Andhra Pradesh State Financial Corporation V. The Deputy Commissioner of Income Tax (Assessments) Special Range-I Aayakar Bhavan, Basheerbagh Hyderabad

ITTA/9/2002

AI Insights

The case involves the Andhra Pradesh State Financial Corporation (appellant) appealing against the decision of the Income Tax Appellate Tribunal, which upheld the disallowance of a deduction claimed for 'Guarantee Commission' paid to the State Government. This commission was related to guarantees provided by the State Government for loans under Section 7 of the State Financial Corporations Act, 1951. The Tribunal had accepted that the deduction was made but disallowed it on the grounds that the payment was not warranted under the SFC Act. The High Court, however, found that the payment of the commission was a legitimate business expense and thus deductible under Section 37 of the Income Tax Act.

• Counselvise Citation: [2014] 140 COUNSELVISE.COM (IT) 805076 (HC-ANDHRA_PRADESH)
• Appeal Type: Others
• Pronouncement Date: 22-07-2014
• Assessment Year: misc
• Other Referred Cases: Siddho Mal & Sons v. Income Tax Officer, New Delhi, Voltas Limited v. Commissioner of Income Tax
• Laws Referred To: Income Tax Act, 1961, State Financial Corporations Act, 1951
• Result in Favour of: Revenue
• Court: HIGH COURT
• Department Lawyers: S R ASHOK
• Assessee Lawyers: KARTHIK RAMANA
• Keywords: Guarantee commission; Income tax appellate tribunal; Income tax deduction; State Financial Corporation
• Section: 37; 7; 260-A

Judgement Text

"* 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 03.10.2001 passed by the Hyderabad Bench ‘B’ of the Income Tax Appellate Tribunal (for short ‘the Tribunal’). The appellant is created under the State Financial Corporations Act, 1951 (for short ‘the SFC Act’), for the State of Andhra. It is also an assessee under the Act and was filing returns year after year. For the assessment years 1990-91 and 1991-92, apart from other amounts, it claimed deduction of what is known as “Guarantee Commission” paid to the State Government towards its obligation for providing guarantees to the lenders under Section 7 of the SFC Act. The State Government, in turn, issued a G.O., on a request made by the appellant herein, to constitute a fund with the amount representing “Guarantee Commission” under the head “Dividend Subvention Fund Account” (for short ‘the Fund’), so that it can be utilised for payment of dividends in the years in which the appellant did not earn any profits. The Income Tax Officer (ITO) did not treat it as 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 filed I.T.A.Nos.1978/Hyd/92 and 1245/Hyd/95 before the Tribunal. The Income Tax Officer and the Commissioner took the view that there was no actual payment or deduction at all and it was almost an illusory accounting treatment. The Tribunal held that the amount representing “Guarantee Commission” can be said to have been paid to the State Government, notwithstanding the fact that it is ‘Accounting Treatment’. However, it took the view that the payment was 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 squarely referable to Section 7 of the SFC Act and though the Tribunal accepted that the deduction was, in fact, made, went beyond the scope of verification under the SFC Act, and disallowed it. He contends that the reference to the correspondence that ensued between the Managing Director of the appellant, on the one hand, and the State Government, on the other hand, was outside the scope of enquiry and the element of propriety than legality, was examined in detail. Learned counsel submits that as long as the deduction is provided for in law, it is immaterial as to at whose instance and in what manner such deduction was made. Sri S.R.Ashok, learned Senior Counsel for the Income Tax Department, on the other hand, submits that the State Government is under obligation to provide guarantee under Section 7 of the SFC Act for the loans borrowed by the appellant and it was not supposed, much less entitled in law, to levy guarantee commission. He contends that for a period of about two decades, ever since the appellant came into existence, no such commission was paid and only from the year 1985, almost an inducement was made for making of payments and claiming deductions with the objective of evading income tax. He submits that the Tribunal recorded a finding of fact to the effect that the deductions were not bona fide in nature and the fact that the amount so deducted is constituted into a separate fund, does not make any difference. Learned Senior Counsel relied upon the judgments of the Delhi High Court in Siddho Mal & Sons v. Income Tax Officer, New Delhi[1] and Bombay High Court in Voltas Limited 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 general observation was made to the effect that any deduction sought under that Act, must be examined from the point of view of ‘commercial expediency’. Having said that, their Lordships proceeded to observe that it should be from the point of view of the assessee. On the facts of that case, it was found that there was no commercial expediency. In the instant case, the assessee is a statutory organisation and it was also mentioned that the gaining of confidence of a borrower by providing guarantee to the State Government, is certainly an act of ‘commercial expediency’. Similarly, in Voltas Limited’s case (2 supra), the Bombay High Court found that the deduction of a donation paid to a relief fund cannot be permitted under Section 37(1) of the Act. It is only under Section 80G of the Act that a claim can be made and allowed, if permissible. In the case on hand, the expenditure is referable to business, and not any donation to any relief fund. The judgments have no application to the facts of the present case. As observed at the threshold, the appellant is the creature under the SFC Act. It is brought into existence with an objective of making available finances to the entrepreneurs within the State and thereby, to encourage industrial development. Chapter II of the SFC Act prescribes the manner in which the appellant can pool its resources or capital. The principal contributors to the capital are the State Government, the Reserve Bank of India (RBI) and the Development Bank (DB). In addition to that, it can also borrow loans from Scheduled Banks, Insurance Companies etc., as provided for under Section 4 of the SFC Act. The Parliament recognised that a State Financial Corporation may need additional capital, to run its activity. Section 7 of the SFC Act is to the effect that the Corporation may, in consultation with the Development Bank and Reserve Bank, issue the bonds and debentures, carrying interest, for the purpose of increasing the working capital. Guarantee for repayment thereof is required to be furnished by the State Government. The provision reads as under: “7. Additional capital of the Financial Corporation and its borrowing powers: (1) The Financial Corporation may, in consultation with the Development Bank and the Reserve Bank, issue and sell bonds and debentures carrying interest for the purpose of increasing its working capital and such bonds and debentures shall, if so required by the Financial Corporation, be guaranteed by the State Government as to the repayment of the principal and the payment of interest at such rate as the State Government may, on the recommendation of the Board based on the advice of the Reserve Bank fix. (remaining part of Section is not treated as relevant for the purpose of this judgment)” The record is not clear as to, for how many years the appellant has borrowed amounts, to create additional capital or whether the State Government had offered guarantee under Section 7 of the SFC Act, and if so, the conditions therefor. It was only from the year 1995 onwards, that the deductions were made in the form of the “Guarantee Commission”, paid to the State Government for its offering guarantee for repayment of amounts referable to Section 7 of the SFC Act. For the assessment years 1990-91 and 1991-92, the ITO did not allow the deduction. The reason therefor is that no amount in the form of Guarantee Commission, in fact, was paid in cash, or otherwise. This conclusion was arrived at, by making reference to G.O.Ms.No.180, dated 12.04.1989. The G.O. is to the effect that the amount received by the State Government towards guarantee commission is made part of the Fund. The purpose for which the fund was created is to ensure that the dividends are paid to the shareholders in any year, during which, profits are not earned. The Tribunal, in a way, has reversed the observation, if not, the finding of the ITO, as well as of the Commissioner, on this aspect. It accepted the contention of the appellant that the amount representing ‘Guarantee Commission’ has been paid, though, through the process of ‘Accounting Treatment’. However, it disallowed the deduction by taking the view that the Commission ought 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 the arguments advanced by the learned Senior Counsel for the Department, the principal objection appears to be that Section 7 of the SFC Act, does not by itself, provide for payment of Guarantee Commission. In this regard, it needs to be observed that the section does provide for the furnishing of guarantee by the State Government for repayment of the loans borrowed towards additional capital. On the question as to whether the State Government was to offer the security or guarantee, free of any cost, the provision is no doubt silent. At the same time, there is no prohibition against such levy. If one takes into account, the activities undertaken by the appellant, it is too difficult to infer or conclude that they are part of the sovereign acts, pure and simple. There is visible presence of elements of commerce and business, in them. The State Government is one of the sources for providing the funds to the appellant. Even on that amount, the State Government is entitled to receive dividends on par with the other financial agencies, such as RBI, and DB. Therefore, an element of commerce is very much present in the activities that are referable to the SFC Act itself. Viewed in this context, the levy or payment of guarantee commission to the State Government cannot be said to be something foreign, or unrelated to the activities contemplated under the SFC Act. The gaining of the confidence of a lender, is an important step, to be taken by a borrower, notwithstanding the fact that the borrower is a statutory undertaking and the lenders. The appellant lends the amount from out of its capital, to the entrepreneurs or companies, for establishment of industries. There is always an element of uncertainty as to the repayments, as per schedule. Instances are galore, wherein quite large number of borrowers of the appellant have become non-performing assets. The impact thereof would certainly be felt, in the context of repayment of the loans borrowed by the appellant from other agencies, be it in the form of dividends or bonds or otherwise. It is in this context, that a reliable guarantee is warranted. By offering itself as guarantor for repayment of the amounts covered by the bonds and dividends raised by the appellant, the State Government would be certainly exposed to the liability. Almost in the form of an insurance premium, the State Government has levied the guarantee commission, to cover the risk. The transaction is in the form of an agreement between the State Government, on the one hand, and the appellant, on the other. The Tribunal, however, took the view that Section 7 of the SFC Act, does not provide for such payments. It is too well-known that a principal legislation would provide only for the broad features on the subject-matter of the Legislation and all details are required to be supplemented through the subordination legislation or even the executive instructions or arrangement between the stakeholders. As long as such steps are not found to be contrary to the provisions of the SFC Act, they cannot be treated as impermissible in law. If one takes into account, the entire structure of the SFC Act, the provision for the payment of guarantee commission, does not appear to be extraordinary. For example, Section 35A of the Act provides for constitution of a Special Reserve Fund with the contributions to be made by the State Government, RBI and DB, from out of the dividends paid to them by the appellant at an agreed proportion. The fund so created would be utilised, to meet the unforeseen contingencies. In the same manner, a fund was created under the G.O., with the guarantee commission, received by the State Government. In a way, the fund created under the G.O., stands on a higher footing, and sub-serves a greater purpose, since the entire guarantee commission and not part of it, as contemplated under Section 35A, is diverted to this. The objective is to make it available for payment of dividends, if in a given financial year, the Corporation did not post any profits. From a reading of the order under appeal, we find that the Tribunal was guided more, by the manner in which the Guarantee Commission came to be paid. To be precise, it gained an impression that the then Managing Director of the appellant had, in a way, volunteered to pay the commission with a view to avoid payment of income tax. This can be blushed aside, if one takes into account, the fact that the amount was brought into the fund through a G.O., to be kept at the exclusive disposal of Corporation for payment of dividends, whenever profits are not posted, a different impression becomes possible. We, therefore, allow the appeal and set aside the order of the Income Tax Officer, disallowing the ‘Guarantee Commission’ paid to the State Government as ‘allowable deduction’, as well as the orders passed by the appellate authority and Tribunal. We hold that such amount is deductable under Section 37 of the Act. There shall be no order as to costs. The miscellaneous petition filed in this writ appeal shall also stand disposed of. ____________________ L. NARASIMHA REDDY, J. _____________________ CHALLA KODANDA RAM, J. Date:22.07.2014 Note: L.R. copy to be marked. (B/o) GJ [1] 122 ITR 839 [2] 207 ITR 47 "