2 September 2014
EY Tax Alert Delhi Tribunal rules secured lender taking possession of mortgaged assets under SARFAESI Act does not result in “transfer”
Executive summary Tax Alerts cover significant tax news, developments and changes in legislation that affect Indian businesses. They act as technical summaries to keep you on top of the latest tax issues. For more information, please contact your EY advisor.
This Tax Alert summarizes a recent ruling of the Delhi Tribunal (ITAT) in the case of Rajasthan Petro Synthetics Ltd. [1] (Taxpayer) on the issue whether taking over physical possession of assets by secured lender under the SARFAESI [2] Act amounts to transfer in the hands of the borrower. The Tribunal held that right to assume possession of borrower’s secured assets in the event of default in repayment of loan was merely a special right granted by SARFAESI Act to the secured lender as a step towards realization of dues from borrower. Such “possession” does not grant ownership right to the lender. The borrower can regain possession by discharge of dues before the sale of assets by the lender. Hence, taking over of “possession” does not pass on ownership rights at any stage to the lenders and consequently, there is no “transfer” in terms of the provisions of the Indian Tax Laws (ITL).
[1]
[ITA No. 1397/Del/2013]
[2]
The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002
Background and facts ►
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Section 2(47) (Section) of the ITL defines “transfer” of capital asset to, inter alia, include sale, exchange or relinquishment of the asset or the extinguishment of any rights therein. The event of “transfer” of capital asset triggers capital gains taxation in the hands of taxpayers. The Taxpayer is a Public limited company engaged in the business of manufacture and trade of synthetic yarn and freight forwarding. The Taxpayer suffered losses and became a sick [3] company on erosion of its net worth. The Taxpayer defaulted on repayment of loans to secured lenders which it had raised for the purpose of purchase of capital assets. During the tax year under reference, the secured lenders took over physical possession of the secured assets by exercising the rights vested in them under SARFAESI Act.
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The total outstanding dues to secured lenders were INR974m out of which INR245m was towards working capital. It appears that the secured lenders waived all outstanding amounts after taking over possession of assets and the Taxpayer was discharged from sick company proceedings. The secured lenders realized INR10m from sale of these assets.
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The Taxpayer offered waiver of working capital loan of INR245m as income and claimed that waiver of balance loan was not taxable.
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The Tax Authority took the view that the taking over of possession of assets amounted to “transfer” of assets from the Taxpayer to secured lenders. It treated the waiver of balance loan of INR729m as sale consideration towards secured assets and assessed the excess over written down value thereof as capital gains.
[3] As per provisions of Sick Industrial Companies (Special Provisions) Act, 1985
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The First Appellate Authority confirmed the Tax Authority’s action.
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Being aggrieved, the Taxpayer appealed further to the ITAT.
Issue before the ITAT ►
Whether taking over of possession of the Taxpayer’s assets by the secured lenders under SARFAESI Act constitutes “transfer” of assets from the Taxpayer to the secured lenders?
ITAT ruling The ITAT ruled in Taxpayer’s favor and held that there was no “transfer” in the present case for the following reasons: ►
SARFAESI Act entitles secured lenders to serve notice to borrower who has defaulted on repayment of dues and grant period of 60 days for repayment failing which secured lender can take over possession of secured assets and sell the assets to realize its dues. The right to assume possession over the secured assets is a special right granted by SARFAESI Act as a step towards realization of the assets for appropriation against the dues recoverable from the borrower. Such rights are for protection of interest of lenders. At no stage does the secured lender acquire any ownership right over the secured asset upon assuming the possession which is for the limited purpose of sale of assets for realization of dues.
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The Supreme Court (SC) in the case of Transcore v. Union of India, while analyzing relevant provisions of SARFAESI Act, has held that “possession” under SARFAESI Act is a relative concept, and not an absolute concept and, thus, it could be either actual or constructive possession.
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The secured lender(s) become owner of mortgaged assets if after taking over physical possession of such assets the lenders appropriate the assets to
chargeable capital receipt and, hence, not taxable. This proposition is supported by Bombay High Court (HC) and Delhi HC rulings in the cases of Mahindra and Mahindra Ltd. v. CIT[5] and CIT v. Tosha International[6].
themselves and reflect them as assets in their own books of account. ►
In fact, SARFAESI Act provides that if the borrower repays the debt before the secured lender sells the possessed assets, the lender cannot sell the assets and is obliged to return them back to the borrower. This also supports that the secured lender does not acquire ownership rights over the possessed assets.
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The above factors support that when secured lenders take over possession of secured assets, it does not result in “transfer” of such assets from borrower to lender and, hence, the takeover of assets in the present case did not trigger capital gains in the hands of the Taxpayer.
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The present case is distinguishable from the one before the SC in the case of Attili N Rao [4] where the taxpayer engaged in abkari business had mortgaged his immoveable property with the state government as security towards statutory dues payable to the state government. On taxpayer’s failure to pay the dues, the state government sold the property, recovered its dues from the sales proceeds and paid over balance to the taxpayer. The SC held that the taxpayer was liable to capital gains on the whole of the sales proceeds realized by the state government and not the net amount paid over to him after adjusting the statutory dues. In the present case, the Tax Authority’s contention is that mere takeover of assets by the secured lenders results in capital gains which is not correct. The sale consideration realized by the lenders and appropriated against outstanding dues will belong to the Taxpayer.
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Even if it is accepted, as contended by Tax Authority, that amount of loan waived by the lenders is the sale consideration for takeover of the assets, it is well settled that waiver of loan used for acquiring capital asset is a non-
[4]
[252 ITR 880]
Comments The present Tribunal ruling provides guidance that mere takeover of possession of secured assets by lenders by exercising rights vested in them under SARFESI Act does not result in “transfer” and consequently, does not trigger capital gains taxation in the hands of the borrower. The secured lender does not acquire ownership right over the asset and right of possession is granted to facilitate eventual sale of the assets for recovery of dues. Capital gains get triggered when the secured lender sells the asset and appropriates the sales proceeds against the borrower’s dues.
[5]
[261 ITR 501]
[6]
[ITA No. 1143/2008
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