1. The only contention that was pressed and argued in this case relates to the disallowance of weighted deduction under Section 35B of the Income-tax Act, 1961 ('the Act') on a sum of Rs. 3,68,312 paid by the assessee as commission.
2. The assessee is a manufacturer and exporter of hand-knotted carpets.
With a view to maintain and increase its exports in Europe, it had entered into an agency agreement with Ingeborg Unadcath of Hamburg. It will be necessary to quote the relevant provisions of this agreement as under: 1. The first party 'KC are the manufacturers of Indian hand-knotted carpets who have agreed to appoint the second party as 'agents', Export Promotion Sole Selling Agents in whole of Europe including the United Kingdom for a period of five years.
2. The 'agents' will secure orders for export of hand-knotted carpets from first class customers.
3. 'KC will manufacture and export the orders submitted and confirmed.
4. It has been decided that a commission of 5 per cent will be paid to 'agents' at the same time when the documents are paid by the customers. 'KC will give irrevocable instructions each time to their bankers to pay 5 per cent commission to the 'agents' from the proceeds.
5. 'agents' will not charge any other expenses such as, telegram, post travelling, etc., and they are only entitled as mentioned above to the 5 per cent commission, commission will be paid on the invoice value.
6. 'agents' will guide 'KC about the trend of the European market, from time to time give new designs for developments.
7. 'KC will ensure execution of the orders, maintain standard of the quality as per the contract and for as per the samples approved by the customers.
8. This agreement will be extended automatically for further five years if not terminated by one year's notice earliest or latest to be given by 31st December, 1982.
The assessee paid a commission of Rs. 3,68,312 based on 5 per cent of the FOB invoice value of the orders actually procured by the agent and shipment made by the assessee on that basis. It claimed, relief under Section 35B on this expenditure, which was allowed by the ITO. The deduction allowed on this account worked out to Rs. 1,22,771.
3. The ITO had made some other disallowances also. Against this, the assessee appealed to the Commissioner (Appeals). The Commissioner (Appeals) also noticed that the ITO had allowed relief under Section 35B as mentioned above. He required the assessee to point out the relevant provisions in the Act under which it was entitled to the required relief. It was submitted before him that the relief had been claimed and allowed under Section 35B(1)(b)(iv). This section reads as under: 35B (1)(a) where an assessee, being a domestic company or a person (other than a company) who is resident in India, has incurred after the 29th day of February, 1968, but before the 1st day of March, 1983, whether directly or in association with any other person, any expenditure (not being in the nature of capital expenditure or personal expenses of the assessee) referred to in Clause (b), he shall, subject to the provisions of this section, be allowed a deduction of a sum equal to one and one-third times the amount of such expenditure incurred during the previous year: Provided that in respect of the expenditure incurred after the 28th day of February, 1973 but before the 1st day of April, 1978, by a domestic company, being a company in which the public are substantially interested, the provisions of this clause shall have effect as if for the words 'one and one-third times', the words 'one and one-half times' had been substituted.
(b) The expenditure referred to in Clause (a) is that incurred wholly and exclusively on--** ** ** (iv) maintenance outside India of a branch, office or agency for the promotion of the sale outside India of such goods, services or facilities; It was contended before the Commissioner (Appeals) that the assessee had maintained an agency for the promotion of its sale of carpets outside India and, therefore, it was also entitled to relief on the expenditure incurred in such maintenance. The Commissioner (Appeals) was of the view that the assessee had actually not maintained any agency outside India. According to him, maintenance represented meeting the entire expenditure. To support his view, he gave the examples of maintenance of a car or an office or a garden. According to him, the assessee could not be said to have maintained any agency inasmuch as it was required to pay only a fixed sum on the fob invoice value of orders booked by that agent and shipped by the assessee and it was not obliged to make additional reimbursement of any loss likely to be sustained by the agent or was also not entitled to the refund of any amount, if not so spent. He, therefore, held that the assessee had actually not maintained any agency and was, therefore, not entitled to deduction under Section 35B. After giving the assessee an opportunity of being heard, he enhanced the income by Rs. 1,22,771.
4. The assessee is now in appeal before us. The learned Counsel for the assessee, Shri Agarwal, submitted before us that the Commissioner (Appeals) had completely misunderstood the provisions of the Act inasmuch as he had compared the legal interpretation of the words 'maintenance' and 'agency' with those understood in common parlance. He submitted that none of the authorities below have doubted the genuineness of the agency agreement or the fact that the assessec had, in fact, made the payment of Rs. 3,68,312 to the agent. He also submitted that the assessee was prudent enough to make the payment only on the invoice value of the goods actually booked and shipped, which was also the direction of the RBI as per their letter dated 6-4-1978.
5. Shri Agarwal next contended that Sub-clause (iv) of Section 35B(1)(b) suggested three modes to an exporter in India namely, maintenance outside India of a branch, maintenance outside India of an office and maintenance outside India of an agency and if expenditure was incurred on any of these, then it was entitled to the relief under Section 35B. Proceeding further, he submitted that the choice of the mode was left to an exporter and it depended upon his capacity and extent of business to adopt either of them. He contended that in the present case, the assessee had adopted the third mode, namely, maintenance of an agency outside India for the promotion of the sale of its carpets. In this connection, he also invited our attention to the following sections of the Indian Contract Act, 1872: Section 182. An 'agent' is a person employed to do any act for another or to represent another in dealings with third persons. The person for whom such act is done, or who is so represented, is called the 'principal'.
Section 184. As between the principal and third persons any person may become an agent, but no person who is not of the age of majority and of sound mind can become an agent, so as to be responsible to his principal according to the provisions in that behalf herein contained.
Shri Agarwal contended that an agent was not a servant and that his status emanated from a contract entered into with the principal. He argued that the German party, admittedly, was the assessee's agent and not the servant of the latter. His next contention was that in terms of Section 185 of the Indian Contract Act, no consideration was necessary to create an agency and that it was enough if there was a contract to that effect between the principal and the agent, which by itself, created an agency between them. On the basis of these legal submissions, his argument was that there was a contract of agency between the assessee and the German firm.
6. Shri Agarwal then referred to dictionary meanings of the words 'maintain' and 'maintenance'. Some of these are given in the order of the Commissioner (Appeals). It is, therefore, not necessary to reproduce them in our this order. Suffice it to say that by maintenance, among others, means to keep in working order or to keep in existence. Although the dictionaries give different meanings, but the only meaning, which can be relevant in context of the matter dealt with by us is the one given by us above. The submission of the learned Counsel, therefore, was that by referring to maintenance of an agency in Sub-clause (iv) of Section 35B(1)(b), the Parliament meant that a principal carried on or kept in working order the relationship of an agency with the agent. To support his submissions, he also referred to the following decisions--CIT v. K.S. Ratnaswamy  122 ITR 217 (SC), S.M. Zackariah Sahib v. CIT  22 ITR 359 (Mad.) and J.M.Abdul Aziz v. CIT  48 ITR 602 (Mad.).
He argued that this was exactly what was done in the present case. The agency between the assessee and the German firm which came into effect on 1-1-1978 was to continue for a period of five years subject to its further renewal. During the assessment year under appeal, therefore, it was maintained by the assessee. He contended that the question of maintaining an agency and an expenditure incurred for such maintenance were two different things and, therefore, it could not be said that unless some expenditure was incurred, the agency could not be said to have been maintained. He finally submitted that the assessee had incurred an expenditure of Rs. 3,68,312 in the maintenance of the above agency, which expenditure was entitled to relief under Section 35B.According to him, therefore, the ITO was justified in allowing the above relief and the Commissioner (Appeals) had committed a legal error in withdrawing it.
7. On behalf of the department, it was submitted that the question of payment was linked with the element of the agency and the two could not be separated. The learned departmental representative, in this connection also referred to certain observations appearing at page 187 of Law and Practice of Income-tax, Vol. 1, Seventh edition by Kanga and Palkhivala. He has also referred to the decision of the Supreme Court in the case of K.S. Ratnaswamy (supra).
8. We have carefully considered the submissions placed before us. We are inclined to agree with the stand of the assessee. There is no doubt that the word 'agency' occurring in Sub-clause (iv) of the section referred to above can only mean an agency as defined in the Indian Contract Act. It is a relationship between the principal and an agent.
An agent is a person employed to do any act for the principal or to represent the latter in dealings with third persons. As per Section 185 of the Indian Contract Act, no consideration is necessary to create an agency. In the light of this interpretation it cannot be denied that the German firm was the agent of the assessee. The second question which arises is what is the meaning of the word 'maintenance'. As shown above, the words 'maintain' and 'maintenance' have different connotations. However, in connection with an agency that only mean keeping the latter in working order or to carry it on. The expression 'maintenance of an agency', therefore, means an act of continuing the relationship of principal and agent for which, as stated above, no consideration is necessary. We find that as per the agreement dated 11-11-1977, this relationship had been maintained by the assessee with the German concern in the year under appeal also. As contended before us, the option was with the assessee either to maintain a branch outside India or to maintain an office outside India or to maintain an agency outside India. Obviously in the case of maintaining a branch or an office, the burden of meeting the entire expenditure would have been upon the assessee. The assessee, however, chose to maintain only an agency. In order to maintain an agency, his responsibility was not to meet its expenses, but to keep the relationship with the German firm intact or to carry it on. This is what the assessee has done. The assessee, therefore, has maintained an agency outside India in terms of Sub-clause (iv) of the section. This view also finds support from the various decisions cited at the bar. We do not agree with the view of the Commissioner (Appeals) that the legal meaning of maintenance of an agency can be compared with the use of the word 'maintenance' in common parlance as in connection with a garden or a car, etc. That concept is wholly outside the scope of Sub-clause (iv) of Section 35B.9. Under Section 35B, the assessee would be entitled to relief on the expenditure which, among others, is incurred wholly and exlusively on the maintenance of an agency. There is no doubt that the assessee has spent a sum of Rs. 3,68,312 on the maintenance of the agency. How that amount has been worked out is not relevant for the purpose. As stated above, it was worked at 5 per cent on the FOB invoice value of the orders booked by the agent and shipped by the assessee. The assessee is, therefore, clearly entitled to relief under Section 35B on the above amount as was allowed by the ITO.10. The other contention relating to relief under Section 35B on Rs. 958 being the value of samples was neither pressed nor argued before us and is, therefore, rejected.