Case Law Details

Case Name : Eastman Industries Ltd. Vs A.C.I.T., Circle 10(1) (ITAT Delhi)
Appeal Number : ITA No. 286/Del./2013
Date of Judgement/Order : 09/06/2017
Related Assessment Year : 2008- 09
Courts : All ITAT (4213) ITAT Delhi (925)
1. The brief facts, relevant to issue No. (iv) above, are that during the assessment proceedings, the assessee had debited a sum of Rs. 10,19,203/- under the head “Commission paid against guarantee by directors”. On being asked, the assessee explained that the assessee company had obtained working capital limits from bank which were secured by way of hypothecation of plant & machinery, fixed assets, stocks, bicycles and auto parts in process, finished goods, book debts, export bills & other receivables and goods in transit. It was further explained that the loans were also secured by equitable mortgage of lease hold rights of Plot No. C- 87 & C-88, Phase V, Focal Point, Ludhiana and also by personal guarantee given by two directors of the company. In lieu of this personal guarantee, the assessee company had paid commission @ 0.6% of the amount of guarantee amounting to Rs. 10,19,293/-. The details of these expenses are as under :
Name of the director Amount of
Guarantee in (Rs)
Commission allowed at the rate Commission paid in (Rs)
Shri J.H. Singal 141410060 @0.60% 927000
Smt. Darshana Singal 14095148 @0.60% 92203
TOTAL 155505208 @0.60% 1019203

The assessee claimed that this expenditure was incurred for the purpose of business and, therefore, is eligible for deduction u/s. 37(1) of the IT Act.

2. The Assessing Officer after considering the reply of assessee, rejected the claim on the premise that the assessee failed to submit any loan sanction documents of the Bank in support of its claim of personal guarantee given by both the above directors. He also failed to adduce any evidence to show the compliance of TDS provisions. The AO further observed that in Schedule X of the Tax Audit Report, the auditors have mentioned payment of commission amounting to Rs. 92203/- to Smt. Darshana Singal and there is no reference with respect to commission paid of Rs. 9,27,000/- to Sh. J.H. Singal, the other director. The AO further observed that there being no nexus of these expenses with the business of assessee company, the guarantee commission so paid is not allowable u/s. 37(1) of the Act. He accordingly, disallowed this expenditure amounting to Rs. 10,19,203/-.

3. The assessee carried the matter in appeal before the ld. CIT(A), who after considering the elaborate submissions made by the assessee and the case laws relied upon by him, deleted the addition observing as under :

“I have considered the submission of the appellant and observation of the Assessing Officer. It has been submitted that the company had obtained working capital limits from bank secured by hypothecation of plant and machinery, stock etc. and personal guarantee by the Directors of the company for which guarantee commission was paid at the rate of 0.6% of the amount of working capital loan. It was also submitted that if personal guarantee of the Directors would not have been given then such refusal would have resulted in reduction or non availability of the loan, thus, affecting the business of the company. The appellant has also relied on the following cases:-

(a) CIT Vs. Metalliziing Equipment C03 ITR 596 (All)

On going through the case of CIT vs. Indian Aluminum Cables of the jurisdictional High Court it is seen that the case is similar to the facts of the case under consideration. In the case referred to above there was a finding of the fact that the bank from which the assessee company had borrowed funds insisted on personal guarantee of the Directors and as such the assessee had no choice but to give the guarantee. In the case under consideration even the appellant has claimed that guarantee of Directors was insisted upon by the bankers for sanctioning of credit limits. In support of its contention, the appellant has filed renewal of credit limits under SBI Exporters Gold card Scheme in the paper book, which is placed at page 16 to 41 of the paper book. Ongoing through the letter it is seen that bank has insisted upon the personal guarantee of the Directors of the appellant company Sh. J.R. Singal and Smt. Darshana. Therefore, it is established that bank has insisted upon the personal guarantee of the Directors for renewal of the credit limits.Therefore, the payment of commission to Directors at the rate of 0.6%  of the sanctioned credit limit was justified and allowable expenditure.

Considering the facts of the case and the judicial pronouncements on the issue, the guarantee commission to Directors is an allowable expenditure. Hence, the dis allowance made by the Assessing Officer of Rs. 10,19,203/- is deleted.”

Aggrieved by this order of ld. CIT(A), the Revenue has challenged the above decision by way of ground No. 2 of its appeal before us.

4. The ld. DR, relying on the order of the Assessing Officer, submitted that the assessee could not adduce any documentary evidence before the AO in support of his claim. He further submitted that the guarantee commission which has been paid to the directors is not legitimate and has no nexus with the business of the assessee company. It was submitted that the assessee company had given sufficient security to the bank as per their requirements and the personal guarantee of the directors was not the part of loan documentation. The comparison of commission paid to directors against their personal guarantee with the commission charged by the bankers against their own guarantee is not justified, as the nature of both the guarantees is quite different. On the strength of these contentions, the ld. DR submitted that the Assessing Officer had rightly disallowed this expenditure u/s. 37(1) of the Act and the ld. CIT(A) was not justified to delete the same.

5. On the other hand, the ld. AR of the assessee, relying upon the elaborate submissions made before the ld. CIT(A), submitted that the first appellate authority was justified in deleting the dis allowance. It was submitted that personal guarantee of the directors was given on the insistence of Bank. Had the directors not given their personal guarantee to the Bank against the limit sanctioned, the assessee company would have not be able to obtain the credit limit, which would be perilous to the business of the company. Therefore, the personal guarantee so given by the directors to the bank and the commission paid to them for this has direct nexus with the business of the assessee company and such commission expenditure is, thus, eligible for deduction u/s. 37(1) of the Act.

6. We have considered the rival submissions, gone through the orders of the authorities below, paper book filed by the assessee and the case laws relied upon. The assessee has submitted before us the renewal documents of the credit limit of working capital loans, available at page 38 of the paper book, in which the bank has mentioned the details of primary security & collateral security. In addition to above security, the Bank has mentioned that “in addition, the credit facilities will be secured by the personal guarantees of the company’s promoter Directors, namely ,

1. Shri Jagdish Rai Singh
2. Smt. Darshana Singal

From the above renewal documents, it is no doubt true that the bank has required the assessee company to furnish the personal guarantee of the above two directors in order to secure the credit facilities. Thus, the finding of the ld. CIT(A) that the directors of the company had offered their personal guarantee on the insistence of the bank is supported by the renewal documentation filed before him. However, the question to be adjudicated by us is –

“Whether the commission paid to the directors for their personal guarantee was lawful/ justified to qualify the deduction in terms of u/s. 37(1) of the IT Act ?”

7. A perusal of the findings recorded by the ld. CIT(A), as reproduced herein before, we find that the ld. CIT(A) has considered the only aspect that the personal guarantee of the directors was given by the assessee company on the instance of the Bank. He however, has not addressed on the core issue whether the commission paid to the directors in lieu of their personal guarantee was legally justified or not to qualify for deduction. In this context, the contention of the assessee has been that whenever any guarantee is given by any person on behalf of some other person, the person giving the guarantee always charges an amount of consideration in the form of commission as a fixed percentage of the amount of guarantee given. The assessee has also contended that no security was required by the bank to be furnished for availing the personal guarantee from the directors of the company. We do not find substance in the above contention of the assessee that each guarantee is given by the guarantor subject to commission. In fact, it depends upon the nature of guarantee and the guarantor. The assessee itself is the best exemplar to support this finding. It is worthwhile to note that the assessee company itself has given guarantee by extending equitable mortgage over land & building situated at C-87 & C- 88, Focal Point Phase V, Ludhiana (the same property which has also been mortgaged as collateral security in the instant case) for working capital limit of Rs. 20 crores, sanctioned by the Bank to Eastman Industrial Company, a partnership firm. This fact is evident from Schedule-III of the balance sheet placed at page 41 of the paper book. However, the assessee company itself has not shown any commission having been received from the said partnership firm. In this context, while considering the justification of payment of impugned commission, as envisaged in the first limb of aforesaid question, we are aware of the Master Circular of Reserve Bank of India pertaining to Guarantees and Co-acceptances, bearing No. RBI/2007- 2008/44 –DBOD. No. Dir.BC.10/13.03.00/2007-08 dated July 2, 2007, which is relevant for the year under consideration. In this Circular, Clause 2.10 stipulates as under :

“2.10. Guidelines relating to obtaining of personal guarantees of directors and other managerial personnel of borrowing concerns Personal guarantees of directors.

Banks should take personal guarantees of directors for the credit facilities, etc. granted to corporate, public or private, only, when absolutely warranted after a careful examination of the circumstances of the case and not as a matter of course. In order to identifying the circumstances under which the guarantee may or may not be considered necessary, banks should be guided by the following broad considerations:

A. ………………………….

B. …………………………

C). Worth of guarantors, payment of guarantee, commission etc.

Where personal guarantees of directors are warranted, they should bear reasonable proportion to the estimated worth of the person. The system of obtaining guarantees should not be used by the directors and other managerial personnel as a source of income from the company. BANKS SHOULD OBTAIN AN UNDERTAKING FROM THE BORROWING COMPANY AS WELL AS THE GUARANTORS THAT NO CONSIDERATION WHETHER BY WAY OF COMMISSION, BROKERAGE FEES OR ANY OTHER FORM, WOULD BE PAID BY THE FORMER OR RECEIVED BY THE LATTER, DIRECTLY OR INDIRECTLY. THIS REQUIREMENT SHOULD BE INCORPORATED IN THE BANK’S TERMS AND CONDITIONS FOR SANCTIONING OF CREDIT LIMITS. DURING THE PERIODIC INSPECTIONS, THE BANK’S INSPECTORS SHOULD VERIFY THAT THIS STIPULATION HAS BEEN COMPLIED WITH. There may, however, be exceptional cases where payment of remuneration may be permitted e.g. where assisted concerns are not doing well and the existing guarantors are no longer connected with the management but continuance of their guarantees is considered essential because the new management’s guarantee is either not available or is found inadequate and payment of remuneration to guarantors by way of guarantee commission is allowed.”

8. If the case of the assessee is tested on the anvil of captioned guidelines, we find that the assessee has failed to submit the original credit facility documentations of the bank either before the authorities below or before us in order to verify whether the terms and conditions of bank documentations/ agreement are in consonance with the above guidelines or not. The assessee, however, has submitted before us the renewal documentation of the bank, which no where contain the stipulation made by RBI as noted above. Unless it is ascertained from the original bank documentations that the said Bank documents/ agreements contain the terms and conditions, as stipulated by RBI in the aforesaid guidelines, it is not possible to decide whether the commission paid by assessee company to its directors in lieu of their personal guarantee was lawful/ justified or not. As per the captioned guidelines of RBI, it is abundantly clear that neither the assessee company was legally obliged to extend any commission to their directors against their personal guarantee given to the bank nor the directors of the company were entitled to receive any such commission in lieu of their personal guarantee. The exceptional stipulation given in the later part of the above guidelines is in different context, which is not applicable to the assessee’s case. On perusal of the exceptional stipulation, as noted above, we find that payment of commission/ remuneration is permissible to the directors against their personal guarantee only on the following conditions:

(i) Where the assisted concerns are not doing well;

(ii) Where the existing guarantors are no longer connected with the management;

(iii) Where the personal guarantee of existing guarantors is essential to continue; and

(iii) Where new management’s guarantee is either not available or is found inadequate.

Given the facts of the present case, we find that none of the aforesaid exceptional conditions, which permit payment of guarantee commission to the directors, exists in the instant case. In the decisions relied by the ld. CIT(A) as well as the assessee, the question of propriety of payment of commission in the light of RBI guidelines, noted above, was not involved before the Hon’ble Court and therefore, the said decisions, being distinguishable on facts do not render any help to the assessee. We, therefore, restore this issue to the file of the Assessing Officer to examine from the original bank documentations/ agreements/ sanction letter and to ascertain whether the requirement of non-payment of commission to the guarantors was incorporated in the terms and conditions of bank for sanctioning of credit limit or whether any undertaking to this effect was taken from the company or not in terms of RBI guidelines noted above. In case, the result of inquiry comes in affirmative, it shall be deemed that the assessee was well aware of the fact that no commission etc. was to be paid against personal guarantee of directors, but the same has been paid to take undue benefit thereof by seeking deduction u/s. 37(1), which is not permissible under the Act. If the result of inquiry comes in negative, the Assessing Officer shall proceed to test the allow ability of the above expenditure, as claimed by the assessee as per law. Accordingly, the ground No. 2 of the Revenue’s appeal is allowed for statistical purposes.

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