Full Judgment Text
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PETITIONER:
THE COMMISSIONER OF INCOME-TAX, DELHI
Vs.
RESPONDENT:
THE DELHI FLOUR MILLS CO., LTD., DELHI
DATE OF JUDGMENT:
03/10/1958
BENCH:
SARKAR, A.K.
BENCH:
SARKAR, A.K.
AIYYAR, T.L. VENKATARAMA
GAJENDRAGADKAR, P.B.
CITATION:
1959 AIR 185 1959 SCR Supl. (1) 28
CITATOR INFO :
RF 1961 SC 692 (12)
ACT:
Excess Profits-Assessment-Assessee company’s agreement with
managing agents-Commission on net profits-Computation -Tax,
if can be deducted-- " Net profits ", meaning of.
HEADNOTE:
An agreement between the assessee company and its managing
agents provided : " In consideration for acting as managing
agents the company should pay to the firm remuneration at
Rs. 750/- p.m............. and in addition a commission
equal to of the annual net profits. Such net profits will
be arrived at after allowing the working expenses, interest
on loans and due depreciation, but without setting aside
anything to reserves or other special funds ". The question
was whether the excess profits tax payable by the company
should be deducted from its profits for the purpose of
arriving at the annual net profits of which a percentage
should be paid to the managing agents as their commission
under the agreement.
Held ’ that,, the words " net profits " in the agreement
meant divisible profits, profits divisible between the
company and the managing agents, and that in ascertaining
such profits, deduction had to be made, besides the items
expressly mentioned in the agreement, of excess profits tax
payable by the company.
James Finlay & Co., Ltd. v. Finlay Mills Ltd., (1942) 47
Bom. L.R. 774 and Walchand & Co., Ltd. v. Hindusthan
Construction Co., Ltd., (1943) 45 Bom. L.R. 951,
considered.
Ashton Gas Company v. Attorney-General, [1906] A.C. 10 and
Re G. B. Ollivant & Co. Ltd.’s Agreement, [1942] 2 All E. R.
528, distinguished.
JUDGMENT:
CIVIL APPELLATE JURISDICTION : Civil Appeal No. 211 of 1955.
Appeal from the judgment and order dated.December 30, 1952,
of the Punjab High Court in Civil Reference Case No. 18 of
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1952.
H. J. Umrigar and R. H. Dhebar, for the appellant.
Hardayal Hardy, for tile respondents.
1958. October 3. The Judgment of the Court was delivered by
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SARKAR J.-By an agreement made in 1936, the assessee company
appointed a firm as its managing agents. The agreement
provided that the managing agents would be remunerated in
the manner following:
"In consideration for acting as Managing Agents the Company
should pay to, the firm remuneration at Rs. 750 p.m. or such
principal sum as may from time to time be deemed reasonable
by the Directors and in addition a commission equal to 10%
of the annual net profits. Such net profits will be arrived
at after allowing the working expenses, interest on loans
and due depreciation, but without setting aside anything to
reserves or other special funds."
The question is whether the commission payable to the
managing agents under this agreement is to be ten per cent.
of the profits of the assessee without deduction of the
excess profits tax payable by it oil its profits or after
deduction.
The question has arisen in the course of the assessment of
excess profits tax payable by the assessee. The Excess
Profits Tax Officer held that the commission has to be
ascertained on the profits remaining after deduction of
excess profits tax. This view was upheld by the Appellate
Assistant Commissioner on an appeal being taken to him by
the assessee. On a further appeal by the assessee to the
Appellate Tribunal it was held that the commission has to be
ascertained on the profits without any deduction of the tax.
The revenue authorities then applied for and obtained, an
order from the Tribunal referring the following question for
decision by the High Court:
" Whether on a true construction of the Managing Agency
Agreement between the assessee Company and its Managing
Agents entered into in 1936, the relevant clause of which is
quoted above, the Excess Profits Tax payable should be
deducted from the profits of the Company for the purpose of
arriving at the annual net profits of which a percentage
should be paid to the Managing Agents as their commission."
The High Court answered the question in the negative.
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The present appeal is by the revenue authorities against the
judgment of the High Court.
The question is a short one. It is one of construction of
the managing agency agreement. Of course, whatever is
payable under this agreement to the managing agents as their
remuneration is a proper expense of the business of the
assessee and has to be deducted in ascertaining its profits
and it is upon such profits that excess profits tax has to
be assessed. There is no dispute about this. The dispute
has arisen because the remuneration of the managing agents
is we leave out now the minimum and fixed remuneration of
Rs. 750 per month as to which no question arises and with
which we are therefore not concerned-itself to be calculated
on the profits. The dispute is whether the proper
construction of the agreement is that the profits, a
percentage of which is to be paid to the managing agents as
their remuneration, are the profits before deduction of
excess profits tax or after.
What then is the true construction ? The agreement is that
"the net profits will be arrived at after allowing the
working expenses, interest on loans and due depreciation but
without setting aside anything to reserves or special
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funds." We can leave out the things expressly made not
deductible for as to these no question arises, the question
being whether something more, namely, excess profits tax,
can be deducted. Working expenses, interest on loans and due
depreciation have however been expressly made deductible in
ascertaining the net profits. If these are all the
deductions that can be made, excess profits tax cannot be
deducted for it does not come under any one of them. But it
seems to us that the agreement was not intended to lay down
all the deductions that can be made. It is not in dispute
that expenses like overhead expenses, litigation expenses
and similar other expenses properly incurred for carrying on
the business can be deducted in arriving at the net profits.
These would not be included within "working expenses " for
that expression is usually understood as referring to
expenses debitable to the trading account
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as having been incurred directly in making the income shown
there. If this were not the sense in which the expression "
working expenses " was used and it was meant to cover all
revenue expenses incurred, then there would have been no
need to mention interest on loans and depreciation
separately, for, these latter would have been included as
revenue expenses in the expression " working expenses ". We
are therefore inclined to think that there are other items
besides those expressly mentioned, which have to be deducted
before the net profits can be arrived at.
What then are these other items? That will depend on what
the parties must be taken to have had in mind when they used
the words " net profits ". The intention of the parties as
to what they meant by these words can be best gathered by
trying to find out what they were about in making the
agreement. The parties were a master and a servant and they
were fixing the remuneration of the servant. They decided
that profits or no profits, the servant would have a certain
fixed sum per month. They also agreed that the servant
would besides the fixed sum, have a certain portion of the
net profits. The net profits, whatever they were, would of
course be a variable figure; in some years they would be
more or less than in other years. The parties therefore
agreed that the remuneration of the servant would increase
or decrease as the net profits were larger or smaller. But
why did they do so ? Obviously because they thought that it
was fair that the servant’s remuneration should be
commensurate with the benefit that his work produced for the
master; the larger such benefit was, the larger the
servant’s remuneration and vice versa. It is difficult to
imagine that the parties agreed that remuneration would be
paid for profits earned by the servant’s efforts of which
the master did not get the benefit. This view of the matter
becomes clearer when one remembers that besides the variable
remuneration dependent oil the profits, the servant had a
fixed minimum remuneration. The agreement, therefore, was
essentially one to share the profits; the agreement was that
part of the profits was
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to go to the servant and part enure for the master’s
benefit. If this is the true construction of the agreement,
as we think it is, then it follows that the net profits
contemplated by the parties are such profits as can be
divided between the master and the servant; they are such of
which both the master and the servant get the enjoyment in
stated proportions. In other words, they are the divisible
profits of the company, divisible, that is to say, between
the master and the servant. In order that the divisible
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profits can be ascertained, excess profits tax has of course
to be deducted. As to that there does not seem to be any
doubt, for, that part of the profits which is taken away by
the State as excess profits tax, is not available either to
the master or the servant and cannot therefore be divided
between them.
It is said that the agreement cannot be construed in this
way because that would be adding a word to it; the word
’divisible not being there, is introduced into the agreement
to support this construction. This however is not so. No
word is being introduced but the words used are only being
explained. It is only stating that the parties meant by "
net profits ", the divisible profits. It is really stating
the same thing in different words.
It is also no objection to the view that we take, that
excess profits tax is a part of the profits itself It
perhaps is so but it is no part of the " net profits "
contemplated by the parties. It is a part which has to be
deducted in arriving at the net profits, that is to say, the
divisible profits which alone the parties had in mind.
As a matter of construction of the agreement before us,-and
we do not think that the question involved in this case can
be decided in any other way-therefore, we come to the
conclusion that the " net profits " mean the divisible
profits and are to be ascertained after deduction of excess
profits tax which is payable by the assessee.
That is how the matter strikes us apart from any authority.
We now turn to some of the authorities which were cited at
the bar. They are In re Condran,
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Condran v. Stark (1), Patent Castings Syndicate Ltd. v.
Etherington (2), Vulcan Motor and Engineering Co. v. Hampson
(3 ), Re G. B. Ollivant & Co. Ltd.’s Agreement James
Finlay & Co. Ltd. v. Finlay Mills Ltd. and Walchand & Co.
Ltd. v. Hindusthan Construction Co. Ltd. (6). These cases
however all turn on the construction of the agreements
involved in them. They are therefore not of much assistance
in construing the agreement that we have before us, for,
each agreement has to be construed according to the words
contained in it and the circumstances in which it was made.
The judgment in Re G. B. Ollivant & Co. Ltd.’s Agreement
(supra) referred to earlier is that of the House of Lords.
In the judgment delivered in this case by the Court Appeal
reported in (1942) 2 All E. R. 528 which was affirmed by the
majority of the House of Lords, Lord Greene M. R. warned
that in questions of this kind authorities were of no
assistance. Referring to the earlier English cases
mentioned above, he said (p. 532):
" They decide that on the true construction of the
agreements there in controversy, the phrase " net profits "
in Etherington’s case, the phrase " profits earned by the
company " in Vulcan’s case and the phrase " net profits " in
Condran’s case, all meant the divisible profits of the
company in the first two cases and of the partnership in the
third. They went on to decide a matter which I should have
thought was not open to question, namely, that in
ascertaining divisible profits excess profits duty fell to.
be deducted ....................................... But
beyond that, those authorities do not appear to me to afford
any assistance. The first part of the decisions, as to the
meaning of " profits " or net profits in those particular
agreements, does not help, because the language is entirely
different from that used in the present case; and the second
part of the decisions, namely, that in ascertaining
divisible profits excess profits duty is to
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(1) [1917] 1 Ch. 639. (3) [1921] 3 K. B. 597.
(5) (1942) 47 Bom. L.R. 774.
(2) [1919] 2 Ch. 254.
(4) [1942] 2 All E. R. 528.
(6) (1943) 45 Bom. L.R. 951.
5
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be deducted, is, as I say, a matter for which I should have
thought authority was not required.........
Like the earlier cases, Re O. B. Ollivant & Co. Ltd.’s
Agreement (1) also ’turned on the language of the ;agreement
involved in it and is not therefore of any great assistance.
The Indian cases mentioned earlier were also decided on the
agreements with which they were concerned. In the James
Finlay & Co. Ltd. case (2) the agreement provided that the "
net profits" were to be ascertained before setting aside any
sum " for payment of income-tax, super-tax or any other tax
on income ". It was held that " any other tax on income "
included excess profits tax which could not therefore be
deducted. Beaumont C. J. observed in this case that it
having been held that income-tax being something which is
payable out of the profits and not a liability to be
deducted in ascertaining the profits, it was difficult to
explain why the same’ principle should not apply to excess
profits duty. He also said that a distinction had been made
between the two taxes in the English cases, to some of which
we have earlier referred, but he did not think it necessary
to consider whether all the grounds of distinction were
sound, because in the case before him he thought that excess
profits tax had been expressly dealt with. In the Walchand
& Co. Ltd. case the agreement was very much like the
agreement that we have before us. It provided that the
managing agents would be paid ten per-cent. of the annual
net profits earned by the company and also stated that in
arriving at the net profits certain deductions would be made
which included the working expenses and that certain other
deductions would not be made, but no mention was made of
excess profits tax as being deductible or otherwise.
Beaumont C. J. who was a member also of the bench which
decided this case, held that the agreement was a profit
sharing agreement and the net profits had to be ascertained
after deducting excess profits tax. Now we do not refer to
these judgments
(1) [1942] 2 All E. R. 528. (2) (1942) 47 Bom. L.R. 774.
(3) (1943) 45 Bom. L.R. 951.
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as supporting anything that we say but because the High
Court unwittingly fell into the error of thinking that the
Walchand & Co. Ltd. case (1) came before the James Finlay &
Co. Ltd. case (2) and that in the latter case Beaumont C. J.
had doubted the correctness of what he had said in the
former. These observations are wholly wrong because, the
James Finlay & Co. Ltd. case (2) was decided long before
the Walchand & Co. Ltd. case (1) had been decided. Neither
do we find that there is any conflict between the two cases.
In the Walchand & Co. Ltd. case (1), Beaumont C. J. gave
reasons for making a distinction between income-tax and
excess profits tax and thought that the distinction between
them made in the English cases to which we have referred,
was not of substance. We do not think it necessary to say
anything as to whether Beaumont C. J. was right in this
view.
Oil behalf of the assessee we were pressed with the same
contention that as it has long been held that income-tax
could not be deducted in ascertaining the net profits of a
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company, excess profits tax could not also be deducted, for,
they were substantially of the same nature each being a tax
on the profits. Indeed in Ashton Gas Company v. Attorney-
General (3), where the House of Lords had to construe the
provision in the incorporating statute of the Gas Company
which provided that the profits to be distributed among the
shareholders in any year should not exceed a given rate, the
following observation occurs in the opinion delivered by
Lord Halsbury L. C. at p. 12:
" Income-tax is a charge upon the profits; the thing which
is taxed is the profit that is made, and you must ascertain
what is the profit that is made before you deduct the tax-
You have no right to deduct the income-tax before you
ascertain what the profit is, I cannot understand how you
can make the income-tax part of the expenditure."
Now it seems to us that there is nothing in the Ashton Gas
Co. case(3) which prevents us from
(1) (1943) 45 Bom. L.R. 951. (2) (1942) 47 Bom. L.R. 774.
(3) [1906] A. C. 10, 12.
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holding that in ascertaining the net profits for the purpose
of the agreement that is before us, excess profits tax has
to be excluded. That was not a case of profit sharing. It
was not concerned with deciding what sums are deductible in
arriving at the divisible profits in a profit sharing
agreement. That is what we have to decide. Therefore we
think that the Ashton Gas Co. case (1) does not assist in
answering the question that has arisen in this case.
Nor do we think it necessary in the present case, as we have
said earlier, to decide whether there are distinctions
between income-tax and excess profits tax. We are not
concerned with the question whether income-tax should be
deducted before the net profits under the agreement can be
ascertained. We will assume that it cannot be. It is
common sense and also firmly established on the authorities
to which reference has already been made, that in ascertain-
ing the divisible profits excess profits tax has to be
deducted. As we have construed the agreement in this case,
net profits mean the divisible profits and therefore they
can be arrived at only after deduction of excess profits
tax.
We wish now to refer to the minority opinions in the House
of Lords in Re G. B. Ollivant & Co. Ltd.’s Agreement (2) on
which the High Court seems largely to have based its
decision. The dissenting opinion of Viscount Simon L. C.
arose from the fact that he did not think that the word
profits in the agreement then before the House meant the
divisible profits. With the reasons for this view we are
not concerned for these turned on the wording of that
agreement. Having held that the word profits did not mean
the divisible profits, he proceeded to consider whether
excess profits tax could be deducted in ascertaining the net
profits and in doing so said that as income-tax could not be
deducted as held in the Ashton Gas Co. case (1), neither
could excess profits tax, for, both were parts of the
profits. He also said that the Court of Appeal was wrong in
thinking that excess profits tax could be debited to the
profit and loss account and therefore held that the net
profit
(1) [1906] A.C. 10, 12.
(2) [1942] 2 All E. R. 528.
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which is usually shown in that account has to be ascertained
without deducting excess profits tax. We are not concerned
with this part of the opinion of the Lord Chancellor either.
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It was given on the basis that the profits were not the
divisible profits and we are concerned only with divisible
profits. The other dissentient speech was by Lord
Macmillan. He said substantially what Viscount Simon had
said, and therefore it is unnecessary to deal with his view
separate y. It does not however appear to us that the
dissentient Judges in the House of Lords held that if the
profits were the divisible profits, excess profits tax could
not be deducted before these could be ascertained. In the
view that we have taken of the agreement before us, we
cannot, therefore, derive any assistance from the
dissentient opinions.
One other case, namely, N. M. Rayaloo Iyer & Sons v. The
Commissioner of Income-tax, Madras (1), was brought to our
attention. This case also purports to follow the reasoning
adopted in the minority judgments in Re G. B. Ollivant & Co.
Ltd.’s Agreement (2) and actually relied on the authority of
the judgment under appeal. It is therefore unnecessary to
refer to it further.
It had been contended by the learned advocate for the
appellant that even if the net profits mentioned in the
agreement were not the divisible profits and even if income-
tax could not be deducted to ascertain these profits, excess
profits tax was a proper deduction to be made. It was said
that excess profits tax was for this purpose different in
nature from income-tax, for, (a) under s. 12 of the Excess
Profits Tax Act, 1940, excess profits tax was deductible as
an expense for the purpose of income-tax assessment; (b)
that where the employer is a company, as in the present
case, the income-tax paid is refundable to the shareholders
which excess profits tax is not; (c) that excess profits tax
is a " debt " of the business and therefore an outgoing, and
(d) that it was in the nature of a licence fee upon the
payment of which alone the business could be carried on. It
is unnecessary to consider these points as in our view the
net profits in this case were
(1) [1954] 26 I.T.R. 265. (2) [1942] 2 All E. R. 528.
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the divisible profits and whether excess profits tax is
distinguishable from income-tax for any of these reasons or
not, it is properly deductible.
We should also refer to an argument advanced by the assessee
which was founded on s. 87-C of the Indian Companies Act,
1913, introduced by an amendment made in 1936, which
provides that the remuneration of the managing agents of a
company shall be a fixed percentage of its net annual
profits, and that in calculating the net profits no
deduction in respect of any tax or duty on income is to be
made. It is said that the statute incorporates the
universal commercial practice and therefore in construing
the present agreement excess profits tax cannot be deducted.
We are not aware whether the section incorporates any
practice but we think that this contention is entirely
unfounded for the section was applied only to a managing
agency agreement made after the amending Act came into
force, while the agreement in the present case was made
before that date.
Lastly, we have to point out that nothing turns on the fact
that at the date the agreement under consideration was made,
Excess Profits Tax Act had not come on the statute book nor
perhaps been thought of, and therefore could not have been
in the contemplation of the parties. If the net profits,
are the divisible profits, everything necessary to be
excluded to arrive at the divisible profits has to be
deducted whether it was in the contemplation of the parties
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or not. It is easy to imagine instances. Suppose after the
agreement the Government imposed a licence fee on the
payment of which alone the business could have been carried
on and that licence fee was not in the contemplation of the
parties when the agreement had been made. None the less it
has clearly to be deducted in finding out the divisible
profits. In the result we would answer the question framed
in the affirmative.
The appeal is therefore allowed with costs in this Court
and in the High Court.
Appeal allowed.
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