Bombay High Court
Pai Paper And Allied Industries Pvt. ... vs Commissioner Of Income-Tax on 1 September, 1993
Equivalent citations: [1994]207ITR410(BOM)
JUDGMENT
Dr. B.P. Saraf J.
1. By this reference made at the instance of the assessee, the Income-tax Appellate Tribunal has referred the following three question of law for opinion under section 256(1) of the Income-tax Act, 1961 :
"1. Whether, on the facts and in the circumstances of the case, the Tribunal erred in holding that the disallowance of a sum of Rs. 1,83,842 out of the amount of commission on sales paid to the International Paper Company, which was a sole proprietary concern of Shri T. S. N. Swamy, had been rightly made under section 40(c) of the Income-tax Act ?
2. Whether, in any event, the Tribunal erred in holding that it was the entire expenditure of Rs. 1,83,842 which was disallowable under section 40(c) without taking into the account the expenditure incurred by the selling agent in discharging his obligation ?
3. Whether, on the facts and in the circumstances of the case, the Tribunal ought to the have held that the provisions of section 40(c) could apply only where, in the first instance some part of the expenditure was found to be excessive and not otherwise ?"
2. The assessee is a private limited company engaged in the business of dealing in paper and allied products. It has only two shareholders, namely, Shri T. S. N. Swamy and his wife, Mrs. S. Swamy, both of whom were the directors in the relevant previous year ended on March 31, 1975, corresponding to the assessment year 1975-76. Messrs. International Paper Co., which was a sole proprietary concern of the late T. S. N. Swamy, was acting as a selling agent of the assessee-company. For the relevant previous year ending March 31, 1975, Commission was payable to Messrs. International Paper Co. for the period from April 1, 1974, to June 30, 1974, as per the terms of an agreement dated May 18, 1973, and according to the amended agreement with effect from July 1, 1974. According to clause 5 on of the agreement dated May 18, 1973, International Paper Co. was entitled all sales effected by it on resale basis to the customers to a discount of five per cent. and where the orders were being handled by the assessee directly, as in the case of Government orders, to a commission of 2 1/2 per cent. There was also a provision to grant additional bonus up to a maximum of 2 1/2 per cent. subject to the working results. According to the amended agreement, as approved in the meeting of the board of directors held on October 16, 1974, with effect from April 1, 1974 the dealer's discount was the revised from 5 per cent. to 7 1/2 per cent. and the commission on the direct orders handled by the assessee was revised from 2 1/2 per cent. to 5 per cent. Some other amendments were also made, which are not material for the present purpose. The appointment of Messrs. International Paper Co. as the sole selling agents on identical terms for the subsequent year as per the agreement dated June 25, 1975, which was on identical terms, was also approved by the Government of India by their letters dated June 17, 1976, and November 29, 1976.
3. During the relevant previous year, the assessee-company paid Shri T. S. N. Swamy, its managing directors, for his service a salary of Rs. 37,200 and commission of Rs. 22,800. It also made commission payments to the sole selling agents, Messrs. International Paper Co. of the which Shri T. S. N. Swamy was the sole proprietor, amounting to Rs. 1,95,842 as under :
Rs.
Commission on sales 1,63,422
Commission on processing charges 32,420
1,95,842
4. The assessee claimed deduction of the above amount as business expenditure. The Income-tax Officer, however, holding that the payment of the above amount by way of commission to the sole selling agent, Messrs. International Paper Company, which was the proprietary concern of Shri T. S. N. Swamy, amounted to payment of further remuneration to the managing director, applied the provisions of section 40(c) of the Act and restricted the allowance of total payments of Swamy including the commission paid to his sole proprietary concern as sole selling agency commission to Rs. 72,000 and disallowed the balance of Rs. 1,83,842 in the computing the total income of the assessee-company for the assessment year 1975-76.
5. The above action of the Income-tax Officer was affirmed, on appeal, by the Appellate Assistant Commissioner of Income-tax and also the Income-tax Appellate Tribunal. The Tribunal rejected the assessee's contention that the remuneration contemplated under section 40(c) was confined to the payment for services rendered by a director managing the affairs of the company. It was further held by the Tribunal that the mere fact that the name does not, in law, create a legal entity or an independent person divorced from the individual managing director and hence, while considering the payment of selling agency commission, it was not possible to the regard Messrs. International Paper Co., which was a sole proprietary concern of the managing director, as a person different from the managing director himself. It further held that what is contemplated by section 40(c) is not the remuneration or benefit or amenity to a director or any person mentioned therein but the expenditure which would bring the about such remuneration, benefit or amenity to the director, etc. The Tribunal rejected the contention of the assessee that section 40(c) only contemplated such expenditure which resulted in remuneration to a director or managing director in his capacity as director or managing director. Hence this reference at the instance of the assessee.
Section 40(c) of the Act, as it stood at the material time, reads as follows :
"40. Amounts not deductible. - Notwithstanding anything to the contrary in sections 30 to 39, the following amounts shall not be deducted in computing the income chargeable under the head 'Profit and gains of business or profession', - . . . . .
(c) in the case of any company -
(i) any expenditure which results directly or indirectly in the provision of any remuneration or benefit or amenity to a director or to a person who has a substantial interest in the company or to a relative of the director or of such person, as the case may be.
(ii) any expenditure or allowance in respect of any assets of the company used by any person referred to in sub-clause (i) either wholly or partly for his own purposes or benefit.
if in the opinion of the Income-tax Officer any such expenditure or allowance as is mentioned in sub-clauses (i) and (ii) is excessive or unreasonable having regard to the legitimate business needs of the company and the benefit derived by a or accruing to it therefrom, so, however, that the deduction in respect of the aggregate of such expenditure and allowance in respect of any one person referred to in sub-clause (i) shall, in no case, exceeds -
(A) where such expenditure or allowance relates to a period exceeding eleven months comprised in the previous year, the amount of the seventy-two thousand rupees :
(B) where such expenditure or allowance relates to period not exceeding eleven months comprised in the previous year, an amount calculated at the rate of six thousand rupees for each month or part thereof comprised in that period :
Provided that in a case where such person is also an employee of the company for any period comprised in the previous year, expenditure of the nature referred to in clauses (i), (ii), (iii) and (iv) of the second proviso to clause (a) of sub-section (5) of section 40A shall not be taken into account for the purposes of sub-clause (A) or sub-clause (B), as the case may be :
Explanation. - The provision of this clause shall apply notwithstanding that any amount not to be allowed under this clause is included in the total income of any person referred to in sub-clause (i); . . . ."
6. The controversy in regard to the interpretation of the above provision came up before different High Courts on different occasions. The consistent stand of the Revenue throughout was that section 40(c) takes with its sweep all expenditure incurred by a company which results directly or indirectly in any benefit or remuneration to a director or to a person who had substantial interest or such other person specified therein. The contention of the Revenue was that what is material to bring an expenditure within the ambit of section 40(c) is that such expenditure results in the provision of any remuneration or benefit etc., to a director or such other person and the purpose of the payment and the capacity in which the payment is made is immaterial. Once the payment is made to the director or persons mentioned therein or the benefit from such expenditure can be said to accrue to the director or such other persons it would fall within section 40(c) and will have to be taken into the account for the purposes of the ceiling prescribed therein. The stand of the assessee, on the other hand, had been that section 40(c) applies only to expenditure which results in any remuneration or benefit to a director in his capacity of director. According to the assessee, section 40(c) cannot be interpreted so widely to bring within its ambit any and every payment to a director or the specified persons without any regard to the purpose of the payment. The Karnataka High Court had occasion to consider this controversy in the case of T. T. Pvt. Ltd. v. ITO [1980] 121 ITR 551. In this case the assessee was carrying on the business of manufacture of pressure cookers and allied products at Bangalore. The sale of the these products was being effected by the assessee through its selling agents at Madras under an agreement. The assessee had been making payment to the said firm for the services rendered in connection with the sale of its products. In the assessment years 1968-69 to 1971-72, the question arose whether the said payments by the assessee could be treated as revenue expenditure and if so to what extent. The Karnataka High Court interpreted section 40(c) of the Act and categorically held that the expenditure incurred by the way of commission paid to a selling agent to act as an independent entrepreneur with an independent organisation who is not subject to the control and supervision of the assessee for the service and the facilities provided to him cannot be considered as benefit within the meaning of section 40(c) of the Act.
7. Learned counsel for the assessee, Mr. Dastur, wanted to place before us a catena of decisions of this court and various High Courts starting from the decisions of this Court in Ramaben A. Thanawala v. Jyoti Limited [1957] 27 Comp Cas 105 and also referred to some of the provisions of the Companies Act, 1956, to satisfy us that the ratio of the various decisions referred to by him under the Income-tax Act or under the Companies Act clearly supported the contentions of the assessee that in order to attract section 40(c) the payment should be a payment made to a director or to any other person mentioned therein in this capacity of director. We do not purpose to dealt with all those decisions and the provisions of the Companies Act in view of the latest decisions of the Supreme Court in Prakash Beedies P. Ltd. v. CIT [1993] 201 ITR 1063, where in section 40(c) has been interpreted by the Supreme Court. In the above decision, the decision of the Karnataka High Court referred to above has also been considered. In the above case, the Supreme Court referred to the Budget Speech of the Finance Minister in regard to the reasons for the introduction of clause (c) of section 40 of the Act and observed (at page 1069) :
"The object behind the provision undoubtedly was to discourage and disallow 'payment of high salaries and remuneration which go ill with the norms of an egalitarian society.' The provisions was, of course, not confined to directors. It took in relatives of directors, persons having substantial interest in the company and their relatives. The clause vested in the Income-tax Officer the power to determine whether any such expenditure or allowance as is mentioned in the said clause was excessive or unreasonable having regard to the legitimate business needs of the company and the benefit derived by or accruing to it therefrom. In addition to it, a ceiling was also prescribed beyond with such expenditure or allowance could not go in any event."
8. In the case before the Supreme Court, payments were made to a partnership firm. The argument of the Revenue was that the partnership firm was not a separate entity and so the payment made to the partnership should be treated as payment made to the partners and the partners were none else but the directors of the assessee-company and in that the view of the matter, the payments to the partnership firm should be construed as payment to the directors and brought within the ambit of section 40(c) for applying the restriction prescribed therein. The above contention was repelled by the Supreme Court in the following words (at page 1070) :
"We assume for the purpose of the arguments that, in this case, payments to the firm were payments to partners. Even so, we think that the said payments did not fall within clause (c). The payments were made in consideration of a valuable right parted with by the firm/partners/directors of the assessee-company in favour of the assessee. So long as the agreement whereunder the said payments were made is not held to be a mere device or a mere screen, the said payments cannot be treated as payments made to the directors as directors (qua directors). The payments were made by way of consideration for allowing the assessee to use a valuable right belonging to them, viz., the brand name. Such a payment may be liable to be scrutinised under sub-section (2) of section 40A, but it certainly did not fall within the four corners of section 40(c)."
9. The Supreme Court also approved the decision of the Karnataka High Court in T. T. P. Ltd. v. ITO [1980] 121 ITR 551 and quoted with the approval the following observations of Venkataramaiah J. (as he then was) in that case (at page 1071) :
"A close reading of the above provision shows that section 40(c) refers to an expenditure incurred by making periodical payments to a person mentioned in that clause apparently for any personal service that may be rendered by him. It cannot have any reference to payments made by the assessee for all kinds of 'service or facilities' referred to in section 40A(2)(a). It is argued that the proviso thereto suggests that any expenditure incurred for any kind of service which is referred to in the main part of section 40A(2)(a) and the expenditure referred to in section 40(c) belong to the same category. This contention is not correct. The expression 'services' in section 40(2)(a) is an expression of wider import . . . . . If the remuneration, benefit or amenity referred to in section 40(c) is treated as the same as what is paid in return for 'the goods, services or facilities' then irrespective of the fair market value of the goods, services and facilities provided by a person who may be a director or a person who has a substantial interest in the company or a relative of the director or of such person, as the case may be, only a maximum of Rs. 72,000 can be allowed to be deducted in computing the income of the company in any one year. We do not think that Parliament ever intended that such a result should follow. The goods, services and facilities referred to in section 40A(2)(a) are those which have a market value and which are commercial in character. Many of the services and facilities referred to above are those which are nowadays provided by independent organisations."
10. We are of the clear opinion that the above decision of the Supreme Court is a clear answer to the controversy sought to be raised in regard to the scope and ambit of section 40(c) of the Act. It stands concluded now that only payments made to directors as directors (qua director) fall within section 40(c). Payments made in consideration of a valuable right parted with by the directors of the assessee-company in favour of the assessee-company are outside the scope of the said section.
11. Turning to the facts of the present case, it is pertinent to note that in the case before us, there is no controversy in regard to the factum of genuineness of the payment or the reasonableness thereof having regard to the legitimate business needs of the assessee. The only dispute is in regard to the scope and ambit of section 40(c), which as stated by us, stands concluded by the above decision of the Supreme Court. We, therefore, hold that the payments in question did not fall within section 40(c) of the Act. In that view of the matter, we answer the first question referred to us in the affirmative, i.e., in favour of the assessee and against the Revenue.
12. In view of the first question having been answered in favour of the assessee and against the Revenue, the other two question become academic and need not be answered. The reference is disposed of accordingly.
13. No order as to costs.