₹3.50 Crore Corporate Guarantee Liability Deductible on Crystallization: Gujarat HC

Gujarat Narmada Valley Fertilizers And Chemicals Limited Vs DCIT (Gujarat High Court)

Summary: The Gujarat High Court allowed the assessee’s appeal concerning deduction of a Rs.3.50 crore liability arising from a corporate guarantee given on behalf of its wholly owned subsidiary, Gujarat Narmada Auto Limited (GNAL), to Gujarat Mineral Development Corporation (GMDC). During Financial Year 1997-98, the assessee had debited a provision of Rs.3.50 crores payable to GMDC in its Profit & Loss Account. The Assessing Officer disallowed the deduction for Assessment Year 1998-99. The CIT(A) subsequently allowed the claim, holding that the loss had become ascertainable during the relevant year. The Tribunal reversed the CIT(A)’s decision, holding that the liability had not been shown to have crystallized during AY 1998-99 and restoring the Assessing Officer’s order.

Before the High Court, the assessee submitted that an amicable settlement had been reached at a meeting held on 03.03.1997, followed by a Board Resolution dated 21.03.1997 and subsequent correspondence concerning payment of Rs.3.50 crores to GMDC in full and final settlement of the guarantee liability. The assessee contended that the provision made in the accounts for the year ending 31.03.1998 was therefore allowable in AY 1998-99. The Revenue submitted that the Consent Terms were filed before the City Civil Court, Ahmedabad, only on 12.05.1999 and argued that the deduction could, at best, be considered for the year of payment.

The High Court noted that the settlement between the parties was not in dispute. It also noted that the first meeting took place on 03.03.1997, correspondence was exchanged between April and July 1997, and the parties had agreed to make the payment of Rs.3.50 crores in the previous year 1997-98 relevant to AY 1998-99. According to the Court, the subsequent filing of Consent Terms in 1999 implemented an arrangement that had already been decided during the relevant previous year.

The Court therefore held that the liability to pay Rs.3.50 crores had crystallized in the previous year 1997-98 and that the fact that the liability was ultimately discharged upon filing the Consent Terms in 1999 did not prevent its deduction for AY 1998-99. The substantial question of law was answered in favour of the assessee and against the Revenue, and the appeal was allowed without any order as to costs.

Background of the Guarantee Liability

During Financial Year 1997-98, the assessee, Gujarat Narmada Valley Fertilizers And Chemicals Limited, had debited a provision of Rs.3.50 crores payable on behalf of GNAL to GMDC to its Profit & Loss Account.

GNAL was the assessee’s wholly owned subsidiary and had availed a loan from GMDC for which the assessee stood as guarantor. GNAL suffered substantial losses, went to BIFR and was subsequently ordered to be wound up by the Gujarat High Court. An Official Liquidator was appointed to take over the assets and liabilities of GNAL.

GMDC invoked the guarantee and filed a civil suit against the assessee as guarantor for recovery of its dues along with interest.

Settlement Between the Parties

A joint meeting involving GMDC and the assessee was held on 03.03.1997 under the chairmanship of the Principal Secretary, Energy & Petrochemical Department, Government of Gujarat. The meeting was attended by the Additional Chief Secretary, Industries, the Managing Director of GMDC and the Managing Director of GNFC.

It was decided that the assessee would pay Rs.3.50 crores to GMDC towards full and final settlement of the dues and that the repayment would be made in instalments. It was also decided that the suit filed by GMDC would be withdrawn in view of the settlement.

The assessee submitted that the decision was subsequently ratified by the Boards of Directors of both companies. Correspondence was exchanged concerning the modalities of payment, and the assessee made a provision for Rs.3.50 crores in its accounts for the year ending 31.03.1998.

Assessment and First Appellate Decision

The Assessing Officer did not allow the deduction claimed for AY 1998-99. The matter had earlier been remanded by the Tribunal by order dated 30.09.2008 passed in ITA No. 1753/AHD/2001 for reconsideration of the assessee’s claim.

The CIT(A) allowed the assessee’s claim. The CIT(A) observed that the assessee had finally arrived at a settlement during the year under consideration and, considering the facts and the decision in CIT vs. Amalgamations Pvt. Ltd. (226 ITR 188), directed the Assessing Officer to allow the claim.

Tribunal’s Decision

The Revenue challenged the CIT(A)’s order before the Tribunal. The Tribunal considered the history of the dispute and noted that the assessee had agreed to pay Rs.3.50 crores in full and final settlement of GNAL’s liability to GMDC.

The Tribunal also recorded that the payments of Rs.50 lakhs each were made in May 1999, August 1999, November 1999, February 2000, May 2000, August 2000 and November 2000. It observed that these payments fell in Financial Years 1999-2000 and 2000-01.

The Tribunal held that even if the CIT(A)’s view that the loss had crystallized on 03.03.1997 were accepted, the crystallization would fall in AY 1997-98 and not AY 1998-99. It further held that no material had been brought on record to show that the liability of Rs.3.50 crores had crystallized during the year under consideration. The Tribunal accordingly set aside the CIT(A)’s order and restored the Assessing Officer’s order.

Submissions Before the Gujarat High Court

Assessee’s Submissions

The assessee submitted that an agreement had been reached between the Managing Directors of GMDC and the assessee, with the Additional Chief Secretary of the State of Gujarat, for an amicable settlement involving payment of Rs.3.50 crores.

It was submitted that the meeting took place on 03.03.1997, followed by a Board Resolution passed at the assessee’s 238th meeting on 21.03.1997. The assessee also referred to correspondence dated 12.04.1997, 23.06.1997, 25.06.1997 and 17.01.1997 concerning the modalities of payment.

The assessee further submitted that the Consent Terms were filed before the City Civil Court, Ahmedabad, in Civil Suit No. 4659 of 1994 on 12.05.1999. According to the assessee, the agreements had already been finalized and the liability had accordingly been provided for in the accounts for the year ending 31.03.1998.

The assessee also submitted that it had made an alternative claim that the amount should be allowed in any of AYs 1997-98, 1998-99 or 1999-2000, but the Tribunal restored the addition without directing the year in which the claim should be allowed.

Revenue’s Submissions

The Revenue submitted that the Tribunal had given cogent reasons for setting aside the CIT(A)’s order. It relied upon the fact that the Consent Terms were filed before the City Civil Court on 12.05.1999 and contended that, at best, the claim could be allowable for AY 2000-01.

The Revenue also relied upon the Tribunal’s earlier order dated 31.03.2000 in ITA Nos. 832 to 834/Ahd/1998 concerning AYs 1992-93 to 1994-95 and submitted that no interference with the Tribunal’s order was warranted.

Gujarat High Court’s Findings

Settlement Was Reached During the Relevant Period

The High Court found that the settlement between the parties was not in dispute. It noted that the meeting between the Additional Chief Secretary and the Managing Directors of the assessee and GMDC had taken place on 03.03.1997 and that the assessee had agreed to pay Rs.3.50 crores to GMDC in full and final settlement of the guarantee liability relating to GNAL.

The Court also noted that GMDC, GNAL and the assessee were government companies in which the State Government was the majority shareholder.

Liability Had Crystallized in FY 1997-98

The Court noted that correspondence had been exchanged between April and July 1997 and that the parties had agreed to make the payment of Rs.3.50 crores in the previous year 1997-98 relevant to AY 1998-99.

According to the Court, the filing of the Consent Terms before the City Civil Court, Ahmedabad, on 12.05.1999 implemented the payment arrangement that had already been decided during the relevant previous year.

The Court therefore held that the liability of Rs.3.50 crores had crystallized in the previous year 1997-98 and was ultimately discharged upon filing of the Consent Terms in 1999.

Final Decision

The Gujarat High Court held that the Tribunal was not right in holding that the amount of Rs.3.50 crores which the assessee was liable to pay to GMDC was not deductible in AY 1998-99.

The substantial question of law was answered in favour of the assessee and against the Revenue. The appeal was accordingly allowed. The Court made no order as to costs.

Cases Discussed

• CIT vs. Amalgamations Pvt. Ltd. (226 ITR 188) — Supreme Court
• CIT Vs. Ganders Arbuthnot & Co. Ltd., 138 ITR 763 — Calcutta High Court
• Gujarat Narmada Valley Fertilizers And Chemicals Limited — ITA No. 832 to 834/Ahd/1998 — ITAT
• Gujarat Narmada Valley Fertilizers And Chemicals Limited — ITA No. 1753/AHD/2001 — ITAT

FULL TEXT OF THE JUDGMENT/ORDER OF GUJARAT HIGH COURT

1. This appeal is admitted by order dated 21.12.2015 for consideration of the following substantial question of law:

“Whether on the facts and in the circumstances of the case, the Tribunal was right in law in holding that the amount of Rs.3.50 crores which the appellant company was liable to pay to GMDC was not deductible in the assessment year 1998-1999?”

2. Brief facts of the case are as under:

2.1 During the Financial Year 1997-98, the assessee debited provision for corporate guarantee of Rs.3.50 crores payable on behalf of the Gujarat Narmada Auto Limited (for short “the GNAL”) to Gujarat Mineral Development Corporation (for short “the GMDC”) to the Profit & Loss Account. The Assessing Officer did not allow the deduction in the impugned Assessment Order passed under Section 143(3)read with Section 250 of the Income Tax Act, 1961 (for short “the Act”) for the Assessment Year 1998-99 when the matter was remanded back by the Tribunal vide order dated 30.09.2008 passed in ITA No. 1753/AHD/2001 to reconsider the claim of the assessee for the year under consideration.

2.2 Being aggrieved, the assessee preferred an appeal before the Commissioner of Income Tax (Appeal), who allowed the appeal by observing as under:

“5.4 On a specific query in the course of appellant proceedings, it was explained by the appellant that the Official Liquidator is left with very nominal amount. In other words, no funds are available with Official Liquidator out of which the appellant can be paid off in respect of amount paid by it under the Corporate Guarantee given by it to GMDC. These facts clearly indicate that though formal closing of account of the Official Liquidator may be pending, there is effectively no balance left and no potential of augmenting the balance as there is no asset of GNAL left available for realization. The loss is allowable as a deduction in the year in which it can be ascertained that there is loss in the transaction of guarantee. As the liquidator is effectively left with no balance out of the realization proceeds and no assets of GNAL for further realization, the ascertainment of loss on account of guarantee is final and therefore the decision of Hon’ble Supreme Court in the case of CIT vs. Amalgamations Pvt. Ltd. (226 ITR 188) is squarely applicable.

5.5 I have further gone through the submissions of the authorized representative and the assessment order. During the course of hearing before me, it was argued that the assessee had given guarantee and undertaking to the GMDC on behalf of GNAL. GNAL, wholly owned subsidiary of the appellant company, was declared sick and was ordered on 02.08.1995 to be wound by Gujarat High Court. Accordingly, GMDC had filed civil suit against the appellant in the civil court of Ahmedabad being the guarantor for recovery of dues along with interest. It was also submitted that to amicable settle the dues, a joint meeting of GMDC with GNFC was held on 03^rd March, 1997 under the Chairmanship of Principal Secretary, Energy & Petrochemical Dept., Govt of Gujarat, which was attended by Addl. Chief Secretary, Industries, M.D, GMDC and MD, GNFC. It was finally decided in the meeting that GNFC should make payment of Rs.3.50 crores towards full and final settlement of dues to GMDC and repayment should be made in installments. It was also decided that in view of settlement, the suit filed by the GMDC also to be withdrawn.

The Board of Directors of both the companies ratified the decision taken in the aforesaid meeting under the Chairmanship of the Principal Secretary and therefore full and final settlement with GMDC can be said to have taken place during the year. To reduce the interest burden, the assessee being the sole guarantor had paid the principal liability of Rs.3.5 crores. It was further argued that Honourable ITAT had allowed the interest in the assessee’s case for AY 1995-96 on same facts.

I have considered the submissions of the Ld. AT and fact of the case. Appellant has finally arrived at the settlement during the year under consideration. Considering the facts of the case and respectfully following the direction of the Honourable ITAT and decision in the case of Commissioner of Income Tax vs. Amalgamations Pvt Ltd. (226 ITR 188), I direct Assessing Officer to allow claim of the assessee. The addition is therefore deleted. The ground No.2 is thus allowed.”

2.3 The respondent – revenue being aggrieved by the order of the CIT(Appeal) for the Assessment Year 1998-99, preferred an appeal before the Tribunal. The Tribunal after considering the facts of the case and documents placed on record, narrated the history of the first round as under:

“6. We have heard rival submissions and perused the orders of the lower authorities and material placed on record. In the instant case, the assessee with a view to diversify from its controlled product area and considering great demand and potential for two wheelers, the assessee took over a running concern and made it a wholly owned subsidiary company, namely, Gujarat Narmada Auto Ltd. (GNAL). The assessee, as a holding company of GNAL, had agreed with the financial institutions by way of an undertaking dated 21.3.1988 that if there is any shortfall in the resources of the borrower l.e. GNAL for completing its projects and/or for the working capital, the assessee shall make arrangements for such additional funds. The assessee agreed with the financial institutions that the assessee shall not withdraw funds advanced by it to GNAL so long as monies due by GNAL to the financial institutions remain outstanding. In the Asstt. Year 1994-95, the assessee had made a provision for Rs.62,84,68,160/- by debiting the amount to profit & loss account as “provision for loan to subsidiary doubtful of recovery”. The AO did not entertain the claim of deduction on two grounds, viz. (1) the amount of Rs.62,84,68,160/- had not been written off to debtor’s account and mainly debited to profit & loss account only on the basis of a provision, and (ii) the loss does not arise directly from the carrying out of the business operation and cannot be said to be incidental to the carrying on of the business of manufacture and sale of chemical fertilizers and chemicals.

7. The CIT(A) upheld the action of the AO on the ground that the amount had not been written off to debtor’s account on the basis of provision. The CIT(A) also held that the facts of the judgment relied upon by the assessee in the case of CIT Vs. Amalgamations Pvt. Ltd.. (1997) 226 ITR 188 (SC) are different from the facts of the assessee.

8. Assessee, being aggrieved, filed appeal before the Tribunal. The assessee submitted that diversification steps taken in June, 1986 were taken in right direction and it was expected that the assessee would realize substantial profits in the years to come, in view of high profit margin of various private sector companies engaged in manufacturing of two three wheelers. However, on account of various constraints, viz. change in market conditions, resistance in the minds of customers against “Girnar” scooters, inefficiency of work-force inherited from government owned corporations and other reasons, GNAL suffered heavy losses. The assessee made all efforts to ensure that GNAL comes to the expectation and start making profit. With the above object in view, the assessee contributed funds to see that GNAL survived and revived so that the investment is saved and safeguarded. However, the above could not be achieved and hopes to recover amount As GNAL has advanced to the subsidiary company have been lost. been declared fit for winding up by the BIFR and the Hon’ble Gujarat High Court vide its order dated 2.8.1994 directed that GNAL be wound up in accordance with law and Official Liquidator be appointed for this It was contended that advances were made to GNAL in the purpose. course of business of the assessee and non-recoverability of these advances is incidental to business and should be allowed as a loss. The advances were made to earn profit and money was advanced in accordance with accepted commercial practice. The aim of the assessee was not to avoid taxes but was purely commercial i.e. earning of income in future. No lumpsum payment was made but funds were furnished in order to augment income in the ordinary course of business. The assessee submitted that nature of advantage expected from investment in GNAL was commercial earning

9. As regards the objections of the Revenue authorities that loss does not arise directly from carrying out of the business operation, was submitted that the AO’s observation that scooter and fertilizers are two different businesses, and therefore, it is not the same business, is not correct, and there is error in the application of the above test. There is clear interlacing, inter-connection and interdependence, and the fertilizers business and manufacture of scooters were carried by the subsidiary. The loss which arose was incidental to the carrying on of business and should be allowed. The assessee further placed reliance on the decision of the Hon’ble Supreme Court in the case of CIT V Amalgamations Pvt. Ltd. (supra), The assessee also relied on the decision of Hon’ble Calcutta High Court in the case of CIT Vs. Ganders Arbuthnot & Co. Ltd., 138 ITR 763.

10. In the alternative and without prejudice to the above submission, it was stated that if loss is not allowed as deduction in the year under consideration, then the same should be allowed in the year in which account is finally settled with the Liquidator.”

2.4 Thereafter, the Tribunal, considering the submissions of the assessee and on perusal of the order passed by the CIT(Appeal), held as under:

“16. We find that in the instant case, the assessee claimed deduction of Rs.3.50 crores under the head “Provision for payment to be made on behalf of Gujarat Narmada Auto Limited”. The relevant facts are that the assessee had a fully owned subsidiary company styled as “Gujarat Narmada Auto Limited” which was engaged in the manufacture of two/three wheelers. The said subsidiary GNAL availed loan from Gujarat Mineral Development Corporation (GMDC) for which the assessee stood as guarantor. The said GNAL had huge loss and went to BIFR, and thereafter, the Hon’ble Gujarat High Court by order on 2.8.1994 directed the said GNAL to be wound up, and Official Liquidator was appointed to take over the assets and liabilities of the said GNAL Thereafter, GMDC invoked guarantee given by the assessee-company and filed a suit against the assessee-company. Thereafter, the assessee-company and GMDC entered into an amicable settlement in a meeting held on 3.3.1997 wherein it was agreed that the assessee-company should pay Rs.3.50 crores in full and final settlement of the amount of liability of GNAL to GMDC. In pursuance to this, the assessee actually paid Rs.3.50 crores to GMDC as under:

These payments were made in the financial year 1999-2000 and 2000-01 relevant to the Asstt. Year 2000-01 and 2001-02. On the above facts, the AO disallowed the claim of deduction made by the assessee in the Asstt. Year 1998-99 on the ground that the Tribunal in the case of the assessee vide its order dated 31.3.2000 passed in ITA No.832 to 834/Ahd/1998 in the Asstt. Yer 1992-93 to 1994-95 has held that the deduction is allowable in the year of final settlement by the Official Liquidator and for want of complete details of liquidation and settlement from the Official Liquidator.

17. On appeal, the CIT(A) allowed the claim of the assessee purportedly following the said decision of the Tribunal and of the Hon’ble Gujarat High Court in the case of CIT Vs. Amalgamations Pvt. Ltd., (1997) 226 ITR 188 (SC). According to the CIT(A), the loss was crystallized on 3.3.1997 when meeting between the assessee-company and GMDC took place.

18. We find that even if the version of the CIT(A) taken as correct, then also, the loss being crystallized on 3.3.1997, the same was in the Asstt. Year 1997-98 and not during the assessment year under consideration i.e. Asstt. Year 1998-99. Therefore, the CIT(A) was not justified in deleting the disallowance on the above count. Further, no material was brought on before us to show that the assessee’s liability to make payment of Rs.3.50 crores was crystallized during the under consideration and that no part of the payments were also made during the year under consideration. Therefore, in our considered view, the CIT(A) was not justified in deleting the disallowance made by the AO.

19. We, therefore, set aside the order of the CIT(A) in respect of the issue under consideration and restore back the order of the AO.’

3 Learned advocate Mr. Manish Shah appearing for the appellant – assessee submitted that there was an Agreement between the Managing Directors of GMDC and the assessee with the Additional Chief Secretary of State of Gujarat to arrive at amicable settlement of payment of lumpsum amount of Rs.3.50 crores by the assessee to GMDC who stood as a guarantor for GNAL and the suit filed by the GMDC for invocation of the guarantee given was to be withdrawn.

3.1 It was submitted that such meeting took place on 03.03.1997 and pursuant to such meeting a Board Resolution was passed in the 238^th Meeting of the assessee held on 21.03.1997 for settlement of the dues with the GMDC. It was submitted that pursuant to such Board Resolution, correspondences were exchanged between the GMDC and the assessee on 12.04.1997, 23.06.1997, 25.06.1997 and 17.01.1997 for determining the modalities of the payment of Rs.3.50 crores agreed to be paid by the assessee to GMDC on behalf of GNAL. It was submitted that the Consent Terms were filed before the City Civil Court, Ahmedabad, in Civil Suit No. 4659 of 1994 on 12.05.1999.

3.2 It was submitted that pursuant to the agreements finalized between the parties, provision was made in the accounts for the year ending on 31.03.1998 for payment of Rs.3.50 crores by the assessee to GMDC and accordingly the same was claimed in the profit and loss account. It was submitted that CIT(Appeal) has rightly considered the issue of allowability of such expenditure in the year under consideration. It was further submitted that the assessee has already made an alternative submission that the amounts may be allowed in any of the three years i.e. Assessment Year 1997-98, 98-99 and 99-2000. However, the Tribunal restored the addition made by the Assessing Officer without giving any direction for allowability of such claim made by the assessee in the particular assessment year.

3.3 It was therefore submitted that the order of the Tribunal may be set aside and the order of the CIT(A) may be restored.

4. On the other hand, learned Senior Standing Counsel Mr. Rutvij Patel for the respondent – revenue, submitted that the Tribunal has given cogent reasons to set aside the order passed by the CIT(Appeal) as admittedly the Consent Terms were filed before the City Civil Court on 12.05.1999 and accordingly at the best such claim, if any, would be allowable for the Assessment Year 2000-01, and therefore, the Tribunal has rightly restored the order passed by the Assessing Officer denying the deduction for the year under consideration i.e. the Assessment Year 1998-99.

4.1 It was further submitted that the Tribunal referred to and relied upon its order dated 31.03.2000 passed in ITA Nos. 832 to 834/Ahd/1998 for the Assessment Year 1992-93 to 1994-95, wherein, the assessee claimed the loss of the GNAL on being taken to the BIFR was not allowed and the assessee agreed to claim such loss in the year in which the BIFR passed an order. It was, therefore, submitted that no interference is called for in the impugned order of the Tribunal.

5 Having heard the learned advocates for the parties and considering the facts of the case it appears that it is not in dispute that there is a settlement between the parties arrived at pursuant to the meeting held between the Additional Chief Secretary and the Managing Directors of the assessee and the GMDC, and accordingly, it was agreed by the assessee to pay the amount of Rs.3.50 crores to the GMDC for the full and final settlement for the guarantee given by the GMDC on behalf of the GNAL which is a subsidiary of the assessee.

5.1 It is also not in dispute that all the companies i.e. GMDC, GNAL and the assessee are the government companies as the State Government is majority shareholder in all the three companies. It is also not in dispute that the first meeting had taken place on 03.03.1997 and the correspondence was exchanged between April and July 1997, and accordingly, it was agreed between the parties to make the payment of Rs.3.50 crores in the year under consideration i.e. in the previous year 1997-98 relevant to the Assessment Year 1998­1999, which was actually implemented by way of filing the Consent Terms before the City Civil Court, Ahmedabad, on 12.05.1999. Therefore, the payment made on filing of the Consent Terms was already decided in the year under consideration. The CIT(Appeal) has therefore rightly allowed the claim of the assessee for the year under consideration which is reproduced hereinabove.

5.2 The Tribunal, without considering the facts of the case in the above perspective has opined that the amount of Rs.3.50 crores was from the year 1997-2001 onwards, and therefore, the claim cannot be allowed for the year under consideration. In view of the findings of fact recorded by the CIT(Appeal) in para 5.5 of the Appellate Order, which is not doubted by the Tribunal, we are of the opinion that the liability of payment of Rs.3.5 crores as crystallized in the previous year 1997-98 which ultimately was discharged on filing of Consent Terms in the year 1999. In such circumstances, we are of the opinion that the Tribunal was not right in holding that the amount of Rs.3.50 crores which the appellant company was liable to pay GMDC was not deductible in the Assessment Year 1998-99. The question of law is therefore, answered in favour of the assessee and against the Revenue. The appeal is accordingly allowed. No order as to cost.