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Petitioner: GREAVES COTTON & Co. LTD. VS Respondent: COMMISSIONER OF INCOME-TAX, BOMBAY CITY-IHonorable Justice V. S. DESAI
1968 P T D 680
1968 P T D 680
[Bombay (India)]
Before Y. S. Tambe and V. S. Desai, JJ
GREAVES COTTON & Co. LTD.
Versus
COMMISSIONER OF INCOME‑TAX, BOMBAY CITY‑I
Income‑tax Reference No. 52 of 1960, decided on 12th July 1962.
Business expenditure‑Company‑Managing Agents‑Termina tion of managing agency in order that board of directors may carry on business‑Compensation for premature termination --Whether business expenditure‑‑Income‑tax Act, 1922, S. 10(2) (xv).
Thapars, a private company, secured the managing a agency of the assessee‑company in 1947, by paying their predecessor a sum of Rs. 27,34,325 and also took over all the shares held by the predecessor in the assessee‑company for Rs. 50,00,000. An agreement was then executed between Thapars and the assessee fixing the duration of the managing agency at twenty years and the remuneration of the managing agents at 21 percent. of the, goods sent to India by a company at Manchester:. In 1950, the assessee converted itself into a public company and increased its share capital by Rs. 55 lakhs with the sanction of the Controller of Capital Issues: A fresh managing agency agreement was, executed on May 10, 1950, for a period of twenty years fixing the remuneration of the managing agents at a monthly office allowance and a commission of 10 percent. of the net profits of the assessee. Thereafter, the Nizam of Hyderabad purchased shares worth Rs. 50 lakhs in the company for cash out‑ of which Rs. 33 lakhs were utilised and Rs. 17 lakhs remained in the hands of the assessee. At a meeting of the board of directors of the assessee held on February 28, 1951, the question of cancellation of the managing agency agreement of May 10, 1950, was referred to a sub‑committee consisting of three executive directors of the company, although the question was not an item in the agenda. The sub‑committee submitted its report on March 16, 1951, stating that the termination of the agreement would be to the benefit of the shareholders and would not be detrimental to or adversely affect the assessee's business and that the board of directors was fully competent to carry on the affairs of the company. The sub‑committee fixed the amount of compensation at Rs. 18,87,620 but was of the view that it was to be paid out of the free profits of the assessee and not, out of the Rs. 17 lakhs in its hands unless sanction was obtained from the Controller. It also stated that if the managing agency was terminated provision should be made for payment of commission to the non‑working directors of the company. On March 17, 1951, the board of directors in its meeting accepted the recommendations and decided that the compensation should be paid lit three equal instalments on April 15, 1951, April 15, 1952, and April 15, 1953. An extraordinary general meeting of the shareholders of the assessee was convened on March 31, 1951, which adopted resolutions confirming the decision of the board. By a letter dated April 10, 1951, Thapars accepted the termination of the managing agency on payment of com pensation of Rs. 18 lakhs and, thereafter, the assessee appro priated in its books of account for 1951‑1952 the amount of Rs. 18 lakhs and claimed deduction of the amount as expenditure laid out wholly and exclusively for the purpose of its business under section 10(2)(xv) of the Indian Income‑tax Act, 1922:
Held, on the facts, that the termination of the managing agency agreement with a view to taking over the management by the board of directors seas an ordinary commercial proposition gone through in an ordinary commercial way and was justified on the ground of commercial expediency. The amount of Rs. 18 lakhs was an admissible deduction under section 10(2)(xv).
The termination of the managing agency agreement before the expiry of its period by the managed company with a view to getting rid of its recurring liability in the matter of payment of managing agency commission and/or taking over the manage ment by its board of directors would be a transaction in the ordinary course of its business in order indirectly to facilitate the carrying on of its business. In such a case compensation paid by the managed company to the managing agents in lieu of the termination of the managing agency agreement would, therefore, in the absence of any evidence that it was an arrangement by way of distribution of profits or that the payment was wholly gratuitous or that the termination was brought about for some improper or oblique purpose, outside the course of business management, be an expenditure wholly and exclusively laid out for the purposes of business.
Anglo‑Persian Oil Co. (India) Ltd. v. Commissioner of Income-tax (1933) 1 I T R 129 ; P. Orr & Sons v. Commissioner of Income‑tax (1959) 35 I T R 556 : Cannanore Spinning & Weav ing Mills Ltd. v. Commissioner of Income‑tax (1961) 42 I T R 528 and Eastern Investments Ltd. v. Commissioner of Income‑tax (1951) 20 I T R 1 (S C) fol.
B. W. Noble Ltd. v. Mitchell (1926) 11 Tax Cas. 372 ; Union Cold Storage Co. v. Jones (1924) 8 Tax Cas 725 and Atherton v. British Insulated and Helsby Cables Ltd. (1925) 10 Tax Cas. 155 ref.
STATEMENT OF CASE
By this application the assessee requires the Appellate Tribunal to refer to the High Court certain questions of law which are said to arise out of the Tribunal's order in I. T. A. No. 9237 of 1958‑59. Inasmuch as, in our opinion, a question of law does arise out of the aforesaid order of the Tribunal, we hereby draw up a statement of the case and refer it to the High Court of Maharashtra at Bombay under section 66(1) of the Indian Income-tax Act, 1922.
2. The subject‑matter of this reference is a claim of the assessee‑company under section 10(2) (xv) in respect of a sum of Rs. 18 lakhs paid as compensation for the termination of the managing agency of Messrs Karamchand Thapar & Bros. Limited. The assessment year is 1952‑53 and the accounting period is the year ending March 31, 1952. The assessee‑company was incorporated as a private limited company on the 29th March 1922. A partnership firm of Messrs Greaves Cotton & Co. was appointed the managing agents of the assessee‑company and was in that office from April 1, 1922, till the resignation on January 7, 1947. Messrs Karamchand Thapar & Bros. Ltd. was thereafter appointed as managing agents of the assessee company on January 8, 1947. Messrs Karamchand Thapar & Bros. Ltd. paid its predecessor‑in office, Messrs Greaves Cotton & Co., Rs. 27,34,325 and secured the managing agency rights of the assessee‑company. It also paid Rs. 50 lakhs and took over all the shares held by Messrs Greaves Cotton & Co. in the assessee‑company. The entire arrangement was completed on January 8, 1947. A managing agency agreement was also entered into on January 8, 1947. This was to enure for a period of twenty years from January 8, 1947. A copy of the managing agency agreement dated January 8, 1947, is Annexure "A" and forms part of the case. In and by that agreement the remuneration payable to the managing agents was fixed at 2 % of the value of shipments to India by the London associate of the managed company, i.e., the assessee‑company. The agreement pro vided for payment of compensation equal to five times the commission earned by the managing agents in the event of termination of the managing agency under certain circum stances. Pursuant to a resolution of the board of directors dated May 4, 1950, it was decided to have a fresh agreement with the managing agents and also to convert the managed company into a public limited company. A copy of the minutes of the meeting of the board of directors held on May 4, 1950, is Annexure "B" and forms part of the case. By virtue of a resolution of the general meeting of the members of the assessee‑company held on May 8, 1950, as mentioned, a fresh managing agency agreement was entered into on May 10, 1950. A copy of the minutes of the general meeting held on May 8, 1950, is Annexure "C" and forms part of the case. A copy of the managing agency agreement dated May 10, 1950, is Annexure "D" and forms part of the case. This agreement provided for the managing agents being paid a sum of Rs. 5,000 per month as office allow ance and a commission at 10% on the not profits of the assessee& company. The managing agency was to enure for a period of twenty years from May 8, 1950. Clause 13 of the agreement pro vided for compensation being paid under certain circumstances and this was fixed at seven years' average emoluments calculated as mentioned above. The assessee‑company in terms of that fresh agreement paid Rs. 2,63,162 as remuneration to the managing agents for the year ending March 31, 1951.
3. In the meantime the assessee company had issued fresh capital to the value of Rs. 55 lakhs Rs. 25 lakhs worth of pre ference shares and Ps. 30 lakhs worth of ordinary shares Out of this Rs. 18 lakhs worth of ordinary shares and Rs. 23 lakhs worth of preference shares were allotted to K. B. C. B. Tarapor wala in his capacity as financial adviser to His Exalted Highness the Nizam of Hyderabad. The object of the issue was to finance expansion of production by the assessee‑company.
4. The board of directors met on February 28, 1951, and con stituted a sub‑committee to consider and report on the question of termination of the managing agency agreement dated May 10, 1950. A copy of the minutes of the meeting of the board of directors held on February 28, 1951 is Annexure "E" and forms part of the case. The said sub‑committee consisted of Messrs T. Kemp, J. Blezard and N. M. Wagle, three of the executive directors of the company, and they were required to submit a report with their recommenda tions to the board of directors for being eventually placed before the general body of the shareholders. The sub‑committee made its report on March 16, 1951. A copy of the report of the sub committee dated March 16, 1951, is Annexure "F" and forms part of the case. In the opinion of the sub‑committee the directors were fully competent to manage the affairs of the company and that the termination of the managing agency agree ment would not adversely affect the business of the com pany. They recommended a sum of Rs. 18,87,620 to be paid as compensation to the managing agents. In the view of the sub committee the termination of the managing agency would streng then the future position of the company and they also recommend ed that the managing agents may be requested to agree to receive the compensation in three instalments to be paid on April 15, 1951, April, 15, 1952, and April 15, 1953, respectively. The directors at their meeting held on March 17, 1951, considered and approved the report of this sub‑committee. They decided to recommend the payment of compensation. They had sufficient funds out of the fresh capital raised as mentioned earlier. A copy of the minutes of the meeting of the board of directors held on March 17, 1951 is Annexure "G" and forms part of the case. Conse quent upon this they recommended to the members of the company to terminate the managing agency agreement with effect from March 31, 1951. They also recommended that the managing agents be paid compensation of Rs. 18, lakhs in three equal in stalments of Rs. 6 lakhs each on or about April 15, 1951, April 15, 1952, and April 15, 1953, respectively. The shareholders of the assessee company met at an extraordinary general meeting on March 31, 1951, and adopted the following resolutions:
"(1) that in the interests of the company, the managing agents, Messrs Karamchand Thapar & Bros. Ltd., be removed from their office as such and that notice be given to them terminating the managing agency agreement dated 10th May 1950, whereby they were appointed managing agents of the company for a period of twenty years from 8th May 1950, with effect from 31st March 1951.
(2) that the managing agents, Messrs Karamchand Thaper & Bros. Ltd., be offered as compensation for loss of their office as such the sum of Rs. 18,00,000 payable by instalments of Rs. 6,00,000 on 15th April 1951, Rs. 6,00,000 on 15th April 1952, and Rs. 6,00,000 on 15th April 1953."
A copy of the minutes of the extraordinary general meeting of the shareholders held on March 31, 1951, is. Annexure "H" and forms part of the case. I he said resolution was followed by the assessee‑company and by issue of a notice dated April 3, 1951, to Messrs Karamchand Thaper & Bros. Ltd., terminated with effect from March 31, 1951, the managing agency agreement dated May 10, 1950. The compensation, already referred to, was also duly offered to the managing agents. By their letter dated April 10, 1951, the managing agents accepted the offer. They also made it clear that in addition to the compensation of Rs. 18 lakhs they should also be paid the commission earned by them in accordance with the agreement for the year ended March 31, 1951. A copy of the letter dated April 10, 1951, written by the managing agents to the assessee‑company is Annexure "I" and forms part of the case.
5. In the profit and loss account of the accounting year the assessee‑company claimed a deduction of this sum of Rs. 18 lakhs, paid as compensation to the managing agents. As the Thapars were controlling both the managing agency company as well as the managed company (vide the list of shareholders and directors at paragraph 3 of the Income‑tax Officer's order), the Income‑tax Officer initiated inquiries to find out whether the payment was, necessary in the interests of the carrying on of the business of the assessee‑company. It was necessary for him to inquire into this aspect, as the assessee‑company could (in fact it has) claim this as an allowable revenue expenditure while the recipient could at the same time claim that, it was a non‑taxable capital.
6. The Income‑tax Officer on a review of the several materials placed before him came to the conclusion that the termination of the managing agency and the consequent payment of compensation was not done on business considerations. 'He finally held:
"It appears to me that the termination of the managing agency was effected in order to give Messrs Karamchand Thaper & Bros. Ltd. capital receipt of Rs. 18 lakhs and to claim revenue deductions of like amount in the hands of the assessee‑company."
He, therefore, disallowed the sum of Rs. 18 lakhs as claimed. A copy of the Income‑tax Officer's order is Annexure "J" arid forms part of the case.
7. The assessee‑company preferred an appeal to the Appellate Assistant Commissioner and contended that this expense claimed was really an allowable deduction under section 10 (2) (xv) of the Act as compensation paid to the managing agents on the termination of their agreement. The Income‑tax Officer on the other hand contended that the whole payment of Rs. 18 lakhs was, for an oblique purpose and that the payment was made only on account of extra‑commercial considerations. The Appellate Assistant Commissioner on a review of the entire evidence on record and after hearing the parties held:
"On the facts of the appellant's case, I agree with the Income‑tax Officer that the whole transaction of termination of the managing agency and payment of the compensation of Rs. 18 lakhs is only a made‑up show. Though the ostensible reason given is `in the interests of the company', in the context and surrounding circumstances of the appellant's case, I am satisfied that the expenditure of the 18 lakhs of rupees ostensibly paid for the termination of the managing agency cannot he held to be an expenditure wholly and exclusively laid out for the purposes of the business within the meaning of section 10 (2) (xv) . . ."
In the result the assessee‑company's appeal was dismissed. A copy of the Appellate Assistant Commissioner's, order is Annexure "K" and forms part of the case.
8. Thereafter, a second appeal was preferred to the Appellate Tribunal. It was also contended before the Tribunal that the Appellate Assistant Commissioner erred in holding that the agreement to terminate the managing agency was made for extra‑commercial considerations and for an oblique purpose, that there was no warrant for the rejection of the claim for Rs. 18 lakhs which the assessee hats agreed to pay as compensation to the managing agents upon the termination of the agreement and that the sum of Rs. 18 lakhs paid was an expenditure wholly and exclusively laid out for the purposes of the business of the assessee‑company and that there was no justification to disallow the claim. The Tribunal also rejected the appeal of the assessee-company. It held,
"5. We have carefully considered the various aspects of the case. We cannot understand how by any stretch of imagination the sum of Rs. 18 lakhs paid to the managing agents can be styled as compensation for the loss of office or money spent a wholly and solely for the purposes of the assessee's business. Committees were appointed not in the interest of the business but as desired by the interested parties. The appointment of the managing agents had only been made a few months before they were removed from the office. Managing agency commis sion is payable for services rendered. How can it be said that the dismissal of the managing agents is wholly and solely for the purpose of the business, unless of course they are inefficient or corrupt? If services of efficient managing agents are dispen sed with, it would follow that efficiency would go down and profits would be reduced. In our opinion, it is not possible to say that the services of the managing agents were terminated solely to make a saving to the company. The company under Article 144 took the power to remunerate directors for work done. It appears that as a result of this change, the manage‑ merit of the business was to be conducted by the board itself.
6. We think that the income‑tax authorities have given valid reasons for holding that the company's main effort was to put a substantial sum in the hands of the managing agents. The whole affair was nothing short of a farce. It is not a payment made solely to compensate the agents for the loss of employ ment. The amount cannot be said to have been spent wholly and solely for the purpose of the, assessee's business."
A copy of the Tribunal's order is Annexure "L" and forms part of the case.
9. On the above facts and the order of the Appellate Tribunal the only question of law that arises is:
"Whether, on the facts and circumstances of this case, the amount of Rs. 18 lakhs paid by the assessee‑company to the managing agents on the termination of their managing agency agreement dated May 10, 1950, was an admissible deduction under section 10 (2) (xv) of the Income‑tax Act?"
10. The following documents are made annexures at the request of the assessee. They are marked as Annexures "M" and. "N" respectively and form part of the case:
(1) A copy of the application to the Controller of Capital Issues dated 19th October, 1949.
(2) A copy of the affidavit of Mr. H. J. Parelwalla sworn on: 8th January 1959, with Annexures `A', B' and 'C' thereto."
11. The Department wants the questions to be framed as, follows:
"(i) Whether on the facts and circumstances of the case there was any evidence before the Tribunal to hold that the payment of Rs. 18 lakhs was not a payment solely to compensate the agents for the loss of employment?
(ii) Whether on the facts and circumstances of the case the assessee is entitled to claim the sum of Rs. 18 lakhs as a deduction under section 10 (2) (xv) of the Income‑tax Act for the assessment year 1952‑53?"
We consider, however, that the question as framed by us is, comprehensive enough.
12. The parties accept the statement of the case. There are no suggestions either by the assessee or by the Department.
N. A. Palkhivala with Dilip Dwarkadas for the Assessee.
G. N. Joshi with R. J. Joshi for the Commissioner.
JUDGMENT
TAMBE, J. 'This is a reference under subsection (1) of sec tion 66 of the Indian Income‑tax Act (hereinafter referred to as the Act). Facts giving rise to this reference in brief are: The assessee company, Messrs Greaves Cotton & Co. Ltd., Bombay, was incor porated as a private limited company sometime in the year 1922. A partnership firm of Messrs Greaves‑Cotton & Co. was appoint ed the managing agents of the assessee‑company and the managing agents continued to manage the assessee‑company till the date of their resignation in January, 1947. In 1947 Messrs Karamchand Thapar & Bros. Limited (hereinafter referred to for brevity's sake as Thapars), a private limited company, were appointed managing agents of the assessee‑company. Thapars paid their pre decessors‑in‑office, via., Messrs Greaves‑Cotton & Co., a sum of Rs. 27,34,325 for securing the managing agency. It appears that Thapars also paid Rs. 50, 00,000 and took over all the shares held by Messrs Greaves Cotton & Co. in the assessee‑company, viz., Greaves Cotton & Co. Limited. The result was that all the shares of the, assessee‑company came to be held by Thapars and Thapars also became the managing agents of the assessee‑company. The entire arrangement was completed by 8th of January 1947. On that day a fresh managing agency agreement was executed by the assessee‑company in favour of Thapars. The duration thereof was 20 years. The remuneration of the managing agents under the agreement was fixed at 212 percent. on the value of all goods shipped to India by Messrs James Greaves & Company of Manchester to and for or on behalf of the said company or at its order whether the same be for the account of the said company or its constituents. The agreement also provided the mode of calculating the commission.
On 19th of October 1949, the assessee‑company made an application to the Controller of Capital Issues, Ministry of Finance, Government of India, for permission to increase its share capital. It prayed for sanctioning the issue of 25,000 five percent. cumulative preference shares of Rs. 100 each and 30,000 ordinary shares of Rs. 100 each. It appears that sanction was accorded by the Controller of Capital Issues on 25th April 1950. The assessee‑company then converted itself from a private limited company to a public limited company on 8th May, 1950. On 10th May 1950, a fresh managing agency agreement was arrived at between the, assesses‑company, which bad by then converted itself into a public limited ‑company and the Thapars for a period of 20 years. Under this agreement, the remuneration of the managing agents was fixed in the following manner:
(a) A sum at the rate of rupees five thousand per month as office allowance payable on the last day of each month for and in connection with the general supervision of the business of company and the maintenance and upkeep of the managing the agents' office in Calcutta including the payment of the rent of the managing agents' office premises in Calcutta.
(b) A commission of 10 percent. of the net profits of the assessee‑company was agreed to be paid to the managing agents.
Since that day Thapars managed the company under the new managing agency agreement of 10th May 1950.
It appears that sometime between the 8th of May 1950, and 28th of February 195.1, H. E. H. the Nizam had purchased shares worth Rs. 50 lakhs and the said amount had been received by the assessee‑company. About Rs. 33 lakhs out of the said amount had been utilised by the assessee‑company and about Rs. 17 lakhs in cash had remained in the hands of the assessee‑company.
At the meeting of the board of directors of the assessee company held on 28th February 1951, the question of cancellation of the‑aforesaid managing agency agreement of 10th May 1950, was considered and it was resolved that the sub‑committee consist ing of Messrs T. Kemp, J. Blezard a ad N. M. Wagle be appointed and instructed to submit a report with their recommendations to the board of directors for submission to the members. It appears that in the agenda mentioned in the notice issued for calling that board meeting, there was no item relating, to consideration of the question of the cancellation of the managing agency agreement, but the subject appears to have been taken up for consideration under the residuary item "any other subject with, the permission of the chairman". It may also be mentioned the said three members of the committee were executive directors of the assessee company. The said sub‑committee submitted its report to the board on 16th March 1951. In this report the sub‑committee stated that it was of the opinion that termination of the agreement would be to the benefit of the shareholders, that the termination of the managing agency would not be detrimental to, nor adversely affect, the business of the company, that the termination of the agreement would be likely to instil a greater degree of public confidence in the, company and its shares and that the board of directors would be fully competent to carry on the affairs of the…
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