2025 (6) TMI 576 - HC - Income Tax

Eligible for deduction of bad debts when the transaction is not in the nature of loan between the parties - whether assessee could have written-off this amount as bad debts? - HELD THAT - It is not disputed that assessee was a promoter of BICL that assessee had pledged 28, 69, 200 shares of BDL and that 25, 15, 200 shares were sold on 01.04.2008 at Rs. 37.65 per share accounting to Rs. 9, 46, 97, 280/- and for the same transaction BICL paid Rs. One Crore to assessee. In our view the cycle is complete. It is also not disputed that BICL became a sick company and it could not repay the loan that it borrowed from ICICI Ltd. Submission of the Revenue that the pledging of shares of BDL by assessee to ICICI is not in the course of business activity the fact is assessee was a promoter of BICL. The shares were pledged so as to enable the sister concern/group company to avail the loan from ICICI. Therefore certainly it has to be in the course of business. It is not the Revenue s case that the decision to pledge the shares or only accept Rs. One crore in full and final settlement was not bona fide. As held in Mahindra and Mahindra 2023 (6) TMI 884 - BOMBAY HIGH COURT whether to treat the debt as bad debt or as business loss/deduction is a commercial or business expediency of the assessee based on the relevant material and possession of the assessee. Once the assessee records the amount as business loss/deductions in his books of account that would prima facie establish that it was not recoverable loss unless the Assessing Officer for good reasons holds otherwise. The burden would be on the Assessing Officer to make out cogent reasons which is not so in the case here. It is quite obvious therefore that the loss incurred by the assessee was for the business expediency of the group company. Such loss/debt should be treated as having been incurred for the purpose of business and directly relatable to the business of the assessee and thus eligible for deduction as loss or bad debt in their return of income. Otherwise it would not reflect the true profit and gain of assessee. A sum of money expended not of necessity and with a view to a direct and immediate benefit to the trade but voluntarily and on the grounds of commercial expediency and in order indirectly to facilitate the carrying on the business may yet be expended wholly and exclusively for the purposes of the trade (Mahindra and Mahindra supra) . The questions of law framed are answered in the affirmative.

Summary

1. ISSUES PRESENTED and CONSIDERED

The Court considered two core legal questions arising under the Income Tax Act, 1961:

(i) Whether the Tribunal was correct in holding that the assessee is eligible for deduction of bad debts amounting to Rs. 8,46,97,280/- when the underlying transaction was not in the nature of a loan between the parties.

(ii) Whether the Tribunal was justified in concluding that the assessee's act of standing as guarantor for a loan availed by its sister concern, and the consequent invocation of the guarantee leading to appropriation of pledged shares to satisfy dues, was undertaken for the purpose of the assessee's business, thereby entitling the assessee to claim deduction of business loss.

2. ISSUE-WISE DETAILED ANALYSIS

Issue 1: Eligibility for deduction of bad debts when transaction is not a loan

Relevant legal framework and precedents: The Court examined provisions under Section 36(1)(vii) of the Income Tax Act, which allows deduction for bad debts, and Section 36(2) which prescribes conditions for such deductions. Precedents considered included the Division Bench judgment in Mahindra and Mahindra Ltd. vs. Commissioner of Income Tax, which held that debts or losses incurred for commercial expediency and directly relatable to the business are deductible. The Court also relied on established principles from British Insulated and Helsby Cables Ltd. v. Atherton and other authorities, which recognize that expenditure or losses incurred voluntarily and for commercial expediency, even without direct immediate benefit, may qualify as wholly and exclusively for business purposes.

Court's interpretation and reasoning: The Court noted that although the transaction was not a conventional loan, the assessee, as promoter of the sister concern (BICL), had pledged shares as security for BICL's loan from ICICI. When BICL defaulted, the pledged shares were sold by ICICI to recover the loan, and the assessee accounted for the amount as dues from BICL. BICL paid only a portion (Rs. 1 crore) and the balance was written off as bad debts by the assessee.

The Court emphasized that the nexus between the assessee and BICL was undisputed and that the loss arose from the assessee's commercial decision to protect its interest in the group company. The decision to write off the balance as bad debts was a commercial or business decision, recorded in the books of account, and prima facie established the loss as irrecoverable unless rebutted by cogent reasons, which the Revenue failed to provide.

Key evidence and findings: The pledge of shares, sale of shares by ICICI, partial repayment by BICL, and the subsequent write-off in the books of the assessee were undisputed facts. The assessee's role as promoter and the commercial relationship with BICL were also not contested.

Application of law to facts: Applying the principles from Mahindra and Mahindra and other precedents, the Court held that the loss was incurred wholly and exclusively for the purpose of the assessee's business, as it was a measure of commercial expediency to protect the group's business interests.

Treatment of competing arguments: The Revenue contended that the transaction was not a loan and thus not eligible for bad debt deduction, and that pledging shares was not a business transaction. The Court rejected this, holding that the pledge was in the course of business as a promoter facilitating the sister concern's loan and that the loss was directly relatable to the assessee's business.

Conclusion: The Tribunal was correct in allowing the deduction of bad debts despite the transaction not being a conventional loan, as the loss was incurred for business purposes.

Issue 2: Whether guarantee and invocation of pledge was for business purpose entitling deduction of business loss

Relevant legal framework and precedents: The Court extensively relied on the Mahindra and Mahindra Ltd. judgment, which clarified that expenditure or loss incurred voluntarily for commercial expediency and to preserve business goodwill or reputation is deductible under the Income Tax Act. The Court also cited the Bombay High Court decision in Vaman Prestressing Co. Pvt. Ltd., which held that advances or guarantees to sister concerns or subsidiaries, if made as a measure of commercial expediency, qualify as business expenditure or loss.

Court's interpretation and reasoning: The Court observed that the assessee's pledge of shares and guarantee for BICL's loan were acts done to enable the sister concern to avail financial assistance, thereby protecting the group's business interests. The invocation of the guarantee and sale of pledged shares to satisfy dues was a natural consequence of the business relationship.

It was held that the assessee's business included promoting and supporting group companies, and the loss arising from the guarantee invocation was directly relatable to its business. The Court reiterated that commercial expediency includes voluntary acts done to protect the business, even if no direct immediate benefit is obtained.

Key evidence and findings: The pledge of 28,69,200 shares, sale of 25,15,200 shares by ICICI, partial repayment by BICL, and the write-off of the balance amount were undisputed. The assessee's continuous financial support to group companies over several years was also noted.

Application of law to facts: Applying the principles from Mahindra and Mahindra and Vaman Prestressing, the Court concluded that the guarantee and consequent loss were incurred for the purpose of business and thus eligible for deduction as business loss.

Treatment of competing arguments: The Revenue argued that the pledge and guarantee were not business transactions and that the deduction was not allowable. The Court rejected this, emphasizing the wide scope of "for the purpose of business" and the principle that commercial expediency includes voluntary acts to protect business interests.

Conclusion: The Tribunal was justified in holding that the assessee's guarantee and the resultant loss were incurred for business purposes and eligible for deduction.

Additional observations: The Court also addressed the Revenue's contention regarding Section 36(2) and the requirement to show recoverability of the amount in any previous year. It held that the liability of BICL to the assessee arose only in the relevant assessment year and that the assessee's commercial decision to write off the bad debt was valid. The Court further emphasized that the Revenue failed to produce cogent reasons to rebut the assessee's bona fide commercial decision.

3. SIGNIFICANT HOLDINGS

The Court affirmed the legal principle that:

"A sum of money expended, not of necessity and with a view to a direct and immediate benefit to the trade, but voluntarily and on the grounds of commercial expediency, and in order indirectly to facilitate the carrying on of the business, may yet be expended wholly and exclusively for the purposes of the trade." (Mahindra and Mahindra Ltd. judgment, para 25)

The Court further held:

"The expenditure/debts should be treated as having been incurred for the purpose of business and directly relatable to the business of the assessee and thus eligible for deduction as business expenditure/loss in assessee's return of business income." (Mahindra and Mahindra Ltd. judgment, para 27)

On the facts, the Court concluded:

"It is quite obvious therefore that the loss incurred by the assessee was for the business expediency of the group company."

"Such loss/debt should be treated as having been incurred for the purpose of business and directly relatable to the business of the assessee and thus, eligible for deduction as loss or bad debt in their return of income. Otherwise, it would not reflect the true profit and gain of assessee."

Addressing the Revenue's argument that pledging shares was not a business transaction, the Court stated:

"As regards the submission of the Revenue that the pledging of shares of BDL by assessee to ICICI is not in the course of business activity, the fact is, assessee was a promoter of BICL. The shares were pledged, so as to enable the sister concern/group company to avail the loan from ICICI. Therefore, certainly, it has to be in the course of business."

Finally, the Court dismissed the appeal, holding that the Tribunal's order allowing the bad debt deduction and recognizing the guarantee-related loss as business loss was legally sound and consistent with established principles of commercial expediency and business purpose under the Income Tax Act.