Deferred Sales Tax Loan-Accounting & Taxation
Facts:
1. X Limited has availed a Deferred Sales Tax loan from the Government of Tamil Nadu which is secured by a charge on the assets both movable and immovable upto extent of the loan. The total amount outstanding as on 31.03.XX is Rs. 50 crores.
2. The State of Tamil Nadu, recently announced a foreclosure scheme (like all other State Governments) offering considerable reduction in the loan payable by various companies in case these sales tax loans are prepaid. A graded scale is proposed in this regard indicating the amount payable by each of the units, which also depends on the number of years the loan is outstanding.
3. On account of earlier prepayment, it is expected that there will be a gain of Rs. 20 crores and the loan liability will be settled around Rs. 30 crores.
Discuss the accounting as well as taxation implications on the gain of Rs. 20 crores which will arise on settlement of the loan.
Answer:
At the outset, one should be clear about the stipulations contained in the Tamil Nadu Sales Tax Deferral Scheme and also whether any changes have been made in recent past, either through notifications or otherwise. One should also keep in mind the reasons for many state Governments permitting companies to foreclose their sales tax loan which is mainly due to the proposed introduction of new sales tax regime.
The answers to the queries are dealt under the following headings.
Under Accounting Preview-
1. Under the accounting convention, any loan waiver normally is taken to capital reserve. On the other hand, any interest waiver is taken to profit & loss account. For example, Reliance in their 96-97 Balance Sheet carried a note as under in respect of benefit they derived at the time of assignment of sales tax loan. Reliance transferred their apparent reduction in their loan account to their capital reserve account. The relevant extract from Reliance Balance Sheet are given below:
“Reserve and Surplus
Capital Reserves:
Particulars
As At 31.03.1997
As At 31.03.1996
Rs.
Rs.
As per last Balance Sheet
2.45
0.58
Add: On redemption of Debentures
0.43
1.87
Profit on reissue of Forfeited Shares (Previous year Rs. 39,540)
On Assignment of interest fee sales tax loan
182.38
Refer Note 11 of Schedule O
185.26
2.45
Note 11:
The company had a liability of Rs. 238.14 crores payable from 01.05.2001 to 01.04.2012 to the sales tax departments of the Governments of Maharashtra and Gujarat in respect of sales tax deferral scheme. The company has assigned the said liability to another company on payment of Rs. 55.76 crores and the difference of Rs. 182.38 crores has been credited to Capital Reserve during the year.
Bharat Forge Limited- 43th Annual Report 2003-04
Schedule “B” Reserve and Surplus
Capital Reserve:
As At March 31, 2004
As At March 31, 2003
i) Special Capital incentive (Under the 1988 Package Scheme of Incentives) As per last Account
2,500
2,500
ii) Capital Surplus arising from early retirement of Sales Tax deferral liability/ Loan under package Scheme of Incentive of Government of Maharashtra
As per last Account (see Note 11) 64,738
Less: Transferred to General Reserve 4,259
60,479
64,738
62,979
67,238
Note 11:
The company, in March, 2003, had prematurely retired its obligations of the Sales Tax Deferral incentive availed under the package scheme of incentives 1993, thereby generating a surplus of Rs. 64,738,075/-. Since the incentive was fundamentally provided to encourage capital investments in designated underdeveloped zones and thereby defray to some extent, deficiencies, the same has been, as per opinion of the “Expert Advisory Committee” set up by the institute of Chartered Accountants of India, credited to “Capital Reserve” to be apportioned to Revenue Reserves over the future/balance life of the underlying investments, at the end of each financial year.
Note 12:
Sales tax deferral incentives attached to erstwhile windmill division, which was demerged to Bharat Forges Utilities Ltd. Under Section 393 and 394 of the Companies act, 1956 sanctioned by the High Court of the Jurisdiction Mumbai, have been passed on thereafter from year to year by the company to the latter, under an arrangement, with the liabilities and obligations attached thereto. Consequently, sales tax deferral liability represents net liability to the Company after such pass on aggregating to Rs. 463 Million (Previous year Rs. 336 Million).
2. Under Indian GAAP:
Expert Advisory Committee of the Institute Compendium of Opinions- Vol. VI
Support can be drawn for directly crediting the reduction in the liability to capital reserve account by drawing reference to the clarification issued by the Expert Advisory Committee of the institute of Chartered Accountants of India. Here, a query was raised as to what is the Accounting treatment one should follow for writing back time barred liabilities incurred for the acquisition of fixed assets. The Institute clarified that “The gain obtained by writing back the liability is of capital nature. There are distinct from the ordinary activities of the business and can also be considered as extra-ordinary items.”
Since the prepayment of the loan arising out of the deferred sales tax liability gives monetary advantage, the company will be in order to credit the gain directly to Capital Reserve.
Under US GAAP:
It is clarified as follows:
The gain or loss on the extinguishment of a debt is recognised immediately in the year of extinguishment and is reported as extra-ordinary item net of related taxes.
(Under U.S. laws, there is no concept of capital reserve and only the criteria which is looked at is whether the gain is available for distribution to shareholders. Since we are governed by the Companies Act and also follow the British system, we have to classify as capital reserve, the gain arising on account of prepayment).
Under Income Tax Preview-
As explained in the judgment of NCL Industries Vs. Jt. CIT – 88- ITD-150, a loan waiver will always result in capital profit and will not form part of taxable income. The relevant extracts from the judgment is given below:
NCL Industries Ltd. Vs. Jt. CIT (Hyd) – 88-ITD-150
The decision of House of Lord in British Mexican Petroleum Co. Ltd.’s case (supra) relied upon by the learned counsel for the assessee was a case where one Company had to pay another Company, a particular amount for cost of oil supplied by it. The second Company was the producing company which was supplying oil to the first company. The producing company released the first company from its liability to pay the balance remaining due viz, INR 945,232 and the first company directly carried this amount to the balance-sheet and has not routed the same through its profit and loss account. In its judgment their Lordship held that the release from liability cannot form a trading receipt in the account of the assessee for the year in which it is granted.”
In this judgment through different on fact the proposition is clearly laid down that there is distinguishable relationship between the assessable income and profits of a business concern in a commercial sense. It is further held that for computation of income for the purpose of income-tax assessment is based on a variety of artificial rules and takes into account several fictional receipts, deductions and allowances. Thus, a clear distinction has been drawn out between commercial profits and assessable profits. Going by Accounting Standard 9 issued by the Institute of Chartered Accountants of India, it is stated thus:
For the purpose of definition of the term revenue for that statement i.e. AS-9 un-realised gains from the re-statement of the carrying amount of an obligation and realised gains resulting from the discharge of an obligation at less than its carrying on amount are not included.”
In another case Mahindra and Mahindra decided by the Bombay High Court is also pointer to the effect that a loan waiver is not income (261-ITR-501).
Conclusion:
Now, it is clear that the reduction in the sales tax loan arising out of foreclosure cannot considered as income of the company. It could be taken to Capital Reserve, to take it away from the ambit of taxation.