In Eastman Industries Ltd v. ACIT, the Delhi ITAT held that a Company is not entitled to get deduction under Section 37(1) of the Income tax Act in respect of commission paid to its directors for their personal guarantee if such payment was not in terms with the RBI guidelines.
Assessee-company had obtained working capital limits from bank which were secured by way of hypothecation of plant & machinery, fixed assets, stocks, bicycles and auto parts in process, finished goods, book debts, export bills & other receivables and goods in transit. The loans were also secured by equitable mortgage of lease hold rights of Plot No. C- 87 & C-88, Phase V, Focal Point, Ludhiana and also by personal guarantee given by two directors of the company. In lieu of this personal guarantee, the assessee company had paid commission @ 0.6% of the amount of guarantee amounting to Rs.10,19,293/-. For the year under consideration, assessee claimed deduction in respect of commission paid by them. However, AO rejected the claim and held that it is not covered by section 37(1) of the Act. The first appellate authority allowed the claim on appeal.
On appeal, the department vehemently argued that the guarantee commission which has been paid to the directors is not legitimate and has no nexus with the business of the assessee company. It was submitted that the assessee company had given sufficient security to the bank as per their requirements and the personal guarantee of the directors was not the part of loan documentation.
The bench noted that the first appellate authority, while holding in favour of the assessee, has considered the only aspect that the personal guarantee of the directors was given by the assessee company on the instance of the Bank. It was observed that the authority has not addressed on the core issue whether the commission paid to the directors in lieu of their personal guarantee was legally justified or not to qualify for deduction.
After analyzing the RBI circular pertaining to Guarantees and Co-acceptances, the bench pointed out that the payment of commission/remuneration is permissible to the directors against their personal guarantee only on the following conditions, i.e., (i) Where the assisted concerns are not doing well; (ii) Where the existing guarantors are no longer connected with the management; (iii) Where the personal guarantee of existing guarantors is essential to continue; and (iii) Where new management’s guarantee is either not available or is found inadequate.
Considering the facts of the case, he bench said that none of the exceptional situation was present in the case. “We, therefore, restore this issue to the file of the Assessing Officer to examine from the original bank documentations/agreements/sanction letter and to ascertain whether the requirement of non-payment of commission to the guarantors was incorporated in the terms and conditions of bank for sanctioning of credit limit or whether any undertaking to this effect was taken from the company or not in terms of RBI guidelines noted above. In case, the result of enquiry comes in affirmative, it shall be deemed that the assessee was well aware of the fact that no commission etc. was to be paid against personal guarantee of directors, but the same has been paid to take undue benefit thereof by seeking deduction u/s. 37(1), which is not permissible under the Act. If the result of enquiry comes in negative, the Assessing Officer shall proceed to test the allowability of the above expenditure, as claimed by the assessee as per law.”
Read the full text of the Order below.
