Commissioner of Income Tax, Bombay vs M/S Jagannath Kissonlal

Rewritten Version Notice: This is a rewritten version of the original judgment.

Court: Supreme Court of India

Case Number: Civil Appeal No. 358 of 1958

Decision Date: 24 November 1960

Coram: J.L. Kapur, M. Hidayatullah, J.C. Shah

The case was titled The Commissioner of Income‑Tax, Bombay City I versus M/S Jagannath Kissonlal, Bombay, and was decided by the Supreme Court of India on 24 November 1960. The judgment was authored by Justice J.L. Kapur, who was joined by Justices M. Hidayatullah and J.C. Shah. The official citation of the decision is 1961 AIR 748 and 1961 SCR (2) 644, with additional citator references R 1961 SC 668 (8) and R 1965 SC 321 (18). The matter fell under the Income‑Tax Act, specifically dealing with money borrowed by two persons for business purposes on a joint and several liability basis, the failure of one borrower to meet his share, the payment of the whole debt by the other borrower, and the deductibility of the unpaid portion as a business loss under Section 10(2)(XV) of the Indian Income‑Tax Act, 1922 (Eleventh Amendment).

For the purpose of its business, the respondent, a firm of commission agents, borrowed a sum of money from the Bank of India by executing a promissory note jointly with an individual named Kishorilal. This borrowing followed a well‑known commercial practice of raising business finance on joint and several liability, which enabled the borrowers to secure a lower rate of interest. The loan amount was divided equally, with each party responsible for half. Kishorilal subsequently became insolvent and was adjudicated bankrupt, and consequently he failed to discharge his share of the liability. The respondent was therefore compelled to pay the full amount of the loan to the bank. Later, the Official Assignee returned to the respondent a portion of the sum that Kishorilal had originally drawn, leaving a balance that remained unpaid. The respondent sought to deduct this outstanding balance as a loss incurred in the course of his business under the relevant provision of the Income‑Tax Act.

The Income‑Tax Officer and the Appellate Assistant Commissioner rejected the respondent’s claim for deduction. The respondent appealed this refusal to the Income‑Tax Appellate Tribunal, which allowed the deduction. The matter was then taken on reference by the Commissioner to the Bombay High Court, which decided the question in favor of the respondent assessee. Dissatisfied with that decision, the Commissioner filed an appeal by special leave to the Supreme Court, challenging the High Court’s view.

The Supreme Court held that the High Court’s decision was correct. The Court observed that there was a well‑established commercial practice of financing business through joint and several liability borrowing, which permitted the respondent to obtain credit at a lower interest rate. It further noted that the borrowers shared a mutual surety arrangement for each other’s loans taken for business purposes. Accordingly, the respondent, while computing his business profits, was entitled to deduct the loss he suffered by paying the amount that his co‑borrower failed to pay. In reaching this conclusion, the Court applied the precedent set in Commissioner of Income‑Tax v. Ramaswami Chettiar [1946] 14 I.T.R. 236, distinguished the decisions in Madan Gopal Bagla v. Commissioner of Income‑Tax [1956] S.C.R. 551 and Commissioner of Income‑Tax v. S.R. Subramanya Pillai [1950] 18 I.T.R. 85, and held that Montreal Coke and Manufacturing Co. v. Minister of National Revenue [1945] 13 I.T.R. Supp. 1 was not applicable. The judgment was delivered in Civil Appeal No. 358 of 1958, an appeal by special leave from the judgment and order dated 8 March 1956 of the former Bombay High Court in I.T.R. No. 55 of 1955.

Advocates A. N. Kripal and D. Gupta appeared on behalf of the appellant, while advocates N. A. Palkhivala and B. P. Maheshwari represented the respondents. The judgment was delivered on 24 November 1960 by Justice Kapur.

This proceeding is an appeal by special leave from the judgment and order of the High Court of Bombay in Income‑tax Reference No. 55 of 1955. The reference before the High Court presented two questions of law for consideration, and the High Court answered both questions in favour of the assessee and against the Commissioner of Income‑tax, who is the appellant in the present appeal, while the assessee is the respondent.

The respondent is a firm duly registered under the law and engaged in the business of acting as commission agents in Bombay. In order to carry out its commercial activities, the firm regularly borrowed money from banks by executing joint promissory notes that bound it and other persons on a joint‑and‑several liability basis.

On 26 September 1949 the respondent executed a joint promissory note with a person named Kishorilal and, on that basis, obtained a loan of one hundred thousand rupees from the Bank of India. Of that loan the respondent drew fifty thousand rupees for its own business purposes, while the remaining fifty thousand rupees were drawn by Kishorilal.

Kishorilal subsequently failed to honour his liability and was declared bankrupt. As a result, the respondent was compelled to repay the entire amount of one hundred thousand rupees together with the applicable interest to the bank.

During the accounting year that ran from 26 August 1949 to 17 July 1950, the respondent received from the Official Assignee a sum of eighteen thousand eight hundred five rupees representing the portion of Kishorilal’s liability that had been realised. The respondent then claimed a deduction for the balance of thirty‑one thousand seven hundred forty rupees, arguing that the loss was incurred in the course of its business.

The assessment year for this accounting period was 1951‑52. Both the Income‑tax Officer and the Appellate Assistant Commissioner disallowed the claimed deduction.

The respondent appealed to the Income‑tax Appellate Tribunal. The Tribunal permitted the deduction, holding that it fell within section 10(2)(xv) of the Income‑tax Act and that it constituted a business loss.

Following the Tribunal’s decision, the Commissioner of Income‑tax instituted a reference before the High Court of Bombay. In the statement of case, which was jointly agreed to by both parties, the Tribunal set out its findings. It stated that, for the purpose of its business, the assessee regularly borrowed money from banks on a joint‑and‑several liability basis, and that such a mode of borrowing represented a recognised commercial practice in Bombay.

The Tribunal illustrated this practice by describing a scenario in which two persons, A and B, each required fifty thousand rupees. The bank would not advance fifty thousand rupees to each of them on the basis of their individual securities, but would be willing to advance one lakh rupees on their joint‑and‑several liability. The bank would then supply the one lakh rupees and A and B would each receive fifty thousand rupees.

The Tribunal further observed that banks sometimes advanced loans to individual borrowers on the basis of personal security, but that the interest rate charged in such cases was higher than the rate applicable when the loan was obtained on a joint‑and‑several liability basis. It concluded that the loan of one hundred thousand rupees obtained by the respondent from the Bank of India was consistent with the commercial practice prevailing in Bombay.

On the basis of the facts that had been established, two points of law were referred to the High Court for determination. The first point asked whether the assessee’s claim could be sustained under section ten two x v of the Income Tax Act. The second point asked whether the assessee’s contention that the loss was a loss incurred in the ordinary course of his business and therefore deductible in the computation of his business profits could be sustained according to law. Both of these questions were answered in favor of the respondent and against the appellant. The counsel representing the Commissioner attempted to challenge the Tribunal’s findings regarding the existence of a recognised commercial practice in Bombay. However, that line of attack was unavailable because the Tribunal had expressly recorded the finding in its order, and the same finding was also restated in the agreed statement of the case, as shown by the quoted passage. The High Court likewise proceeded on the assumption that such a commercial practice existed. In the judgment that is under appeal, the learned Chief Justice observed that the Tribunal’s finding was clear and explicit: the assessee’s activity was not extraordinary, but rather he was borrowing money on joint and several liability in a manner that was established as a commercial practice. Consequently, the transaction was clearly part of the business and incidental to it, and it was this transaction that produced a loss to the assessee because he was required to honour the surety liability. Therefore, the appeal had to be decided on the premise that a commercial practice of financing business by borrowing on joint and several liability was firmly established. The appellant argued that the decision in Madan Gopal Bagla v. Commissioner of Income Tax, West Bengal (1) had decided against allowing such losses. Nevertheless, the Court observed that, when the facts of that case were examined closely, they were distinguishable and the earlier decision did not support the appellant’s contentions. Although certain aspects of the two cases were similar, they differed in essential respects. In the earlier case, the assessee was a timber merchant who obtained a loan of one lakh rupees from the Bank of India on the joint security of himself and a person named Mamraj, a loan that the assessee subsequently repaid. Mamraj also obtained a loan of one lakh rupees on his joint security with the assessee, but Mamraj later became insolvent, obliging the assessee to pay the entire amount together with interest. The assessee received a dividend from the Receiver and wrote off the remaining amount as a bad debt in the assessment year, claiming it as an allowable deduction under section ten. The High Court held that the debt could not be characterised as a debt incurred in the course of the assessee’s business because the assessee was not engaged in the business of standing surety for others nor was he a money‑lender; he was merely a timber merchant.

In the present case the Court observed that the assessee, a timber merchant, had neither demonstrated nor been accused of regularly standing as surety for other persons “along with them for purposes of securing loans for their use and benefit.” The Court further noted that even if money had been borrowed in the manner described in the earlier decision (1) [1956] S.C.R. 551 and a loss had resulted, such loss would be treated as a capital loss rather than a loss arising from the business of the assessee. This principle of law, previously approved by the Court, required the presence of mutuality as an essential element of the custom alleged. The Court found that mutuality was missing, as illustrated by the following excerpt from the judgment under review.

The custom reported to the Appellate Assistant Commissioner held that businessmen in Bombay commonly obtained loans from banks on joint security in order to obtain financial assistance at lower rates of interest. A businessman could obtain a loan on his own, but he would have to pay a higher rate of interest. He could secure a lower rate of interest if another businessman, acceptable to the bank, stood as his surety. The Court clarified, however, that this practice did not necessarily imply that mutual accommodation among businessmen formed an inherent part of the custom. While person A could invite persons B, C or D to act as his surety to obtain favourable loan terms, the custom did not require that A must, in turn, act as surety for the loans that B, C or D obtained for their own businesses. Unless such reciprocal suretyship was established, merely arranging for B, C or D to act as surety would not be enough to sustain the custom that the appellant sought to rely upon. Consequently, the appellant’s act of joining Mumraj Rambhagat as surety for the loan that Mumraj obtained from the Imperial Bank of India could not be characterised as an activity carried out in the ordinary course of the appellant’s timber business, nor could the resulting loss be treated as a trading loss or a bad debt of the timber business.

Continuing on page 558, the Court observed that the present case lacked both the element of mutuality and the essential feature of a money‑lending business that had been proven to exist in the earlier case. The Court thus concluded that the custom relied upon in the earlier authority was not present here. Counsel for the respondent correctly argued that the decision in Madan Gopal Bagla’s case (1) had been rendered against the assessee because the custom of persons mutually standing as sureties for each other, together with the element of mutuality—an essential ingredient in Commissioner of Income Tax, Madras v. S. A. S. Ramaswamy Chettiar (2)—was not established.

It was held that the alleged custom was not proved. In the earlier case, Commissioner of Income Tax, Madras v. S. A. S. Ramaswamy Chettiar, the court had established that a well‑recognised custom existed among Chettiars for raising funds for their money‑lending business by executing joint promissory notes, and that a loss incurred by one executant who had to pay the whole debt because the other executant could not pay was a deductible loss. The appellant also relied on a judgment of the Madras High Court in Commissioner of Income Tax v. S. R. Subramanya Pillai. In that case the assessee, a book‑seller, had at times borrowed money jointly with another person, using a portion of the loan for his trade while the other debtor received the balance. When the latter became insolvent, the assessee paid the entire amount and claimed a deduction under section 10(2)(xi) or section 10(2)(xv) of the Act as a business loss. The court held that the assessee was not entitled to the deduction because the loss was too remote from the book‑selling business and not sufficiently connected with the trade, therefore it fell outside the range of amounts that could properly be brought into the profit and loss account. The decision in Commissioner of Income Tax v. S. A. S. Ramaswamy Chettiar was distinguished on the ground that its reasoning was confined to its own peculiar facts and could not be applied to a business such as that of Subramanya Pillai. The following passage from the judgment of Viswanatha Sastri, J., is therefore relevant: “But there the business was one of money lending and the Court found that according to the well‑known and well‑recognised mercantile custom of Nattukottai bankers, they were in the habit of raising ‘funds which formed the stock‑in‑trade of their money‑lending business by the execution of joint promissory notes in favour of bankers.’ That was apparently the usual technique of obtaining credit adopted by the Nattukottai Chetti community money‑lenders. In the context this Court held that where a Nattukottai Chetti money‑lender paid off in their entirety the debts jointly due by him and another as a result of the latter’s inability to pay, the loss sustained as a result of this transaction was a loss of the money‑lending business itself and therefore a deductible item in computing profits.” In the present case it was found that a well‑recognised commercial practice existed in Bombay of carrying on business by borrowing money from banks on joint and several liability. It was also observed that by borrowing on such a basis the borrower could obtain a lower rate of interest than would otherwise be payable; the respondent, following this commercial practice, borrowed the money and was required to return the whole amount because the joint promisor, Kishori Lal, became bankrupt, and mutuality was therefore proved.

In this case the Court observed that the respondent, following the recognised commercial practice, had borrowed the sum of money and was required to repay the entire amount because the co‑promisor Kishori Lal had become bankrupt; the Court also found that mutuality was proved. The Court stated that the essential feature of the present dispute was not fundamentally different from the principle laid down in Commissioner of Income‑tax v. Ramaswamy Chettiar (1). In both decisions the finding was that there existed mutuality and a customary practice of borrowing on joint promissory notes for the purpose of carrying on business. Accordingly, after considering the circumstances established in the present case, the facts proved, and the findings recorded, the Court held that the respondent was correctly entitled to deduct the loss he incurred in the transaction that was the subject of the appeal. Counsel for the assessee referred the Court to a judgment of the Privy Council in Montreal Coke and Manufacturing Co. v. Minister of National Revenue (1) reported in (1946) 14 I.T.R. 236. The Court explained that that decision could not be applied to the present facts because, in that case, the assessee’s financial arrangements were shown to be distinct from the activities by which the assessee earned income, and the expenditure incurred in financing the business was not regarded as expenditure incurred in earning income within the statute. The assessee also contended that the respondent’s loss constituted a capital loss and relied upon the Court’s earlier decision in Madan Gopal Bagla’s case (2), particularly the passage on page 559 where Bhagwati, J. quoted with approval the observations of the High Court. The Court noted that the facts of that earlier case were distinguishable and that its observations did not apply to the facts and circumstances proved in the present matter. Consequently, the Court affirmed the High Court’s judgment, dismissed the appeal with costs, and recorded the dismissal of the appeal.