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Did I tell you about this terrific book I have been reading? It’s got all the essential ingredients a potboiler needs to have —- drama, intrigue and suspense. The plots and sub-plots are so intricately woven by the author that each page will leave you guessing. I wont give away more, but I fully recommend reading The Income Tax Act, 1961.
This week, we are going to examine one of the sub-plots of this thriller, which deals with gift tax.

Actually, gift tax had been discontinued from October 1, 1998 to March 2005.
From April, 2005, Sec. 56(2)(v) was introduced, which basically resuscitated the earlier gift tax by way of a backdoor entry as income tax. In other words, gift tax was brought back by way of an income tax on the recipient.

Now, as per the law, if a sum of money over Rs 50,000 is received by an individual or an HUF without consideration, the aggregate value of such sum will be taxable as the receiver’s income. There are seven exceptions:
Gifts received:
a) from any relative; or
b) on the occasion of the marriage of the individual; or
c) under a will or by way of inheritance; or
d) in contemplation of death of the payer; or
e) from any local authority.
f) from any fund or foundation or university or other educational institution or hospital or other medical institution or any trust or institution referred to in Sec. 10(23); or
g) from any charitable trust or institution.

In fact, points ‘e’, ‘f’ and ‘g’ above were added in 2006 as an afterthought when it was found that as per a strict reading of the law, any scholarship, donations, medical grants, etc would be taxable since these were essentially sums of money received by an individual without consideration.

What about interest-free loans? What if you were to take an interest-free loan from a non-relative - say a close friend who would like to help you out but does not want to make it into a commercial transaction by charging interest. The absence of interest would make the transaction look prima facie as a gift given by a non-relative and hence taxable as per the above law.

Well, one Chandrakant Shah faced precisely such a situation. He had borrowed over Rs 50 lakh from close associates for 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 reportedly argued that an interest-free loan could not be taxed under Section 56 (2)(v) 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, the counsel maintained that it was inessential that an interest component should exist to make a transaction of extending money a loan transaction.

The Tribunal bench concurred with Shah and stated 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 a clearly a case of loan transactions and not a case of gift as held by the assessing officer.

The bench further went on to rule that a loan transaction should be examined in the light of the provisions of section 68 and not under provisions of section 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.

In the present case, it was clear to the bench that provisions of Sec. 68 were not applicable at all since all the requirements of that section i.e., identity; creditworthiness and genuineness of the transactions had been proved.

The bench wondered, if an interest-free loan cannot be added under section 68, how could it be added as income of the recipient under section 56(2)(v) of the Act? 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., Section 68 and 56(2)(v) for the same type of income.

When a specific provision exists in law for a particular thing, then that thing is liable to be examined thereunder 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, the bench said. For example, if an item falls under the head “Profits and Gains of Business or Profession,” but if the same cannot be taxed thereunder 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 section 56(2)(v). On the contrary when it was found that Sec. 68 was being satisfied, Sec. 56(2)(v) 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 Section 68 and not under provisions of Section 56(2)(v) of the Act and for this reason alone, this addition to Shah’s income is liable to be deleted.

The writer is director, Wonderland Consultants, a tax and financial planning firm.