K.T. Desai, C.J.
1. This is a reference under section 66(1) of the Indian Income-tax Act, 1922. The assessee in this case is J. R. Patel & Sons Private Limited, the assessment year being 1957-58, the accounting year being the calendar year 1956. The assessee company was acting as the managing agent of the Mahendra Mills Ltd. with effect from 20th August, 1945, the period of managing agency being twenty years. Under the terms of the agreement the assessee company was entitled to an office allowance of Rs. 1,000 per month and to a commission calculated at the rate of ten per cent. on the annual net profits of the managed company. A. J. Patel was the managing director of the assessee company. He was also a director of the managed company. He was employed by the managed company to render technical service to the managed company and the managed company used to pay to him a sum of Rs. 2,500 per month. He was also acting as the selling agent of the managed company and the managed company was paying to him a commission at the rate of two and half per cent. on the sale price of healds and reeds. The assessee company was paying to him a sum of Rs. 12,000 per annum as and by way of remuneration for attending to the affairs of the assessee company as its managing director. On 1st April, 1956, the Companies Act, 1956, came into force. The Mahendra Mills Ltd. is a public limited company. Under the provisions of section 198 of the Companies Act, 1956, it was provided that save as otherwise expressly provided by the Act in the case of a public company, the total remuneration payable by the company to its directors, its managing agent or secretaries and treasurers, if any, shall not exceed eleven per cent. of the net profits of that company computed as therein provided, the percentage being exclusive of any fees payable to directors for meetings of the board attended by them. Section 354 of the Act provided that the managing agent shall not be paid any office allowance but he may be reimbursed in respect of any expenses incurred by him on behalf of the company and sanctioned by the board or by the company in general meeting. Section 356 of the Act provided that no managing agent and no associate of a managing agent shall receive any commission or other remuneration from the company, in respect of sales of goods produced by the managed company, if the sales were made from the premises at which they were produced or from the head office of the managing agent or from any place in India. The expression 'associate of a managing agent' has been defined in section 2(3) (c). Section 2(3) (c) lays down that where the managing agent is a body corporate, the expression would, inter alia, include a director of such body corporate, and where the managing agent is a private company, it would also include any member of the private company. Shri Patel was an associate of the assessee company which was the managing agent of the managed company. In view of the provisions of section 356, Patel could not receive any commission or other remuneration from the managed company in respect of the sales of healds and reeds produced by the managed company. Section 361 of the Companies Act, 1956, provided that all the contracts in force at the commencement of the Act, to which a company or the managing agent or an associate of the managing agent of a company was a party, would in so far as the contracts relate to any of the matters referred to in sections 356 to 360, be deemed to terminate on the first day of March, 1958, unless they terminated on an earlier date.
2. On 13th June, 1956, Patel addressed a letter to the directors of the assessee company drawing the attention of the directors that from 1st April, 1956, the office allowance that was being paid to the assessee company by the managed company, namely, Rs. 12,000 per year, had ceased to become payable by the managed company to the assessee company. He stated in that letter that he was receiving from the managed company remuneration as technical adviser at the rate of Rs. 2,500 per month and an annual bonus of Rs. 3,000. He stated that in view of section 198 of the Companies Act, 1956, it appeared that the managed company could not make that payment because it would cause the total remuneration permitted by that section to exceed eleven per cent. of their net profits. He further stated that he was working as a selling agent of the managed company for the sale of healds and reeds on remuneration of two and a half per cent. on the sale price and that section 356 of the Companies Act had prohibited the appointment of an associate as a selling agent and that he had, therefore, ceased to work as a selling agent from 1st April, 1956. He stated that it was not necessary in order that he may devote his attention to the work which he used to do as technical adviser and also devote his attention to the sale of heads and reeds that he should be remunerated for that work by the assessee company as it was in the interest of the assessee company itself that the same attention was continued to be paid to the sales of heads and reeds as also to the technical side of the working of the mills and that he should be sufficiently remunerated for looking after the management of the mill company on behalf of the assessee company. He suggested that the assessee company should remunerate him out of its earnings, that his remuneration as technical adviser was Rs. 33,000 per annum and that the commission as selling agent which he earned in 1955 at the rate of two and a half per cent. amounted to Rs. 20,628-11-0 and that Rs. 12,000 was received as office allowance and that he in one capacity or the other received in all a sum of Rs. 65,628-11-0. He further stated that as the members of the board had desired that he should continue to assist the managed company in the same manner as he used to do before as that was in the large interests of the assessee company itself and that they had agreed to remunerate him so that he should be placed in the same position as he had been occupying before, he requested the board to convene an extraordinary general meeting for voting remuneration to him.
3. In pursuance of that request the board of directors called an extraordinary general meeting of the assessee company and on 31st July, 1956, the assessee company passed the following resolution :
'Resolved that Mr. Ambalal Jivabhai Patel be paid remuneration as managing director of the company as follows :
(a) Rs. 30,000 per year.
(b) Further, in any year in which the remuneration from the Mahendra Mills Ltd. for that year exceeds rupees one lakhs, an amount equal to thirty per cent. of such excess over rupees one lakh.
In respect of the period from 1st April, 1956, to 31st December, 1956, Mr. Ambalal be paid Rs. 22,500 as remuneration plus 3/4th of the excess over Rs. 1 lakh referred to in (b) above.'
4. Having regard to the aforesaid resolution, a sum of Rs. 44,367 was paid by the assessee company to Patel and the said amount was calculated as follows :
Rs.(i) Remuneration at the rate of Rs. 1,000 per mensemfor theperiod 1st January, 1956 to 31st March, 1956,as per theold arrangement :... 3,000(ii) Remuneration calculated at the rate ofRs. 2,500 permensem for the period 1st April, 1956,to 31st December,1956... 22,500(iii) 3/4th of 30% of the excess over rupees1 lakhreceived as managing agency remuneration... 18,867-------Total 44,367-------
5. The assessee company claimed a deduction in respect of the payment made as aforesaid under the provision contained in section 10(2) (xv) of the Indian Income-tax Act, 1922. Section 10(1) provides that the tax shall be payable by an assessee under the head 'Profits and gains of any business, profession or vocation' in respect of the profits or gains of any business, profession or vocation carried on by him. Sub-section (2) thereafter provides that such profits or gains shall be computed after making the following allowances :
'.... (xv) any expenditure (not being an allowance of the nature described in any of the clauses (i) to (xiv) inclusive, and not being in the nature of capital expenditure or personal expenses of the assessee) laid out or expended wholly and exclusively for the purposes of such business, profession or vocation.'
6. The assessee company contended that the sum of Rs. 44,367 paid by it to Patel was an expenditure laid out or expended wholly and exclusively for the purpose of the business of the assessee company. The Income-tax Officer by his order dated January 30, 1958, allowed out of this sum of Rs. 44,367 only a sum of Rs. 12,000 at the rate of Rs. 1,000 per mensem, being the amount which was being allowed to be deducted in previous years on account of payment made to Patel in the previous years. He disallowed the balance of Rs. 32,367. In the course of his decision he observed as follows :
'The sum and substance of the explanation is that since Shri Ambalal Jivabhai Patel would not get his technical adviser's remuneration and bonus from the Mahendra Mills Ltd., the assessee company decided to compensate him by increasing his remuneration as the managing director of the company. The assessee company was asked as to whether there were any additional services rendered by the managing director to the assessee company during the year than those which were rendered by him in the past. The assessee company is silent on this query and, therefore, it is presumed that no such additional service were rendered. Under the circumstances it has to be decided now as to whether the increased remuneration is justifiable.'
7. He further stated that the assessee company did not produce any evidence to show that there was any justification in increasing the remuneration paid to the managing director. It was argued before him that had there been no such increase made, then the assessee company would have got a lesser amount by way of managing agency commission from the managed company. It was further argued that whatever amount the managing director had been paid during year was comparatively less than what he used to get in the past from the assessee company and the managed company jointly. The Income-tax Officer held that these two arguments could not constitute adequate reasons for increasing the remuneration and that what had to be considered was both how much the managing director was paid and whether what he was paid a reasonable payment or not in the light of the services rendered by him to the assessee company. He held that only an amount of Rs. 12,000 would be the reasonable remuneration that could be treated as wholly and exclusively laid out or expended by the assessee for the purpose of its business. The matter was carried in appeal before the Appellate Assistant Commissioner who passed an order thereon on February 26, 1959. He expressed the opinion that the Income-tax Officer was correct in holding that while considering the question of increase in the remuneration of the managing director, one must look to the services rendered to the assessee company rather than services rendered to the managed company and that what the appellant company had done was that for services rendered by Patel to the managed company as a technical adviser, it had undertaken to bear the remuneration payable by the managed company, that in short the assessee company had tried to circumvent the provisions of the new Companies Act in the matter of earning of managing agency commission and payment of remuneration to the directors of the managing agents. He took the view that the remuneration paid by the assessee company to Patel for his services as a technical adviser to the managed company were not connected with or were part of his duties as a managing director of the assessee company, that the functions and duties of the managing agents and the duties and functions of a technical adviser of the managed company were different and distinct, that the liability for services rendered by a technical adviser to a managed company constituted part of the liability of the managed company while the liability for payment for the general duties rendered by the managing director of a managing agency company was that of the managing agency company. He held that the portion of remuneration which related to the services performed for the managed company by Patel as a technical adviser was not admissible, being not wholly and exclusively laid out for the business of the assessee company. The matter was carried further before the Income-tax Appellate Tribunal and the Tribunal gave its decision on July 29, 1960. The Tribunal did not accept the argument that this payment was motivated by considerations of commercial expediency. In the course of its judgment, it has observed that it was not disputed that A. J. Patel had not rendered any extra services to the assessee which he had not rendered in the prior years and that if the payment of a thousand rupees per month could be proper recompense for such service in earlier years, unless some special circumstances were pointed out in order to justify a larger payment, the allowance of a larger payment could not be considered to be as being laid out wholly and exclusively for the purpose of the appellant's business and the appeal was dismissed.
8. At the instance of the assessee this reference has been made to us and the question which has been referred to us is the following :
'Whether, on the facts and in the circumstances of the case, the sum of Rs. 32,367 paid in accordance with the resolution dated July 31, 1956, and disallowed by the Income-tax Officer could be allowed as a deduction under the provisions of section 10(2) (xv) ?'
9. The assessee had desired that the Tribunal should refer the following two questions for our decision :
'(1) Whether, on the facts and in the circumstances of the case, the applicant company was entitled to a deduction in respect of the whole amount of Rs. 44,367 paid to Shri Patel
(2) Whether there was any evidence before the Tribunal to justify the finding that the sum of Rs. 32,367 out of the total remuneration of Rs. 44,367 paid to Shri Patel was not laid out wholly and exclusively for the purpose of the applicant company's business ?'
10. In our view, the question referred to us brings out the real point in controversy between the parties and it is not necessary to amend the same.
11. The law in connection with the question as to what expenditure could be allowed having regard to the provisions contained in section 10(2) (xv) has been well-settled. As the section itself indicates, such expenditure must be laid out or expended wholly and exclusively for the purpose of the business of the assessee. Mr. Kaji, the learned advocate for the assessee, relied upon a decision of the Bombay High Court in the case of Tata Sons Ltd. v. Commissioner of Income-tax. In that case, the assessee company was the managing agent of another company. Under the managing agency agreement the assessee company was to be paid a commission at a certain rate which was to be computed upon the net profits of the managed company. During the relevant year the assessee company paid voluntarily a certain sum as its share of the bonus which the managed company paid to some of its officers. The assessee company claimed that the payment made by it was a permissible deduction under section 10(2) (xv) of the Act. After referring to the decision of the Privy Council in the case of Tata Hydro-Electric Agencies Ltd. v. Commissioner of Income-tax, Chief Justice Chagla in that case has observed that the decided cases showed how difficult it was to discriminate between expenditure which was, and expenditure which was not, solely expended and incurred for the purpose of earning profits or gains, that the cases further showed that one has not got to take an abstract or academic view of what was proper expenditure laid out or expended wholly and exclusively for the purposes of one's business but one had got to take into consideration questions of commercial expediency and the principles of ordinary commercial trading and that the main consideration that had got to weigh with the court was whether the expenditure was a part of the process of profit-making. With respect, we entirely agree with the aforesaid observations made by Chief Justice Chagla in that case. In that case, it had been urged on behalf of the Commissioner that the payment that had been made by the assessee company was a voluntary payment, that the assessee company was under no obligation to share the bonus which the managed company had to pay to its employees. In dealing with this argument the court observed that if it could be shown that there was a very important nexus between the assessee company and the managed company which necessitated the assessee company making the payment to the employees of the managed company, then again it would be possible for the assessee company to satisfy the court that the expenditure was one which fell within the ambit of section 10(2) (xv), that it could not be seriously disputed that the bonus was paid by the managed company to its employees in order to increase the efficiency of the working of the managed company, that an increased efficiency of that company would incidentally result in higher and better profits, that the assessee company would be as much interested in the working of the managed company being more efficient as the managed company itself and that whatever tended to increase the income and profits of the managed company would also tend to increase the income and profits of the assessee company. He further observed that once it was assumed that bonus was paid out of commercial consideration by the managed company, then in the payment of that bonus the assessee company would be interested and that when it shared that bonus it received part of the benefit which went to the managed company, and that part of the benefit would be the increased commission that the assessee would get by reason of the employees of the managed company being contented and having an impetus to work wholeheartedly and producing more profits for the employers. We will have to consider on the facts of the present case whether the payment made by the assessee company to its managing director was a payment made on grounds of commercial expediency for the ultimate benefit of the assessee company, whether that benefit accrued immediately or whether it accrued after a lapse of time directly or indirectly.
12. Another decision on which some reliance was placed by the assessee company was the decision of the Supreme Court in the case of Eastern Investment Ltd. v. Commissioner of Income-tax. In that case the question arose whether deduction could be claimed under the provisions of section 12(2) of the Indian Income-tax Act, 1922. The Supreme Court in that case has observed at page 5 that the test for the purpose of that case was whether the transaction was properly entered into as a part of the assessee's legitimate commercial undertakings in order indirectly to facilitate the carrying on of its business. If the transaction had been entered into on the ground of commercial expediency in order even indirectly to facilitate the carrying on of the business of the assessee company, it would attract the provisions of section 12(2) even though the transaction may have been voluntarily entered into.
13. In the case of F. E. Dinshaw Ltd. v. Commissioner of Income-tax, to which our attention was drawn by the learned advocate for the assessee company, it has been laid down that if the payment was made with an indirect or improper motive for some considerations aliunde the business or out of generosity, then the payment was not liable to be regarded as one covered by the provisions of section 10(2) (xv), that the matter had to be viewed in the light of principles of commercial trading and commercial expediency and that what was required was that the expenditure must be germane to the business of the assessee and not something which is de hors the business.
14. Applying these well-known principles to the facts of the case, we will consider whether the expenditure incurred by the assessee company to the extent that it has been disallowed could be regarded as an expenditure wholly and exclusively laid out for the purpose of the business of the assessee company. As stated by the Income-tax Tribunal, Patel did not render any extra services to the assessee which he had not rendered in prior years. The mere fact that so far as the assessee is concerned Patel did not render any extra services cannot be regarded as the only relevant circumstance which may be considered in deciding whether the expenditure had been wholly and exclusively laid out for the purpose of the business of the assessee company. The services for which the assessee company sought to remunerate its managing director were services which were to be rendered by the managing director not to the assessee company but to the managed company. The question that we would have to consider would be whether there was such a nexus between the managed company and the assessee company which would justify the assessee company in entering into such a transaction from the point of view of business expediency. Rightly or wrongly, the assessee company considered that its managing director, Patel, was not entitled to receive the remuneration which he was receiving in the past for the services rendered by him personally to the managed company, as the law precluded the managed company from making such payment to Patel. It was an attempt on the part of the assessee company to pay to Patel what it considered could not be paid to him by the managed company. The services which were rendered by Patel to the managed company were those of a technical adviser and those of a selling agent in connection with the sales of healds and reeds manufactured by the managed company. Under the terms of the agreement entered into by the assessee company with Patel, it was directed that the agency company was to pay to Patel Rs. 30,000 per year and was also to pay a sum equal to thirty per cent. of excess over rupees one lakh received by the agency company in any year as and by way of remuneration from the managed company. As a result of this agreement, the agency company was parting with a substantial part of the income which it was to receive from its business as the managing agent of the managed company. Even if the view which the agency company as well as Patel took about the legal position was correct and if some person other than Patel had been appointed to do the work of a selling agent and to do the work of a technical adviser to the managed company, the amount of the managing agency commission would then have been reduced to the extent of ten per cent. of the amounts which the managed company would have had to pay to such other technical adviser and such other selling agent. In order to avoid this loss of ten per cent., the agency company entered into an agreement whereunder it gave away to Patel many times more than amount. No evidence has been led which would show that expenditure of this nature had been incurred by the assessee company for considerations of business or commercial expediency or that the expenditure was laid out wholly or exclusively for the purpose of the business of the agency company or that as a result of the arrangement the agency company derived any gain or a long term advantage or was expected to derive such advantage either directly or indirectly. Having regard to the facts and the circumstances of the case, it is not possible for us to come to the conclusion that the sum of Rs. 32,367 being the balance of the sum of Rs. 44,367 referred to by us earlier was laid out or expended wholly and exclusively for the purpose of the business of the assessee company and was liable to be allowed as a deduction under the provisions of section 10(2) (xv) of the Act.
15. We answer the question in the negative. We order the assessee to pay to the Commissioner the costs of the reference.
16. There will be no order on the Civil Application No. 12 of 1962 filed for sending the statement of the case back to the Tribunal for alterations and additions being made therein and for raising an additional question of law.
17. Question answered in the negative.