1. The following question has been referred by the Tribunal under Section 256(1) of the Income-tax Act, 1961.
'Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was justified in holding that the commission paid to the selling agents, Metalware & Co., in excess of 5% of the turnover was not an expenditure under Section 10(2)(xv) ?'
2. C.T. Narayana Chettiar and Ramanlal Kamdar entered into a partnership on 10th April, 1950, to carry on business in the manufacture of stainless steel and utensils. The terms of the partnership were reduced to writing on 12th February, 1952. Narayana Chettiar was the financing partner and Ramanlal Kamdar, the working partner. The firm carried on business under the name and style of Indo-Metal Industries.
3. The marketing of its products was done by the firm known as 'V.C. Ramalingam & Sons' remunerated by a commission of 61/4% of the turnover. Apparently, the firm 'Indo-Metal Industries' was not satisfied with the way in which V.C. Ramalingam & Sons was promoting the sales. The selling arrangement was, therefore, terminated from December, 1953.
4. Indo-Metal Industries thereafter entered into an agreement with a firm known as Metalware & Co. It may be mentioned herein that Ramanlal Kamdar, the working partner, has three brothers by name, Amritlal, Chandulal and Rashiklal. The respective wives of Amritlal, Chandulal and Rashiklal were Sarada, Kusum and Kanchan. The four ladies, viz., the wives of Ramanlal and his brothers, started a firm known as Metalware and Co. with a capital of Rs. 10,000 and with its office at No. 123, Big Street, Triplicane. Chandulal was to be in charge of the management and supervision of the activities of this firm. In the agreement entered into on 24th December, 1953, with this firm it was provided that the agency firm was to store the goods in its branches and was to be the custodian ensuring the safety of the materials. The agency-firm was not to deal in goods similar to those manufactured by the assessee-firm. The agency firm was to be in charge of all the sale proceeds realised by the sale of goods. It was to be paid a commission of 5% of the turnover. The agreement was terminable at will.
5. More than a year and a half after this agreement on August 1, 1955, Narayana Chettiar retired from the firm and Ramanlal Kamdar took it over as a proprietary concern. He carried on the business in his individual capacity till March 31, 1956. With effect from. 1st April, 1956, he took into the firm his brothers, Amritlal, Chandulal and Rashiklal, as partners. Ramanlal Kamdar died on 27th April, 1957, and. the assessee-firm has, thereafter, continued with the three surviving partners.
6. The agency firm dealt in the goods manufactured by the assessee and also in the goods which were not competitive with the manufactured products of the assessee, The following table brings out the extent of the turnover in the agency goods, that in other goods and also the profit in both these lines:
Accounting yearCommission sales of assessee's goodsCommission earnedSale of other goodsProfit
7. It will be seen from the above table that while the turnover in the agency goods was only Rs. 2,80,000 in 1953-54 it has gone up to Rs. 14,72,734 in the accounting year. 1959-60, while the dealings in the other goods were of the value of Rs. 1,18,958 in 1959-60. Oh March 15, 1959, the agency firm wrote to the assessee-firm asking for the enhancement of the commission from 5% to 10% pointing out that its purchases from others had gone down, that the cost of living had gone up, that other manufacturers like Vummidiars (Mfgs.) Private Ltd. and Mysore Premier Metal Factory were allowing 10% to their dealers and that unless the commission was increased from 5% to 10%, it might not be possible for them to continue the agency. On 1st April, 1959, an agreement was entered into between the assessee and the agency firm increasing the commission from 5% to 10%.
8. The Income-tax Officer was allowing as deduction the amount of commission paid to the agency firm up to and including the accounting year 1958-59 relevant for the assessment year 1959-60, In the assessment for 1960-61 the Income-tax Officer noticed that on the turnover similar to the earlier year the assessee had earned a profit of 55'6% in this year as against 47% in the earlier year. He observed that Ramanlal, who was the sole proprietor of the business till 1st April, 1956, appointed a firm consisting of his wife and the wives of his brothers as his 'sole selling agents' and that the entire affairs of this firm-were conducted by Chandulal KSmdar, his brother, who was already working in his own business and subsequently became a partner with him. In his view, the deduction claimed on account of the agency firm was entirely fictitious. He, therefore, disallowed a sum of Rs. 1,07,214 which was the commission due according to the revised terms from 1st April, 1959, to 31st of March, I960. This figure differs from the figure shown as column 3 of the table extracted earlier in relation to the accounting year there given is that which relates to the agency-firm and it is different from the financial year adopted by the assessee-firm as its previous year.
9. Simultaneously he reopened the assessments for three earlier assessment years and sought to disallow the commission on the ground that it was fictitious. He proceeded for this purpose under Section 147(b) of the Income-tax Act, 1961.
10. The assessee appealed against the reassessments for 1957-58 to 1959-60 and against the assessment for 1960-61. Regarding the disallowance of the commission paid to the agency-firm, the Appellate Assistant Commissioner observed in the course of his order that it was not the Income-tax Officer's case that the selling agency was not a genuine firm or that it did not do any service for the assessee. The commission was paid for the services rendered and it had not been shown that the selling agents had not discharged their functions under the agreement. He found that the selling agency firm had incurred large expenses by way of establishment charges, rent and other expenses including commission paid to canvassing agent. He considered the facts, viz., the selling agency firm not being a mushroom concern nor of its being a creature of the assessee-firm, as it had its own business side by side and Chandulal had assisted the selling agency firm as its regular employee from 1953 onwards. In short, he found that the selling agency had its own independent origin and separate existence and was not a mere appendage of the assessee-firm. As regards the earlier years he held that the Income-tax Officer had only changed his opinion on the facts already before him and he, therefore, cancelled the reassessments. As far as the assessment year 1960-61 was concerned, .he was not impressed with the case for the doubling of the commission payment from 5% to 10%. In his view, the selling agents were left with a comfortable margin even after meeting their entire expenses and the increase in the turnover could not be attributed to the personal efforts of the selling agents. He observed that the improvement in the sales might be partly due to the general market conditions. He was satisfied that no case was made out for doubling the commission rate from 5% to 10%. In effect, he disallowed one-half of the commission claimed as deduction.
11. The assessee appealed to the Tribunal for the assessment year 1960-61 and the department appealed against the order of the cancelling the reassessment for the earlier years and also against the allowance of 50% of the commission as claimed for 1960-61. The appeals came to be heard together. As far as the earlier years were concerned, the Tribunal agreed with the Appellate Assistant Commissioner in the matter of cancellation. Nothing more turns on them, as the present reference does not cover the earlier years. As far as the year under reference was concerned, the Tribunal's view was that the department had not made out a case for rejecting the assessee's entire claim for deduction of the agency commission. It pointed out that the agency agreement had been entered into at a timewhen the assessee-firm consisted of two partners, viz., Narayana Chettiar and Ramanlal. Narayana Chettiar was a stranger to all the partners of the agency firm. It did not see anything wrong in Chandulal continuing to take interest in the agency firm and also in the assessee-firm. It was observed that the department had not brought on record any material which required the unsettling of the previous findings whereby the assessee's claim for payment of commission at 5% had been accepted by department.
12. Then, turning to the assessee's claim for deduction of 10% it pointed out that, in spite of the fact that the assessee was getting higher margin in the dealings in the goods of others, it had not asked for any increase in the commission. As regards the dealership commission of 10% given by Mysore Premier Metal Factory, etc., it was of the opinion that there was risk of bad debt and other losses in the case of a dealer, while the selling agent had not to run such a risk. It pointed out that the agency firm had not claimed that the increase in the turnover was due to its efforts and that the enhancement of the commission did not appear to have been prompted by business considerations. After referring to some cases, which we shall presently consider, it came to the conclusion on a study of all the facts of the case that the payment of extra commission was not exclusively and wholly for the purposes of the assessee's business. It is as against this order that the question as already extracted has been referred to this court. The point is confined to the alienability of commission in excess of 5%.
13. On behalf of the assessee its learned counsel submitted that when once the agency firm was found to be genuine, to have rendered services and to have been paid the remuneration as claimed, the Tribunal was not justified in determining a part of the commission as not having been laid out wholly and exclusively for the purpose of the business. His submission was that neither the income-tax authorities nor the Tribunal could justifiably claim to put itself in the arm-chair of the businessman and assume the role of ascertaining how much was the reasonable remuneration having regard to the circumstances. For the department the learned counsel strenuously contended that it was for the assessee to show that the increase in the remuneration or commission was justified, that it was found as a fact that the circumstances pointed out in justification for the increase did not support the claim and that in these circumstances the income-tax authorities and the Tribunal could justifiably disallow a portion of the amount as claimed by the assessee. In effect, his submission was that it would be a tall claim having regard to the language of Section 10(2)(xv) of the 1922 Act or Section 37 of the 1961 Act for the assessee to say that, when once the agency firm was found to be genuine and hadrendered services, the question of reasonableness of the commission was beyond the purview of the income-tax authorities or the Tribunal.
14. The question of deducibility of the remuneration or commission paid in any given case has been considered by the Supreme Court on a number of occasions. In Commissioner of Income-tax v. Chart and Chari Ltd. : 57ITR400(SC) a limited company, which was carrying on business in hides and skins, tobacco and other commodities and as managing agent of companies, ,was appointed as its agent by the Central Government for buying, checking, weighing, leaf drying, storing, transporting, retaining and reselling tobacco in accordance with its directions to be issued from time to time. One of the directors of the assessee-company was placed in special charge of this work, which had to be done both at Guntur and at Madras Port. The company agreed to pay him 30% of the net profit earned under the terms of the appointment of the Central Government as his remuneration. For the assessment year 1952-53 a sum of Rs. 29,094 was claimed as deduction under this head. The Income-tax Officer allowed only 10% of the profits on the ground that the particular director and another director of the assessee in that case were brothers and that the particular director, who was remunerated, was bound to attend to all the activities of the company. The disallowance made by him ultimately reached the Supreme Court. At page 404 it was laid down as follows:
'In considering whether the expenditure to remunerate a person for services rendered is allowable under Section 10(2)(xv), the Income-tax Officer must have regard to all the circumstances, such as, the nature and special character of the service, the practice, if any, in the trade for payment of a percentage of profit to an employee in similar circumstances, the qualifications of the employee for rendering the service, the amount, if any, paid by the assessee to another person for rendering similar service, the normalcy of the allowance having regard to the practice in the trade, the existence of any other extraordinary and abnormal circumstances in the arrangement or special reasons or circumstances which may suggest that the transaction was abnormal, and the like.'
15. At page 406 it was added as follows:
'If the management of the respondent as prudent businessman for advancing the interest of the respondent bona fide regarded 30% of the net profits as reasonable remuneration, the revenue authorities were not justified in reviewing their opinion and reducing the rate of remuneration.'
16. On the facts the Supreme Court, affirming the view of the High Court, allowed the remuneration at 30% as claimed by the assessee.
17. In Commissioner of Income-tax v. Walchand & Co. Private Ltd. : 65ITR381(SC) the Supreme Court had to consider the disallowance of the increase in theremuneration paid to certain directors and executive officers of a company. In that case also the Tribunal had disallowed a part of the increase in the remuneration paid to the directors and executive officers. At page 384, the Supreme Court observed as follows :
'It is open to the Tribunal to come to a conclusion either that the alleged payment is not real or that it is not incurred, by the assessee in the character of a trader or that it is not laid out wholly and exclusively for the purpose of the business of the assessee and to disallow it. But it is not the function of the Tribunal to determine the remuneration which in their view should be paid to an employee of the assessee.'
18. In that case the Supreme Court agreeing with the High Court upheld the allowance of the remuneration as claimed by the assessee. In other words, the disallowance of a part of the remuneration paid to the directors and executive officers was not accepted. The same principle has been reiterated in J. K. Woollen Manufacturers v. Commissioner of Income-tax : 72ITR612(SC) .
19. On the other line, there are cases decided by the Supreme Court which have upheld the disallowance. In Swadeshi Cotton Mills Ltd. v. Commissioner of Income-tax (No. 1), : 63ITR57(SC) a company amended its articles and provided for payment to the directors of a commission of 1% of the net profits in addition to their monthly remuneration of Rs. 100 till then in force. The allowability of the percentage of the net profits to the directors was in question. The Tribunal found that the directors had not rendered any special service, that the remuneration of Rs. 100 per month was not considered by the directors to be inadequate in earlier years and that the increase in the profits of the company was due to the control of cloth having been lifted and not any special exertion of the directors. Therefore, the whole of the increase was disallowed as not having been incurred wholly and exclusively for the purpose of the business. In considering the correctness of this conclusion the Supreme Court observed at page 60 as follows :
'It is an erroneous proposition to contend that as soon as an assessee has established two facts, viz., the existence of an agreement between the employer and the employee and the fact of actual payment, no discretion is left to the Income-tax Officer except to hold that the payment was made wholly and exclusively for the purposes of the business. Although the payment might have been made and although there might be an agreement in existence, it would still be open to the Income-tax Officer to take into consideration all the relevant factors which will go to show whether the amount was paid as required by Section 10(2)(xv).'
20. It was pointed out that this question has to be decided in the light of the circumstances of each case. Having regard to the facts of that casewherein there was a finding that no special service had been rendered, the Supreme Court upheld the disallowance.
21. A Similar question came up for consideration in Lachminarayan Madan Lal v. Commissioner of Income-tax, : 86ITR439(SC) . That was a case where a firm which was manufacturing and selling aluminium utensils, had effected sales direct to the customers up to a particular time. Thereafter, it entrusted the sales to a selling agency firm which consisted of four major partners, three of whom were the wives of the partners of the firm in that case and the fourth a major son of one of them. Two minors had already been admitted to the benefits of the partnership. In effect the share of profit of the partners of the manufacturing firm was equal to the share of profit referable to the share of their wives or relations in the agency firm. There were also findings to show that the selling agency firm had not even come into existence when the selling agency agreement was executed, that the only male adult partner was a partner in another manufacturing firm situated at a different place and that the selling agency firm had no godown of its own nor any transport vehicles to deliver the goods. On these findings the Tribunal reached the conclusion that the selling agency firm was not genuine and that the agreement was only a make-believe arrangement or a device to minimise the tax liability. After reiterating the principles laid down in Swadeshi Cotton Mills Co. Ltd. v. Commissioner of Income-tax (No. 1), the Supreme Court held that the findings of the Tribunal were findings of fact and that it was a case where the assessee, by adopting a device, had made it to appear that the income which belonged to it had been earned by some other person.
22. This question has been considered by a Bench of this court in Commissioner of Income-tax v. Raman and Raman Ltd. : 71ITR345(Mad) . That was a case where a managing director and a director were voted substantial remuneration. The remuneration so paid to them was disallowed by the income-tax authorities. But the Tribunal allowed it in full. In upholding the order of the Tribunal, this court observed at page 348 as follows :
'We accept the principle that for eligibility of an allowance under Section 10(2)(xv), there should be a nexus between the expenditure and the purpose of the business and the expenditure should have been wholly and exclusively laid out for that purpose. The first part of this proposition may not raise any problem of complexity, for its determination will be on a factual basis. From the given facts, it should be easy to say whether there is any connection between the expenditure and the purpose of the business. But the expression, 'wholly and exclusively laid out' is capable of raising fine questions. But we do not propose in this case to embark on that aspect, for it has not been suggested at any stage of the assessment proceedings that factually the payment as remuneration has not been made and in that character. It is also obvious that the remuneration was paid to the directors in that capacity. Once those facts sre found, seldom can the revenue or the court justifiably claim to put itself in the armchair of a businessman or in the position of the board of directors and assume the role of ascertaining how much is a reasonable remuneration, having regard to all the circumstances. That is a matter of business expediency and should be wisely left to the businessman concerned or the board of directors. But that is not to say that the revenue or the court should simply take it for granted that once the payment has been as a fact made as remuneration, it is necessarily wholly and exclusively laid out for the purpose of the business. There may be cases where the quantum of remuneration claimed to have been paid is so patently excessive that it may throw doubt at the honesty and purpose of the outgoing.'
23. Where a person to whom the remuneration is paid is not a genuine entity or the recipient has not rendered any service, then there will be no difficulty in disallowing the amount paid as not having been wholly and exclusively laid out for the purpose of the business. Where, however, the recipient entity is genuine and where it is found that service had been rendered, it would not be proper for the income-tax authorities or the Tribunal to determine what, according to them, can be a reasonable remuneration. Where the amount paid is so patenly excessive, it could throw doubt on the honesty and purpose of the outgoing so as to merit the disallowance. Where, however, it is found that the recipient entity is a genuine one, that it has rendered service and that the remuneration is not patently excessive then it would not be proper to proceed to disallow the amount either on subjective standards or from extraneous considerations. The businessman must have an elbow-room to operate so as to consider for -himself the expenditure to be incurred for the purpose of carrying on his business. It would be difficult to evolve any formula as such in cases of this kind and the question of disallowance has to be considered from the point of view of a businessman and in the light of all the facts and the circumstances of each case.
24. Applying the principle mentioned above, we may consider the justification made by the Tribunal for the disallowance. The fact that the assessee-firm has not asked for increase in the earlier years is neither here nor there. The increase has to be asked for at some particular point of time and it cannot be denied merely because it had not been put up at any earlier point of time. The genuineness of the selling agency firm is not in dispute here and cannot be in dispute especially because it has dealt inother goods for substantial amounts, and earned substantial profits for several years. The fact that it has rendered services has all along been recognised including the year under consideration, as otherwise the remuneration as claimed in the earlier years or a part of the claim in this year would not have been allowed. In our opinion, it is illogical to say that 10% discount would be reasonable if it is allowed to a dealer as such but 10% commission would be unreasonable, if it is allowed to an agent. The fact that an agency was required to market the products is not open to dispute, as in this case, there has been a marketing agency right from the commencement. In fact, the earlier agency of V. C. Ramalingam & Sons was remunerated at 61/4% while the assessee-firm that succeeded it was granted only 5%. The need for the agency having been established, the question ultimately turns on the reasonableness of the remuneration. If 10% as discount is reasonable if paid to a dealer, then the same percentage to an agent cannot be considered so patently excessive as to merit the disallowance. It is true that a dealer would have to bear the losses, while an agent may not have to bear the losses. But this consideration is only theoretical and academic as far as this case is concerned. There is no material to show that the agent herein had entered into sale transactions on credit entailing any loss to the assessee firm. Nor is there any material to show that the assessee-firm was saddled with the accumulated stock of unsold goods as a result of any inaction or failure on the part of the agency firm, to sell the goods. Further, if and when any such loss occurs, it would be open to the assessee to terminate the agreement as it is one at will.
25. The circumstances that the partners of the selling agents are relations of the partners of the assessee-firm cannot cloud the issue here. The appointment as the selling agent was made at a time when Narayana Chettiar was the financing partner and Ramanlal was only a working partner. It is not as if Ramanlal was free to appoint selling agents of his choice without reference to other partners. In our view, the conclusion of the Tribunal that a part of the remuneration was not wholly and exclusively laid out for the purpose of the business is devoid of any material to support it. We consider that the disallowance as made by the Tribunal is not proper.
26. In the result, we answer the question referred in the negative and against the revenue. The assessee will have its costs. Counsel's fee Rs. 250.