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Petitioner: J. K. WOOLLEN MANUFACTURERS (PRIVATE) LTD. VS Respondent: COMMISSIONER OF INCOME TAX, U. P.Honorable Justice BRIJLAL GUPTAR. S. Pathak,Gopal Behari
1969 P T D 7
1969 P T D 7
[Allahabad (India)]
Before M. C. Desai, C. J. and Brijlal Gupta, J
J. K. WOOLLEN MANUFACTURERS (PRIVATE) LTD.
versus
COMMISSIONER OF INCOME TAX, U. P.
Income tax Reference No. 424 of 1958, decided on 22nd May 1962.
Business expenditure----
--- Commission paid to employee Power of Income tax authorities to disallow wholly or in part Applicability and scope of S. 10(2)(x), (xv) Tests for determining whether expenditure is allowable under S. 10(2)(.xv) Income tax Act, 1922, S. 10(2)(x), (xv) Law before and after 1953.
Even if there is an express agreement to pay commission at a certain rate, the question of its admissibility can be considered under section 10(2)(x) of the Income tax Act.
Under section 10(2)(xv) of the Income tax Act as it stood before the words "not being an allowance of the nature described in any of the clauses (i) to (xiv) inclusive" were added to the clause, even if an amount was held not to be allowable under section 10(2)(x), it might still be considered whether it was allowable under section 10(2)(xv).
Where a claim is made for an allowance under section 10(2)(xv) of the Act, the question whether the expenditure was laid out or expended wholly or exclusively for the purposes of the business is essentially a question of fact, and the burden is on the assessee to prove that it was so laid out or expended. It is for the Income tax Officer to decide upon a consideration of all the materials produced before him by the assessee whether the assessee has in the particular case succeeded in proving that the conditions of the clause have been fulfilled. If he does not believe those materials or if he does not believe the materials to the whole extent, it is open to him to reject the claim either wholly or in part. For rejection of those materials it is sufficient for him to say that he does not accept their veracity or sufficiency to prove the assessee's case. It is not necessary for him to have material of a positive character for the rejection of the whole or a part of the assessee's claim.
In considering whether an expenditure of this stature is allowable under section 10(2)(xv) the following circumstances may be taken into consideration : (i) whether the payment was made to a near relation, (ii) the extent of the business, (iii) the particulars of service rendered, (iv) whether the service was such as to require special remuneration, (v) what was the quantum of payment, (vi) whether the payment was or was not grossly out of proportion to the work done by the employee, (vii) the practice in the trade for payment to an employee in similar circumstances, (viii) the qualifications of the employee, (ix.) the amount paid to a predecessor or a successor rendering the same service, (x) whether the allowance of a certain percentage was a normal allowance or was extraordinary having regard to the profits and the practice in the trade, (xi) whether the method of working out profits for calculating the percentage of commission was the normal method or an abnormal method and (xii) if there was anything extraordinary or abnormal in the arrangement and any special reason or circumstances for such extraordinariness or abnormality.
The assessee who had taken a textile mill on lease appointed a person as its power of attorney agent and this person appointed his own son, who was only an undergraduate and who had no special engineering or business qualification as general manager on a salary of Rs. 1,000 a month and other allowances and a commission of 25 per cent. on the net profits if such profits exceeded Rs. 1,00,000. The assessee claimed an allowance of a sum of Rs. 75,465 which it had paid as commission to the general manager, but the Appellate Tribunal agreeing with the Appellate Assistant Commissioner held on the above and other circumstances of the case that the entire sum of Rs. 75,465 could not be regarded as having been wholly and exclusively laid out or expended for the purposes of the business and allowed only one half of this amount :
Held, that on the facts and in the circumstances of the case, the sum of Rs. 37,733 which had been disallowed by the Appellate Tribunal was not an amount laid out or expended wholly or exclusively for the purposes of the business of the assessee and was rightly disallowed.
Aspro Ltd. v. Commis.clnner of Taxes (1936) 4 I T R 264 ; Commissioner of Income tax v. Calcutta Agency Ltd. (1951) 19 I T R 191 ; Indermani Jatia v. Commissioner of Income tax (1951) 19 I T R 342 ; Jethabai Hirji & Co. v. Commissioner of Income tax (1949) 17 I T R 533 ; Nihori Lal Prabhudayal v. Commissioner of Income tax (1951) 19 I T R 240 and Subodhchandra Popatial v. Commissioner of Income tax (1953) 24 I T R 566 ref.
STATEMENT OF CASE
In compliance with the order of the High Court dated December 17, 1957, in Misc. Case No. 61 of 1952, we hereby draw up a statement of the case and refer it to the High Court of judicature at Allahabad under section 66(2) of the Income tax Act, 1922.
2. The statement of the case relates to the assessment year 1948-49.
3. The assessee is a registered firm. The business of the assessee was the manufacture and sale of blankets and other woollen cloth. During the year under consideration., the assessee claimed a deduction of Rs. 75,465 paid as commission to the general manager, Shri J. P. Vaish. The Income tax Officer by a notice under section 23(3) called upon the assessee to prove the admissibility of this payment. The assessee then filed his written reply dated 16th June 1949. 1n that letter, the assessee stated the qualifications of Shri J. P. Vaish. It was stated that Shri J. P. Vaish was entitled to the commission by the terms of his appointment. A copy of the reply given by the assessee is part of the case and is Annexure "A" To prove the terms of appointment, a letter written by Shri Sital Prasad who held a power of attorney on behalf of the partners and who was also the father of Shri J. P. Vaish was filed. According to the terms of appointment, Shri J. P. Vaish was to draw a salary of Rs. 1.000 per month and a commission of 12 % on the net profit of the firm payable after the account had been ascertained fully by the auditors. He was also given a car allowance of Rs. 250 per month. It was stated in that letter that in arriving at the net profit, the minimum amount of lease money of Rs. 24,000, but not any money in excess thereof paid to Smt. Indramani Singhania was to be deducted. It was also one of the terms of the appointment that in case the profit exceeded Rs.1 lakh, the commission payable to Shri J. P. Vaish was 25 %. Shri J. P. Vaish was also given free medical facility for himself and for the members of his family. A copy of the letter of appointment dated 20th of September 1944, is part of the case and is Annexure "B". The Income tax Officer considered the evidence on record and found that the total profits of the year under consideration amounted to Rs. 1,29,110.
He also took into consideration the general practice of giving commission in the line of business carried on by the assessee and came to the conclusion that the payment of Rs. 75,465 as commission was excessive and was not solely for business consideration. In his opinion, a sum of Rs. 5,000 was the only commission that could be held admissible under section 10(2)(x) of the Income tax Act. He accordingly allowed a sum of Rs. 5,000 and disallowed the sum of Rs. 70,465 and added it back. The assessment order passed by the Income tax Officer is also part of the case and is Annexure "C". On appeal, the Appellate Assistant Commissioner held that a commission of 12 % would be reasonable. He accordingly reduced the add back from Rs. 70,465 to Rs. 37,733. A copy of the order passed by the Appellate Assistant Commissioner is part of the case and is Annexure "D".
4. Against the order passed by the Appellate Assistant Commissioner the assessee preferred a second appeal before the Tribunal and contended that there was no justification in disallowing the commission paid to Shri J. P. Vaish. It was stated that the commission was paid for business purposes and was in accordance with the terms of employment. The assessee produced before the Tribunal a letter purported to have been sent to the Income tax Officer, Section B of Excess Profits Tax Circle, Kanpur, dated 16th of June 1949. It was stated in that letter that after the death of Mr. Vaish in July 1947, the firm was converted into a company and the post of the general manager was abolished and one of the directors who managed the affairs of the company was given Rs. 18,000 per annum as remuneration and Rs. 6,000 per annum as allowance. A copy of the letter is part of the case and is Annexure "A". The Tribunal, for the reasons recorded by it in its order dated 10th of July 1950, confirmed the disallowance of Rs. 37,733. In its order, the Tribunal observed as under :
"It is for the Income tax Officer to decide whether any remuneration paid to the employee by the employer is wholly and exclusively for the purpose of his business. It has been held that it is erroneous to contend that as soon as an assessee has established two facts, viz., the existence of an agreement between an employer and an employee and the fact of actual payment, no discretion is left to the Income tax Officer except to hold that the payment was made wholly and exclusively for the purposes of the business. Although the payment might have been made and although there might be an agreement in existence it would be open to the Income tax Officer' to take into consideration various factors which would go to show whether, the amount was paid as required by the section. In this particular case, the contention of the income tax Officer is that the amount paid was not wholly and exclusively for the business."
A copy of the order of the Tribunal is part of the case and is Annexure E .
5. On these facts, we refer the following question of law for the opinion of their Lordships :
"Whether, in the circumstances of the case, the sum of Rs. 37,733 paid to the general manager, Shri J. P. Vaish, which has been disallowed by the Income tax Appellate Tribunal was an amount laid out or expended wholly and exclusively for the purpose of the business of the assessee?"
6. The draft statement of the case was placed before the parties. The assessee as well as the Commissioner of Income-tax, U. P., made some minor suggestions which have been accepted. The statement of the case is finalised.
R. S. Pathak for the Assessee.
Gopal Behari for the Commissioner.
JUDGMENT
BRIJLAL GUPTA, J. This is an income tax reference. It comes on a requisition by this Court on an application under section 66(2). The question for the opinion of the Court is
"Whether, in the circumstances of the case, the sum of Rs. 37,733 paid to the general manager, Shri J. P. Vaish which has been disallowed by the Income tax Appellate Tribunal, was an amount laid out or expended wholly and exclusively for the purpose of the business of the assessee?"
The facts giving rise to the reference are : that the assessee which is a registered firm took on lease a woollen mills called Baijnath Bankebehari Lal Woollen Mills. The terms of the lease appear to have been that a minimum amount of Rs. 24,000 as lease money was payable to Smt. Indramani Singhania, the widow of the proprietor of the mills and in case the profits of the lessee from the mills exceeded the sum of Rs. 1,00,000 the lease money was to be payable at the rate of 0-7-9 in the rupee.
It appears that the partners of the assessee firm appointed one Sri Shital Prasad by a power of attorney to manage the business of the mills on behalf of the partnership. Sri Shital Prasad, by letter dated September 20, 1944, appointed his own son, Sri J. P. Vaish, to be the general manager of the lessee firm The terms regarding his remuneration are stated in this letter in paragraph 6 as follows :
"6. Your remuneration and allowances will be as follows :
(a) A fixed salary at the rate of Rs. 1,000 p. m. including the period of probation from 1st May 1944, up to date.
(b) A commission of 12% on the net profits of the firm payable after the accounts have been ascertained and vouched by the auditors, the certificate of the auditors to be conclusive
Provided, firstly, that the net profits shall be arrived at after defraying all manufacturing charges, including cost of raw materials, stores, coal, steam power, electric energy consumed, wages, salaries of clerks, supervisors, accountants, mill staff including technical experts, depreciation on machinery employed in the business, interest, taxes, overhead charges and only the minimum sum of Rs. 24,000 per annum payable to Mrs. Indramani Singhani on account of rental of the mills. Any amount found payable to her in excess of Rs. 24,000 in any year shall not be deducted for arriving at net profits for the purposes of this clause :
Provided, secondly, that if in any year the profits calculated above exceed Rs. 1,00,000 the commission payable to you will be 25 % of such profits.
(c) You will be allowed Rs. 250 p. m. as car allowance and you will use your own car till the firm is able to purchase one for your use.
(d) You will be entitled to free medical attendance and treatment for yourself and your family."
It will be noticed that one extraordinary feature 4 these terms regarding the determination of the remuneration of Sri J. P. Vaish was that even when the profits exceeded Rs. 1,00,000 only the minimum amount of Rs. 24,000 as lease money was to be deducted in arriving at the figure of profits on which the commission of Sri J. P. Vaish at 25 % was to be worked out. The figure of profits for determination of the commission was not to be worked out after the deduction of the entire amount of lease money at 0-7-9 in the rupee which was to be paid to Smt. Indramani Singhania when the profits exceeded one lakh of rupees.
The year in question in this reference is the assessment year 1948 49. In this year the total remuneration paid to Sri J. P. Vaish was as follows Rs. Salary at Rs. 1,000 p. m . 12,000 Car allowance at Rs. 250 p. m. 3,000 Expenses on medical treatment 2,000 As the profits exceeded Rs. 1,00,000 the commission at 25 % 75,465 Total 92,465
The commission was worked out in this way :
Net profits 1,29,110 Commission 75,465 Lease money 1,21,385 Total 3,25,860 Less minimum lease money 24,000 Net balance 3,10,860 Commission at 25 % 75,465
It will be noticed that if the entire lease money, of Rs. 1,21,285 had been deducted from the total profits of Rs. 3,25,860 then the net profits would have been only Rs. 2,04,575 and commission at 25 %. of this amount would have been only Rs. 51,143-12-0.
Apart from the salary, car allowance and expenses on medical treatment which were debited by the assessee to the profit and loss account, the assessee claimed the amount of Rs. 75,465 paid as commission to Shri J. P. Vaish as an allowable deduction under section 10(2). 7 he Income tax Officer, by notice under section 23(3), called upon the assessee to prove the allowability of this amount. The notice required the assessee to state : (1) the previous employment of Shri J. P. Vaish, (2) the salary drawn by him and (3) the technical and other qualifications by reason of which this amount of Rs. 75,465 became payable to Shri Vaish. The assessee filed a written reply dated June 16, 1949. In this reply regarding point No. 1, viz., previous employment, it was stated as follows
"He had training in the Aluminium Corporation of India Ltd., Laxmiratan Cotton Mills Ltd. and the Food Products Ltd., Rampur.
From this it is clear that he was not previously employed anywhere. He was merely a trainee in the three concerns mentioned. None of these concerns was a woollen textile mills. The period of his training was not mentioned. The particular line in which he took training was also not mentioned.
Regarding point No. 2, viz., the salary drawn by him, it was mentioned.
"His salary during the period is not known."
It is clear that the assessee (sic) withheld information about his salary, if any. It may be that as he was merely a trainee and not an employee, he may not have been in receipt of any salary at all. It has already been pointed out that the period of his training was not mentioned.
Regarding the third point, viz., his technical and other qualifications by reason of which the commission of Rs. 75,465 was paid to Shri J. P. Vaish, it was stated as follows
"Mr. Vaish was educated in the Public School, Dhera Dun, and passed the Senior Cambridge from that school. He then joined the Banaras College and passed the Intermediate Examination. He studied for a year in the Engineering College of the Banaras Hindu University for electrical and mechanical engineering and then joined the Commerce College at Delhi. After that he had training in the Aluminium Corporation of India Ltd., Laxmiratan Cotton Mills Ltd., and the Food Products Ltd., Rampur.
From this it is clear that he had merely a general education but was not even a graduate. He could not possess any qualification, worth speaking of, as an electrical and mechanical engineer, having been in the Engineering College only for a year. The period of his stay at Commerce College is not mentioned. Presumably, the stay at that college was of very short duration. Thereafter, he was apprenticed to the three companies mentioned, none of which was a woollen textile mills. The period of his training or the line in which he took training were not mentioned.
Upon a consideration of these facts and upon a consideration of the fact that the appointment was made by the father of Shri J. P. Vaish, the Income tax Officer came to the conclusion that "the letter of appointment is not solely actuated by business considerations". It was also observed by the Income tax Officer that "there was no reason why the lease money which increased by 0 7 9 in a rupee if the profits exceeded one lakh of rupees should not be made deductible for calculating the percentage of commission. He concluded that this clause "was not dictated by business considerations . It was also pointed out by him that commission at 25 % was a "very high rate of commission particularly when no maximum has been fixed". On this last ground the Income tax Officer did not treat the case of one Shiv Bhagwan, manager of another concern, as a parallel case. Lastly, the Income tax Officer observed that, having regard to the share of profits of the three partners of the assessee, the remuneration of Shri J. P. Vaish amounting to Rs. 92,465 was "highly excessive and unreasonable .
As a matter of law the Income tax Officer took the view that irrespective of the fact that commission was payable to Shri J. P. Vaish under the letter of appointment, the question of reasonableness or otherwise of the commission paid fell to be determined under section 10(2)(x). He went on to apply tests laid down under that provision and observed that having regard to the salary and allowances of Shri J. P. Vaish and further having regard to the profits of the year the amount of Rs. 75,465 commission was "very excessive and unreasonable". He also found that there was " no general practice of giving commission at 25 % of the net profits of business in the assessee's line of business". In the result he allowed a sum of only Rs. 5,000 on account of commission and disallowed the balance of Rs 70,465.
From the above it will be clear that, even though the Income-tax Officer ultimately determined the question of the allowability of the commission by reference to section 10(2)(x), in the earlier part of his order, he also considered the question on considerations which are relevant only under the provisions of section 10(2) (xv) viz., (1). That the appointment was made by the fatter, Sri Shital Prasad, of his own son, Sri. J. P. Vaish. The reference to the relationship shows that the Income tax officer attached some importance to the fact and was possibly of the view that the total remuneration of Sri J. P. Vaish might have been influenced by that consideration and not by purely business consideration, (2) He appears to have derived support for this view from the facts that Sri J. P. Vaish possessed no special qualification and had no particular experience and in reply to the notice under section 23(3) information about his previous salary, if any, was withheld. (3) He concluded that the remuneration was not "solely actuated by business considerations", from the extraordinary clause in the letter of appointment about working out the net profits for purpose of computation of commission by deducting the minimum amount of lease money of Rs. 24,000 only and not the increased amount of lease money at 0-7-9 in the rupee when the profits exceeded one lakh of rupees. (4) Lastly he considered the general practice in this line of business regarding the percentage of profits allowable as commission to managers and held that there was no practice of allowing commission at 25 % and also noticed that in the alleged comparable case of Shiv Bhagwan, manager, there was a maximum fixed but in the present case there was no such maximum fixed.
It is true that he also examined and ultimately determined the question of allowability from the point of view of the considerations under section 10(2)(xv) but it is clear from what has been stated above that the considerations which are relevant under section 10(2) (xv) were fully present to his mind and from his view of these considerations, it appears that it would have made no difference to his decision if he had not even referred to section 10 (2)(x) and had relied solely upon section 10(2)(xv).
The assessee went up in appeal to the Appellate Assistant Commissioner. The Appellate Assistant Commissioner did not confirm the finding of the Income tax Officer that the rate of commission was not dictated by business considerations for the reasons that : (1) the annual accounts showing the payment of commission were signed by the proprietors and (2) that Mr. Vaish was not related to the proprietors. It is noticeable that the Appellate Assistant Commissioner did not fully meet the point raised by the Income tax Officer. The Income tax Officer had observed that "the letter of appointment was not solely actuated by business considerations". An agreement may be entered into for "business considerations" but it may not be "solely" for such considerations. Under section 10 (2)(xv) unless the expenditure is "wholly and exclusively" for purposes of business,, it is not allowable. From what the Appellate Assistant Commissioner went on to hold it is clear that he was of the view that the whole of the commission was not paid exclusively for business purposes even though has the Appellate Assistant Commissioner considered the payment under section 10 (2)(x) he did not specifically use the language which he would have used if he had applied section 10 (2)(xv). He was, however, not very much impressed by the qualifications and experience of Sri Vaish and observed that the commission of 25 Y over and above the salary and allowances of Sri Vaish were "quite high". He significantly remarked "No other businessman is known to have been allowing commission at such high rates". He also observed that there was no reason why the deduction of only the minimum lease amount of Rs. 24,000 should have been stipulated as being deductible for arriving at the net profits for purposes of computation of a commission at 25%. Lastly, he observed in this connection that having regard to the fact that the net profits were only Rs. 1,29,110 the incidence of commission at Rs. 75,465 worked out to a much higher percentage (nearly 59 %) of the net profits rather than 25 Y.. He went on to negative the argument of the a3sessee that increased profits in this year were due to the skill or the effort of the manager and found that "the extraordinary profits were due to war conditions and the efforts of the director of this concern rather than to the skill or the effort of the manager". The Appellate Assistant Commissioner also referred to the practice in similar businesses and to the alleged comparable case of Shiv Bhagwan where a maximum was fixed even though the commission to be paid was a graded commission and concluded that half of the amount of Rs. 74,465, viz., 37,732, was allowable and not merely Rs. 5,000 nor the entire amount of Rs. 75,465.
The assessee had argued before the Appellate Assistant Commissioner that where commission was payable under an agreement its allowability or otherwise could not be considered under section 10(2)(x). The Appellate Assistant Commissioner negatived this argument and held that the subsection did, even by implication, exclude cases governed by a contract, but even though the Appellate Assistant Commissioner considered the question under section…
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