Tulzapurkar, Actg. C.J.
1. The question that has been referred to us by the Tribunal in this reference under s. 256(1) of the I. T. Act, 1961, runs thus :
'Whether, on the facts and in the circumstances of the case, the amount of Rs. 1,86,000 outstanding in the account of Palanpur Co. could be allowed as a deduction in determining the assessee's business profits for the assessment year 1963-6 ?'
2. The question relates to the assessment year 1963-64, the corresponding previous year being the year which ended on March 31, 1963. The assessee-company was incorporated in 1941 for carrying out the objects mentioned in its memorandum of association. In particular, from its very inception, it started carrying on business as managing agents and became the managing agents of two companies, viz., (1) Investa Machine Tools and Engineering Co. Ltd. (hereinafter referred to as 'Tools Co. ') in 1942 and (2) Palanpur Vegetable Products Ltd. (hereinafter referred to as 'Palanpur Co. ') in the year 1946. From 1945, it started financing the Tools Co. and from 1949 it started financing Palanpur Co. As on March 31, 1963, the loan financed to Tools Co. stood at Rs. 1,50,000 and the interest that had been charged on this loan account had been offered for taxation as part of the company's income and that was accordingly being taxed as business income by the income-tax authorities. As regard Palanpur Co., the loan to that company from the assessee as on March 31, 1951, amounted to Rs. 1,86,000. It appears that during the accounting periods 1949-50 to 1950-51, interest of Rs. 5,291 and Rs. 8,211 was charged to this loan account and the same was offered for taxation as part of the assessee-company's business income and was charged to tax as such. During the subsequent accounting years also whatever interest was received or charged to Palanpur Co. was brought to tax as business income of the assessee-company. It appears that the financial position of Palanpur Co. deteriorated some time in 1953 and actually its factory was closed down from June, 1953. Interest on this loan account was, therefore, forgone by the assessee-company during the years 1952-53 and 1953-54. It further appears that even the recovery of the principal amount itself became doubtful, with the result in the balance-sheet as on 31st March, 1953, the loan was shown as doubtful. In view of this situation no interest was charged during the subsequent accounting years 1954-55 to 1956-57 (both inclusive). During 1957-58, it was agreed between the parties, viz., the respondent-company and Palanpur Co., to treat this loan as interest-free loan until such time as the Palanpur Co. was in a position to pay. Attempts were made to restart the Palanpur Co.'s business by change in the management and those attempts fructified when the managing agency of Palanpur Co. was taken over by Forbes Campbell & Co. Ltd., in October, 1959, and the business was restarted in February, 1960, by the new managing agents. In the beginning the results were encouraging and in respect of the accounts of the year 1960, the directors in their report to the shareholders expressed the hope that the company would be able to earn some profit. But despite all efforts the financial position of Palanpur Co. deteriorated and it was taken into creditors' voluntary winding up on 12th March, 1963. It thus became clear to the assessee-company that Palanpur Co. was not going to revitalize its business and the assessee-company's shareholding therein as also its loan were items of dead loss. Accordingly, the assessee-company wrote off in its account books during the year ended 31st March, 1963, the amount of Rs. 1,86,000 which was outstanding as a bad debt or irrecoverable loan or business loan. On August 7, 1963, the assessee-company received a letter from the liquidator of Palanpur Co. stating that the unsecured creditors would get nothing.
3. On the aforesaid facts the assessee-company claimed a deduction of Rs. 1,86,000 in determining its total profit for the assessment year 1963-64. This claim was rejected by the ITO who took the view that the facts of the case before him were similar to the facts in the case decided by the Madras High Court in the case of CIT v. Essen Private Ltd. : [1963]50ITR569(Mad) and following the Madras decision he came to the conclusion that the amount in question was clearly a capital loss and could not be allowed either as a bad debt or trade loss. The matter was carried by the assessee-company to the AAC challenging this disallowance of this item. The AAC held that the financing was not incidental to the carrying on of the assessee's business as managing agents and the character of the loan got changed with the assumption of the office of the managing agency by another company-Forbes Campbell & Co. Ltd. -and as such the item could not be allowed as a trade loss. As regards the claim made on the basis of the item being deductible as bad debt under s. 36(2), he took the view that the assessee had declared that debt as doubtful from 31st March, 1963, onwards and since then no attempts were made for recovery of the said amount. In this view of the matter he confirmed the ITO's order. When the matter was carried further in second appeal to the Tribunal it was contended on its behalf that granting of loans or providing financial assistance to the managed company was incidental to the business of the assessee, that in fact the assessee had granted loans to companies under its management and that the loss sustained was incidental to the assessee's business and, therefore, the same was deductible while computing the business income of the assessee under s. 28 of the Act. On behalf of the department, the orders passed by the taxing authorities were sought to be supported. It was contended that the amount was neither a bad debt nor a trading loss inasmuch as there was no obligation on the part of the assessee-company to finance or grant loan to the managed company and that the loan not being in the course of business, the item could not be allowed as a deduction. It was also pointed out that since no security for such a large advance had been taken by the assessee-company from the managed company the loan could not be regarded as a loan advanced in the course of business. The Tribunal negatived the contentions that were urged on behalf of the department and allowed the loss under s. 28(1) of the Act. It came to the conclusion that the advances made by the assessee-company to Palanpur Co. were part of or incidental to the carrying on of the assessee's business as managing agents, that termination of the managing agency of Palanpur Co. and taking over of the same by another concern did not bring about a change in the real character of the loan which since its inception was a loan incidental to carrying on of the business and that the writing off of the loan by the assessee-company was neither premature nor belated. At the instance of the CIT, Bombay City-I, Bombay, the question set out above at the commencement of the judgment has been referred to us for our determination.
4. At the outset it may be stated that Mr. Mehta for the assessee did not press the contention that the item should be allowed as a deduction as being a bad debt under s. 36(2) of the Act and the only question that was debated at the Bar was whether the said item could be regarded as an allowable deduction as a trading loss while computing the business income of the assessee-company for the relevant assessment year under s. 28 of the Act. Mr. Joshi appearing for the revenue urged before us that if due regard be had to the memorandum of association of the assessee-company it would be clear that there was no obligation on the part of the assessee-company to make any advance or to make any finances to the managed-company and in the absence of any such obligation being there, the advances made could not be regarded as advances or finances incidental to the carrying on of the assessee's business. He also urged that the loan also could not be regarded as a loan having been made in the course of business, inasmuch as there was no security obtained by the assessee-company from the managed-company for such large advances. He also pressed into service the aspect that the loan could be said to have changed its character from October, 1959, when there was a change in the managing agency of Palanpur Co. He, therefore, urged that the item in respect of which a claim of deduction was made could not be regarded as a loss incidental to the carrying on of the business by the assessee-company. It is not possible to accept any of these submissions of Mr. Joshi for the reasons which we shall presently indicate.
5. It is true that in the memorandum of association or articles of association of the assessee-company there is no obligation cast upon the assessee-company to finance the managed-company nor was there any such obligation to be found in the agreement dated December 7, 1946. But it was not disputed before us by Mr. Joshi that it was the usual practice obtaining in the country for the managing agents to make advances or finances to the managed companies. It could very well be said that it was by way of following this general practice of the managing agents in this part of the country that the assessee-company could be said to have made these advances to Palanpur Co. It may be stated that instances of such general practice to make such advances had been judicially noticed by Sir John Beaumont C.J. in the case of CIT v. Tata Sons Ltd. : [1939]7ITR195(Bom) . At page 202 of the report, this is what the Chief Justice has observed :
'...... the ordinary practice in this country is for the managing agents to finance the company of which they are such agents. I do not mean to suggest that the assessee were bound in law to procure finance for the Tata Iron and Steel Co. Ltd. but for practical purposes the finance would have to be provided by them, if it was to be procured at all.'
6. It is, therefore, clear that having regard to the conduct of the assessee in commencing to make its finances from January, 1948, to Palanpur Co. and having regard to the general practice which has been noticed by this court in Tata Sons case : [1939]7ITR195(Bom) , it would be difficult to accept the contention of Mr. Joshi that the finances that were made available by the assessee-company to Palanpur Co. were not part of or were not incidental to the carrying on of the business by the assessee-company as managing agents. It cannot be disputed that the relationship between the assessee-company and the managed-company was of a commercial nature which involves granting of loans or finances to the managed-company. However, the Tribunal has recorded a finding of fact that the finances made by the assessee-company to Palanpur Co. were part of or incidental to the carrying on of the business by the assessee-company as managing agents and we have to approach this question referred to us on the basis of the aforesaid finding of fact that has been recorded by the Tribunal. Reference to the decision of the Madras High Court by the taxing authorities will have to be regarded as misplaced, for, Mr. Joshi fairly stated before us that when Essen Private Ltd.'s case : [1963]50ITR569(Mad) was carried to the Supreme Court, the Supreme Court had reversed the decision of the Madras High Court and the decision of the Supreme Court has been reported in : [1967]65ITR625(SC) Essen P. Ltd. v. CIT. It is true that no security of any kind was obtained by the assessee-company while making its finances to the managed-company, but we do not think that the absence of such security would make any difference to the assessee's claim. After all it was by way of commercial relationship that subsisted between the assessee-company on the one hand and the managed-company on the other that the advances were made by the assessee-company to Palanpur Co. Moreover, there is nothing to prevent a financier to make unsecured advances. The last fact on which reliance was placed by Mr. Joshi was that in or about October, 1959, there was a change in the managing agency of Palanpur Co. and the managing agency was taken over by M/s. Forbes Campbell & Co. Ltd. Relying upon this fact it was urged by Mr. Joshi that this factor would alter the character of loans or advances that were made by the assessee-company to the managed-company. It is not possible to accept this submission of Mr. Joshi, for, if once the advances are seen to have originated in carrying on the business of the assessee, then, the dissociation of the assessee from the managed-company by the termination of the managing agency agreement will not convert the loan into any advances of any different kind. Advances having been made as a part of or incidental to the carrying on of the business by the assessee-company as managing agents, that character continued to obtain notwithstanding the change in the management of Palanpur Co. If that be so, if as a result of the managed-company having gone into liquidation, the advances became irrecoverable, the loss will have to be regarded as a trading loss and the same will have to be allowed as a deduction while computing the income of the assessee-company.
7. Having regard to the above discussion, in our view, the Tribunal was right incoming to the conclusion that the amount of Rs. 1,86,000 outstanding in the account of Palanpur Co. could be allowed in determining the assessee's business profit for the relevant assessment year. In this view of the matter, the question referred to us is answered in the affirmative and in favour of the assessee-company.
8. Revenue will pay the costs of the reference to the assessee.