Whether when loan advanced by JV partner for purchase of capital assets is converted into share premium of loss-making assessee company, same can be treated as trading receipt - NO: ITAT

THE questions before the Bench are - Whether when the loan advanced by the JV partner for purchase of capital assets is converted into share premium of loss-making assessee company, the same can be treated as trading receipt and Whether conversion of sundry creditors liability into shares amounts to cessation of liability and such sum can be added to taxable income u/s 41(1). And the verdict goes against the Revenue.

Facts of the case

Assessee was a joint venture between ‘F’ and ‘O’, a Government owned trading organization from Russia. Assessee was not doing any activity for last six years due to heavy losses. AO made addition for loan converted into shares, share application money and for liabilities converted into share capital and premium. Assessee contended that it received

outstanding share application money and other loans from foreign collaborator. Due to heavy losses, promoters agreed to convert share application money and other loans outstanding in the books of account for enhancement of share capital to the extent of authorized capital available and balance as share premium account enabling the company to get it closed under Simplified Exit Scheme as the company had already disposed off its trawlers in the previous years.

Assessee submitted that provisions of section 41(1) were not applicable in the case of the assessee company as this Section provides that where an allowance or deduction is granted to the assessee in any previous year in respect of any loss, expenditure or trading liability and subsequently, the assessee receives any amount in respect of such expenditure, the amount of liability is extinguished, then the amount so received or extinguished shall be charged to tax in the previous year in which the amount is received or the liability is extinguished, no such conditions are applicable in this case. The amount of share premium account credited to the share premium account had never been claimed as an expenditure. Section 115-JB provides for the preparation of the accounts of the company, as per the Schedule-VIPart I and Part-II u/s 211 of the Companies Act. This itself provides that reserve is to be created on account of share premium account but no corresponding deduction is claimed in the Profit & Loss Account. Assessee had not claimed any deduction out of the current income in the Profit & Loss Account and no further adjustment was required. Regarding applicability of provisions of Sec. 28(iv), it was contended that no reasons had been furnished by AO as to why this amount was sought to be treated as falling within the provisions of this sub-section. It was neither any benefit nor any perquisite arising from the exercise of business. The share premium was on account of the capital and what is the chargeable to tax is only the receipt which are of revenue in nature.

AO made addition stating that loan amount which had been converted into share capital and share premium was outstanding for about a decade and it was not acceptable that a loan outstanding to be paid had been waived off by a company without any consideration. The loan amount was not advanced in normal course of business, it was given against a trawler and the same was a trading liability at a point of time. Even in the case of Share Application Money which was pending for allotment for about a decade, it cannot be said that the same is marinating its capital nature. The share application money got changed into revenue receipt. It is nothing but an income in the form of benefit to the assessee because the assessee had not to return this money and was subsequently used for the purpose of its business by setting off brought forward losses. Such benefit is covered u/s 28(iv) which includes income chargeable to tax "the value of any benefit or perquisite, whether convertible into money or not, arising from business or the exercise of a profession". The liabilities of sundry creditors and expenses payable had been converted into share capital and share premium which had been set off against the brought forward losses. Thus, no liabilities had been paid by the assessee and these were ceased liabilities of the assessee, hence the amount of sundry creditors and expenses payable were as ceased liability u/s 41 (1) and added to the income of the assessee.

CIT (A) allowed the appeal of the assessee stating that it was not a case of either waiver of loan or liability. The liabilities as outstanding in the shape of loan or sundry creditor have been-settled by issuing shares and such settlement does not constitute income under the Act. Mere allotment of shares against share-application to the shareholder could be no basis to tax the sum as income. Mere fact that, share application money was pending for allotment for a decade could not be a ground to suggest that, such share-application money represents income of the appellant company on allotment of shares. So far as waiver of loan is concerned, even a debt waived or forgone cannot partake the character of income either u/s 41 (1) or section 28.

After hearing both the parties, the ITAT held that,

++ the loan was taken for acquiring the capital asset in the form of trawlers. This loan was taken from ‘O’ who is also a joint venture partner in the company. This loan was carrying on interest @ 6%. The interest accrued up to 31.03.1995 was taken into account. Thereafter, this amount remained unchanged. Since assessee incurred heavy losses the loan could not be repaid. The capital asset in the form of trawler was registered in assessee’s name and reflected in the books of account of the assessee and the same was used for business purposes. This amount was converted into the shares and share premium. This amount was not taken to the profit & loss account. Thus, this amount has not changed its character from capital to revenue. The liability was not ceased. The assessee has not derived any benefit out of this conversion of one liability to another liability. AO has invoked section 28(iv) which covers the benefits in perquisites received in kind and it has no applicability to any transaction which involves money. The loan was taken to invest in the capital asset. There was no waiver of the loan, therefore, conversion of the loan into share capital shall not constitute a trading receipt. To attract the provisions of section 28(iv), the sum in question must be a benefit or perquisite arising in the course of business is of nature, other than cash or money. Thus, the order of CIT (A) is upheld.

++ an amount was pending for allocation of shares to ‘O’ since 1995. During the year under consideration, the company has allotted shares. The outstanding share application money has not been carried out to the profit & loss account. Thus, the provisions of section 28(iv) of the Income-tax Act, 1961 cannot be made applicable;

++ the amount of outstanding liability had been converted into the share capital plus premium. The creditors have confirmed the allocation of the shares in their favour. Conversion of the outstanding liability into shares cannot be termed as cessation of liability. Thus, the addition made u/s 41(1) is correctly deleted.