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Commissioner of Income-tax, Gujarati Ii, and Another Vs. Kasturbhai Lalbhai and Another. - Court Judgment

LegalCrystal Citation
SubjectDirect Taxation
CourtGujarat High Court
Decided On
Case NumberIncome-tax Reference No. 18 of 1965
Reported in[1968]70ITR267(Guj)
AppellantCommissioner of Income-tax, Gujarati Ii, and Another
RespondentKasturbhai Lalbhai and Another.
Cases ReferredJoint Stock Discount Company v. Brown
Excerpt:
- - ..we are convinced that the managing agents, so constituted, are not in a position to discharge their duties satisfactorily in the best interests of this company. we are satisfied about the good faith of the assessees in this case. it is impossible to take the view that if a director does not like the conditions in which he is called upon to work, he can resign, and that he cannot undertake any expenditure which will secure more satisfactory conditions of work. we, therefore, uphold the claim of the assessees under section 12(2)'.it is clear from this passage that the tribunal accepted the first contention of the assessees and held that the expenditure was not incurred by the assessees for the purpose of gaining any personal end or gratification of the ego, but the purpose was to.....bhagwati j. - the principal question which arises for determination in this reference is whether a certain expenditure incurred by the assessee can be said to be expenditure incurred solely for the purpose of making or earning fees directors so as to be a permissible deduction within section 12(2) of the income-tax act, 1922. lord macmillan pointed out in tata hydro-electric agencies ltd. v. commissioner of income-tax :'.... the decided cases show how difficult it is to discriminate between expenditure which is and expenditure which is not, incurred solely for the purpose of earning profits or gains.'and this reference is no exception. the facts giving rise to the reference are a little important and in order to arrive at a proper determination of the question, it is necessary to state.....
Judgment:

BHAGWATI J. - The principal question which arises for determination in this reference is whether a certain expenditure incurred by the assessee can be said to be expenditure incurred solely for the purpose of making or earning fees directors so as to be a permissible deduction within section 12(2) of the Income-tax Act, 1922. Lord MacMillan pointed out in Tata Hydro-Electric Agencies Ltd. v. Commissioner of Income-tax :

'.... the decided cases show how difficult it is to discriminate between expenditure which is and expenditure which is not, incurred solely for the purpose of earning profits or gains.'

And this reference is no exception. The facts giving rise to the reference are a little important and in order to arrive at a proper determination of the question, it is necessary to state them in some detail.

The reference arises out of two separate assessments made on the assessee for the assessment year 1962-63. The relevant account year of the first assessees, namely, Kasturbhai Lalbhai, is Samvat year 2016, commencing from 1st November, 1959, and ending on 20th October, 1960, that of the second assessee, namely, Gautam Sarabhai, is the financial year 1960-61. The assessees are two prominent industrialist of Ahmedabad and both of them were, during the relevant period of account, directors of the Ahmedabad Electricity Co. Ltd. a public limited company carrying on business of generating and distributing electrical energy in Ahmedabad. Killick Industries Limited was the managing agent of the company at the relevant time. In or about the beginning of 1960, differences arose between the assessees on the one hand and the managing agent and the other directors of the managed company on the other, as a result of alleged mismanagement of the managed company on the part of the managing agent and the majority directors. The genesis of the starting point of the on behalf of the managed company with an English concern called International Combustion Limited. The technical adviser of the central administration department of the managing agent found that the price for which this order was placed with International Combustion Limited was substantially higher than the price at which similar machinery was available from another equally reputable company, namely, Babcock and Wilcox Limited and he reported this fact to the directors of the managed company. As the matter was of sufficient gravity to justify an investigation, the directors asked Messrs. Merz and MacLellan, a leading firm of consulting engineers in England, to make a report in the matter and the report was submitted by Messrs. Merz and MacLellan on 15th July, 1958. The report said that the price for which the order was placed with International Combustion Limited was higher than the price quoted by Babcock and Wilcox Limited by Pounds 1,23,420 that is, approximately Rs. 16,51,360. Fortunately, however, the managed company was saved this excess amount as the import as the import licence for the order placed with International Combustion Limited was not received and the order was, therefore, canceled and a fresh order placed with Babcock and Wilcox Limited at the proper price. All this was evidently the result of the disclosure made by technical adviser. An attempt was, therefore, made by E. D. Sheppard and K. G. Milne, chairman, and managing director respectively of the managing agent, supported by A. N. Haksar, a director, to victimise the technical adviser and they urged that disciplinary action should be taken against him on the ground of in subordination and he should be dismissed from service. This proposal was opposed by Sir Chunilal V. Mehta. Sir Pushottamdas Thakurdas and Shri Jaisinh Vithaldas who were three of the then directors of managing agent and due to their opposition the proposal could not be carried through. But soon thereafter, these three directors resigned, Sir Chunilal V. Mehta in July, 1959, and Sir Purshottamdas Thakurdas and Shri Jaisinh Vithaldas in September, 1959. Various other changes were also brought about in the opinion of the assessees, were detrimental to the interests of the managed company. It is not necessary for the purpose of the reference to refer to these changes. One Clark, who was the chairman of the managed company, was removed from the chairmanship in March, 1960 and about that time the technical adviser and two other competent officers of the managing agent with long records of faithful service were deprived of responsible work. On 24th March, 1960 a meeting of the board of directors of the managed company was held and at this meeting of the board of directors of the managed company was held and two other competent officers of the managing agent with long records of faithful service were deprived of the responsible work. On 24th March, 1960, a meeting of the board of directors of the managed company was held and at this meeting A. N. Haksar read out a letter from the managing agent stating that Clark had been replaced as ex-officio chairman by A. N. Haksar under the articles of association of the managed company. The other items on the agenda included the appointment of new directors and the reappointment of Killick Industries Limited as managing agent, but since the first assessee had gone abroad and was not present, the second assessee requested A. N. Haksar and the other directors not to take a decision in regard to these matters during the absence of the first assessee. No decision was accordingly taken in regard to these matters at this matting of the board of directors, but within a few days thereafter, though the first assessee was still abroad and the second assessee was not in a position to attends, two meetings of the board of directors, one on 30th March, 1960, and the other on 4th April, 1960, were called by A. N. Haksar at vary short notice and at these meetings important decisions were taken regarding the appointment of new directs, reappointment of Killick Industries Limited as managing agent, and appointment of Nixon Forest and Company Limited as agent of the managed company in U. K. Earlier, a decision had already been taken by the board of directors to obtain a report on the advantages of the appointment of the agent in U. K. as also information about the constitution of Nixon forest and company Limited and the interest in that company of the persons previously connected with Killick Industries Limited and the managed company; but despite this decision, without waiting for such report or information, Nixon forest and company Limited was appointed agents of the managed company; but despite this decision, without waiting for such report or information, Nixon Forest and Company Limited was appointed against of the managed company in U. K. The next meeting of the board of directors was held on 28th April, 1960, and at that meeting the assessee recorded their protest against the holding of the meetings dated 30th March, 1960, and 4th April, 1960, at such short notice as also against the appointment of A. N. Haksar as chairman of the managed company in place of Clark, the appointment of new directors without the consent and approval of all the directors and the appointment of Nixon Forest and Company Limited as agent of the managed company in U. K. This protest made by the assessees was, however, not recorded in the minutes of the meeting held on 28th April, 1960, and the assessee, therefore, drew the attention of the chairman to this omission in the minutes of the meeting of the board of directors held on 26th May, 1960, and moved a resolution disapproving the conduct of the managing agent and in particular of the chairman, A. N. Haksar, in regard to the proper maintenance of the minutes of the board of directors held on 28th April, 1960. This resolution was, however, ruled out of order by A. N Haksar and the protest of the assessees remained unrecorded. The assessees were outnumbered on the board of directors and in these circumstances they felt that it was their duty as directors to bring these facts to the notice of the shareholders and they, accordingly, issued a circular dated 11th July, 1960, pointing out these facts to the shareholders. Three paragraphs of this circular have been relied upon by the Tribunal and they and they run as follows.

'We, the undersigned directors of your company regret that differences have arisen between the directors and also between some directors and Killick Industries Limited, the managing agents of the company, on matters of vital importance to the satisfactory conduct; as it is, we consider it our duty to place the following facts and views before the shareholders believing it to be in the discharge of our responsibility to the shareholders. The safeguarding of the interest of the shareholders in our principal obligation as members of the board.

What happens within Killick Industries Limited would be of no concern to us if they were not the managing agents of this company and their ability to discharge their duties as managing agents in the day to day conduct of our business remained unaffected... we are convinced that the managing agents, so constituted, are not in a position to discharge their duties satisfactorily in the best interests of this company.

We have no substantial interest in either the Ahmedabad Electricity Company Ltd. or the managing agency company (our shareholding including that of our families, is about 1,158 and 83 shares in the Ahmedabad Electicity Co Ltd. and nil and 386 shares respectively in Killick Industries Ltd.) and we are not interested in acquiring the managing agency of the Ahmedabad Electricity Co. Ltd. or seeking a position of profit. We have been elected directors of the company and we feel unable to assume the responsibility we owe to the shareholders as long as as Mr. Haksar continues as chairman of the company and without the board of directors being properly reconstituted, since we are outnumbered in the present board. The only course open to us therefore, is to place the matter before the shareholders.'

It appears that thereafter a circular dated 12th August, 1960 was issued by A. H. Haksar in reply to the circular dated 11th July, 1960 and certain statements were made in that circular which according to the assessees did not represent the correct facts. The assessees, therefore, issued another circular dated 5th September, 1960, pointing out the incorrect statements made in the circular of A. N. Haksar. In the meantime, it appears a notice requisitioning a general meeting of the shareholders of the managed company was filed and resolutions were proposed to be moved for removal of newly appointed directors, appointing Nixon Forest and Company Limited as agents of the managed company in U. K. The assessees thereupon started collecting proxies and collected proxies from about 3,25,000 shareholders. Before, however, the general meeting of the shareholders was held, the disputes in regard to the management of the managed company were settled as a result of the intervention of Shri Morarji Desai and the resolution sought to be moved at the general meeting were withdrawn. The general meeting was thereafter filed on 29th November, 1960, and at this meeting the board of directors of the managed company was reconstituted as suggested by the assessees. The first assessee had already attained the age of 65 years on 19th December, 1959, but he was again elected as a director after complying with the provisions of section 281 of the Companies Act, 1956, and on 26th April, 1961, he was elected Chairman of the board of directors. Now, in issuing the circulars dated 11th July 1960 and 5th September 1960 and collecting proxies from the shareholders, the assessees jointly spent an aggregate sum of Rs. 33,299 and each of the assessees claimed 1/2 of this amount as a deduction in his assessment for the assessment year 1961-62. The claim for deduction was founded both under section 12(2) and section 10(2) (xv). The Income-tax Officer disallowed the claim and on appeal the view taken by the Income-tax officer was confirmed by the Appellate Assistant Commissioner. Each of the two assessees thereupon preferred an appeal to the Tribunal and the two appeals were heard together by the Tribunal. The Tribunal rejected the claim of the assessees in so far as it was based on section 10(2) (xv) but upheld the claim based on section 12(2) and allowed the expenditure as a permissible deduction under section 12(2). This view taken by the Tribunal is challenged by the Commissioner in the present reference.

The first question that arises for consideration is whether the claim for deduction made by the assessees is sustainable under section 12(2). The answer to the question depends not so much on the construction as on the application of section 12(2). The construction of section 12(2) is now no longer a matter of doubt or controversy and must be regarded as settled by judicial decisions which are binding on this court. Section 12(2) provides that income, profits and gains from other sources shall be computed after making allowance for any expenditure (not being in the nature of capital expenditure) incurred solely for the purpose of making or earning such income, profits or gains. There is a proviso which adds that no allowance shall, however, be made on account of any personal expenses of the assessee. Keeping the proviso apart for the time being, let us see what the substantive part of the section 12(2) enacts. The deduction that is permissible under section 12(2) is an expenditure incurred solely for the purpose of making or earning the income which is subjected to tax. Therefore, in order to decoded whether are expenditure is a permissible deduction under section 12(2), we have to examine the nature of the expenditure. The purpose for which the expenditure is incurred must be in order to earn the income and here we must not confuse purpose with motive. What section 12(2) emphasizes is the purpose for which the expenditure is crude and the word 'purpose' does not mean motive for the transaction. The motive which may have operated on the minds of the assessees in making the expenditure is quite irrelevant : Bai Bhuriben Lallubhai v. Commissioner of Income-tax and Ormerods (India) Private Ltd. v. Commissioner of Income-tax. Moreover, the purpose of making or earning the income must be the sole purpose for which the expenditure is incurred. If the expenditure is incurred for the purpose of making or earning the income as also for another purpose or, in other words, the purpose, in the making or earning the income it mixed up with another purpose in the making of the expenditure, as was the case in Commissioner of Income-tax v. Sir Homi H. Metha and Commissioner of income-tax v. Jagmohandas J, Kapadia the expenditure would be outside the scope and ambit of section 12(2) and would not be a permissible deduction under that section. The expenditure in order to fall within section 12(2) must, therefore, be incurred solely for the purpose of making or earning the income sought to be assessed. But how is this to be determined What test is to applied The answer to this question is provided by the decision of the Supreme Court in Eastern Investments Ltd. v. Commissioner of Income-tax. Bose J. delivering the judgment of the Supreme Court in this case, stated the propositions relevant to the determination of this question in the following terms :

'(a) though the question must be decided on the facts of each case the final conclusion is one of law : Indian Radio and Cable Commissioner Ltd. v. Commissioner of Income-tax and Tata Hydro-Electric Agencies Ltd. v. Commissioner of Income-tax;

(b) it is necessary to show that the expenditure was a profitable one or that in fact any profit was earned : Moore v. Stewarts and Lloyds and Ushers case;

(c) it is enough to show that the money was expended not of necessity and with a view to a direct and immediate benefit to the trade, but voluntarily and on the ground of commercial expediency, and in order indirectly to facilitate the carrying on of the business : British Insulated and Helsby Cables Ltd. v. Atherton;

(d) beyond that no hard and fast rule can be laid down to explain what is meant by the word solely.'

The second proposition shows that the expenditure need not be a profitable or fruitful one; it is not necessary to show that in fact it produced any income. Moreover, as the third proposition shows, the expenditure need not be incumbent or obligatory nor is it necessary that it should directly and immediately result in the earning of the income, or in other words, the earning of the income need not be the direct consequence of the expenditure. It is sufficient expenditure is incurred voluntarily on the ground of commercial expendiency 'in order indirectly to facilitate the carrying on of the business'.

Now, the words 'in order indirectly to facilitate the carrying on the business' are obviously inopposite in a case falling with in section 12(2) for there can be no question of creating on of business in such a case. What then do those words mean in their application to section 12(2) On this point there was a controversy between the parties. The assessees contended that this expression has obviously reference to the activity which is the that this expression has obviously reference to the activity which is the source of the income and what is, therefore, required by section 12(2) is that expenditure must be incurred in order indirectly to facilitate the carrying of the activity producing the income and, if there is some connection or nexus between the expenditure incurred and the activity which is the source of income, it is sufficient to bring the expenditure within the scope and coverage of section 12(2), The assessees pointed out that their Lordships of the Supreme Court were conscious that they were dealing with a case under section 12(2) and yet they used the expression 'in order indirectly to facilitate the carrying on of the business' and, since there is admittedly no concept of business in section 12(2), the reference must necessarily be to the carrying on of the activity producing the income and the expenditure must he incurred in order indirectly to facilitate the carrying on of such activity. This argument was sought to be reinforced by reference to certain passages in the judgment of the Supreme Court where there are reference such as :

'The test for present purpose is.... whetheer it was properly entered into as a part of the appellants legitimate commercial undertakings in order indirectly to facilitate the carrying on of its business.... it is clear that this transaction was voluntary entered into in order indirectly to facilitate the carrying on of the business of the company.....'

'Now, if the judgment of the Supreme Court is read literally without reference to the terms of section 12(2), it does seem to support the argument is correct. What section 12(2) says in so many terms is that the expenditure must be incurred for the purpose of earning the income, and therefore, there must be some connection or nexus between the expenditure in order to be 12(2) must be incurred directly or indirectly to facilitate the earning of the some income, for them only we can say that we can say that expenditure is incurred for the purpose of earning the income. It must be remembered that the third proposition quoted by the Supreme Court was taken from the decision in British Insulated and Helsby Cables Ltd. v. Altherton, and that was a case relating to income from business and that is why the words used were 'in order indirectly to facilitate the carrying on of the business'. But when the Supreme Court applied that proposition in the construction of section 12(2), it must be read in the context of that section and so it is clear that the words 'in order indirectly to facilitate the carrying on of the business' in their application to section 12(2) must mean 'in order indirectly to facilitate the earning of the income', vide also the difference in language between section 10(2) (xv) and section 12(2). What the third proposition, therefore, provides is that the expenditure need not be obligatory nor incurred with a view directly and immediately to result in the earning of the income but it would be sufficient if the expenditure is incurred voluntarily on the ground of commercial expediency in order indirectly to facilitate the earning of the income. There must be a connection, direct or indirect, between the expenditure incurred and the income earned (Bai Bhuriben Lallubhai v. Commissioner of Income-tax) and, in judging whether in respect of particular expenditure there is such connection, we should not be guided by abstract or academic consideration but should take into consideration questions of commercial expediency and principles of ordinary commercial trading. The matter must be viewed in the light of the principles of commercial trading and commercial expediency. If the expenditure is incurred on consideration of commercial expediency in order directly or indirectly to facilitate the earning of the income, it would be expenditure incurred for the purpose of earning income within the meaning of section 12(2). This is the test which must be applied for the purpose of determining whether the expenditure in the present case is allowable under section 12(2) and that calls for an examination of the facts found by the Tribunal.

Turning to the facts we find that two contentions were advanced on behalf of the assessees before the Tribunal and they are set out in paragraph 8 of the order of the Tribunal. The first contention was that there was mismanagement of the managed company and in the circumstances no honest director could keep quiet and all he could do was to approach the shareholders and that is exactly what the assessees did. The purpose of the expenditure was, it was argued on behalf of the assessees, to bring the mismanagement to the notice of the shareholders and not satisfaction of any personal end or gratification of personal go as contended by the revenue. It was also contended, and that was the contention that the directorships of the assessees were in jeopardy and they ran the risk of being turned out of the board of directors, notwithstanding their position in industry and the expenditure was, therefore, incurred for protecting their directorships. On these contentions it was urged on behalf of the assessees that the expenditure was incurred solely for the purpose of making or earning the income by way of directors fees and was therefore allowable under section 12(2). After setting out these contentions in paragraph 8, the Tribunal proceeded to give its conclusion in paragraph 9 as under :

'We are inclined in this case to accept the contention for the assessees. There is prima facie evidence of mismanagement and of acts prejudicial to the interests of the Ahmedabad company. We are satisfied about the good faith of the assessees in this case. It is impossible to take the view that if a director does not like the conditions in which he is called upon to work, he can resign, and that he cannot undertake any expenditure which will secure more satisfactory conditions of work. It is difficult to say, for purposes of section 12(2), that a person has earned his income, if he does nothing but attend meetings of the board. One cannot take a negative view of things. The decision under section 12(2) will depend upon the facts of each case, and it will not be that every expenditure is allowable under section 12(2). The assessees have very small shareholdings, and though some power will naturally come to them by reason of the directorship, it is impossible to ignore the responsibilities, and it cannot he held in this case that the expenditure was incurred to gain a personal end or to gratify the ego. We, therefore, uphold the claim of the assessees under section 12(2)'.

It is clear from this passage that the Tribunal accepted the first contention of the assessees and held that the expenditure was not incurred by the assessees for the purpose of gaining any personal end or gratification of the ego, but the purpose was to point out the mismanagement of the managed company to the shareholders with a view to bringing such mismanagement to an end and the Tribunal was satisfied as regards the good faith of the assessees in this respect. So far as the second contention of the assessees was concerned, namely, that their directorships were in jeopardy, the Tribunal did not give any finding in regard to that contention. It was one of the contentions of the assessees before us that though no specific finding was given by the Tribunal on the question whether the directorships of the assessees were in jeopardy, there was such finding implicit in the first sentence with which paragraph 9 opened, namely, 'we are inclined in this case to accept the contentions for the assessees'. We are unable to read this sentence in the manner contended for on behalf of the assessees. It is no doubt true that the Tribunal commenced paragraph 9 by saying that they were inclined to accept the contention of the assessees but then they proceeded to point out which contentions they were accepting and paragraph 9 shows that the only contention of the assessees which was accepted by the Tribunal was the first contention. We cannot, therefore, accept the argument of the assessees that there was a finding of the Tribunal that the directorships of the assessees were in jeopardy. The assessees obviously wanted to take advantage of the decision of the Bombay High Court in Commissioner of Income-tax v. Sir Purshottamdas Thakurdas, where expenditure incurred by Sir Purshottamdas Thakurdas in successfully defending a suit brought for a declaration that his election as a member of the Local Board of the Reserve Bank of India was invalid was held to be an allowable deduction under section 12(2). But there being no finding of the Tribunal that the directorships of the assessees were in jeopardy, this decision cannot avail the assessees. The only question which, therefore, falls for consideration is whether, on the finding of the Tribunal that the expenditure was incurred by the assessees, not for the purpose of gaining any personal end or gratification of the ego but for the purpose of bringing the mismanagement of the company to the notice of the shareholders with a view to bringing such mismanagement to an end, it can be said that the expenditure was incurred solely for the purpose of making or earning the income within the meaning of section 12(2).

Now, the income which was sought to be assessed was income by way of fees as directors of the managed company and, therefore, applying the test above formulated, the question which we must ask ourselves is whether the expenditure was incurred of necessity or voluntarily on the ground of commercial expendiency in order directly or indirectly to facilitate the earning of the directors fees. The assessees contended that in issuing the circulars dated 11th July, 1960, and 5th September, 1960, and collecting proxies from the shareholders, they acted in performance of their duty or obligation as directors and the expenditure was, therefore, incurred of necessity in order indirectly to facilitate the earning of the directors fees. Now, it is indisputable and indeed no attempt to dispute it was made on behalf of the revenue that if any expenditure is incurred by a director in performance of the duties and obligations attaching to his office, the expenditure would be one incurred in order to facilitate the earning of the directors fees. There is clear and indubitable connection between the performance of the duties and obligations and the earning of the directors fees : the latter cannot be dissociated from the former. But the question is : whether in the circumstance of the case the assessees were under any duty or obligation as directions to act in the manner they did. The argument of the assessees was that a director has a fiduciary duty to the company to see that the company is properly managed and if there is any mismanagement he is bound to take all reasonable steps to bring it to an end : his duty does not end by merely recording a protest at the meeting of the board of directors, if he cannot set right the mismanagement by persuading his colleagues on the board of directors, he must bring the mismanagement to the notice of the shareholders and, if necessary, organise the voting strenght of the shareholders by collecting proxies with a view to putting an end to the mismanagement. This argument was sought to be supported by reference to a decision of the English Court of Chancery in Joint Stock Discount Co. v. Brown. But we do not think the argument can be sustained. It is undoubtedly true and the assessees are right to this extent that a director has a fiduciary duty to the company and is bound to act in the best interests of the company and to use fair and reasonable diligence in the management of the companys affairs but we do not think he is under any duty to take any positive steps for the purpose of bringing to an end mismanagement of the company. If a director finds that any action is being taken by the board of directors which is illegal, fraudulent, ultra vires or contrary to the interests of the company, he can dissociate himself from such action by voting against it and in a given case he would also be justified in approaching the shareholders, but there is no duty on him to take action with a view to preventing general mismanagement of the company. Considerable reliance was placed on the decision in Joint Stock Discount Company v. Brown but if this decision is carefully scrutinized, it does not go as far as the assessees would have it. In order to understand the true import of this decision, it is necessary to notice the facts on which the decision was given. One Brown was a director of a joint stock company and at a meeting of the board of of directors of the company held on 19th June, 1865, at which Brown was present, it was resolved that an application should be made for 10,000 shares in a new company called Barnads Banking Company limited. The minutes of this resolution were confirmed at another meeting of the board of directors and at this subsequent meeting also, Brown was present. Brown, thereafter went of London and during his absence, the first cheque in part payment of 30,000 being the purchase price of 3,000 shares was drawn and paid by the company. Upon his return on 7th July 1865 he wrote two letters one to his co-director and another to his solicitor director, protesting against the purchase of the shares. No protest was entered in the minutes, but at a subsequent board meeting his letter to the directors was read. He attended several subsequent meeting, and took no further steps. Now the purchase of the shares was admittedly ultra vires the powers of the company and the directors were, therefore, sought to be held liable, for the amount improperly applied in the purchase of the shares. Brown, who was also sought to held liable, contended that he should not be saddled with liability because he had protested against the purchase of the shares and having done so, there was nothing more he could do with a view to protecting the interests of the company. This defence was negative by Vice-Chancellor James and after setting out the action taken by Brown in regard to the purchase of the shares, the learned Vice-Chancellor observed.

'Then it is said, What was he to do Was he to have filed a bill to prevent the directors carrying out what they thought was authorized by the first resolution All I can say is this, if he could have done it in no other way, it was his duty as a director, knowing what was going on, not to have remained quiescent, or acquiescent, which is much the same thing, in what his brother directors were doing; but to have filed a bill, supposing that a bill was necessary. But can any body suppose that a bill would have been necessary If he had simply called the directors together, put on the minutes of the company the letters that he wrote to Mr. Nixon and the directors and insisted on taking the vote of the directors upon those letters, I am satisfied the matter would never have gone beyond that. But if that had not been done, if he had found that his brother directors insisted on misappropriating the money of the company, and bringing them under what might have been a very onerous engagement as to these shares in spite of his protest, he might have sent a general circular to every one of the shareholders to tell them what the directors were doing; or in the last resort, he might have come to the Court of Chancery and stopped the thing in a moment.

These observations were strongly relied upon on behalf of the assessees is support of their contention that if a director finds that there is mismanagement of the company and he is not in a position to put an end to it by persuading his 'brother directors', he is bound to send a general circular to the shareholders to tell them what the directors are doing and in the last resort he may even approach the court for the purpose of putting an end to the mismanagement, Now, it must be remembered that these observations were made in the context of a specific transaction which was being entered into by the directors and which was ultra vires the company and which was inititially approved by Brown by voting in favour of it. Though Brown originally voted in favour of the transaction yet, when it dawned upon him that the transaction was ultra vires the company and the moneys of the company were being wrongly misappropriated, he did nothing except addressing a letter of protest to the directors. The learned Vice-Chancellor held in these circumstances that mere protest did not disprove acquiescence on his part. It was his duty as a director, knowing what was going on, not to have remained 'quiescent, or acquiescent', but should have sent a general circular to every one of the shareholders to tell them what the directors were doing; or in the last resort, he might have approached the Court of Chancery and 'stopped the thing in a moment'. He was, therefore, held liable as having participated in the breach by acquiescence. Vide the observations of Gower in his well known book on Company Law at page. 501. We cannot read the above quoted observations from the judgment of the learned Vice-Chancellor as meaning that whenever there is mismanagement of the company, a director, in order to protect himself, must bring the mismanagement to the notice of the shareholders by issuing a circular to them and if he fails to do so, he renders himself liable to be charged of misfeasance. This decision does not, therefore, advance the contention of the assessees and it is not possible to say that in the circumstances of the instant case there was any duty or obligation on the assessees-directors to issue the circulars dated 11th July, 1960, and 5th September, 1960 and to collect proxies from the shareholders and the expenditure incurred by the assessees cannot be said to be incurred as of necessity in order indirectly to facilitate the earning of the directors fees.

But the question then arises whether the expenditure was incurred voluntarily on the ground of commercial expendiency in order to indirectly facilitate the earning of the directors fees and here we think the assets are on firmer ground in so far as the expenditure incurred on the issue of the circulars dated 11th July, 1960, and 5th September, 1960, is concerned. The position in which the directors found themselves at the date when they issued the first circular dated 11th July, 1960, was as follows : Killick Industries Limited, who were the managing agents, had some time before entered into a transaction for the purchase of machinery on behalf of the managed company which was highly detrimental to the interests of the managed company and it was only due to the fatuities circumstance of non-receipt of the import licence that the managed company had been saved a large amount of about Rs. 16,51,360. The chairman and the managing director of Killick Industries Limited supported by A. N. Haksar had tried to victimise the technical adviser, who had tried to protect the interests of the managed company by disclosing to the directors and the managed company that the price at which the order for machinery was placed by Killick Industries Limited was substantially higher than the price at which similar machinery was available from another equally reputable company. Thereafter Clerk was replaced as chairman of the managed company by A. N. Haksar and the technical adviser and two other competent officers of Killick Industries Limited with long records of faithful service were deprived of responsible work. Meetings of the board of directors dated 31st March, 1960 and 4th April, 1960, were convinced by A. N. Haksar at extremely short notice taking advantage of the absence of the assessees and at these meetings new directors were appointed, the new managing agency agreement with Killick Industries limited was approved and Nixon Forest and Company Limited were appointed, agents of the managed company in U. K. This last decision was taken despite an earlier decision of the board of directors not to take any action until after obtaining a report on the advisability of appointing an agent in U. K. and information regarding the constitution of Nixon Forest and Company Limited and the interest in that company of persons who were concerned with Killick Industries Limited or the managed company. Moreover according to information of the assessees, E. D. Sheppard and K. G. Milne were interested in Nixon Forest and Company Limited. The assessees protested against this action on the part of the other directors at the meeting of the board of directors held on 28th April, 1960, but the protest was not even recorded. The assessees were manifestly outnumbered on the board of directors and it was not possible for them to set right the aforesaid state of affairs at the meeting of the board of directors. The assessees as prudent commercial men had, therefore, no choice but to point out these facts to the shareholders. It must be remembered that a company has two primary organs through which it acts, namely the board of directs and the shareholders. The assessees as directors found that it was not possible to secure proper management of the affairs of the company by approaching the board of directors and they, therefore, approached the primary organ of the company, namely the shareholders Judged by considerations of commercial expediency, we do not think that the action of the assessees in issuing the circulars dated 11th July 1960 and 5th September, 1960 was unconnected with the earning of the directors fees. The assessees honestly and reasonably conceived it to be their duty as directors to bring the aforesaid facts to the notice of the shareholders when they found that they were outnumbered on the board of directors and it was not possible to mend the matters by approaching the other directors and this cannot be said to be so unrelated to the carrying on of their activity as directors that we would regard it as unconnected with the earning of the directors fees. The assessees incurred the expenditure in issuing the circulars voluntarily on the ground of commercial expendiency in order to indirectly facilitate the earning of directors fees and the expenditures must, therefore, be held to be an expenditure incurred solely for the purpose of earning the directors fees.

The position is, however, different when we come to the expenditure incurred by the assessees in collecting proxies from the shareholders. The action of the assessees in collecting proxies from the shareholders for the purpose of setting right the mismanagement of the company was certainly a very commendable one but we do not think it was connected even indirectly with the earning of the directors fees. Even stretching the principles of commercial expediency to the farthest extent, the action of organizing the voting strength of the shareholders by collecting proxies for the purpose of setting right the mismanagement of the company cannot be regarded as a function legitimately appertaining to the office of director. A director may certainly, as prudent commercial man bring mismanagement to the notice of the shareholders so that the shareholders can take appropriate action for the purpose of bringing it to an end, but no considerations of commercial expediency can justify him in his capacity as a director and here we are concerned only with his capacity as a director and here we are concerned only with his capacity as a director - to channelize and organize the voting strength of the shareholders by collecting proxies for the purpose of putting and end to mismanagement. It is undoubtedly difficult to draw a line between cases where certain action taken by a director may be, but it is not necessary for us to draw the line, for we have no doubt that, wherever the line may be drawn the action of the assessees in collecting proves from the shareholders must fall on the wrong side of the line. We are, therefore, of the view that the expenditure incurred by the assessees in collecting proxies from the shareholders cannot be regarded as expenditure incurred for the purpose of earning directors fees.

We, accordingly, reach the conclusion that the expenditure incurred by the assessees in issuing the circulars dated 11th July, 1960 and 5th September, 1960 is allowable as a deduction under that section. 12(2) while the rest of the expenditure is not allowable under that section. The assesses have also based their claim for deduction on section 10(2) (xv) and the contention based on section 10(2) (xv) was pressed before us on behalf of the assessees. We are not at all sure whether section 10(2) (xv) can have any application in the present case but it is not necessary to decide that question since we are of the view that even if section 10(2) (xv) were applicable the expenditure which we have disallowed under section 12(2) would, for the same reasons, be not allowable under section 10(2) (xv) as well, as there is not even an indirect connection between such expenditure and the carrying on of the activity of a director. Our answer to the question referred to us, therefore, is that the expenditure incurred by the assessees in issuing the circulars dated 11th July, 1960, and 5th September, 1960 was an allowable deduction under section 12(2) while the rest of the expenditure was not an allowable deduction either under section 10(2) (xv) or section 12(2). Since the Commissioner has partly succeeded and partly failed, the proper order for costs would be that each party should bear and pay its own costs.


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