2011 (5) TMI 571 - HC - Income Tax

Trading loss in business of purchase and sale of flats disallowed - Held that - The transaction between the assessee and PCL where assessee paid a sum of Rs. 44.50 lacs to the PCL on 12.03.1982 was one where perhaps money had been lent to enable PCL to bid. At that stage contrary to what the assessee had sought to portray there was no intention to purchase commercial space in the proposed building as the plot which PCL sought to bid for was nowhere on the scene. Therefore the expense was certainly not incurred for the purposes of the assessee s business notwithstanding the fact that it may or may not have earned income or profits. If the test of prudence is applied from the point of view of a businessman and not that of the revenue the assessee fails to pass the test as that a prudent businessman would not have committed his money for purchase of commercial space at a stage when there were no rights acquired by PCL. By their own admission PCL was a company which had at the relevant point a share capital of Rs 24000/- No prudent businessman would have committed such a large sum of money without ensuring that the vendor had something tangible offer in its hands in the instant case PCL being the vendor. The suit filed by PCL is still pending adjudication. It is not understood as to why the assessee would suddenly choose to claim a deduction in the assessment year 1989-90 based on a letter of PCL dated 14.12.1988 followed by a legal opinion received from its lawyer when the amount stood forfeited on 04.05.1985. Admittedly the assessee has made no demands to recover the amount from PCL - Decided against the assessee

Summary

Issues Involved:
1. Whether the ITAT erred in disallowing the loss of Rs. 31.05 lakhs claimed by the assessee as a trading loss in its business of purchase and sale of flats.

Detailed Analysis:

Background Facts:
The assessee, engaged in the business of construction, purchase, and sale of flats, had financial transactions with its sister concern, Pragati Construction Co. (P) Ltd. (PCL). PCL participated in an auction held by the Delhi Development Authority (DDA) for a plot and was declared the highest bidder. The assessee issued a cheque of Rs. 44.50 lakhs to PCL ostensibly to purchase commercial space in the proposed multi-storey building. However, PCL faced issues with DDA regarding control drawings, leading to disputes and litigation. Eventually, PCL's earnest money was forfeited by DDA.

Assessing Officer's Decision:
The assessee initially claimed the amount as a bad debt, but the Assessing Officer (AO) disallowed it, stating it was an advance and not a debt. The AO concluded that the amount could not be written off as a bad debt under Section 36(1)(vii) of the Income Tax Act, 1961 (I.T. Act), as it was not shown as a trading receipt in any year.

CIT(A)'s Decision:
The Commissioner of Income Tax (Appeals) [CIT(A)] upheld the AO's decision, noting that the amount was not reflected as income in any previous year. The CIT(A) also considered the amendment to Section 36(2)(i) of the I.T. Act, effective from 01.04.1989, which required the debt to be accounted for in computing the income of the assessee.

Tribunal's Decision:
The Income Tax Appellate Tribunal (ITAT) sustained the orders of the AO and CIT(A), leading to the present reference.

High Court's Analysis:
The High Court examined whether the deduction could be allowed under Section 37 of the I.T. Act. The assessee argued that the transaction was not collusive and the deduction should not be disallowed merely on the grounds of lacking business prudence. The Court noted the following key points:

1. Nature of Transaction: The payment was made on the auction date, and PCL was not in a position to allot any space. The dispute with DDA regarding control drawings persisted, and no commercial space could be sold without DDA's permission.

2. Agreement and Adjustments: The assessee entered into an agreement with PCL after the disputes arose. Despite PCL's forfeiture of earnest money, the assessee debited the sum only after receiving a letter from PCL in 1988, indicating its inability to refund the money.

3. Prudence and Commercial Expediency: The Court emphasized that a prudent businessman would not have committed funds without ensuring tangible assets from PCL, which had a share capital of only Rs. 24,000. The transaction appeared to be a loan rather than a business expense.

4. Legal Precedents: The Court referred to several judgments, including S.A. Builders Ltd. vs CIT, which highlighted that commercial expediency should be judged from the perspective of a prudent businessman. However, the facts in the present case did not support the claim of commercial expediency.

5. Pending Litigation: The suit filed by PCL against DDA was still pending, and the assessee had not made any effort to recover the amount from PCL. The Court found no justification for the write-off based on a letter and legal opinion received years after the forfeiture.

Conclusion:
The High Court concluded that the amount paid by the assessee to PCL was neither for the purposes of business nor incidental to its business. The deduction under Section 37 of the I.T. Act was not justified, and the Tribunal's judgment was sustained. The question of law was answered in the negative against the assessee, and the reference was disposed of with costs following the result.