1. In this reference the assessee before us is a private limited company. The reference is under s. 256(1) of the I.T. Act, 1961, and the following two questions are referred to us by the Income-tax Appellate Tribunal :
'(1) Whether, on the facts and in the circumstances of the case, the assessee is entitled to a deduction of the sum of Rs. 1,60,185 being the value of the shares held by the assessee in Navanagar Industries Ltd., now in liquidation
(2) Whether, on the facts and in the circumstances of the case, the assessee is entitled to a deduction of the sum of Rs. 1,30,925 either under section 10(2)(xi) first part, or, in the alternative, under section 12B as a capital loss ?'
2. We are concerned in this reference with the assessment for the year 1961-62, the corresponding accounting period being the financial year ending March 31, 1961. The assessee was incorporated on June 11, 1945. According to the memorandum of association of the company, the main object of the assessee was to acquire certain managing agency business from the predecessor firm as also to carry on business as managing agents of Wallace Flour Mills Co., and also to carry on business as managing agents, selling agents, commission agents, macadam's and brokers of any other company, concern or person. The memorandum of association also enabled the assessee-company further to carry on business of money lending, discounting and purchasing of bills and other negotiable instruments.
3. The assessee-company along with two others promoted a company called Navanagar Industries Ltd. The assessee and the two others, whom the Tribunal has, in the statement of the case, designated as partners, also started another company called V.H.D. Agencies Ltd., to manage Navanagar Industries as its managing agents. The shares in this company, i.e., V.H.D. Agencies Ltd., were held equally by the three parties, viz., the assessee-company and the two others. These three parties, who were shareholders in V.H.D. Agencies Ltd., also acquired certain shares in Navanagar Industries Ltd., which was promoted by the three parties. The assessee had also advanced certain moneys to Navanagar Industries Ltd.
4. During the year under consideration Navanagar Industries Ltd., went into liquidation, and the assessee accordingly claimed in its assessment the sum of Rs. 1,60,185 as loss in respect of the value of shares held by the assessee in Navanagar Industries Ltd. It also claimed the sum of Rs. 1,30,925, being the amount outstanding from the said Navanagar Industries Ltd., as a business loss. As far as the first claim is concerned, the ITO held that the assessee was not a dealer in shares. As regards the claim of Rs. 1,30,925, the ITO observed that the assessee could not be considered to be money-lender. According to him, 'the only object of advancing the money was to provide finance for a company in which the assessee was substantially interested' The ITO laid special stress on the fact that interest had not been charged from the very outset, and, according to him, no prudent money-lender would advance amounts in this manner to a debtor whose financial condition was going bad. According to him, it was obvious, therefore, that the moneys advanced were not in the course of money-lending activities of the assessee-company and, therefore, the amount written off could not be allowed as revenue deduction. The assessee, being aggrieved by the order of the ITO, preferred an appeal to the AC. The AAC agreed with the approach and conclusion of the ITO regarding the first head of loss claimed, viz, the investment in the shares of Navanagar Industries Ltd. As regard the loss of moneys advanced to Navanagar Industries Ltd., the AAC agreed with the ITO that these advances could not be regarded as being in the course of the assessee's money-lending business. According to him, therefore, the loss arising therefrom could only be treated as a capital loss and not a business loss. Thereafter, the assessee, being aggrieved, preferred an appeal to the Tribunal. In such appeal, as far as the first head of loss was concerned, principal reliance was placed on the earlier order of the Tribunal for the year 1952-53, in support of the assessee's stand that the assessee must be regarded as a dealer in shares as far as the shares in Navanagar Industries Ltd., were concerned. As far as the second head of loss was concerned, it was not urged before the Tribunal that the assessee did carry on the business of money-lending. It was, however, contended that this must be regarded as lending in the course of the carrying on of the business of the assessee as shareholders in a company which carried on the business of managing agency. Reliance was placed on the first part of s. 10(2) (xi) of the Act in support of the contention that this must be regarded as business loss. The Tribunal found it difficult to accept the submission of the assessee was not the managing agent of Navanagar Industries Ltd., but only a shareholder of the company which had acted as managing agent of Navanagar Industries Ltd. The connection, according to the Tribunal, was remote and the claim could not be said to have arisen or sprung directly from any business activity of the assessee. It may be mentioned that the Tribunal went on the observes that even on the assumption that it was a lending by a managing agent to the managed company, the amount loaned could not be allowed as a deduction in view of the decision of the Madras High Court in the case CIT v. Essen P. Ltd. : 50ITR569(Mad) . In the view of the Tribunal, therefore, the reasons given by the ITO and the AAC for rejection of this claim were sound and it did not find any necessity for interference. It may be mentioned that before the Tribunal the assessee had also contended that the amount of loan should be held as a capital loss within the purview of s. 12B on the footing of relinquishment. The Tribunal found itself unable to accept this contention. According to the Tribunal, relinquishment denotes a conscious act on the part of the person relinquishing. It means, according to the Tribunal, forsaking, abandoning or giving up; a certain amount of volition is involved in such act. This was not the case on the facts found. The claim was, therefore, not accepted under this alternative head also.
5. In this court as far as investment in shares of Navanagar Industries Ltd., is concerned, the learned advocate for the assessee has placed reliance on the earlier order of the Income-tax Appellate Tribunal in Income-tax Appeal No. 5293 of 1955-56, for the assessment year 1952-53, in which amongst other things it was observed that, apart from the share investment in Wallace Flour Mills and Laxmi Cotton Mills, the remaining shares must be regarded as held by the assessee as its stock-in-trade and it must be regarded as dealer in shares in connection therewith. A copy of this order is annexed as annex. c to the statement of the case. In the said appeal, the Tribunal was directly concerned with the excess realised by the assessee from sale of shares; and as far as Wallace Flour Mills and Laxmi Cotton Mills are concerned, it was observed by the Tribunal that both the scrips were taken over by the assessee on the information of the limited company, that they were not purchased in the open market and that accordingly the profit realised in respect of the two scrips was required to be treated as capital appreciation and not as profit liable to tax. The mind of the Tribunal was principally applied to these two scrips and the general observations to be found in para. 4 of the order regarding the remaining shares cannot be regarded as a definite or considered conclusion pertaining to these shares. these observations have to be read as general observations only and the view taken by the subsequent Tribunal that there was no clear finding as these shares are concerned will have to be accepted. The Tribunal in Income-tax Appeal No. 133329 of 1964-65, with which we are concerned, also rightly that it had to examine the material on record for itself and come to a proper conclusion could not be bound by the earlier observations which were of a casual nature. The Tribunal then noted the circumstances in which the assessee had come to purchase the shares of Navanagar Industries Ltd. It further observed that it had never traded in these shares and it rightly concluded that there was nothing to show that they had been acquired by the assessee with a view to trade in them. In view of these findings, the Tribunal held that the department was justified in rejection the assessee's claim regarding the write-off of the value of the shares held by the assessee in Navanagar Industries Ltd. We are in full agreement with the approach and the ultimate decision of the Tribunal on this point.
6. The second question, however, requires serious consideration. Relying upon the decision of the Madras High court in CIT v. Essen P. Ltd. : 50ITR569(Mad) , the Tribunal observed that even where the managing agent has lent certain amount to the managed company and the amount was subsequently lost, it could be allowed as a deduction. It may be pointed out that the Madras decision has been subsequently set aside by the Supreme court in its decision in Essen P. Ltd. v. CIT : 65ITR625(SC) . It is true that in the aforesaid case the managing agency agreement between the assessee-company, which was the appellant before the Supreme Court, and the managed company provided that the assessee-company should lend or advance necessary amounts required by the managed company, and amounts had been advanced from to time in accordance with the said agreement. This was one of the factors which induced the supreme Court to hold that there was material for the Tribunal to hold that the debt in question was incurred in the course of the business so as to make the loss deductible under s. 10(2)(xi).
7. A similar question was considered by a Division Bench of this court in CIT v. F. M. Chinoy and Co. (P.) Ltd. : 74ITR780(Bom) and the principle was extended to a case where there was no specific agreement making it obligatory on the managing agents to lend moneys, the court observing that it was the practice of the managing agents in the course of their duties as managing agents to procure finance for the company they had to manage. It may be mentioned that, as far as this court is concerned, this practice was noted as far back as in 1939 in CIT v. Tata Sons Ltd. : 7ITR195(Bom) . It may be further noted that the advance in Chinoy's case was not directly, made but through the device of a bank guarantee and the Division Bench concluded that the adoption of such device cannot make any real difference to the application of the principle.
8. A similar loan by the erstwhile managing agent to its managed company came to be considered in CIT v. Investa Industrial Corporation Ltd., in Income-tax Reference No. 56 of 1967 (an unreported decision of Tulzapurkar, Acting C.J., and Desai J. decided on December 11, 1976) (since reported in : 119ITR380(Bom) . It was held that the advances made by the assessee-company to Palanpur Vegetable Products Ltd., were part of or incidental to the carrying on of the assessee's business as managing agent, that termination of the managing agency of the said Palanpur Vegetable products Ltd., and taking over of the same by another company did not bring about a charge in the real character of the loan which since its inception was a loan incidental to the carrying on of the business and the writing of the loan was proper and the write-off was allowable as a deduction. The earlier decisions of this court in CIT v. Tata Sons Ltd. : 7ITR195(Bom) and of the Supreme Court in Essen P. Ltd. v. CIT : 65ITR625(SC) were noted and applied. It was further observed that when the managed company went into liquidation, the advances would become irrecoverable and in such circumstances the loss must be regarded as a trading loss and allowed as a deduction in computing the income of the assessee although at the time when the advances became irrecoverable the assessee-company was not the managing agent of the debtor-company.
9. Mr. Joshi very strenuously contended that the principle which was directly applicable to a managing agent or an erstwhile managing agent cannot and ought not to be extended further and applied where the assessee-company was merely a shareholder of V. H.D. Agencies Ltd. (the managing agents). It was submitted by him that in order to be allowed under s. 10(2)(xi) the business or trading debt should spring directly from the carrying on of the business or trade and should be incidental to it and it cannot be just any loss sustained by the assessee even if it has some connection with its business. This was the principle enunciated by the Supreme court in A. V. Thomas and Co. v. CIT : 48ITR67(SC) , at page 75 and reaffirmed in Indian Aluminium Co. Ltd. v. CIT : 79ITR514(SC) .
10. To turn once again to the statement of the case and the facts found therein, it is important to bear in mind that the memorandum of association of the assessee permitted it to carry on business as managing agents of any other company. Further, as stated in para. 3 of the statement of case, the assessee-company along with two others (the two other parties designated by the Tribunal as its partners) promoted Navanagar Industries Ltd., as also its managing agency company, V.H.D. Agencies Ltd., in which all the three parties had an equal shareholding. the short question which then arises and which is required to be answered in this reference is: can the principle which has been accepted in respect of a loan by the managing agency to the managed company be extended to apply to a constituent of the managing agency company of the type and nature of the assessee-company (bearing in mind the description of the three shareholders as partners by the Tribunal). It is true that this description is not strictly tenable in law. But it must be realised that the Tribunal was well aware of the legal or technical distinction between a limited company and a partnership firm, and being aware of this distinction of chose to describe the three shareholders as the three partners of V.H.D. Agencies Ltd., the managing agents. The question then is: if one of the three shareholders, constituents of the managing agency company, were to lend amounts to the managed company, can the advances be not regarded as springing directly from the carrying on of business or trade and incidental to it but only regard able as merely having some connection with the trade or business of the constituent If it is the former, then the amount lost to the assessee-company will be allowed as a deduction; it it is the latter, it cannot be so allowed.
11. In our view, bearing in mind the basic reality of the situation as derived from the facts stated by the Tribunal, this would be one of the cases in which the court is entitled to pay regard to the economic realities which existed behind the legal facade. The assessee-company under its memorandum of association is entitled to undertake managing agency business. It undertook that business in the instant case and in the case of Navanagar Industries Ltd., but not directly and wholly but acting in concert with two other parties and through the device of a limited company, viz., V.H.D. Agencies Ltd. We do not see how the moneys lent by the assessee-company to the managed company could not be regarded as finance provided for a company in which the assessee was substantially interested. This is in fact very phraseology employed by the ITO who was of the opinion that even if this be so, unless this was part of the money-lending activity of the assessee, the deduction had to be disallowed. We are of opinion that it was not necessary for the assessee-company to have undertaken any money-lending activity. If the object of the advancing of money was to provide finance for a company in which the assessee was substantially interested, the debt must be regarded as directly springing from its business activity and the connection cannot be considered to be too remote for the purpose of the allowance as a trading debt. The test and the approach to be applied in this case must be that of a businessman and on that approach we are of opinion that the answer given by the Tribunal cannot be sustained and the amount will have to be allowed to the assessee as a trading debt for the year in question.
In the result, the two questions referred to us are answered as follows :
Question No. 1 - In the negative and against the assessee.
Question No. 2 - In the affirmative and in favour of the assessee.
12. The assessee has partly succeeded and partly failed, and accordingly the parties are directed to bear their own costs of this reference.