Appellant Came Into Existence, No Such Commission Was Paid Andonly From The Year 1985, Almost An Inducement Was Made For Makingof Payments And Claiming Deductio v. Income

* THE HON’BLE SRI JUSTICE L.NARASIMHA REDDY AND THE HON’BLE SRI JUSTICE CHALLA KODANDA RAM + I.T.T.A.No.9 of 2002 % Date: 22.07.2014 The Andhra Pradesh State Financial Corporation … Appellant And $ The Deputy Commissioner of Income Tax (Assessments) Special Range-I Aayakar Bhavan, Basheerbagh Hyderabad … Respondent ! Counsel for Appellant: SriKarthik Ramana ^ Counsel for Respondent: Sri S.R. Ashok < GIST: HEAD NOTE: ? Cases referred 1. 122 ITR 839 2. 207 ITR 47 THE HON’BLE SRI JUSTICE L.NARASIMHA REDDY AND THE HON’BLE SRI JUSTICE CHALLA KODANDA RAM I.T.T.A.No.9 of 2002 JUDGMENT:(Per the Hon’ble Sri Justice L.Narasimha Reddy) This appeal under Section 260-A of the Income Tax Act, 1961(for short ‘the Act’) is preferred assailing the order, dated 03.10.2001passed by the Hyderabad Bench ‘B’ of the Income Tax AppellateTribunal (for short ‘the Tribunal’). The appellant is created under the State FinancialCorporations Act, 1951 (for short ‘the SFC Act’), for the State ofAndhra. It is also an assessee under the Act and was filing returnsyear after year. For the assessment years 1990-91 and 1991-92, apart fromother amounts, it claimed deduction of what is known as “GuaranteeCommission” paid to the State Government towards its obligation forproviding guarantees to the lenders under Section 7 of the SFC Act. The State Government, in turn, issued a G.O., on a request made bythe appellant herein, to constitute a fund with the amountrepresenting “Guarantee Commission” under the head “DividendSubvention Fund Account” (for short ‘the Fund’), so that it can beutilised for payment of dividends in the years in which the appellantdid not earn any profits. The Income Tax Officer (ITO) did not treat itas expenditure to be allowed as deduction under Section 37 of the Act. The appeal preferred before the Commissioner of Income Tax(Appeals) was not fruitful. Thereupon, the appellant filedI.T.A.Nos.1978/Hyd/92 and 1245/Hyd/95 before the Tribunal. The Income Tax Officer and the Commissioner took the viewthat there was no actual payment or deduction at all and it wasalmost an illusory accounting treatment. The Tribunal held that theamount representing “Guarantee Commission” can be said to havebeen paid to the State Government, notwithstanding the fact that it is‘Accounting Treatment’. However, it took the view that the paymentwas not warranted or provided for under Section 7 of the SFC Act,and therefore, it is not deductible. Hence, this appeal. Sri Karthik Ramana, learned counsel for the appellant,submits that the deduction affected by the appellant is squarelyreferable to Section 7 of the SFC Act and though the Tribunalaccepted that the deduction was, in fact, made, went beyond thescope of verification under the SFC Act, and disallowed it. Hecontends that the reference to the correspondence that ensuedbetween the Managing Director of the appellant, on the one hand,and the State Government, on the other hand, was outside the scopeof enquiry and the element of propriety than legality, was examinedin detail. Learned counsel submits that as long as the deduction isprovided for in law, it is immaterial as to at whose instance and inwhat manner such deduction was made. Sri S.R.Ashok, learned Senior Counsel for the Income TaxDepartment, on the other hand, submits that the State Government isunder obligation to provide guarantee under Section 7 of the SFCAct for the loans borrowed by the appellant and it was not supposed,much less entitled in law, to levy guarantee commission. Hecontends that for a period of about two decades, ever since the appellant came into existence, no such commission was paid andonly from the year 1985, almost an inducement was made for makingof payments and claiming deductions with the objective of evadingincome tax. Sri S.R.Ashok, learned Senior Counsel for the Income TaxDepartment, on the other hand, submits that the State Government isunder obligation to provide guarantee under Section 7 of the SFCAct for the loans borrowed by the appellant and it was not supposed,much less entitled in law, to levy guarantee commission. Hecontends that for a period of about two decades, ever since the appellant came into existence, no such commission was paid andonly from the year 1985, almost an inducement was made for makingof payments and claiming deductions with the objective of evadingincome tax. He submits that the Tribunal recorded a finding of fact to the effectthat the deductions were not bona fide in nature and the fact that theamount so deducted is constituted into a separate fund, does notmake any difference. Learned Senior Counsel relied upon thejudgments of the Delhi High Court in Siddho Mal & Sons v. Income Tax Officer, New Delhi[[1]]and Bombay High Court in VoltasLimited v. Commissioner of Income Tax[[2]]. The subject-matter of the judgment in Siddho Mal’s case (1 supra) is not any deduction referable to SFC Act. A generalobservation was made to the effect that any deduction sought underthat Act, must be examined from the point of view of ‘commercialexpediency’. Having said that, their Lordships proceeded to observethat it should be from the point of view of the assessee. On the factsof that case, it was found that there was no commercial expediency.In the instant case, the assessee is a statutory organisation and itwas also mentioned that the gaining of confidence of a borrower byproviding guarantee to the State Government, is certainly an act of‘commercial expediency’. Similarly, in Voltas Limited’s case (2 supra), the BombayHigh Court found that the deduction of a donation paid to a relieffund cannot be permitted under Section 37(1) of the Act. It is onlyunder Section 80G of the Act that a claim can be made and allowed,if permissible. In the case on hand, the expenditure is referable tobusiness, and not any donation to any relief fund. The judgmentshave no application to the facts of the present case. As observed at the threshold, the appellant is the creatureunder the SFC Act. It is brought into existence with an objective ofmaking available finances to the entrepreneurs within the State andthereby, to encourage industrial development. Chapter II of the SFC Actprescribes the manner in which the appellant can pool its resourcesor capital. The principal contributors to the capital are the StateGovernment, the Reserve Bank of India (RBI) and the DevelopmentBank (DB). In addition to that, it can also borrow loans fromScheduled Banks, Insurance Companies etc., as provided for underSection 4 of the SFC Act. The Parliament recognised that a State Financial Corporationmay need additional capital, to run its activity. Section 7 of the SFCAct is to the effect that the Corporation may, in consultation with theDevelopment Bank and Reserve Bank, issue the bonds anddebentures, carrying interest, for the purpose of increasing theworking capital. Guarantee for repayment thereof is required to befurnished by the State Government. The provision reads as under: “7. Additional capital of the Financial Corporationand its borrowing powers: (1) The Financial Corporation may, in consultationwith the Development Bank and the Reserve Bank, issue andsell bonds and debentures carrying interest for the purpose ofincreasing its working capital and such bonds and debenturesshall, if so required by the Financial Corporation, beguaranteed by the State Government as to the repayment ofthe principal and the payment of interest at such rate as theState Government may, on the recommendation of the Boardbased on the advice of the Reserve Bank fix. (remaining part of Section is not treated as relevant forthe purpose of this judgment)” The record is not clear as to, for how many years theappellant has borrowed amounts, to create additional capital or “7. Additional capital of the Financial Corporationand its borrowing powers: (1) The Financial Corporation may, in consultationwith the Development Bank and the Reserve Bank, issue andsell bonds and debentures carrying interest for the purpose ofincreasing its working capital and such bonds and debenturesshall, if so required by the Financial Corporation, beguaranteed by the State Government as to the repayment ofthe principal and the payment of interest at such rate as theState Government may, on the recommendation of the Boardbased on the advice of the Reserve Bank fix. (remaining part of Section is not treated as relevant forthe purpose of this judgment)” The record is not clear as to, for how many years theappellant has borrowed amounts, to create additional capital or whether the State Government had offered guarantee under Section7 of the SFC Act, and if so, the conditions therefor. It was only fromthe year 1995 onwards, that the deductions were made in the form ofthe “Guarantee Commission”, paid to the State Government for itsoffering guarantee for repayment of amounts referable to Section 7 ofthe SFC Act. For the assessment years 1990-91 and 1991-92, the ITO didnot allow the deduction. The reason therefor is that no amount in theform of Guarantee Commission, in fact, was paid in cash, orotherwise. This conclusion was arrived at, by making reference toG.O.Ms.No.180, dated 12.04.1989. The G.O. is to the effect that theamount received by the State Government towards guaranteecommission is made part of the Fund. The purpose for which thefund was created is to ensure that the dividends are paid to theshareholders in any year, during which, profits are not earned. TheTribunal, in a way, has reversed the observation, if not, the finding of the ITO, as well as of the Commissioner, on thisaspect. It accepted the contention of the appellant that the amountrepresenting ‘Guarantee Commission’ has been paid, though,through the process of ‘Accounting Treatment’. However, itdisallowed the deduction by taking the view that the Commissionought not to have been paid at all, to the State Government,irrespective of the form. From the observations made by the Tribunal as well as thearguments advanced by the learned Senior Counsel for theDepartment, the principal objection appears to be that Section 7 ofthe SFC Act, does not by itself, provide for payment of GuaranteeCommission. In this regard, it needs to be observed that the section does providefor the furnishing of guarantee by the State Government for repayment of the loans borrowed towards additional capital. On thequestion as to whether the State Government was to offer thesecurity or guarantee, free of any cost, the provision is no doubtsilent. At the same time, there is no prohibition against such levy. If one takes into account, the activities undertaken by theappellant, it is too difficult to infer or conclude that they are part of thesovereign acts, pure and simple. There is visible presence ofelements of commerce and business, in them. The StateGovernment is one of the sources for providing the funds to theappellant. Even on that amount, the State Government is entitled toreceive dividends on par with the other financial agencies, such asRBI, and DB. Therefore, an element of commerce is very muchpresent in the activities that are referable to the SFC Act itself. Viewed in this context, the levy or payment of guarantee commissionto the State Government cannot be said to be something foreign, orunrelated to the activities contemplated under the SFC Act. If one takes into account, the activities undertaken by theappellant, it is too difficult to infer or conclude that they are part of thesovereign acts, pure and simple. There is visible presence ofelements of commerce and business, in them. The StateGovernment is one of the sources for providing the funds to theappellant. Even on that amount, the State Government is entitled toreceive dividends on par with the other financial agencies, such asRBI, and DB. Therefore, an element of commerce is very muchpresent in the activities that are referable to the SFC Act itself. Viewed in this context, the levy or payment of guarantee commissionto the State Government cannot be said to be something foreign, orunrelated to the activities contemplated under the SFC Act. The gaining of the confidence of a lender, is an importantstep, to be taken by a borrower, notwithstanding the fact that theborrower is a statutory undertaking and the lenders. The appellantlends the amount from out of its capital, to the entrepreneurs orcompanies, for establishment of industries. There is always anelement of uncertainty as to the repayments, as per schedule. Instances are galore, wherein quite large number of borrowers of theappellant have become non-performing assets. The impact thereofwould certainly be felt, in the context of repayment of the loansborrowed by the appellant from other agencies, be it in the form ofdividends or bonds or otherwise. It is in this context, that a reliableguarantee is warranted. By offering itself as guarantor for repayment of the amountscovered by the bonds and dividends raised by the appellant, the State Government would be certainly exposed to the liability. Almostin the form of an insurance premium, the State Government haslevied the guarantee commission, to cover the risk. The transactionis in the form of an agreement between the State Government, on theone hand, and the appellant, on the other. The Tribunal, however,took the view that Section 7 of the SFC Act, does not provide forsuch payments. It is too well-known that a principal legislation would provideonly for the broad features on the subject-matter of the Legislationand all details are required to be supplemented through thesubordination legislation or even the executive instructions orarrangement between the stakeholders. As long as such steps arenot found to be contrary to the provisions of the SFC Act, they cannotbe treated as impermissible in law. If one takes into account, theentire structure of the SFC Act, the provision for the payment ofguarantee commission, does not appear to be extraordinary. Forexample, Section 35A of the Act provides for constitution of aSpecial Reserve Fund with the contributions to be made by the StateGovernment, RBI and DB, from out of the dividends paid to them bythe appellant at an agreed proportion. The fund so created would beutilised, to meet the unforeseen contingencies. In the samemanner, a fund was created under the G.O., with the guaranteecommission, received by the State Government. In a way, the fundcreated under the G.O., stands on a higher footing, and sub-serves agreater purpose, since the entire guarantee commission and not partof it, as contemplated under Section 35A, is diverted to this. Theobjective is to make it available for payment of dividends, if in agiven financial year, the Corporation did not post any profits. From a reading of the order under appeal, we find that theTribunal was guided more, by the manner in which the Guarantee Commission came to be paid. To be precise, it gained animpression that the then Managing Director of the appellant had, in away, volunteered to pay the commission with a view to avoidpayment of income tax. This can be blushed aside, if one takes intoaccount, the fact that the amount was brought into the fund through aG.O., to be kept at the exclusive disposal of Corporation for paymentof dividends, whenever profits are not posted, a different impressionbecomes possible. From a reading of the order under appeal, we find that theTribunal was guided more, by the manner in which the Guarantee Commission came to be paid. To be precise, it gained animpression that the then Managing Director of the appellant had, in away, volunteered to pay the commission with a view to avoidpayment of income tax. This can be blushed aside, if one takes intoaccount, the fact that the amount was brought into the fund through aG.O., to be kept at the exclusive disposal of Corporation for paymentof dividends, whenever profits are not posted, a different impressionbecomes possible. We, therefore, allow the appeal and set aside the order of theIncome Tax Officer, disallowing the ‘Guarantee Commission’ paid tothe State Government as ‘allowable deduction’, as well as the orderspassed by the appellate authority and Tribunal. We hold that suchamount is deductable under Section 37 of the Act. There shall be noorder as to costs. The miscellaneous petition filed in this writ appeal shall alsostand disposed of. ____________________ L. NARASIMHA REDDY, J. _____________________ CHALLA KODANDA RAM, J. Date:22.07.2014 Note: L.R. copy to be marked. (B/o) GJ