Madras High Court
Commissioner Of Income Tax vs M/S.Star Investments Pvt. Ltd on 3 June, 2025
2025:MHC:1272
TCA No.22 OF 2016
IN THE HIGH COURT OF JUDICATURE AT MADRAS
DATED: 03.06.2025
CORAM
THE HON'BLE MR.K.R.SHRIRAM, CHIEF JUSTICE
AND
THE HON'BLE MR.JUSTICE SUNDER MOHAN
Tax Case Appeal No.22 of 2016
Commissioner of Income Tax,
Chennai : Appellant
versus
M/s.Star Investments Pvt. Ltd
No.9, Bazullah Road,
T.Nagar,
Chennai 600 017 : Respondent
Prayer: Appeal filed against the Judgment passed by the Income Tax
Appellate Tribunal, Madras, 'A' Bench dated 22.05.2015 in ITA
No.50/Mds/2013.
For Appellant : Mr.J.Narayanasamy
For Respondent : Mr.I.Dinesh
Page 1 of 23
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JUDGMENT
(Judgment of the Court was delivered by the Hon'ble Chief Justice)
This appeal, filed under Section 260A of the Income Tax Act, 1961,
(for short, 'the Act') came to be admitted on 27.01.2016, and the following
two substantial questions of law were framed:
“1. Whether on the facts and circumstances of the case the Tribunal
was right in holding that the assessee is eligible for deduction of bad
debts of Rs.8,46,97,280/- when the transaction is not in the nature of
loan between the parties.
2. Whether on the facts and circumstances of the case the Tribunal
was right in holding that the assessee's action of standing as
guarantor for the loan availed by its sister concern and consequential
invocation of the guarantee clause by the bank and appropriation of
the amounts by the sale of the share held by the assessee to satisfy the
dues of the defaulting sister company is for the purpose of the
assessee's business and the assessee is entitled for deduction of
business loss?”
2. Assessee is an investment company engaged in the trading of
shares. Assessee was promoted by Balaji Group of Companies. Assessee also
held shares in Balaji Distilleries Ltd (BDL) as promoter. Assessee held these
shares as stock-in-trade. One of the companies which was promoted by
Assessee was Balaji Industrial Corporation Ltd (BICL).
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3. BICL availed a loan of Rs.10 Crore from the Industrial Credit and
Investment Corporation of India Ltd (ICICI Ltd). As one of the conditions
required for disbursing the loan, understandably to secure the repayment of
the loan, assessee, being the promoter of BICL, had to pledge the shares
that it held in BDL, to ensure asset coverage of 1.5 times of loan sanctioned
by ICICI and guarantee assistance on market value basis. Accordingly,
assessee pledged 28,69,200 equity shares of BDL.
4. Over a period, BCIL was unable to repay its loan to ICICI. ICICI, to
recover the amount that was payable to it by BICL, under the terms and
conditions of loan and guarantee given by assessee, sold on 1.4.2008, out
of 28,69,200 shares pledged, 25,15,200 equity shares at Rs.37.65 per share,
which was the prevailing market value on 01.04.2008. Accordingly,
assessee accounted for Rs.9,46,97,280/- of the dues from BICL to ICICI.
5. Assessee having guaranteed repayment on behalf of BICL, to ICICI,
naturally, BICL had to pay any amount that assessee paid on its behalf to
ICICI. Consequently, BICL became liable to pay to assessee a sum of
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Rs.9,46,97,280/- on 01.04.2008 (AY 2009-10). Indisputably, BICL paid
only Rs.One crore to assessee and assessee accepted the same in full and
final settlement of the outstanding amount of Rs.9,46,97,280/-. The unpaid
amount of Rs.8,46,97,280/-, assessee decided to write it off as bad debts in
the books of accounts for the year ending 31.03.2009 (AY 2009-10). As
noted above, liability of BICL to assessee also arose only in AY 2009-10.
6. This write-off as bad debts was not accepted by the Assessing
Officer. The assessee filed an appeal before the Commissioner of Income
Tax (A), who also confirmed the order of the Assessing Officer. Aggrieved,
assessee preferred an appeal before the Income Tax Appellate Tribunal. The
Appellate Tribunal, by the impugned order pronounced on 22.05.2015,
reversed the findings of the AO as well as CIT (A) and accepted assessee's
stand that the amount of Rs.8,46,97,280/- can be written-off. It is against
this order, the present appeal is preferred.
7. The question in short to be answered by us, is whether assessee
could have written-off this amount as bad debts.
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8. Shri Narayanasamy appearing for the Revenue submitted that the
assessee was an investment company engaged, among other things, in
trading of shares. The sale proceeds of the shares pledged by the assessee
was appropriated by ICICI towards outstanding loan of BICL. The loan
availed by BICL and the sale consideration received by ICICI on sale of
pledged shares has nothing to do with the assessee company. The write-off
claimed was not wholly and exclusively for the business purpose of assessee
because what was sold was only because of the mortgage of shares by
assessee for the loan availed by BICL.
9. It was also submitted that the voluntary act of pledging the shares
for the loan taken by BICL cannot be considered to be an act of business
transaction and hence, assessee cannot claim the amount as deduction
under Section 36(1)(vii) of the Act. It was also submitted that the condition
prescribed under Section 36(2) of the Act has not been satisfied inasmuch
as assessee has not shown in any year that this amount was recoverable by
BICL.
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10. In our view, the issue in this case is squarely covered by a
judgment of a Division Bench of the Bombay High Court in Mahindra and
Mahindra Ltd. vs. Commissioner of Income Tax1 , which was authored by
one of us (Chief Justice).
1 1. In that case, Mahindra was a promoter holding more than 27% of
the equity shares of its group company called Machinery Manufacturers
Corporation Ltd (“MMC”). It had to incur certain miscellaneous expenses
amounting to Rs.42,89,185/- on behalf of MMC. It also had to recover a
sum of Rs.6,22,01,000/- which was not allowed to be written-off. Mahindra
had also provided guarantee of Rs.200 lakhs to IDBI for the rehabilitation
assistance disbursed by IDBI to MMC. Mahindra, to preserve and protect
the value of good-will attached to it, decided to bear the unavoidable
expenditure of Rs.42.89 lakh of MMC and included the same in
miscellaneous expenses. The Assessing Officer disallowed the same as also
the amount of Rs.6,22,01,000/- that it had written-off. The Court held that
since the expenditure was wholly incurred for the purpose of commercial
1 [2023] 151 taxmann.com332 (Bombay)
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expediency because MMC was a group company of Mahindra and the nexus
between Mahindra and MMC was not disputed, the AO failed to appreciate
the claim in its proper perspective. 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 Mahindra's return of business income.
12. It will be apposite to reproduce paragraphs 25 to 27 of Mahindra
and Mahindra (supra).
“25. One can understand the Assessing Officer had disallowed these
amounts after arriving at a conclusion that the decision to incur the
expenses mentioned above or the debts mentioned above was not
bonafide. That is not the case. Whether to treat the debt as bad debt
or as business loss/deduction under Section 28 of the Act is a
commercial or business decision of the assessee based on the relevant
material in possession of the assessee. Once the assessee records the
amounts 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 also not in dispute that the amounts spent
were against/recoverable from group company MMC. It is quite
obvious for reasons mentioned above that the amounts in question
were incurred by appellant for the business expediency of the group
company. It is not disputed that there existed a nexus between
appellant and MMC. Such expenditure/debt should be treated as
having been incurred for the purpose of business and directly
relatable to the business of appellant and thus eligible for deduction
as business expenditure in their return of business income. Otherwise
it would not reflect the true profit and gain of appellant. A sum of
money expended, not of necessity and with a view to a direct and
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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 as held in British Insulated and Helsby
Cables Ltd. V/s. Atherton [1926] AC 205.
26 In Commissioner of Income Tax, Delhi V/s. Delhi Safe Deposit Co.
Ltd.8 the Apex Court was examining whether the amount in question
can be treated as an expenditure laid out or expended wholly and
exclusively for the purposes of the business of the assessee which is
admissible as a deduction under Section 37 of the Act when the
assessee was claiming deductions on the ground that the expenditure
was incurred due to commercial expediency. In that case also the
assessee had incurred the expenditure in question to avoid any
adverse effect on its reputation like the case at hand. The Apex Court
held that the expenditure incurred was a deductible expenditure. In
fact that was the case where three persons A, B and the assessing
company, which had also other businesses, were partners in a
managing agency firm with 50%, 25% and 25% shares, respectively.
At the instance of A, a large sum of money was advanced by the
managed company to another firm at Calcutta. When the demand for
repayment was made, the Calculta firm repudiated the claim and, out
of the loss of Rs.1,90,092/- to the managed company, the sum of
Rs.95,092/- was agreed to be borne by B, the assessee company and
D, who was the brother of A, who was inducted into the managing
agency firm as partner in place of A. The assessee's claim to have the
sum of Rs.9,500/- which was paid by it to the managed company
during the previous year relevant to the assessment year 1962-1963
in partial discharge of its liability of Rs.47,500/- deducted as business
expenditure, was disallowed by the Income Tax Officer and the AAC
confirmed the order of the Income Tax Officer on the ground that the
amount was actually the loss of a firm which was no longer in
existence, that the loss had been borne by the assessee on personal
considerations and that the managing agency firm had not claimed
the loss in its return. The Appellate Tribunal reversed the order of the
AAC and allowed the assessee's claim on the ground that though
there was a change in the constitution of the firm, the assessee's
liability had not ceased, that since the assessee was a company there
was no question of any personal consideration and that the assessee
had made the payment purely on business considerations with the
sole object of maintaining its business connection which was yielding
profit. On a reference, the High Court held that the assessee was
entitled to the deduction claimed. On appeal, the Apex Court held
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that the assessee incurred the expenditure in question to avoid any
adverse effect on its reputation, to protect the managing agency,
which was an income earning apparatus, and for retaining it with the
reconstituted firm in which the interest of the assessee was the same
as before. The Apex Court, therefore, held that the expenditure was
laid out on purely business considerations and wholly for the purpose
of the assessee's business. The Apex Court also held that the true test
of an expenditure laid out wholly and exclusively for the purposes of
trade or business is that it is incurred by the assessee as incidental to
his trade for the purpose of keeping the trade going and of making it
pay and not in any other capacity than that of a trader and the
expenditure incurred on the preservation of a profit earning asset of a
business is always a deductible expenditure. It will be useful to
reproduce the relevant portion, which reads as under :
The first question which needs to be examined is whether
the amount in question can be treated as an expenditure
laid out or expended wholly and exclusively for the
purposes of the business of the assessee which is admissible
as a deduction under s. 37 of the Act. It is no doubt true
that the solution to a question of this nature sometimes is
difficult to arrive at. But, however difficult the task may be,
a decision on that question should be given having regard
to the decisions bearing on the question and ordinary
principles of commercial trading and of commercial
expediency. The facts found in the present case are that the
assessee was carrying on business as a partner of the
managing agency firm and it also had other businesses, the
managing agency agreement with the managed company
was a profitable source of income and that the assessee had
continuously earned income from that source. But on
account of the negligence on the part of one of its partners,
there arose a serious dispute which could have ordinarily
resulted in a long drawn out litigation between the
managing agency firm and the managed company affecting
seriously the reputation of the assessee in addition to any
pecuniary loss which the assessee as a partner was liable to
bear on account of the joint and several liability arising
under the law of partnership. The settlement arrived at
between the parties prevented effectively the hazards
involved in any litigation and also helped the assessee in
continuing to enjoy the benefit of the managing agency
which was a sound business proposition. It also assisted the
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assessee in retaining the business, reputation unsullied
which it had built up over a number of years. It is also
material to notice here that it was not shown that the
settlement was a gratuitous arrangement entered. into by
the assessee to benefit the defaulting partner, exclusively
even though he might have been benefited to some extent.
It is no doubt true that it was voluntary in character but on
the facts and in the circumstances of the case, whether it
would make any difference at all is the point for
consideration.
Dealing with the question whether an expenditure incurred
by a brewery in aid of their tenants of tied houses as a
necessary incident of the profitable working of the brewery
business was an admissible expenditure in the computation
of the income-tax liability of the brewery, Lord Sumner
upholding the above claim observed in Usher's Wiltshire
Brewery L'd. v. Bruce [1915] AC 433, 469 (HL), thus:
Where the whole and exclusive purpose of the
expenditure is the purpose of the expender's trade,
and the object which the expenditure serves is the
same, the mere fact that to some extent the
expenditure enures to a third party's benefit, say
that of the publican, or that the brewer incidentally
obtains some advantage, say in his character of
land- lord, cannot in law defeat the effect of the
finding as to the whole and exclusive purpose.
In British Insulated and Helsby Cables Ltd. v. Atherton
[1926] AC 205; [1925] 10 TC 155, 193 (HL), Lord Cave
observed:
It was made clear in the above cited cases of Usher's
Wiltshire Brewery v. Bruce [1915] AC 433 (HL) and
Smith v. Incorporated Council of Law Reporting for
England and Wales [1914] 3 KB 674 (KB), 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
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of the trade......
Rowlatt J. in Mitchell v. B. W. Noble Ltd. (1927) 1 KB 719;
1 1 TC 372, held that the money spent on getting rid of a
director and saving the company from scandal was
deductible. Affirming the above view, the Court of Appeal
(whose judgment appears at p. 731) held that as the
payment was not made to secure an actual asset so as
effectually to increase the capital of the company but was
made in order to enable the directors to carry on the
business of the company as they had done in the past
unfettered by the presence of the retiring director, which
might have had a bad effect on the credit of the company,
it must be treated as revenue and not as capital
expenditure and was deductible as such for income-tax
purposes.
The true test of an expenditure laid out wholly and
exclusively for the purposes of trade or business is that it is
incurred by the assessee as incidental to his trade for the
purpose of keeping the trade going and of making it pay
and not in any other capacity than that of a trader. In CIT
v. Malayalam Plantations Ltd. [1964] 7 SCR 693; 53 ITR
140, 180, Subba Rao J. (as he then was) summarised the
legal position, at p. 705, thus:
The aforesaid discussion leads to the following result: The
expression for the purpose of the business' is wider in scope
than the expression for the purpose of earning profits. Its
range is wide: it may take in not only the day to day
running of a business but also the rationalization of its
administration and modernization of its machinery; it may
include measures for the preservation of the business and
for the protection of its assets and property from
expropriation, coercive process or assertion of hostile title;
it may also comprehend payment of statutory dues and
taxes imposed as a pre-condition to commence or for
carrying on of a business; it may comprehend many other
acts incidental to the carrying on of a business. However
wide the meaning of the expression may be, its limits are
implicit in it. The purpose shall be for the purpose of the
business, that is to say, the expenditure incurred shall be
for the carrying on of the business and the assessee shall
incur it in his capacity as a per- son carrying on the
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business.
In the instant case, the assessee incurred the expenditure in
question to avoid any adverse effect on its reputation, to
protect the managing agency which was an income earning
apparatus and for retaining it with the reconstituted firm in
which the interest of the assessee was the same as before.
It was likely that but for the expenditure, the fair name of
the assessee would have been tarnished or rendered
suspicious and the managing agency would have been
terminated. The expenditure incurred on the preservation
of a profit earning asset of a business has always been held
to be a deductible expenditure by courts. In the
circumstances, it is difficult to hold that the expenditure
incurred by the assessee was either gratuitous or one
incurred outside the trading activities of the assessed, The
expenditure was, therefore, rightly held to be deductible
under s. 37.
27. In the case at hand also the expenditure incurred were wholly
incurred for the purpose of commercial expediency because MMC was
a group company of appellant and appellant was, as could be seen
from the orders passed by BIFR, keen in the preservation of MMC and
to keep it as a going concern. The nexus between appellant and MMC
is also not disputed. The Assessing Officer failed to appreciate the
claim in the proper perspective. Appellant participated in the
rehabilitation scheme of MMC and lent rehabilitation assistance by
paying amounts to MMC as well as by converting its existing ICDs
with MMC into rehabilitation assistance. Appellant also provided a
guarantee of Rs.200 lakhs to IDBI for the rehabilitation assistance
disbursed by IDBI to MMC. If there was no commercial expediency,
there was no reason for appellant to incur these amounts or
participate in the rehabilitation scheme of MMC. Appellant was also
the managing agents of MMC and MMC was also a Mahindra Group
Company. It is certainly not necessary for the name of Mahindra and
Mahindra to be used in the name of MMC to prove it was a group
company. These 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. The
expenditure incurred by appellant or the debts that were recoverable
from MMC, in our view, therefore, would certainly be deductible
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expenditure under Section 28 of the Act.”
13. In the case in hand also, 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.
14. 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.
15. It is not the Revenue's case that the decision to pledge the shares
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or only accept Rs.One crore in full and final settlement was not bona fide.
As held in Mahindra and Mahindra (supra), 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.
16. It is quite obvious therefore that the loss incurred by the assessee
was for the business expediency of the group company.
17. 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
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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).
18. It will also be useful to reproduce paragraphs 16 to 18 of a
judgment of the Bombay High Court in Vaman Prestressing Co. Pvt. Ltd.
V/s. The Additional Commissioner of Income Tax2
“16. The law on this is settled in as much as in S.A. Builders Ltd.
(supra), the Hon'ble Apex Court was considering an almost identical
situation. The assessee in that case had transferred a huge amount of
Rs.82 Lakhs to its subsidiary company out of the Cash Credit Account
of the assessee in which there was a huge debit balance. The
Assessing Officer held that since the assessee had diverted its
borrowed funds to a sister concern without charging any interest,
proportionate interest relating to the said amount out of total interest
paid to the bank deserved to be disallowed and he disallowed a
particular sum. The Hon'ble Apex Court held that extending such a
loan would fall under the expression used for the purpose of business.
If the amount has been advanced as a measure of commercial
expediency, the interest on funds borrowed by the assessee should be
allowed as deduction under Section 36(1)(iii) of the Act. Paragraph
Nos. 19 to 36 of S.A. Builders Ltd. (supra) read as under :
19. We have considered the submission of the respective
parties. The question involved in this case is only about the
allowability of the interest on borrowed funds and hence
we are dealing only with that question. In our opinion, the
approach of the High Court as well as the authorities below
on the aforesaid question was not correct.
2 [2023] 154 taxmann.com325 (Bombay)
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20. In this connection we may refer to Section 36(1)(iii) of
the In- come Tax Act, 1961 (hereinafter referred to as the
'Act') which states that "the amount of the interest paid in
respect of capital borrowed for the purposes of the business
or profession" has to be al- lowed as a deduction in
computing the income tax under Section 28 of the Act.
21. In Madhav Prasad Jantia vs. Commissioner of Income
Tax U.P. AIR 1979 SC 1291, this Court held that the
expression "for the pur- pose of business" occurring under
the provision is wider in scope than the expression "for the
purpose of earning income, profits or gains", and this has
been the consistent view of this Court.
22. In our opinion, the High Court in the impugned
judgment, as well as the Tribunal and the Income Tax
authorities have approached the matter from an erroneous
angle. In the present case, the assessee borrowed the fund
from the bank and lent some of it to its sister concern (a
subsidiary) on interest free loan. The test, in our opinion,
in such a case is really whether this was done as a measure
of commercial expediency.
23. In our opinion, the decisions relating to Section 37 of
the Act will also be applicable to Section 36(1)(iii) because
in Section 37 also the expression used is "for the purpose of
business". It has been consistently held in decisions relating
to Section 37 that the expression "for the purpose of
business" includes expenditure voluntarily incurred for
commercial expediency, and it is immaterial if a third party
also benefits thereby.
24. Thus in Atherton vs. British Insulated & Helsby Cables
Ltd (1925)10 TC 155 (HL), it was held by the House of
Lords that in order to claim a deduction, it is enough to
show that the money is expended, not of necessity and
with a view to direct and immediate benefit, but
voluntarily and on grounds of commercial expediency and
in order to indirectly to facilitate the carrying on the
business. The above test in Atherton's case (supra) has
been approved by this Court in several decisions e.g.
Eastern Investments Ltd. vs. CIT (1951) 20 ITR 1,CIT vs.
Chandulal Keshavlal & Co. (1960) 38 ITR 601 etc.
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25. In our opinion, the High Court as well as the Tribunal
and other Income Tax authorities should have approached
the question of allowability of interest on the borrowed
funds from the above angle. In other words, the High Court
and other authorities should have enquired as to whether
the interest free loan was given to the sister company
(which is a subsidiary of the assessee) as a measure of
commercial expediency, and if it was, it should have been
allowed.
26. The expression "commercial expediency" is an
expression of wide import and includes such expenditure
as a prudent business- man incurs for the purpose of
business. The expenditure may not have been incurred
under any legal obligation, but yet it is allowable as a
business expenditure if it was incurred on grounds of
commercial expediency.
27. No doubt, as held in Madhav Prasad Jantia vs. CIT
(supra), if the borrowed amount was donated for some
sentimental or personal reasons and not on the ground of
commercial expediency, the inter- est thereon could not
have been allowed under Section 36(1)(iii) of the Act. In
Madhav Prasad's case (supra), the borrowed amount was
donated to a college with a view to commemorate the
memory of the assessee's deceased husband after whom the
college was to be named. It was held by this Court that the
interest on the borrowed fund in such a case could not be
allowed, as it could not be said that it was for commercial
expediency.
28. Thus, the ratio of Madhav Prasad Jantia's case (supra)
is that the borrowed fund advanced to a third party should
be for commercial expediency if it is sought to be allowed
under Section 36(1)(iii) of the Act.
29. In the present case, neither the High Court nor the
Tribunal nor other authorities have examined whether the
amount advanced to the sister concern was by way of
commercial expediency.
30. It has been repeatedly held by this Court that the
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expression "for the purpose of business" is wider in scope
than the expression " for the purpose of earning profits"
vide CIT vs. Malayalam Plantations Ltd. (1964) 53 ITR
140, CIT vs. Birla Cotton Spinning & Weaving Mills Ltd.
(1971) 82 ITR 166 etc.
31. The High Court and the other authorities should have
examined the purpose for which the assessee advanced the
money to its sister concern, and what the sister concern did
with this money, in order to decide whether it was for
commercial expediency, but that has not been done.
32. It is true that the borrowed amount in question was not
utilized by the assessee in its own business, but had been
advanced as inter- est free loan to its sister concern.
However, in our opinion, that fact is not really relevant.
What is relevant is whether the assessee advanced such
amount to its sister concern as a measure of commercial
expediency.
33. Learned counsel for the Revenue relied on a Bombay
High Court decision in Phaltan Sugar Works Ltd. Vs.
Commissioner of Wealth- Tax (1994) 208 ITR 989 in which
it was held that deduction under Section 36(1)(iii) can
only be allowed on the interest if the assessee borrows
capital for its own business. Hence, it was held that interest
on the borrowed amount could not be allowed if such
amount had been advanced to a subsidiary company of the
assessee. With respect, we are of the opinion that the view
taken by the Bombay High Court was not correct. The
correct view in our opinion was whether the amount
advanced to the subsidiary or associated company or any
other party was advanced as a measure of commercial
expediency. We are of the opinion that the view taken by
the Tribunal in Phaltan Sugar Works Ltd (supra) that the
interest was deductible as the amount was advanced to the
subsidiary company as a measure of commercial
expediency is the correct view, and the view taken by the
Bombay High Court which set aside the aforesaid decision
is not correct.
34. Similarly, the view taken by the Bombay High Court in
Phaltan Sugar Works Ltd. vs. Commissioner of Wealth-
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TCA No.22 OF 2016
Tax(1995) 215 ITR 582 also does not appear to be correct.
35. We agree with the view taken by the Delhi High Court
in CIT vs. Dalmia Cement (Bhart) Ltd. (2002) 254 ITR 377
that once it is established that there was nexus between the
expenditure and the pur pose of the business (which need
not necessarily be the business of the assessee itself), the
Revenue cannot justifiably claim to put itself in the arm-
chair of the businessman or in the position of the board of
directors and assume the role to decide how much is
reasonable expenditure having regard to the circumstances
of the case. No businessman can be compelled to maximize
its profit. The income tax authorities must put themselves
in the shoes of the assessee and see how a prudent
businessman would act. The authorities must not look at
the matter from their own view point but that of a prudent
businessman. As already stated above, we have to see the
transfer of the borrowed funds to a sister concern from the
point of view of commercial expediency and not from the
point of view whether the amount was advanced for
earning profits.
36. We wish to make it clear that it is not our opinion that
in every case interest on borrowed loan has to be allowed if
the assessee advances it to a sister concern. It all depends
on the facts and circumstances of the respective case. For
instance, if the Directors of the sister concern utilize the
amount advanced to it by the assessee for their personal
benefit, obviously it cannot be said that such money was
advanced as a measure of commercial expediency.
However, money can be said to be advanced to a sister
concern for commercial expediency in many other
circumstances (which need not be enumerated here).
However, where it is obvious that a holding company has a
deep interest in its subsidiary, and hence if the holding
company advances borrowed money to a subsidiary and
the same is used by the subsidiary for some business
purposes, the assessee would, in our opinion, ordinarily be
entitled to deduction of interest on its borrowed loans.
17. In this case, from 2003-04 itself petitioner has been granting
loans and advances to sister and associate concerns. Even for
Assessment Years 2004-05 to 2008-09, the Revenue has not made any
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TCA No.22 OF 2016
disallowance of interest expense in those years thereby accepting that
the deployment of funds is for business purpose. The disallowance
made during Assessment Year 2003-04 has been set aside in appeal
by CIT[A] as well as the ITAT. Moreover there can be no other reason
but commercial expediency for petitioner to give loans and advances
and capital to ICON. The Revenue cannot justifiably claim to put itself
in the arm-chair of the businessman or in the position of the board of
directors and assume the role to decide how a prudent businessman
should act. The authorities must not look at the matter from their
own point of view but that of a prudent businessman.
18. In view of what is recorded above, it is evident that there was
absolutely no basis to respondent no.1 to form a belief that any
income chargeable to tax has escaped assessment within the meaning
of substantive provisions of Section 147 of the Act. As held by this
court in Prashant S. Joshi (supra) Explanation 2 to Section 147
creates a deeming fiction of cases where income chargeable to tax has
escaped assessment. Clause (b) deals with a situation "where a return
of income has been furnished by the assessee but no assessment has
been made and it is noticed by the A.O. that the assessee has
understated the income or has claimed excessive loss, deduction,
allowance or relief in the return." For the purpose of Clause (b) to
Explanation 2, the Assessing Officer must notice that the assessee has
understated his income or has claimed excessive loss, deduction,
allowance or relief in the return and taking of such notice must be
consistent with the provisions of the applicable law. It cannot be at
the arbitrary whim or caprice of the Assessing Officer and must be
based on a reasonable foundation. Though the sufficiency of the
evidence or material is not open to scrutiny by the court but the
existence of the belief is the sine qua non for a valid exercise of
power. Paragraph No. 20 of Prashant S. Joshi (supra) reads as under :
20. For all these reasons, it is evident that there was
absolutely no basis for the first respondent to form a belief
that any income chargeable to tax has escaped assessment
within the meaning of the substantive provisions of section
147. Explanation 2 to section 147 creates a deeming fiction
of cases where income chargeable to tax has escaped
assessment. Clause (b) deals with a situation "where a
return of income has been furnished by the assessee but no
assessment has been made and it is noticed by the
Assessing Officer that the assessee has understated the
income or has claimed excessive loss, deduction, allowance
or relief in the return." For the purpose of clause (b) to
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TCA No.22 OF 2016
explanation 2, the Assessing Officer must notice that the
assessee has understated his income or has claimed
excessive loss, deduction, allowance or relief in the return.
The taking of such notice must be consistent with the
provisions of the applicable law. The act of taking notice
cannot be at the arbitrary whim or caprice of the Assessing
Officer and must be based on a reasonable foundation. The
sufficiency of the evidence or material is not open to
scrutiny by the Court but the existence of the belief is the
sine qua non for a valid exercise of power. In the present
case, having regard to the law laid down by the Supreme
Court it was impossible for any prudent person to form a
reasonable belief that the income had escaped assessment.
The reasons which have been recorded could never have
led a prudent person to form an opinion that in- come had
escaped assessment within the meaning of section 147. In
these circumstances, the petition shall have to be allowed
by set- ting aside the notice under section 148.”
19. Therefore, the questions of law framed are answered in the
affirmative.
20. The appeal is dismissed. There shall be no order as to costs.
(K.R.SHRIRAM, CJ.) (SUNDER MOHAN, J.)
03.06.2025
Index : Yes/No
Neutral Citation : Yes/No
tar
To
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TCA No.22 OF 2016
1.The Commissioner of Income Tax,
Chennai
2.The Income Tax Appellate Tribunal,
Madras, 'A' Bench
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TCA No.22 OF 2016
THE HON'BLE CHIEF JUSTICE
AND
SUNDER MOHAN, J.
(tar)
03.06.2025
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