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Commissioner of Income-tax Vs. British India Corporation - Court Judgment

LegalCrystal Citation
SubjectDirect Taxation
CourtAllahabad High Court
Decided On
Case NumberIncome-tax Reference No. 65 of 1978
Judge
Reported in(1982)31CTR(All)203; [1983]142ITR563(All)
ActsIncome Tax Act, 1961 - Sections 36(1) and 147
AppellantCommissioner of Income-tax
RespondentBritish India Corporation
Appellant AdvocateM. Katju, Adv.
Respondent AdvocateR.R. Agarwal and ;Bharatji Agarwal, Advs.
Cases ReferredC. Duraiswami Iyangar v. United India Life Assurance Co. Ltd.
Excerpt:
.....assessments were completed without referring to the memorandum and articles of association of the assessee-company. the fact that the company had made contributions to its employees' provident fund was clearly shown in the profit and loss account. the tribunal, therefore, held that the ito could not reasonably believe that any income of the assessee had escap d assessment on account of the assessee's failure to disclose fully and truly all material facts. ito [1961]41itr191(sc) it cannot be said that any belief on the part of the ito that any income of the assessee in the three years had escaped assessment is attributable to any failure on the part of the assessee to disclose fully and to bring all material facts on the record of the case. as the ito could not reasonably believe that..........company did not declare any dividend. the ito, therefore, felt that the contributions made by the assessee-company to the provident fund in these years were ultra vires and not allowable as deductions. he, therefore, required the assessee to show cause why the contributions made by it for these three years should not be disallowed.3. the company claimed that the articles of association could not override the law of the land. it was under a legal obligation to make contributions to its employees' provident fund, recognised by the commissioner of income-tax and set up as far back as december, 1944. accordingly, the contributions made by the assessee to the said fund in accordance with the scheme, therefore, were allowable as deductions. it was also pointed out on behalf of the assessee.....
Judgment:

H.N. Seth, J.

1. Income-tax Appellate Tribunal has, in the case of the assesses, British India Corporation, Kanpur, for the assessment years 1956-57, 1958-59 and 1959-60, stated the case and referred the following questions of law for the opinion of this court :

'1. Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the Income-tax Officer could not reasonably believe that any income of the assessee had escaped assessment during these years on account of the assessee's failure to disclose fully and bring all the material facts ?

2. H the answer to question No. 1 is in the negative, whether on the facts, and in the circumstances of the case, the Tribunal was correct in holding that the amounts paid by the assessee as contributions to the provident fund were allowable as a deduction during these years ?'

2. According to the statement of the case, the assessee is a public limited company which maintains its accounts on calendar year basis. Originally assessments for the years 1956-57, 1958-59 and 1959-60 were completed on March 8,1961, January 31, 1962, and February 14, 1962, respectively. In these assessments the ITO, while computing the assessee's income, deducted the amount contributed by it to the provident fund account of its employees. Subsequently, these assessments were reopened by issuing notices under Section 148 on March 23, 1974, on the ground that the assessee had not disclosed the primary facts which were relevant for deciding its claim for deduction of its contributions to the provident fund of its employees. The ITO found that these contributions had been made by the assessee in violation of Article 116 of the articles of association, which provided that the company was riot to make any contribution to the provident fund for any year in respect of which the shareholders were paid dividend at a rate lower than one anna per share. For the calendar years 1955, 1957 and1958, the company did not declare any dividend. The ITO, therefore, felt that the contributions made by the assessee-company to the provident fund in these years were ultra vires and not allowable as deductions. He, therefore, required the assessee to show cause why the contributions made by it for these three years should not be disallowed.

3. The company claimed that the articles of association could not override the law of the land. It was under a legal obligation to make contributions to its employees' provident fund, recognised by the Commissioner of Income-tax and set up as far back as December, 1944. Accordingly, the contributions made by the assessee to the said fund in accordance with the scheme, therefore, were allowable as deductions. It was also pointed out on behalf of the assessee that Article 116 of the articles of association had been amended by the shareholders in an extraordinary general body meeting held on May 8, 1959. After its amendment, Article 116 did not contain any restriction on the payment of contributions to the provident fund. Further, the shareholders had also, in the same meeting, ratified the contributions made by the company to the employees' provident fund during the calendar years 1955, 1957 and 1958, In the circumstances, it could not be said that the contributions made by the assessee were ultra vires and that the same were rightly allowed as deduction by the ITO, while framing the original assessment orders for each of the three years.

4. The ITO held that amendment of Article 116, made on 8th of May,1959, did not have any retrospective effect. It had no application to the years under consideration. He ruled that the contributions made by the assessee-company to the provident fund during the years under consideration were unauthorised and illegal. In the result, he disallowed these deductions and completed reassessment of the assessee accordingly.

5. The assessee challenged the reassessment orders before the AAC. It claimed that the ITO was not justified in reopening the assessments under Section 147(a) inasmuch as all primary facts necessary for its assessment had, during the course of original assessment proceedings, been fully and truly disclosed to the ITO and that, in substance, the assessment proceedings had been reopened on a mere change of opinion which could not be done under the law. It also urged that the contributions to the employees' provident fund made by it during all these three years were allowable deductions. According to it Article 116 could not override the assessee's obligation under a contract with its employees to make regular contributions to their provident fund. Further, the amendment of Article 116 of the articles of association, made in the extraordinary general body meeting of the shareholders held on 8th of May, 1959, was to operate retrospectively and the amended provision became effective for the relevant assessment years as well. Any contribution made to the employees' provident fund in consonance with the amended Article 116 of the articles of association could not be disallowed on the ground that they were beyond the scope of Article 116 of the articles of association as they stood prior to its amendment.

6. The AAC held that in the instant case the material and primary facts which the assessee was bound to disclose were : (i) the provisions contained in Article 116 of the articles of association of the company, and (ii) the quantum of dividend declared every year. During the original assessment proceedings, the assessee did not bring the provisions of Article 116 to the notice of the ITO. It could, to this extent, be said that the assessee did not disclose the material facts in the original assessment proceedings and that the contributions made by the assessee to the provident fund were allowed as deductions because of such non-disclosure on its part. Accordingly, the provisions of Section 147(a) of the I.T, Act, 1961, were attracted and initiation of the proceedings for reassessment in respect of the three years were perfectly valid.

7. As regards the assessee's claim that contributions made by it to the provident fund were allowable as deduction, the AAC held that the assessee-company was bound by its articles of association. It was, therefore, not competent for it to make contributions to the provident fund during these three years. The fact that the assessee was required to make these contributions under the contract with its employees could not override the provisions of Article 116 of the articles of association. The amendment of the articles of association made on 8th of May, 1959, did not have any retrospective operation. In the result, the AAC agreed with the ITO that the contributions made by the assessee to the provident fund for each of these three years were in excess of its powers and were ultra vires. The disallowances made by the ITO were accordingly upheld.

8. Being aggrieved, the assessee took up the matter in appeal before the Tribunal. After examining the reasons recorded by the ITO for reopening the three assessments, the Tribunal observed that even though the ITO had mentioned that the assessee did not disclose the primary facts in the course of the original assessment proceedings, he did not point out as to which such facts were omitted to be disclosed by the assessee. According to the Tribunal, the assessee had categorically stated that all the time the articles of association were available to the ITO and this statement of the assessee was not denied by the Department which merely claimed that the assessee should have filed another copy of its articles of association in the course of assessment proceedings and should have specifically referred to Article 116. The Tribunal felt that the provisions of the I.T. Act did not require that the company should keep on filing a copy of the memorandum and articles of its association every year along with its return. The assessee was not expected to point out to the ITO the relevant articles with reference to which he was to examine the various claims made by it. Any failure on the part of the assessee to specifically point out the provisions of Article 116 to the ITO could not, therefore, be held to be a nondisclosure of primary facts, which could justify a reopening of its assessments under Section 147(a). The Tribunal further proceeded to record a finding that the original assessment orders for the three years in question showed that they had been made after a detailed scrutiny and it was difficult to believe that all these assessments were completed without referring to the memorandum and articles of association of the assessee-company. The fact that the company had made contributions to its employees' provident fund was clearly shown in the profit and loss account. The claim had been duly examined in the course of original assessment proceedings and the contributions made to the unrecognised provident fund were disallowed in all these years. The fact that the company did not declare any dividend for the years in question was also apparent from the directors' report and the copies of the balance-sheet. The Tribunal, therefore, held that the ITO could not reasonably believe that any income of the assessee had escap d assessment on account of the assessee's failure to disclose fully and truly all material facts.

9. The Tribunal, however, proceeded to consider the claim of the assessee that even on merits, the amounts contributed by it to the recognised provident fund to its employees were allowable as deduction during the years in question. It did not accept its contention that the amendment of Article 116 of the articles of association made by the shareholders in their meeting on May 8, 1959, had any retrospective operation so as to affect the contributions to the provident fund made by the company in the years in question. It, however, accepted the contention that the shareholders whohad necessary power to amend the articles of association could, in the circumstances of the case, be deemed to have amended the same by accepting the provident fund scheme whereunder the contributions in question had been made. Thus, the contributions were intra vires the company and the shareholders were fully competent to accept and ratify the action of the directors in making the same. It further opined that the admissibility of the claim for deduction made by the assessee had to be judged and dealt with in accordance with the provisions of the I.T. Act and had to be accepted even if it was found to be in derogation of the articles of association of the company. In the result, the Tribunal held that even on merits, the assessee was entitled to a deduction of these contributions if on verification of the provident fund scheme, as it stood during the years under consideration, it was found that the assessee was liable to make them even though it did not declare any dividend in these three years.

10. The Commissioner thereafter made an application to the Tribunal which stated the case and referred the aforementioned two questions for our opinion.

11. In the instant case, it is not disputed that the provident fund to which the assessee made the contribution during the calendar years 1955, 1957 and 1958 had been recognised by the Commissioner of Income-tax, U.P. and Bihar, Lucknow, vide his order dated 16th December, 1944, and that the said provident fund was a recognised provident fund within the meaning of Section 238 of the I.T. Act, 1961. The assessee's claim, that it was entitled to a deduction of the contributions made by it to the aforementioned provident fund during the calendar years 1955, 1957 and 1958 is based on Section 36(1)(iv) of the I.T. Act, 1961, which lays down that while computing the income under the head 'Profits and gains of business or profession', any sum paid by the assessee as an employer by way of contribution towards a recognised provident fund has, subject to such limit as may be prescribed for the purpose of recognising the provident fund, to be deducted. Accordingly in the instant case the primary facts which the assessee had to disclose to the ITO for claiming deduction under the provisions of Section 36(1)(iv) of the I.T. Act were :

(1) that the amount in question was paid by it as an employer by way of contribution to the provident fund set up for its employees;

(2) that the said fund was a recognised provident fund; and

(3) that the contribution made by it to such provident fund was within the limits, if any, prescribed for the purposes of recognising the said fund.

11. Our attention has not been invited to any provision in the Income-tax Act laying down that contributions made by an assessee, in derogation of its articles of association to a recognised provident fund shall, not-withstanding the provisions of Section 36(1)(iv), be not allowed as deduction. We are accordingly of opinion that it was not obligatory for the assessee to have specifically invited the attention of the ITO concerned to Article 116 of the articles of association with a view to anticipate and meet a possible legal submission on behalf of the Department that the said contributions being not consistent with the articles of association of the company were not admissible deductions.

12. There is no controversy before us that all the primary facts indicated by us above had been, for purposes of claiming deduction under Section 36(1)(iv), truly and fully disclosed by the assessee. Accordingly, on the principles laid down in the case of Calcutta Discount Company Ltd. v. ITO : [1961]41ITR191(SC) it cannot be said that any belief on the part of the ITO that any income of the assessee in the three years had escaped assessment is attributable to any failure on the part of the assessee to disclose fully and to bring all material facts on the record of the case.

13. Moreover, it is not disputed that articles of association of the asses-see-company were, even though they had not been filed along with the return submitted by it, in fact available to the ITO, when he made the original assessments. The Income-tax Appellate Tribunal has, in this connection, made the following observations :

'The original assessment orders for these years show that they were made after a detailed scrutiny and as observed by the Hon'ble Supreme Court in the case of Calcutta Discount Company Ltd. : [1961]41ITR191(SC) , it was difficult to believe that the assessment for all these years were completed without referring to the memorandum and articles of association of the company...'

14. These observations, in our opinion, imply a finding by the Tribunal that the assessee had placed the articles of association before the ITO who had scrutinised the same carefully before accepting the assessee's case that in computing its income under the head, 'Profits and gains of business or profession', it was entitled to a deduction in respect of the amounts contributed by it to the recognised provident fund to its employees and that there was no non-disclosure on the part of the assessee in respect of the articles of association of the company. As the ITO could not reasonably believe that any income of the assessee had escaped assessment on account of the assessee's failure to disclose fully and truly all the material facts, the necessary condition for reopening the assessee's assessment under Section 147(a) did not exist and the same could not be reopened under that provision. The first question referred to us has, therefore, to be answered in the affirmative and in favour of the assessee.

15. We now proceed to deal with the second question referred to us by the Tribunal on the assumption that the reopening of the assessment ofthe assessee by the ITO was justified under Section 147(a) of the I.T. Act, 1961, inasmuch as there was some failure on the part of the assessee to fully disclose and place all material facts before the ITO. . Main contention of the Department is that in the instant case Article 116 of the articles of association of the company while enabling directors of the assessee-company to establish a provident fund for the benefit of its employees and to make contributions thereto, specifically provided that no such contribution shall be made for any period in respect of which the ordinary shareholders received a dividend at a lower rate than one anna per share per annum. As admittedly no dividend had been declared by the assessee-company in respect of calendar years 1955, 1957 and 1958, it was, in view of the provisions contained in Article 116 of the articles of association, not open to the company to make any contribution to the employees' provident fund established by it. The contributions so made were illegal and cannot be taken notice of.

16. We have already adverted to the provisions of Section 36(1)(iv) of the I.T. Act which provides for deduction of contributions made by the assessee to a recognised provident fund set up by it for the benefit of its employees. A deduction in respect of such contribution has to be allowed unless by some process of reasoning it can be said that the contributions to the recognised provident fund made by the assessee, in derogation of the provisions of its articles of association were illegal in the sense that they were no contributions in the eye of law.

17. Section 26 of the Companies Act, 1956, makes it clear that the articles of association of the company are required to be registered with a view to provide for regulating its own affairs and not with a view to affect the legality of transactions entered into between the company and outsiders; while the articles regulate rights of the members, inter se, they do not, it would seem, constitute a contract between the company and its members, and, therefore, the rights and liabilities of members as members under the articles can only be enforced by or against the members through the company. The articles do not, in any circumstances, as between the company and a person who is not a member, constitute a contract of which that person can take advantage. (See Halsbttry's Laws of England, vol. 7, paras. 119 and 120). It, therefore, follows that a transaction entered into between the company and a third person cannot be said to be vitiated for the reason that in entering into the said transaction the company had acted in derogation of the provisions contained in its articles of association. In this view, we are supported by the following observations made by a Division Bench of the Madras High Court, in the case of C. Duraiswami Iyangar v. United India Life Assurance Co. Ltd. [1956] 26 Comp Cas 12, 20 ; AIR 1956 Mad. 316 at p. 319 ;

'It is now well established that, though the articles constitute a contract between the company and a member in respect of his rights as a member, the articles do not constitute a contract between the company and third persons, a third person who purports to have rights against the company would be precluded from relying on the articles as the basis of his claim and must prove a special contract.'

18. In the case of CIT v. Ramakrishna Mills (Coimbatore) Ltd. : [1974]93ITR49(Mad) the question that arose for consideration before the Madras High Court was whether the payment which infringed the provisions of Section 348 of the Companies Act could be allowed as a deduction under Section 10(2) of the Indian I.T. Act, 1922. The learned judges, in this regard, observed thus (p. 58) :

'...assuming that the said payment infringed Section 348 of the Companies Act, still the company is entitled, in our view, to the deduction under Section 10(2)(xv). As pointed out by the Tribunal, in considering the allowability of an expenditure under Section 10(2)(xv) one cannot travel outside the provisions of the Income-tax Act and deny the benefit of deduction under the Section on the ground that the payment is unauthorised or has been prohibited by some other statute.'

19. Similar view was taken in the case of CIT v. Rajendra Mills Ltd. : [1974]93ITR122(Mad) wherein the question with regard to admissibility of deduction under Section 10(2)(xv) of the Indian I.T. Act, 1922, in respect of remuneration paid to the general manager in contravention of the provisions of Section 360 of the Companies Act, 1956, came up for consideration. The Madras High Court ruled that even though there was an infringement of Section 360 of the Companies Act, 1956, there being admittedly an actual payment for actual services rendered, the amount paid was an allowable deduction under Section 10(2)(xv) of the Act.

20. We are accordingly of opinion that in the instant case even if it be assumed that the assessee made its contribution to the employees' provident fund in derogation of the provisions contained in Article 116 of its articles of association, it cannot be said that such contributions made in pursuance of a provident fund scheme, binding between the assessee and its employees, were illegal in the sense that they could, in law, not be treated as contributions and are non est. Such contributions made in circumstances permitting there being allowed as deduction under Section 36(1)(iv) of the I.T. Act, therefore, could not be disallowed merely for the reason that they had been made in derogation of Article 116 of the articles of association.

21. In support of his submission that an expenditure incurred in contravention of the articles of association of the company treating it to be a statutory provision, could not be allowed as deduction, learned counselfor the Department referred us to the case of Haji Aziz and Abdul Shakoor Bros v. CIT : 1983ECR1942D(SC) , wherein it had been held that no expense which was paid by way of penalty for a breach of the law, even though it might have involved no personal liability, could be said to be an amount wholly and exclusively laid out for the purpose of the business of the assessee within the meaning of Section 10(2)(xv) of the I.T. Act and the fine paid by the assessee was not an allowable deduction under that section. In that case the question that was being considered by the court was as to whether an amount paid by an assessee by way of penalty for committing breach of some law, could be considered to be an expenditure laid out wholly and exclusively for purposes of his business and the court ruled that it could not be deducted under Section 10(2)(xv) as expenditure laid out wholly and exclusively for purposes of the assessee's business. Such a controversy is not there in the case before us. In the instant case, the deduction is not being claimed on the basis that it is an expenditure laid out wholly and exclusively in connection with the assessee's business (Section 37(1)), but on the basis of Section 36(1)(iv), which provides for making a deduction in respect of the amounts contributed by the assessee to recognised provident funds set up for its employees. In our opinion, there is nothing in the cases cited by learned counsel for the Department which may support his submission that contributions made by the employer-company to recognised provident fund, in derogation of its articles of association are illegal and are to be treated as non est.

22. Learned counsel also invited our attention to the case of Raj Woollen Industries v. CIT , wherein the learned judges of the Punjab High Court, relying upon the decision of Chagla C.J. in the case of CIT v. Haji Aziz and Abdul Shakoor Bros. : [1955]28ITR266(Bom) , observed that an amount spent by the assessee to carry out the business unlawfully cannot be allowed as a deduction under Section 10(2)(xv) of the Indian I.T. Act, 1922.

23. The view of the Punjab High Court, stated above, does not appear to be in consonance with the decision of the Supreme Court in the case of CIT v. Piara Singh : [1980]124ITR40(SC) , wherein the respondent, who was carrying on smuggling activity, was apprehended by the Indian police, while crossing the border into Pakistan, and a sum of Rs. 65,000 in currency notes was recovered from his person. On interrogation he stated that he was taking the currency notes to Pakistan to purchase gold there and smuggle it into India. The customs authorities confiscated the currency notes. The I.T. authorities found that the assessee was carrying on the business of smuggling and that he was liable to income-tax on income from that business and such income was assessed to tax. The question that arose for consideration before the Supreme Court was as to whether theassessee was entitled to deduction under Section 10 of the Indian I.T. Act, 1922, of the loss of Rs. 65,000 arising by the confiscation of the currency notes. The court held that the carriage of the currency notes across the border was an essential part of the smuggling operation and detection by the customs authorities and consequent confiscation was a necessary incident and constituted a normal feature of such an operation. The confiscation of the currency notes was a loss occasioned in pursuing the business of smuggling; it was a loss in much the same way as if the currency notes had been stolen or dropped on the way while carrying on the business. It was a loss which sprang directly from the carrying on of the business and was incidental to it and its deduction had to be allowed under Section 10.

24. The court approved the observations made in the case of CIT v. S.C. Kothari : [1971]82ITR794(SC) , wherein it had been observed (p. 802):

'If the business is illegal neither the profits earned nor the losses incurred would be enforceable in law. But, that, does not take the profits out of the taxing statute. Similarly, the taint of illegality of the business cannot detract from the losses being taken into account for computation of the amount which can be subjected to tax as 'profits' under Section 10(1) of the Act of 1922. The tax collector cannot be heard to say that he will bring the gross receipts to tax. He can only tax profits of a trade or business. That cannot be done without deducting the losses and the legitimate expenses of the business.'

25. In the same judgment, the learned judges of the Supreme Court pointed out that there was a distinction between the cases like the one before it and those where an amount had been paid by way of penalty for a breach of law. In their opinion, expenses or loss incurred in connection with a particular business, though illegally had to be accounted for in computing the figures of profits to be brought to tax and cases where a penalty was levied for committing a breach of law payment of which certainly could not be accounted for under Section 10 of the 1922 Act.

26. It cannot, on the basis of the cases cited by learned counsel for the Department, be said that an expenditure which otherwise qualifies for deduction in computing the income derived by the assessee under the head 'Profits and gains of business or profession' is not to be allowed as deduction merely for the reason that it was incurred by the assessee in derogation of its articles of association. In our opinion, any contribution made by a company even if it be in derogation of its articles of association, would qualify for deduction in accordance with Section 36(1)(iv) of the I.T. Act, 1961. As the contributions in question had in fact been made, fulfilling all the conditions specified in Section 36(1)(iv) of the I.T. Act, and as these did not, exist any such feature which could impel the courtto take the view that the said contribution could, in law, be treated as non est, the assessee was entitled to a deduction in respect thereof in computing its income under the head 'Profits and gains of business or profession '.

27. In the result, both the questions referred to us for opinion are answered in the affirmative and in favour of the assess27.ee. The assessee is entitled to costs which are assessed at Rs. 250.


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