1. This reference under Section 66 (2) of the Income-tax Act arose out of the proceedings for the assessment year 1947-48 ; the accounting year ended on 3142-1946.
2. The assesses was a private limited company owning a studio and engaged in the production of motion pictures. There were six shareholders. Of these Hamanathan Chettiar was the managing director and Banerjee and Tehrani were directors. Baner-jee, Tehrani and Nagoor were employed respectively as Chief Cameraman, Chief Sound Engineer and Art Director in the studio. The managing director and the three technicians were remunerated by payments of what were catted honoraria, which really meant salaries as pointed out by the Appellate Tribunal itself, and also by payments of commission on a fixed percentage basis. In addition each of them got a car allowance, and when the profits justified it, payment of a month's salary as bonus. In 1944 and 1945 what was paid as honoraria, that is, salary, to these four amounted to Rs. 18,000 a year. Their scale of salaries was revised for 1946, by a resolution passed by the shareholders on 30-3-1946, and the total came to Rs. 59,100 for 1946. The genuineness of the payment of that amount of Rs. 59,100 was never in dispute. The assessee claimed this payment as a deduction under Section 10 (2) (xv) of the Act. The Income-tax Officer held :
"I consider that the reasonable course will in the circumstances be to limit the admissible deduction under this head to an amount not exceeding twice the amount allowed in each of the preceding years."
The difference between Rs. 36,000 allowed and the sum of Rs. 59,100 claimed, that is, Rs. 23,100 was disallowed. That disallowance was confirmed by the Appellate Assistant Commissioner and by the Appellate Tribunal. It was on these facts that the following question was referred to this Court for determination :
"Whether on the facts and in the circumstances of the case the disallowance of a sum of Rs. 23,100 out of the expenses incurred by the assessee for payment of remuneration to the Managing Director and the other Technician Directors is permissible under the provisions of Section 10 (2) (xv) of the Income-tax Act.''
Though the question, refers to the remuneration paid to the managing director and the technician directors, it should be noted that one of the technicians, Nagoor, who was also paid a remuneration, was not a director though he was also a shareholder. That however docs not affect the real question at issue.
3. Section 10 (2) (xv) provides for the deduction of any expense (not being in the nature of a capital expenditure or personal expenses of the assesses) laid out or expended wholly and exclusively for the purpose of the business of the assesses.
4. In -- 'Eastern 'Investments Ltd. v. Commissioner of Income-tax, West Bengal', (A), the supreme Court referred to Section 12(2) of the Act, which provides for the deduction of an expenditure incurred "solely for the purpose of making oc earning such income, profits or gains" and summarised the principles to be kept in view :
(1) Though the question must be decided on the facts of each case, the final conclusion is one of law.
(2) It is not necessary to show that the expanditure was a profitable one or that in fact any profit was earned;
(3) It is enough to show that the money was expended "not of necessity and with a view to direct an 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."
(4) Beyond that no hard and fast rule can be laid down to explain what is meant by the word 'solely'.
5. In--'Rayaloo Iyer and Sons v. Commissioner of Income-tax, Madras', (S) (B). a Bench of this Court held that the
principles laid down by the Supreme Court with reference to Section 12 (2) of the Act should also be applied in deciding under Section 10 (2)(xv) whether the expenditure was incurred wholly and exclusively for the purpose of the business of the assessee and the Court pointed out that the test prescribed by Section 10(2)(xv) of the Act included that of commercial expediency. At page 62 the learned Judge pointed out :
"In applying the test of commercial expediency to determine whether the expenditure is wholly and exclusively laid out for the purpose of the business, the reasonableness of the expenditure should be considered from the point of view of the businessman and not from the point of view of outsiders including the Income-tax Officer."
It was the (same principle to which Lord Wright referred in--'Craddock v. Zeo Finance Co., Ltd.', (1947) 27 Tax Cas 267 at p. 290 (C).
"The transaction here being a perfectly straight-forward and honest bargain between the two companies, it seems to me that if the present claim were upheld it would amount to a precedent enabling the Revenue to revise every such bargain and to defeat what the parties had agreed on. The revenue in a case under Schedule D has 110 power to examine what they think was reasonable or to say what expenditure was necessary."
6. It is with reference to these principles we have to decide whether the Appellate Tribunal was justified in disallowing the sum o Rs. 23,100 out of the total amount of Rs. 59,100 that was actually expended by the assessee company in the year of account 1948 as payment of salaries to. four of its employees. That these employees were also shareholders of the assessee company and that three of them were also directors are not relevant at all. Nor did the Tribunal itself treat it as a relevant consideration. The findings of the Tribunal were that the amount of Rs. 59,100 though called honorarium really represented salary, (2) the entire amount was paid during the accounting year, (3) this payment was authorised by the resolution of the share-holders on 30-3-1946, and (4) that these four persons turned out substantial work in the year of account.
7. In deciding whether the claim for deduction under Section 10 (2)(xv) should be allowed, the departmental authorities could and should consider whether the expenditure could be justified on grounds of commercial expediency. Certainly that does not provide for any subjective standard of reasonableness to be adopted by the taxing authorities. In this case, however, nothing more than such a subjective standard of the Income-tax Officer appears to have been considered by the Appellate Tribunal. The Income-tax Officer at least considered as a relevant factor the fact that while the gross receipts of the assessee firm in 1945 was Rs. 2,26,982, the receipts for the year of account were Rs. 3,78,734 and that did not justify a three-fold increase in the honoraria (salaries) paid in the year of account. The Tribunal dismissed, the increase in the gross receipts as virtually irrelevant with the observation, that "that in itself can be no guide because there is no evidence to show what was the real cause for the increase in the receipt." We agree that the gross receipts of the assessee firm would not be a relevant factor at all, though not for the reason given by the Appellate Tribunal. In the statement of the case, the Tribunal referred to the fact, that the net profits of the company increased from Rs. 41,541 in 1945 to Rs. 1,05,871 in the year of account. That again may not be a relevant factor, because as pointed out by the Supreme Court in ' (A)', it is not necessary for the assessee to show that the expenditure was a profitable one or that in fact any profit was earned. If the gross receipts, which the Income-tax Officer took into account, and the net profits, which the Appellate Tribunal did not take into account, are left out of consideration, the position remains that it was only with reference to an apparently subjective standard of what constituted a reasonable expenditure that the Income-tax Officer disallowed the claim of the assessee; and it was that view that was ultimately upheld by the Tribunal. We need hardly point out that there is no room for such a subjective standard in applying the test of commercial expediency.
8. That means there was really no basis at all on the evidence placed before the Tribunal for the conclusion it reached that the whole of Rs. 59,100 expended as salaries during the year of account could not be claimed as a legitimate deduction under Section 10 (2)(xv). The increase in salaries, it should bs remembered, was in March 1946 long before the assessee company was even in a position to know whether there would in fact be a substantial increase in the gross receipts or net profits. We are stressing this only to show that it was an item of proof of good faith on the part of the assessee company in revising the salaries payable to the four persons, who between them virtually helped to earn the profits of the company. There was certainly nothing to indicate that the increase in salaries the share-holders authorised was a colourable devise to divert a portion of the anticipated profits of the company to four of its share-holders. In fact there was no occasion for taxing authorities or for the Tribunal even to consider such a possibility.
9. Under our taxing system, it is for the assessee to conduct his business, and in his wisdom or otherwise to fix the remuneration to his staff. The Income-tax Act docs not clothe the taxing authority with any power or jurisdiction to determine the reasonableness of the amount so iixcd and paid by the assessee. The only test for the deducibility of such remuneration is whether the expenditure has been incurred solely and exclusively for the purpose of the business. If the reality of the payment is challenged or is in dispute different considerations arise; so also in cases where the tax authorities are able to point to some consideration other than the purpose of the business as accounting for any portion of the payment made. In such cases of course such portion of the amount claimed, which is either not held to have been paid or is held to have been paid for reasons other than business expediency, could and should be disallowed; but the reason for the disallowance is because either the portion disallowed is not paid, or because the expenditure is not solely and exclusively for the business, and not on the ground that in the opinion of the Income-tax Officer or other taxing authority the remuneration is "unreasonably" high--either because the employee does not, in the authority's opinion deserve so much, or because the assessee could have secured other employees on more favourable terms.
10. The assessee certainly satisfied third of the tests postulated by their Lordships in the--'Eastern Investments case' (A), that the money was expended "not of necessity and with a view to direct and immediate benefit to the trade but voluntarily and on the ground of commercial expediency, and in order to facilitate the carrying on of the business". Even necessity for the expenditure docs not enter this test.
11. The question referred to us is answered in the negative and in favour of the assessee. The assessee will be entitled to the costs of this reference. Counsel's fee Rs. 250. Answer in the negative.