Some of what a bank waives in a one time settlement can become taxable income, and many borrowers find out only after they have paid the settlement amount. Which part is taxed depends on who the borrower is, what the loan was used for, and whether the borrower claimed a deduction on it earlier. The rule in the title is true for some waivers and false for others, and the law moved in 2023 and again in 2026.
This article sets out how loan waiver tax India works for business borrowers and for individuals, which court rulings still matter, and what to ask your tax adviser before you sign a settlement letter. It is written for borrowers negotiating a bank loan settlement India deal, including MSMEs, and for anyone weighing an OTS bank loan offer from a lender.
The short answer by type of waiver
| What the bank waives | Likely tax position | Why |
| Interest on a business loan that you claimed as a deduction in an earlier year | Taxable in the year of waiver | Section 41(1) of the 1961 Act taxes remission of a liability for which a deduction was allowed |
| Interest that was never allowed as a deduction | Generally not taxed under Section 41(1) | The Section needs an earlier allowance. Check what was claimed |
| Principal of a business working capital loan | Likely taxable | Courts have treated it as a trading liability, and the 2023 amendment to Section 28(iv) widened the net |
| Principal of a business term loan used to buy a capital asset | Open for waivers in the amended period | Protected before 2023 by Mahindra & Mahindra; the 2023 amendment changed the wording |
| Principal of a personal loan taken by an individual with no business use | Generally outside Sections 28 and 41; Section 56(2)(x) is argued but not settled | No business income and no earlier deduction |
| A bank’s technical write-off | No waiver, so no remission to tax | The RBI Directions say it does not waive any claim against the borrower |
Treat the table as a map of questions to put to a chartered accountant, not as advice on your facts. It applies to an MSME loan settlement India deal in the same way as to any other business borrower.
Which Act applies
The Income-tax Act, 2025 replaced the Income-tax Act, 1961 from 1 April 2026. A waiver granted from that date falls under the new Act, and earlier years stay under the old one. Concordances published online map old Section 28 (business income) to new Section 26 and old Section 41 (remission of liability) to new Section 38. The ideas of loan waiver tax India carry across, but confirm the new section and sub-section numbers against the 2025 Act before you rely on a citation. This article uses the 1961 numbering because most of the decided cases do.
Section 41(1): the earlier-deduction test
Section 41(1) taxes the remission or cessation of a trading liability if the borrower was allowed a deduction, loss or allowance for it in an earlier year. Two conditions must both be met: the liability must be a trading one, and a deduction must have been allowed. For a bank loan, this usually decides the treatment of interest and of working capital.
- Interest. Interest paid on a business loan is usually claimed as a deduction. If the bank later waives part of that interest, the waived amount is generally taxed in the year of waiver, to the extent it was allowed earlier. If the interest was unpaid and was never allowed (for example because Section 43B restricted it to the year of payment), there may be nothing for Section 41(1) to reverse. That is a fact question for your accountant.
- Working capital. A cash credit or overdraft used to buy stock or fund trading was usually spent on items that went through the profit and loss account, so a deduction was in effect allowed. Commentary on the Bombay High Court’s decision in Solid Containers (2008) treats a waived trading loan as income, and concludes that working capital waivers are likely taxable. Check the judgment for the section under which it reached that result.
- Capital loans. In Mahindra & Mahindra (Supreme Court, 24 April 2018), the Court held that Section 41(1) did not apply to a waived loan taken to buy capital equipment. The loan was not a trading liability, and no deduction had been claimed for the principal or for the interest.
Section 28(iv) and the 2023 amendment
Section 28(iv) taxes the value of a benefit or perquisite arising from business. For years it was a shelter for cash waivers. In Mahindra & Mahindra the Supreme Court held that Section 28(iv) does not apply where the benefit is in the form of cash or money, and a loan waiver was treated as a cash receipt.
The Finance Act 2023 changed the clause. It now covers the value of a benefit or perquisite arising from business or profession, whether or not convertible into money and whether in cash, in kind or partly both. The Finance Bill memorandum applies it from assessment year 2024-25, meaning income of the financial year 2023-24 onward. Commentators say the change was aimed at the cash-benefit reasoning in Mahindra. The Karnataka High Court, deciding an assessment year 2006-07 case in I.G. Petrochemicals (2023), applied the old wording, held that the nature of the loan was not decisive, and said the amendment supports the Supreme Court’s reading of the earlier law.
What follows for a business borrower today:
- Pre-amendment years are better protected. If a waiver fell before the amended period, Mahindra and the Karnataka decision help even for working capital loans.
- Waivers in the amended period are exposed. The clause now reaches cash benefits. Whether a bank’s waiver of a business term loan is a benefit “arising from business” is the open point, and no appellate ruling that settles it was available when this article was prepared.
- Do not assume the old shelter. A settlement signed today should be planned on the basis that the principal waiver may be taxed unless your adviser has a reasoned view that it is not.
Capital loan or revenue loan
Before the 2023 amendment, the Delhi High Court in Logitronics (2011) held that whether a waiver is taxable depends on the purpose of the loan. A loan taken for a capital asset gave no income under Section 28(iv) or 41(1). A loan taken for trading and treated that way in the books did. The Mumbai ITAT in King Prawns held that a reduction in a bank loan under a one-time settlement scheme was not taxable under Sections 28(i), 28(iv) or 41(1). These cases are the base of the argument that a term loan principal can still be shielded. They were decided on the older wording, so they need to be tested against the amended clause.
The purpose of the loan still matters in two other ways. It tells you whether Section 41(1) can apply, and it tells you how the waiver will be recorded in the books.
Individuals and non-business borrowers
An individual who borrowed for a house, a car or education and has no business link is outside Sections 28 and 41, which need business income or a trading liability. The remaining question is Section 56(2)(x), which taxes money received without consideration. One view is that a loan involves consideration, namely interest and a promise to repay, so the section does not apply to a waiver. A Chandigarh ITAT decision on a business borrower, Jai Pal Gaba (2019), held a waiver not taxable under Sections 28(iv), 41(1) or 56, but it turned on its own facts, pre-dates the 2023 amendment and has not been tested above the tribunal. Individuals should still ask for a view before signing.
No TDS does not mean no tax
Section 194R requires deduction of tax at source on business benefits and perquisites. CBDT Circular No. 18 of 2022 (13 September 2022) says banks and certain other lenders need not deduct tax under Section 194R on a one-time loan settlement or a waiver granted on reaching settlement. It also says the taxability of the waiver is governed by the relevant provisions of the Act. So a bank that does not deduct tax on an OTS bank loan settlement has taken no position on what the borrower owes. The borrower must work that out and report it.
Companies, IBC resolutions and book profit
For a company, the tax cost of a waiver may be felt twice. A company that follows Ind AS records a gain when a liability is derecognised, and commentators note that this gain can raise book profit and so bring minimum alternate tax into play under Section 115JB. ICAI material records that loss carry-forward restrictions on a change in shareholding (Section 79) do not apply to a change under an approved resolution plan. These points are for a chartered accountant to confirm for the year concerned. The same questions arise in a settlement with a bank outside the IBC.
If the borrower has business losses, ask whether the income from the waiver can be absorbed by current or carried-forward business losses. That can change the cash cost sharply, but it is limited by other rules, including those on change of shareholding.
A technical write-off is not a waiver
A bank may write off an account in its books and still pursue the borrower. The RBI’s Commercial Banks Resolution of Stressed Assets Directions, 2025 (RBI/DOR/2025-26/165), the current text of RBI stressed asset resolution for commercial banks, say that a technical write-off does not involve any waiver of claims against the borrower. If that is all that has happened, the borrower has not had a liability remitted, so there is no waiver to tax on that basis. The tax question arises when the bank actually agrees to accept less than the dues. Under the Directions that make up RBI stressed asset resolution for commercial banks, compromise settlement is not a right and that a settlement paid over more than three months is treated as a restructuring, so the tax position should be considered together with the terms of the settlement. For more, see Hectogon’s comparison of write-off, OTS and restructuring.
Before you sign an OTS: seven questions
- Which components are being waived? Ask for the settlement letter to show principal, interest and charges separately.
- Was each component ever deducted? Check your returns for the interest claimed in each earlier year.
- Was the loan capital or revenue? Link it to what the money bought.
- Which year does the waiver fall in? Ask your adviser whether it is the year of sanction, payment or closure, and which Act applies.
- How will the books record it? An Ind AS gain affects book profit and the MAT position.
- Can losses absorb it? Check the brought-forward business losses and any shareholding change.
- Can you pay the tax? Plan the tax cash flow before you commit funds to the settlement amount, because a bank loan settlement India deal that saves interest can still leave a tax cost. A borrower who has just paid a one time settlement can still face a tax bill the following year, and the same is true of an NPA one time settlement with an account already classified as non-performing.
For an NPA one time settlement or any loan settlement India deal, and for MSME borrowers in particular, the same questions sit beside the documentation and registration points in Hectogon’s pieces on the MSME one time settlement bank process and MSME loan settlement India applications. An MSME one time settlement bank proposal should be costed after tax, not before.
Frequently asked questions
Is a loan waiver by a bank taxable in India?
It depends. Interest that was claimed as a deduction earlier and is then waived is taxable under Section 41(1) of the 1961 Act. The principal of a business loan can be taxable, and the 2023 amendment to Section 28(iv) widened that risk. A personal loan waived for an individual with no business link is generally outside Sections 28 and 41.
Is the principal waived in a one time settlement taxable?
For a business borrower, possibly. Before the 2023 amendment, the Supreme Court in Mahindra & Mahindra (2018) held that a cash loan waiver is outside Section 28(iv) and that Section 41(1) did not apply to a capital loan. Section 28(iv) now covers benefits in cash or in kind from assessment year 2024-25, so the shelter is weaker. Take advice on your year and loan type.
Does the bank deduct TDS on a loan waiver or OTS?
No. CBDT Circular No. 18 of 2022 says banks and certain other lenders need not deduct tax under Section 194R on a one-time loan settlement or waiver granted on settlement. The circular adds that the borrower’s liability is governed by the relevant provisions of the Act, so the absence of TDS does not mean the waiver is tax-free.
Is a bank’s technical write-off taxable for the borrower?
Not on that basis alone. The RBI’s 2025 Directions say a technical write-off does not waive any claim against the borrower, so no liability has been remitted. The tax question arises when the bank actually agrees to accept less, for example in a settlement. Confirm the position with a chartered accountant.
Which tax law applies to a waiver granted now?
The Income-tax Act, 2025 applies from 1 April 2026, and the 1961 Act continues for earlier years. Old Section 41 maps to new Section 38 and old Section 28 to new Section 26 in published concordances. Check the section numbers in the 2025 Act before you cite them.
