Commissioner of Income-Tax, Calcutta v. Birla Bros. (P) Ltd.

Judgment

COMi\USSIONER OF INCOME-TAX, CALCUTTA BIRLA BROS. (P) LTD. April 23, 1970 [J. C. SHAH, K. S. HEGDE AND A. N. GROVER, JJ.] Jiulian lnmmNux Acr. 1922, s. 10(2)(xi)-A.r.\'C.Vste company ct Mannginf.f Age1H-Selling agent of conJpany 11u1nagecl by as.\·essee taki11/.f /oc11t' fron1 ti ht111k e1nd tlSSt!l'St!e .\·tc111ding guarantee for tlrt loan-Loan not. re~paid hy ,seJ/i11f.f agent hut hy ll.\·:,.essee ar ft(Uc11·antor-Asse.\·see failing /(} recorer loan fro111 selling agent-loan aniount c/airned as a ht1d th'ht- Ad111i.l',\'ihilily of clai111. The asses.cc was a Private Limited Company. It carried on the businc;s of banking and financing as also of managing agency. Starch Pro· ducts Lt<l., was one of various companies. which was being managed by the assessce. Starch Products had appointed the U.P. Sales Corporation Ltd., as its selling agent. The assessee claimed to ·have stood guarantee for a loan of Rs. 6 lacs which was advanced to U.P. Sales Corporation Ltd., by the Gwalior Industrial Bank.

The borrower failed to pay the loan which on August 2, 1948 stood at Rs. 5,60,199. This amount was ipaid by the asscssec pursuant to the guarantee. Thereafter the assessec treated the U .P. Sales Corporfttion as ils debtor for the aforesaid amount. That company \vent into liquidation and as the assessee could not recover anything from it. a sum of Rs. 5,60.199 was written off in the books of the assessee company. Before the Income-tax Office·r the said amount was claimed as a bad debt under s. 10(2) (xi) o·f the Income-tax Act, 1922. The Income-tax Officer rejected the claim. The assessee's appeal; before the Assistant Commissioner failed.

The Appellate Tribunal, nowever, held that the guarantee given by the assessee was of indirect oenefit to the assessee's husincss because if it had not guaranteed the h1an fri ques .. lion the company managed by it would have had to give extended credit to its selling agent which it could not have done without borrowing money either from the assessee or some third party. In reference, the High Court also held that the guarantee was in tho larger interest of the ~1ssessee's business. The Commissioner of Income-tax appealed to this Court by special leave. HELD: (i) While computing profits or· gains of business under s. W certain allowances have to be made under sub-s. (2). The allowance covered by cl.

(xi) thereof has to be made, when the assessce's accounts in respect of any part o'f his business, profession or vocation are not" kept on a cash basis, of such sum, in respect of the bad and doubtful debts, due to the assessce in respect of that part of his business profession and vocation. and in the case of an assessee c.arrying on a banking or money lending busmess o'f such sum in respect loans made in the ordinary course of such business as the Income-tax Officer may estimate to be irrecoverable but not exceeding the amount actually written •off as irrecoverable in the books of the asseS!jee. A bad d_ebt mea~s a debt ~hich would have gone in :o the llalance-shcet as. a tradmg debt m the busmess or trade. It must arise in the course of .and as a result of the assessee's business. The deduction• claimed should not be too remote frpm the business carried on by the ru;~cssee. [361 B-E] Ll2 Sup. C 1/70-9 Sl,JPREME CO\JRT .REPORTS [ 197 I] I S.C.R. In the present case, neither the memorandum· of ~sociarion nor the managing ·agency agreement. contained any such provisions hy which it could be said that he guarantee of the loan made by the ba.nk to the selling agents was. done in the course of the managing agency business.

There Was no privity of contract or any Jegal relationship between the assessee and the selling agent. Neither under custom nor under any · statutory provision. or any contractual obligation \vas the assessee bo•1nd to guarantee the loan advanced by the bank to the selling agent. The gua-rantee could not . be said to he indirectly in the interest of the assessee's bu$iness, or as held by the High Court, in its larger interest. The Tribunal and the High Court were, therefore, in error in holding that the .sum in question was allowable as a. deduction under s. 10(2)(xi). [362 D-E, F-H] Ma_dan G_opa/ Bag/a v. Commissioner of Income-tax, Wesl Bengal, 30 I.T.R. 174 and Commissioner of· Income-tax, Bombay v. A bd11/labhai . Abdulkadar, 31 l.T.R. 72, applied. 'Essen Private Ltd. v. Commissioner of Income-tax, 65 I.T.R. 625, distinguished. CIVIL APPELLATE J\JRISDI0T!ON: Civil Appeals Nos. 2380 and 2381 of 1966. Appeals from the .iudgment and order dated January 7.

1966 (Jf the Calcutta High Court in Income-tax References Nos. 7 and 176 of 1961. S. Mitra, S. K. Aiyar, R. N. Sachthey and B. D. Sharma, for the appellant (\n both the appeals) . A. K. Sen, 0. P. Khaitan and B. P. Maheshwari. for the respondent (in both the appeals). The Judgment of th.~ Court was delivered "1 Grover, J. These appeals by certificate arise out of a common judgment of the Calcutta High Court in two Income tax References. The assessee is a private limited company. It carried on the busim.ess of banking and financing as also of managing agency. Starch Products Ltd. was one of the various companies which was being managed by the assessee. Starch Products had appointed the U.P. Sales Corporation Ltd. as its selling agent. The assessee claimed to have stood guarantee for a Joan of Rs. 6 Jakhs which was advanced to the U.P. S>Jles Corporntion Ltd. by the Gwalior Industrial Bank Ltd. The borrower failed to pay the loan which Qn August 2:1948 stood at Rs. 5,60, 199.

This amount was paid by the assessee pursuant to the guarantee. Thereafter the assessee treated the U.P. Sales Corporation Ltd. as its debtor for the afore· i;aid amount. That company went il).to liquidation and as the assessee could not recover anything from it a sum of Rs. 5,60.199 was written off in the books of the assessee company.. The claim was not entertained either by the Income tax Officer or the Appellate Assistant Commissioner. Before the Income tax Officer the r 8 C,I. T. v. BIRLA. BROS. {Grover, I.) said amount was claimed as bad debt vide assessee's letter dated September 12, 1957. The Income tax Officer rejected the explanation tuniished by the assessee for advancing such a large amount to a ~ompai1y whose financial position was far from satisfactory. According to him the advance was not a bona fide money lendilllg investment.

Subsequently it was sought to be established before the Income tax Officer, that an indemnity had been given to the Gwalior Industrial Bank Ltd. in the matter of the loan account of the 0.P. Sales Corporation Ltd. and the payment had been made on its failure to clear the debt of the Bank. According to the Income tax Officer the assessee \vas asked to produce evidence about the guarantee having been furnished but he was not satisfied that. · there was any directors' resolution authorising the furnishing of a guarantee or that the document purporting to be a guarantee had been properly stamped or that there was other sufficient evidence to establish the transaction. Before t• Appellate Assistant Commissioner the only substal)tial ground· taken was that the Income tax Officer had wrongly disallowed the claim for bad debt amounting to Rs. 5,60,199. The Appellate Assistant Commissioner con~ sidered the question of the aforesaid amount being an admissible deduction or a~lowance under s.

10(2) (xi) of the Income tax Act 1922. In his opinion the guaranteeing· of irlo3lll though made in the interest of the assessee's business and as a matter of commercial expediency did not represent an advance made_ in the normal course of the assess~'s business. Such an ad¥11nce could have been made only if it had been. made to the company managed by the assessee under a contractu~l obligation to guarantee the finances of the managed company. According to him the· claim for irrecoverable loan would have been also admissible if the assessee could establish that the loan represented an int~est bearing advance made m the course of the assessee's money lending business but that was not the case of the assessee. And since the loan had been advanced to assist a concern having trade relations with one of the managed companies it could not be ·allowed as a permissible deduction.

The appellate tribunal did not agree with the finding of the Appellate Assistant Commissioner that the 1oss was not directly incidental to the assessee's business. This is what the tribunal stated in itS ord$r : "The Appellate Assistant Commissioner, in our Qpinion, failed to appreciate the special nature of the business carried on by the assessee. This is not a case where any money was advanced by the asse'ssee for the pu{pcse of earning 'interest. All that the assessee did was to stand surety for the money advanced by a Bank to the selling agent of one of its manased companies. If such a (l97l] l S.C.R guarnntee was not given Messrs. Starch Products Ltd .. one of the managed companies, would have had to give extended credit to the selling agent and this could be possible if the managed company'in its turn was financed either by the managing agents or a third party.

It was to obviate the necessity of such borrowi·ng by the managed company that the assessee company stood guarantee for the loan given by Gwalior Industrial Bank Ltd. to U.P. Sales Corporation Ltd. It was only on the failure on the part of the borrower, i.e. U.P. Sales Corporation Ltd., to fulfil its committment that the assessee as a guarantor came into the picture. There was. therefore, no question of earning of any interest on any money advanced. It was in the. larger interest of the assessee"s business that the guarantee was given. The standing of surety for the sales cf'ga.nisation of the managed company and the consequent loss arising therefrom was in our opinion germane to the assessee's business.

It is now well-established that a sum of money extended not of necessity and with a view to give a direct and immediate benefit to the trade but voluntarily and on the ground of commercial expediency and in order to indirectly facilitate the carrying on of the business, may yet be an allowable deduction in computing the profits and gains of the business." foe Tribunal held that the assessee's claim for the loss of Rs. 5 60 199 was an admissible deduction. At the instance o.f the Com'missioner of Income tax, the Tribunal referred the following question of law to the High Court :- "Whether on the facts and in the circumstances of the case, the sum of Rs. 5,60, I 99 was an admissible deduction in computing the business profits of the assessee ?'' Three other questions were referred to the High Court on an application made under s. 66 ( 2) of the Act. It is unnecessary to refer to them as the real controversy has centred on the above question alone.

The High Court address.ed itse1f to the question whether the amount in dispute fell within s. I 0 ( 2) (xi) of the Act. The finding of the Appellate Assista.nt Commissioner that the guarantee had in fact been furnished to the Bank was not disputed. This is what the High Court said after referring to certain decided cases and the relevant portion of the Tribunal's judgment :- "We agree that it was in the larger interest of the assessee's business that the guarantee was given and we 8 C.I.T. \". BIRLA BROS.'(Grover, J.) are of the opinion that the debt was incidental to the business of the assessee within the meaning o! s. 10(2)- ( xi) of the Act and such a debt was found to be irrecoverable in the relevant accounting year commencing on the 3 lst October 1951 and ending on the 18th October 1952."' Joi While computing profits or gains of business under s. 10 cert;1in allowances have to be made under sub-s. ( 2).

The allowance covered by clause (xi) thereof has to be made when the assessee's accounts in respect of any part of his business, profession or voca· tion are not kept on the cash basis, of such sum, in respect of bad and doubtful debts, due to the assessee in respect a! that part of his business. profession or vocation, and in the_ case of an assessee carrying on a banking .or money,lending business of such sum in respect of loans made in the ordinary course of such business as the Income tax Officer may estimate to be irrecoverable but not exceeding the amount actually written off as irrecoverable in the books of the assessee. Now a bad debt means (l debt which would have gone into the balance sheet as a trading debt in the busi,ness or trade. It must arise in the course of and as a result of the assessee's business. The deduction claimed should not be too remote frmn the business carried on by the assessee. In Madan Gopal Bag/a v. Ccm1r.i1Sioner of lnc'Qme tax West Bengal(') the principle which was accepted was that the debt in·order to fall within s.

10(2)(xi) must be ,one whi~h can properly be called a trading debt i.e. debt of the trade the ptofits of which are being computed. It was observed that the assessee in that case was not a person carrying on business of standing' surety for other persons nor was he a money-lender. He was simply a timber merchant. There was some evidence that he had from time to t'.me obtained finances for his business by procuring loans on the joint security of himself and some other person. But it was not established that he was in the habit of standing surety for other persons along with them for the purpose of securing loans for their use and benefit. Even if such had been the case any loss suffered by reason of having to pay a debt borrowed for the benefit .of another would have been a capital loss to him and not a business loss at all. A businessman may have to stand surety for some one in order to get monies for his own business.

There may be a custom of the business by which that may be the only method whereby he could get money for the purpm.~ of his own business. If he is to discharge a surety debt and if any su~h custom is established it would be a business debt, If the assessee has made a payment not voluntarily but to dischar<>e a legal obligation which arises .from his business he would be e~­ titled to have the mnount deducted as a bad debt und~t s. 10(2)(xi); see Commissioner of Income tax Bombay v. ii) J) T.T.R. 174. [1971] I S.C.R. Abdu//abhai Abdu/kadar('). Jn Essen Private Ltd. v. Commis- .1io11er of Income tax(') Madras, the appellant carried on business as a managing agent of several concerns. Pursuant to the agree· ment with one of the companies managed by it, it advanced large sums of money to tlte managed company and also guaran_teed a loan of Rs. 2 lakhs obtained by that company from a Bank.

The mor:.:iged company failed in its business and upon the Bank press- · & ing for payment the appellant in accordance with its guarantee made certain payments to that Bank. The assessee had' ultimately to write off certain sum in its books as bad debts and it claimed that allowance under s. IO(l)(xi). The Tribunal found that the advances to the managed company and the agreement guarantee· ing the loan to the managed company were in pursuance of its objects and were made in the course of its business and the claim was allowed. That decision was finally affirmed by this Court. Tn this case there was a cause in the memorandum of association by which the assessee was entitl.ed to land monies and to guarantee the performance of contracts. Simifarly the managing agency agreement contained a clause about lending and advancing of money to the managed company. It was found by the appellate tribunal that it was a part of the managing agency to provide funds to the managed company.

In the present case none of those facts have been found. Neither the memorandum of association nor ·th·~ managing agency agreement contained any such provision by which it could be said that the guaranteeing of the loan made by the Bank to the selling agents was done in the course of the managing agency business. In our judgment the facts relied upon by the appellate tribunal and the High Court are barely sufficient for bringing the allowance claimed under s. 10(2)(xi). It may be mentioned that the case of the assessee was confined to that provision and no reliance was placed oin any other provision under which such an allowance could be claimed. There was no privily of contract or any legal relationship between the assessee and the selling agent. Neither under custom nor under any statutory provision or ~ny contractual ob!igation was the assessee bound to guaraintee the Joan advanced by the Bank to the selling agent.

It is difficult how it was in the interest of the assessee's business that the guarantee was given. There was even no material to establish that the managed company was under any legal obligation to finance the selling agent or to guarantee any loans advanced to the selling agent by a third party. It is incomprehensible in what manner the guaranteeing of the loan advanced to the selling agent indirectly ~acilitated the carrying O!f of 1he assessee's business. It is equally difficult to appreciate the observations of the High Court that it was in the larger interest of (I) 31 l.T.R. 72. (2) 65 !.T.R._625. C.l.T. v. BIRLA BROS. (Grover, J.) 36.'! the assess~e·s business that the guarantee was given. In our opinion the view c-f the appellate tribunal was based on a complete misapprehension of the true legal position. The High Court also fell into the same error The allowance which was claimed did not fall withins. 10(2)(xi).

No attempt was made nor indeed it could be usefully made to claim any allowance under s. 10(2) (xv)of the Act. Fur the reasons given above the correct answer to the question referred should be in the negative and against thli! assessee. The. appeals are thus allowed with costs and the judgment of the High Court is set aside. One heari;1g fee. G.C. Appeals allowed.