RAJAGOPALAN, J. - Of the questions that were referred to this Court under section 66(1) of the Income-tax Act, the two that remain for determination are :-
(I) Whether, on the facts and circumstances of the case, the disallowance by the Excess Profits Tax authorities of the commission paid to branch managers is justified under rule 12 of Schedule I of the Excess Profits Tax Act and
(2) Whether the commission payment to the branch managers, assistant managers and other employees is an expenditure laid out wholly and exclusively for the purpose of the business ?
By its order dated 11th January, 1954, (the judgment has been reported in Rayaloo Iyer and Sons v. Commissioner of Income-tax) this Court directed the Tribunal to submit a further and better statement of the case with reference to these two questions. The Court pointed out that, despite the frame of the questions, the second of the questions had really to be dealt with under section 10(2)(x) of the Income-tax Act and not under section 10(2)(xv). The scope of the two sub-sections and that of rule 12 of Schedule I of the Excess Profits Tax Act was explained by the Court in that judgment. It should, however, be convenient to set out the relevant facts over again before we answer the questions. The Tribunal submitted the statement called for by this Court. The statement was renumbered as R. C. 4 of 1955, though the original references themselves remained to be answered in full.
The assessee was one of the distributors of the products of the Imperial Chemical Industries (hereinafter referred to as the I. C. I.). That business the assessee carried on under the name of 'Colours Trading Company'. The assessee had a number of branches, each in charge of a manager. The number of assistant managers and other employees in a branch depended on the turnover of that branch. The heaviest turnover was in the Madurai and Madras branches. Mahadevan (the son of one of the partners of the assessee firm) was the superintendent of all the branches. The manager and other employees in the branches were in receipt of salaries and dearness allowances. Each of them was also paid a bonus, which in some of the accounting years amounted to a years basic salary. The deductions claimed by the assessee for these payments were all allowed. In addition to these expenses, the assessee claimed that it had allowed a special commission to its managers and assistant managers in the several branches in the relevant accounting years and the relevant chargeable accounting periods. But that claim was disallowed by the taxing authorities, with whom the Tribunal agreed.
The assessee was paid a basic commission by the I. C. I. on the sale price of their products. That basic commission ranged from 7 1/2% to 12%, depending on the nature of the products. That commission the assessee retained for itself. In addition to this basic commission, the I. C. I. allowed what was called an 'emergency' commission between 1st January, 1944, and 1st April, 1949. It was 5% from 1st January, 1944, to 1st March, 1945, 15% from 1st March, 1945, to 1st September 1946, 10% from 1st September, 1946, to 15th April, 1948, and 5% from 15th April, 1948, to 1st April 1949. The additional commission was discontinued after 1st April, 1949. Even when announcing the grant of this additional or emergency commission, the I. C. I. advised the assessee, along with the other distributors, to share this additional commission with its sub-dealers. The assessee was asked to pass on not less than 1% of the additional 5%. When the additional commission was raised to 15%, the assessee was asked to pass on the sub-dealers not less than 6% and when the additional commission was reduced to 10%, the assessee was asked to pass on not less than 4% to the sub-dealers. It should be noted that the I. C. I. suggested only the minima that should be paid to the sub-dealers. Whether more than the minima should be passed on to the sub-dealers was left to the discretion of the distributor, in this case, the assessee. But that the emergency additional commission should be shared with the sub-dealers was what the I. C. I. made clear.
The assessee accepted the suggestion of the I. C. I. and shared the emergency commission, which it obtained, with its managers and assistant managers in its several branches, giving them the benefit, which would have gone to the sub-dealers had there been any. The assessee paid to its employees more than the minima recommended by the I. C. I. The details of the total additional commission received from the I. C. I., the sums paid out to the several employees and the turnover of each branch were furnished in the statements submitted by the Tribunal and marked Annexure C series to its original statement. A tabulated summary was furnished by the Tribunal in paragraph 6 of its further statement. The maxima and the minima and the percentages allowed to each employee were also shown in the tabulated summary. If however each branch was considered as a unit, the maxima were in some cases higher than those recorded by the Tribunal in this summary.
In 1944-45, the assessee received an additional 5% commission and it passed on 4 1/2% of this to the managers at Madurai and Madras, with two employees each to share that 4 1/2%. The managers of the other branches each got 4%. The minimum recommended, it should be remembered, was only 1%. In 1945-46, the assessee received 15%. The minimum recommended was 6%. The assessee actually paid out 10% to the managers at Madurai and Madras; four employees in each of these two branches shared at 10%. The managers of the other branches were each paid 7 1/2%. They were all paid at the same rates up to 1st February, 1946, during 1946-47. After 1st September, 1946, the additional commission the assessee received from the I. C. I. was reduced to 10%. The minimum recommended was 4%. The assessee paid a total of 4 1/2% to two employees at Madurai, 3 1/2% to an employee at Madras, and 4% to each of its employees at its other branches. In 1947-48, the additional commission was 10% and the minimum recommended was 4%. Four employees at Madurai between them got 7 1/2%, five employees between them at Madras got 7%, two employees at Rajapalayam between them got 5% and one employee at each of the other branches, except Pondicherry, got 4%. The manager at Pondicherry was paid only 2%.
Thus, while the assessee passed on a substantial share of the additional emergency commission to its managers and assistant managers in the branches, well above the minima recommended by the I. C. I., the rates themselves were well within the percentages allowed by the I. C. I. as additional commission; and the balance of the additional commission retained by the assessee after these payments was also substantial, as the tabulated summary in paragraph 6 of the further statement of the Tribunal showed.
That the payment were all made to the employees was not doubted by the Tribunal. The Tribunal did not find that any consideration other than that of business actuated those payments. Whether the claim for reduction preferred by the assessee satisfied the conditions of section 10(2)(x) of the Income-tax Act and rule 12 of Schedule I of the Excess Profits Tax Act was what the Tribunal had to determine. In paragraph 16 of its further statement, the Tribunal recorded :
'...... in all the circumstances of the case, it must be held that the assessee had failed to make out a case for the payment of any emergency commission over and above the minimum suggested by the I. C. I. in their aforesaid letters (annexures D, D-I and D-2), and in any event, the entire facts are hereby placed before their Lordships for consideration.'
Whether the material on record justified such a restriction of the claim of the assessee is the question we have to determine.
In paragraph 9 of its further statement of the case, the Tribunal correctly summarised the points it was directed to keep in view by the order of this Court dated 11th January, 1954. The Tribunal rightly held that the fact, that the additional commission was shared with managers and assistant managers of branches, who could not strictly be called sub-dealers, did not affect the validity of the assessees claim either under section 10(2)(x) of the Income-tax Act or under rule 12 of Schedule I of the Excess Profits Tax Act. The Tribunal also kept in view what was pointed out by this Court, that the object of the I. C. I. was that the additional commission should not be retained in full by the assessee. The other factors they had to consider were : (1) the reasonableness of the commission had to be judged in the light of the conditions laid down in section 10(2)(x) of the Income-tax Act; (2) whether the percentage allowed, which was above the minimum suggested by the I. C. I. was reasonable or not in the circumstances; and (3) the need for maintaining the good reputation of the I. C. I. and the distributor in the conditions that prevailed during that period when blackmarketing in such products was rampant.
We are constrained to observe that the Tribunal made no real attempt to analyse the evidence before it or justify its conclusion, that only the minima recommended by the I. C. I. satisfied the requirements under section 10 (2)(x) of the Income-tax Act or rule 12 of Schedule I of the Excess Profits Tax Act, and that anything in excess would not satisfy the test of reasonableness.
Three factors are prescribed by section 10(2) of the Income-tax Act :
(a) the pay of the employee and the conditions of his service;
(b) the profits of the business for the year in question; and
(c) the general practice in similar businesses,
The Tribunal observed that there was no acceptable evidence to prove any general practice in similar businesses. It was an exceptional situation created by the I. C. I. that the additional commission should be shared could itself be viewed in the circumstances of this case as regulating the practice of that trade during that period. Of course, there was no evidence of any practice to indicate what would constitute a reasonable share as between the distributor and the person who actually sold the goods.
We are thus left with the question, whether the test of reasonableness prescribed by section 10 (2)(x) was satisfied with reference to the other two factors, emoluments and conditions of service of the employee and the profits made by the assessee.
Though the Tribunal had detailed lists of the different sub-heads of the payments made to the employees, there is really nothing in the appellate order or even in the further statement of the case to show that the Tribunal applied its mind to these details, or to explain why the Tribunal considered that the payments in excess of the minima recommended by the I. C. I. did not satisfy the test of reasonable expenditure. The amount paid out was no doubt large in each year. But there were so many employees to share it. Even after that payment, a substantial amount was retained by the assessee as its share of the emergency commission, i.e., its profits. Whether the test of reasonableness is that prescribed by section 10(2)(x) of the Income-tax Act, or whether the reasonableness has to be judged with reference to commercial expediency under rule 12 of Schedule I of the Excess Profits Tax Act, the reasonableness of the expenditure should be judged from the point of view of the businessman, and not by the application by subjective standard of a taxing officer. No doubt, the Tribunal appeared to abandon that subjective standard along with the decision based on that when it submitted the further statement. But it appears to have surrendered its judgment to that of the I. C. I., apparently overlooking the fact, that what the I. C. I. recommended was only the minimum that they expected their distributors to pass on to the persons who actually sold the goods. One of the questions the Tribunal set itself out to consider was whether payments in excess of the minima were reasonable. But on what basis the Tribunal considered them unreasonable we were really unable to gather even from the further statement of the case submitted by the Tribunal. If it was again only a subjective satisfaction, that the excess over the minimum was not reasonable, there was no room for the adoption of any such standard. We have considered the details furnished in Annexure C series, and we are unable to see anything per se unreasonable in the percentages actually adopted by the assessee for payment to the managers and assistant managers in the branches, though they were in excess of the minima recommended by the I. C. I. As we have pointed out, the payments were made and the payments were not actuated by any consideration other than that of the needs of his business in those years. If there was nothing unreasonable in the I. C. I. allowing an extra 15% as commission, with the virtual direction to share it with those who sold the products, a payment of even up to 10% does not become unreasonable. We are certainly not prepared to hold that the minimum recommended by the I. C. I. provided this 5th standard or even an absolute standard for judging whether anything paid in excess would be unreasonable. No doubt, the employees of the assessee were in receipt of regular salaries and bonuses. But then, a sub-distributor, if he had not been paid a salary, would have had to be paid a share of the basic commission itself. What the assessee got in the years in question was in the nature of a windfall. It shared it with its employees. It had been instructed to share it. The emergency commission was allowed by the I. C. I. so that the distributors could maintain the reputation of the I. C. I., in the market even under the disturbed conditions that prevailed in those years. If, to maintain that reputation and to maintain its own, the assessee paid to its employees even on a liberal basis a share of that emergency commission, it is a little difficult to hold that, while receipt of the emergency commission was reasonable, sharing it beyond a particular point would be per se unreasonable, in the sense that no prudent businessman in that line of business, in those years, and in the market conditions that prevailed then, with ample scope for black-marketing, would have paid out commission on such a basis.
We shall refer only to two features of the assessees case among those considered by the Tribunal to show that the Tribunal made no real attempt to appreciate the view point of the businessman, even after it had been told by the Court that that was the only view point that mattered. The Tribunal pointed out that a large commission was paid to the managers and assistant managers at Madurai, though that was the headquarters of the assessee, and though the superintendent of the branches, Mahadevan, was also at Madurai. Surely the Tribunal did not expect the partners of the assessee firm or even the superintendent, who was there to supervise the work in all the branches, to sit at the counter and attend to the sales at the Madurai branch. And Madurai had about the largest turnover among the branches of the assessee firm. The other feature on which the Tribunal commented was that, while the assessee told its managers in advance that only those with turnover of over a lakh in a year would be eligible for the commission which the assessee was prepared to pay from out of the emergency commission it received from the I. C. I., the assessee ultimately paid commission even at those branches which showed a turnover of less than a lakh. The Tribunal apparently declined to allow any discretion to the assessee in running its own business.
Though of course, it was for the assessee to show that it was entitled to the deductions claimed under section 10(2)(x) of the Income-tax Act and rule 12 of Schedule I of the Excess Profits Tax Act, there was really no basis on record to show that, judged from the point of view of a businessman, payments in excess of the minima recommended by the I. C. I. were not reasonable. We are of opinion that the entire claim should have been allowed both under section 10(2)(x) of the Income-tax Act and under rule 12 of Schedule I of the Excess Profits Tax Act on the ground that the statutory requirements were satisfied by the assessee.
The first question is answered in the negative and in favour of the assessee. The second question, as we have already pointed out, has to be answered with reference to the requirements of section 10(2)(x) of the Income-tax Act, and our answer to that question is that the amount of commission paid out by the assessee to its branch managers and assistant managers was reasonable.
The assessee will be entitled to its costs in each of the two references, 53 of 1952 and 44 of 1953. Counsels fee Rs. 250.
Reference answered in favour of the assessee.