Facts of the Case

The assessee, WGF Financial Services Pvt. Ltd., filed its return for Assessment Year 2015-16 declaring a loss, which was later revised. The assessment under Section 143(3) resulted in additions including long-term capital gains, disallowance of bad debts amounting to ₹27.76 crore, and disallowance of legal expenses.

The bad debt arose from a Commitment Agreement dated 18.11.2009, under which the assessee and other group entities stood as guarantors for loans availed by group companies from Indiabulls Financial Services Ltd. Upon default by the borrowers, the assessee discharged the guarantee obligation. Subsequently, a settlement was entered into with one borrower, Carissa Investment Pvt. Ltd., whereby only part recovery was made and the balance amount of ₹27.76 crore was written off as bad debt in FY 2014-15.

Issues Involved

Whether the amount written off by the assessee on account of discharge of guarantee obligation for a group company was allowable as bad debt under Section 36(1)(vii) read with Section 36(2) or as a business loss, and whether the ITAT was justified in treating the transaction as a prudent business decision rather than a colourable device.

Appellant’s Arguments

The Revenue contended that the assessee was not in the business of providing guarantees and that furnishing a guarantee for group companies was a one-time transaction not undertaken in the ordinary course of business. It was argued that no guarantee commission was ever recognised as income and that the conditions under Section 36(2) were not satisfied. The Revenue further alleged that the arrangement was a colourable device intended to transfer losses within the group to reduce tax liability.

Respondent’s Arguments

The assessee argued that it was engaged in financing activities and that furnishing guarantees fell within the scope of its business. It was contended that the loss was genuine, arose during the course of business, and was therefore allowable either as bad debt or as business loss. The assessee also submitted that it was commercially prudent not to pursue legal recovery in view of the borrower’s financial position.

Court Order / Findings

The Delhi High Court examined the objects of the assessee company and found that standing as a guarantor was neither its main business nor an activity carried out in the ordinary course of business. The Court noted that the guarantee in question was a one-off transaction involving group companies and not an adventure in the nature of trade.

The Court held that the conditions under Section 36(2) were not satisfied, as the alleged commission income was never recognised and the assessee was not engaged in the business of money lending or standing surety as a regular activity. The Court also found merit in the Revenue’s contention that the assessee deliberately refrained from recovery despite the borrower having the capacity to make payments, indicating a colourable arrangement within the group.

Relying on Supreme Court decisions in Madan Gopal Bagla and Birla House (P) Ltd., the Court held that losses arising from guarantees not given in the ordinary course of business cannot be allowed as bad debts or business losses.

Important Clarification

The Court clarified that for allowance of bad debts or business loss, it is essential that the transaction giving rise to the loss be undertaken in the ordinary course of business. One-time guarantees furnished for group entities, without regular business practice or income recognition, do not qualify for deduction merely on grounds of commercial prudence.

Final Outcome

The appeal filed by the Revenue was allowed. The Delhi High Court set aside the order of the Income Tax Appellate Tribunal and restored the disallowance of bad debts amounting to ₹27.76 crore. The questions of law were answered in favour of the Revenue and against the assessee.

Link to download the order - https://www.mytaxexpert.co.in/uploads/1770017087_PRINCIPALCOMMISSIONEROFINCOMETAX7VsWGFFINANCIALSERVICESPVT.LTD..pdf

 

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