ORDER
Mahavir Singh, J.M.
The appellant- assessee is in appeal against the order of learned Commissioner (Appeals), Tiruchirapally, dated 30-9-2002.
2. The brief facts of the case are that the appellant- company is a private limited company manufacturing HDE pipes. The company filed its return of income for the relevant assessment year admitting ‘Nil’ income. Assessment was framed under section 143(3).
3. Before us, the appellant has contested two issues:
The first issue is regarding disallowance of Rs. 4,20,000, confirmed by the Commissioner (Appeals), being the commission paid to the directors, and the second issue is regarding confirming the disallowance by Commissioner (Appeals), the amount of Rs. 13,47,894 being the interest payable in respect of investments made in M/s Virgo Polymers India ITD.
4. Now, we will consider the first issue, i.e., the commission paid to the three directors amounting to Rs. 4,20,000. In its return of income, the appellantcompany had claimed expenditure on account of sales commission to its three directors, namely, Shri A. Ramadoss, Smt. R. Lalathi, wife of Shri Ramadoss and Shri R. Chakravarthy S/o Shri Ramadoss, amounting to Rs. 1,20,000 each to the first two, and Rs. 1,80,000 to the third. While framing assessment, the assessing officer asked for justification of the above payments. The appellant-company replied that the commission had been duly accounted for and that all the recipients are income-tax assessees and they had declared the commission received, in their respective returns of income. Purther, the assessing officer required the appellant to show what services were rendered by each of the recipients of the commission. The assessing officer made addition of this commission of Rs. 4,20,000 and disallowed the entire Claim of the. appellant- company by giving the reasons that the appellant had not furnished specific evidence in support of the services rendered by the directors and also that orders attributed to them could not have been secured. Aggrieved, the appellant moved before the first appellate authority, Tiruchirapally.
4.1 The learned Commissioner (Appeals), by giving various reasons, upheld the order of the assessing officer and confirmed the addition made on account of the sales commission amounting to Rs. 4,20,000 paid to the three directors.
4.2 Before us, the counsel for the appellant-assessee argued that the sales commission was paid to the three directors @ 5 per cent of the total value of orders secured from M/s Shree Balaji Poly Packs, of the value of Rs. 30.72 lakhs for the year 1996-97, Rs. 32.24 lakhs for 1997-98 and Rs. 25.34 lakhs for the year 1998-99. It was further argued that M/s Shree Balaji Poly Packs insisted on personal guarantees of the direttors for the purpose of delivery of goods for conversion and these three directors furnished guarantees and the appellantcompany was to pay commission to these three directors as they had furnished guarantees. It was further argued by him that all the directors had declared the income of sales commission in their respective returns of income for the relevant assessment years and further drew our attention towards a letter dated 26th Feb., 1996, from M/s Shree Balaji Poly Packs to the appellant- company by which M/s Shree Balaji Poly Packs has specifically asked that “you may send your acceptance along with guarantee for performance as wen as value of our goods lying at your end either from any bank or other institutions or by way of personal guarantee by all of your directors”. Even a copy of the board’s resolution dated 4-3-1996, was filed and this was already available in the assessment record. On the other hand, the learned departmental Representative argued that there was a direct relationship as Shri R. Chakravarthy was a partner in M/s Shree Balaji Poly Packs before the close of the year and he was also a director in the appellant- company, and further that no specific evidence was given to prove that this commission expenditure was required or not. Sales cornmission/personal guarantee commission was not given in normal practice of business. In reply to this, the counsel for the appellant argued that personal guarantee can be sued for non-performance of guarantee and even the Commissioner (Appeals) had already admitted this fact in his order vide para 3.31, and he cited the complete parawhich is as under :
“The fact remains that the three directors did not render any services towards securing orders from M/s Shree Balaji Poly Packs. They merely offered personal guarantees to M/s Shree Balaji Poly Packs for “performance and value of goods” received from this concern for conversion. This being the case, there is no reason why this appellant did not show the.commission in question under the head ‘guarantee commission” which would have been appropriate. The reasons for showing the commission under the wrong head ‘sales commission’ have not been explained.” The counsel further argued that section 40A(2) was not invoked while disallowing this sales commission by the assessing officer.
4.3 On this issue, we have heard rival submissions and contentions and perused the materials placed before us. The counsel also placed before us, a paper book containing pp. 1 to 36. It is seen that the sales commission was paid to the three directors @ 5 per cent of the total value of the order secured from M/s Balaji Poly Packs for the value of Rs. 30.72 lakhs for the year 199697, 32.24 lakhs for 1997-98 and Rs. 25.34 lakhs for the year 1998-99. For these years, all the three directors stood personal guarantees for the performance and value of goods and in order to meet the above demand of personal guarantees by the directors, the appellant- company had paid sales commission/guarantee commission as insisted by Shree Balaji Poly Packs vide letter dated 26th Feb., 1996 and all the directors had declared the income from sales commission to the extent of Rs. 4,20,000 in their respective returns of income for the relevant assessment years. Even it is not denied by the assessing officer or it is claimed by the assessing officer that excess payments have been made. Even the first appellate authority had not doubted these payments or their reasonableness. Rather, the Commissioner (Appeals) had admitted that the three directors have offered personal guarantees to Shree Balaji Poly Packs for performance and value of goods. Rather, the Commissioner (Appeals) suggested that there was no reason why the appellant did not show the commission in question under the head 1. guarantee commission” which would have been appropriate. It is seen from the Commissioner (Appeals)’s order that the three directors have given personal guarantees to several concerns for securing loan for M/s Virgo Polymers India ITD. The learned Commissioner (Appeals) in his order has tried to find a nexus between the guarantees given by the three directors and the net worth and that in the business it is common and usual that guarantees are given and taken. By these means expenditure on sales commission cannot be disallowed. Rather, it shows that the three directors are men of ‘means’, especially when Tainil Nadu Industrial Investment Corporation ITD., the Lakshmi Vilas bank ITD., the Commercial Tax department of the Government of Tamil Nadu and M/s Industrial Development bank of India have accepted their guarantees as per the Commissioner (Appeals). Even it is not the case of the revenue that the expenditure incurred or payment made is excessive or unreasonable having regard to the Fair Market Value (FMV) of the services rendered or facilities for which payment is made or the legitimate needs, of the business of the assessee and the benefits derived by the assessee. The. Assessing Officer has not even invoked provisions of section 40AM(a) of the Act. In view of the above submissions and discussions, the appellant was justified in paying commission to its directors against value of the order secured from M/s Shree Balaji Poly Packs ITD. and the personal, guarantees offered by the directors for the performance and value of goods delivered for conversion. In view of the above, we allow this issue of this appeal in favour of the assessee and set aside the order of the Commissioner (Appeals) in confirming the order of the assessing officer on this issue.
5. The next issue in the appeal is regarding confirming of disallowance made of Rs. 13,47,894 being the alleged interest payable in respect of investment made in M/s Virgo Polymers India ITD. The assessing officer, while framing the assessment saw that the appellant-assessee had claimed a loss of Rs. 31,70,350 in the P&L a/c on account of the investment. Since the appellant-assessee had made investment to the tune of Rs. 95,09,550 as on 31-3-1997, in acquiring 3,98,200 shares of M/s Virgo Polymers India ITD., the assessing officer after taking over the investment for the assessment year 1997-98 at Rs. 74,88,300 and by applying a flat rate Of 18 per cent on this investment, the interest worked out was Rs. 13,47,895. The assessing officer disallowed this amount of interest as not relating to business even though it was stated before the assessing officer that the investment had not been made out of any borrowed funds and that no interest had been paid for the amount invested in hares. The assessing officer treated the amount invested as loans taken from TI1C. For making the addition, he gave the finding that the amounts borrowed were invested in various fields such as shaking trade, machineries, etc. Repayments are being made out of the day-to-day transactions realised during the course of business. This being the case, it cannot be stated that no portion of the borrowed funds had been actually used by the assessee for the purpose of investments in M/s Virgo Polymers India ITD. and keeping in view these circumstances, the assessing officer held that the interest @ 18 per cent per annum on the average debit balance amounting to Rs. 13,47,894 is disallowed as not relating to business purpose. Aggrieved by this, the appellant preferred appeal before the Commissioner (Appeals).
5.1 Before the Commissioner (Appeals), it was argued that no part of the investment in shares of M/s Polymers India ITD. had been made out of interest-bearing borrowed funds and the borrowals as referred to by the assessing officer in the assessment year and thus there was no nexus between the interest-bearing borrowed funds and investment made in shares of M/s Virgo Polymers India ITD. But the Commissioner (Appeals), by giving various reasons, upheld the order of the assessing officer and confirmed the addition made on account of the interest amounting to Rs. 13,47,894.
5.2 Before us, the counsel for the appellant-assessee argued that there was no nexus between the interest-bearing borrowed funds and the amount invested in securing the shares.of M/s Virgo Polymers India ITD. He further argued that this investment in securing shares of M/s Virgo Polymers India ITD. was made for the purpose of business and there was no diversion of funds as such. The investment in public issue was for the purpose of business and he argued that the assessing officer erred in presuming.and the Commissioner (Appeals) erred in confirming the presumption of the assessing officer that the appellant’s investment with M/s Virgo Polymers had no business nexus and that, on the contrary, the appellant- company was getting orders from M/s Virgo Polymers right from its inception, and it was further argued that the very existence of the appellant- company depended on the orders received from M/s Virgo Polymers. Therefore, the investment was made keeping in view the commercial interest of the appellant. The counsel further argued that the investment in question had no connection whatsoever with the interest-bearing loans as against the investment made in the abovementioned concern was on or before 3rd April, 1996. Again, the counsel argued that the allegation of the Commissioner (Appeals) in linking the investment with the loan taken from M/s THC amounting to Rs. 60 lakhs, he argued that this loan was taken only on 23-5-1996. He further argued that the assessing officer had not brought out a single instance in linking the nexus between interest-bearing loans and investment made by the appellant-company. Further, it was argued that the funds so utilised were not in the nature of borrowals, let alone, interest-bearing borrowals. The investment made in shares is for the purpose of business and only for the purpose of business and he also drew our attention to the judgment of the Hon’ble Bombay High Court in the case of CIT v. Amiltaben R. Shah (2000) 158 CTR (Bom) 195: (1999) 238 ITR 777 (Bom). He distinguished this case of the Hon’ble Bombay High Court on the facts that, there the shares held were not for controlling the other company. He also stated that there was improvement in the business after making the investment in the shares and even on disallowance of interest, he argued that it was not a notional interest. For this purpose, he drew our attention towards the Apex Court judgment in the case of CIT v. Rajendra Prasad Moody 1978 CTR (SC) 141 : (1978) 115 ITR 519 (SC). The learned counsel alternatively argued that proportionate interest should have been allowed as deduction either under section 57(i) or section 57(iii) or section 37(1) of the Income Tax Act. He drew our attention to the fact that the memorandum of association provided for such investment and, therefore, the same should have been considered as part of the appellants business activity. He also justified the investment referring to the long standing commercial relationship with M/s Virgo Polymers ITD. On the other hand, the learned departmental Representative argued that the memorandum of association lists investment as one of the objects and he read out the objects which are as under
“The memorandum of association no doubt lists out one of the objects as to invest any money of the company in such investment other than stock or share in the company as may be thought proper and to hold, sell or otherwise such investments”.
He further argued that from the above, it was clear that in making the impugned investments, the appellant had not complied with the object clause in the memorandum which authorises investment in shares only from out of idle funds. He further argued that such type of investment could not be construed as partaking the nature of the appellant’s business activity.
5.3 We have heard rival submissions and contentions and perused the materials placed before us including the paper book filed by the counsel for the appellant- company bearing page Nos. 1-36. It is seen that the appellantcompany had made investments on or before 3-4-1996, in shares of M/s Virgo Polymers India ITD. for the’relevant assessment year for securing 3,98,200 shares. The assessing officer while framing assessment, disallowed proportionate interest to the extent of Rs.. 13,47,894 on this investment. While making the addition, the assessing officer had not gone into whether all the interest-bearing borrowals had been invested or otherwise. If at all any diverse inference has to be drawn by the assessing officer, on interest from advances, it is his duty to give categorically his findings that such advance had directly originated from interest-bearing loans. The assessing officer went wrong and further the Commissioner (Appeals) also went wrong in upholding the assessing officer.’s version that appellant’s investment with M/s Virgo Polymers ITD. had no business nexus. On the other hand, it is apparent from the records, the appellant was getting orders from M/s Virgo Polymers ITD. and the appellant’s very existence depended on the orders received from M/s Virgo Polymers ITD. to the extent of 80 to 90 per cent. Therefore, investment in shares was made keeping in view the commercial interest of the appellant.
It is further seen from copy of the memorandum of association of the appellant-company that investment in shares was one of the appellant’s business objectives. Since the memorandum of association provides, as one of its objectives, to make investment, why the same should not be considered as part of the appellant’s business activity even though the appellant had made investment through public issue. The learned departmental Representative argued that the memorandum of association no doubt lists one of the objects as to invest any money of the company in such investment other than stock or share in the company as may be thought. He further argued that this however, does not mean that any and every listed item will have to be considered as business activity of the company. It is not right on the part of the learned departmental Representative that when a particular activity listed in the memorandum of association or article of association of a company states that when investment of the money of the company is listed as one of the objects, undoubtedly, the memorandum states that only surplus funds are authorised to be invested in stocks and shares.
It is pertinent to mention that either the assessing officer or the Commissioner (Appeals) had not brought on record that the funds invested were not surplus. No doubt, from the records, it is clear that the appellant- company owed Rs. 36,49,502 to M/s Virgo Polymers ITD. as on 31st March, 1996 and this payment had practically been received by the appellant through banking channels. Even this does not make anything clear either from the order of the assessing officer or Commissioner (Appeals) whether this advance has been utilised by the appellant for acquisition of shares. Even the loan raised from the TI1C amounting to Rs. 60 lakhs was received on 23rd May, 1996 and the investment was made on or before 3rd April, 1996, by the appellant- company. This has no nexus at all between the investment and the interest-bearing funds. During the course of hearing, the counsel for the assessee drew our attention towards Bombay High Court judgment in (2000) 158 CTR (Bom) 195 : (1999) 238 ITR 777 (Bom) (supra) and also Kerala High Court judgment in the case of CIT v. V1 Baby & Co. (2002) 174 CTR (Ker) 164 : (2002) 254 ITR 248 (Ker). In the present case, from the order of the assessing officer and that of the Commissioner (Appeals), it is not clear that the amount invested by the appellant- company was out of diverted funds and diverted out of interest-bearing loans. So, in view of this, the facts in the Kerala High Court decision are distinct from the facts of the present case. The decision of the Kerala High Court was as under :
“An assessee with liquidity cannot claim that it can give interest-free advances to the partners and others and then borrow funds from the bank on interest for business purposes. Such borrowings will not be for business purposes, but for supplementing the cash diverted by the assessee without any benefit.
In these circumstances, the learned Commissioner (Appeals) has erred in giving the finding that the investment made by the appellant in M/s Virgo Polymers India ITD. had not been made from out of appellant’s business consideration. Even the Commissioner (Appeals) had not proved a direct nexus between the interest-bearing funds and investments made by the appellant- company.
Even on the alternative plea of the appellant- company that the interest was disallowed, should have been allowed as expenditure under the head “income
from other sources”, i.e., income from dividends. We have gone through the arguments of the appellant’s counsel that proportionate interest should have been allowed under section 57(iii) and that it was not notional interest as envisaged by Commissioner (Appeals) . Sec. 57(iii) reads :
“any other expenditure (not being in the nature of capital expenditure) laid out or expended wholly and exclusively for the purpose of making or earning such income”.
Section 57(iii) refers to expenditure actually incurred and that too only. exclusively and necessarily for the purpose of earning income from other sources and not to
notional interest and the present is not notional interest. Since, if at all the Commissioner (Appeals) did not agree with the first plea of the appellant-company, at least proportionate interest disallowed by the assessing officer should have been considered for deduction under the head “income from other sources”, as envisaged under section 5704.1t is clear That the investment made by the appellant was made with a view to earning dividends. From the foregoing discussions, it is clear that proportionate interest attributed to investment made by the appellant-company in Ws Virgo Polymers ITD. should have been allowed as deduction under section 57(iii) but since the issue is decided in favour of the assessee on the first plea and the action of the Commissioner (Appeals) in confirming assessing officer’s disallowance of interest paid on the investment made by the appellant-company in the shares of Ws Virgo Polymers ITD. is quashed, and. in the result, the issue is decided in favour of the assessee.
6. In the result, the appellant- company’s appeal is allowed.