1. The following question has been referred to us for our opinion under Section 256(1) of the Income-tax Act, 1961 :
'Whether, on the facts and in the circumstances of the case, the disallowance of Rs. 62,144 out of the remuneration paid to the managing agent for their services from January 1, 1960, to August 15, 1960, is justified in law ?'
2. The circumstances under which the question came to be referred are these. The assessee-company entered into an agreement, dated April 20, 1942, with Messrs. Bagyalakshmi and Company, whereunder the said Bagyalakshmi and Company was appointed managing agents of the assessee for a period of 20 years. Under the terms of the said agreement, the managing agents were entitled to be paid as remuneration for their services, the following amounts :
(a) a monthly allowance of Rs. 1,000 ;
(b) a commission of 2% on the cost of buildings, machinery and electrical plants purchased, constructed or erected ;
(c) a commission of 1% on the cost of cotton kappas; cotton and stores purchased and on the cost of the electric energy consumed for the purpose of the company ; and
(d) a commission of 10% of the net profits of the company available after deducting all working expenses and interest and the aforesaid commission, but before providing for depreciation and excess profits tax and appropriating funds for income-tax reserve or special funds.
3. After obtaining sanction from the Government of India, the terms relating to the managing agency remuneration had been varied by providing a minimum remuneration in case the company incurs loss during any particular assessment year, and the relevant resolution of the company was this:
'That the managing agents of the company be paid a minimum, remuneration of Rs. 50,000 in case of absence or inadequacy of profits for each and every financial year commencing from January 1, 1957, as sanctioned by the Central Government and that the variation in the terms of the managing agency agreement to the extent be and is hereby approved. Further resolved that the minimum remuneration of Rs. 50,000 as above be paid to the managing agent in four equal installments on the last day of every quarter of a calendar year, viz., 31st March, the 30th June, the 30th September and 31st December every year.'
4. By virtue of Section 330 of the Companies Act, the term of office of the managing agents expired on August 15, 1960. The remuneration payable to the managing agency firm up to the period August 15, 1960, was calculated at the proportion of 7^/12 on the 10% of the net profits of the assessee-company, and the remuneration so determined was Rs. 94,505. This sum was actually paid by the company to the managing agency firm. The company claimed deduction of the said sum of Rs. 94,505 from its income for the assessment year 1961-62, the relevant accounting year being the year ended December 31, 1960. The Income-tax Officer, however, held that the remuneration payable as per the agreement to the managing agents has to be worked out on the basis of the minimum remuneration fixed thereunder, and adopting a proportion of 7 1/2/12 on Rs. 50,000, he allowed Rs. 32,361 as deduction, and disallowed the balance of Rs. 62,144 on the ground that it was excessive remuneration paid to the managing agents.
5. The assessee-company, thereafter, preferred an appeal to the Appellate Assistant Commissioner, who held that the managing agents, having rendered services to the company till August 15, 1960, were entitled to their remuneration calculated at 7 1/2/12 out of 10% of the net profits as on August 15, 1960. In that view, he allowed the deduction in respect of the entire sum of Rs. 94,505.
6. On a further appeal to the Tribunal by the revenue the Tribunal took the view, based on the decision of the Supreme Court in E.D. Sassoon & Co. Lid. v. Commissioner of Income-tax : 26ITR27(SC) and Cotton Agents Ltd. v. Commissioner of Income-tax : 40ITR135(SC) that the managing agents were not entitled to payment of remuneration calculated at 10% of the net profits as they had ceased to be managing agents on August 15, 1960, i.e., before the end of the accounting year, when alone the right to receive the remuneration accrued. In that view, the Tribunal restored the order of disallowance of Rs. 62,144.
7. At the instance of the assessee-company, the question set out above has been referred.
8. The view of the Tribunal is that the managing agents are not entitled to any remuneration, for they have not continued to be managing agents up to the end of the accounting year, when alone the net profits of the company and the 10% thereof could be determined. The decisions in E. D. Sassoon and Company v. Commissioner of Income-tax and Cotton Agents Ltd. v. Commissioner of Income-tax have been referred to as supporting the Tribunal's view. We are not, however, inclined to agree with the Tribunal that the managing agents cannot at all claim remunera-tion for the services rendered till August 15, 1960, when the managing agency agreement ceased to be effective in view of Section 330 of the Companies Act.
9. In E. D. Sassoon & Company Ltd. v. Commissioner of Income-tax, there was an assignment of the managing agency agreement and the question arose whether in the relevant assessment year both the assignor as well as the assignee could be assessed on the whole of the commission or a proper apportionment being made between them. Their Lordships of the Supreme Court took the view that the managing agency commission was not liable to apportionment between the assignor and the assignee in the proportion of the services rendered as managing agents by each one of them and that the entire managing agency commission received by the assignee after the close of the accounting year was liable to be taxed in the hands of the assignee. The reasoning adopted in that case is that the contract of service between the company and the managing agents was one and entire and that the remuneration or commission became due to the managing agents only on completion of a definite period of service, and that under the managing agency agreement, the remuneration or commission was not payable for fractional periods.
10. In Cotton Agents Ltd. v. Commissioner of Income-tax, there was an agreement between the company and its managing agents, under which the managing agents were entitled to a commission at the rate of 3 1/2% on the gross profits of all sales of yarn, cloth, waste and other articles manufactured by the company in any accounting period. There was a transfer of the managing agency rights. While dealing with the question as to when the liability for payment of the commission provided under the said managing agency agreement arose, the Supreme Court expressed the view that, under the managing agency agreement, no commission accrued or arose on the sale proceeds at the time of each transaction of sale, that there was no debt created nor any right to receive payment existed on the date of each transaction of sale, that the commission became due to the managing agents at the end of the financial year when it actually accrued.
11. These two decisions were followed in Commissioner of Income-tax v. Ashokbhai Chimanbhai : 56ITR42(SC) wherein it has been pointed out by the Supreme Court that the profits do not accrue from day to day or even from month to month and that they have to be ascertained by comparison of assets at two stated periods and that unless the right to profits comes into existence, there is no accrual of profits and the quantum of the profits must be determined by the title on the date on which they accrue or arise.
12. In Commissioner of Income-tax v. Bangalore Transport Co. Ltd. : 66ITR373(SC) a transport company was taken over by the State of Mysore, under the provisions of the statute providing for the acquisition of industrial undertakings, on the 1st of October, 1956. The company received the compensation for the loss of its undertaking and other assets. The company was assessed in respect of its income for the broken period, i.e., up to 30th September, 1956. The contention of the company was that since the profits from the business of the company can only accrue at the end of the accounting period and not before the company having been forced to close down its business in the middle of the accounting year, it is not liable to be assessed at all for that accounting year under the Income-tax Act. In support of that contention, the above observations of the Supreme Court in Commissioner of Income-tax v. Ashokbhai Chimanbhai earlier referred to were relied on. The Supreme Court distinguished the said decision on the ground that in that case the right to receive a share in the profits had been transferred or divested and that by virtue of such a transfer or divestiture no income could accrue or arise to the assessee. Dealing with the facts of the case before them, their Lordships of the Supreme Court held that profits directly arose to the company till its undertaking was taken over and such profits could be ascertained by the method of accounting normally adopted by the company at the end of the year or when the business was closed. Though the said decision of the Supreme Court was in relation to the actual income for a period up to which the company carried on business, the same principle will apply in respect of the expenditure incurred in relation to the business carried on for a broken period.
13. The Tribunal has proceeded on the basis that the managing agents were not entitled to any remuneration as they had not continued to function as managing agents up to the end of the accounting period.
14. In view of the said decision the managing agent's entitlement for remuneration up to August 15, 1960, the date when the managing agency agreement stood terminated by virtue of Section 330 of the Companies Act cannot be disputed. The managing agents were prevented from functioning by the statute after August 15, 1960. The fact that they did not continue to serve the company after August 15, I960, will not disentitle them to remuneration for the period they served the company. It is true that the liability to pay the remuneration can accrue or arise only after the end of the accounting year and not before, for, the remuneration payable is at a certain percentage of the net profit of the company which can be ascertained only after the end of the year. The quantum of remuneration, of course, can be determined only after the end of the year. But,on that ground, one cannot say that the managing agents are not entitled to any remuneration.
15. The Income-tax Officer has, in fact, proceeded on the basis that the managing agents will be entitled to remuneration up to August 15, 1960, calculated on the basis that the company has earned no profits. The Income-tax Officer, presumably, felt that, in the circumstances of this case, the clause in the agreement providing for a remuneration at 10% on the net profits cannot be worked out, as it cannot be postulated that the company has, in fact, earned profits as on August 15, 1960.
16. The question is whether the Income-tax Officer was right in proceeding on the basis that the managing agents are entitled to the proportionate minimum remuneration. The learned counsel for the revenue seeks to sustain the calculation as made by the Income-tax Officer, on the ground that the agreement only provided for a remuneration at the rate of 10 per cent, of the net profits of the company at the end of the accounting year, and it does not provide for the profit being ascertained in the middle of the year. It is also stated that it is because of the difficulty in exactly determining the profits of the company as on August 15, 1960, the Income-tax Officer proceeded to calculate the remuneration up to August 15, 1960, on the basis that the company has not earned profits during the accounting year.
17. Mr. Swaminathan, the learned counsel for the assessee-company, would, however, contend that though the agreement has provided for two modes of determination of the quantum of remuneration payable to the managing agents, one when the company has earned profits and the other when the company has not earned profits, the Income-tax Officer was not justified in proceeding on the basis that the company has not earned profits, when it has actually been found that the company has earned profits at the end of the accounting year.
18. According to Mr. Swaminathan, the inability to determine the profits which is to be taken as the basis for calculating the remuneration payable to the managing agents cannot lead to the assumption that the company has not earned profits, while, in fact, it has earned profits during the accounting year. We are inclined to agree with Mr. Swaminathan that the Income-tax Officer is not justified in proceeding on the basis that the company has not earned profits during the accounting year and calculating the remuneration on that basis. Therefore, the remuneration payable to the managing agents has to be worked out on the alternative basis given under the agreement, i.e., 10% of the net profits of the company. Admittedly, the managing agents rendered services up to August 15, 1960. If they had served as managing agents during the entire accounting year.they would have been entitled to 10% of the net profits of the company during the accounting year as remuneration.
19. Therefore, the reasonable basis on which remuneration has to be calculated is by adopting the proportion of the period of service to the entire year on the 10% of the net profits. Such a pro rata basis had been adopted even by the Income-tax Officer in this case when he calculated the remuneration payable by the managing agents on the basis of the minimum remuneration. Where the managing agents are found to be entitled to the remuneration for the period of their service, their remuneration has to be calculated on a reasonable basis, having in mind the terms of the agreement.
20. In view of the fact that the managing agents, in this case, have been prevented from functioning as managing agents by virtue of the statute, it is quite reasonable to expect that if they had worked as managing agents for the whole year, they will be clearly entitled to the 10% of the net profits of the company during the accounting year.
21. On that basis, for the period of 7 months during which the managing agents did service, their remuneration has to be calculated proportionately having regard to the remuneration they would have earned for the whole year, if they had served. It is not in dispute that the sum of Rs. 94,505 was the amount of remuneration worked out on the above pro rata basis and that the same was actually paid to, the managing agents during the assessment year. It cannot be contended by the revenue that the said sum was not an expenditure incurred for the purpose of the business of the company.
22. In these circumstances, we hold that the entire sum of Rs. 94,505 is allowable. The question referred to us is, therefore, answered in the negative and in favour of the assessee. The assessee will be entitled to costs. Counsel's fee Rs. 250.