-1- IN THE HIGH COURT OF JUDICATURE AT BOMBAY O.O.C.J. Income Tax Appeal No.195 of 2001 The Commissioner of Income ) Tax, Mumbai City III, Mumbai ) Aayakar Bhavan, M.K.Road ) Mumbai 400 020 ) ..Appellant vs. Mehta Pvt.Ltd. ) N.K.Mehta International House ) 178, Backbay Reclamation, ) Mumbai 400 020 ) ..Respondent Mr.Vimal Gupta for appellant Mr.F.B.Andhyarujina, Sr.Counsel with Mr.Pramodkumar Parida i/b P.R.Toprani for respondent. Judgment Reserved on: 13.8.2008 Judgment Pronounced on:12.9.2008 CORAM: Dr.S.RADHAKRISHNAN & CORAM: Dr.S.RADHAKRISHNAN & CORAM: Dr.S.RADHAKRISHNAN & S.J.KATHAWALLA JJ. S.J.KATHAWALLA JJ. S.J.KATHAWALLA JJ. 12th September,2008 12th September,2008 12th September,2008 J U D G M E N T (Per S.J.KATHAWALLA J.) J U D G M E N T (Per S.J.KATHAWALLA J.) J U D G M E N T (Per S.J.KATHAWALLA J.) 1. The above appeal is filed by the appellant (revenue) impugning the order dated 14th September,2000 passed by the Appellate Tribunal arising out of I.T.A.No.542/MUM/1997 for Assessment year 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 -2- 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 and Chemical India Ltd.(SCCIL), Mehta Pvt.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? 2. The relevant facts arising in the present appeal are as under: i) M/s Agrima Projects Engineering and Consultancy Services Ltd. (Agrima) was 100% subsidiary of the assessee company. By an order of this Court, Agrima was amalgmated with the assessee company with effect from 1st January, 1983. Prior to its amalgamation, Agrima, inter alia, carried on business of a financer. During the accounting year ended on 31st December, 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. -3- 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 I.D.B.I. By its letter dated 8th April, 1980, I.D.B.I. 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 I.D.B.I. In order to comply with the said condition and secure the said loan from I.D.B.I. Maharana Mills approached SCCIL to provide to Maharana Mills an unsecured loan of Rs.50,00,000/- for a period of five -4- 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% interest against security of a second charge to rank immediately next after the charge/mortgage in favour of I.D.B.I. 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 I.D.B.I., the Reserve Bank of India and other concerned Banks. Agrima 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 -5- 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 dated 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 case 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. Name of the Bank Loans advanced Ruppes in Lacs 1980 1981 1982 1983 Bank of Barodaa 80.00 -- -- Central Bank of India 9.03 4.92 -- -- State Bank of Saurashtra 5.87 51.30 38.84 29.49 I.D.B.I. -- 43.00 3.50 -- Others 1.00 -- 26.50 -- -6- ------------------------------------- 15.00 179.22 68.84 29.49 vi) As stated above, Agrima stood amalgmated with the assessee Company with effect from 1st January, 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 August, 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 instalments. viii) The assessee company in its return for the -7- Assessment Year 1986-87 had, inter alia, claimed loss of Rs.74,89,041/- During the assessment proceedings before Dy.CIT(Spl)/R.27, Bombay the assessee, interalia 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 Assessing Officer 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 Assessing Officer was also of the view that the object clause 13, as -8- 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 Assessing Officer, therefore, by his order dated 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 under sec.271(1)(c) of the Income Tax 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 Assessing Officer dated 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 Assessing Officer 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 -9- critically examined by IDBI, Reserve Bank of India and Finance Ministry. The Assessee also submitted that it is most pertinent to note that the Assessing Officer 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 Assessing Officer 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 Reserve Bank of India and the Finance Ministry. The assessee submitted that the Assessing Officer 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 Assessing Officer erred in appreciating all the relevant facts and erred in -10- disallowing the claim of the assessee. xi) The assessee before CIT(A), interalia, relied on the decision of the Hon’ble Supreme Court in CIT Vs. Birla Cotton Spinning and Weaving Mills reported in 82 ITR 166 (SC). 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 was 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 over confident in his convictions, the assessee might appear in the light of the ultimate decision, the expenditure in prosecuting the -11- 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 in as much 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 Sasoon Vs.CIT reported in 118 ITR 261 (SC) 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 Limited Vs. CIT reported in 72 -12- ITR 296 (Allahabad) 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 dated 17th October, 1996 after considering the facts available on record and the various decisions of the Hon’ble Supreme Court as well as the High Court 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 Assessing Officer that these funds were misappropriated by the Directors or were frittered away in utter disregard to the revival scheme. CIT(A) contrary to the assessing officer’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 Assessing Officer was accordingly directed to allow -13- the loss claimed by the assessee. xv). Aggrieved by the said order of the CIT (A) dated 17th October, 1996, an appeal was filed by the revenue before the Appellate 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 Appellate 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 guatrantee would be an allowable deduction. The Assessing Officer made the impugned disallowance on irrelevant considerations. The assessing officer over looked 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 Assessing Officer 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 Reserve Bank of India and Finance Ministry have also accorded necessary approval to the said scheme of modernisation. -14- xvi). It appears from the order of the Appellate Tribunal that the revenue has highlighted only one point from the order of the Assessing Officer, 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 McDowel’s case reported in 154 ITR 148. xvii). The Appellate Tribunal by its order dated 14th September, 2000 has, inter alia, observed that the facts set out in paragraphs 5.2 to 5.12 of the order of CIT(A) are not refuted by the revenue. The Tribunal has recorded that CIT (A) 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 Appellate 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 Appellate 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. -15- 3. Being aggrieved by the order of the Appellate Tribunal dated 14th September, 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 paragraph 1 above. 4. 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 Appellate Tribunal. We do not agree with the finding of the A.O. 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 also 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 have -16- only highlighted the fact that the three companies were controlled and managed by the same group of persons. 6. 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 in Mc Dowel’s case, 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. Infact, 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 Assessing Officer that these funds were misappropriated by the directors or were frittered away. CIT(A) have, therefore, reached a finding of fact that the guarantee given by Agrima was genuine. This finding of fact is also accepted by the Appellate 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. -17- 7. 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. 8. 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. (S.J.KATHAWALLA J.) (Dr.S.RADHAKRISHNAN J.) (S.J.KATHAWALLA J.) (Dr.S.RADHAKRISHNAN J.) (S.J.KATHAWALLA J.) (Dr.S.RADHAKRISHNAN J.)