Whether when assessee, a manufacturer of beer, advances loan to sister concern for setting up new line of business, such assistance can be characterised as expenditure incurred exclusively for business - NO: HC

THE issue before the Bench is - Whether when assessee being a manufacturer of beer and liquor, advances loan to sister concern for setting up a new line of business, such assistance can be characterised as expenditure incurred wholly and exclusively for business of assessee. And the verdict goes against the assessee.

Facts of the case

The assessee is a public limited company carrying on the business of manufacture and sale of beer and liquor. The case of the asessee is that it established a subsidiary company M/s.U.B.Resorts Ltd. which was also incorporated as a company and registered with the Registrar

of Companies, with a view to extend the business of the assessee company. In 2001, they informed the Registrar of Companies to strike off the name of M/s.U.B.Resorts Ltd. under Section 560 of the Companies Act, 1956 for the reasons that the subsidiary Company could not do any business or commercial activity as laid down in the memorandum of association and that the same had become defunct. M/s.U.B.Resorts Ltd. was a wholly owned subsidiary of the assessee. Till the financial year 1997-98, all the expenditure incurred on the executives of the subsidiary company were absorbed by the assessee as the employees were on the rolls of the assessee company. It was only later that the expenditure incurred for the year 1999-2000 and 2000-01 were debited to M/s.U.B.Resorts Ltd. Since no business was carried on by M/s.U.B.Resorts Ltd., the amounts owed by M/s.U.B.Resorts Ltd. were written off during the year ended 31.3.2001 by the assessee. The main purpose of the said subsidiary was to put up resorts at important tourist destinations and since the date of incorporation, expenses like employee cost and other establishment costs were being incurred regularly. The said company was referred to as a division of the M/s.United Breweries Ltd., the assessee for all practical purposes. The said division was consisting of specialized staff having requisite experience in running / operating well reputed hotels and other resorts in the country. During the financial year ending on 31.3.2001, the assessee made a claim of bad debts written off, including the amount which was given as a loan to the subsidiary company.

The Assessing Officer held that there is no entity by name M/s.U.B.Resorts Ltd. that is in existence. While filing the returns of income, the assessee did claim the expenditure under the head 'bad debts' / 'advances written off' with a specific indication that the claim is under the head 36(1)(vii) of the Act. During enquiry, as the assessee was unable to substantiate the said claim and since such expenditure does not relate to any of the existing activities of the company, it was not allowable. The said claim was given up and withdrew the said claim under Section 36(1)(vii) and an alternative claim under Section 37 was put forth contending that it is an expenditure expend wholly and exclusively for the purpose of the business. The Assessing Authority was of the view that the said expenditure was not incurred by the assessee wholly and exclusively for the purpose of the business and therefore, he disallowed the claim.

The Commissioner of Income Tax (Appeals) held that that the impugned expenditure related to the setting up of an altogether new business pertaining to tourism like putting up resorts, etc. It is separate and distinct from the existing business of manufacture and sale of liquor and beer. The impugned expenditure cannot be considered as a business loss. The impugned expenditure cannot be allowed as a revenue expenditure. It cannot be treated as a business loss since loss, if any, will be a loss on capital account and therefore, the order passed by the Assessing Authority was upheld and the appeal came to be dismissed.

Tribunal was of the view that the impugned amount was spent towards the project cost. The subsidiary company has not done any business right from the date of incorporation and is also not intending to do any business or commercial activity and had become defunct. Request to strike off the name of U.B. Resorts Limited was accepted by the Assistant Registrar of Companies. Therefore, both the companies are separate legal entities and the loss incurred by the subsidiary company in abandoning the new project cannot be allowed in the hands of the assessee company. Therefore, the Tribunal confirmed the order passed by the Appellate Authority as well as the Assessing Officer.

Assessee contended that the impugned expenditure was incurred by the assessee for the business of the subsidiary. It was contended that there was a direct nexus between the business of the assessee and the business of the subsidiary company. The business of the subsidiary if it had been carried on would have helped and expanded the business of the assessee. Therefore, any expenditure laid out or expanded fully or exclusively in the business of subsidiary had to be allowed in computing the income chargeable under the profits and gains of business or profession of the assessee.

Revenue contended that the expenditure which was incurred for expansion of business had no nexus with the business carried on by the assessee. It could not allow deductions in the hands of the assessee. It was contended that the subsidiary company was established in the year 1994 and closed in the year 2001-02 and the expenditure incurred by the subsidiary company were bunched under the head "U.B. Resorts Division" and a claim was putforth which was only an afterthought and not permissible in law.

Having heard the parties, the Court held that,

++ the Apex Court in the case of Travancore Titanium Product Limited vs. Commissioner of Income Tax held as under:-

"6. But every item of expenditure merely because it is connected with the trade may not necessarily be treated as a permissible deduction. A fairly reliable approach for determining what may be regarded normally as expenditure laid out or expended wholly and exclusively for the purpose of the business has to be looked into.

The nature of the expenditure or outgoing must be adjudged in the light of accepted commercial practice and trading principles. The expenditure must be incidental to the business and must be necessitated or justified by commercial expediency. It must be directly and intimately connected with the business and be laid out by the tax payer in his character as a trader. To be a permissible deduction, there must be a direct and intimate connection between the expenditure and the business i.e. between the expenditure and the character of the assessee as a trader, and not as owner of assets, even if they are assets of the business."

++ Apex Court in the case of Commissioner of Income Tax vs. Malayalam Plantations Limited (1964) 53 ITR 140(SC) explaining the meaning of the word "for the purpose of business" has held as under:-

"The expression "for the purpose of 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 commerce 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 person carrying on the business."

++ Apex Court in the case of S.A. BUILDERS LIMITED VS. COMMISSIONER OF INCOME TAX(APPEALS) AND ANOTHER - (2006-TIOL-179-SC-IT) explaining the meaning of the word "commercial expediency" used in Section 37 of the Act has held as under:-

"20. In our opinion, the decisions relating to Section 37 of the Act will also be applicable to S.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.

21. Thus, in Atherton vs. British Insulated & Helsby Cables Limited (1925) 10 Tax Cases 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 facilitate the carrying on the business. The above test in Atherton’s case has been approved by this Court in several decisions e.g. Eastern Investments Limited .vs. CIT 2002-TIOL-519-SC-IT-LB, CIT vs. Chandulal Keshavlal & company (1960) 38 ITR 601 (SC), etc.

22. In our opinion, the High Court as well as the Tribunal and other IT 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.

23. The expression "commercial expediency" is an expression of wide import and includes such expenditure as a prudent businessman 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".

++ further it was observed that:-

"What is relevant is whether the assessee advanced such amount to its sister concern as a measure of commercial expediency. Once it is established that there was nexus between the expenditure and the purpose of the business (which need not be necessarily be the business of the assessee itself), the Revenue cannot justifiably claim to put itself in the armchair 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 IT 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 viewpoint but that of a prudent businessman."

++ then they have cautioned the Courts from being carried away by and has observed as under:-

"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. 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".

++ therefore, what the sister concern did with this money has to be found out in order to find out whether it was for commercial expediency or not. In the background of the aforesaid judgments, when we look at the facts of this case, the assessee was incorporated in the year 1951. Subsequently, from time to time there is alteration of objects. It was pointed out that though the assessee is primarily in the business of breweries, in their Memorandum of Association at Clause(13) one of the object of the company was as under:-

"To carry on the business of real estate and development in all its branches, to any lands, buildings, purchase and take on lease and otherwise, acquire any lands, buildings and structure or interest of rights therein and to develop such lands into buildings, sites and/or construct and let out, sell plots of lands and buildings and structures. To construct, let out, furnish and carry on all or any of the functions or properties of flats, maisonettes dwelling houses, shops, offices, clubs, tourists houses, hotels, theatres and restaurants. To act as agents, General Agents, Land Owners, Estate Owners, Property Agents and Agencies of any other types."

++ therefore, when the assessee is in the business of manufacture and sale of beer and liquor, if they have lent money to a sister concern, may be a subsidiary, for the purpose of setting up a new line of business, it cannot be said that the money lent by them to the subsidiary company as an assistance could be characterized as an expenditure laid down and expanded wholly and exclusively for the purpose of business of the assessee. In fact, the material on record discloses that the subsidiary company was in existence from 1994 to 2001. The entire money is lent and spent only towards payment of salary and travelling expenses over a period of four to five years and no deductions were claimed in each year when such payments were made. On the contrary, for the first time the claim was putforth as bad debts. After writing off the same when they could not substantiate the said claim, then as an alternative, a claim was putforth under Section 37 of the Act. Though mere mentioning of a wrong provision would not deprive the assessee of the benefit of deductions or exemptions, in trying to find out the real nature of transaction, intention of the parties at an undisputed point of time, clearly go to show that this expenditure was not incurred wholly and exclusively for the purpose of business of the assessee. The said claim is only made after the claim was not accepted under Section 36(1)(vii) of the Act. If the argument of the assessee is to be accepted, whenever a holding company lends money to a subsidiary company, then the holding company would be entitled to the said benefit. That is not the intent of law. Though there is no prohibition in law for starting subsidiary company, to get the benefit of Section 37, the money lent should be laid out and expended only for the purpose of business of the assessee. There should be a direct nexus between the assessee and the business for which the money is lent. If that connection is not there, merely because the money was lent to a sister concern or to a subsidiary company would not enable the assessee to claim such deduction. The Assessing Officer and the appellate authorities on careful consideration of the material on record have recorded the finding of fact. In the circumstances, we do not see any justification to interfere with the said concurrent finding of fact recorded.

++ the substantial questions of law framed in this appeal is answered in favour of the revenue and against the assessee. There is no merit in this appeal.