when the agreement between the lender and the borrower shows it is a loan. One safeguard measure would be to record the lending / borrowing as loan. Even otherwise, when the borrower has recorded the money borrowed as loan it cannot be taxed as his income. The notional interest on loan taken cannot be taxed as income and in fact if the interest was paid it would have been an allowable expenditure. An expenditure when not claimed, it cannot be notionally computed for the purpose of collecting tax on the same since the character of the calculation is for expenditure which cannot be taxed as income.

Quiz for the week (04 Nov 2024):

Dhyaneshwar (P) Ltd is engaged in manufacturing activity. It has huge production capacity but has insufficient working capital and therefore it could not achieve economies of largescale purchase of raw materials and allowance of extended credit period to its customers. This has dented its profit margin. The directors of the company decided to give interest-free loan to the company and accordingly, it was resolved that the company would accept the said loans. Some of the directors borrowed money in their personal capacity from banks and gave loan to the company and a few gave out of their own sources.

Are the loans received by the company or the notional interest on such loans, liable to tax under section 56(2)(x) of the Income-tax Act?

Best Answer :

Section 56(2)(x) says that-where any person receives, in any previous year, from any person or persons on or after the 1st day of April, 2017-

(a) any sum of money, without consideration, the aggregate value of which exceeds Rs.50,000, the whole of the aggregate value of such sum – is taxable as income;

Section 56(2)(x) is worded to cover receipt of money without consideration. If there is consideration, then the provision will not apply. Receipt of interest free loan is only a benefit which is not covered in section 56(2)(x). A benefit or concession in the course of business is not covered by section 56(2)(x). When a director gives loan, it is for the company to do business more efficiently / profitably or at least to get over the financial difficulty.

If such advancing of money is taken as benefit liable to tax, then to charge an income therefrom, there must be a specific legal provision. A hypothetical income is always not taxable. The section is intended to tax receipt of money and not the receipt of such loan with or without interest.

One may gainfully refer to the observation of Delhi High Court in the case of CIT v. Mridu Hari Dalmia (1982) 133 ITR 550 (Del) where the court observed "a transaction of a loan implies an agreement to repay the money i.e. borrowed. Shri Harihar Lal cited a definition of loan from Corpus Juris Secundum (Vol.54 p.654). According to this passage a loan of money is defined as "a contract by which one delivers a sum of money to another and the later agrees to return at a future time a sum equivalent to that which he borrows"; and again as "the delivery by one party and the receipt by the other party of a given sum of money on an agreement, express or implied, to repay the sum lent with or without interest". These definitions can be accepted as succinctly summarising or analysing the ingredients of a loan. They are in line with the definitions enunciated by our Supreme Court (vide K.M.S.Lakshmanier and Sons v. CIT (1953) 23 ITR 202 (SC); Badridas Daga v. CIT (1958) 34 ITR 10 (SC) and other cases). They make it clear that a loan involves an enforceable agreement between two parties, one of whom is the lender and the other the borrower. The former lends moneys to the latter. The latter receives the sum and promises to repay it by an equivalent amount at a future date with or without interest. The essence of a loan is a contract". [Emphasis supplied].

One may refer to the decision in the case of ITO v. Paramveer Abhay Sancheti (2018) 95 taxmann.com 258 (Nagpur-Trib) where the Assessing Officer taxed the receipt of loan as income on the ground that there was no legally enforceable repayment agreement with the lender. Hence, the amount borrowed was taxed under section 56(2). It was held by ITAT that the borrower had treated the amount received as loan in the books of account and therefore a contrary stand could not be taken by the Assessing Officer. Also refer Nilesh Janardhan Thakur v. ITO (2017) 88 taxmann.com 166 (Mumbai-Trib).

Therefore, receipt of loan from directors cannot be taxed as income of the borrowing company when the agreement between the lender and the borrower shows it is a loan. One safeguard measure would be to record the lending / borrowing as loan. Even otherwise, when the borrower has recorded the money borrowed as loan it cannot be taxed as his income.

The notional interest on loan taken cannot be taxed as income and in fact if the interest was paid it would have been an allowable expenditure. An expenditure when not claimed, it cannot be notionally computed for the purpose of collecting tax on the same since the character of the calculation is for expenditure which cannot be taxed as income.