Payment Towards Corporate Guarantee Settlement Allowable as Deductible Business Expenditure u/s 37(1): ITAT [Read Order]

In a recent ruling, the Delhi Bench of the Income Tax Appellate Tribunal (ITAT) held that a payment made towards the settlement of a corporate guarantee qualifies as a deductible business expenditure under Section 37(1) of the Income Tax Act, 1961, thereby allowing the claimed deduction.

The assessee, Escorts Limited, had provided a corporate guarantee to a Korean supplier, L.S. Cables, Korea (LSM), to secure supplier credit for its US step-down subsidiary, Farmtrac North America LLC (FNA).

The subsidiary defaulted, and the guarantee was invoked, leading to arbitration before the International Chamber of Commerce (ICC), which culminated in an award against the assessee and a subsequent settlement of USD 7.17 million. To protect its business interests, the assessee entered into a settlement agreement and paid the first installment of 50% of the settlement amount in Assessment Year (AY) 2016-17.

The liability (Rs. 47.64 crores) was claimed as a business expenditure under Section 37(1), which the Assessing Officer (AO) disallowed, holding that the expenditure was not incurred wholly and exclusively for business purposes. The Commissioner of Income Tax (Appeals) (CIT(A)) upheld the AO’s decision, leading to the present appeal.

The appellant contended that the said expenditure arose from a corporate guarantee given in the ordinary course of business to support its subsidiary and promote its own business operations. The guarantee was given wholly and exclusively for business purposes, as FNA was promoting the assessee's "Farmtrac" brand in the US market. Once the subsidiary defaulted and the guarantee was invoked, the resulting liability was a direct business obligation.

They also relied on W.S. Industries (India) Ltd. and M/s Wires & Fabrics (SA) Ltd., contending that identical corporate guarantee claims had been consistently allowed and that the AO couldn’t negate commercial expediency without rebutting the assessee's assertions. Therefore, the settlement amount paid pursuant to the arbitration award was incurred for legitimate business purposes and must be allowed as a deduction under Section 37(1).

The Revenue argued that no valid corporate guarantee existed, as the Korean supplier (LSM), in whose favor the guarantee was extended, had not countersigned the agreement. Further, the assessee's own challenge to the guarantee's validity during arbitration proceedings undermined its own claim.

Additionally, the assessee also failed to establish that the expenditure was incurred for its own business purposes, as FNA was merely a step-down subsidiary in which the assessee held only a 75% beneficial interest.

So it contended that the claim, having been made only in the revised return, lacked substantiation and did not satisfy the requirements of Section 37(1).

The bench comprising Satbeer Singh Godara (Judicial Member) and Naveen Chandra (Accountant Member) observed that the guarantee's existence and validity had been conclusively established through ICC arbitration and the compromise settlement before the Punjab & Haryana High Court and could not be questioned at a belated stage by the AO.

The Bench rejected the Revenue's argument that the assessee undertook no real liability, holding that the liability stood fortified by both the arbitration award and the High Court execution proceedings. Referring to SA Builders Ltd. v. CIT, the Tribunal noted that the “department could not sit in the armchair of a businessman” to decide how business affairs are conducted and that once a guarantee is entered into in earlier years, the liability arising on invocation cannot be disallowed under Section 37(1).

Accordingly, the appeal was allowed, and the disallowance of Rs. 47.64 crores was deleted in its entirety.

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