2010 (1) TMI 86 - HC - Income Tax

Not deductible as bad debts or Business Expenditure under section 36(1)(vii), 37, Business Expenditures The assessee in the course of its activity of manufacture and sale of beer had furnished guarantee for repayment of certain loans and advances which its subsidiaries companies and their business associates had raised from banks and financial institutions and on the failure of the subsidiary companies or the business associates to repay the amounts on the premise that they have become incapable of repayment, reimbursed the guarantee amount to the creditors and claimed that amount as an expenditure under section 36 or 37 for the assessment year 1996-97 and 1997-98. The assessee also claimed deduction of amounts advanced to associated and subsidiary companies for purchase of shares. The claims were rejected by the Assessing Officer and the Commissioner (Appeals) after considering the material of records the Tribunal allowed them. -The assessee claimed that the amount spent to obtain legal advice on the feasibility of acquiring another company was revenue expenditure. The Assessing officer and the Commissioner (Appeals) disallowed the claim but the tribunal allowed it. - The assessee had advanced sums to its business associated and the agreement specified the rate of interest. The assessee submitted that it had not received such interest and it was not assessable. The Assessing officer and Commissioner (Appeals) held that the amount was assessable but the Tribunal held that it was not assessable. In this case Karnataka High Court-held that except for question related to the obtaining of feasibility/viability report for purchasing national Sirghum Breweries, South Africa was a business expenditure all other questions for this assessment year and all questions for the assessment year 1997-98 are answered in favour of the Revenue and against the assessee. The order of the assessing authority as affirmed by the first appellate authority in so far as it relates to all other findings other than the finding relating to the fee towards obtaining feasibility report for acquiring brewery unit at South Africa are all restored and affirmed. The order of the Tribunal is reversed to the extent mentioned above. While I. T. A. No. 492 of 2001 is allowed in part levying cost of Rs.10,000 on the respondent in favour of the Revenue, I. T. A. No. 89 of 2003 is allowed in full levying cost of Rs. 5,000 on the respondent in favour of the Revenue.Cost to be paid within four weeks from today, failing which the Revenue can realize the amount as part of recovery on its own.

Issues Involved:
1. Bad debts written off
2. Discharge of guarantee obligations
3. Legal expenses incurred
4. Real income theory and interest income

Detailed Analysis:

1. Bad Debts Written Off:
The assessee claimed deductions for bad debts written off under section 36(1)(vii) of the Income-tax Act, 1961. The adjudicating authority and the first appellate authority disallowed these claims, stating that the amounts were either capital advances or lacked sufficient evidence to be considered as bad debts. The Tribunal reversed these findings, allowing the claims. The High Court noted the absence of material evidence to support the claims and emphasized that a debt must be a legal obligation recoverable by action. The court concluded that the amounts claimed as bad debts were not substantiated with adequate proof of efforts to recover them and thus disallowed the claims, answering the related questions in favor of the Revenue.

2. Discharge of Guarantee Obligations:
The assessee claimed deductions for amounts paid to discharge guarantees given for loans taken by its subsidiaries. The adjudicating and appellate authorities disallowed these claims, stating that the liabilities were capital in nature and not directly related to the assessee's business. The Tribunal allowed the claims, following its earlier decision for the assessment year 1995-96. The High Court, however, emphasized that each assessment year is distinct and that the principle of res judicata does not apply to tax matters. The court found that the guarantees were not directly related to the assessee's business and disallowed the claims, answering the related questions in favor of the Revenue.

3. Legal Expenses Incurred:
The assessee claimed deductions for legal expenses incurred for obtaining advice on acquiring a foreign company. The adjudicating and appellate authorities disallowed this claim, considering it as capital expenditure. The Tribunal allowed the claim, treating it as revenue expenditure. The High Court agreed with the Tribunal, stating that the expenses were incurred for obtaining expert opinion on business expansion and not for acquiring a capital asset. Thus, the court allowed the deduction, answering the related question in favor of the assessee.

4. Real Income Theory and Interest Income:
The assessee excluded accrued interest income on the grounds of "real income" theory, claiming that the income was not realizable. The adjudicating and appellate authorities included this income for tax purposes. The Tribunal allowed the exclusion, following the real income theory. The High Court disagreed, stating that under the mercantile system of accounting, income accrues with the lapse of time and must be offered to tax. The court emphasized that the concept of real income cannot override statutory provisions and disallowed the exclusion, answering the related question in favor of the Revenue.

Conclusion:
The High Court allowed the appeal in part, reversing the Tribunal's findings on bad debts, discharge of guarantee obligations, and interest income, while upholding the deduction for legal expenses. The court imposed costs on the respondent for both appeals.

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