BRITISH INDIA CORPORATION versus COMMISSIONER OF INCOME-TAX, U.P. LUCKNOW

524

BRITISH INDIA CORPORATION v. COMMISSIONER OF INCOME-TAX, U.P .. LUCKNOW October 3, 1972 [K. S. HEGDE, P. JAGANMOHAN REDDY AND I. D. DUA, JJ.J Excess Profits Tax Ac: .. 1940, Schedule I, r.12

(!)-Determination

by office,. H'llether expenditure is ireasonab/e and 11ec£•ssary-Tests for.

Rule 12 ( 1) of Schedule I to the Excess Profits Tax Act. D40. is designed to prevent the dissipation of excess pofits by intlating °'penditure which bas_ no relation to the requirements of the business. The test is whether the expenditure is unreasonable and unnecessary haring regard to the requirements of the business, and, in the case of directors' fees or other payments for services, to the actual services rendered. A!l ::-elevant facts, especiaUy commercial expediency or commercial practice, must be taken into consideration b)· the ExCess Profits Tax Officer in con3idering whether the expenditure is reasonable and necessary; that is, he c"1lld not ap.PlY the nile to increases that can be justified on ordinary commercial principles, because, an increase iit profits n1ay in certain cases b~ Clue to increase in the activity of the management or increase in the estab!ishmcnt justifying a corresponding increase in the expenditure. But when huge profits are earned,. not due to any activity of managers but due to national emergencies such as war situati<>.n•, the govem,ment is entitled to a certain share of the excess profits computed under the Act. Any commission paid on the excess profits for which the manage!\' pr employees made no sort of contribution would ex facie be unreasonable and unnecessary and the Excess Profits Tax Officer would be justified in disallowing the proportion, which, according to him, was unreasonable and unnecessary having regard to the requirements of the business. [530A-D; 53 !G-H; 532A]

In the present case, the assessee is a public limited com.Panv having It hds a Board of Directors several branches and subsidiary compaimes. which looks after its business. The managers who look after the branche' of the c'ompany are also members of the Board. The assossee was rem· underating its directors 'by way of commission based on a certain fixed percentage of its net audited profits. The phrase 'net audited profits' was clarified to mean the amount after depreciation ha.d been allowed for, but prior to any allocation or appropriation of profits including provision· for taxation. The Excess Profits Tax Act came into force on April 5, 1940, and on 27th Inly. 1940, the phrase 'including provision for tax' in the clarification, was further clarified that it was intended to like cover all forms of taxation including excess profits tax and other impositions. Therefore, no deduction of ex_t;ess profits tax was to be mad~ prior to the calculation of managerial commissions. For the char· gea.ble accounting years 1945 and 1946 the Excess Profits Tax Officer found that the assessee had made large profits and held that if the comm is~ion was to be paid on the \net audited profits the whole exce3S p"e>lits would be taken into account for the payment of commission; that a por tion of the commission attributable to extess profits, in the peculiar cir cumstances of war conditio:ris. was _not reasonable an'1 necessaJ1Y wjthin· the meaning of r. 12 (I), and that any pdyment, in excess of the agreed proportion of the net profits after deduction of excess profits tax, was nM justified. He. therefore, dis>allowed a percentage of the said excess profits ·which would be payable to the State on actje>unt of exress proftts ta.x liability. [526A-H; 527A-C]

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llRfflSH INDIA CORP. V. C.I.T. (Jaganmohan Reddy, J.)

525

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On the question \Vhcthcr the disaJIOYia~ncc for each of the years was

rightly made, the Tribunal and the High Court held against the assessec.

Dismissing thL' <ippcal to this Court,

HELD : The Excess Profits Tax Officer and the Tribunal have given valid reasons for not a\lov•ing the entire commision claimed on the basis of the audited accounts without deducting the excess profits tax .. [5310]'•

A !1111edahad Ma11ufact11ring &. Calico Printing Co. v. Commt'. oJ,

E.P.T., 38 l.T.R. 675 followed.

British India Corporalio11 Ltd. v. Commr. of E.P. T •• 33 and Shya111/a/ Pra1111arain v, · C.l.T .. 27 l.T.R. 404 referred to

l.T.R. 826

CIVIL APPELLATE JURISDICTION : Civil Appeal Nos. 1987 to

1988 of )969.

Appeals by certificate from the judgment an<l order dated October 22, 1965 of the Allahabad High Court in Income-tax Reference No. 154 of 1957.

S. T. Desai. Alok Kumar Verma and B. P. SinJ?h for the appel

lant.

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B. Sen, J. Ramam1m/1y, B. D. Sharma artd R. N. Sachthey for

the respondent.

The Judgment of the Court was delivered by

JAGANMOHAN REDDY, J. These appeals-are by certificate against the Judgment of the Allahabad High Court in a reference under s. 21 of the Excess Profits Tax Act, 1940 (hereinafter called the 'Act') read with s. 66(2) Qf the Indian Income-tax Act, 1922. The questions referred were in respect of the two chargeable accounting periods being January l, 1945 to December 31, 1945 and January 1, 1946 to March 31, 1946 and are given below:- ·

I. Whether on the facts and circumstances of this case the amount of Rs. 5,39,057 /- was rightly disallow ed under rule 12 (1) of the Schedule to the Excess Profits Tax Act ?

2. Whether on the facts and circumstances of this case the amount of Rs. 1,28,743/- was rightly dis allowed under rule 12 (I) of Schedule I to the Excess Profits Tax Act ?

Both these questions were answered in the affirmative.

The facts and circumstances of the case on which

these answers were given are :-The assessee is a public limited com pany (herinafter called the 'Corporation') havi_ng several _branches It has a Board of Directors wluch looks and subsidiary companic» 'after its husincS'. The branches of the Company are )naked after It hy managers who ar~ members of the Board of D1rcclnrs.

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SUPREME COURT REPORTS

[1973] 2 S.C.R.

appears that for a long time and even before the Act came into force the corporation has been remunerating its directors includ in~ ~e Managing Directo~ and branch managers by way of com Illlss1on based on a certam fixed percentage of its net audited profits. This commission was in addition to the directors''-fees In the case of a branch mana and/ or stipulated monthly salary. ger the amount of commission to be paid was calculated on the profits of the branch of which l)e was in charge. In the case of others the profits made by the Corporation as a whole were taken into consideration. The commissiun (o be ptid was either fixed at the time of appointment or by resolution passed subsequently. In so far as the two chargeable accounting periods are concerned, thi;: position in regard to the payment of the commission has been set out in the .statement of the case but this is not relevant for the purpose of these appeals except to note, as we have earlier men tioned, that the commission was to be calculated with reference to the net audited profits which phrase was Clarified by a resolution of the Corporation dated February 24, 1940. That resolution is as follows :--

"Commission.

In order to regularise previous Resolutions on the subject of Managerial Commission, the Board· resolved that commission oil profits would be payable the Managing Director and the Branch Managers entitled thereto, on net audited profits, only after depreciation had bee1.1 allowed for but prior to any allocation or appropriation of such profits for taxation."

including provision

to

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Though it is not mentioned in the statement of the case we can take judicial notice of it that the Excess Profits Tax Bill was introduced in the Central Legislative Assembly on January 27, F 1940 and after it was passed, received the assent of the Govemor General on April 5, 194\l. On July 27. 1940 the phrase 'including provision for taxation' was further clarified by following resolution : -

the

that

"The Board, therefore, resolved

the words 'including provision for taxation' were intended to and did specifically cover all forms of taxation including the Excess Profits Tax and other impositions and, therefore, no deduction of excess profits tax and other like impositions from the audited profits should be made prior to the calculation of Managerial commissions. The Board also resolved that this ruling. which could only be regarded as fair and reasonable should have effect retrvsoectivelv to the commission paid in respect of the year 1939." ·

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BRITISH INDIA CORP, v. C.I.T. (Jaganmohan Reddy, J.)

In respect of the chargeable accounting period ending December 31, 1945 the Excess :Profits Tax Officer had observed in his order dated December 15, 1947 a~ follows : -

"For reasons stated m the order dated 30-3-1945 and Rule 12 Schedule I for the chargeable accounting period Up to 31-12-1943, I hold that, having regard to the requirements of the business and the actual services rendered by the persons concerned, the commission allowed to the management and directors is both un reasonable and unnecessary. Any payment in excess of the agre~ proportion of the net profits after deduc tion of Excess Profits Tax is not justified."

The Excess Profits Tax Officer accordingly held that Rs. 11,47,143 for the first chargeable accounting period and Rs. 11,06,693 for ihe second ~hargeable accounting period could not be allowed and was further of the view that a portion of it was not reasonable and necessary having regard to the requirements of the business and the actual services rendered by the persons concerned. It was pointed out that the commission of the nature under consideration was beir1g paid by the Corporation ~ven before the Act came into force and that such commission was being allowed in its entirely for purposes of computing profits under s: 10 of the Income-tax Act, 1922 in the two corresponding assessments made under s. I 0 of the Income-tax Act. Though this was so under the Income-tax Act the Excess Profits Tax Officer on the facts of the case and having regard to rule 12 of the Schedule to the Act took the view that since the commission in the respective chargeable accounting periods were paid out of the profits which could not be retained by the Corporation, a portion of the commission attributable to the Excess Profits Tax Act earned in the peculiar circumstances of a national calamity was not "reasonable and necessary" within the meaning of the said rule. It was found that for the first charge able accounting period the Excess profits payable were approxi mately Rs. 64,36,000/- but if the commission was to be paid on the net audited profits of Rs. 1.37 crores, the whole excess profits which could not be retained by the Corporation for its own use would be taken into account for the payment of the commis sion as such be determined the portion to be disallowed was at 8.43 of the said excess profits which will be payable to the State on account of the Exces Profits Tax liability. On this basis the amount worked out was Rs. 5,39,057. Applying the same method for the following. accounting chargeable period ended March 31, 1946 he determined the amount as Rs. 1,28,743/-. These two amounts were disallowed in ihe assessments respective for the In arriving at these amounts .. th~ chargeable accounting periods. Excess Profits Tax Officer ignored the terms of appointment and the resolutions and drew support from the orders passed by the

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SUPREME COURT REPORTS

(1973] 2 S.C.R.

Tribunal in respect of the two prior assessments for the accounting ·periods ended December 31, 1943 and December 31, 1946, against which orders of the Tribunal a reference had earlier been made to the Allahabad High Court. This reference wits then pending before it when the subsequent assessments were being dealt with. In the appeals against assessments made for the accounting periods in the instant case, it was admitted on behalf of the Corporation before the Tribunal that there was no new material other than what was on record in the Excess Profits Tax assessment files and the Tribunal files relating to the chargeable accounting periods for the years 1943 and 1944. These files were produced before the Tribunal in the appeals for the assessments in question. The Tribunal however dismissed those appeals following its earlier deci sion relaiing to the chargeable accounting periods for 1943 and J 944. Against that order the High Court on a reference under the Act considered a similar question, viz. whether the amounts claimed by the Corporation in respect of each of the assessment year was rightly disailowed under rule 12 ( 1 ) of the First Schedule to the Act.

In the earlier reference for the assessment in respect of the as.sessment years I 943 and 1944, a Bench of the Allahabad High Court in British India Corporation Ltd. v. Commr. of E.P.T. (') consisting .of Hhargava, J. (as he was) and Mehrotra, J. were of the view that the findings of the Excess Profits Tax Officer that the payments were both not necessary and not reasonable amounted to:holding that'the previous practice and agreements gave no indi ,'chtion that the commission had to be paid without deducting the excess profits tax from the net profits and that the payments made were beyond the terms of the agreement. According to that court this was not the basis on which the question of reasonableness and necessity of the payments had to be decided. But what the officer and the Tribunal .ought to have decided is the question whether or hot these payments were necessary and justified, having regard to the ordinary commercial practice and co.11mercial expediency und taking .into account the services rendered by the persons to whom the _payments were made. Bhargava, J. who delivered the judge ment of the Bench in arriving at the conclusion that the disallow ance of the amounts was act justified followed a J'.ull Bench judge ). In that ment of that Court in Shyamlal Pragnarain v. C.l.T.( 2 Full Bench it was observed that what the Excess Profits Tax Officer had to bear in mind is that the amount could be disallowed in whole or in part if it was found that it was not reasonable and it was not necessary having regard to the requirements of the busi ness and the actual services rendered by the managers. The quesion as to the terms of the contract, it said "may have been a

(I) 33 T.T.R. 826.

(2) 27 J.T.R. 404.

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BR!TiSH !NOIA CORP. V. C.l.T. (Jaganmohan Red(iy, J.)

529

matter of importance as between the employer and the employee but not ier the purposes of the determination of the question of reasonableness or necessity either under the Income-tax Act or the Excess Profits Tax Act" which had to be judged in the light of the requirements of business and to the exigencies of the busi- ness keeping in view ordinary commercial practice and conunercial expediency.

When the Tribunal decided the appeal which is the subject matter <'f this reference, the decision of the High Court, as we said earlier, had not been rendered and consequently it did not have. the benefit of that decision the High Court in the judgment under "ppeat however obser<-ed : -

"The Full Bench did not discuss whether for disallow ing a deduction both unreasonableness and want of Decessity are required or either is enough and presumed presumably from the fact that both reasonableness and necessity are required for allowing it that both are required. As the question was not expressly raised be fore and decided by Bhargava and Mehrotra, JJ. in one c~se and the Fulll Bench in the other case, the assump- ti'.>n on which they proceeded would. not bind us."

It appears

In our view, these observations are not justified because in both those cases the aspects referred to were certainly kept in view in dete'.1llining the questions·before them. the Revenue did not appeal against the decision of Bhargava and Mehro:ra. JJ. in the case above referred. The Excess Profits Ta~ Officer had made the assessments basing them on the reasons given in the earlier orders relating to the chargeable accounting years 1943 and 1944 which were referred to in the statement of the case. We also find that the High Court in its earlier judgment was neot justified in thinking that the Excess Profits Tax Officer had not applied the requirements of rule 12 of the Schedule to the A.ct.

that

Rule 12(1) of Schedule I which is relevant is as follows: "(I) In c<;>mputing the _profits of any chargeable accountmg penod no deduction shall be allowed in res- pect of expenses in excess of the amount which the Excess Profit< Tax Officer consid~rs reasonable and necessary havmg regard to the reqmrements of the business and i~ the case of directors' fees or other payments for ser'. VIces, to the a,ctual services rendered by . the person concerned;

Provided that no disallowance under this rule shall be made by the Excess Profits Tax Officer unless he has obtained the prior authority of the Commissioner of Excess Profits Tax."

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SUPREME COURT REPORTS

[1973] 2 s.c.R.

This rule is designed to prevent the dissipation of tne excess profits by inflating expenditure which has no relation to the requirements of the business. The test is, whether .the expenditure is unreason able and unnecessary having regard to the requirements of the business and in the case of directors' fees or other payments for services to the actual services rendered. There is of course no reference in this rule to commercial expediency or commercial practice in considering whether an expenditure is unreasonable and unnecessary paving regard to the requirements of the business. But that is another way of saying that all releva11t factors niust be taken into consideration by the Excess Profits Tax Officer in con sidering whether that expenditure is reasonable and necessary. What it means is that the Excess Profits Tax Officer could not apply the rule to increase that can be· justified on ordinary com mercial principles because an increase. in profits may in certain cases be due to increase in the activity of the management or in crease .in the establishment justifying a corresponding increase in the expenditure. The Full Bench decision in Shyamlal's case came up consideration by this Court in Ajzmedabad Manufacturmg & Calico Printing Co. v. Commr. of E.P.T.('). That was also a case where the question was whether in determining the profits on which the percentage had to be dete1mined for payment of bonus to five of its employees and the contribution to be made to the provident funds of 53 employees, deduction,of depreciation. income tax and super-tax in respect of first category and deduction of income-tax or excess profits tax in respect of the second category could. be made before arriving at the profits., The Excess :Orofits Tax Officer came to the concfusion that the payments were un necessarily lar~e and unreasonable having regard to the require ments of the business and without taking up each individual case he held, applying rule 12 that it was not necessary for the assessee company for the purpose of its business to calculate the bonus or the contribution on that basis of net profits before the deduction of excess profits tax. He accordingly disallowed the excess of the In upholding payment calculated without deduction of. that tax. the disallowance. this Court held that there was material on which the Excess Profits Tax Officer could arrive at a finding and on In that case also which the Tribunal could confirm that finding. the Excess Profits Tax Officer, in the assessment order relating to the chargeable accounting year ending December 31, 1943 gave sufficient reasons for disailowing the an10unts which reasons were inco~rated by reference in the assessment orders pertaining to the d1sal!owance of the claim in the chargellble accounting years in question. In the earlier order the reasons given were as fol lows:-

"The rates of commission ·were fixed long prior. to the commencement of the present war and no deduction

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(1) 38 I.T.R. 675.

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BRITISH INDIA CORP, v. C.l.T. (Jagannwhan Reddy, J.)

531

was admitedly made for the Exce8s Profits Tax liability in ccmputing the net profit of the corporation for the purpOSe of calculating commission payable to directors and management. As a result of war conditions the profits of the Corporation have gone .up tremendously from about Rs. 10 lakhs in the pre-war period to about Rs. 2 crores during the relevant chargeable accounting period and the commission to managerrient on the basis of net profhs has risen in the same proportion. Since the Excess Profits Tax, which is intended to prevent the owner of a business from making a large fortune out of what is a national danger, is ItOt deducted out of net profits in calculating commission, 'an employee stands to benefit from the national emergency to a greater extent than an employer'; (Wd{chand & Co. Ltd. v. The Hin dustan Construction Co. Ltd. It therefore, appears both unnecessary and unreasonable to pay more than the agreed proportion of the profits after deduction of Excess Profits Tax. In the circumstances, I hold that the increased expenditure under commission although of a nature which under the provisions of s. 10 of the Income-tax Act, is in itself an allowable deduc tion, is unreasonable and unnecessary having regard to the requirements of the business and the actual services rendered by the persons concerned." After giving these reasons he went on to say :

I.T.R. 104 ).

( 12

"Having held that the aforesaid payments of com mission are unjustifiable and exceptional the question arises as to what the reasonable amount, having regard to the requirements of the business and the actual ser vices rendered by the persons should be. As mentioned above, any payment in excess of the agreed proportion of the net profits after deduction of Excess Profits Tax is unreasonable and unnecessary."

The Excess Profits Tax Officer accordingly computed what was the reasonable amount of commission which should be allowed. We can find very little justification in the criticism that no reasons have been given by the Excess Profits Tax OIEcer or the Tribunal for not allowing the entire commission claimed on the basis of the audited accounts without deducting the taxes paid including the excess prqfits tax. It is obvious that when huge profits are e:irne~ not due to any activity of the managers but due to war s1tuat1on, the Government is entitled to a certain share of the excess profits computed under the Act. Any commission paid on the excess profits for which the managers or employees made no sort of contribution would ex facie be unreasonable and un necessary and the Excess Profits Tax Officer was perfectly iustified

532

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(1973) 2 S.C.R.

in disaliowing certain. proportion which according to him was A unreasonable and unnecessary having regard to the requiremen(s In this view, the answers rendered by Jhe High of the business. Court cannot be disturbed and these appeals are accordingly dis missed with costs.

V.P.S.

Appeals dismissed.