Every year, the announcement of the Union Budget is eagerly awaited as one of the key tax policy events in India. This year was no different.

Amongst various tax amendment proposals announced this year, proposal for taxing ‘cash’ benefits and perquisites is likely to have a wide-reaching impact on the taxpayers, especially in the context of waiver of debts due from a corporate debtor. More than the corporate debtor, the amendment may prove to be burdensome for the lender waiving such debts due to withholding tax liability imposed upon such lender.

This article aims to discuss the proposed amendment and its impact in the context of waiver of debt.

Taxation of benefits or perquisites

The Income-tax law provides for taxing of any benefit or perquisite arising from business or exercise of profession in the hands of the recipient [Section 28(iv) of the Income Tax Act (‘IT Act’)]. There also exists a withholding tax provision, which requires the provider of such benefit to withhold tax [Section 194R of the IT Act].

Taxation of ‘cash’ benefit or perquisite under Section 28 has been a litigative issue since ages. In 2018, the Apex Court of India in the case of Mahindra & Mahindra Ltd. [2018] 93 taxmann.com 32 (SC), brought much needed respite for the taxpayers by holding that Section 28(iv) of the IT Act is applicable only in case of non-monetary benefits and waiver of loan will not be taxable in the hands of the borrower.

Now, with amendment proposed by Union Budget 2023, the law laid down by Apex Court has been proposed to be legislatively amended. The amendment provides that ‘cash’ benefit or perquisite arising from business or exercise of profession shall be chargeable to tax as income from business or profession. Also, the withholding tax provision has been amended to specifically provide that the provider of such ‘cash’ benefit or perquisite shall be required to withhold tax.

Interestingly, even prior to the amendment, the Central Board of Direct Taxes (CBDT) had clarified that withholding tax provision shall be applicable even for cash benefit or perquisite. However, the taxpayers could have argued that said clarification is not binding upon the taxpayers and the position as enunciated in Mahindra & Mahindra (supra) shall continue to be applicable. Now, with legislative amendment, the taxpayers will not be able to take shield of the Apex Court judgment.

Impact of amendment on waiver of trading liabilities

In case a taxpayer had claimed a particular liability as an expense/ loss in any prior year and subsequently, the taxpayer receives benefit by way of cessation or remission of said liability, the said benefit is already chargeable to tax under Section 41 of the IT Act. However, earlier the taxpayers could have taken a position that the provider of such benefit shall not be required to withhold tax under Section 194R of the IT Act.

Now with the amendment, the creditor waiving the debt may be under obligation to withhold tax under Section 194R of the IT Act at the rate of 10% of such waiver. The same may result in increased burden for the creditor.

Apart from suffering a loss due to non-recovery of debts, the creditor may also be required to bear the withholding tax liability as the creditor may not be able to recover the said TDS amount from the debtor. The problem is acute in cases where proceedings have been initiated against the corporate debtor under the Insolvency and Bankruptcy Code (IBC) as the amount of tax withheld will surely not be recoverable from the corporate debtor owing to ill financial health.

Impact of amendment on waiver of loan

As usually a loan is not claimed as deduction by the borrower, the provisions of Section 41(1) of the IT Act may not get attracted due to waiver of such loan. In such scenario, the amended provisions of Section 28(iv) of the IT Act may be invoked to tax such cash benefits, which earlier were not taxable in the light of the Apex Court judgment. Also, the withholding tax provision shall also come into play in the hands of the provider of such benefit.

Where the loan has been waived by banks and certain specified financial institutions (specified in Circular No. 18/ 2022), the withholding tax provision shall not be applicable. However, in case waiver is done by lenders other than specified banking/financial institutions, the provisions of Section 194R shall get attracted.

Potential arguments for non-applicability of Section 194R of the IT Act

As is apparent, said section is applicable only when the benefit or perquisite is ‘arising from business or profession’ carried on or exercised by the recipient of such benefit. In case at the time of waiver of such debt, the recipient of the benefit is not carrying on any business, it can be argued the so-called benefit has not arisen out of the business or profession of the debtor. Accordingly, said section shall not be applicable. The argument may specifically be suited in cases where IBC proceedings have been initiated against the debtor.

The strength of the argument will vary depending upon facts of each case.

Conclusion

In the context of waiver of debt or loan, the amendment proposed by Budget 2023 is like rubbing salt on the wound. Apart from taking a haircut on the funds lent, the lender may also be burdened to discharge withholding tax liability out of its own pocket. It is necessary that before enactment of the proposed amendment, suitable clarifications are issued to restrict the applicability of said provisions to certain scenarios. If not all, exemption should surely be granted for cases where debt is waived during IBC proceedings.

[The author is a Principal Associate, Direct Tax Team, Lakshmikumaran & Sridharan Attorneys, New Delhi]