1. This is a reference by the Commissioner of Income-Tax in the following terms in regard to the business of the Indian Turpentine and Rosin Company, Limited:
Is the share of the profits of the company in 1925-26, which was paid to the Government of the United Provinces as additional royalty in 1926-27, expenditure incurred solely for the purpose of earning the profits of the company assessable in 1926-27 within the meaning of Section 10(2)(9) Incom-tax Act?
2. The origin of this company is as follows: Originally the Government of the United Provinces owned a factory for the production of resin in Bareilly and that factory received crude resin from the Forest Department. In the year 1923 the Local Government desired to have the factory transferred to a company and accordingly it entered into a deed of sale and an annexed schedule of agreement with a certain syndicate of three gentlemen who eventually floated the company called the Indian Turpentine and Resin Company, Limited. The primary object of the Local Government was to have an assured market for the crude resin obtained from its Forest Department. Accordingly, in addition to becoming a shareholder to the extent of half the shares in the company to be floated, certain clauses were made in Sch. 2 of the agreement by virtue of which agreements were to be made each year between the Forest Department and the company as to the amount of crude resin which was to be supplied in the following season by the Forest Department. This schedule further provided in Clause (7) that the cost of supply of the crude resin was to embrace; (a) The estimated expenditure on materials, labour and special staff, (b) A certain allowance for delivery. (c) An allowance of Re. 1 par maund net weight of crude resin as royalty.
3. Clause (8) provided:
In addition a share of the net profits of the company, as described in Clause 30, shall be payable to the Forest Department by the company as additional royalty on the crude resin supplied.
4. Clause 30 provides as follows:
In addition to the payments to be made by the company to the Forest Department under Clauses 16 and 27, a share of the net profits of the Company, as mentioned in Clauses 8 and 26, shall be paid annually by the company within three months of the close of each tapping season.' This share shall be calculated as follows;
If the profits of the company is any year exceed 15 par centum of the capital of the company ranking for dividend, then the Company will pay the Forest Department as additional royalty such proportion of 40 per centum of the amount by which the profits exceed the above-mentioned 15 par centum as the number of maunds of crude resin either supplied by the Forest Department to the company or collected and extracted by the company from the channels made available by the Forest Department in the preceding tapping season (or if the year coincides with the tapping season then in the tapping season concerned) bears to the total number of maunds of crude resin received by the company in that period.
The profits of the company for the purposes of this agreement shall be such profits as may be ascertained by the company's auditors from year to year after deducting all working and other expenses chargeable against revenue and proper depreciation on all buildings, machinery, plant and materials. The certificate of the auditors of the company regarding the amount due to Government under this clause shall be accepted,
5. The arrangement, therefore, is that a certain quantity of crude resin is supplied in a certain year and for that a certain price for cost of labour and delivery and Re. 1 royalty is paid during that year. In the following year a further payment is made which varies with the profits of the company if those profits exceed 15 per cent.
6. The question before us is whether that extra sum paid in the following year is a distribution of profits by the company in which case it is liable to pay income-tax or whether it is to be regarded as a business expense of the company. It was held by the Income-tax Officer that as this royalty was dependent on the earnings of profits, therefore it was an allocation of profits to one of the biggest shareholders of the company. That position, however, was abandoned in the Court of appeal before the Assistant Commissioner of Income-tax, because it was pointed out that if Government sold all its shares in the company, the company would still have to pay the same amount of royalty. Therefore the payment could in no sense be regarded as an allocation of profits to one of the cosharers in the company. It is merely an unconnected fact that Government are at present shareholders in the company. The grounds on which the Assistant Commissioner of Income-tax proceeded were that the additional royalty was calculated in a certain manner and the liability to pay it arose in a certain manner both of which were connected with the profits earned by the company. He held, therefore, that it could not be considered as a payment for resin supplied nor could it be considered as an expense necessary for the earning of the profits of the company. The case has been very ably argued before us and we consider that the relevant points are as follows:
(1) We consider that the matter is analogous to the payment of a share of profits of a business to a managing director. The managing director gives his services to the business and after the close of any financial year he is given in the following year a proportion of the profit of the business. That proportion of the profits is counted as one of the expenses of the business incurred solely for the purpose of earning the profits of the business and, therefore is not liable to assessment to income-tax under Section 10(1)(9), Income-tax Act. (2) In considering the question as to whether this payment is profit of the company or a business expenditure, we consider that the fact that in its annual balance-sheets this would not be shown as profit available for distribution to the shareholders is a relevant fact. The profit is not available for distribution to the shareholders. It is to be paid for the cost of the crude resin supplied in the previous year. (3) if the company was calculating the cost of production of its resin, it would certainly have to take into account this additional royalty paid to the Government. (4) As regards the definition of price, Section 77, Contract Act states 'sale' is the exchange of property for a price. There is nothing in this definition which precludes the inclusion of this additional royalty as part of the price of the crude resin supplied to the company. In Sch. 2 it is laid down that this payment is to be made to the Forest Department. This payment is made on behalf of the crude resin supplied and is part of the price of that crude resin. It is in no sense part of the consideration for which Government sold the factory in Bareilly. (5) Looking at the origin of the agreement of sale between Government and the Syndicate which resulted in the eventual formation of the company, we notice that the primary object of Government was to obtain a market for its resin.
7. In the order of appeal of the Assistant Commissioner of Income-tax it is stated that the Chief Conservator of Forests stated that owing to want of previous experience in the matter the additional royalty was imposed merely by way of securing a fair price for the crude resin supplied. This indicates that at the time of entering into the agreement in Sch. 2 Government and the Syndicate were not in a position to ascertain what would be a fair charge for a royalty on the crude resin supplied. Accordingly a nominal royalty of Re. 1 per maund was taken and the agreement in Clause 30 was made in order that if that amount proved to be too low a price in view of the market conditions, an extra sum would be paid to Government in order to bring the royalty to a proper figure. In view of all these considerations we answer the enquiry in the affirmative and we consider that the sum of Rs. 24,328-12-0 paid out of the profits of the year 1925-26 as additional royalty to the Local Government is a sum which should not be included in the assessment of income-tax on the profits of the Indian Turpentine and Resin Company, Limited. The company is allowed the costs of this reference
8. I agree with my learned brother in answering the reference in the affirmative and in agreeing that the costs should be paid as directed by him. The operative portion of his judgment, therefore, stands as the judgment of the Court. The facts of the case are given in detail by my learned brother. I have only to add one thing and it is this. In my opinion the correct answer to the question put to us can be had by answering a simple question. That question is this. What is the consideration for the money paid to the Local Government (being a part of the profits earned) when the profits earned exceed 15 per cent? It is clear that the payment is not made to the Local Government as 'shareholders'. The payment is made on account of resin supplied. If this is not the case, then there is no consideration whatsoever for this payment. I have not the least doubt that the sum in question, paid to the Local Government, was paid as the price of resin supplied and that therefore the money so spent was a part of the expenditure incurred solely for the purpose of earning the profits of the company.