Kalpesh Classes

Capital Loan Written off – Not Income

Section 32 deals with depreciation. It says that in respect of certain tangible and intangible assets which are owned by the assessee and used for the purposes of the business, a deduction on account of depreciation would be allowed at the rate prescribed in the rules from time to time. The depreciation would be allowed on the 'actual cost' of the assessee or the 'written down value'. These terms are defined in section 43. Sub-section (1) of section 43 defines 'actual cost' to mean 'actual cost of the assets to the assessee, reduced by that portion of the cost thereof, if any, as has been met directly or indirectly by any other person or authority'. This definition came up for consideration before several High Courts in the context of the subsidy granted by the Central or State Governments as an incentive for development of industries. The subsidy was granted with the aim of industrializing the State and particularly the industrially backward areas. The quantification of the subsidy was made as a percentage of the capital investment made by the assessee, which included land, building, plant and machinery etc. The revenue treated these subsidies as amounts paid by the Government towards meeting the cost of the assets and, accordingly, applying the definition of 'actual cost', suitably reduced the claim of depreciation. The dispute ultimately reached the Supreme Court in the case of CIT v. P.J. Chemicals Ltd. [1994] 210 ITR 830 /76 Taxman 64 (SC).​​ The dispute was resolved in favour of the assessee, with the Supreme Court holding that the object of the subsidy was to promote industrial growth in the States and merely because the quantum of the subsidy was calculated as a percentage of the capital investment made by the assessee in the assets such as land, building, plant and machinery etc., it cannot be said that the Government met a portion of the cost of the asset directly or indirectly. Accordingly, the assessee was held entitled to the depreciation on the actual cost without being reduced by the amount of the subsidy. ​​​​ In case of CIT v. P.J. Chemicals Ltd. - The Explanation 10 to section 43(1) was inserted w.e.f. 1-4-1999. The Apex Court in CIT v. P.J. Chemicals Ltd. [1994] 76 Taxman 611 has held that grant or subsidy given by the Government as incentive for setting-up industries in backward area will go to reduce the actual cost of the assets. Depreciation on such assets will not be disturbed or reduced due to subsidy or grant given by the Government.​​ 

In CIT v. Tata Iron & Steel Co. Ltd. - In CIT v. Tata Iron & Steel Co. Ltd. [1998] 98 Taxman 459 (SC). The most important observation of the Apex Court was that 'the amount may have been borrowed by the assessee, but even if the assessee did not repay the loan it will not alter the cost of the asset. If the borrower defaults in repayment of a part of the loan, the cost of the asset will not change. What has to be borne in mind is that the cost of an asset and the cost of raising money for purchase of the asset are two different and independent transactions'.

The assessee-company acquired certain depreciable assets through foreign loans. As a result of fluctuation in the rate of foreign exchange, the assessee had to repay much lower amount. The department’s case was that this would go to reduce the actual cost of the assets for computing depreciation.​​ However, the High Court held that the cost of the assets would not change.​​ On appeal to the Supreme Court HELD The manner of repayment of loan cannot affect the cost of the assets acquired by the assessee. What is the actual cost must depend on the amount paid by the assessee to acquire the asset. The amount may have been borrowed by the assessee, but even if the assessee does not repay the loan, it will not alter the cost of the asset. If he, borrower, defaults in repayment of a part of the loan, the cost of the asset will not change. What has to be borne in mind is that the cost of an asset and the cost of raising money for purchase of the asset are two different and independent transactions. Even if an asset is purchased with non-repayable subsidy received from the​​ Government, the cost of the asset will be the price paid by the assessee for acquiring the asset. In the instant case, the allegation was that at the time of repayment of loan, there was a fluctuation in the rate of foreign exchange as a result of which the assessee had to repay a much lesser amount than he would have otherwise paid. This was not a factor which could alter the cost incurred by the assessee for purchase of the asset. The assessee might have raised the funds to purchase the asset by borrowing but what the assessee had paid for it was the price of the asset. That price could not change by any event subsequent to the acquisition of the asset. The manner or mode of repayment of the loan had nothing to do with the cost of an asset acquired by the assessee for the purpose of his business.​​ The questions were, therefore, rightly answered by the High Court. Hence, the appeals were dismissed.

In case of Steel Authority of India Ltd. v. CIT - The Delhi High Court in Steel Authority of India Ltd.'s case made a passing reference to the Apex Court's judgment and held that after the introduction of Explanation 10 it is no longer possible to contend that subsidy given by the Government, by whatever name called, cannot be reduced from the actual cost of asset in terms of section 43(1) of the Act for the purpose of allowing depreciation. It admitted that the Explanation 10 does not cover waiver of loan.​​ 

In case of CIT v. Hides & Leather Products Pvt. Ltd. - In CIT v. Hides & Leather Products Pvt. Ltd. [1975] 101 ITR 61 (Guj.) the assessee imported machinery from a foreign company. The amount payable to the supplier was shown in the account as a liability. Since the amount was not claimed by the foreign company, it was transferred to capital reserve account. With regard to claim of depreciation the Court held that the assessee was eligible for depreciation on the actual cost, notwithstanding cessation of liability. The amount forgone by the supplier (impliedly inferred in this case) did not go to reduce either the actual cost or the depreciation claim.​​ 

In case of CIT v. Cochin Co. (P.) Ltd. - In CIT v. Cochin Co. (P.) Ltd. [1990] 52 Taxman 178 (Ker.) the assessee acquired a machinery. It was acquired out of the loan taken from a financier. After a few years the assessee could not pay the amount and the financier wrote off the amount outstanding. The Court held that section 43(1) covering cost of asset met directly or indirectly by any other person would mean such meeting of cost at the time of purchase or acquisition. Where the amount is funded and subsequently waived off by the lender, such a waiver cannot be called as meeting a part of the cost of asset directly or indirectly by any other person. The amount waived off by the financier was held as not liable for reduction from the cost or WDV of the asset.​​ 

Ordinary business loan written off – Income

Solid Containers Ltd (Bom) Assessee had taken a loan from ‘P’ during previous year for business purposes which was written back in relevant assessment year as a result of consent terms arrived at between ‘P’ and assessee - Assessee claimed that said loan was a capital receipt and, therefore, did not come under section 41(1) - Assessing Officer rejected assessee’s contention and held that​​ credit balance written back was income of assessee​​ in view of fact that it was directly arising out of business activity of assessee and, thus, was liable to tax under section 28 - Commissioner (Appeals) as well as Tribunal, following decision of Supreme Court in CIT v. T.V. Sundaram Iyengar & Sons Ltd. [1996] 88 Taxman 429 , upheld order of Assessing Officer - Whether order of Tribunal was in accordance with settled position of law and, therefore, it was to be upheld - Held, yes

The Supreme Court in Sundaram Iyengar & Sons Ltd.’s case ​​ has held 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 capital character, yet the amount changes its character when the amount becomes the assessee’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.​​