Commissioner of Income Tax, Madras vs T.N. Krishnaswami

Ramanujam, J.—The following two question have been referred to this court by the Income Tax Appellate Tribunal at the instance of the

Revenue;

Whether, on the facts and in the circumstances of the case, the assessee is entitled to deduction of Rs. 52,083 being the amount due to him

from Shri H. V. Gandhi as a bad debt for the assessment year 1973-74 ?

Whether, on the facts and in the circumstances of the case, loss has to be computed for the assessment year 1973-74 and such loss has to be

set off against the income of the assessment year 1974-75 ?

The assessee, in this case, carries on business of money-lending and the profession of financial adviser. On the recommendations of the

assessee, M/s. Annamalai Timber Trust (P.) Ltd., hereinafter referred to as ""the company"", lent to one Shri Gandhi a sum of Rs. 50,000 on

January 31, 1972, on a promissory note executed by Shri Gandhi for a sum of Rs. 50,000 agreeing to repay the same with interest thereon at 15%

per annum. The assessee had given a letter of guarantee to the company on January 27, 1972, guaranteeing due repayment of the aforesaid sum of

Rs. 50,000 together with interest thereon by Shri Gandhi. Sri Gandhi paid interest on the sum borrowed up to the end of April. 1972. However,

he defaulted to pay interest thereafter. In view of the said default, the company called upon Shri Gandhi to repay the loan. Shri Gandhi did not

repay the loan and pleaded his inability to repay by his letter dated August 9, 1972. The company, however, called upon him to pay the amount

immediately the a letter dated September 11, 1972. The assessee also wrote to Shri Gandhi on September 26, 1972, calling upon him to pay the

amount and informing him that otherwise the guarantee letter executed by the assessee would be enforced by the company. Shri Gandhi by his

letter dated September 30, 1972, informed the assessee that he is not in a position to repay any part of the principal or interest due to the

company. The company thereupon recovered the said loan of Rs. 50,000 form the assessee along with interest of Rs. 2,083.30. Thereafter the

company returned the promissory note executed by Shri Gandhi with the endorsement of discharge. The assessee thereafter called upon Shri

Gandhi to pay the amount of Rs. 52,083 which he paid to the company on account of Shri Gandhi to pay the amount of Rs. 52,083 which he paid

to the company on account of Shri Gandhi. But Shri Gandhi had left India for taking up an employment in Thailand. Some of the creditors have

also filed suits against Shri Gandhi for recovery of the various amounts due to them. One of the creditors has moved the court to declare Shri

Gandhi an insolvent and the petition was pending. The assessee at that stage wrote off the sum of Rs. 52,083 as irrecoverable in his books of

account.

For the year 1973-74, the assessee filed a return disclosing a loss of Rs. 10,268 which, inter alia, included loss of Rs. 22,782 under the head

Business"". In doing so, he had deducted a sum of Rs. 52,083 claimed to have been written off as bad debt. The ITO found that the assessee had

not lent any money to Shri Gandhi but had only guaranteed the due repayment of the loan by the said Shri Gandhi to the company and that the

guaranteeing of repayment of the loan is not part of the assessee''s business of money-lending. Hence, he held that the assessee''s claim for bad

debt could not be allowed. The assessee put forward an alternative contention before the ITO that the said loan should be treated as short-term

capital loss and set off against the income under the other heads under s. 71(3) of the I T Act, 1961, hereinafter referred to as ""the Act"". But this

contention was not, however, considered by the ITO. For the assessment year 1974-75, practically the same contentions were advanced before

the ITO but he had taken a view consistently with the view taken by him in the previous year.

Aggrieved by the assessment, the assessee preferred two appeals reiterating the contention that were but forward before the ITO. The AAC

also held that guaranteeing of loans was not part of the assessee''s business of money-lending and, hence, the loss suffered by him by reason of

such guarantee being enforced could not be considered as a business loss. He, therefore, held that the claim was not allowable either under s.

36(1)(vii) or under s. 28 of the Act. Regarding the assessee''s contention that the loss should be treated as a short-term capital loss and, therefore,

should be set off against the income under the other heads under s. 71(3) of the Act, he held that there was no extinguishment of the right of the

assessee in the debt owing to him by Shri Gandhi and hence there is no question of any capital loss at all. He, accordingly, confirmed the

assessment for both the years.

Aggrieved by the orders of the AAC, the assessee preferred appeals to the Income Tax Appellate Tribunal reiterating the same contentions that

had been put forward the authorities. The Tribunal found that there was nothing on record to show that Shri Gandhi had requested the assessee in

the first instance for a loan of Rs. 50,000, that the assessee had not charged anything for his having guaranteed the repayment of the loan by Shri

Gandhi to the company and that the assessee had not given such a guarantee to any other loan on any other occasion. On those facts the Tribunal

held that the transaction as a result of which the assessee came to pay Rs. 52,083 to the company was not one in the course of the assessee''s

money-leading business. The Tribunal, however, held that the payment of the sum of Rs. 52,083 by the assessee to the company in discharged of

the loan due by Shri Gandhi should be taken to have arisen in the course of the assessee''s money-lending business, and, therefore, the assessee is

entitled to claim the said amount as a bad debt for the accounting year 1973-74, and that, subsequently, the loss computed for other assessment

year 1973-74 should be carried forward and set off against the income of the assessee for the year 1974-75. In view of the said findings of the

Tribunal, it did not consider the alternative contention put forward by the assessee that in any event the assessee had sustained a short-term capital

loss and the same has to be set off under s. 71(3) of the Act. Aggrieved by the order of the Tribunal, the Revenue sought and obtained a reference

on the question set out above.

At the outset we must say that the Tribunal has given somewhat inconsistent findings on the question as to whether the debt written off as a bad

debt has arisen in the course of the assessee''s business as a money-lender. At one stage the Tribunal says that the assessee is not in the habit of

guaranteeing loans taken by third parties from other sources that the guarantee given by the assessee for the loan taken by Shri Gandhi to the

company is a solitary instance and that even in giving that guarantee the assessee has not charged anything and as such the transaction is a

gratuitous one. On the basis of these facts the Tribunal had specifically held that the assessee''s transaction of giving guarantee for Shri Gandhi''s

loan is not in the course of the assessee''s business as a financier. However, curiously the Tribunal in the latter portion of its order has held that the

liability incurred by the assessee on default of payment of the loan by Shri Gandhi to the company is a liability arising out of the assessee''s business

as a financier. The Tribunal seems to take the view that incurring of a liability arising out of the guarantee and the discharging of the same stand on a

different footing and, therefore, they should be taken to arise in the course of the assessee''s business as a money-lender. We are of the view that

the mere fact that the assessee has chosen to treat his liability arising out of the default committed by Shri Gandhi, the borrower, as per the terms of

the guarantee, as a liability arising in the course of his business as a financier cannot be treated as conclusive. That is a unilateral act by the assessee

and when the question arises as to whether such a liability arose in the course of the assessee''s business, the court has to consider the nature of the

liability irrespective of the assessee''s unilateral conduct. If, as found by the Tribunal, the transaction of the guarantee is not in the course of the

assessee''s business, then it should be taken to be his personal liability. In discharge of that personal liability, he has been made to pay the amount

borrowed by Shri Gandhi along with interest to the company which lent it. That cannot be taken to arise in the course of the assessee''s business as

a financier. It may be that the assessee had treated his personal liability as the liability arising out of the business. But that cannot be taken to be

decisive or conclusive on the question whether the debt has been incurred in the course of the business. The character of the debt or the liability

due by Shri Gandhi cannot be different from the character and nature of the guarantee transaction. If the guarantee transaction is not in the course

of the assessee''s business, the liability arising out of the transaction cannot be taken to arise in the course of the assessee''s business. It is no doubt

true that as a result of discharging the liability arising out of the guarantee, the assessee has become a creditor of Shri Gandhi. But that credit also

should be taken to be of the same character and nature as the original transaction of guarantee which had been held by the Tribunal itself to be not

in the course of the assessee''s money-lending business. Therefore, the Tribunal may not be right in holding that the debt written off in this case was

a debt arising in the course of assessee''s business as a financier, merely because the assessee''s liability arising out of the guarantee was discharged

by utilising his business or trading assets.

In V. Ramaswami Ayyangar and K.R. Subramania Ayyar, Receivers to the Estate of late Rm. A.R.A. R Rm. Arunachalam Chettiar Vs. The

Commissioner of Income Tax, , the question arose as to whether the overdrawings by an employee of money-lender against his salary could be

considered as a loan made to him by the money-lender in the ordinary course of his money-lending business within the meaning of s. 10(2)(xi) of

the Indian I.T. Act, 1922. This court has held that there was on borrowing of capital by the employee within the meaning of s. 10(2)(iii), that in

order to enable the money-lender to write off the debt as a bad debt or irrecoverable debt, he must show that it was even from the very beginning

a loan and not an advance or overdrawing of the employee and that the face that, subsequently, a promissory note had been taken from the

employee would not affect the nature of the transaction at its inception. The principle of the said decision applies to facts of this case. The original

guarantee transaction was not in the course of the assessee''s money-lending business. Subsequent discharge of the liability by the assessee arising

out of the guarantee transaction cannot change the transaction as a loan transaction in the course of the assessee''s business merely because the

assessee chose to meet his personal liability arising out of the guarantee transaction out of the funds of his business. The money said to have been

paid by the assessee to the company in discharge of his obligation as a guarantee cannot be taken to have been utilised for earning profits and,

therefore, the sum of Rs. 50,000 payable by Shri Gandhi to the assessee cannot be said to be an amount advanced in the course of the assessee''s

business.

In BRIJ MOHAN LAXMI NARAIN Vs. COMMISSIONER OF Income Tax, DELHI., , the Punjab High Court dealt with more or less a

similar situation. In that case, the assessee whose main business was money-lending stood surety for certain loans advanced by a bank to a

company of which the assessee was a director. When the bank pressed for payment, the assessee sold his house and paid a certain sum towards

satisfaction of the loan. The amount borrowed by the company became irrecoverable. The assessee claimed the amount paid by him as an

allowable deduction either as a bad debt under s. 10(2)(xi) or as a business expenditure. The court held that the transaction of guarantee did not

arise out of the assessee''s money-lending business and was not related to it in any way, that there was no consideration for the guarantee given by

the assessee to the bank and the loss which the assessee sustained in the enforcement of the guarantee was a capital loss and did not amount to a

business loss and, therefore, the assessee was not entitled to claim deduction either under clause (xi) or clause (xv) of s. 10(2), nor in general terms

of the I.T. Act. The said decision applies on all fours here. Here also, as pointed out earlier, there was no consideration for the guarantee given by

the assessee to the company for repayment of the loan advanced to Shri Gandhi and, therefore, the transaction of guarantee cannot be said to have

been given in the course of the assessee''s business as a financier and, therefore, it has to be held that the deduction claimed is not a business loss

or a bad debt arising out of the assessee business.

K. S. Janakiram Vs. Commissioner of Income Tax, Madras, , also dealt with a more or less similar case. In that case a freight broker

guaranteed a loan of charterer to a shipping line as part of a transaction of charter-party. A share of profits from the shipping line (borrower) was

the consideration. The shipping line was not able to repay the loan. The result was that the broker had to discharge the loan as a guarantor. He,

thereafter, wrote off the amount in his account and claimed it as a bad debt. When the matter came to this court, this court held that no part of the

sum which was guaranteed by the assessee could be treated as a bad debt as furnishing of guarantee is not a normal incident in the course of

business of freight brokerage and it is also not customary for freight brokers to undertake such an obligation on behalf of shipping lines. The court

was of the view that the connection between the business of a freight broker and the business of securing advances to shipping lines is far too

tenuous to support a claim that it was incident to the business and the fact that the assessee was to receive a part of the profits of the shipping line

from the transaction showed that it was not entered into in the course of the business of the freight broker and since securing advance to the

shipping line is not a necessary part of the normal course of business of brokerage nor could it be said to be closely inter-linked with his business

the loss incurred by discharge of his obligation as a guaramtor cannot be treated as a bad bebt. In this case, the Tribunal has specifically found that

the furnishing of guarantee has not been done in respect of any other borrower or on any other occasion, that giving of guarantee is not not part of

the assessee''s line of business nor is it closely inter-linked with his business as a financier. Even for the guarantee given to the company to secure

repayment of the loan taken by Shri Gandhi, he has not received any consideration and as normally business involves earning of profit, the assessee

cannot be taken to have given the guarantee in the course of his business. Even if the assessee has got consideration for giving guarantee, as per the

decision referred to above, the assessee will not be entitled to claim a deduction for the guarantee given by him, as it is not proved to be in the

course of his business.

In Commissioner of Income Tax (Central), Calcutta Vs. Birla Bros. P. Ltd., , the assessee company carried on business of banking and

financing and also of managing agency. One of the managed companies appointed a selling agent and the assessee-company stood as guarantee for

a loan of Rs. 6 lakhs which was advanced by a bank to the said selling agent. The selling agent failed to pay the loan which at the relevant time

stood at Rs. 5,60,199. The assessee was forced to pay the said amount pursuant to the guarantee and, thereafter, the assessee treated the spelling

agent as his debtor for the amount. The selling agent ultimately went into liquidation and the assessee was not able to recover any part of the

amount. He, therefore, wrote off the sum of Rs. 5,60,199 in its accounts and claimed deduction thereof as a bad debt under s. 10(2)(xi) of the

Act. On those facts, the question arose as to whether the assessee was entitled to make the said claim for deduction. The Supreme Court held that

neither the memorandum of association of the company nor the managing agency agreement contained any provision whereby it could be said that

the guaranteeing of the loan to the selling agent was done in the course of the managing agency business nor was there any material to show that the

managing company was under any legal obligation to finance the selling agent or to guarantee loans to the selling agents and, therefore, the

guaranteeing of the loan could not be said to have indirectly facilitated the carrying on of the assessee''s business. Nor could it be said that it was in

the larger interest of the business of the assessee that the guarantee was given and, therefore, the deduction cannot be allowed. The Supreme

Court has thus laid down the proposition that unless the guarantor is under a legal obligation to give the guarantee, or the guarantee has been given

as part of or incidental to the assessee''s business, the guarantee as a bad debt or as a business loss or as a business expenditure. Having regard to

the above decision with which we agree, we have to answer the first question in the negative and against the assessee.

So far as the second question is concerned, the assessee put forward an alternative contention that the loss should be treated as a short-term

capital loss and should be set off against the income under other heads under s. 71(3) of the Act. On this aspect, the Tribunal has not expressed its

views. Hence, the second question is returned unanswered with a direction to the Tribunal to consider the said contention of the assessee and give

its views. The Revenue will be entitled to its costs. Counsel''s fee Rs. 500 (One set).