1. The assessee who had purchased more than 51% shares of Chopda Electric Supply Co. Ltd., became its managing director with effect from March 1, 1948, and the appointment was to continue for a period of 20 years. The assessee was to get a fixed remuneration of Rs. 300 per months as also a commission of 10% on the net profits of the company. We are concerned in this reference with the assessment year 1960-61. Chopda Electric Supply Co. Ltd., was carrying on the business of generating and distributing electricity under a licence issued by the State Govt. The company was not making profits and admittedly the assessee neither drew the monthly allowance of Rs. 300 nor did he receive any amount by way of commission at any time.
2. In 1952, the company borrowed monies from the Bank of India and the assessee stood surety for the repayment of the loan advanced by the bank to the company. The company had also executed a promissory note in favour of the assessee and the assessee has assigned the said promissory note in favour of the bank.
3. The electricity undertaking of the company was compulsorily acquired by the the State of Bombay in 1957 and the licence granted for generating and distributing electricity was canceled with the result that the company went into liquidation in February, 1958. The liquidation proceedings were completed by the middle of 1965. On January 22, 1959, the Bank of India demanded a sum of Rs. 73,520.80 on account of the amount of the loan outstanding against the company which the assessee being the guarantor of he said loan paid to the Bank of India by cheque on February 11, 1959. The assessee was not able to recover any money from the company in order to reimburse himself in respect of the amount paid by him as guarantor.
4. In the assessment for the assessment year 1960-61, the assessee claimed that the amount of Rs. 73,520.80 should be allowed to be deducted as loss under s. 10(2)(xv) of the Indian Income-tax Act, 1922 (hereinafter referred to as 'the Act'), out of his total income. The ITO rejected this claim on the round that the loss caused was a capital loss and not a business loss. In he appeal by the assessee, the AAC held that the loss had no direct connection with the assessee's activity of earning the dividend or managerial remuneration and in any case the loss being a capital loss, the assessee was not entitled to set off that loss as the company had ceased to function during the previous year and the assessee had not received any remuneration or dividend therefrom.
5. The assessee then appealed to the Income-tax Appellate Tribunal before whom the deduction was claimed primarily under s. 10(2)(xv) of the Act and alternatively under s. 12(2) of the Act. The Tribunal held that the amount in question could not be held to be an expenditure, to which alone the above mentioned provisions applied. The Tribunal found that there was scanty material to hold that the activity carried on by the assessee in relation to Chopda Electric Supply Co., was in the nature of carrying on of a business. The Tribunal recorded a finding that there was absence of satisfactory material to establish that the assessee carried on a regular business of managing the company. Thus, the claim made in the nature of a set-off of loss by deduction under s. 10 of the Act was rejected on the ground that the basic fact of the assessee carrying on the business was not proved. The Tribunal further held that even otherwise the assessee was not carrying on the so-called business on February 11, 1959, when he paid the amount to the bank and, therefore, he was not entitled to set off the loss as argued. The Tribunal then considered the contention of the assessee that all activities carried on by him in relation to various companies either in his capacity as a sitting director or managing director formed one single integrated activity of carrying on the business of managing companies. Proceeding on the assumption that the activities carried on by the assessee in regard to various companies amounted to carrying on the business, the Tribunal considered the question whether the activities in relation to different companies constituted different and distinct business or constituted the same business. The Tribunal found that there was a complete absence of any material to satisfy the Tribunal that the activities carried on by the assessee in relation to different companies constituted the same business. The Tribunal considered the claim of the assessee under s. 12(2) of the Act and found that the assessee's claim in substance was a claim for set off of a loss and was not a claim for the deduction of an expenditure and, therefore, s. 12(2) of the Act did not apply. The Tribunal further held that it was difficult to see as to how the incurring of the loss of Rs. 75,201 (sic) could be said to have been necessitated solely for the purpose of making or earning such income. On these facts, the following question has been referred at the instance of the assessee to this court of opinion :
'Whether, on the facts and in the circumstances of the case, the assessee was entitled to the deduction of Rs. 75,201 (sic) as an expenditure or as a business loss out of his income ?'
6. Shri Mehta, the learned counsel for the assessee, had restricted his argument to only to alternative contenting raised before the Tribunal and, according to the learned counsel, the assessee was carrying on an organised activity consisting of his investment in shares, becoming a director in various companies, getting director's fees, drawing remuneration as a managing director and earning commission. The contention of the learned counsel is that the amount which is required to be paid by him in his capacity as a guarantor was liable to be allowed as deduction under s. 10(2)(xv) of the Act because he had made the payment to the Bank of India as guarantor in respect of the loan which was taken with a view to see that the business of the company could go on in which the assessee was vitally interested. The learned counsel contended that if the company did not borrow money from the bank, the business of the company could not have been salvaged and, therefore, the amount in question should be treated as expenditure not being capital expenditure not being capital expenditure but laid out or expended wholly and exclusively for the purpose of the business of the company.
7. It will be proper at the outset to consider the exact nature of the liability discharged by the assessee when he paid off the amount which was demanded from him by the bank because he was the guarantor in respect of the loan which was borrowed by the company. Under the provisions of s. 128 of the Contract Act, the liability of the surety is co-extensive with that of the principal debtor, unless it is otherwise provided by the contract. Under the contract of guarantee, the creditor would be entitled to recover the amount of the loan from the guarantor himself. In the instant case, the Bank of India could not recover monies from the Chopda Electric Supply Co. Ltd., and the obligation incurred by the assessee by virtue of the guarantee repayment of the loan was, therefore, enforced by the Bank of India. On the enforcement of the contract of guarantee, the guarantor was subrogated to the position of the creditor, section 140 of the Contract Act provides that where a guaranteed debt has become due, or default of the principal debtor to perform a guaranteed duty had taken place, the surety, upon payment or performance of all that he is liable for, is invested with all the rights which the creditor had against the principal debtor. In the present case, the assessee, having repaid the loan due from the company, had stepped into the shoes of the creditor and he was, therefore, entitled to receive from the company the amount which he had paid to the Bank of India. The legal position, therefore, was that the assessee was the creditor of the company. Whether he would be entitled to recover anything from the company or not was a different matter. There is no material on record to show as to whether in the liquidation proceedings the assessee had made any claim and whether such claim was either wholly or partly satisfied in respect of the amount of the loan. So far as the assessee is concerned, if the amount repaid on account of the loan of the company is not recovered by him, the loss in the hands of the assessee will be clearly in the nature of a capital loss.
8. What the learned counsel for the assessee, however, claims is that notwithstanding the general position of law that the assessee would step into the shoes of the creditor, in so far as the provisions of the I.T. Act are concerned, the assessee will be entitled to claim this amount as a deduction if he is able to show that the satisfied the requirements of s. 10(2)(xv) of the Act. It was in that context that the learned counsel for the assessee canvassed the proposition that the assessee was carrying on an organised activity. No., it is difficult for us to see how the three factors relied upon by the assessee can indicate that the assessee was carrying on any organised activity. Primarily, the activity of the assessee was investment in shares and the election as a director of different companies or his appointment as a managing director was the consequence of such investment. It is no doubt true that the assessee was a director in six or seven companies and earned director's fees and in the company in question he was the managing director. It is not now canvassed before us that being a director or being a managing director itself amounted to carrying on business. As already pointed out what was accrued we that all the activities should be taken together and should be treated as a business. Now, as pointed out by the Supreme Court in Narain Swadeshi Weaving Mills' case : 26ITR765(SC) , the word 'business' connotes some real, substantial and systematic or organised course of activity or conduct with a set purpose. The assessee does not deal in shares and in spite of the fact that he has invested his monies in shares, that cannot be said to be his business, though investment in shares would be a source of income of the assessee. Basically, if the assessee had occupied the office of a director or has become the managing director, that was because he was a shareholder, and, being a shareholder of a company and in addition a director or managing director of a company, cannot, in our view, be called a business. Directorship and managing directorship are offices which are held by a person in a company and merely because the managing director earns remuneration and in some cases remuneration is also in the form of commission paid to a meaning director, that dies not amount to carrying on of a business.
9. The learned counsel for the assessee has referred us to a decision of the Assam and Nagaland High Court in Dwijendra Chandra Chowdhury v. CIT : 61ITR97(AP) in support of the proposition that the managing director can be held in given circumstances to be carrying on business. We have gone through that decision and it is obvious that he joint managing directors of a private limited company, who under the articles of association were entitled to a remuneration of Rs. 1,000 per month and 5% commission on sales, were held to be agents of the company and not mere servants of the company and the remuneration paid to them was held to be business income under s. 10 of the Act. A careful perusal of that decision will show that those inferences were drawn on certain features of the articles of association of the company and it was held that the joint managing directors were made the agents of the company and they filed in the capacity as managing agents within the meaning of the Companies Act. It is on this footing that the income derived by them from the company was held to be remuneration paid to them in their capacity as managing agents and that was why it was held that the commission 'partakes of the character of business income assessable under section 10 of the Act' and that it does not partake of the nature of a salary. That decision must be treated as having been rendered on the facts of that case.
10. Really speaking, once we come to the conclusion that the three kinds of activities cannot be held to result in the carrying on of any business as contended, the claim of the assessee under s. 10(2)(xv) or under s. 12(2) of the Act must also consequently fail. Under s. 10(2)(xv), before a deduction is claimed, it must be established that the amount is an expenditure and it has further to be shown that the said expenditure is laid out or expended wholly and exclusively for the purpose for the business. We may even assume for a moment that the assessee was carrying on business as contended by him but then again it becomes difficult to hold that the repayment of the loan amounted to expenditure which was laid out or expended wholly and exclusively for the purposes of such business. There was no legal obligation on the assessee as a managing director, much less as a shareholder or a director, to guarantee the loan borrowed by the company of which he was the managing director. There is, therefore, no nexus whatsoever between the liability which is discharged by the assessee and the business which, according to the assessee, he was carrying on. By virtue of the provisions of the Contract Act he occupied an entirely new capacity, viz., initially as the guarantor and then as the creditor of the company, which capacity had nothing to do with his capacity as the shareholder or a director or managing director of the company. It is also difficult for us to see how any claim for deduction of the amount in question as expenditure could be made under s. 12(2) of the Act. The licence of the company was terminated in the year 1957. Therefore, the so-called business of the assessee had been discontinued though it is sought to be urged before us that after he ceased to be the managing director of Chopda Electric Supply Co. Ltd., he had later become the managing director of some other companies. So far as the present liability is concerned, however, there is no connection whatsoever with the other companies of which the assessee had become the managing director. Under s. 12(2) of the Act, the only expenditure which is permissible to be deducted is expenditure which is not capital expenditure and is incurred solely for the purpose of making or earning such income, profits or gains. No connection is established between the amount repaid on account of the loan borrowed by the company and the return which the assessee was receiving an account of dividend on the investment which he had made in the form of shares either in Chopda Electric Supply Co. Ltd., or in other companies. So far as s. 12 of the Act is concerned, the assessee's income from dividend was assessed as income from other sources and it is extremely difficult for us to see how the amount paid to the Bank of India can, by any stretch of imagination, be said to be related to any dividend earned from the shares or even to the director's fees earned on account f being a director of some other companies. The claim appears to us to be wholly misconceived and impermissible to be granted under any of the provisions of the said Act. Consequently, the question referred to us is answered in the negative and against the assessee. The assessee to pay the costs of this reference.