I.T.AS. NOS. 790, 791 AND 403/KB OF 1981-82, DECIDED ON 30TH MARCH, 1988. Versus I.T.AS. NOS. 790, 791 AND 403/KB OF 1981-82, DECIDED ON 30TH MARCH, 1988.
1. SIKANDAR HAYAT KHAN (MEMBER). --A difference of opinion having arisen between the learned J.M and the learned A.M. , in regard to the fact whether the assessee seas entitled to a sum of Rs.39,00,000 on account of revenue deduction incidental to business or as a bad debt under section 22(a) read with section 23(1) of the Income-tax Ordinance, 1979 (hereinafter called the Ordinance), or not the following question of law emerging out of their finding has been referred to me for the purpose of evolving a majority opinion:--
2. "Whether on the facts and in the circumstances of the case, the loss claimed at Rs.39,00,000 was admissible either as revenue loss incidential to business or as a bad debt under section 22(a) or 23(1) of the Income-tax Ordinance, 1979."
3. Even though views of learned J.M. and learned A.M. in regard to the fact whether assessee was entitled to a sum of Rs.39.00,000 either as revenue loss incidental to business or as a bad debt or not, are already on record yet with the object of resolving the controversy, it is desirable to put on record briefly the relevant facts of this case in consequence of which assessee claimed a sum of Rs.39,00,000 by way of bad debt in its return for the charge year 1980-81. Before proceeding further it is also necessary to mention here that Mr. Muhammad Farid, learned D.R. has stated at the Bar that since guarantee was discharged by the English Biscuits Manufacturing Company Ltd., (hereinafter called the E.B.M.), in June 1978, therefore, business loss, if any, could only be claimed against profit of the previous year relevant to the charge year 1978-79. This objection having been sustained by learned J.M, relevant part of his finding is set out below:--
4. "As pointed out earlier, F Mr, Muhammad Farid, alternatively argued that since the guarantee was discharged by E.B.M. in June, 1978, therefore, the business loss, if any, should have been claimed from the profit of assessment year 1978-79. In this connection, he relied upon cases of Indian Overseas Bank & National Petroleum (Supra), which substantially supported his contention. It is true that where accounts are kept on receipt basis, allowance must be granted in the year of disbursement irrespective of the question when the liabilities arose. Similarly, where the accounts are kept on mercantile basis, allowance must be granted in the year in which the liability is incurred, irrespective of the question whether disbursement had been made or not. However, the question as to when a liability should be deemed to have been incurred is a question not free from difficulty. In (1965) 56 I T R 1, Associated Banking Corporation of Indian v. C.I.T. the Indian Supreme Court pointed out that so long as reasonable chance of restitution exists, the loss in a commercial sense might not be said to have resulted. According to their Lordships, it occurs when a reasonable prospect of recovery no more exists. As such, before E.B.M. claimed the business loss of June 178, in assessment year 1980-81, it was incumbent on it to prove that it was in assessment year 1980-81 that reasonable prospect of recovery ceased to exist. However, we do not find any material on record, which proves it. Moreover. Since this plea wag riot taken before the income-tax Officer, therefore, he also could not thrash out its pros and cons. Unfortunately, the learned Commissioner of Income-tax (Appeals) also did not consider this aspect of the matter. As such, though we agree with the learned Commissioner of Income-tax (Appeals), that E. B. M suffered loss of Rs 39,00,000,the question as to whether it was rightly claimed in assessment year 1980-81 remains unanswered. It was for 'the E.B.M. to prove that the prospects of recovery ceased to exist in assessment year 1980-81, in order to claim it in this assessment year. Under these circumstances, we feel though reluctantly that in the interest of justice the respondent should be given a chance to prove its claim of business loss in assessment year 1980-81. Let us point out here that it was necessary for E.B.M. to prove as to when the liquidation proceedings started against ARAG and when the recovery of Rs.39,00,000, became impossible. Similarly, it should have also proved resolution of the Board authorising E.B.M. to write off the business loss."
5. In view of the above finding, learned J.M. proposed setting aside of assessment with a direction to the I. T.-O. , that he should call upon E.B.M. to establish its claim for trading loss of Rs.39,00,000 in the assessment year 1980-81.
6. The E.B.M., a company involved in the manufacture of biscuits, was incorporated as a private limited company, in 1965, with a paid up capital of Rs.20,00,000 and continued to suffer losses from the very first year of its business as was observed by learned C. I. T. (Appeals), in his order, dated 29-8-1981. In this connection, details of the losses suffered by it from 1968-69, are listed below:--
7. Assessment year
8. Profit as per return
9. Losses ascomputed by the Income-tax department including unabsorbed depreciation.
10. 1968-69
11. Rs.21,28,049
12. 1969-70
13. Rs.20,80,893
14. 1970-71
15. Rs. 9,37,641
16. 1971-72
17. Rs. 6,51,184
18. 1972-73
19. Rs. 2,75,300
20. 1973-74
21. Rs.6,80,284
22. Rs.25,90,151
23. (Excluding (Unabsorbed depreciation).
24. 1974-75
25. Rs.15,28,212
26. Rs.10,61,939
27. -do?
28. 1975-76
29. Rs. 4,08,224
30. Rs. 3,90,887
31. -do?
32. 1976-77
33. Rs.11,09,122
34. Rs.26,33,529
35. (Unabsorbed depreciation).
36. 1977-78
37. Rs.40,54,887
38. (inclusive of business loss of Rs.11,21,672)
39. 1978-79
40. Rs.17,56,532
41. Rs.22,99,355
42. 1979-80
43. Rs.19,79,611
44. Rs. 3,18,744
45. ???????????????????????
46. ???????????????????????????????????????????????
47. Since the assessee had been suffering losses from the very inception of its business, M/s. Arag Industries Limited (hereinafter called Arag) had been providing EBM with necessary finances from 1969 to 1976, the details of which are given below:-
48. Date
49. Amount financed by M/s. Arag Industries Ltd.
50. 30-6-1969
51. Rs. 1,73,489
52. 30-6-1970
53. Rs.18,99,485
54. 30-6-1971
55. Rs.30,30,103
56. 30-6-1972
57. Rs.37,18,676
58. 30-6-1973
59. Rs.40,93,520
60. 30-6-1974
61. Rs.43,02,744
62. 30-6-1975
63. Rs.49,05,079
64. 30-6-1976
65. Rs.49,66,492
66. From the information tabulated above, it is quite evident that financial position of E.B.M., was not sound and, therefore, in April 1969, ARAG, a public limited company, carrying on cloth business, purchased 74-75% shares of E.B.M. thus, obtaining a controlling interest in it. At this stage, it is relevant to mention here that 1,49,500 shares of the face of Rs.14,95,500, were purchased by ARAG for a sum of Rs.2,15,106 only. After gaining controlling interest ARAG star ed financing E.B.M. and as on 30-6-1972, it was indebted to ARAG o the extent of Rs.37,18,676. The- ARAG also secured credit facility for E.B.M. on its guarantee from the City Bank, Karachi to the extent of Rs.30,00,000. Subsequently, however, ARAG needed money for its business activities necessitating taking of loan amounting to Rs.58,00,000 from the City Bank, Karachi on the basis of securities, receivables, fixed assets and on the additional guarantee tendered by E. B. M.
67. With a credit facility of Rs.30,00,000 and funds provided by ARAG, E.B.M. started showing better book results with effect from 73-74, and onwards although after adjusting unabsorbed depreciation brought forward from earlier years, the significance of book profits was hardly meaningful. Sometimes in 1976, ARAG, had to face serious problems due to textile crisis, labour unrest and closure of its mills. In consequence thereof, E.B.M. was called upon by the City Bank, Karachi on 23-8-1976, to pay back a sum of Rs.47, 26,144 as it had guaranteed payment of loan to the Bank. Subsequently on 25-4-1978 the City Bank, Karachi asked E.B.M. to discharge liability of ARAG to the extent of Rs.51,13,717 under the same guarantee. At about the same time another banker of E.B.M., namely M/s. Grindlays Bank Limited, which had advanced credit facility asked E.B.M. to get the guarantee given by it to the City Bank, Karachi released. On the basis of these demands and with the object of avoiding liquidation proceedings, E.B.M. was obliged to negotiate a settlement with its creditors. In consequence thereof, E.B.M. paid a sum of Rs.39,00,000 to the City Bank, Karachi and debited this amount to the account of ARAG with a credit entry to the account of Bank. With this payment, the City Bank, Karachi, a released E.B.M's. guarantee. This amount of Rs.39,00,000 paid in June 1978, was written off during the previous year relevant to the charge year 1980-81, as E.B.M. had lost all hopes of recovery in that year in consequence of liquidation proceedings initiated against A RAG in the High Court :, Sind, Karachi, which by virtue of its order No. J.Misc-36, dated 22-11-1980, had frozen all assets of ARAG thereby reducing it to the state of non--entity. On account of the foregoing circumstances E.B.M claimed sum of Rs.39,00,000 in its account books as a deduction under section 230)(x) of the Ordinance. The said clause reads w, under:--
68. "23(l) (x)
69. In respect of bad debts, such amount (not exceeding the amount actually written off by the assessee) as may be determined by the income-tax Officer to be irrecoverable;"
70. The question whether a sum of Rs.39,00,000 could be allowed as a bad debt, was in the first instance considered by the I.-T.O. whose finding on it is set out below:--
71. "A bad debt pre-supposes the existence of a debt, and in a case in which there never was any debt owing to the assessee, no question can arise of making a claim for bad debt. One of the most important conditions for allowance of a bad debt is that the debt should have been taken into account in computing the income of the assessee of the accounting year or of an earlier accounting year. In other words, the debt should have been brought in as a trading receipt to swell the profits or reduce the loss of any year. Thus the claim of Rs.39,00,000 is not a debt."
72. When the matter went in appeal before learned CIT (Appeals), he also held that a sum of Rs.39,00,000 could not be treated as a bad debt. On the other hand, he concluded that the amount under consideration was a trading loss. In this connection his finding is given below:--
73. "From the foregoing discussion, it follows that the appellant could borrow Rs.30,00,000 from the City Bank, only after agreeing for advance of loan of Rs.58,00,000 to ARAG Industries. Ltd., on joint and several security. In view of these facts, it is impossible to distinguish the two loans as a separate transaction and attribute the loss with regard to, one transaction to one business and with regard to the other transaction to the other business. Besides, the foregoing discussion further goes to prove that as held in various decided cases (Supra) that the appellant suffered a loss of Rs.39, 00, 000 in the course of its business and that it was incidently to its business. The necessary corollary to the finding as arrived at is that the loss of Rs.39,00,000 suffered by the appellant was incurred in the course of its business."
74. From summation of the case by learned C.I.T. (Appeals), I have been left in no manner of doubt that he allowed a sum of 1is.39,00,000 not as a bad debt but on account of revenue loss incurred during the normal course of business and being incidental to it. Therefore, he ordered its deletion against which the department came up in second appeal before the Tribunal.
75. Having heard learned counsel of E. B.M., at some length learned J.M. agreed with him that a sum of Rs.39,00,000 was a trading loss. Therefore, as a necessary corollary to it, he did not find ratio of the following decisions to be relevant for supporting the view that E.B.M. was entitled to Rs.39,00,000 as a trading loss.
(I) ??????? (1971) 24 Tax 12 (C.I.T. v. Birla Brothers, Limited).
(II) ?????? (1965) 30 ITR 174 (Madan Gopal Bagla v. C.I.T. West Bengal).
76. However, alternative plea of learned D.R. was accepted to a point and consequently assessment was proposed to be set aside with a directive to the I.T.-0. to examine whether E.B.M. was entitled to a sum of Rs.39,00,000 for the charge year 1978-79 or 1980-81? When the proposed order of learned J. M. was placed before learned A.M., he recorded a dissenting note supported by relevant decisions of the High Courts and the Supreme Court of India. These decisions which have been found relevant for the purpose of deciding whether a sum of Rs.39,00,000 was admissible as revenue loss incidental to business or as a bad debt under section 22(a) or 23(1) of the Ordinance are discussed hereunder.
77. Learned A.M. has first relied on a case cited as (1965) 30 ITR 174 (S C of India), in which their Lordships of the Supreme Court having appreciated the judgment of the High Court, observed that the Chief Justice whose order was under appeal before them had correctly summed up the whole position and consequently quoted it in their judgment in extenso:
78. "The debt must, therefore, be one which can properly be called a trading debt and a debt of the trade the profits of which are being computed. Judged by that test, it is difficult to see how the debt in the present case can be debt in respect of the business of the assessee."
79. In respect of the case before me it has been contended that E. B. M., had given a guarantee on behalf of ARAG that the amount of debt which was payable by it to the City Bank, Karachi if it could not be paid by it will be paid by E.B.M. Since ARAG could not discharge its liability to the City Bank, Karachi, E.B.M. was required to pay a sum of Rs.39,00,000 to it. The precise question for consideration, therefore, is whether a sum of Rs.39,00,000 was a bad debt in accordance with the provisions of clause (x) of section 23(1) of the Ordinance or not? On a plain reading of the clause it is not possible for me to hold that guarantee for the payment of debt could be considered as a debt. In arriving at this conclusion, I have been fortified by the definition of the word "debt" on page 363 Black's Law Dictionary (5th edition) which is given below for facility, of reference:--
80. " Debt "
81. A sum of money due by certain, and express agreement. A specified sum of money owing to one person from another, including not only obligation of debtor to pay but right of creditor to receive and enforce payment, State v. Ducey, 25 Ohio App 2nd 50, 266 N.E: 2nd 233, 235. Libaility on a claim of Bankruptcy Act 101(11).
82. A fixed and certain obligation to pay 'money or some other valuable thing or things, either in the present or in the future. In a still more general sense, that which is due from one person to another, whether money, goods, or service. In a broad sense, any duty to respond to another in money, labour or service; it may even mean a moral or honorary obligation, unenforceable by legal action. Also sometimes an aggregate of separate debts, or the total sum of the existing claims against a person or company. Thus, we speak of the "national debt", the bonded debt" of a corporation, etc."
83. From a careful interpretation of the word "debt" as has been given above, I have no hesitation in stating that it does not cover at guarantee which in the present case E.B.M. was required to pay to the City Bank, Karachi on the basis of a negotiated settlement. The question of debt and its admissibility came up for examination in a case cited as 77 I T R 751 (SC India) wherein judgment of the High Court reported as C.I.T. v. Birla Brothers (Pvt.) Ltd., (1956) 72 ITR 44, was reversed holding that in the opinion of their Lordships, "the view of the Appellate Tribunal was based on a complete misapprehension of the legal position and that the High Court fell into the same error and the allowance claimed did not fall under section 10(2)(xi) as bad debt." This is what learned D.R. has, emphasised and with which I find myself in complete agreement.
84. Their Lordships of the Supreme Court of India while explaining the decision of the Supreme Court in Madan Gopal Bagla v. C.I.T. (1965) 30 I T R 174 (SC India) had held that the principle accepted was that the "debt in order to fall within section 10(2)(xi) must be one, which can properly be called a trading debt i.e. a debt of the trade the profits of which are being computed." In respect of the case before me, learned counsel of the assessee has not been able to establish that a sum of Rs.39,00,000 was either trading debt or debt of the business, the profits of which were liable to assessment for the charge year 1980-81. Therefore, ratio of decision supports the view that a sum of Rs.30,00,000 was not admissible as a bad debt under section 23(1)(x) of the Ordinance. With this finding, I now proceed further to examine whether the proposal of learned J.M. treating a sum of Rs.39,00,000 as trading loss should be accepted or for that matter finding of learned A.M. against his proposal, deserves more consideration. Having heard both the parties at some length, my views in regard to the proposition may be read in the paras hereafter.
85. To resolve the controversy, 1 have first given my earnest consideration to the question of guarantee that was given by E.B.M. on behalf of ARAG, to the City Bank; Karachi for securing finances with the object of running business. There is no denying the fact that from June 1969, to June 30, 1976, the amount of finances given by ARAG to E. B.M. increased from Rs.1,73,499 to Rs.49,66,492 in addition to the loan which it had taken from the City Bank, Karachi amounting to as:30,00,000. Subsequently on account of financial strains due to labour unrest, lockups and textile crisis, ARAG needed money to put its own house in order. Therefore, ARAG negotiated a sum of Rs.58,00,000 from the City Bank, Karachi on the basis of its security and the alleged guarantee furnished by E.B.M. It is also an admitted fact that! ARAG obtained credit facility of Rs.58,00,000 from the City Bank, Karachi and gave guarantee for its payment. Such a remark, however, cannot he recorded in respect of E.B.M. as it had taken a loan in 1.969 to the: extent of Rs.30,00,000 on the strength of its own guarantee which was still continuing in 1972, when a new guarantee was given by ARAG to the City Bank, Karachi. Suffice it to say that EBM had not given a fresh gurantee to the City Bank Karachi in 1 972 for a loan that was extended to ARAG. This act having been conceded b learned counsel o assessee at the bar has made my task easier or answering the question that has been re erred to me or adjudication. Based on this admission the relevant question is whether on the basis of existing guarantee in favour of the City Bank, Karachi, E.B.M. could claim a sum of Rs.39,00,000 by way of trading loss because ARAG could not discharge its loan to the City Bank, Karachi. This question has been examined hereunder.
86. In respect of the case before me, 'I find that E.B.M. did not have a history/ practice of standing sureties for other persons nor was it a money-lender it also did not allow itself to be used for the purpose of securing loans on behalf of other persons for their benefit. Therefore, case of learned counsel of the assessee that E.B.M. was entitled to a sum of Rs.39.00,000 by way of trading loss does not have a sound foundation on which to rely. In consequence thereof, ratio of decision in a case reported as Ata Hussain Khan Ltd. v. C.I.T. Dacca (1970) Taxation 21, is not applicable in respect of the case of E.B.M., as the said case revolved round its own facts. This thing apart, learned counsel of assessee has not been able to establish that payment of Rs.39,00,000 to the City Bank, Karachi on account of guarantee was undertaken by E.B.M. voluntarily and was incurred on the ground of commercial expediency and in order indirectly to facilitate carrying on of its business. This conclusion is based on the ground that E.B.M. had neither given a fresh guarantee to the City Bank, Karachi in 1972, for a loan extended to ARAG nor there was any commercial expediency for it. In fact, from the City Bank Karachi's letter, dated 26-5-1981, I have been led to say that E.B.M. was drawn into an arrangement, which was necessarily meant for the benefit of ARAG. Even otherwise, notwithstanding the fact that w.e.f, assessment years 1973-74 to 1976-77, E.B.M. had declared profits yet with adjustments of brought-forward depreciation, resultant amount was a loss for the charge years 1973-74 to 1976 and onward till 1979-80. Therefore, there was no commercial expediency on the part of E.B.M. even if I were to accept that it had given a fresh guarantee in 1972, for giving a guarantee to the City Bank, Karachi on behalf of ARAG. Before proceeding further, it is also desirable to mention here that even if I were to accept which however, is not the case before me that arrangement negotiated between ARAG and the City Bank, Karachi for a loan of Rs.58,00,000 was guaranteed by E.B.M. yet the said arrangement is held not to have facilitated carrying on of business on its part and, therefore, it was not entitled to deduction of Rs.39,00,000 as a business loss incidental to business.
87. Their Lordships of the Supreme Court of India while explaining decision of the High Court in the case of M/s Madan Gopal Bagla v. C.I.T., reported as (1965) 30 I T R 174 (SC India) held as under:--
88. "But it was not established nor does it deem to have been alleged, that he in his turn was in the habit of standing surety for other persons alongwith them for the purpose of securing loans for their benefit. Even if such had been the case any loss suffered for 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."
89. Based on the above holding I have been obliged to conclude that since E.B.M. was not engaged in the habit of standing surety for other persons for securing loans for their use and benefit, and even if such had been the case, E.B.M. was not entitled to claim Rs.39,00,000, as a loss incidental to its business, on the ratio of decision in (1967) 67 I T R 625 (SC India) in which it was held as under:--
90. "In this case, there was a clause in the memorandum of association by which the assessee was entitled to lend moneys and to guarantee performance of contract. Similarly, managing agency agreement contained a clause about lending and advancing of money to the managed company......."
91. Since learned counsel of assessee has not shown me a clause in the memorandum of association of E.B.M. on the basis of which it could have lent money or guaranteed payment of loans ratio of decision in the case of M/s. Essen Private Ltd. v. C.I.T., is not available to R.B.M. for the purpose of claiming a sum of Rs.39,00,000 which it was obliged to pay as a guarantee on behalf of ARAG.
92. In respect of another case namely M/s Calcutta Company Ltd. v. C.I.T. (1959) 37 ITR-1, the Supreme Court of India held that in respect of that case, the expression "profits & gains" had to be understood in its commercial sense and there could be no computation of profits and gains until the expenditure necessary for earning those profits and gains is deducted there from and that when there is no specific provision under section 10(2) in regard to claim made, its allowability would depend on accepted commercial practice and trading principles and it would be allowed if it could be said to arise out of the carrying on of the business and incidental to it.
93. After having a look on the facts of the case before me, it can be said with absolute certainty that guaranteeing of loans by E.B.M. was not in accordance with an accepted commercial practice and trading principle in the City of Karachi nor has it been so established by learned counsel of assessee. Another test, namely, furtherance of the business was also non-existent in respect of the guarantee that was in any case not given by E.B.M. in 1972. Therefore, the criterion laid down for the admissibility of expenditure against business profits] as laid down in Bombay City-1 v. Jagganoth Kisonlal, was absent in respect of the case before me.
94. I On account of the above reasons, E.B.M. was not entitled to a sum of Rs.39,00,000 by way of deduction against its profits during the previous year relevant to the charge year 1980-81. With this finding, it is not necessary for me to record my views in regard to the ratio of decision in a case cited as Jokhiram Ramchandra v. C.I.T., Bombay City-I, because claim of assessee for a sum of Rs.39,00,000 has been held to be neither in connection with carrying on of its business not incidental to it. Therefore, the question referred to me is answered in the negative.
95. M.B.A. ??????????????????????????????????????????????????????????????????????????????????????????????? Answered in negative