1. This is an appeal by the department against the Commissioner (Appeals)'s order dated 20-12-1982 in the 1979-80 income-tax assessment proceedings of a registered firm.
2. The appeal raises two disputes. The first relates to the action of the Commissioner (Appeals) holding that an amount of Rs. 5,42,872 could not be disallowed under Section 40(6) of the Income-tax Act, 1961 ('the Act'). The second dispute relates to the decision by the Commissioner (Appeals) that an amount of Rs. 89,606 could not be disallowed under Section 40A(5) of the Act.
3. In the assessee-firm, there are three partners. The first partner is a limited company, Sapulchre Bros. (India) Ltd., with 60 per cent share and the other two are ladies, Mrs. Chandravati D. Ghorpade and Mrs.
Shivamala Urs, each with 20 per cent share each. The partnership agreement is dated 24-6-1965. The recital of the agreement states that Mrs. Chandravati D. Ghorpade and Mrs. Shivamala Urs were parties of the first and the second part and Sapulchre Bros. (India) Ltd. was the party of the third part to the partnership deed dated 21-6-1965. Prior to the commencement of the business by the firm, the business was carried on by the parties of the first and second parts in partnership with one Mr. Christopher George Beard under the name and style of the Mysore Company (1961). The Mysore Company (1961) had certain arrangements with Indian Oxygen Ltd., the terms of which were recorded by an agreement dated 20-3-1962. Under that arrangement, Mysore Company (1961) had appointed Sapulchre Bros. (India) Ltd., the party of the third part, as agent for the operation of the agreement that Mysore Company (1961) had with Indian Oxygen Ltd. The earlier referred Mr.
Beard retired from Mysore Company (1961) from 1-4-1964 and the business of Mysore Company (1961) was then decided to be carried on by the two ladies and the limited company in partnership. According to Clause 10 of the partnership deed dated 21-6-1965, it was provided that-- (10) The management of the business of the firm shall be vested in the party of the third part who shall be solely responsible for carrying on the business of the firm and to promote the interests of the firm to the best of their ability." "(14) The net profits shall be arrived at after taking into account all expenses, outgoings and interest paid or payable by the firm and in particular but without prejudice to the generality of the foregoing, salaries or wages of the employees who may be on the roll of the party of the third part but employed in connection with the work of the firm with the approval of the parties of the first and second part." It appears that in accordance with the manner of carrying on business, the supervisory staff for the firm's business was engaged by the limited company who naturally used to make the salary payments. The limited company used to allot for the purposes of partnership different staff members and the entire expenditure incurred by the limited company in respect of such staff members used to be reimbursed by the firm. Records disclose that from the assessment years 1966-67 to 1976-77, the ITO had not initiated any action under Section 40(b) for processing any amount that was reimbursed by the firm to the limited company. In Section 144B of the Act proceedings for the assessment year 1976-77, it is seen for the first time that the IAC had to consider this issue of reimbursement of the sum of Rs. 3,46,812 which were proposed to be disallowed by the ITO under Section 40(7?). In terms of his directions vide paragraphs 5 and 6, dated 24-9-1979, the IAC did not agree with the finding of the ITO that the reimbursement could be disallowed under Section 40(b). Same was the position for the assessment year 1977-78.
4. For the assessment year 1979-80, the year under consideration, the ITO proposed to disallow an amount of Rs. 5,42,871 which was a reimbursement of the expenses. According to the ITO, the disallowance was necessary in terms of Section 40(b). According to the ITO, the partner has to manage the business of the firm.
5. It appears that the ITO was further of the view that since the partner was a limited company, a limited company as a partner might have some persons to look after the management of the business of the firm. However, if for managing the business of the firm, a partner, if it be a limited company, incurred any expenditure and was reimbursed that of necessity has to be considered in the nature of remuneration to that partner and as such that amount has to be disallowed under the provisions of Section 40(b). In terms of a letter dated 14-4-1982 the assessee raised objections against the ITO's proposed action to disallow the amount of Rs. 5,42,871. It was pointed out that this was the addition which was considered in details by the department in the earlier years and that as such the ITO was not justified in re-agitating the same issue. The ITO's attention was specifically drawn to the assessment for the years 1976-77 and 1977-78. Vide para l(c) of that letter it was represented that-- 1(c) The amount of Rs. 5,42,871 in question is an expense reimbursed to the managing partners, Sapulchre Bros. (India) Ltd., for employees' costs incurred by them in loaning the services of their staff for the work of Indian Lime Corporation. As is evident from the operations of the firm its turnover is in the region of Rs. 57,80,000 and we have operations (inter alia, consisting of depots, transportations, sales, etc.) all over India which necessitated the use of the services of the persons without which the operations would not have been possible. Had the firm employed its own employees, it would have been likely incurred much larger expenditure by employment of the persons with the same experience and qualifications and ability. Therefore, it is not practical or economical for the firm to engage its own employees and, hence, the firm uses the service and reimburses to the managing partner company the expenditure incurred by it on those employees whose services were loaned for the work of the firm. Such an expenditure can by no stretch of imagination be deemed to be remuneration (by way of profit, benefit or otherwise) to the managing partner and, consequently, constituting non-business expenditure. In fact, there cannot be in this case anything like 'non-business expenditure' as held by you. Once the payment is held by you to be an expenditure of the firm, it cannot be treated as 'non-business' nor can it be disallowed. Besides, it is of importance to understand the difference between a payment made to a partner for services rendered to the firm by him and services rendered by third parties (for remuneration paid to such third parties) which are arranged by a partner." On this issue by his direction under Section 144B dated 15-9-1982 vide page (2) the IAC observed as under: "It, thus, follows that any remuneration paid by the assessee firm to Sapulchre Bros. (India) Ltd. by whatever name called, partakes of the nature of remuneration to the partner and, therefore, it has to be treated as such under the law. An attempt to make the distinction that this remuneration is compensation for the payments made by the company to its employees and not the remuneration received by the partner from the assessee is certainly not founded on sound basis.
In effect the company being an artificial person has rendered the services to the assessee-firm through its employees and has received remuneration for rendering these services." 6. On appeal vide para (4) of his order the Commissioner (Appeals) has observed: "In the present case, however, the partner, i.e., the company, employ the staff, who are loaned to the firm and, hence, to confuse the salary paid to the employees of the company as being salary paid to the company is obviously an error. The reimbursement to the partner is only of the actual expenditure incurred on the employment of staff and nothing more. There is no extra charge paid to the partner which can be termed as remuneration or benefits to the partners. There was no such payment made by the assessee to any of the partners which is prohibited by Section 40(b). The partner incurred initially the expenses on the staff loaned by it to the firm, paid postal charges, etc., and got the actual expenditure reimbursed to it. This arrangement was only for the efficient and smooth conduct of the assessee's business. Clearly, this did not extend any benefit or pay any remuneration to the partner." It is against this decision of the Commissioner (Appeals) that the ITO has come up in appeal urging that the AAC erred in deleting the addition of Rs. 5,42,871 made under Section 40(6).
7. Shri Roy Alphonso for the department strongly relies on the order of the ITO and the direction of the IAC. Since Shri Alphonso had not received the full records, Shri Pooran, the assessee's advocate, filed copies of the various documents as -filed before the lower authorities.
On examiation of these numerous documents and in particular the profit and loss account for the year under consideration and the details thereof, all what Shri Alphonso submits is that the assessee has incurred expenses of Rs. 7,12,409 of which an amount of Rs. 5,42,871.38 has been paid as management expenses to Sapulchre Bros. (India) Ltd. Shri Alphonso is not in a position to challenge the correctness of the primary facts stated by the Commissioner (Appeals) when the Commissioner (Appeals) observed that "reimbursement to the partner is only of the actual expenditure incurred on the employment of staff and nothing more. There is no extra charge paid to the partner which can be termed as remuneration or benefits to the partner". On this issue of Rs. 5,42,871 Shri Pooran supports the order of the Commissioner (Appeals).
8. Having heard the parties and examined the record so far as this ground of appeal is concerned, we find that there is merit in the assessee's submission that the ITO had examined this issue earlier on more than one occasion. Even the examination during the assessment year under consideration does not remotely suggest that by paying to Sapulchre Bros. (India) Ltd. the amount of Rs. 5,32,871.38, the firm was making any payment to the limited company which would remotely be called as remuneration to the partner. We are satisfied that it is merely reimbursement of the expenses incurred in running the business of the partnership firm. As such, we do not find any reason justifying any interference with the decision of Commissioner (Appeals).
9. The second dispute in appeal relates to the action of the Commissioner (Appeals) in deleting a disallowance of Rs. 89,606 made by the ITO in terms of Section 40A(5). As on the first point on this issue as well, detailed facts were given initially by Shri Pooran, which facts were got checked by Shri Alphonso, with reference to various letters written to the lower authorities during the assessment proceedings. On that basis, the facts relating to the employment of Mr.
Shivram out of whose remuneration the ITO disallowed an amount of Rs. 89,606 are to be seen as under: i. Mr. Shivram was in the employment of Sapulchre Bros. (India) Ltd. from 1947. From 1962, Sapulchre Bros. (India) Ltd. acted as the agent of Mysore Company (1961) as recited in the partnership deed being at pages 1-7 of compilation No. II. From 1965, Mysore Company (1981) was dissolved and Indian Lime Corporation was formed in which Sapulchre Bros. (India) Ltd. became a partner.
At that time Mr. Shivram was appointed as the manager to look after the lime operation in Bombay. He was already a manager of Glass & Export Division. He continued to be in the employment of Sapulchre Bros. (India) Ltd., he received commission of 5 per cent from Indian Lime Corporation in respect of Bombay operations and in later years on Ahmedabad and Delhi operations; the commission on Delhi operations being restricted to 2 1/2 per cent. He also received commission at 3 per cent on Glass indenting business from Sapulchre Bros. (India) Ltd. which was Rs. 483 in accounting year 1978-79. The ITO's computation under Section 40A(5) is marked as Annexure 'A'.
2. From the very first year of Indian Lime Corporation, he received commission as aforesaid till he retired on 30-11-1982.
3. From 1-4-1973, his terms of remuneration were revised as per the letter dated 21-9-1973 as per copy enclosed and marked Annexure 'B'.
This letter, no doubt refers to the commission being paid by Indian Lime Corporation to Mr. Shivram apparently through mistake. This mistake occurred because Sapulchre Bros. (India) Ltd. was the managing partners and combined two letters, one regarding salary paid by SBIL and the other regarding commission paid by Indian Lime Corporation in one letter. In a broad sense the letter reflects the total emoluments Mr. Shivram received in his two capacities.
However, the employer-employee relationship existed only between Sapulchre Bros. (India) Ltd. and Mr. Shivram and further Mr. Shivram received the commission directly from Indian Lime Corporation by ILC cheques drawn on Indian Lime Corporation account as per particulars given hereunder and not through Sapulchre Bros. (India) Ltd.:Date of payment Amount paid The commission being calculated on the year's workings, is debited on 31st March, in this case 31st March, 1979. However, it is paid in the previous year 1979-80 through expenses payable account.
On this issue, in terms of his direction on facts, the IAC considered it proper to conclude that-- Mr. P.S. Shivram is actually an employee of Indian Lime Corporation and the facade of his appointment with Sapulchre Bros. (India) Ltd. has been created only to avoid applicability of Section 40A(5) of the Income-tax Act. On behalf of the assessee it has been stated that Mr. P.S. Shivram is an employee of Sapulchre Bros. (India) Ltd. since 1947 and the managing partners of the firm thought it fit to provide this gentleman's services for the management of various activities of the assessee-firm." Shri Alphonso relied on the fact that Shri Shivram is the main functionary of the assessee-firm and as regards his remuneration, 'salary part is received by him from Sapulchre Bros. (India) Ltd. while the commission is received from this assessee-firm. However, one need not be swayed by the more form of this arrangement. In substance Mr.
Shivram is discharging all the functions of an employee of Indian Lime Corporation, the assessee-firm'. On this basis, the IAC upheld the ITO's action.
On appeal, the Commissioner (Appeals) agreed with the assessee's submission that there is no employer-employee relationship between Shri Shivram and the appellant-firm. He has been deputed by Sapulchre Bros.
(India) Ltd. to attend to the lime business which he attends as an employee of Sapulchre Bros. (India) Ltd. He could be removed from this job and entrusted with other duties. He is not under the control of the appellant-firm. Since Mr. Shivram is in receipt of salary from Sapulchre Bros. (India) Ltd., when the question of applying provisions of Section 40A(5) cannot arise".
10. On the above facts, Shri Alphonso submits that technically it may be a fact that Shri Shivram is an employee not of the assessee but of Sapulchre Bros. (India) Ltd. However, Shri Alphonso urges that on the basis of facts stated by the assessee almost 90 per cent of the work which Shri Shivram does, he does it for the assessee. Shri Alphonso supports this statement on the basis of Annexure 'A' as given by Shri Pooran. The Annexure 'A' is as under: Payments to Mr. P.S. Shivram--Income-tax Department's groundPaid by Sapulchre Bros.
Reimbursement from(India) Ltd. Indian Lime Corporation Rs. Rs. For Section 40A(5), if reimbursement to Sapulchre Bros. (India) Ltd. is also considered:Reimbursement Rs. 36,515--3,160 = 33,355Commission paid directly by ILC 1,06,251 1,39,606Less: Allowable 60,000Disallowable 79,606 Shri Alphonso submits that the IAC was justified in coming to the conclusion that in the manner in which Sapulchre Bros. (India) Ltd. and the assessee-firm have arranged their affairs and made payments for services rendered by Shri Shivram, neither in the case of Sapulchre Bros. (India) Ltd. nor in the case of the assessee, the restrictive provision of Section 40A(5) could apply. Shir Alphonso submits that if on the first ground the department fails, it should follow that Sapulchre Bros. (India) Ltd. was merely a conduit pipe for the assessee to incur expenditure of an amount of Rs. 5,42,871, it being added that the amount of Rs. 36,575 and other amount of commission paid to Shivram but a part of the larger amount. Shri Alphonso submits that as such transaction be considered from the larger point of view and not that a restricted view be taken.
Proceeding on that basis, in the assessment of the present firm, Shri Alphonso urges that the amount of Rs. 79,606 at least has to be disallowed. The working of Rs. 79,606 is given at under:Reimbursement Rs. 36,515--3,160 = 33,355Commission paid directly by ILC 1,06,251 1,39,606Less: Allowable 60,000Disallowable 79,606 11. Shri Pooran for the assessee relies on the circumstances in which Shri Shivram was employed and was remunerated. It was added by Shri Pooran that as observed by the IAC in fact Shri Shivram was managing, if not wholly, substantially the business of the firm. It was submitted that as such the partners of the assessee-firm considered it advisable to remunerate Shri Shivram. In reply to a query, Shri Pooran accepted the fact that in the assessment of Sapulchre Bros. (India) Ltd. for the purposes of processing the expenditure incurred on providing remuneration to Shri Shivram, the commission paid to Shri Shivram by the assessee-firm has not been taken into account.
12. Having heard the parties and examined the record, we find even though directly the assessee may not have arranged its affairs with a view to avoid the applicability of Section 40A(5), we find merit in the observations of the IAC to which our attention was drawn by Shri Alphonso and to which we have made a reference earlier that in the manner in which Shri Shivram is remunerated, neither in the case of the assessee-firm nor in the case of Sapulchre Bros. (India) Ltd. of which Shri Shivram is officially an employee, the provision of Section 40A(5) would be ignored if one were to accept Shri Pooran's submission.
Considering from that angle, we find that in the present case, the form must be overlooked and substance must be considered. We find merit in the IAC's observation that the firm has been adopting the particular mode of operations to reduce taxation. In the circumstances, we do not find justification in the Commissioner (Appeals)'s decision to accept the assessee's submission that Rs. 89,606 cannot be disallowed under Section 40A(5). Since up to the stage of appeal before the Commissioner (Appeals), the figure mentioned in dispute is Rs. 89,606 and it was only before us that it was clarified that the correct figure is not Rs. 89,606 but Rs. 79,606, we will restore the ITO's order on this part, subject to the arithmetical examination of the amount to be disallowed.