2025 (3) TMI 226 - HC - Income Tax

Disallowance of bad debts - Borrowers defaulted in the repayment obligations to the Lender - It is the Assessee s case that CIPL had become financially sick on account of heavy losses and therefore it was not feasible to recover any further amount from the said company ITAT set aside the deletion of bad debts as it found that the Assessee was engaged in the business of lending and advancing money and therefore furnishing a guarantee to the Lender fell within the scope of its business and accepted the Assessee s explanation that it was unable to recover the guarantee commission as CIPL was not in the financial condition to pay the same - HELD THAT - In terms of the Commitment Agreement the income by way of commission would accrue after the expiry of three years of the agreement. Thus the Assessee could not account for the income by way of commission prior to the expiry of three years from the date of the Commitment Agreement. However by that time the Borrowers had defaulted in payment of the amounts due to the Lender and therefore it is clearly doubtful whether the commission could be recovered. In the given circumstances non-recording of income by way of commission on bank guarantees could not be a ground for rejecting the expense of bad debts suffered if the same was during the course of its business. We find no infirmity with the decision of the learned ITAT in not accepting the AO s decision that the bad debts were not allowable as expense as the Assessee had not recognized the commission receivable in respect of guarantees as income in the given facts. The first question projected by the Revenue is not a substantial question of law in the given facts of this case. Whether the amount of bad debts as claimed by the Assessee is allowable as an expense under Section 36 (1) (vii) read with Section 36 (2) (i) of the Act and whether the Assessee s claim for this allowance is a colorable device to reduce the tax liability - ITAT has misdirected itself. The issue flagged by the AO and learned CIT(A) was that the Assessee had deliberately refrained from taking any steps for recovering the dues from CIPL as it was a group company. Further the facts indicated that CIPL had the wherewithal to pay at least part of the funds. This was established by the fact that it had made a donation of Rs. 10 crores during the said financial year. The AO and the learned CIT(A) had found that the Assessee had arranged the affairs in a manner whereby it had reflected a loss on account of bad debts which could be set off against its income. On the other hand CIPL which had suffered losses would in any event not be liable to pay tax on account of writing off its liability. Thus the arrangement in effect transfers the loss within the same group from a loss-making entity to a profit making entity and conversely profits resulting from remission of liability to a loss making entity. The allowance in respect of bad debts Under Section 36(1)(vii) of the Act is allowable only if (a) the debt was taken into account for computing the income of the assessee in the previous year in which the amount is written of or prior previous years; or (b) represents money lent in the ordinary course of business of banking or money lending. In the present case we concur with the decision of the learned CIT (A) that none of the two conditions are satisfied. Substantial questions are answered in favour of the Revenue and against the Assessee.

Summary

1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered in this judgment were:

A. Whether the Income Tax Appellate Tribunal (ITAT) erred in allowing the discharge of guarantee obligation as a business loss when the Assessee company did not recognize guarantee commission as business income.

B. Whether the amount of Rs. 27,76,92,000/- claimed as a business loss is allowable under Section 36 (2) (i) of the Income Tax Act.

C. Whether the ITAT's order is perverse for considering the transaction as a prudent act instead of a colorable device, despite evidence suggesting that the third party (IBFSL) vanished after the guarantee obligation was discharged by the Assessee.

2. ISSUE-WISE DETAILED ANALYSIS

Issue A: Recognition of Guarantee Commission as Business Income

- Legal Framework and Precedents: The claim of business loss must be substantiated by recognition of corresponding income, as per Section 36 of the Income Tax Act.

- Court's Interpretation and Reasoning: The Court noted that the ITAT accepted the Assessee's explanation that it could not recover the guarantee commission due to the financial condition of CIPL. The ITAT found that the Assessee was engaged in the business of financing, which included standing as a guarantor.

- Key Evidence and Findings: The Assessee did not record the commission as income due to the default by CIPL. The ITAT found no evidence of the transaction being a colorable device.

- Application of Law to Facts: The Court found no infirmity in the ITAT's decision regarding the commission not being recorded as income.

- Conclusions: The Court concluded that the non-recording of commission income was not a substantial question of law in this case.

Issue B: Allowability of Bad Debt under Section 36 (2) (i)

- Legal Framework and Precedents: Section 36 (2) (i) requires that a debt must be accounted for in computing income or represent money lent in the ordinary course of business.

- Court's Interpretation and Reasoning: The Court concluded that the Assessee's furnishing of a guarantee was not in its ordinary course of business, as standing as a guarantor was not one of the main objects of the Assessee company.

- Key Evidence and Findings: The Assessee had not engaged in similar transactions, and the transaction was isolated. The CIT(A) noted that the Assessee and Borrowers were part of the same group, indicating control over financial decisions.

- Application of Law to Facts: The Court found that the Assessee's claim did not satisfy the conditions of Section 36 (2) (i), as the debt was not part of its ordinary business.

- Conclusions: The Court ruled in favor of the Revenue, stating that the transaction was not a business loss under Section 36 (2) (i).

Issue C: Transaction as a Colorable Device

- Legal Framework and Precedents: A transaction is considered a colorable device if it is designed to evade tax without genuine business purpose.

- Court's Interpretation and Reasoning: The Court disagreed with the ITAT's finding that the transaction was not a colorable device. The Court noted the Assessee's lack of efforts to recover the debt and the financial activities of CIPL, such as making a significant donation.

- Key Evidence and Findings: The Court highlighted the relationship between the Assessee and CIPL, suggesting an arrangement to transfer losses within the group.

- Application of Law to Facts: The Court found that the transaction was structured to create a tax advantage, supporting the Revenue's contention.

- Conclusions: The Court concluded that the transaction was a colorable device and ruled in favor of the Revenue.

3. SIGNIFICANT HOLDINGS

- Core Principles Established: The Court emphasized that for a bad debt to be allowable, it must be part of the ordinary course of business or have been accounted for in computing income.

- Final Determinations on Each Issue: The Court allowed the Revenue's appeal, setting aside the ITAT's order regarding the bad debt claim. The Court found that the Assessee's claim did not meet the requirements under Section 36 (2) (i) and was a colorable device to reduce tax liability.