Commissioner of Income Tax vs Mehta (P) Ltd.

S.J. Kathawalla, J.—The above appeal is filed by the appellant (Revenue) impugning the order dt. 14th Sept., 2000 passed by the Tribunal arising out of ITA No. 542/Mum/1997 for asst. yr. 1986-87. The substantial question of law on which the appeal is admitted by this Court is as follows:

Whether on the facts and circumstances of the case and in law, the Tribunal was right in law in confirming the order of CIT(A) allowing the claim of the assessee for loss of Rs. 74,89,041 being guarantee written off, failing to appreciate that Saurashtra Cement & Chemical India Ltd. (SCCIL), Mehta (P) Ltd., Maharana Mills Ltd. and Agrima Project had common directors and were under the same management and the entire exercise was collusive and only to book losses?

The relevant facts arising in the present appeal are as under:

(i) M/s Agrima Projects Engineering & Consultancy Services Ltd. (Agrima) was 100 per cent subsidiary of the assessee company. By an order of this Court, Agrima was amalgamated with the assessee company w.e.f. 1st Jan., 1983. Prior to its amalgamation, Agrima, inter alia, carried on business of a financer. During the accounting year ended on 31st Dec, 1980 Agrima''s total advances to various parties amounted to Rs. 2,90,74,994 besides the loan of Rs. 15,00,000 advanced to Maharana Mills Ltd. The interest income of Agrima for the said year was Rs. 24,70,785. The assessee company also had business dealings with Maharana Mills. It had supplied cotton and yarn worth Rs. 3.22 crores over a period of time and had received payments towards the same aggregating to Rs. 3 crores. The balance amount of Rs. 22,43,489 was outstanding since the year 1979. The assessee company together with Agrima had to recover a total amount of Rs. 37,43,489 from Maharana Mills as on 31st July, 1980. Maharana Mills which was a profit earning concern earlier had financial problems due to the damage caused to the mill by cyclonic storms and consequent closure of the mill for a long period. Maharana Mills was trying to revive itself with the help of borrowings from banks/financial institutions etc.

(ii) A loan of Rs. 70,00,000 was sanctioned to Maharana Mills by IDBI. By its letter dt. 8th April, 1980, IDBI informed Maharana Mills that the said loan was sanctioned to enable Maharana Mills to tide over its financial difficulties and to modernise its plant subject to the condition, inter alia, that Maharana Mills should source subordinated unsecured loans/ deposits of Rs. 50,00,000 from any party on such terms and conditions approved by IDBI. In order to comply with the said condition and secure the said loan from IDBI Maharana Mills approached SCCIL to provide to Maharana Mills an unsecured loan of Rs. 50,00,000 for a period of five years. The board of directors of SCCIL resolved in its meeting held on 23rd April, 1980 to grant a loan of Rs. 50,00,000 to Maharana Mills at 12 per cent interest against security of a second charge to rank immediately next after the charge/mortgage in favour of IDBI and subject to the said loan being guaranteed by some party for its repayment.

(iii) Maharana Mills accordingly requested Agrima to be a guarantor for the repayment of the said loan of Rs. 50,00,000 agreed to be advanced by SCCIL. Agrima took note of the fact that a scheme was prepared to modernise the plant and machinery and to make Maharana Mills a viable concern. Agrima also took note of the fact that after scrutinising and studying the said scheme in depth the same was approved by IDBI, the RBI and other concerned banks. Agrlma was of the view that if IDBI advanced an amount of Rs. 70,00,000 to Maharana Mills and if SCCIL advanced a further loan of Rs. 50,00,000, Maharana Mills would overcome its financial difficulties and would be able to start earning profits and to gradually pay off its creditors including Agrima who had to recover Rs. 15,00,000 from Maharana Mills. Agrima was convinced that it did not run any risk in agreeing to stand as a guarantor since the scheme was approved by banks and financial institutions which had necessary experience and expertise in the matter. According to Agrima, it, therefore, took a well considered wise and prudent business decision to guarantee the payment of Rs. 50,00,000 to SCCIL and improve the prospects of recovery of its own loan and to protect and preserve its assets in the form of a loan so advanced.

(iv) In the circumstances, Agrima issued a guarantee dt. 31st July, 1980 to SCCIL under which Agrima agreed to pay Rs. 50,00,000 with interest to SCCIL in case Maharana Mills did not repay the said loan with interest to SCCIL.

(v) It is the cese of Agrima that even thereafter i.e. in the year 1980 and in subsequent years the banks and financial institutions continued to advance additional loans to Maharana Mills as shown below:

(vi) As stated above, Agrima stood amalgamated with the assessee company w.e.f. 1st Jan., 1983. As a result of this amalgamation, there was a complete fusion of the assets and liabilities of Agrima with that of the assessee.

(vii) In March, 1984, SCCIL addressed a letter to Maharana Mills demanding repayment of the aforesaid loan of Rs. 50,00,000 and advanced by it along with the agreed rate of interest. As Maharana Mills failed to repay the aforesaid loan and interest thereon, SCCIL in August, 1985 called upon the assessee to make good the payment of loan of Rs. 50,00,000 with interest thereon upto 23rd Aug., 1985, aggregating to Rs. 74,89,041 in terms of the guarantee executed by Agrima. In view of the amalgamation of Agrima with the assessee, the assessee paid the said amount along with interest aggregating to Rs. 74,89,041 to SCCIL. Since the assessee was not in a position to repay the whole amount at a time, the same was paid by the assessee to SCCIL between the period 31st July, 1986 to 28th April, 1988 by installments.

(viii) The assessee company in its return for the asst. yr. 1986-87 had, inter alia, claimed loss of Rs. 74,89,041. During the assessment proceedings before Dy. CIT, Special Range-27, Bombay the assessee, inter alia sought, that the loss of Rs. 74,89,041 claimed by the assessee be allowed. In support of its submission the assessee, inter alia, relied upon object Clause No. 13 of the memorandum and articles of association of Agrima which reads as under:

To guarantee (whether or not for any consideration) the performance of any contract or obligation and/or the payment of money of or by any person or company or corporation and to secure any guarantee so given in such manner as the company may think fit and in particular by mortgage, pledge or other security upon all or on any other property of the company.

The AO after noticing that some of the directors in SCCIL, Maharana Mills Ltd., the assessee company and Agrima were common, took a view that all the companies were under the same management and a device was adopted to receive maximum benefit out of the said transaction which smacked of collusion. The AO was also of the view that the object Clause 13, as set out above, is a comprehensive Clause which required that the guarantee given should be secured in particular by mortgage, pledge or other security upon all or any of the properties of the company and that this condition was not adhered to by Agrima. The AO, therefore, by his order dt. 1st March, 1989 declined to allow the said amount of Rs. 74,89,041 towards loss claimed by the assessee and also proposed to initiate penalty proceedings u/s 271(1)(c) of the IT Act for submission of inaccurate particulars and claiming a loss which is not due to the assessee.

(ix) Being aggrieved by the order of the AO dt. 1st March, 1989, the assessee preferred an appeal before the CIT(A). The assessee before the CIT(A) narrated facts and advanced submissions on the lines set out in Clauses (i) to (vii) above and also relied upon several judgments of this Court as well as the Hon''ble Supreme Court of India.

(x) The assessee also submitted before the CIT(A) that the AO has overlooked all the facts pertaining to the case though they were fully and exhaustively explained to him including the fact that the whole project put forward by Maharana Mills for modernising the mill was critically examined by IDBI, RBI and Finance Ministry. The assessee also submitted that it is most pertinent to note that the AO has not at all doubted or disputed any of the facts stated before him nor has he doubted or disputed the fact that the loans, were actually given by IDBI and SCCIL and from the said loans plant and machinery were in fact purchased by the Maharana Mills. It was submitted that the AO has not commented on the scheme and the combined package offered to Maharana Mills by IDBI, ICCIL and Agrima which was examined and approved by the RBI and the Finance Ministry. The assessee submitted that the AO merely referred to the common directors amongst the three companies and in absence of any evidence, documentary or otherwise, reached an erroneous finding that the transaction was collusive. The assessee submitted that the three companies were independent entities and acted as such at arm''s length irrespective of the fact that there were common directors. The assessee further submitted that the guarantee was given as a part of Agrima''s business and the same was covered by the object Clause in the memorandum and articles of association of assessee. The assessee, therefore, submitted that the AO erred in appreciating all the relevant facts and erred in disallowing the claim of the assessee.

(xi) The assessee before CIT(A), inter alia, relied on the decision of the Hon''ble Supreme Court in Commissioner of Income Tax, West Bengal I Vs. Birla Cotton Spinning and Weaving Mills Ltd., . In that decision the question arose whether the expenditure incurred by the assessee in engaging lawyers and conducting proceedings before the Investigation Commission and also in Courts where the vires of the statute under which the Commission was constituted were challenged, was a revenue expenditure and a permissible deduction. Allowing the claim of the appellant, the Hon''ble Supreme Court held that the essential test which has to be applied is whether the expenses were incurred for preservation and protection of the assessee''s business from any such process or proceedings which might have resulted in the deduction of its income and profits and whether the same were actually and honestly incurred. It was pointed out that the Hon''ble Supreme Court had in the said decision opined that the deductibility of such expenditure does not depend upon the final outcome of those proceedings and that however wrong headed, ill adviced, unduly optimistic or overconfident in his convictions, the assessee might appear in the light of the ultimate decision, the expenditure in prosecuting the civil proceedings cannot be denied as permissible deductions if it is reasonably and honestly incurred to promote the interest of the business. It was asserted by the assessee that this test is clearly satisfied in the instant case inasmuch as Agrima actually and honestly stood as a surety for the repayment of the loan advanced by SCCIL for preservation and protection of the loan advanced by it in the normal course of its business to Maharana Mills.

(xii) Agrima, relying on the decision in Sassoon J. David and Co. Pvt. Ltd., Bombay Vs. Commissioner of Income Tax , Bombay, contended before CIT(A) that Agrima though not under any legal obligation, voluntarily and with the object of preserving and protecting its assets, namely, loan advanced by it to Maharana Mills stood as a surety. It was for Agrima to decide whether it was in the interest of its own business to do so. Since it stood as a surety out of the commercial and business considerations and to preserve and protect its assets, the loss suffered by it as a consequence thereof was a loss incidental to carrying on of its business and permissible deductions.

(xiii) The assessee relying on the decision in J.K. Commercial Corporation Ltd. Vs. Commissioner of Income Tax, pointed out before the CIT(A) that the test of allowability is not what a prudent man would do in similar circumstances. That the assessee did not act like a prudent man is entirely irrelevant in determining the question whether the expenditure ought to be allowed as deduction.

(xiv) CIT(A) by his order dt. 17th Oct., 1996 after considering the facts available on record and the various decisions of the Hon''ble Supreme Court as well as the High Courts relied upon by Agrima, came to the conclusion that sincere efforts were made by the financial institutions/banks to revive Maharana Mills for which they themselves advanced huge amounts. These amounts as well as the loan taken from the SCCIL were utilised in purchasing new machinery which was also installed. CIT(A) also recorded that it is not alleged by the AO that these funds were misappropriated by the directors or were frittered away in utter disregard to the revival scheme. CIT(A) contrary to the AO''s finding that the transaction was collusive reached a categorical finding that it was very clear from the facts that the act of Agrima of giving guarantee to SCCIL was genuine and the assessee''s claim was allowable. The AO was accordingly directed to allow the loss claimed by the assessee.

(xv). Aggrieved by the said order of the CIT(A) dt. 17th Oct., 1996, an appeal was filed by the Revenue before the Tribunal inter alia impugning the decision of CIT(A) in allowing the claim of Rs. 74,89,041 being loss incurred under the guarantee. The assessee before the Tribunal reiterated its arguments advanced before CIT(A) viz. that the guarantee was given as a part of the assessee''s business and the activity of giving guarantee was covered by the object Clause in the memorandum of association of Agrima. The guarantee was furnished on business considerations. Hence loss arising out of such guarantee would be an allowable deduction. The AO made the impugned disallowance on irrelevant considerations. The AO overlooked the fact that the three companies were independent entities and acted as such at arm''s length irrespective of the fact that there were common directors. The AO overlooked the fact that the whole project put forward by Maharana Mills for modernising the mill was carefully examined by IDBI before it agreed to advance the loan of Rs. 70,00,000. It was pointed out that the RBI and Finance Ministry have also accorded necessary approval to the said scheme of modernisation.

(xvi). It appears from the order of the Tribunal that the Revenue has highlighted only one point from the order of the AO, namely, that the three companies were under the control and management of the same group of persons which fact warranted the applications of principles enunciated by the Hon''ble Supreme Court in McDowell and Co. Ltd. Vs. Commercial Tax Officer, .

(xvii). The Tribunal by its order dt. 14th Sept., 2000 has, inter alia, observed that the facts set out in paras 5.2 to 5.12 of the order of CIT(A) are not refuted by the Revenue. The Tribunal has recorded that CFTtA) has discussed the decisions relied on by the assessee and has come to the conclusion that the said decisions render assistance to the assessee in claiming the impugned loss. The Tribunal further recorded that on appraisal of material on record the CIT(A) has recorded a finding of fact that the act of Agrima giving guarantee to SCCIL was genuine. The Tribunal has held that this finding of fact could not be challenged by the Revenue by bringing on record any adverse material. The Tribunal, therefore, declined to interfere with the order passed by CIT(A) and dismissed the appeal of the Revenue.

Being aggrieved by the order of the Tribunal dt. 14th Sept., 2000 the Revenue impugned the same before this Court by filing the above appeal which was admitted on the question of law set out in para 1 above.

We have heard the advocates for the Revenue as well as the assessee. They have reiterated their submissions made before the CIT(A) and the Tribunal. We do not agree with the finding of the AO that Clause 13 of the memorandum of articles of association is a comprehensive Clause and in view of that Clause Agrima cannot give any guarantee without security. We are of the view that according to Clause 13 of the object Clause Agrima could guarantee the performance of any contract or obligation/payment of money of or by any person or company or corporation. In addition to this, the said object Clause 13 also allows Agrima to secure any guarantee in such a manner as the company may think fit and in particular by the mortgage, pledge or other security upon all or on any other properties of the company. This would not mean that Agrima cannot give guarantee without security. In any event, it also appears that the Revenue has not pressed this issue before the Tribunal and has only highlighted the fact that the three companies were controlled and managed by the same group of persons.

As regards the contention of the Revenue that the three concerns/companies were under the control and management of the same group of persons and, therefore, warranted application of principles initiated (sic-enunciated) in McDowell''s case (supra), we are of the view that such a contention in the absence of any material in support thereof should be outright rejected. It is argued by the assessee before all the authorities that the said three companies are independent and acted as such at arm''s length. In fact, SCCIL is a listed company. This contention of the assessee is accepted by CIT(A) who has reached a finding of fact that the amounts received by Maharana Mills from the banks and financial institutions and from SCCIL were utilised in purchasing new machinery which was also installed and it is not the allegation of the AO that these funds were misappropriated by the directors or were frittered away. CIT(A) has, therefore, reached a finding of fact that the guarantee given by Agrima was genuine. This finding of fact is also accepted by the Tribunal. In view of these concurrent findings of fact we see no reason as to why we should interfere with the said finding of fact.

In view thereof we are of the view that except for making a bare allegation that the entire exercise of giving guarantee by Agrima to SCCIL was collusive and only to book losses on the ground that the companies have common directors and were under the same management, the Revenue has failed to produce any material in support of their case that the guarantee given by Agrima was not genuine. Only because some directors were common one cannot reach to a serious conclusion that the entire transaction was collusive and colourable only to book losses.

In view of the above we answer the above question raised in the appeal against the Revenue and in favour of the assessee. The appeal stands dismissed with no order as to costs.