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Loss occasioned by guarantee is capital loss

Q: I have given my residential apartment to State Bank of India as a collateral security to the working capital loan of my brother-in-law's private limited company. I have no share in the company but my wife is having 7.5 per cent share in that company. Now the company committed default and SBI proceeded to Debt Recovery Tribunal for the recovery of dues on the promoters and on me as a guarantor (claiming personal guarantee). Neither the company nor the promoters are able to repay the compromise settlement amount of Rs. 10 lakhs. I have paid the amount and released the apartment and liability.

Please clarify whether I can claim Rs. 10 lakhs as loss in my personal tax returns. How I can adjust this amount of loss under the Income-tax Act. Please do reply at an early date.

A: Though the loan advanced is for working capital of the borrower, the advance is a capital transaction in the hands of the reader, because he is apparently not in money lending business. He merely obliged the company because of the fact that it belonged to his brother-in-law and his wife. Hence the loss is a capital loss, which cannot be allowed as a deduction, the charge being self-created.

Since the reader has paid the amount in cash, even the chance of claiming loss against capital gains on sale of property offered as collateral security is not possible. In fact, even if the property had been brought to sale, such loss arising out of moneys paid on compromise settlement would still be not deductible from the capital gains for the reason that the charge is self-created for the benefit of close relatives, but also because the guarantor has the right of recovery against the persons for whom he has furnished the guarantee. But in a case, where such right of recovery was only a theoretical right, since the person is not in a position to make good the payment, it was allowed by Kerala High Court in CIT v Thressiamma Abraham (No.1) (1997) 227 ITR 802 (Ker). Such claims are sometimes admitted against capital gains on the ground that there is diversion by overriding title in favour of the person, who has a claim over the property by way of charge at the time of sale. But such decisions rendered prior to V. S. M. R. Jagadischandran v CIT (1997) 227 ITR 240 (SC) may not be found valid especially in the light of a still later decision in CIT v Attili N. Rao (2001) 252 ITR 880 (SC), where the payment to State Government which brought the property for sale for recovery of the amount due towards State excise was held not allowable as a deduction from sale proceeds, though the property had been pledged with the State Government.

S. Rajaratnam

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