Should interest-free loan be taxed?
Chandrakant Shah had borrowed over Rs 50 lakh from close associates, who were not his relatives, for the purposes of buying a flat. Since the loan was interest-free, the Assessing Officer treated the transaction as a sum received without consideration and taxed it. Shah then approached the Commissioner (Appeals) but to no avail. Not someone who easily gives up, Shah then knocked on the doors of ITAT, Mumbai.
Shah’s counsel argued that an interest-free loan could not be taxed u/s 56 (2v), as the repayment of the loan itself was the consideration between two parties. By referring to a decision of the Court of Appeal of State of California, counsel maintained that it was in essential that an interest component should exist to make a transaction of extending money as a loan transaction The Tribunal bench concurred with Shah (Appeal ITA 3966/MUM/2008 dt 12.1.08) and maintained that the law needs to be followed in letter as well as spirit. Both aspects needed to be considered. The loans had been shown by Shah in the balance sheet submitted along with the return of income as loans and the lenders had also confirmed the same as such. Thus, it was clearly a case of loan transactions and not of gift as held by the AO. The bench ruled that a loan transaction should be examined in the light of provisions of Sec. 68 and not Sec. 56(2)(v). Sec. 68 basically states that where a certain sum is found to be credited in the books of the taxpayer and the taxpayer can offer no explanation about the nature and the source thereof, the Assessing Officer may charge such sum to income tax as income of the taxpayer.
It was clear to the bench that provisions of Sec. 68 were not applicable since all the requirements of that Section, i.e. identity, creditworthiness and genuineness of the transactions were proved. The bench wondered if an interest free loan has not been added u/s 68, then, how could such loan be added as income of the recipient u/s 56(2v)? This type of addition would lead to a situation of having two provisions for charging one type of income, i.e. it would mean that the legislature has provided two charging sections, i.e. Sec. 68 and 56(2v) for the same type of income.
In this regard, the bench opined that when a specific provision exists in law for a particular thing, then, that thing is liable to be examined there under only and if that item cannot be taxed under that provision, then, that thing cannot be charged to tax under other provisions of the Act. For example, if an item falls under the head “Profits and Gains of Business or Profession” but if the same cannot be taxed there under for any reason, then, it cannot be taxed under any other head. Surprisingly, in the present case, it is not that provisions of Sec. 68 were not applicable at all, hence, the Assessing Officer invoked the provisions of Sec. 56(2v). On the contrary when it was found that Sec. 68 was being satisfied, Sec. 56(2v) was sought to be invoked in a bid to tax the transaction one way or another. This was patently unfair to the assessee. The bench finally held that a loan transaction has to be treated as a loan transaction only and it should be examined in the light of provisions of Sec. 68 and not those of Sec. 56(2v) and for this reason alone, this addition to Mr. Shah’s income is liable to be deleted.