Full Judgment Text
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PETITIONER:
BRITISH INDIA CORPORATION
Vs.
RESPONDENT:
COMMISSIONER OF INCOME-TAX, U.P., LUCKNOW
DATE OF JUDGMENT03/10/1972
BENCH:
REDDY, P. JAGANMOHAN
BENCH:
REDDY, P. JAGANMOHAN
HEGDE, K.S.
DUA, I.D.
CITATION:
1973 AIR 416 1973 SCR (2) 524
1973 SCC (3) 285
ACT:
Excess Profits Tax Act 1940, Schedule I, r.12
(1)--Determination by officer whether expenditure is
reasonable and necessary--Tests for.
HEADNOTE:
Rule 12 (1) of Schedule I to the Excess Profits Tax Act,
1940, is designed to prevent the dissipation of excess
profits by inflating expenditure which has no relation to
the requirements of the business. The test is whether the
expenditure is unreasonable 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. All relevant facts, especially
commercial expediency or commercial practice, must be taken
into consideration by the Excess Profits Tax Officer in
considering whether the expenditure is reasonable and
necessary; that is, he could not apply the rule to increases
that can be justified on ordinary commercial principles,
because, an increase in profits may in certain cases be due
to increase in the activity of the management or increase in
the establishment 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 situations, 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 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; 531G-H; 532A]
In the present case, the assessee is a public limited
company having several branches and subsidiary companies It
has a Board of Directors which looks after its business.
The managers who look after the branches ,of the company are
also members of the Board. The assessee was remunerating
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
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depreciation had 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 July, 1940, the phrase "including
provision for tax’ in the clarification, was further
clarified that it was intended to cover all forms of
taxation including excess profits tax and other like
impositions. Therefore, no, deduction of excess profits tax
was to be made prior to the calculation of managerial
commissions. For the chargeable accounting years 1945 and
1946 the Excess Profits Tax Officer found that the assessee
had made large profits and held that if the commission was
to be paid on the ,net audited profits the whole excess
profits would be taken into account for the payment of
commission; that a portion of the commission attributable to
excess profits, in the peculiar circumstances of war
conditions. was not reasonable and necessary with. the
meaning of r. 12 (1), and that any payment, in excess of the
agreed proportion of the net profit’s after deduction of
excess profits tax, was not justified. He, therefore,
disallowed a percentage of the said excess profits which
would be payable to the State on account of excess profits
tax liability. [526A-H;, 527A.C]
525
On the question whether the disallowed we for each of the
years was rightly made, the Tribunal and the High Court held
against the assessee.
Dismissing the appeal to this Court,
HELD : The Excess Profits Tax Officer and the Tribunal have
given valid reasons for not allowing the entire commission
claimed on the basis of the audited accounts without
deducting the excess profits tax., [531G]
Ahmedabad Manufacturing & Calico Printing Co. v. Commr of
E.P.T., 38 I.T.R. 675 followed.
British India Corporation Ltd. v. Commr. of E.P.T., 33
I.T.R. 826 and Shyamlal Pragnarain v. C.I.T., 27 I.T.R. 404
referred to
JUDGMENT:
CIVIL APPELLATE JURISDICTION : Civil Appeal Nos. 1987 to
1988 of 1.969.
Appeals by certificate from the judgment and 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. Singh for the
appellant
B. Sen, J. Ramamurthy, B.D. Sharma and 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) of the
Indian Income-tax Act, 1922. The questions referred were in
respect of the two chargeable accounting periods being
January 1, 1945 to December 31, 1945 and January 1, 1946 to
March 31, 1946 and are given below
1. Whether on the facts and circumstances
of this case the amount of Rs. 5,39,057/- was
rightly disallowed 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
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rightly disallowed under rule 12 (1) 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
company (hereinafter called the ’Corporation’) having
several branches and subsidiary companies. It has a Board
of Directors which looks after its business. The branches
of the Company are looked after by mangers who ,ire members
of the Board of Directors. It
526
appears that for a long time and even before the Act came
into force the corporation has been remunerating its
directors including the Managing Director and branch
managers by way of commission based on a certain fixed
percentage of its net audited profits. This commission was
in addition to the directors’ fees and/or stipulated monthly
salary. In the case of a branch manager the amount of
commission to be paid was calculated on the profits of the
branch of which he was in charge. In the case of others the
profits made by the Corporation as a whole were taken into
consideration. The commission to be paid was either fixed
at the time of appointment or by resolution passed
subsequently. In so far as the two chargeable accounting
periods are concerned, the 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 mentioned, 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 on profits
would be payable to the Managing Director and
the Branch Managers entitled thereto, on net
audited profits, only after depreciation had
been allowed for but prior to any allocation
or appropriation of such profits including
provision for taxation."
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, 1940 and after it was passed,
received the assent of the Governor-General on
April 5, 1940. On July 27, 1940 the phrase
’including provision for taxation’ was further
clarified by the following resolution :-
"The Board, therefore, resolved that the words
’including provision for taxation’ were
intended to and did specifically cover all
forms of taxation including the Excess Profits
Tax and other like 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 retrospectively to the commission paid
in respect of the year 1939."
527
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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 as follows :-
"For reasons stated in the order dated 30-3-
1945 and Rule 12 Schedule I for the chargeable
accounting period up to 31-12-1943, 1 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 agreed proportion of the net
profits after deduction 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 the second chargeable 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 being
paid by the Corporation even 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. 10 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 chargeable accounting period the Excess profits
payable were approximately 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 commission as such be
determined the portion to be disallowed was at 8.4 % 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 3 1. 1946 he determined the amount as Rs. 1,28,743/-.
These two amounts were disallowed in the assessments for the
respective chargeable accounting periods. In arriving at
these amounts the Excess Profits Tax Officer ignored the
terms of appointment and the resolutions and drew support
from the orders passed by the
528
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 was 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
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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 decision relating to the
chargeable accounting periods for 1943 and 1944. 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 disallowed under rule 12(1) of
tile First Schedule to the Act.
In the earlier reference for the assessment in respect of
the assessment years 1943 and 1944, a Bench of the
Allahabad High Court in British India CorPoration Ltd. v.
Commr. of E.P.T.(1) consisting of Bhargava, 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 save no indication 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 not these payments
were necessary and justified, having regard to the ordinary
commercial practice and commercial expediency ,and taking
into account the services rendered by the persons to whom
the _payments were made. Bhargava, J. who delivered the
judgement of the Bench in arriving at the conclusion that
the disallowance of the amounts was act justified followed a
Full Bench judgement of that Court in Shyamlal Pragnarain v.
C.I.T.(2). In that 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 business and the
actual services rendered by the managers. The question as
to the terms of the contract, it said "may have been a
(1) 33 I.T.R. 826.
(2) 27 I.T.R. 404.
529
matter of importance as between the employer and the
employee but not for 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 business keeping in view ordinary
commercial practice and commercial expediency.
When the Tribunal decided the appeal which is the subject
matter of 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 appeal however observed :-
"The Full Bench did not discuss whether for
disallowing a deduction both unreasonableness
and want of necessity 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 before and decided by Bhargava and
Mehrotra, JJ. in one case and the Full Bench
in the other case, the assumption on which
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they proceeded would not bind us."
In our view, these observations are not
justified because in both those cases the
aspects referred to were certainly kept in
view in determining the questions before them.
It appears that the Revenue did not appeal
against the decision of Bhargava and Mehrotra,
JJ. in the case above referred. The Excess
Profits Tax 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 not justified in thinking that
the Excess Profits Tax Officer had not applied
the requirements of rule 12 of the Schedule to
the Act.
Rule 12(1) of Schedule I which is relevant is
as follows
"(1) In computing the profits of any
chargeable accounting period no deduction
shall be allowed in respect of expenses in
excess of the amount which the Excess profits
Tax Officer considers reasonable and necessary
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 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."
530
This rule is de-signed to prevent the dissipation of the
excess profits by inflating expenditure which has no
relation to the requirements of the business. The, test is,
whether the expenditure is unreasonable 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 having regard to the
requirements of the business. But that is another way of
saying that all relevant factors must 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 commercial principles because an
increase in profits may in certain cases be due to increase
in the activity of the management or increase 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 Ahmedabad
Manufacturing & Calico Printing Co. v. Commr. of E.P.T.(1).
That was also a case where the question was whether in
determining the profits on which the percentage had to be
determined for payment of bonus to five of its employees and
the contribution to be made to the provident funds of 5 3
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
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could be made before arriving at the profits. The Excess
Profits Tax Officer came to the conclusion that the payments
were unnecessarily large and unreasonable having regard to
the requirements 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 payment
calculated without deduction of that tax. In upholding the
disallowance this Court held that there was material on
which the Excess Profits Tax Officer could arrive at a
finding and on which the Tribunal could confirm that
finding. In that case also the Excess Profits Tax Officer,
in the assessment order relating to the chargeable
accounting year ending December 31, 1943 gave sufficient
reasons for disallowing the amounts which reasons were
incorporated by reference in the assessment orders
pertaining to the disallowance of the claim in the
chargeable accounting years in question. In the earlier
order the reasons given were as follows :
"The rates of commission were fixed long prior
to the commencement of the present war and no
deduction
531
was admittedly made for the Excess Profits Tax
liability in computing 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
prewar period to about Rs. 2 crores during the
relevant chargeable accounting period and the
commission to management on the basis of net
profits 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 not deducted out of net
profits in calculating commission, ’an
employee stands to benefit from the national
emergency to a greater extent than an
employer’; (Walchand & Co. Ltd. v. The Hin-
dustan Construction Co. Ltd. (12 I.T.R. 104).
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 deduction, 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
"Having held that the aforesaid payments of
commission are unjustifiable and exceptional
the question arises as to what the reasonable
amount, having regard to the requirements of
the business and the actual services rendered
by the persons should be. As mentioned above,
any payment in excess of the agreed proportion
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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 Officer
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 profits tax.
It is obvious that when huge profits are earned not due to
any activity of the managers but due to war situation, 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
justified
532
in disallowing certain proportion which according to him was
unreasonable and unnecessary having regard to the
requirements of the business. In this view, the answers
rendered by the High Court cannot be disturbed and these
appeals are accordingly dismissed with costs.
V.P.S.
Appeals dismissed.
533