Supreme Court of India
Commissioner Of Income-Tax, Kerala vs Alagappa Textile (Cochin) Ltd on 19 September, 1979
Equivalent citations: 1980 AIR 235, 1980 SCR (1) 723, AIR 1980 SUPREME COURT 235, 1980 (1) SCC 214, 1980 TAX. L. R. 2, 1979 UJ (SC) 919, (1979) 55 TAXMAN 89, (1979) 2 TAXMAN 535, (1979) 49 COMCAS 947, 1979 49 COMP CAS 947, (1979) 5 TAX LAW REV 427, (1979) 55 TAXATION 89, (1979) 12 CURTAXREP 408, 1980 (1) ITJ 220, 1980 SCC (TAX) 81, 1980 UPTC 861, 49 COM CAS 947, 1980 U P T C 881, (1980) 1 SCR 723 (SC), (1979) 120 ITR 480, (1980) 1 SCJ 306
Author: V.D. Tulzapurkar
Bench: V.D. Tulzapurkar, R.S. Pathak
PETITIONER:
COMMISSIONER OF INCOME-TAX, KERALA
Vs.
RESPONDENT:
ALAGAPPA TEXTILE (COCHIN) LTD.
DATE OF JUDGMENT19/09/1979
BENCH:
TULZAPURKAR, V.D.
BENCH:
TULZAPURKAR, V.D.
PATHAK, R.S.
CITATION:
1980 AIR 235 1980 SCR (1) 723
1980 SCC (1) 214
ACT:
Business Expenditure-Section 10(2)(xv) of the Income-
Tax Act, 1922-Whether the remuneration towards the 'Manager'
Kamala Mills Ltd. is falling within the meaning of Section
384 read with s. 2(24) of the Companies Act allowable as
"business expenditure"-Construction of the terms of
Agreement-Whether the managing company falls within the
meaning of Section 2(24) of the Companies Act, 1956.
HEADNOTE:
Respondent, assessee (M/s. Alagappa Textiles (Cochin)
Limited company was carrying on business of manufacture and
sale of yarn. It entered into an Agreement dated November
10, 1955 with Kamala Mills Ltd., Coimbatore for financing
and managing the assessee Mills at Alagappa Nagar for a
period of five years. Clause 8 of the Agreement provided
that Kamala Mills Ltd. shall be paid for the services,
rendered by it by way of purchases, sales and management
remuneration at the rate of 1% on all purchases made by it
for the assessee Mills and at half a percent on all sales of
yarn, yarn waste and cotton waste and other products of the
Mill. Clause 13 of the agreement was to the effect that "the
company (assessee) either represented by its managing Agent
or Board of Directors shall not exercise the powers
delegated to the Managers (Kamala Mills Ltd. under the
foregoing clauses, except by way of general supervision and
advice nor interfere with discretion of the managers in the
exercise of their functions and powers vested in them by
virtue of this Agreement." Clause 14, provided that the
Managers (Kamala Mills Ltd.) powers were limited in the
manner aforesaid and shall not be deemed to be manager in
charge of the whole affairs of the company within the
meaning of section 2(9) of the companies Act, 1913. Clause
16 provided that the agreement shall be in force for a
period of five years commencing from the date thereof and
that "this Agreement for management being an Agency coupled
with interest" could be revoked before the expiry of the
said period of five years by 12 months' notice in writing
being given by one party to the other, but if the assessee
were to revoke it the assessee shall be liable to compensate
Kamala Mills for the loss of remuneration for, the
unexpired period of the Agreement at the average rate at
which Kamala Mills Ltd. had been earning by way of
remuneration under the Agreement fill the date of such
notice of termination
Pursuant to the aforesaid terms, Kamala Mills Ltd. drew
remuneration to the tune of Rs. 1,03,547/- and Rs. 18,249/-
respectively for the calendar years 1957 and 1958
corresponding to the assessment years 1958-59 and 1959-60.
The amounts were assessed to tax in the hands of Kamala
Mills Ltd. Respondent, Assessee in its assessment
proceedings for the said two assessment years claimed
deduction in respect of the said two Amounts as business
expenditure under section 10(2)(xv) of the Income-tax Act.
The claim was disallowed by the Income Tax officer on the
ground that under section 384 of the companies Act. 1956
which had come into force on April 2, 1956 the continuation
of a
724
body corporate as manager was prohibited for the period
beyond six months from the coming into force of the Act,
that the remuneration paid to Kamala Mills Ltd. subsequent
to October 1, 1956 was illegal being in violation of s. 381.
The Appellate Assistant Commissioner rejected the Appeal
mainly on the ground that the assessee by its own conduct
had disputed its liability to pay any remuneration to Kamala
Mills Ltd. as after October 1, 1956 and in that behalf he
relied on an admitted fact that the assessee had filed a
suit against Kamala Mills to recover such remuneration which
had been paid to it in contravention of section 384 of the
Companies Act on the basis that since the payment was
illegal Kamala Mills was holding such amounts of
remuneration in trust for and on behalf of the assessee.
Respondent carried the matter in further appeals to the
Tribunal, but the Tribunal confirmed the view of the taxing
authorities. On a reference, the High Court answered the
question in the negative in favour of the assessee and
against the Revenue. The High Court held that Kamala Mills
could not be said to be "subject to the superintendence,
control and directions of the Board of Directors" of the
respondent and therefore was not a "manager" of the assessee
within the meaning of section 2(14) of the Companies Act, so
as to attract the illegality under section 384 ibid. and (b)
that in view of the provisions of section 41(1) of the
Income-tax Act, the pendency of an appeal against the
Judgment the suit for recovery could not be a valid ground
for disallowing the deduction permissible under ) section
10(2)(xv) of the Income-tax Act.
Dismissing the appeal by Revenue by special leave, the
Court
^
HELD: 1. Section 384 of the Companies Act, 1956 in
express terms prohibits, after the commencement of the Act,
the appointment of a firm or a body corporate or an
association of persons as manager as also the continuation
of such employment after expiry of six months from such
commencement. To attract the prohibition or
disqualification, under this section, a firm, body corporate
or association must be a "manager" within the meaning of
section 2(24), that is to say, it should be in management of
the whole or substantially the whole of the affairs of a
company and should be under superintendence, control and
direction of the Board of Directors of the company [730 C-D,
E-F]
2. Section 2(24) of the Companies Act requires three
conditions to be satisfied: (a) the Manager must be an
individual, which means that a firm or body corporate or an
association is excluded and cannot be a Manager (a fact
which is expressly made clear in section 384). (b) he should
have the management of the whole or substantially the whole
affairs of the company and (c) he should be subject to the
superintendence, control and directions of the Board of
Directors in the matter of managing the affairs of the
company. Subject to the changes made in the aspect covered
by (a) and (b), in both the definitions [s. .2(9) of 1913
Act and s. 2(24) of the 1956 Act], the aspect that a Manager
has to work or exercise his powers under the control and
directions of the Board of Directors is common and
essential. In fact, it is this aspect which distinguishes
'Manager' from "Managing Agent". A comparison of the
definition of "Manager" as given in s; 2(24) of the 1956 Act
with that of "Managing Agent" in s. 2(25) makes it clear
that though there is an overlapping of the functions of the
Manager as well as the Managing Agent of the company the
essential distinction is that whereas the
725
Manager has to be subject to the superintendence, control
and direction of the Board of Directors, the managing Agent
is not so subject. [729 G-H, 730 A-C]
3. On a perusal of the clauses and in particular
clauses 8, 13, 11 and 16 of the Agreement dated November 10,
1955 in the instant case, two or three things stand out very
clearly. It is true that at the commencement of the deed
Kamala Mills Ltd. has been described and referred to as the
"Managers" of the asses see throughout the document but mere
label or nomenclature given to a party in the document will
not be decisive. It is also true that the several powers and
functions were entrusted to Kamala Mills Ltd. under clause 1
of the Agreement to enable it "to manage or run the Mill" of
the assessee. But simply because powers and functions were
given to Kamala Mills Ltd. for the purpose of "managing and
running the Mills" of the assessee, it could not follow that
Kamala Mills Ltd. was in truth and substance a 'manager' of
the assessee within the meaning of s. 2(24) of the 1956 Act.
For this purpose the Agreement will have to be read as a
whole and the Court w ill have to decide what was the true
intention of the parties in entering into such Agreement.
[733 E-G]
4. The dominant object with which the Agreement was
entered into was that Kamala Mills Ltd. should really act is
a financier so-that the assessee Mill could run and since
heavy finances were to be procured by Kamala Mills Ltd.
large powers and functions connected with the working of the
mill were entrusted to it. This aspect become abundantly
clear from cl. 16 of the Agreement wherein the parties
expressly provided that this Agreement for management was by
way of and amounted to an Agency coupled with interest so
far as Kamala Mills Ltd. was concerned and, therefore,
revocation of the Agreement before the expiry of five years'
period was made dependent upon 12 months' notice in writing
being given by one party to the other and further if such
revocation was done by the assessee suitable compensation
was made payable to Kamala Mills Ltd. In other words,
managerial functions were incidental and had to be entrusted
to Kamala Mills because of the financier's role undertaken
by it. The large powers and functions entrusted to Kamala
Mills Ltd. under the several sub-clauses of cl. 1 of the
Agreement do show that management of substantially the
whole, if not the whole, of the affairs of the assessee
company had been made over to Kamala Mills Ltd. [734 B-E]
5. Clause 13 of the Agreement which is very eloquent.
provided that so far as the powers conferred and the
functions entrusted to Kamala Mills Ltd. were concerned, the
Board of directors shall not exercise or perform the same
except by way of general supervision and advice and it was
further made clear that the Board of Directors shall not
interfere with the discretion of Kamala Mills Ltd in the
exercise of their functions and powers vested in it by
virtue of the Agreement. In other words, the general
supervision or advice of the Board of directors was of such
character that the Board had no way whatsoever nor could it
interfere with the discretion of Kamala Mills Ltd. in the
matter of the exercise of the powers and the discharge of
the functions entrusted to Kamala Mills Ltd. under the
Agreement. It is thus clear that the dominant object of the
Agreement was that Kamala Mills Ltd. should act as
financiers of the assessee Mill and in the matter of the
exercise of its powers and discharge of its functions Kamala
Mills Ltd. was never "subject to the superintendence control
or direction" of the Board of
726
directors of the assessee. This is the position which
clearly emerges on true construction of the Agreement. [734
F-H, 735A]
6. Therefore, Kamala Mills Ltd. was not acting or
working as the "Manager" of the assessee within the meaning
of s. 2(24) of the Companies Act, 1956 and as such the
illegality of section 384 of the Act was not attracted. In
this view of the matter, the remuneration paid by the
assessee to Kamala Mills Ltd. for the two calendar years
1957 & 1958 relevant to the assessment years 1958-59 and
1959-60 could not be regarded as being in violation of s.
384 of the companies Act, 1956 and as such the expenditure
incurred by way of paying such remuneration would be
deductible as "Business Expenditure" under section 10(2)(xv)
of the Income-tax Act, 1922. [735A-D]
JUDGMENT:
CIVIL APPELLATE JURISDICTION: Civil Appeals Nos. 2001- 2002 of 1978.
Appeals by Special Leave from the Judgment and order dated 14-12-1971 of the Kerala High Court in Income Tax Reference No 19 of 1969.
V. S. Desai, S. P. Nayar and Miss A. Subhashini for the Appellant S. T. Desai, N. Sudhakaran and P. K. Pillai for the Respondent.
The Judgment of the Court was delivered by TULZAPURKAR, J. These appeals by special leave raise a common question whether on proper construction of the Agreement dated November 10, 1955, entered into by the assessee with Kamala Mills Ltd., the latter was the "manager" of the assessee within the meaning of s. 384 read with s. 2(24) of the Companies Act, 1956 and if so, whether the remuneration paid by the assessee to the latter in the two calendar years 1957 and 1958 relevant to the assessment years 195859 and 1959-60 cannot be allowed as business expenditure under s. 10(2) (xv) of the Indian Income-Tax Act, 1922?
The facts giving rise to the question may briefly be stated as follows: The assessee (M/s Alagappa Textiles (Cochin) Ltd.) is a public limited company carrying on business of manufacture and sale of yarn and has its registered office at Alagappa Nagar in Kerala State. It entered into an Agreement dated November 10, 1955 with Kamala Mills Ltd. Coimbatore for financing and managing the assessee mills at Alagappa Nagar for a period of five years. Clause 8 of the Agreement provided that Kamala Mills Ltd. shall be paid, for the services rendered by it by way of purchases, sales and management, remuneration at the rate of 1% on all purchases made by it for the assessee mills and at half a per cent on all sales of yarn, yarn waste and cotton waste and other products of the mill. Pursuant to the aforesaid term Kamala Mills Ltd. drew remuneration to the tune of Rs. 1,03,547/- and Rs. 18,294/- respectively for the calendar years 1957 and 1958 727 corresponding to the assessment years 1958-59 and 1959-60. These amounts were assessed to tax in the hands of Kamala Mills Ltd. The assessee in its assessment proceedings for the said two assessment years claimed deduction in respect of the said two amounts as business expenditure under s. 10(2) (xv) of the Act. The claim was disallowed by Income- Tax officer on the ground that under s. 384 of the new Companies Act, 1956, which had come into force on April 1. 1956, the continuation of a body corporate as manager was prohibited for the period beyond six months from the coming into force of the Act, that remuneration paid to Kamala Mills Ltd. subsequent to October 1, 1956, was illegal being in violation of s. 384 and, therefore, the deduction claimed in respect of such payment for the calendar years 1957 and 1958 could not be allowed. In the appeals preferred by the assessee against the decision of the Income Tax officer, it was contended that though the payment of remuneration to a body corporate as Manager after October 1, 1956 was illegal under s. 384, the payments were for services rendered and were fully justified by commercial expediency and as such the same should be allowed under s. 10(2) (xv) of the Act. It was also urged that even if the expenses incurred were in violation of the statute such expenses should be allowed since in computing the profits even of illegal business only the net profit was taxed after allowing all the expenses. The Appellate Assistant Commissioner was not impressed by these arguments; but he disallowed the deduction mainly on the ground that the assessee by its own conduct had disputed its liability to pay any remuneration to Kamala Mills Ltd. after October 1, 1956 and in that behalf he relied on an admitted fact that the assessee had filed a suit against Kamala Mills Ltd. to recover such remuneration which had been paid to it in contravention of s. 384 on the basis that since the payment was illegal Kamala Mills Ltd. was holding such amounts of remuneration in trust for and on behalf of the assessee and in such a situation the deduction could not be allowed. The assessee carried the matter in further appeals to the Tribunal, but the Tribunal confirmed the view of the taxing authorities that under s. 384 of the Companies Act, 1956 it was not legal for the assessee to have permitted Kamala Mills Ltd. to continue to work as its Manager after October 1, 1956 and that the payment of remuneration after the said date was illegal and could not be considered as valid expenditure for the purpose of Income Tax Act. fn this behalf the Tribunal relied on two decisions in C.I.T. v. Haji Aziz and Abdul Sakoor Bros. and Raj Woollen Industries v. C.I.T. An argument was raised before the Tribunal that Kamala 728 Mills Ltd. was not only a manager but also a financier and that the remuneration should be treated as having been paid to the financier While observing that it was a new case put forward by the assessee, the Tribunal negatived the contention holding, on construction of the Agreement, that it was by virtue of its position as Manager that Kamala Mills Ltd. was allowed to carry on the financial affairs of the assessee and the remuneration was payable to it as Manager and in no other capacity. The Tribunal also held that the claim for deduction was in respect of a disputed liability inasmuch as the assessee had not merely filed a suit to recover the amount but had in the meantime obtained a decree against Kamala Mills Ltd., and, therefore, the amounts could not be lawfully claimed as permissible deduction.
At the instance of the assessee the following question was referred to the High Court for its opinion:
"Whether on the facts and in the circumstances of the case, the Tribunal was justified in law in disallowing the claim of the assessee for deduction of Rs. 1,03,547/- and Rs. 18,294/- from the income of the assessment years 1958-59 and 1959-60 as not an admissible business expenditure under sec. 10(2)(xv) of the Indian Income Tax Act, 1922 -"
The High Court answered the question in the negative in favour of the assessee and against the Department. The High Court, on construction of the Agreement dated November 10, 1955, took the view that since in the matter of the exercise of its powers and the discharge of its functions thereunder Kamala Mills Ltd. could not be said to be "subject to the superintendence control and direction of the Board of Directors" of the assessee, Kamala Mills Ltd. was not a "manager" of the assessee within the definition given in s. 2(24) of the Companies Act, 1956, and, therefore, the illegality under s. 384 was not attracted and as such the remuneration paid by the assessee to Kamala Mills Ltd. for services rendered during the calender years 1957 and 1958 was allowable as a business expenditure under s. 10(2) (xv) of the Act. As regards the decree that had been obtained by the assessee against Kamala Mills Ltd. the High Court observed that the appeal filed by Kamala Mills Ltd. against the said decree was still pending in the High Court and if ultimately the appeal was dismissed and the amounts were recovered back from Kamala Mills Ltd., the assessee could be taxed on those amounts under s. 41(1) of the 1961 Act, but that could not be a valid ground for disallowing the deduction claimed by the assessee. The Revenue has challenged in these appeals the view of the High Court that Kamala Mills Ltd. was not the Manager of the 729 assessee within the meaning of s. 384 read with s. 2(24) of the Companies Act, 1956 and the further view that the remuneration paid to Kamala Mills Ltd. during the calendar years 1957 and 1958 was deductible as business expenditure under s. 10(2) (xv) of the Act.
Before we consider the principal question relating to the proper construction of the Agreement dated November 10, 1957, it will be desirable to note the relevant provisions of the Indian Companies Act, 1913 as also the new Companies Act, 1956, which have a bearing on the question at issue. Since the Agreement between the assessee on the one hand and the Kamala Mills Ltd. On the other was entered into at a time when the Indian Companies Act, 1913 was in force it will be proper first to refer to the definition of 'Manager' given in s. 2(9) of the said Act. Section 2(9) ran thus:
"2(9) "manager" means a person who, subject to the control and direction of the directors has the management of the whole affairs of a company, and includes a director or any other person occupying the position of a manager by whatever name called and whether under a contract of service or not. It will be clear that to satisfy the aforesaid definition a person, which could include a firm, body corporate or an association of persons, apart from being in management of the whole affairs of. a company had to be "subject to the control and direction of the directors". This definition has undergone a substantial change under the Companies Act, 1956. Under this Act s. 2(24) defines the expression "manager" thus.
2(24) "manager means an individual (not being the managing agent) who, subject to the superintendence, control and direction of the Board of directors, has the management of the whole, or substantially the whole, of the affairs of a company, and includes a director or any other person occupying the position of a manager, by whatever name called, and whether under a contract of service or not."
In this definition three conditions are required to be satisfied: (a) the manager must be an individual, which means that a firm or a body corporate or an association is excluded and cannot be a manager (a fact which is expressly made clear in s. 384), (b) he should have the management of the whole or substantially the whole affairs of the company and (c) he should be subject to the superintendence, control and directions of the Board of Directors in the matter of managing the affairs of the company. Subject to the changes made in the aspects 730 covered by (a) and (b), in both the definitions the aspect that a manager has to work or exercise his powers under the control and directions of the Board of Directors is common and essential. In fact it is this aspect which distinguishes 'Manager' from 'Managing Agent'. If the definition of 'Manager' as given in s. 2(24) is compared with that of 'Managing Agent' as given in s. 2(25) it will appear clear that though there is an overlapping of the functions of the manager as well as the managing agent of the company the essential distinction seems to be that whereas the manager has to be subject to the suprintendence, control and direction of the Board of directors the managing agent is not so subject.
Section 384 of the Companies Act, 1956 in express terms prohibits, after the commencement of the Act, the appointment of a firm or a body corporate or an association of persons as a manager as also the continuation of such employment after expiry of six months from such commencement. It runs thus:
"384. No company shall, after the commencement of this Act, appoint or employ, or after the expiry of six months from such commencement continue the appointment or employment of, any firm, body corporate or association as its manager.
The aforesaid provision positively disqualifies a firm, body corporate or association from being appointed as manager of a company or from continuing the employment of a firm, body corporate or association as manager after the expiry of six months from the commencement of the Act. Obviously, to attract the prohibition or disqualification contained in s. 384, a firm, body corporate or association must be a "manager" within the meaning of s. 2(24), that is to say, it should be in management of the whole or substantially the whole of the affairs of a company, and should be under superintendence, control and direction of the Board of directors of the company. It was not seriously disputed that under the terms and conditions contained in the Agreement dated November 10, 1955, Kamala Mills Ltd. could be said to be in management of substantially the whole of the affairs of the assessee mills but the question is whether it was working under the superintendence, control and direction of the Board of directors of the assessee so as to be its 'Manager' within s. 2(24) of the Act?
Turning now to the Agreement in question it may be stated that at the commencement of the deed the parties thereto have been described in a particular manner, namely, the assessee has been described 731 and referred to as the "Company" while Kamala Mills Ltd. has been described and referred to as the "Managers" throughout the document. Then follow two recitals which make very clear the object or purpose with which the Agreement was entered into; according to these recitals the assessee was not having sufficient finance to carry on its business of manufacture and sale of yarn and the Board of directors thought it proper of find out a financier who was agreeable to help the assessee monetarily and take active interest in its business and that since Kamala Mills Ltd. agreed to assist the assessee with sufficient finance and to manage the assessee's mill on certain terms and conditions which the Board of Directors had approved, the Agreement was executed between the parties. Then follow the operative parts of the deed setting out the terms and conditions on which Kamala Mills Ltd. agreed to provide sufficient finance as also to manage the business of the assessee. Clause 1 enlisted in sub-clauses (b) to (m) the powers and functions which were to be exercised and performed by Kamala Mills Ltd. during the period of five years for which the Agreement was to operate; such powers were conferred and functions entrusted for the purpose of "managing and running the mill"
of the assessee; inter alia, Kamala Mills Ltd. was to make purchases of all cotton, staple fibre or any other raw material for the manufacture of the yarn and to enter into contracts in that behalf at such rates and prices as it may deem fair and proper and make payments for all such purchases and incur all expenses incidental thereto; it was also to make purchases of all stores and spares and other materials necessary for the manufacture of yarn; it was to appoint all staff, technical or non-technical and workers skilled and unskilled as also clerks and other staff necessary for the working of the mill and fix their terms and remuneration and could discharge or dismiss or take disciplinary action against them; it had to sell and make contracts for sale for immediate or future delivery of yarn, yarn waste or cotton waste or any other material or products of the mill at such rates or prices and on such terms and conditions as it may think fit; it could decide, lay down and change from time to time the programme of manufacture of yarn and other products of the mill and to insure against fire and other risks all cotton, yarn, material, stock-in- trade and incur and pay all premia necessary in that behalf; it could pledge, secure and hypothecate all stocks and stores and stock-in-trade with such bank or banks where arrangements for overdrafts shall have been completed by the Board of Directors; and it could claim, demand, realise and sue for all goods, materials and amounts due to the assessee in the exercise and carrying out of any or all of the powers conferred under sub-cls. (a) to (k). Clause 2 of the Agreement stipulated that Kamala Mills Ltd. shall 732 provide funds or arrange for finance necessary for exercising the powers of purchase of cotton, stores and other materials and for payment of wages, salaries, commissions and allowances and for meeting all expenses incidental to manufacture and sale of yam and other pro- ducts of the mill. Under clause 3 the assessee was to open a separate Current Account and an overdraft Account for a limit not exceeding Rs. 30,00,000/- with such bankers as Kamala Mills may require with power to Kamala Mills to operate on the said accounts exclusively by itself and in the name of the assessee and it was to have power to receive, endorse, sign, transfer and negotiate all bills, cheques, drafts etc. that may be received in the name of the assessee in the course of the management of the mill and it was specifically agreed that no one except Kamala Mills shall have power to operate on the said accounts. Clause 4 entitled Kamala Mills Ltd. to charge the assessee interest at the rate of 7.5% per annum with half-yearly rests on all advances made by it and funds provided for the purposes set out in clause 2. Clause 5 gave Kamala Mills Ltd. a first and prior charge on all the stocks and stores and stock-in-trade for all the moneys and amounts that may be advanced by it to the assessee except to the extent of any charge or security of such stocks and stores and stock-in-trade that may be created in favour of the banks for the overdraft account and such charge in favour of Kamala Mills was to be a possessory charge. Clause 8 quantified the remuneration payable to Kamala Mills Ltd. for services rendered by way of purchases, sales, and the management of the mill at the rate of 1 % on all purchases made by it for the assessee mill and at 0.5% on all sales of products effected for and on behalf of the assessee. Clause 10 required Kamala Mills Ltd. to maintain proper accounts in respect of all purchases, sales and expenses, commissions and remunerations due to it etc. and submit to the assessee monthly statements of accounts. Clause 11 put the outer limit of Rs. 15,00,000/- at any one point of time on the advances and financial assistance to be given by Kamala Mills Ltd. to the assessee and it was provided that if and when sums over and above the said limits become necessary to be advanced, Kamala Mills would be entitled to appropriate and take for itself as owner such quantity of yarn as may be in stock as in value would be equivalent, at cost or market value whichever was lower, to the sum that it may be obliged to advance over and above Rs. 15,00,000/-. Clause 13 of the Agreement is very important having a crucial bearing on the question at issue and may be set out verbatim. It ran thus:
"13. The Company (assessee) either represented by its Managing Agent or Board of Directors shall not exercise the powers delegated to the Managers (Kamala Mills Ltd.) 733 under the foregoing clauses, except by way of general supervision and advice, nor interfere with the discretion of the Managers in the exercise of their functions and powers vested in them by virtue of this Agreement."
Under cl. 14 it was provided that the Managers' (Kamala Mills Ltd.) powers were limited in the manner aforesaid and they were not and shall not be deemed to be managers in charge of the whole affairs of the company within the meaning of s. 2(9) of the Indian Companies Act, a significant provision showing the intention of the parties that Kamala Mills Ltd. was not to be regarded as a 'Manager' under the Indian Companies Act, 1913. Clause 16 is significant and it provided that the Agreement shall be, in force for a period of five years commencing from the date thereof and that "this Agreement for management being an Agency coupled with interest", it could be revoked before the expiry of the said period of five years by 12 months notice in writing being given by one party to the other but if the assessee were to revoke it the assessee shall be liable to compensate Kamala Mills for the loss of remuneration for the unexpired period of the Agreement at the average rate at which Kamala Mills Ltd. had been earning by way of remuneration under the Agreement till the date of such notice of termination. A modification by introducing one additional term. in the Agreement was made on November 21, 1955 but the additional term is not material for our purposes.
On a perusal of the aforesaid clauses of the Agreement in question two or three things stand out very clearly. It is true that at the commencement of the deed Kamala Mills Ltd. has been described and referred to as the "Managers" of the assessee throughout the document but mere label or nomenclature given to a party in the document will not be decisive. It is also true that the. several powers and functions were entrusted to Kamala Mills Ltd. under cl. 1 of the Agreement to enable it "to manage or run the mill" of the assessee. But simply because powers and functions were given to Kamala Mills Ltd. for the purpose of "managing and running the mills" of the assessee, it would not follow that Kamala Mills Ltd. was in truth and substance a 'manager' of the assessee within the meaning of s. 2(24) of the 1956 Act. For this purpose the Agreement will have to be read as a whole and the Court will have to decide that was the true, intention of the parties in entering into such agreement. The two recitals clearly indicate the object with which and the purpose for which the Agreement was entered into. It does appear that the assessee was in financially straightened circumstances and on that account was utterly unable to carry on its business of manufacture and sale of yarn and, therefore, 734 the board of directors were in search of a financier who would make available the necessary finances for the running of the mill as also to take active interest in the business of the assessee and when Kamala Mills Ltd. agreed "to assist the company (assessee) with sufficient finance and manage the mill" belonging to the assessee on terms and conditions that were approved b-y the Board of Directors of the assessee that the Agreement was entered into between the parties; in other words, it is clear that the dominant object with which the Agreement was entered into was that Kamala Mills Ltd. should really act as financier so that the assessee mill could run and since heavy finances were to be procured by Kamala Mills Ltd. large powers and functions connected with the working of the mill were entrusted to it. This aspect becomes abundantly clear from cl. 16 of the Agreement wherein the parties expressly provided that this Agreement for management was by way of and amounted to an Agency coupled with interest so far as Kamala Mills Ltd. was concerned and, therefore, revocation of the Agreement before the expiry of the five years' period was made dependent upon 12 months' notice in writing being given by one party to the other and further if such revocation was done by the assessee suitable compensation was made payable to Kamala Mills Ltd. In other words, managerial functions were incidental and had to be entrusted to Kamala Mills because of the financier's role undertaken by it. The large powers and functions entrusted to Kamala Mills Ltd. under the several sub-clauses of cl. 1 of the Agreement do show that management of substantially the whole, if not the whole, of the affairs of the assessee company had been made over to Kamala Mills Ltd. But the crucial question is whether such management was to be done by Kamala Mills Ltd. under "the superintendence, control and direction of the Board of Directors" of the assessee and in that behalf cl. 13 of the Agreement which we have quoted above is very eloquent. In terms it provided that so far as the powers conferred and the functions entrusted to Kamala Mills Ltd., were concerned, the Board of Directors shall not exercise or perform the same except by way of general supervision and advice and it was further made clear that the Board of Directors shall not interfere with the discretion of Kamala Mills Ltd. in the exercise of their functions and powers vested in it by virtue of the Agreement. In other words, the general supervision or advice of the Board of Directors was of such character that the Board had not say whatsoever nor could it interfere with the discretion of Kamala Mills Ltd. in the matter of the exercise of the powers and the discharge of the functions entrusted to Kamala Mills Ltd. under the Agreement. It is thus clear to us that the dominant object of the Agreement was that Kamala Mills Ltd. should act as financiers of the assessee mill and in the 735 matter of the exercise of its powers and discharge of its functions Kamala Mills Ltd. was never "subject to the superintendence, control or direction" of the Board of directors of the assessee. If this position clearly emerges on true construction of the Agreement in question then it is obvious that Kamala Mills was not acting or working as the "Manager" of the assesses within the meaning of s. 2(24) of the Companies Act, 1956 and as such the illegality of s. 384 of that Act was not attracted. In this view of the matter, the remuneration paid by the assessee to Kamala Mills Ltd.. for the two calendar years 1957 and 1958 relevant to the assessment years 1958-59 and 1959-60 could not be regarded as being in violation of s. 384 of the Companies Act, 1956 and as such the expenditure incurred by way of paying such remuneration would be deductible as business expenditure under s. 10 (2) (xv) of the Income Tax Act. 1922.
In view of our aforesaid conclusion the aspects whether the assessee had disputed its liability to pay such remuneration to Kamala Mills Ltd. Or had filed a suit at the instance of the Company Law Board to recover it back from Kamala Mills Ltd. Or had obtained a decree in that behalf against Kamala Mills Ltd. become irrelevant. However, we would like to place on record the fact that the decree obtained by the assessees against Kamala Mills Ltd. has been reversed or set aside in appeal by the Kerala High Court-a fact which was brought to our notice by the Advocate-on- Record for the assessee communicated to him by his client in a letter dated 22nd August, 1979. However, even 7 if in further appeal the trial court's decree were restored and the assessee were to recover back the remuneration the assessee can be taxed on the two amounts under s. 41(1) of the 1961 Act.
In our view, therefore, the High Court was right in answering the question in favour of the assessee. The appeals are, therefore, dismissed with costs.
V.D.K. Appeals dismissed.
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