The judgment of the court was delivered by
DIVAN J. - This reference has been made at the instance of the Commissioner of Income-tax and the following question has been referred to us :
'Whether, on the facts and in the circumstance of the case, the Tribunal was right in holding that the assessee is entitled to deduction of the Rs. 76,161 ?'
The facts giving rise to this reference are as follows : The assessee is a public limited company and is carrying on business of manufacturing and dealing in textiles. The relevant assessment year is 1963-64 and the previous year was accounting year 1962 (calendar year). It appears that in the year of the account in question in pursuance of an agreement, dated March 1, 1962, the assessee paid a sum of Rs. 76,161 to the liquidator of the Raipur Mills Employees Co-operative Credit Society Ltd. (hereinafter called 'the society') and this society was for the benefit of the employees of the assessee-company and the members of the society were the employees of the assessee. This society was sponsored by the assessee and was registered as a co-operative society under the provisions of the Bombay Co-operative Societies Act, 1926. The managing committee of the society consisted of the officers of the assessee-company nominated by the assessee and some elected representatives of the members. In 1952, a sum of Rs. 2,35,268 was found to have been misappropriated from the funds of the society. One Ranchhodlal Parshottamdas was involved in this misappropriation. Thereafter, criminal proceedings were instituted against the said Ranchhodlal Parshottamdas and in 1966 he was convicted and sentenced to undergo a certain term of imprisonment. Fixed deposits aggregating to Rs. 1,15,248 were lying with the society and out of this amount Rs. 1,02,648 belonged to the employees of the assessee. The society went into liquidation and the liquidator started misfeasance proceedings against some persons including some of the members of the managing committee and he held them liable for the amount misappropriated. Some of the members preferred an appeal against the decision of the liquidator and during the pendency of the appeal, the matter was compromised and an agreement between the liquidator of the society and the assessee-company was arrived at on March 1, 1962; and under that agreement, the company paid the said sum of Rs. 76,161 to the liquidator. In the assessment proceedings to income-tax, the assessee claimed deduction of this amount of Rs. 76,161. The Income-tax Officer rejected the claim of the assessee and held that it was purely an ex gratia payment and as such not liable to be deducted under section 37 of the Income-tax Act, 1961. Against this order of the Income-tax Officer, there was an appeal and the Appellate Assistance Commissioner dismissed the appeal. The matter was then taken in appeal to the Tribunal and the Tribunal upheld the contention of the assessee and held that there was sufficient evidence on the record to show that the expenditure in question was incurred by the assessee-company only with a view to preserve peace in its business. The Tribunal held that, though the payment by the company resulted in benefit to some of the members of the managing committee, the expenditure was incurred by the company for the purpose of its business. The Tribunal, therefore, held that the assessee was entitled to deduction of this amount of Rs. 76,161. Thereafter, at the instance of the revenue, the above-mentioned question has been referred to us.
In order to appreciate the background against which the agreement, dated March 1, 1962, came to be entered into, it is necessary to set out certain further facts. On October 20, 1956, the board of directors of the assessee-company passed a resolution setting out the facts of the defalcation committed by Ranchhodlal Parshottamdas and it was further stated in the resolution that the members of the society were the workers of the company and this act of misappropriation on the part of Ranchhodlal had deprived the poor workers of company of their hard earned saving lying with the society either in form of share capital or deposit; and as a result of such misappropriation there was great unrest amongst the worders against the company and the worders used to throng the office of the company for relief of their loss and on several occasions situation became very tense and even the police was called into control the mobs and to restore peace and order; and it was apprehended that, if such tense situation was allowed to linger for long, it might lead to concerted action on the part of the workers which might lead to strikes, stoppage of work and loss of lives of some of the officers of the company and neglect in work which might adversely affect the working of mill company and thereby affect the quantity and quality of production. Against this background of a tense situation thus set out in the resolution, the board of directors authorised Kasturbhai Lalbhai, a partner of the manging agency firm of the assessee-company and one of the directors of the company, to conduct negotiations and enter into any agreement with Shyamprasad Vasavada, who was at that time the general secretary of the Textile Labour Association, Ahmedabad, in order to negotiate and compromise with the said Vasavada regarding the claims of depositors and shareholders of the society. In pursuance of this authority, negotiation appear to have been carried on between Kasturbhai Lalbhai and Shyamprasad Vasavada and ultimately and agreement appearment appears to have been arrived at on November 12, 1956, between two of them. A report regarding this agreement was, thereafter, made to the board of directors and at its metting held on January 28, 1957, the board of directors of the assessee-company approved the agreement arrived at between Kasturbhai Lalbhai and Shyamprasad Vasavada, as stated above, on November 12, 1956. Under that agreement the company was to pay and aggregate sum of Rs. 96,875-10-0 to the liquidator of the society for paying to the members and depositors of the said society at the rate of 40% of the share capital and 50% of the amount of deposists and for paying the fees of the liquidator and auditors of the said society. In spite of this agreement between Kasturbhai Lalbhai and Vasavada, the majority of the members and depositors of the society did not accept the terms of that agreement and ultimately by further resolution, dated September 16, 1957, the board of directors of the assessee-company noted the fact that the agreement, dated 12, 1956, had come to an end and the agreement could not used or produced in the any court by any one and the management of the assessee-company disclaimed and liability in the matter. It appears that, thereafter on March 1, 1962, the board of directors of the assessee-company, after setting out the previous history and after also nothing that the liquidator of the society had started misfeasance proceeding under section 50A of the Company Co-operative Societies Act against Ranchhodlal and Balkrishna and three members of the manging committee of the society, the resolution noted the fact that one N. K. Desai was appointed by the Deputy Registrar of Co-operative Societies to conduct an inquiry and the said N. K. Desai made a report to the Deputy Registrar holding the said five persons liable for misappropriation committed by Ranchhodlal and Balkrishna. The Deputy Registrar confirmed the report and against this decision of the Deputy Registrar, the three members of the managing committee preferred an appeal to the Registrar of Co-operative Societies. During the pendency of the appeal, the company wrote a letter, dated October 26, 1961, to the liquidator sending some proposals for compromise. These proposals were accepted in writing by a majority of the creditors of the society in number and value and the writing was produced before the Registrar of Co-operative Societies and the liquidator of the society agreed to the said proposals and submitted his report accordingly to the Registrar of Co-operative Societies; and that officer by his order, dated January 2, 1962, authorised the liquidator to accept the compromise and to compromise the matter. A draft tripartite agreement was entered into between the liquidator of the society, the company and the three members of the managing committee; and a copy of the draft agreement was produced before the board of directors of the assessee-company at their meeting on March 1, 1962. The resolution passed at the meeting of March 1, 1962, by the board of directors stated :
'Resolved that in view of the facts and circumstances hereinabove mentioned and with a view to establish and maintain industrial peace and good relations with the employees of the company, the board of directors of the company hereby approves of and consents to, an agreement being entered into between the company, Shri Ratilal H. Dagli, the liquidator of the Raipur Mills Employees Co-operative Credit Society Ltd. (in liquidation) and Shri Keshvalal Havashabhai Patel, Anantrai Chhotalal Mehta and Dinshaw Nanabhai Dastur, for the compromise and settlement of the claim proved by the creditors of the said society.......'
In pursuance of this resolution of March 1, 1962, on that very day a formal agreement was entered into between the assessee-company and the liquidator and thereafter the said amount of the Rs. 76,161 was paid by the assessee.
It was contended on behalf of the revenue before us that this payment of Rs. 76,161 was an ex gratia payment, i.e., payment made out of generosity but was not a payment made out of commercial expediency. It was further contended that this payment was made to protect three officers of the company who were member of the managing committee and who were held liable in the misfeasance proceedings under section 50A of the Bombay Co-operative Societies Act. It was lastly contended that whatever might have been the situation between 1952 and 1957, there was no evidence as to what was the position in 1962 regarding the feelings of the employees of the company regarding the misappropriation of the funds of the society. It was contended in this connection that there was no evidence to show that the threats held out in 1956, as set out in the resolution of the board of directors, dated October 20, 1956, still continued in 1962, when the agreement was entered into; and it was contended that in March 1962, when the agreement to pay the sum of the Rs. 76,161 was entered into, there was no pressure on the company land hence it could not be said that the payment was made because of any commercial expediency.
We may note that when the Tribunal dealt with the matter and allowed this deduction to the company it found that there was sufficient evidence on the record to show that the expenditure in question was incurred by the assessee-company not for any third but only for itself with a view to preserve peace in its business. The Tribunal observed :
'Finally, we have also before us the boards resolution, dated March 1, 1962, and the agreement which was eventually arrived at between the concerned parties on that very date showing that the company had agreed to make the payment only to pacify the workers and to restore smooth working of its factory. It is thus very evident from all three materials that the payment in question was made not with the view to help the society nor out of any philanthrophical motives but purely from a business point of view. We find that there were two alternatives before the assessee-company, viz., one to stick to its legal rights and to resist all the demands of the workers to get reimbursement from the funds of the company, and thus to invite the posibility of a strike, stoppage of work and rowdyism in the mill premises and, as result of this, a substantial loss in the production. The second alternative was to make some sacrifice and thus to purchase peace so that the company could go on with its production and would thereby be able to make its usual profits with the co-operative of its workers. The company has obviously chosen the second alternative which to the best of its judgment was more conductive to this business interests.'
Thus, the finding the Tribunal was that this payment was made by the assessee-company to buy peace and to see that the employees were contented and that there was no disturbance in the smooth working of tis factory because of strike, stoppage of work or rowdyism in the mill premises.
There are a large number of decisions laying down as what is 'business expediency' and we need refer to only two cases in this connection. The first case is of the Bombay High Court in Tata Sons Ltd. v. Commissioner of Income-tax. There the assessee, limited company, held the managing agency of another company. Under the managing agency agreement the assessee 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 paid voluntarily a certain sum as its share of the bonus which the managed company paid to some of its officers. The bonus paid by the managed company was not an unreasonable bonus and it was not such that a deduction could not be claimed by the managed company under section 10(2) (x) of the Indian Income-tax Act, 1922. The assessee claimed that the payment made by it was a permissible deduction under section 10(2) (xv) of the Act of 1922; and the Bombay High Court held that looking at the payment from the point of view of commercial principles what the assessee had done was company and thereby increasing its own share of the commission and, expended for the purposes of its business and was an allowable deduction under section 10(2) (xv) of the Act. Chagla C.J., delivering the judgment of the Division Bench, observed at page 467 of the report :
'Now, the decided cases show that one has not got to take an abstract or academic view of what is proper expenditure laid out or expended wholly and exclusively for the purpose of ones business. One has got to take into consideration questions of commercial expediency and the principles of ordinary commercial trading and the main consideration that has got to weigh with the court is whether the expenditure was a part of the process of profit-making. If the expenditure helps or assists the assessee in making or increasing the profits, then, undoubtedly, that expenditure would be expended wholly and exclusively for the purposes of business. It has been urged........ that the payment made by the assessee was a voluntary payment. That is perfectly true, because there was no obligation whatever upon the assessee to share the bonus with the managed company, and in sharing the bonus the assessee did an act which it was under no obligation to do. But, even a voluntary act if performed for commercial expediency would still be an expenditure falling within section 10(2) (xv) if it can be shown that it was intended for the purpose of making or increasing the profits of the assessee-company. It has also been urged that the payment has been made not to the employees of the assessee company but to the employees of the managed company, a different entity altogether. Here again, if it can 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 us that the expenditure was one which fell within the ambit of section 10(2) (xv). Now, it cannot be seriously disputed that the bonus was paid by the managed company to their employees in order to increase the efficiency of the working of the company. An increased efficiency would incidentally result in higher and better profits, and the assessee-company would be as much interested in the working of the managed company being more efficient as the managed company itself. Whatever tended to increase the profits of the managed company would also tend to increase the income and profits of the assessee-company. Therefore, it cannot be suggested that the assessee-company had an indirect or ulterior motive in making this payment. The only motive by which it was actuated was a purely commercial and pecuniary one and that was to see that more profits were made by the managed company so that its own commission should thereby be increased.'
The other decision, which has a bearing on the point, is our own decision in J. R. Patel and Sons (P.) Ltd. v. Commissioner of Income-tax, and there we held that in deciding whether a payment was made for purposes of business, the correct approach would be to see whether it was made on grounds of commercial expediency for the ultimate benefit of the business. Whether that benefit is to accrue immediately or after a lapse of time and whether directly or indirectly is immaterial. At page 787, the following principles culled out by a Division Bench of this High Court from the earlier reported cases were reproduced, with which we respectfully agreed :
'(1) 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 ones business but one has got to take into consideration questions of commercial expediency and the principles of ordinary commercial trading and the main consideration that has got to weigh with the court is whether the expenditure was a part of the process of profit-making.
(2) The test for the purpose of deciding whether a particular amount can be allowed as deductible allowance under section 12(2) of the Act is whether the transaction is properly entered into as a part of the assessees 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, it would attract the provisions of section 12(2) even though the transaction might have been voluntarily entered into.
(3) If the payment was made with an indirect or improper motive for some considerations aliunde the business or out of generosity, then the payment is not liable to be regarded as one covered by the provisions of section 10(2) (xv) : that the matter has to be viewed in the light of principles of commercial trading and commercial expediency and what is required is that the expenditure must be germane to the business of the assessee and not something which is de hors the business.'
In the instance case, the glaring facts, as pointed out by the Tribunal, are that in 1956 there was considerable discontent because of the misappropriation and economic suffering amongst the workers. The resolution, dated October 20, 1956, points out that a feeling of discontent and unrest prevailed amongst the workers against the company and the workers used to throng the office of the company for relief in their loss; on several occassions the situation became very tense and even the police was called in to control the mobs and to restore peace and order; and it was apprehended that if such a tense situation were allowed to linger for long, it might lead to concerted action on the part of the workers which might lead to strikes, stoppage of work and loss of lives of some of the officers of the company and neglect in work which might adversely affect the working of the mill-company and thereby affect the quantity and quality of production. It is true that a considerable period had elapsed since the time this situation was noted in 1956 and 1962 when the assessee-company through its board of directors resolved to pay the amount of Rs. 76,161 to the liquidator of the society under the agreement, dated March 1, 1962. But, one must not lose sight of the background against which the assessee-company agreed to pay and did pay the amount in question. The resolution which was passed in this connection itself notes that the amount was being paid with a view to maintain peace and good relations with the employees of the company. But, apart from that recital in the resolution itself because this was a co-operative society sponsored by the assessee-company for the benefit of its employees and because some of the officers of the assessee-company were nominated as members of the managing committee of the society, and as a matter of fact some of the persons who were held liable for the misfeasance under section 50A of the Bombay Co-operative Societies Act were officers of the company, it is not unreasonable to infer that at the time when the assessee-company decided to make the payment in 1962, there were two alternative before the company, as has been held by the Tribunal. The first alternative was to refuse to make any payment and to stick to its strict rights; and the other alternative which was not altogether an imaginary one in the light of the events that had happened in the past was to invite strike, stoppage of work and rowdyism in the mill premises and thus suffer a substantial loss in production. If in order to avoid such consequences which might lead to loss to the assessee-company the assessee-company decided to purchase peace so that the company could go on with its production by securing the co-operation of its workers, and the company decided to make this payment, it cannot be said that the payment was not made out of commercial expediency. Just as in the case of Tata Sons Ltd. an attempt was made to secure the contended and satisfactory working of the officers of the managed company, in the instant case, the assessee-company has made an attempt to buy peace in order to see that the peaceful working of the factory of the assessee-company was not disturbed in any way. It is true, as was the case in Tata Sons Ltd. case, the assessee-company was not bound to make the payment; and in that sense it was a voluntary payment; but at the same time the nexus between the payment by the assessee-company, and commercial expediency is very clear, viz., smooth working of the factory of the assessee-company being ensured by making of this payment, as unrest amongst the employees of the company would, to a certain extent be eliminated by such a payment.
Under these circumstances, in our opinion, the Tribunal was right in coming to the conclusion that the expenditure in question was laid out wholly and exclusively for the purposes of the assessee-companys business.
In view of the above discussion, we answer the question referred to us in the affirmative. The Commissioner will pay the costs of this reference to the assessee.
Question answered in the affirmative.