23 April 1970
Supreme Court


Case number: Appeal (civil) 2380 of 1966






DATE OF JUDGMENT: 23/04/1970


CITATION:  1970 AIR 1531            1971 SCR  (1) 357  1970 SCC  (2)  88

ACT: Indian Income-tax Act, 1922, s. 10(2)(xi)-Assessee company a Managing Agent-Selling agent of company managed by  assessee taking loan front a bank and assessee standing guarantee for the  loan-Loan not re-paid by selling agent but by  assessee as  guarantor-Assessee failing to recover loan from  selling agent-Loan  amount  claimed as a bad debt  Admissibility  of claim.

HEADNOTE: The  assessee was a Private Limited Company.  It carried  on the  business of banking and financing as also  of  managing agency.  Starch Products Ltd., was one of 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 loan of Rs. 6 lacs which was advanced to  U.P.  Sales Corporation  Ltd.,  by  the  Gwali  Industrial  Bank.    The borrower  failed  to pay the loan which on  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 as its debtor for the  aforesaid amount.   That  company  went 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 Officer the said amount  was claimed as a bad debt under s. 10(2) (xi) of the  Income-tax Act, 1922.  The Income-tax Officer rejected the claim.   The assessee’s appeal before the Assistant Commissioner  failed. The  Appellate  Tribunal, however, held that  the  guarantee given  by  the  assessee  was of  indirect  benefit  to  the assesse’s business because if it had not guaranteed the loan in question 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 the  larger  interest  of  the assessee’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. 10 certain allowances have to be made under  sub-s. (2).   The allowance covered by cl. (xi) thereof has  to  be made, when the assessee’s accounts in respect of any part of 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 assessee in respect of that part  of  his business  profession  and  vocation and in the  case  of  an assessee carrying an a banking or money lending business  of 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 assessee.   A  bad debt  means a debt which would have gone into  the  balance- sheet  as a trading debt in the business or trade.  It  must arise  in  the course of and as a result of  the  assessee’s business.   The deductions claimed should not be too  remote from the business carried on by the assessee. [361 B-E] 12 Sup.  C 1/70-9 358 In  the present case, neither the memorandum of  association nor  the  managing  agency  agreement  contained  any   such provisions  by which it could be said that he  guarantee  of the loan made by the bank to the selling agents was done  in the  course of the managing agency business.  There  was  no privity  of contract or any legal relationship  between  the assessee  and the selling agent.  Neither under  custom  nor under any statutory provision or any contractual  obligation was the assessee bound to guarantee the loan advanced by the bank to the selling agent.  ’The guarantee could not be said to be indirectly in the interest of the assessee’s business, 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] Madan  Gopal  Bagla  v.  Commissioner  of  Income-tax,  West Bengal, 30 I.T.R. 174 and Commissioner of Income-tax, Bombay v. Abdullabhai Abdulkadar, 31 I.T.R. 72, applied. Essen Private Ltd. v. Commissioner of Income-tax, 65  I.T.R. 625, distinguished.

JUDGMENT: CIVIL  APPELLATE JURISDICTION: Civil Appeals Nos.  2380  and 2381 of 1966. Appeals from the judgment and order dated January 7, 1966 of 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 (in both the appeals). A.   K.  Sen,  O. P. Khaitan and B. P. Maheshwari,  for  the respondent (in both the appeals). The Judgment of the Court was delivered by 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  business 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 loan of Rs. 6 lakhs which was  advanced  to the  U.P. Sales Corporation Ltd. by the  Gwalior  Industrial Bank  Ltd.   The borrower failed to pay the  loan  which  on



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 aforesaid amount.  That company  went  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.  The claim  was  not  entertained either by the Income tax Officer or the Appellate  Assistant Commissioner.  Before the Income tax Officer the 359 said  amount Was claimed as bad debt vide assessee’s  letter dated  September 12, 1957.  The Income tax Officer  rejected the explanation furnished by the assessee for advancing such a large amount to a company whose financial position was far from  satisfactory. According to him the advance was not  a bona  fide  money lending 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  U.P.  Sales Corporation  Ltd.  and  the payment had  been  made  on  its failure to clear the debt of the Bank.  According to the In- come tax Officer the assessee was 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 the Appellate  Assistant Commissioner the only substantial ground taken was that  the Income tax Officer had wrongly disallowed the claim &or  bad debt  amounting  to Rs. 5,60,199.  The  Appellate  Assistant Commissioner considered the question of the aforesaid amount being  an admissible deduction or allowance under  S.  10(2) (xi)  of  the  Income  tax Act 1922.   In  his  opinion  the guaranteeing  of a loan though made in the interest  of  the assessee’s business and is a matter of commercial expediency did  not represent an advance made in the normal  course  of the  assessee’s business.  Such an advance could  have  been made only if it had been made to the company managed by  the assessee  under  a contractual 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 interest   bearing  advance  made  in  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  loss  was  not directly  incidental  to the assessee’s business.   This  is what the tribunal stated in its order :               "The Appellate Assistant Commissioner, in  our               opinion,  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 assessee for the  purpose               of  earning interest.  All that  the  assesses               did was to stand surety for the money advanced               by  a Bank to the selling agent of one of  its               managed companies,.  If such a               3 60               guarantee   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 borrowing 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   fulfill   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 Organisation 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." The Tribunal held that the assessee’s claim for the loss  of Rs.  5,60,199 was an admissible deduction.  At the  instance of the Commissioner 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.               5,60,199   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 addressed itself to the question whether  the amount in dispute fell within S. 10(2) (xi) of the Act.  The finding  of  the Appellate Assistant 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               3 6 1               are   of  the  opinion  that  the   debt   was               incidental  to  the business of  the  assessee               within the meaning of s. 10(2)(xi) of the  Act               and such a debt was found to be  irrecoverable               in the relevant accounting year commencing  on               the  31st October 1951 and ending on the  18th               October 1.952." While  computing  profits or gains of business under  s.  10 certain  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 vocation are not kept on  the  cash basis,  of such sum, in respect of bad and  doubtful  debts, due to the assessee in respect of 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 a debt which would have gone into the balance sheet  as a trading debt in the business 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 from  the  business carried on by the  assessee.   In  Madan Gopal Bagla v. Commissioner of Income tax West Bengal(1) the principle  which was accepted was that the debt in order  to fall within s. 10(2) (xi) must be one which can properly  be called a trading debt i.e. debt of the trade the profits  of which are  being  computed.   It  was  observed  that  the assessee in that ease 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 time 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 purpose of his own business.  If he is to  discharge a surety debt and if any such custom is established it would be a business debt.  If the assessee has made a payment  not voluntarily but to discharge a legal obligation which arises from  his business. he would be entitled to have the  amount deducted as a bad debt under s.    10(2)(xi);            see Commissioner of Income tax Bombay v. (1) 30 I.T.R. 174. 362 Abdullabhai Abdulkadar(1).  In Essen Private Ltd. v. Commis- sioner  of  Income tax(2) Madras, the appellant  carried  on business as a managing agent of several concerns.   Pursuant to the agreement with one of the companies managed by it, it advanced large sums of money to the managed company and also guaranteed  a loan of Rs. 2 lakhs obtained by  that  company from a Bank.  The managed company failed in its business and upon  the  Bank  pressing  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. 10(1) (xi).  The Tribunal found that the  advances to  the managed company and the agreement  guaranteeing  the loan  to the managed company were in pursuance  its  objects and  were made in the course of its business and  the  claim was  allowed.   That decision was finally affirmed  by  this Court.  In this case there was a cause in the memorandum  of association  by  which  the assessee was  entitled  to  land monies  and  to  guarantee  the  performance  of  contracts. Similarly  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  the  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  on  any  other provision  under which such an allowance could  be  claimed. There  was no privity of contract or any legal  relationship between  the assessee and the selling agent.  Neither  under customer   nor   under  any  statutory  provision   or   any contractual  obligation was the assessee bound to  guarantee the  loan 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  facilitated  the carrying on of  the  assessee’s business.   It  is  equally  difficult  to  appreciate   the observations  of  the High Court that it was in  the  larger interest of (1) 31 I.T.R. 72. (2) 65 I.T.R  625. 363 the  assessee’s business that the guarantee was  given.   In our opinion the view of 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 within s. 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. For  the  reasons  given above the  correct  answer  to  the question referred should be in the negative and against the, assessee.   The appeals are thus allowed with costs and  the judgment of the High Court is set aside.  One hearing fee. G.C.                           Appeals allowed. 364