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Commissioner of Income-tax, Kerala Vs. Alagappa Textiles (Cochin) Ltd. - Court Judgment

LegalCrystal Citation
SubjectDirect Taxation
CourtSupreme Court of India
Decided On
Case NumberCivil Appeal Nos. 2001-2002 of 1978
Judge
Reported inAIR1980SC235; [1979]120ITR480(SC); (1980)1SCC214; [1980]1SCR723; 1979(11)LC919(SC)
ActsIndian Companies Act, 1956 - Sections 2(24) and 384; Indian Companies Act, 1913 - Sections 2(9); Income Tax Act, 1922 - Sections 10(2); Income Tax (Amendment) Act, 1961 - Sections 37 and 41(1)
AppellantCommissioner of Income-tax, Kerala
RespondentAlagappa Textiles (Cochin) Ltd.
Appellant Advocate V.S. Desai,; S.P. Nayar and; A. Subhashini, Advs
Respondent Advocate S.T. Desai, ; N. Sudhakaran and ; P.K. Pillai, Advs.
Cases Referred and Raj Woollen Industries v. C.I.T.
Prior historyAppeal by Special Leave from the Judgment and Order dated December 14, 1971, of the Kerala High Court in Income Tax Reference No. 19 of 1969--
Excerpt:
.....aforesaid clauses of the agreement in question two or three things stand out very clearly. the two recitals clearly indicate the object with which and the purpose for which the agreement was entered into. if this position clearly emerges on true construction of the agreement in question then it is obvious that kamala mills was not acting or working as the 'manager' of the assessee within the meaning of section 2(24) of the companies act, 1956 and as such the illegality of section 384 of that act was not attracted. however, we would like to place on record the fact that the decree obtained by the assessees against kamala mills ltd......on proper construction of the agreement dated november 10, 1955, entered into by the assessee with kamala mills ltd., the latter was the 'manager' of the assessee within the meaning of section 384 read with section 2(24) of the companies act, 1956 and if so, whether the remuneration paid by the assesses to the latter in the two calendar years 1957 and 1958 relevant to the assessment years 1958-59 and 1959-60 cannot be allowed as business expenditure under section 10(2) (xv) of the indian income-tax act, 1922 2. the facts giving rise to the question may briefly be stated as follows : the assessee (m/s. alagappa textiles (cochin) ltd.) is a public limited company carrying on business of manufacture and sale of' yarn and has its registered office at alagappa nagar in kerala state, it.....
Judgment:

V.D. Tulzapurkar, J.

1. These appeals by special leave raise a common question whether on proper construction of the Agreement dated November 10, 1955, entered into by the assessee with Kamala Mills Ltd., the latter was the 'manager' Of the assessee within the meaning of Section 384 read with Section 2(24) of the Companies Act, 1956 and if so, whether the remuneration paid by the assesses to the latter in the two calendar years 1957 and 1958 relevant to the assessment years 1958-59 and 1959-60 cannot be allowed as business expenditure under Section 10(2) (xv) of the Indian Income-Tax Act, 1922

2. The facts giving rise to the question may briefly be stated as follows : The assessee (M/s. Alagappa Textiles (Cochin) Ltd.) is a public limited company carrying on business of manufacture and sale of' yarn and has its registered office at Alagappa Nagar in Kerala State, It entered into an Agreement dated November 10, 1955 with Kamala Mills Ltd. Coimbatore for financing and managing the assessee mills at Alagappa Nagar for a period of five years. Clause 8 of the Agreement provided that Kamala Mills Ltd. shall be paid, for the services rendered by it by way of purchases, sales and management, remuneration at the rate of 1% on all purchases made by it for the assessee mills and at half a percent on all sales of yarn, yam waste and cotton waste and other products of the mill. Pursuant to the aforesaid term Kamala Mills Ltd. drew remuneration to the tune of Rs. 1,03,547/-and Rs. 18,294/- respectively for the calendar years 1957 and 1958 corresponding to the assessment years 1958-59 and 1959-60. These amounts were assessed to tax in the hands of Kamala Mills Ltd. The assessee in its assessment proceedings for the said two assessment years claimed deduction in respect of the said two amounts as business expenditure under Section 10(2) (xv) of the Act. The claim was disallowed by the Income-Tax Officer on the ground that under Section 384 of the new Companies Act, 1956, which had come into force on April 1, 1956, the continuation of a body corporate as manager was prohibited for the period beyond six months from the coming into force of the Act, that remuneration paid to Kamala Mills Ltd. subsequent to October 1, 1956, was illegal being in violation of Section 384 and, therefore, the deduction claimed in respect of such payment for the calendar years 1957 and 1958 could not be allowed. In the appeals preferred. by the assessee against the decision of the Income Tax Officer, it was contended that though the payment of remuneration to a body corporate as Manager after October 1, 1956 was illegal under Section 384, the payments were for services rendered and were fully justified by commercial expediency and as such the same should be allowed under Section 10(2) (xv) of the Act. It was also urged that even if the expenses incurred were in violation of the statute such expenses should be allowed since in computing the profits even of illegal business only the net profit was taxed after allowing all the expenses. The Appellate Assistant Commissioner was not impressed by these arguments; but he disallowed the deduction mainly on the ground that the assessee by its own conduct had disputed its liability to pay any remuneration to Kamala Mills Ltd. after October 1, 1956 and in that behalf he relied on an admitted fact that the assessee had filed a suit against Kamala Mills Ltd. to recover such remuneration which had been paid to it in contravention of Section 384 on the basis that since the payment was illegal Kamala Mills Ltd. was holding such amounts of remuneration in trust for and on behalf of the assessee and in such a situation the deduction could not be allowed. The assessee carried the matter in further appeals to the Tribunal, but the Tribunal confirmed the view of the taxing authorities that under Section 384 of the Companies Act, 1956 it was not legal for the assessee to have permitted Kamala Mills Ltd. to continue to work as its Manager after October 1, 1956 and that the payment of remuneration after the said date was illegal and could not be considered as valid expenditure for the purpose of Income Tax Act. In this behalf the Tribunal relied on two decisions in C.I.T. v. Haji Aziz and Abdul Sakoor Bros. 281. T. R. 266 and Raj Woollen Industries v. C.I.T. . An argument was raised before the Tribunal that Kamala Mills Ltd. was not only a manager but also a financier and that the remuneration should be treated as having been paid to the financier. While observing that it was a new case put forward by the assessee, the Tribunal negatived the contention holding, on construction of the Agreement, that it was by virtue of its position as Manager that Kamala Mills Ltd. was allowed to carry on the financial affairs of the assessee and the remuneration was payable to it as Manager and in no other capacity. The Tribunal also held that the claim for deduction was in respect of a disputed liability inasmuch as the assessee had not merely filed a suit to recover the amount but had in the meantime obtained a decree against Kamala Mills Ltd., and, therefore, the amounts could not be lawfully claimed as permissible deduction.

3. At the instance of the, assessee the following question was referred to the High Court for its opinion :

Whether on the facts and in the circumstances of the case, the Tribunal was justified in law in disallowing the claim of the assessee for deduction of Rs. 1,03,547/- and Rs. 18,294/- from the income of the assessment years 1958-59 and 1959-60 as not an admissible business expenditure under Section 10(2) (xv) of the Indian Income Tax Act, 1922-

The High Court answered the question in the negative in favour of the assessee and against the Department. The High Court, on construction of the Agreement dated November 10, 1955, took the view that since in the matter of the exercise of its powers and the discharge of its functions thereunder Kamala Mills Ltd. could not be said to be 'subject to the superintendence control and direction of the Board of Directors' of the assessee, Kamala Mills Ltd., was not a 'manager' of the assessee within the definition given in Section 2(24) of the Companies Act, 1956, and, therefore, the illegality under Section 384 was not attracted and as such the remuneration paid by the assessee to Kamala Mills Ltd. for services rendered during the calender years 1957 and 1958 was allowable as a business expenditure under Section 10(2) (xv) of the Act. As regards the decree that had been obtained by the assessee against Kamala Mills Ltd. the High Court observed that the appeal filed by Kamala Mills Ltd. against the said decree was still pending in the High Court and if ultimately the appeal was dismissed and the amounts were recovered back from Kamala Mills Ltd., the assessee could be taxed on those amounts under Section 41(1) of the 1961 Act, but that could not be a valid ground for disallowing the deduction claimed by the assessee. The Revenue has challenged in these appeals the view of the High Court that Kamala Mills Ltd. was not the Manager of the assessee within the meaning of Section 384 read with Section 2(24) of the Companies Act, 1956 and the further view that the remuneration paid to Kamala Mills Ltd. during the calendar years 1957 and 1958 was deductible as business expenditure under Section 10(2)(xv) of the Act.

4. Before we consider the principal question relating to the proper construction of the Agreement dated November 10, 1955, it will be desirable to note the relevant provisions of the Indian Companies Act, 1913 as also the new Companies Act, 1956, which have a bearing on the question at issue. Since the Agreement between the assessee on the one hand and the Kamala Mills Ltd. on the other was entered into at a time when the Indian Companies Act, 1913 was in force it will be proper first to refer to the definition of 'Manager' given in Section 2(9) of the said Act. Section 2(9) ran thus :

2(9) 'manager' means a person who, subject to the control and direction of the directors has the management of the whole affairs of a company, and includes a director or any other person occupying the position of a manager by whatever name called and whether under a contract of service or not.

It will be clear that to satisfy the aforesaid definition a person, which could include a firm, body corporate or an association of persons, apart from being in management of the whole affairs of a company had to be 'subject to the control and direction of the directors'. This definition has undergone a substantial change under the Companies Act, 1956. Under this Act Section 2(24) defines the expression 'manager' thus :

2(24) manager means an individual (not being the managing agent) who, subject to the superintendence, control and direction of the Board of directors, has the management of the whole, or substantially the whole, of the affairs of a company, and includes a director or any other person occupying the position of a manager, by whatever name called, and whether under a contract of service or not.

In this definition three conditions are required to be satisfied : (a) the manager must be an individual, which means that a firm or a body corporate or an association is excluded and cannot be a manager (a fact which is expressly made clear in Section 384), (b) he should have the management of the whole or substantially the whole affairs of the company and (c) he should be subject to the superintendence, control and directions of the Board of Directors in the matter of managing the affairs of the company. Subject to the changes made in the aspects covered by (a) and (b), in both the definitions the aspect that a manager has to work or exercise his powers under the control and directions of the Board of Directors is common and essential In fact it is this aspect which distinguishes 'Manager' from 'Managing Agent' If the definition of 'Manager' as given in Section 2(24) is compared with that of 'Managing Agent' as given in Section 2(25) it will appear clear that though there is an overlapping of the functions of the manager as well as the managing agent of the company the essential distinction seems to be that whereas the manager has to be subject to the superintendence, control and direction of the Board of directors the managing, agent is not so subject.

5. Section 384 of the Companies Act, 1956 in express terms prohibits, after the commencement of the Act, the appointment of a firm or a body corporate or an association 61 persons as a manager as also the continuation of such employment after expiry of six months from such commencement. It runs thus :

384. No company shall, after the commencement of this Act, appoint or employ, or after the expiry of six months from such commencement, continue the appointment or employment of, any firm, body corporate or association as its manager.

6. The aforesaid provision positively disqualifies a firm, body corporate or association from being appointed as manager of a company or from continuing the employment of a firm body corporate or association as manager after the expiry of six months from the commencement of the Act. Obviously, to attract the prohibition or disqualification contained in Section 384, a firm, body corporate or association must be a 'manager' within the meaning of Section 2(24),.that is to say, it should be in management of the whole or substantially the whole of the affairs of a company, and should be under superintendence, control and direction of the Board of directors of the company. It was not seriously disputed that under the terms and conditions contained in the Agreement dated November 10, 1955, Kamala Mills Ltd. could be said to be in management of substantially the whole of the affairs of the assessee mills but the question is whether it was forking under the superintendence, control and direction of the Board of directors of the assessee so as to be its 'Manager' within Section 2(24) of the Act?

7. Turning now to the Agreement in question it may be stated that at the commencement of he deed the parties thereto have been described in a particular manner, mainely, the assessee has been described and referred to as the 'Company' while Kamala Mills Ltd. has been described and referred to as the 'Managers' throughout the document. Then follow two recitals which make very clear the object or purpose with which the Agreement was entered into; according to these recitals the assessee was not having sufficient finance to carry on its business of manufacture and sale of yarn and the Board of directors thought it proper of find out a financier who was agreeable to help the assessee monetarily and take active interest in its business and that since Kamala Mills Ltd. agreed to assist the assessee With sufficient finance and to manage the assessee's mill on certain, terms and conditions which the Board of Directors had approved, the Agreement was executed between the parties. Then follow the operative parts of the deed setting out the terms and conditions on which Kamala Mills Ltd. agreed to provide sufficient finance as also to manage the business of the assessee. Clause 1 enlisted in Sub-clauses (b) to (m) the powers and functions which were to be exercised and performed by Kamala Mills Ltd. during the period of five years for which the Agreement was to operate; such powers were conferred and functions entrusted for the purpose of 'managing and running the mill' of the assessee; inter alia, Kamala Mills Ltd. was to make purchases of all cotton, staple fibre or any other raw material for the manufacture of the yarn and to enter into contracts in that behalf at such rates and prices as it may deem fair and proper and make payments for all such purchases and incur all expenses incidental thereto; it was also to make purchases of all stores and spares and other materials necessary for the manufacture of yarn; it was to appoint all staff, technical or non-technical and workers skilled and unskilled as also clerks and other staff necessary for the working of the mill and fix their terms and remuneration and could discharge or dismiss or take disciplinary action against them; it had to sell and make contracts for sale for Immediate, or future delivery of yarn, yarn waste or cotton waste or any other material or products of the mill at such rates or prices and on such terms and conditions as it may think fit; it could decide, lay down and change from time to time the programme of manufacture of yarn and other products of the mill and to insure against fire and other risks all cotton, yarn, material, stock-in-trade and incur and pay all premia necessary in that behalf; it could pledge, secure and hypothecate all stocks and stores and stock-in-trade with such bank or banks where arrangements for overdrafts shall have been completed by the Board of Directors; and it could claim, demand, realise and sue for all goods, materials and amounts due to the assessee in the exercise and carrying out of any or all of the powers conferred Under Sub-clause (a) to (k). Clause 2 of the Agreement stipulated that Kamala Mills Ltd. shall provide funds or arrange for finance necessary for exercising the powers of purchase of cotton, stores and other materials and for payment of wages, salaries, commissions and allowances and for meeting all expenses incidental to manufacture and sale of yarn and other products of the mill. Under Clause 3 the assessee was to open a separate Current Account and an Overdraft Account for a limit not exceeding Rs. 30,00,000/- with such bankers as Kamala Mills may require with power to Kamala Mills to operate on the said accounts exclusively by itself and in the name of the assessee and it was to have power to receive, endorse, sign, transfer and negotiate all bills, cheques, drafts etc., that may be received in the name of the assessee in the course of the management of the mill and it was specifically agreed that no one except Kamala Mills shall have power to operate on the said accounts. Clause 4 entitled Kamala Mills Ltd. to charge the assessee interest at the rate of 7 1/2 per annum with half-yearly rests on all advances made by it and funds provided for the purposes set out in Clause 2. Clause 5 gave Kamala Mills Ltd. a first and prior charge on all the stocks and stores and stock-in-trade for all the moneys and amounts that may be advanced by it to the assessee except to the extent of any charge or security of such stocks and stores and stock-in-trade that may be created in favour of the banks for the overdraft account and such charge in favour of Kamala Mills was to be a possessory charge. Clause 8 quantified the remuneration payable to Kamala Mills Ltd. for services rendered by way of purchases, sales, and the management of the mill at the rate of 1 % on all purchases made by it for the assessee mill and at 1/2% on all sales of products effected for and on behalf of the assessee. Clause 10 required Kamala Mills Ltd. to maintain proper accounts in respect of all purchases, sales and expenses, commissions and remunerations due to it etc. and submit to the assessee monthly statements of accounts. Clause 11 put the, outer limit of Rs. 15,00,000/- at any one point of time on the advances and financial assistance to be given by Kamala Mills Ltd. to the assessee and it was provided that if and when sums over and above the said limits become necessary to be advanced, Kamala Mills would be entitled to appropriate and take for itself as owner such quantity of yarn as may be in stock as in value would be equivalent, at cost or market value whichever was lower, to the sum that it may be obliged to advance over and above Rs. l5,00,000/-. Clause 13 of the Agreement is very important having a crucial bearing on the question at issue and may be set out verbatim. It ran thus :

13. The Company (assessee) either represented by its Managing Agent or Board of Directors shall not exercise the powers delegated to the Managers (Kamala Mills Ltd.) under the foregoing clauses, except by way of general supervision and advice, nor interfere with the discretion of the Managers in the exercise of their functions and powers vested in them by virtue of this Agreement.

Under Clause 14 it was provided that the Managers' (Kamala Mills Ltd.) powers were limited in the manner aforesaid and they were not and shall not be deemed to be managers in charge of the whole affairs of the company within the meaning of Section 2(9) of the Indian Companies Act, a significant provision showing the intention of the parties that Kamala Mills Ltd. was not to be regarded as a 'Manager' under the Indian Companies Act, 1913. Clause 16 is significant and it provided that the Agreement shall be in force for a period of five years commencing from the date thereof and that 'this Agreement for management being an Agency coupled with interest', it could be revoked before the expiry of the said period of five years by 12 months notice in writing being given by one party to the other but if the assessee were to revoke it the assessee shall be liable to compensate Kamala Mills for the loss of remuneration for the unexpired period of the Agreement at the average rate at which Kamala Mills Ltd. had been earning by Way of remuneration under the Agreement till the date of such notice of termination. A modification by introducing one additional term in the Agreement was made on November 21, 1955 but the additional term is not material for our purposes.

8. On a perusal of the aforesaid clauses of the Agreement in question two or three things stand out very clearly. It is true that at the commencement of the deed Kamala Mills Ltd. has been described and referred to as the 'Managers' of the assessee throughout the document but mere label or nomenclature given to a party in the document will not be decisive. It is also true that the several powers and functions were entrusted to Kamala Mills Ltd. under Clause 1 of the Agreement to enable it 'to manage or run the mill' of the assessee. But simply because powers and functions were given to Kamala Mills Ltd. for the purpose of 'managing and running the mills' of the assessee, it would not follow that Kamala Mills Ltd. was in truth and substance a 'manager' of the assessee within the meaning of Section 2(24) of the 1956 Act. For this purpose the Agreement will have to be read as a whole and the Court will have to decide that was the true, intention of the parties in entering into such agreement. The two recitals clearly indicate the object with which and the purpose for which the Agreement was entered into. It does appear that the assessee was in financially straightened circumstances and on that account was utterly unable to carry on its business of manufacture and sale of yarn and, therefore, the board of directors were in search of a financier who would make available the necessary finances for the running of the mill as also to take active interest in the business of the assessee and when Kamala Mills Ltd. agreed 'to assist the company (assessee) with Sufficient finance and manage the mill' belonging to the assessee on terms and conditions that were approved by the Board of Directors of the assessee that the Agreement was entered into between the parties; in other words, It is clear that the dominant object with which the Agreement was entered into was that Kamala Mills Ltd. should really act as a financier so that the assessee mill could run and since heavy finances were to be procured by Kamala Mills Ltd. large powers and functions connected with the working of the mill were entrusted to it. This aspect becomes abundantly clear from Clause 16 of the Agreement wherein the parties expressly provided that this Agreement for management was by way of and amounted to an Agency coupled with interest so far as Kamala Mills Ltd. was concerned and, therefore, revocation of the Agreement before the expiry of the five years' period was made dependent upon 12 months' notice in writing being given by one party to the other and further if such revocation was done by the assessee suitable compensation was made payable to Kamala Mills Ltd. In other words, managerial functions were incidental and had to be entrusted to Kamala Mills because of the financier's role undertaken by it. The large powers and functions entrusted to Kamala Mills Ltd. under the several Sub-clauses of Clause 1 of the Agreement do show that management of substantially the whole, if not the whole, of the affairs of the assessee company had been made over to Kamala Mills Ltd. But the crucial question is whether such management was to be done by Kamata Mills Ltd. under 'the superintendence, control and direction of the Board of Directors' of the assessee and in that behalf Clause 13 of the Agreement which we have quoted above is very eloquent. In terms it provided that so far as the powers conferred and the functions entrusted to Kamala Mills Ltd.; were concerned, the Board of Directors shall not exercise or perform the same except by way of general supervision and advice and it was further made clear that the Board of Directors shall not interfere with the discretion of Kamala Mills Ltd. in the exercise of their functions and powers vested in it by virtue of the Agreement. In other words, the general supervision or advice of the Board of Directors was of such character that the Board had no say whatsoever nor could it interfere with the discretion of Kamala Mills Ltd. in the matter of the exercise of tile powers and the discharge of the functions entrusted to Kamala Mills Ltd. under the Agreement. It is thus clear to us that the dominant object of the Agreement was that Kamala Mills Ltd. should act as financiers of the assessee mill and in the matter of the exercise of its powers and discharge of its functions Kamala Mills Ltd. was never 'subject to the superintendence, control or direction' of the Board of directors of the assessee. If this position clearly emerges on true construction of the Agreement in question then it is obvious that Kamala Mills was not acting or working as the 'Manager' of the assessee within the meaning of Section 2(24) of the Companies Act, 1956 and as such the illegality of Section 384 of that Act was not attracted. In this view of the matter, the remuneration paid by the assessee to Kamala Mills Ltd. for the two calendar years 1957 and 1958 relevant to the assessment years 1958-59 and 1959-60 could not be regarded as being in violation of Section 384 of the Companies Act, 1956 and as such the expenditure incurred by way of paying such remuneration would be deductible as business expenditure under Section 10(2) (xv) of the Income Tax Act, 1922.

9. In view of our aforesaid conclusion the aspects whether the assessee had disputed its liability to pay such remuneration to Kamala Mills Ltd. or had filed a suit at the instance of the Company Law Board to recover it back from Kamala Mills Ltd. or had obtained a decree in that behalf against Kamala Mills Ltd. become irrelevant. However, we would like to place on record the fact that the decree obtained by the assessees against Kamala Mills Ltd. has been reversed or set aside in appeal by the Kerala High Court-a fact which was brought to our notice by the Advocate-on-Record for the assessee communicated to him by his client in a letter dated 22nd August, 1979. However, even if in further appeal the trial court's decree were restored and the assessee were to recover back the remuneration the assessee can be taxed on the two amounts under Section 41(1) of the 1961 Act.

10. In our view, therefore, the High Court was right in answering the question in favour of the assessee. The appeals are, therefore, dismissed with costs.


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