M. H. BEG J. - Two question have been referred to us by the Income-tax Appellate Tribunal under section 66(1) of the Indian Income-tax Act (hereinafter referred to as the Act) by means of a consolidated order on three reference applications. The first to these questions relates to the assessment year 1950-51 and the same question had arisen out of the assessees case for the assessment year 1949-50. This question has already been answered by this court on April 29, 1966, in Income-tax Reference No. 207 of 1962 (J. K. Cotton, Shining & Weaving Mills Co. Ltd. v. Commissioner of Income-tax).
The assessee is a private limited company, which had employed Sri H. P. Pasari in 1939 as the general manager of its mills. It had also employed Sri Madan Lal Singhania in 1936 as printing master in its calico department. There was no written contract of service between either of these two employees and the assessee. Both these employees were involved in a murder case and remained in jail us under-trial prisoners from August 23, 1948, to April, 1950. They were both acquitted in 1950. In these circumstance, the question arose whether the amount paid towards their salaries and bonuses during the period for which they were in jail as under-trial prisoners was an allowable business expense under section 10(2)(xv) of the Act. This court held that the payments made to both of these employees, who are closely related to Sri Sohan Lal Singhania, the director-in-charge, and Sri P. D. Singhania, the director of the assessee-company, were made due to extra-commercial considerations. Hence, the whole amount could not be deducted under section 10(2)(xv) of the Act, but the amounts paid to Sri H. P. Pasari for a period of 29 1/2 days and to Madan Lal Singhnia for 24 1/2 days, for which periods these gentlemen could remain on leave on full salary under their terms of service, could be allowed to be deducted. The first question before us was framed as follows :
'Whether, on the facts and in the circumstances of the case, the payments of salaries and bonuses made to Madan Lal and H. P. Pasari during the period of their jail custody are allowable as deduction under section 10(2)(xv) of the Income-tax Act and consequently under the Business Profits Tax Act ?'
The Tribunals finding of facts left no room for doubt that the payments to the extent to which they were found by this court, in answering Income-tax Reference No. 207 of 1962, to be not allowable under section 10(2)(xv) of the Act were made for reasons outside the scour of commercial expediency. The allegations of the assessee that the payments had been made in order of prevent leakage of trade secrets and that the employees had contained to give advice and guidance concerning their respective departments during their jail succeed were disbelieved by the income-tax authorities right up to the Tribunal. We, therefore, see no reason to give any other answer than the one already given by this court in the above-mentioned Income-tax Reference No. 207 of 1962. Consequently, we give the answer in the negative to the above-mentioned question and hold that the salaries and bonuses paid to the two employees could not be deducted except for the period for which they were lawfully entitled to leave under the terms of their service with the assessee-company.
The second question referred to us relating to the assessment year 1951-52 is framed as follows :
'Whether, on the facts in the circumstances stated above, the payment of Rs. 2,50,000 to the U. P. Government is allowable as a deduction under section 10(2)(xv) ?'
The assessee-company had revealed for the first time by means of an unsigned and undated letter filed before the Appellate Assistant Commissioner senior, the following facts :
In May, 1946, the Anti-corruption police had raided the premises of M/s. Kanodia Brother who used to make purchase of cloth from the assessee-company. The police seized a number of alleged cash memos of the assessee-companys retail shop and a number of other documents. The garden of Laxmi & Company, the distributing agents of the assessee-company, was also sealed by the police. As a result of some negotiations with the U. P. Government, a committee, consisting of the then Home Minister, the Joint Chief Secretary in the U. P. Government, and another high Government official (who subsequently became a judge of this court) was constituted to discuss matters with Lal Sohan Sighania, the director-in-charge of the company. They matters discussed related to : (1) sale of fents. i.e., cloth pieces under one yard; (2) sale of about 1,500 turbans packed in 10, 1/2 bales; (3) nine bales of cloth found in the godown of M/s. Laxmi & Co.; (4) a number of cash memos of the assessee-companys retail shop alleged to have been recovered from the premises of Messrs. Kanodia Brothers; and (5) fabrication of ready-made garments.
The above-mentioned unsigned and undated letter contained an expression of what the assessee though were the views of the above-mentioned 'high-powered' committee. The document summarised the alleged views of the high-powered committee as follows :
'(i) That even though there might be grounds for suspicion or technical breaches, the Government had no water-tight case in respect or any of the above matters.
(ii) That if proceedings were started against the company, they would take a lot of public and require expenditure of a lot of public money.
(iii) That the matter had become stale as more than 2 years had lapsed since the police raid on the premises of Messrs. Kanodia Brothers.
(iv) That the matter may have to be tough out up to the highest court in the land and would take a number of years.
(v) That if the Government lost the case, it would not reflect any credit on them of their officers and advisers.
(vi) That the company though that, even if the proceedings failed, the mere fact of the proceedings having been launched against it would reflect adversely on its business reputation.
(vii) That the officers of the company would not be able to give their whole time and attention to the business of the company and the business of the company would, therefore, suffer.
(viii) That the proceedings might be long drawn out and the company might lose lakhs of rupee in profit during the period of litigation.
(ix) That a large amount of expenses may have to be incurred over a number of years during which the proceedings might continue from one court to another.
(x) That it might be advisable from a business point of view to purchase peace from the Government in the interest of in interrupted working to the company.
(xi) That it would be inadvisable to fall foul of the wishes of the Government and not compromise the case.'
The Income-tax Appellate Tribunal was, quite naturally, mystified and found 'the nature and purpose of the payment of Rs. 2,50,000 is shrouded in mystery'. It also held that the assessee not having produced its correspondence with the Government was obviously afraid that its production will not serve its interest. The Tribunal observed : 'It passes our comprehension why the company paid such a large sum if rally it had a cast-iron case in its favour as the assessee would have us believe. Preservation of reputation why the company paid such a large sum if really it had a cast-iron case if its favour as the assessee would have us believe. Preservation of reputation and purchasing of peace are all vague and unsubstantiated, and, if we may say so, mere empty words. We do not know how the reputation was at stake or the peace was endangered.' It held : 'The rigidity of the section requires the assessee to prove that the expenses were wholly and exclusively laid out for the purposes of the business. If the company really believed that the Government had no case, and we refuse to believe it, then it owed it to its shareholder to prove its honesty before parting with such a large sum. At least in one instance it had to admit that there was breach, e.g., in regard to the sale of fents. The assessee has failed to convince us that this large sum was an expenditure laid out wholly and exclusively for the purpose of business by its failure to prove the true nature of this payment.' Finally, the Tribunal came to the conclusion that the payment did not represent' a loss incidental to business.'
As the nature of the case taken up initially was not clear to us from the findings of the Tribunal, we looked at the assessment order where we found that the assessed had admitted before the Income-tax Officer that the above-mentioned payment was the 'composition money' paid to the U. P. Government in connection with a criminal proceedings which the Government proposed to take against the assessee-company. Apparently, the assessee-company was not willing to reveal very much about the nature of the transaction, and it contented itself by placing its case no higher then that a payment was made for avoiding prosecution for infringement of control orders. In seating the case to us, the Tribunal pointed out that its finding was that the assessee had not discharged it saunas of proving that the payment of Rs. 2,50,000 was made 'wholly and exclusively' for the purpose of business as required by section 10(2)(xv) of the Act. As we are of the opinion that the Tribunal had not committed by error of a law in coming to the conclusion that the assessee had not discharged it onus of proof, on the fact and circumstances stated above, we could very briefly answer the second question by pointing out that no question of law could arise on the findings of fact properly recorded by the Tribunal after correctly placing the burden on the assessee.
The question whether the onus of proof has been rightly placed upon a party is one of law, but the we question whether such onus, although rightly placed upon a party, has been discharged or not by the evidence before a judicial authority is a question of fact only as observed by the Privy Council in Wali Mohammad v. Mohammad Baksh. However as considerable argument was addressed to us on the test which were applicable in this case in judging whether the expense was wholly and exclusively for purpose of business, we consider it proper and necessary to discuss this matter also.
It was contended on behalf of the assessee that the payment made by the assessee will fall within the proves of the principle enunciated by Viscount Cave L. C. in Altherton v. British Insulated and Helsby Cables Ltd. in the following words (at page 191) :
'It was made clear in the above cited cases of Ushers Wiltshire Brewery v. Bruce and Smith v. Incorporated Council of Law Reporting that a sum of money expended, not of necessity and with a view to a direct and immediate benefit to the trade, but voluntarily and on the grounds of commercial expediency, and in order indirectly to facilitate the carrying on of the business, may yet be expended wholly and exclusively for the purposes of the trade; and it appears to me that the findings of the Commissioners in the present case bring the payment in question within that description. They found (in words which I have already quoted) that the payment was made for the sound commercial purpose of enabling the company to retain the service of existing and further members of their staff and of increasing the efficiency of the staff, and after referring to the contention of the Crown that the sum of pounds 31,784 was not money wholly and exclusively laid out for the purpose of the trade under the rule above referred to, they found that the deduction was admissible - thus, in effect, although not in terms, negativing the Crowns contention.'
It is clear that Viscount Cave L. C. was dealing with a case in which the assessee-company had contributed to the nucleus of a pension fund established by a trust deed for the benefit of clerical, technical and salaried staff. In our opinion, offering of such benefit to the employers in order to give them a feeling of security and make the service conditions of the employer more attractive, could not be equated with a payment of a rather mystifying character to the Government with the vague object of 'purchasing peace' whatever that may imply.
Reliance was also placed on behalf of the assessee on Golder v. great boulder proprietary Gold Mines Ltd., where civil actions were brought against the assessee-company for alleged for use and deceit but the company had paid Pounds 25,000 to settle the claims and had incurred certain legal costs. It was contended for the Crown that is was no part of the companys business to indulge in fraudulent or deceitful transactions, but this arguments was repelled on the ground that the amount paid did not represent the damages for deceit or fraud, but consisted an amount paid for securing an under taking that the company will neither as sued nor the actions against the company will be continued. It was held there that the amount paid also did not bear the character of a penalty incurred for some proved infraction of the law. It was pointed out there by Donvan J. that the allegations against the assessee-company, 'although serious and weighty, were never admitted or proved.' It was also noticed there that the assessee-company had been legally advised that the allegations of framed against it were not likely to succeed. Hence, this case was relied upon strongly before us on the ground that the allegations against the assessee-company were also, similarly, neither admitted nor proved. The 'composition money' was, according to the assessee, paid to secure peace or immunity from possible proceedings, the very nature of which was not established. The contention was that, before the commencement of any proceedings against the assessee-company, the character of possible proceedings in futuro which were not taken at all cannot possible be determined. On this ground, it was attempted to equate the assessees settlement with the U. P. Government, with a transaction of a civil character and to bring it within the ambit of 'commercial expediency.'
The difficulty, in the assessees case before us arises from the fact that if the payment could be dissociated from any criminal charges or proceeding against the assessee-company, the character of the payment becomes so nebulous and difficult to determine that we find it impossible to say that it could be covered by the principle of commercial expediency. Even assuming that the principle may cover expenditure which may not be immediately beneficial or obviously or directly needed for arraigning, profits, it must, in our opinion, be an expense which is reasonably necessary or incidental to or flow naturally from the carrying on of the assessees business, profession or vacation. If its connecting with the assessees profit-making activities becomes too indirect or remote, it cannot be reasonably covered by rather emphatic words 'wholly and exclusively for the purposes of business' - used in section 10(2)(xv) of the Act.
The purpose of the business has to be judged by a reference to the character of the business carried on. An allowable deduction under the head must be incurred by the assessee in its character as a business or trading concern. This principle was expressed in Strong and Co. v. Woodifield by the Lord Chancellor as follows :
'In my opinion, however, it does not follow that if a loss is in any sense connoted with the trade, it must always be allowed as a deduction; for it may be only remotely connected with the trade or it may be conceded with something else quite as much as or even more than with the trade. In think only such losses can be deducted as are connected with if in the sense that they are really incidental to the trade itself. They cannot be deducted if they are mainly incidental to some other vacate, or fall on the trader in some character other than that of trader. The nature of the trade is to be considered.'
In this very cased Lord Davey explained the expression 'for the purpose of the trade' as follows :
'These words are used in other rules, and appear to me to mean for the purpose of enabling a person to carry on and earn profits in the trade &c.; In think the disbursements permitted are such as are made for that purpose. It is not enough that the disbursement is made in the course of, or arises out of, or is connected with, the trade or is made out of the profits of the trade. It must be made for the purpose of earning the profits.'
In a later case, Smiths Patato Estates Ltd. v. Bolland, at pages 284 and 297, we find that, although Viscount Simon and Lord Oaksey preferred to explain away Lord Daveys exposition in Strong & Co. v. Woodifield, the majority of the law Lord approved of the rather stick statement of principle by Lord Davey in Strong & Co. v. Woodifiled.
In a still later case, Morgan v. Tate and Lyle Ltd. the majority of the law Lords purported to apply the principle laid down by Lord Devey but held that expenses incurred in law propaganda campaign to oppose a threatened nationalisation of the sugar refinery industry was money 'wholly and exclusively laid out for the companys trade and was a admissible deduction.'
On behalf of the assessee our attention has been directed to Eastern Investments Ltd. v. Commissioner of income-tax, where the interest paid by the assessee on debentures was held by the Supreme Court of India to be 'expenditure (not being in the nature of capital expenditure) incurred solely for the purposes of making such incomes, profits or gains as provided by section 12(2) of the Income-tax Act.' We do not think that this case can help the assessee at all, because the expenditure in that case was definitely incurred by the assessee in its character as a profit making concern and for earnings profits.
In Haji Aziz and Abdul Shaker Bros. v. Commissioner of Income-tax, where their Lordships of the Supreme Court were considering a case of an expense incurred in paying a penalty for a breach of the law, the above mentioned principle, as stated by Lord Davey and applied subsequently by English court, was approved and applied. It was held there :
'If a sum is paid by an assessee conducting his business, because in conducting it he has acted in a manner which has rendered him liable to penalty, it cannot be claimed as a deductible expense. It must be a commercial loss and in its nature must be contemplable as such. Such penalties which are incurred by an assessee in proceedings launched against him for an infraction of the law cannot be called commercial losses incurred by an assessee in carrying on his business. Infraction of the law is not a normal incident of business and, therefore, only such disbursements can be deducted as are really incidental to the business itself. They cannot be deducted if they fall in the assessee in some character other than that if a trader.'
On behalf of the Commissioner of Income-tax, reliance was placed on Commissioner of Income-tax v. H. Hirjee, where their Lordships of the Supreme Court made a distinction between the expenditure incurred on civil and criminal litigation and observed that an expenditure on a purpose which cannot be easily dissociated from the purpose of saving the accused from a possible conviction and the imposition of a prescribed penalty was not an allowable deduction. Attempts were made on behalf of the assessee to distinguish the case before us from Hirjees case, on the ground that a protection had taken place in Hirjees case, whereas no prosecution at all took place in the present case. It was also contended that a distinction between expenses incurred on criminal an civil litigation is not enough because some civil litigation may be for purposes which are very reprehensible and disconnected with earning of profits legitimately, while the purpose of defending the company or its employees from false, malicious and vexatious criminal prosecution may be very lawful and laudable purpose upon which expensed may be very necessary of preserving the very conditions under which a business can be carried on. It was also contended that under the present conditions when, there is plethora of rapidly changing laws and control orders, it is not easy for an ordinary citizen to know when he will collide with some legal provision without any culpable negligence on his part. It was contended that all these consideration were not present before their Lordships of the Supreme Court in deciding Hirjees case, It was contended that settlement of the kind which is before us between the Supreme Court in Hirjees case, which must be confined to a case in which a prosecution had actually taken place.
Learned counsel for the assessee also cited J. N. Singh & Company v. Commissioner of Income-tax, where the expenses incurred by a company in defending its Bombay branch manager successfully from a charge of criminal breach of trust by one of the customers was held to be a permissible deduction under section 10(2)(xv) of the Act by the Punjab High Court on the ground that the expenses arose out of the normal conduct of business and were entirely due to a prosecution which had 'emanated with regard to an act which took place in the ordinary course of business'. Such expenditure was held to be 'wholly and exclusively' for the purpose of business. The Punjab High Court distinguished Hirjees case, on the ground that in Hirjees case, the expenses had been incurred by an owner of the bossiness in defending himself from criminal prosecution whereas in the case before the Punjab High Court the expenses had been incurred in defending an employee of the assessee-company while he was acting in the discharge of his normal business activities as an employee of the assessee. The short answer to this argument is that the case before us in is not that of an employee at all but of the assessee-company itself which had, presumable, worded off criminal prosecution by paying a very large sum of money to the U. P. Government. The Tribunal had not, in our earned in assuming that the company had not acted imprudently in paying such a large sum of money. The circumstance did give rise to the presumption that the company must have been conscious of the infringement of the law which was discussed with its representative by the high powered committee.
On the authorities as they stand we are unable to see how the purpose of which the expense was incurred could be dissociated from warding off criminal prosecution for activities which must he held to be outside the scope of business of the assessee-company. On the other hand, if that purpose was not to ward off the criminal prosecution but only to make a payment to please the Government, we do not think that such a purpose can be covered by the words 'wholly and exclusively for the purpose of the business.' Pleasing the Government may be an object which the representatives of the company might consider very laudable and necessary for their own private advantage. It, however, seems to us very difficult to make out a connection between such a purpose and the normal cause or the assessees business. We may also notice here a former case of the assessee-company, J. K. Cotton Spinning and Weaving Co. v. Commissioner of Income-tax, where a Division Bench of this court held that a payment of Rs. 7,50,000 by the assessee-company to compound a criminal offence with the income-tax authorities, after the managing director of the assessee-company had been served with a notice to show cause why criminal proceedings should not be instituted against him for concealing the assessees income, was not an allowable deduction. That case was sought to be distinguished from the case before us on the ground that a notice had been served in that case upon the managing director of the assessee-company, whereas in the present case no such notice was served. We do not think that this could make any difference to the application of the principle. And, in any case, the assessee-company having failed to discharge its onus of proving that the payment made to the U. P. Government was for a purpose which authorised a deduction under section 10(2)(xv) of the Act, our answer to the question is in the negative and against the assessee. We allow Rs. 250 as costs to the Commissioner of Income-tax and Rs. 250 as counsels fee.
MANCHANDA J. - I agree with the answer to the question as given by my brother, Beg J., and also to the order as to costs. I would, however like to add a few words on an aspect of the case in respect of the second question, which was stressed by learned counsel for the assessee. That was that the only test to be applied in a case of this nature was one of commercial expediency. He relied upon a decision of the Supreme Court in Eastern Investments Ltd. v. Commissioner of Income-tax. It is no doubt true that the decision of the English courts in Incorporated Council of Law Reporting v. Smith and the observations of Lord Cave in British Insulated and Helsby Cables Ltd. v. Atherton were approved by the Supreme Court in Eastern Investments Ltd. In those English cases it was held that a payment made voluntarily, on grounds of a commercial expediency and in order indirectly to facilitate the carrying on of the business may be wholly and exclusively expended for the purpose of the trade. The Supreme Court while approving pointed out that the test of commercial expediency would apply where the expenditure was for the real and primary scope of the business A fortiori, there should be a direct concern and purpose for which money is expended with the carrying don of the business and not merely to produce some remote or indirect result. Can it be said in the present case that the real and primary purpose of the payment, assuming it to have been proved, was for the purpose of carrying on the business of the assessee or was the primary purpose to save the company or its directors from embarrassment and trouble in respect of some criminal enquiry or prosecution which was threatened or at least round the corner The primary purpose as found by the Tribunal was to save themselves that trouble and embarrassment and the secondary or the indirect purpose was to protect the fair name of the company.
A reference in this connection may usefully be made to the observations of Pollock M. R. in union Cold Storage Company Ltd. v. Jones :
'The two items that they seek to deduct may have been widely expended; it may have been prudent that as owners they should keep the premises insured, but what they secured by it is not a further market for their business, not an increased sale of their commodities, not an enlarged use of their services which they are prepared to render. What they have secured is an indirect result perhaps useful to, but not directly necessary to their own trade. The rule in Users case, you must not be pressed beyond what it is applicable to. In these cases in following Usher case you must look at what is the direct concern and direct purpose for which the money is laid out, and I do think that you can go to the remoter or indirect results for which it may be possible useful to lay out money.'
The warning given by Pollock M. R. was that the test of commercial expediency must not be pushed too far. Wheatcroft in British Tax Encyclopedia, volume 1, has also pointed out that there is another test overlapping the test of commercial expediency and that is :
'Any loss not connected with or arising out of the trade; and although the two tests cover rightly different kinds of cases, their combined operation is extensive. Under one or both of them the courts have deleted expenditure on penalties for illegal trading (although illegal trading is a taxable trade), on costs of defence of a criminal prosecution arising from professional activities, on damages and cost awarded against a trader for libel in a business communication, on costs of prosecuting an income-tax appeal, on costs of reducing a company capital on income-tax paid, abroad, on losses of loans paid by solicitor to his client for the purpose of obtaining business, on fire insurance premiums paid on premises abroad and owned by the taxpayer but occupied by a third party under a trading arrangement and on travailing expenses of a barrister.'
In any event, the hurdles in the way of the assessee, in claiming the composition fee of Rs. 2,50,000 under the stringent conditions laid down in section 10(2)(xv) that the expenditure should be one wholly and exclusively laid out for the purpose of the business are almost insuperable. They are : (1) the earlier decision of this court in the case of this very assessee on a some-what similar question in J. K. Cotton Shining and Weaving Co. Ltd. v. Commissioner of Income-tax, (2) the ratio of the decisions of the Supreme Court in (i) Commissioner of Income-tax v. Calcutta Agency Ltd. (ii) Commissioner of Income-tax v. H. Hirjee and (iii) Haji Aziz and Abdul Shakoor Bros. v. Commissioner of Income-tax.