1. Two questions were referred under Section 66 (2) of the Income-tax Act in R. O. No. 97 of 1953 and four more under Section 66 (1) In R. C. No. 93 of 1955. These questions arose out of proceedings-to assess the Madura Knitting Co., to income-tax and excess profits tax during the assessment, years 1945-46, 1946-47, 1947-48 and 1948-49.
Whether it was liable to income-tax or to excess profits tax, the factors for consideration were virtually the same with reference to each of two of the three items in dispute: (i) com-missions paid by the assessee company to Krishnaram, Kamadhenu and Co., and Sekhar and Co.; (ii) commissions paid to seven employees who held managerial posts. The third item' in dispute was as regards the profits earned by the partnership concern known as Ambal Stores.
The questions as framed and referred to this Court mixed up to some extent the three different heads of disputed liabilities, and we would prefer to discuss first the questions at issue between the assessee company and the department, independent of the frame of the question.
2. The Madura Knitting Co., consisted of seven partners, drawn from three family groups and each group had a third share. The N. M. R. family group consisted of three brothers, Venkatakrishna Iyer, Subbaraman and Krishnamurthi. They were divided inter se and each had a ninth share. The V. S. M. family group consisted of Gopalakrishna Iyer, Rajarama Iyer and Mohan-ram. They were also divided inter se, and each of them had a ninth share.
The sole member of the other family unit was M. K. Ramaswami Iyer, who had a third share. Venkatakrishna Iyer, Subbaraman, Krishnamurthi and Ramaswami Iyer has each married 8 sister of the V. S. M. brothers.
3. The three N. M. R. brothers had other. business activities besides those of the Madura Knitting Co. They were partners of the Colours Trading Co., a concern wholly independent of the Madura Knitting Co. These three along with others were also partenrs of the Royal Talkie Distributors, a concern independent of the Madura Knitting Co., and Colours Trading Co. N. M. R. Venkatakrishna Iyer was a partner in each or these three concerns, but what we should remember, and what the departmental authorities and the tribunal apparently endeavoured to forged was, that he was only one of the partners.
4. Pour of the married daughters of N. M. R, Venkatakrishna Iyer constituted a partnership, which traded under the name of Ambal Stores. It is enough at this stage to record two other features of this partnership. It bought goods Of the Madura Knitting Co., sold them and derived fairly large profits. In the rest of this judgment we can refer to the Ambal Stores as 'the partnership.' The partnership banked its monies with Colours Trading Co., which paid interest at six per cent, per annum on the amounts to the credit of the partnership.
5. It is against this background that we have to consider the questions at issue and the evidence bearing thereon.
6. We shall first deal with the question of the profits earned by the partnership, Ambal Stores. The Tribunal upheld the decision of the Departmental authorities, that the profits made out of the trading activities of the Ambal Stores, Rs. 18,030 and Rs. 1.07,199 should be assessed as the profits of the assessee company, Madura Knitting Co., for the assessment years 1947-48 and 1948-49 respectively. It is the correctness of that decision that question No. 3 in R. C. No. 93 of 1955 raises for adjudication.
7. The partnership firm of Ambal Stores consisted of four ladies C. R. B. Jayammal, S. S. E. Kamala, M. P. V. R. Padmasani and P. A. B. K. A. Nirmala. The fourth, Nirmala, was a minor and she was admitted to the benefits of the partnership. They were all married, and their husbands were men of affluence. The deed of partnership was dated 27th January 1947. The partnership was registered by the Income-tax authorities themselves under Section 26A of the Income-tax Act, and the profits of the partnership were also assessed to income-tax in the relevant assessment years.
It was only a nominal capital of Rs. 2400 that was contributed by the three adult partners. But then the business was such that no. larger capital was needed. The Madura Knitting Co., sold a portion of its products to Ambal Stores, and that firm in. its turn sold the goods for export outside India to persons who held quota permits. The constituents of the partnership were comparatively few in number, not more than nine as is apparent from an affidavit dated 10th March 1952.
Of these U. P. Agencies, Benaras, was one. These nine constituents were not old customers of the Madura Knitting Co. The Madura Knitting Co., 'charged the Ambal Stores for the goods sold to that firm the same prices it charged the other wholesale buyers, and no special concession was shown to have been extended to the partnership by the Madura Knitting Co., itself.
It was, however, not disputed that the partners of Ambal Stores had not engaged themselves in any trading activity prior to January 1947. The partnership claimed to have carried on its business at 120 South Masi Street, Madura. That house belonged to the father of the Partners, N.M.R. Venkatakrishna Iyer, and they did not pay any rent. The partnership had no godown, but then it needed none, as the goods it obtained of the Madura Knitting Co., were cleared almost Immediately after, by the constituents of the partnership, to whom It sold the goods.
Balusami Iyer, an employee of the Colours Trading Co., attended to the clerical work of the Ambal Stores. All funds of the partnership --and the profits it earned were the main items of those funds -- were deposited with the Colours Trading Co., which paid interest at six 'per cent, per annum on those deposits. The profits of the partnership were apportioned between the partners, and these were duly recorded in their books.
Barring the amounts drawn for payment of income-tax, there were very few occasions when any of the partners of Ambal Stores drew monies for their own needs. Even these were subsequent to the assessment years in question. On such occasions the required money was drawn by the partnership from the Colours Trading Co., and the partners accounts in the books of Ambal Stores were duly debited, with those withdrawals.
There was, however, nothing in the evidence on record to show that the amounts to the credit of the partnership, Ambal Stores, with the Colours Trading Co., were drawn upon by anyone else, either Venkatakrishna Iyer, or the Colours Trading Co., or the Madura Knitting Co.
8. The finding of the Income-tax Officer in his assessment order for 1947-48 with reference to the assessee, the Madura Knitting Co., was:
'Taking all these facts into consideration, the only, conclusion that one can draw is that the Ambal Stores is only a bogus creation and that it is really a branch of the Madura Knitting Co.'
9. At least there was something definite and precise about this finding which could not really be claimed of the findings, either of the Appellate Assistant Commissioner or of the Appellate Tribunal. The Appellate Assistant Commissioner recorded:
'I agree with the Income-tax Officer that the Ambal Stores is really a leak device introduced between the Madura Knitting Co., and the exporters abroad for taking out the surplus profits arising on sales for exports.'
10. The Tribunal recorded; 'The facts relating to Ambal Stores are given in extenso in the Income-tax Officer's order and the Appellate Assistant Commissioner's order and it is not necessary for us to reproduce them here. We are firmly convinced that this is a simulate arrangement to divert the profit and we would accordingly set out face against treating this as a genuine one.'
11. Before we deal with the question, whether there was any evidence on record to sustain the finding of the tribunal, we have to point out that it was apparently never the case of the department, that the transactions were conducted by the partnership, Ambal Stores, for the benefit of the assessee, the Madura Knitting Co. Benami would imply that the partnership was a real concern, as real as the assessee company; only the assessee Company alone was entitled to the profits earned.
A plea of benami would really raise the problem, who was the beneficial owner. Was it Venkatakrishna Iyer, the father of the four partners of Ambal Stores, who gave them the business premises free of rent; or was the beneficial owner the Colours Trading Co., which had the use of all the monies of the partnership, though with a liability to pay interest and which lent the services of one of its employees Balusami Iyer to the partnership? Or was the beneficial owner the Madura Knitting Co., which treated the partnership of Ambal Stores Just like any of its other constituents? If then Venkatakrishna Iyer or the Colours Trading Co., was the beneficial owner of the trade to which the Ambal Stores merely lent Its name, that would certainly be enough to negative any possible claim of the Madura Knitting Co., that the profits earned by Ambal Stores really belonged to the Madura Knitting Co.
That Venkatakrishna Iyer was a common factor in relation to himself, the Colours Trading Co., and the Madura Knitting Co., would certainly not be enough to prove that whatever Venkatakrishna Iyer or the Colours Trading Co., got, really belonged to the Madura Knitting Co.
12. Quite apart from the factor, that had it been a plea of benami, the burden would have lain upon the department to prove that what was apparent was not real, there was no evidence to sustain any finding, that the partnership, Ambal Stores, conducted its operations, and accumulated its profits benami for the benefit of any one else. But then, as we pointed out earlier, that was not the specific plea that either the departmental authorities or the tribunal ever investigated.
13. The position would have been the same, if the tribunal confused the issue and was really of the view that it was a case of benami when it recorded that the Ambal Stores was a sham or bogus concern. The tribunal, it should be remembered, called it a 'simulate arrangement'. One thing, however, seems to us to be clear. 'The tribunal failed to keep a correct perspective, to keep apart from one another the identity of the Madura Knitting Co., the Colours Trading Co., Venkatakrishna Iyer and the Ambal Stores.
14. If the question at Issue is narrowed down to the reality of the partnership, Ambal Stores, we are clearly of the opinion that the evidence is all one way to prove that the partnership was a real entity. There was really no evidence at all to prove that it was a sham concern.
15. In dealing with the contention of the assessee 'the firm (Ambal Stores) was registered under the Indian Income-tax Act, and that it would not be correct on the part of the departmental officers, to breathe hot and cold about the genuineness of the firm,' the tribunal observed:
'the departmental representative mentioned that the assessment made on Ambal Stores was only a precautionary one so that revenue might not be lost in case Ambal Stores was, held to be a genuine partnership by the higher authorities. The department's case, he strenuously urged, was as strong as ever in spite of it (Ambal Stores) being assessed as a separate registered firm. We are of the view that simply because the department made precautionary assessment that by itself, without any other supporting evidence, would not prove the genuineness of the firm.'
16. We have first to observe, whether the plea was one of benami or of sham, that the burden lay not upon the assessee company but upon the department to prove that what was apparent was not real. The assessee pointed out two facts: (i) that the partnership,. Ambal Stores was treated as a real one by the Income-tax authorities when they accorded registration to that firm under Section 26A of the Act; and (ii) the Income-tax authorities treated the Ambal Stores as a real entity when they taxed its profits.
With reference to the second factor, the tribunal observed that it was a case of precautionary assessment. The first factor they Ignored. It is difficult to envisage a precautionary registration under Section 26A of the Act. Thus, the contention of the assessee was well founded, that for the purpose of taxing the Ambal Stores the departmental authorities accepted the partnership as a real concern; the registration still stood.
When dealing with the Madura Knitting Co., however, the Income-tax authorities elected to treat the registered concern, Ambal Stores, as a bogus concern, a sham concern, a concern which had no existence at all. Of course, it is not for us to balance the evidence for and against the conclusion drawn by the tribunal. But the tribunal overlooked a very relevant factor, that the partnership, Ambal Stores, was recognised as a real concern, when it was registered under Section 26A of the Act, is quite clear.
17. One of the factors on which both the Income-tax Officer and the Appellate Assistant Commissioner relied was, that the premises 120 South Masi Street, Madura, in which the partnership conducted its business, belonged to the-father of the partners, N. M, R. Venkatakrishna Iyer, and that the daughters paid no rent to him.
Once again we have to point out that to confuse the identity of the Madura Knitting Co., with one of its partners, Venkatakrishna Iyer, is not a correct approach. Whatever belonged to Venkatakrishna Iyer certainly could not be claimed to belong to the Madura Knitting Co. In deciding the question at issue, whether the trading operations conducted in the name of Ambal Stores were for the benefit of the Madura Knitting Co., the fact that the business premises of Ambal Stores belonged to Venkatakrishna Iyer one of the seven partners of the Madura Knitting Co., can have no evidentiary value at all.
That no rent was paid to Venkatakrishna Iyer for those premises did not in any way affect the Madura Knitting Co., or enlarge its rights.
18. Similarly, the fact that Baluswami Iyer an employee paid out of the funds of the Colours Trading Co., did the clerical work, of Ambal Stores, without any further payment from the funds of Ambal Stores, can have no evidentiary value to decide whether whatever the Ambal Stores did was on behalf of and for the benefit of the Madura Knitting Co. There was no identity between Madura Knitting Co., and the Colours Trading Co., though three of the partners of the Colours Trading Co., were also partners of the Madura Knitting Co.
(19) The Income-tax Officer pointed out:
'Purchase invoices have been signed by N. M, B. Venkatakrishna Iyer on behalf of the Madura Knitting Co., and all sales bills have.been signed by one R. M. Baluswami Iyer.'
Madura Knitting Co., was the seller, and there was nothing suspicious in Venkatakrishna Iyer signing on behalf of the company as seller. We have already referred to the fact that Baluswami Iyer, who acted on behalf of the Ambal Stores, was certainly not an employee of the Madura Knitting Co.
20. The Income-tax Officer further observed:
'No orders are seen to have been booked straight but only through P. D. Ranga Iyer, who is a commission agent of Madura Knitting Co.'
21. The finding was not that he was an employee of the Madura Knitting Co., or that anything that Ranga Iyer did was to the detriment of the Madura Knitting Co. Surely a commission agent can work for more than one principal; that the same commission agent was employed by more than one concern would not prove that all concerns should be treated as one for the purposes, of income-tax.
22. The departmental authorities and the tribunal commented on the fact, that the partnership, Ambal stores, deposited its funds with the Colours Trading Co. They overlooked the fact, that the. books of the Colours Trading Co., showed that the partnership was credited with interest at six per cent. per annum. It was never the case of any one, that the Colours Trading Co., and the Madura Knitting Co., constituted one business concern.
What benefit the Colours Trading Co., derived by retaining the deposits of Ambal Stores, it certainly did not share with the Madura Knitting Co. There was no evidence at all to prove that any of the moneys accumulated by Ambal Stores found its way to the Madura Knitting Co.; nor was there anything to show that the Madura Knitting Co., could lay a legal claim to the profits made by the Ambal Stores.
23. The real test that the tribunal should have adopted was if the Madura Knitting Co., claimed that all the profits earned by the Ambal Stores really belonged to the Madura Knitting Co., was there any material on record on which any court or tribunal could sustain a claim? We are unable to see any evidence on record which could possibly sustain such a claim. The Tribunal observed:
'During the course of hearing we pointedly put the question to the assessee's representative -- as to why quota holders could hot purchase goods directly from the Knitting Co., instead at going to Ambal Stores whose existence they might or might not be aware of. The representative at once blurted out that the quota holders were new customers and as such the Knitting Co., would not supply goods to them.
If that were so, Ambal Stores also was a new customer and there is no reason why the assessee should favour Ambal Stores to the other quota holders who are regular dealers in that line' of business and from whom the assessee could normally expect longstanding business dealings. This fact is just mentioned to show the hollow-ness of the claim.'
24. Apparently the tribunal overlooked the fact that the Madura Knitting Co., claimed to have employed selling agencies. But independent of that, there was ample evidence, on which the tribunal relied for other purposes, 'to show that the Madura Knitting Co., sold their goods to a number of whole-salers all over India. If the gravamen of the charge was that the Madura Knitting Co., could have itself sold the goods to the exporters direct and made the profits itself, without employing any of the whole-salers, and at any rate without employing Ambal Stores, even that would not help to establish that the profits really accrued to the Madura Knitting Co., or that the Ambal Stores had no legal existence at all.
Once again we have to point out that it was common ground that the Ambal Stores was not treated differentiy by the Madura Knitting Co., nor accorded any privilege which was withheld from any of the concerns to which the Madura Knitting Co., sold its products.
25. As we see it, neither the departmental authorities nor the tribunal examined the evidence on record, freed of the obsession, that whatever Venkata Krishna Iyer was interested in or' whatever even the Colours Trading Co., was shown to have been interested is really accrued, to the benefit of the Madura Knitting Co, We have no hesitation in coming to the conclusion that there was no evidence on record on which the tribunal could come to the conclusion that the partnership, Ambal Stores, was not a real concern, and that the profits made by Ambal Stores accrued either as a fact or in law to the Madura Knitting Co.
26. During the, arguments before us learned counsel for the assessee company produced the accounts of the Ambal Stores, which showed that, one of the partners Jayammal had withdrawn on three occasions monies for her own use, once in 1951 and twice in 1952. Similarly, another partner, Kamala, was shown to have withdrawn moneys for her own use on two occasions in 1953-
These were transactions subsequent to the relevant assessment years we have had to consider. We do not propose to let this factor influence our decision one way or another. We-have already pointed out that there was no evidence on record to show that the profits that ac--crued to Ambal Stores were drawn upon or utilised by the Madura Knitting Co., or for the matter of that even by the Colours Trading Co., or by Venkatakrishna Iyer.
27. Question No. 3 in B. C. No. 93 of 1955 runs:
'Whether there was material for the tribunal to hold that the partnership of Ambal Stores was not genuine and that the profits of Ambal Stores should be treated as the profits of the assessee firm for the assessment years 1947-48 and 1948-49.'
28. Our answer to that question is in the negative and in favour of the assessee.
29. Question No. 4 in B. C. No. 93 of 1955, which we shall consider next runs:
'Whether the commission paid to the factory and sales managers of the assessee's firm for the assessment years 1946-47 to 1948-49 is not an allowable expenditure or deduction, under Section 10 of the Income-tax?'
Ancillary to that was the claim of the assessee to deductlon of these payments from computation for purposes of excess profits tax, for the chargeable accounting period ending 3lst March 1946. That was included in the second question in R. C. No. 97 of 1953.
30. These employees of the assessee company, Rajadevadoss; P. B. Sundararaman, P. B. Krishnamurthi, Section K. Sundararam Iyer, D. M. Sundararaja Iyer and B. P. Govinda Iyer, held managerial posts, and C. A. Gopala Iyer was the branch manager of Mohanrams, admittedly a branch of the assessee company, engaged in weaving bed sheets and towels.
Upto 13th April 1945, each of these seven employees paid basic salary with the usual clearness allowance and bonus. No commission was paid to any of them. The basic salaries of these employees ranged from Rs. 100 a month and upwards. Rahadevadoss, factory manager, was the highest paid employee, and his basic salary was Rs. 306 a month. On 13th April 1945, the assessee company entered into agreements with each of these seven employees, which provided for the payment in addition of a commission on the net profits of the company.
Three of them, the factory manager, the office manager and the joint office manager, were allowed 21/2 per cent each. The sales manager got 11/2 per- cent, the two assistant managers were allowed one per cent each. Oopala Iyer, the branch manager of Mohanrams, was allowed ten per cent but that was calculated not on the net profits of the company as a whole but only on the net profits of the branch.
The details of the salary, dearness allowance, bonus and commission paid to each of these seven employees in the three relevant assessment years were set out in the statement of the case submitted by the Tribunal.
31. The genuineness of the payments in the three relevant accounting years was not disputed. The employees were assessed to tax on the basis of those payments. The Income-tax Officer was of the view, that the agreements between each of these employees and the Madura Knitting Co. were not genuine. The Assistant Commissioner recorded :
'I agree with the. Income-tax officer that the manner in. which the agreements have been obtained from the employees is suspicious and in any case the agreements do not conclude the matter.'
The Tribunal did not record any specific finding on, the issue, whether the agreements themselves were genuine or not, in the sense whether they were entered into on 13-4-1945. But as the Assistant Commissioner pointed out, whether the agreements were executed on 13-4-1845, may not be material, when the genuineness of the payments to each of these employees in each of the three relevant accounting years was not in dispute. No doubt the income tax Officer recorded:
'There are grounds to suspect that the alleged agreements are not genuine and they were got up long after the profits of the firm were ascertained.'
32. But that left untouched the genuinenesa of the payments themselves.
33. The assessee claimed these amounts paid to the employees as deductions under Section 10 (2) (x) of the Income-tax Act. Section 10 (2) (x) runs :
'Any sum paid to an employee as bonus or commission for services rendered, where such sum would not have been payable to him as profits or dividend if it had not been paid as bonus or commission;
Provided that the amount of the bonus or commission is of a, reasonable amount with reference to--
(a) the pay of the employee and the conditions of his service;
(b) the profits of the business, profession or vocation for the year in question; and
(e) the general practice in similar businesses, professions or vocations.'
The Tribunal upheld the decision of the departmental authorities, who disallowed the assessee's claim. The final conclusion of the tribunal as recorded in its order on appeal was:
'We have said enough to show that this does not satisfy Clause (a) of the proviso. We have not also been shown that there was a general practice in similar business during those years of account. In the absence of this we are afraid that neither condition (a) nor condition (c); let alone condition (b), is satisfied. We therefore disallow the entire commission.'
It should be taken as well settled now that, when a claim is preferred by an employer under Section 10 (2) (x) of the Act, the reasonableness or otherwise of the payment to an employee is to be judged, not with reference to any subjective standards of the assessing authority, but with reference to commercial expediency and with specific reference to the factors listed in Clauses (a), (b) and (c) of the proviso to Section 10 (2) (x).
34. The Tribunal was right in pointing outthat item (c) did not apply. There was no evidence of any general practice in business similarto the one in which the Madura Knitting Co. wasengaged. That left items (a) and (b) of theproviso to Section 10 (2). (x) for consideration.
35. The Tribunal recorded in its order on appeal:
'In the case on hand, the employees were remunerated by way of commission' at rates varying from 1 to 21/2 per cent of net profits of the company. It might be noted that it is on the net profits of the company and is not based on production or the services rendered. It was mentioned that this commission was given as a sort of incentive to the employees to produce more goods so that the company's profits might increase. These were already remunerated by way or salary, dearness allowance, Deepavali allowance and annual bonus etc. The commission on net profits is a new feature Introduced into the accounts for the first time in these assessment years.'
36. That was a correct summary of facts. The Tribunal went on to observe:
'This is an odd contract. We fail to see the connection between the efforts put in by these particular employees and the net profits. As is well known the net profit does not depend upon production alone and depends upon several circumstances, notably market conditions, political conditions, use of machinery, presence or absence of competition, availability of raw materials and machinery parts, and facilities of distribution, sagacity in buying, soiling and, not the least of all, the management. Thus, in our opinion, there can be no tie between the efforts put in by these employees and the net profit.'
37. We are constrained to point out that this line of reasoning ignored the specific statutory provision in Clause (b) of the proviso to Section 10 (2) (x). of the Act. When the Legislature in its wisdom correlated the payments to the profits and prescribed that as one of the tests to decide whether the payments were reasonable, it was certainly not for the tribunal to disregard that. No doubt what item (b) refers to is 'profits.'
Obviously net profits would not be excluded. by the statutory provision. That other factors entered into the making of the net profits certainly would not make net profits of the company an irrelevant factor in deciding whether the payments made to the employees were reasonable. It was thus a very relevant factor that the tribunal excluded.
38. In the passage we have extracted above the tribunal referred to the contention of the assessee, that the grant of the commission was an incentive to the employees to produce more goods, so that the company's profits might increase. The tribunal did not really deal with the question, whether in addition to the salaries, dearness allowance, bonus etc., an additional incentive was in fact provided by the agreements to pay commissions to the employees.
Learned counsel for the assessee repeated his contention, which apparently had been urged before the tribunal, that in the relevant accounting years those who held managerial posts as well as labourers had to work under difficult conditions. The company naturally wanted to make the most of the boom in the market subsequent to 1944 by increasing its production. In the annexure to the statement of the case in R. C. No. 97 of 1953 were furnished figures of the quantity of banians, one of the Items produced by the Madura Knitting Co., sold between 1942 and 1946.
During the accounting year ending 12th April 1944, the. sale had shrunk to 84679 dozens. In 1944-45 the sales Increased to 1,89,475 dozens; in the next year the sales increased to 2,317235 dozens. The Increase in' sales of this one item alone certainly proved a large increase, in production, Yet the Assistant Commissioner with reference to the assessment year, 1946-47, corresponding account year having ended with 12th April 1945, remarked :
'There are no new circumstances, no Increase in the volume of business as compared to the previous year'.
That was not quite correct. The production did show a marked increase. That was decided by the Tribunal itself in connection with a different claim made by the assessee. In the tabular statement at page 53 of the typed papers in R. C. No. 93 of 1955, that is, the judgment on appeal by the Appellate, Tribunal, the tribunal referred to the increase ' in production, the unit being a dozen
In the assessment year 1942-43, it was 88000; in 1943-44, 86000. then there was a progressive increase 1,34,000 in 1944-45; 1,74,000 in 1945-46; 2,32,000 in 1946-47; 2,24,000 in 1947-48 and 2,52,000 in 1948-49. This again, apparently referred only to banians. But even there, the Increase in production was substantial. Earlier in its judgment the tribunal allowed another claim of the assessee, though only in part, towards the cost of erecting temporary structures, sheds, both in the premises of the Madura Knitting Co. and in Mohanrams, for coping with the increase, in production. 75 per cent of that cost was allowed in relation to Madura Knitting Co. and 50 per cent to Mohanrams.
That certainly substantiated the claim of the assessee, that temporary structures had to be put up for coping with the increase of production, and that made conditions in the factory not very easy. These very relevant factors the tribunal appears to have completely overlooked in deciding whether the established increase in production, under factory conditions which were by no means easy, could sustain, the claim of the assessee, that it was a reasonable agreement it entered into with its employees in charge of production and sales, to grant them a commission based upon the net profits, as an incentive to keep up the sustained increase in production.
39. The tribunal was no doubt right in referring to the details of pay, dearness allowance and bonus these seven employees were paid. Those were certainly factors to be taken into account under Sub-clause (a) of the proviso to Section 10 (2) (x) of the Act. But then that was not the only factor the tribunal had to take into account. The basic pay was left untouched in the relevant accounting years.
What the tribunal failed to consider was whether a prudent businessman, faced with the problem the assessee company had to face, would have raised the basic salaries, as an alternative to grant of commissions correlated to the net profits, the hope for increase in profits being to a large ex-lent dependant on the capacity and willingness to increase production, to take full advantage of : the temporary boom.
40. Judged by the test prescribed by Sub-clauses (a) and (b) of the proviso to Section 10 (2) (x), and Judged from the only point of view permissible, commercial expediency, the claim of the that the payments were reasonable, was well established. There was really no basis at all for the conclusion of the tribunal that the commissions were unreasonable.
41. We answer the fourth question in B. C. No. 93 of 1955 in the affirmative and in favour of the assessee.
42. The relevant part of the second question in R. C. No. 97 of 1953 dealt with the payments to these employees for the chargeable account period ending with 31st March 1946, is answered in the negative and in favour of the assessee.
43. We shall next deal with the deductions claimed by the assessee company on the basis of the payments claimed to have been made to three-of their selling agents, V. S. M. Krishnaram, Kamadhemi and Company and Sekhar and Company. Questions Nos. 1 and 2 in R. C. No. 97 of 1953 are really merged in questions Nos. 1 and 2 in R. O. No. 93 of 1955, which dealt with all the four assessment years, with which we are now concerned.
44. The assessee's case was that it had large stocks on hand and sales were low upto 1944. Subsequently, even in the boom period, they had to face keen competition from other manufacturers of hosiery goods. The assessee company decided to appoint agents for canvassing orders for the goods produced by it.
45. On 7th April 1944, they appointed Kamadhenu and Co., as its agents for promoting sales of its goods within the City of Madras. Kamadhenu 'and Co., was offered a commission of 61/4 per cent. Rajagopala Iyer and Narasimha Iyer were the partners of Kamadhenu and Co. They were also partners of Rayal Talkie Distributors, a concern with which the Madura Knitting Co., had no real connection.
But the three N. M. R. brothers were partners both in the Madura Knitting Co., and the Rayal Talkie distributors. Kamadhenu and Co., purported to have an office at Madras. But that was in the premises which belonged to the Colours Trading Co.
46. On 14th April 1944, the Madura Knit-ting Co., entered into an agreement with Shekhar and Co., Madura, by which Shekar and Co., was appointed as agents for the distribution and sale of the assessee's products in all parts of India except the Presidency of Bombay and South India. Sekhar and Co., also was offered a commission or 6 1/4 per cent. The partners of Sekhar and Co., were Chandrasekhara Iyer and Venkatachalapathi Iyer. who were related to' N. M. R. Venkatakrishna Iyer.
47. On 17th August 1944, the Madura Knitting Co. wrote a letter to V. S. M.' Krishnaram, confirming the previous oral agreement between them. Krishnaram was appointed as a canvassing agent for areas south of Madura with a commission of 21/2 per cent.
48. The details of the payments made by the Madura Knitting Co., to Kamadhenu and Co., Sekhar and Co., and Krishnaram in the relevant years of assessment 1945-46 to 1948-49 were set out at page 7 of typed papers In the statement of the case submitted by the tribunal in R. C. No. 93 Of 1955.
49. Deduction of these payments was claimed by the assessee company under Section 10 (2) (xv) of the income-tax Act. The relevant portion of Section 10 (2) (xv) runs :
'any expenditure ..... laid out or expended wholly and exclusively for the purpose of such business.....'
To attract the application of the statutory provision in Section 10 (2) (xv), two factors at least had first to be proved by the assessee in this case (i) that the amount had been expended by the asses-see; and (ii) that the payments had been made for services rendered to the assessee company.
That was the specific case the assessee put forward for acceptance. After establishing both these factors, the assessee had still to satisfy the test prescribed by Section 10 (2) (xv), that the expenditure had been incurred wholly and exclusively for the purpose of its business. In cqnsidering whether that test was satisfied, the view point should have been commercial expediency.
But if either of the preliminary factors had not been proved, that is, if no payment had been made at all or if a payment was made, which was not correlated to any services rendered to the assessee, the question of deciding whether commercial expediency would sanction the claim that the money had been expended wholly and exclusively for the business of the company, could not arise at all for consideration.
50. The claim of the assessee was with reference to the payments made to three differentgroups of persons, and the payments were madein each of the four years now under consideration. Each claim for each year had necessarilyto be investigated separately. There was a fulldiscussion in the orders of the Income-tax officer,the Appellate. Assistant Commissioner and theAppellate Tribunal, with reference to the assessment year 1945-46. We shall first deal with thosefindings. .
51. With reference to V. S. M. Krishnaram, the Income-tax Officer pointed out that Krishna-ram was a wholetime employee who devoted his entire time to the work of the Colours Trading Co. The finding of the Income-tax Officer was:
'Since Mr. Krishnaram happens to be a close relative of the managing partners, the payment to him appears to have been made more out of love and affection than for services rendered.'
With reference to Kamadhenu and Co., the finding, of the Income-tax Officer was even more specific :
'actually it is seen that no services of any kind have been rendered by Kamadhenu and Go.'
Dealing with Sekhar and Co., the Income-tax Officer recorded :
'Thus from all the evidence available it is clear that no business is canvassed by Sekhar and Co., and the business shown to have been done in the name of Sekhar and Co., was only business canvassed by the assessee's employees.'
52. Thus, the Income-tax Officer found that none of the three selling agents Krishnaram, Kamadhenu and Co., and Sekhar and Co., rendered any services to the assessee company during the relevant accounting year 1944-45.
53. The Assistant Commissioner was further of the view that the payments to Krishnaram and Sekharam and Co., were not genuine. The Tribunal, however, did not record any specific finding on the issue whether the payments pleaded by the assessee company in the four relevant accounting years were genuine or not.
54. On the question, whether these three selling agents rendered any services in the relevant accounting year 1944-45, the Tribunal agreed with the Income-tax Officer. With reference to Krishnaram the finding of the Tribunal was:
'The orders for purchase came directly from the constituents and not through Krishnaram and no evidence is on record that Krishnaram worked up this field and it was through his, efforts that these orders came.'
With reference to Kamadhenu and Co., the Tribunal found :
'In fact there is nothing -on record to show that these persons did any work. On the other hand, there is enough evidence on record to show that the stockists mentioned earlier dealt directly with the Madura Knitting Co., and they were always getting supplies directly, payments also being made directly.'
The assessee claimed that Sekhar and Co., had an office in Calcutta. Sekhar and Co., had its headquarters at Madura. The Tribunal found that Sekhar and Co., had no office in Calcutta. The tribunal further pointed out that, though the agreement with Sekhar and Co., provided for commission on sales effected virtually throughout Northern India, the commissions were confined: only to sales effected in Calcutta.
With reference to those sales the tribunal was of the view, that it was the assessee's branch at Calcutta that did all the work. Virtually most of the sales were to two constituents of the company at Calcutta.
55. As we pointed out, while the Assistant Commissioner doubted the genuineness of payments to Krishnaram and Sekhar and Co., the Tribunal did not go into that question. It apparently assumed without deciding it that the payments were genuine. The Tribunal recorded :
'Our finding is that, apart from the question whether the payments were genuinely made or not, these were not expended wholly and exclusively for the purpose of the business.'
The finding of fact recorded by the Tribunal that none of the three selling agents, Kamadhenu and Co., Sekhar and Co., and Krishnaram, rendered any services under their respective contracts to the assessee company in the relevant accounting year 1944-45 to justify any payment to them, should suffice to reject the claim of the assessee company to a deduction under Section 10 (2) (xv) of the Act. It is on that narrow basis that we are content to rest our decision.
56. The tribunal also took other factors into account in deciding whether the amounts could be claimed to have been expended wholly and exclusively for the business of the assessee company. It is really not necessary for us to discuss these features. No doubt it was provect that the amounts paid to Sekhar and Co., and Kamadhenu and Co., were eventually credited to their accounts with the Colours Trading Co.
But then, the Colours Trading Co., was something quite independent of the Madura Knitting Co. The Tribunal was also of the view, that there was no need in 1944 to appoint any selling agents. The question of need had to be decided with reference to commercial expediency. But that does not appear to have been adopted as the view point by the tribunal. But, 'as we said, it is not necessary to dwell upon these features of the order of the tribunal.
When the assessee failed to prove that the payments, It claimed it had made in the relevant account years, were for services actually render. ed to the assessee company by. the selling agents, there was no need to examine anything else, to reject the claim of the assessee founded on Section 10 (2) (xv) of the Act.
57. Though the findings, we have referred to above were with specific reference to the assessment year 1945-56, the learned counsel for the assessee admitted that the position was not in any way different in the three succeeding assessment years. If at least the assessee had offered to place before us further evidence with reference to the assessment years which succeeded 1945-46, to prove that in those years the selling agents had rendered services, we could have examined the need to call for a better statement of the case from the Tribunal.
That need did not arise. No such evidence was placed before us. It was assumed all through that the position in relation to the assessment years 1946-47, 1947-48 and 1948-49 was the same as in relation to 1945-46. There was apparently ho evidence which the assessee could produce, that in the three succeeding years any or all the three selling agents did render services to the assessee company.
Learned counsel for the assessee urged that the disallowance of the claim under this head for the four assessment years in question should not in any way prejudice the claim of the assessee, if one were to be made in the assessment years subsequent to 1948-49. As we have pointed out, the claim with reference to each item of expenditure has to be examined with reference to each assessment year, and with reference to the evidence made available for such an assessment.
58. We have discussed the question so far with reference to the requirements of Section 10 (2) (xv) of the income-tax Act. The claim under the Excess Profits Tax Act has to be decided with reference to the provisions of Rule 12 of Schedule I of that Act. A contention was urged before the tribunal, that if the requirements of Section 10 (2) (xv) were satisfied, that should suffice to uphold the claim under Rule 12 of Schedule I of the Excess Profits Tax Act.
That question does not really arise for determination, because we have held that the requirements or Section 10 (2) (xv) of the Income-tax Act have not been satisfied. Even if payments were made, if those payments 'were not correlated to 'any services rendered by the recipients, no. question of deduction either under Section 10 (2) (xv) of the Income-tax Act or Rule 12 of Schedule I of the Excess Profits Tax Act can arise for further consideration in view of the case put forward by the assessee.
59. Our answer to question No. 1 and that part of question No. 2, which referred to Krishnaram, Kamadhenu and Co., and Sekhar and Co., In B. O. No. 97 of 1953 is against the assessee. Similarly, our answer to questions Nos. 1 and 2 in R. C. No. 93 of 1955 is also against the assessee.
60. Since neither side has wholly succeeded in its contentions we direct that there be no order as to costs in either of the two references.