Income Tax Appellate Tribunal - Madras
Sree Annapoorna Gowrishankar Hotels ... vs Assistant Commissioner Of Income-Tax on 26 March, 1991
Equivalent citations: [1991]37ITD541(MAD)
ORDER
T.N.C. Rangarajan, Vice President
1. This appeal is directed against the sustention of two disallowances made in computing the income of the assessee.
2. The assessee is a private limited company carrying on the business of running a chain of hotels in Coimbatore. This business was originally started by Shri K. Damodaraswamy Naidu as an individual. Later he took his three brothers and his son as partners and carried on the business as a firm called K. Damodaraswamy Naidu & Brothers. Subsequently, the assessee-company was incorporated on 5-7-1984 for the purpose of taking over the business. Damodaraswamy Naidu and his three brothers were the only shareholders of the assessee-company and they were also the Directors of the company. By a deed dated 16-7-1984 the firm gave on lease the premises and furniture and fittings owned by it to the assessee-company on a rent of Rs. 5,000 per day for the building and Rs. 6,500 per day for the other assets. In terms of that agreement the assessee had paid a sum of Rs. 40,25,000 in the previous year ended 30-6-1985, corresponding to the assessment year 1986-87. The ITO considered that if the rent is estimated at Rs. 5 per sq. ft. for a total plinth area of 37,000 sq. ft. it would come only to Rs. 22,20,000 and if another Rs. 5,00,000 is added for the equipments, the assessee need not have paid more than Rs. 27,20,000. He accordingly added back the difference of Rs. 13,05,000 under Section 40A(2)(a). The assessee appealed and contended that the expenditure was not less than the market value of the facilities provided. The CIT (Appeals) thereupon looked into the question whether the agreement was genuine and asked the assessee to explain the business purpose involved in leasing outgoing business with good profit record and also to establish that the agreement was actually given effect to. He then considered the materials produced by the assessee which included a demonstration that there was no camouflaging of the profits inasmuch as there was no reduction in the incidence of tax as a result of the lease agreement. He was, therefore, satisfied that the business had, in fact, been carried on by the assessee company pursuant to the lease agreement and it was not a device for tax avoidance. However, he considered the application of Section 40A(2) and required the assessee to produce a working sheet explaining the basis for the lease rent. On going through that working sheet, he observed that the payment of Rs. 4 per sq. ft. for an area of 12,000 sq. ft. used for cycle parking etc. was excessive and if it is taken at Rs. 3 per sq. ft. an addition of Rs. 2,00,000 was required to be maintained.
3. In this appeal it is painted out that the basis for this inference of the CIT(A) was incorrect inasmuch as the area of 12,000 s.ft. referred to an annexe building and not open space. It was pointed out that only 4000 s.ft. on Subramaniam Road had been used as a godown and, therefore, the flat rate of Rs. 4 per s.ft. taken for both the annexe building and the godown could not be regarded as excessive. The revenue supported the order of the CIT(A) particularly when no appeal had been filed by the revenue against his order. We find that the working sheet had taken both the annexe building and the building on Subramaniam Road together for estimating the rate of Rs. 4 per s.ft. When it is seen that the other properties were given at a rate of Rs. 5 per s.ft. on the main road and this was a little away, and there being no other comparable case, it is difficult to assert that the rate taken at Rs. 4 per s.ft. was accessive or unreasonable. In the circumstances, we delete this addition of Rs. 2 lakhs.
4. The assessee company had also entered into an agreement dated 16-7-1984 with four directors agreeing to pay a sum of Rs. 20 lakhs as compensation for not competing with the company for a period of five years. The amount was to be paid in five equal annual instalments. In this year the assessee had paid a sum of Rs. 4 lakhs to them. The Income-tax Officer was of the view that the firm had already parted with the assets with which the business could be carried on, that these Directors were engaged in managing the affairs of the firm as partners, that it would be impossible for them to find time/money/premises to compete with the company, and hence there was no necessity for such an agreement at all. Therefore, he contended that the payment was only a device to reduce the profit of the company which would otherwise have been payable to the directors/shareholders by way of dividend. He accordingly added back the amount as payment made for extra commercial consideration invoking the provisions of Section 40A(2)(a) also.
5. On appeal, the CIT(Appeals) posed the question as to what was the commercial expediency in making the payment. He answered it by observing that the expenditure was not laid out for the purpose of the business inasmuch as the Director was a full time Director of the company and was adequately remunerated. He also rejected the contention of the assessee that the amount having been taxed in the hands of the Directors should not be disallowed in its hands since it would lead to double taxation of the same amount.
6. In the further appeal before us it was contended on behalf of the assessee that the agreement was a genuine agreement conforming to commercial practice, that the expenditure was revenue nature as accepted in the decisions such as CIT v. G.D. Naidu [1987] l65 ITR 63(Mad.), CIT v. Lahoty Bros. Ltd. [1951] 19 ITR 425 (Cal.), CIT v. Piggot Champan & Co. [1949] 17 ITR 317 (Cal), CIT v. Coal Shipments (P.) Ltd. [1971] 82 ITR 902 (SC), Empire Jute Co. Ltd. v. CIT [1980] 124 ITR 1 (SC) and Jugal Kishore Baldeo Sahai v. CIT [1967] 63 ITR 238 (SC). It was further argued that Section 40A would not apply because there were no goods or services for which the payment was made which could not be evaluated in the market. Lastly it was pointed out that even considered as remuneration to the Directors, the payment could not be considered to be unreasonable because they had been paid only Rs. 2,500 per month as salary and adding this amount of Rs. 1,00,000 each the amount paid to them could not be considered to be unreasonable or excessive.
7. On the other hand, it was contended on behalf of the revenue that since it was the duty of the Directors to look after the business of the company as whole-time Directors, there was no necessity to pay any amount to them to restrain them from starting a competing business particularly when such a venture would automatically reduce their income from this company as they were the only shareholders of the company. Reliance was placed on the decision in the case of CIT v. Hindustan Pilkington Glass Works [1983] 139 ITR 581 (Cal.) to contend that such an expenditure should be treated as a capital expenditure and it was argued that even if it was a revenue expenditure it could be disallowed as not required for the business or in any case excessive under Section 40A(2).
8. On a consideration of the rival submissions, we are of the opinion that this addition cannot be maintained under the provisions of the Act. The contention of the revenue is that there was no necessity for this agreement cannot be accepted. It must be remembered that before the Directors floated the company, they were carrying on the same business as partners of a firm. In the case of a partnership, if a partner carries on a business of competing nature, he has to account for the profits of the firm and, therefore, it may be considered unusual to have an agreement with the partners to restrain them from engaging in a competitive business. But it was observed by Lord Eldon, L.C. in the case of Morris v. Colman [1812] 18 ves. 437 that,-
In partnership engagement, a covenant that the partners shall not carry on for their private benefit that particular commercial concern, in which they are jointly engaged, is not only permitted, but is the constant course.
It follows that in the case of a company also even though the Directors may be expected to devote their whole time to the business of the company, an agreement with them to restrain them from starting a competitive business cannot be considered to be out of the ordinary or unnecessary. It is possible for Directors to have more than one iron in the fire and, therefore, it is not for the revenue to say that the company cannot perceive of any threat of competition or that the company need not have an agreement restraining the Directors from starting a competing business. It was pointed out on behalf of the revenue that in the lease agreement with the firm one of the conditions was that the firm shall not interfere with the affairs of the business of the company and shall not carry on similar business in the name of Sree Annapoorna Gowrishankar and, therefore, another agreement with the Directors was not required, we are unable to understand how a term in the agreement with the firm can prevent the Directors starting a similar business. In any case, that restraint is only with reference to the name whereas the agreement with the Directors restraints them from starting any hotel business and, therefore, wider in scope.
9. After looking into the several decisions cited by both sides, we find that the judicial trend is to recognise expenditure laid out for restraining competing business as a revenue expenditure.
10. The remaining question is whether the expenditure laid out by the assessee could be considered to be excessive or unreasonable. Since we have already held that the agreement was a commercial transaction, the entire amount cannot be disallowed as not for the purposes of the business at all. The power to disallow part of the expenditure as unreasonable or excessive is granted under Section 40A(2) and hence the revenue relied on that section. However, in the present case the expenditure resulted in indirectly making a provision of a benefit to the Director which falls within the scope of Section 40(c). No doubt the provisions of Section 40A(2) would apply to this payment in the absence of Section 40(c)(i). But the accepted canon of construction is that the special excludes the general, i.e., whenever there is any particular enactment and a general enactment in the same statute, and the latter, taken in its most comprehensive sense, would overrule the former, the particular enactment must be operative, and the general enactment must be taken to affect only the other parts of the statute to which it may properly apply. From this point of view while Section 40A(2) requires every expenditure to be tested for unreasonableness or excessiveness, Section 40(c)(i) requires expenditure resulting in a benefit to a Director to be rested according to a different standard. In this situation, the provisions of Section 40(c)(i) which apply specially to expenditure resulting in remuneration to the Director have to be applied in preference to the general provisions of Section 40A(2). We must also remember that the Supreme Court has held in the case of Union of India v. India Fisheries (P.) Ltd. [1965] 57 ITR 331 that if there is an apparent conflict between two independent provisions of law, the special provision must prevail. The proviso to Section 40A(2)(a) also makes this clear. It is not in dispute that this expenditure resulted in a benefit to the Directors. Therefore, this expenditure has to be added to the remuneration already paid to the directors to consider whether the ceiling prescribed under Section 40(c) is exceeded. We direct the Income-tax Officer to conduct this exercise and make the necessary disallowance.
11. In the the appeal is treated as allowed.