1. The following question has been referred by the Appellate Tribunal, Calcutta Bench, to the High Court for its opinion:
'Whether on the facts and in the circumstances of this case, the sum of Rs. 22,500 was taxable in the hands of the applicant company.'
2. The applicant is a private limited company incorporated in August 1932. From the Memorandum of Association of the company, it appears that it was brought into existence to float various companies including cotton mills.
3. In November 1932 a cotton mill was floated under the name of Basanti Cotton Mills Ltd. By Article 132 of the Articles of Association, the applicant company, the Calcutta Agency Ltd., was appointed the Managing Agent of the said Mill.
4. The Managing Agents were to receive a monthly allowance of Rs. 500 so long as the subscribed capital did not exceed Rs. 5,00,000 and a commission of 3 per cent on all gross sales of goods manufactured. In case the subscribed capital exceeded Rs. 5,00,000, then for every Rs. 2,00,000 of the increase the Managing Agents were to get an additional monthly allowance of Rs. 150.
5. It appears that Nath Bank Ltd. instituted four suits against the Basanti Cotton Mills Ltd. In two out of the said four suits the Calcutta Agency Ltd. was impleaded as the co-defendant. The claim of the Nath Bank Ltd. was on certain hundies drawn by one Mr. S. C. Mitter purporting to act on behalf of the Calcutta Agency Ltd. These suits were decreed for Rs. 31, 593/9/3 and Rs. 21, 054/2/9. These decrees were passed by consent of the parties,
6. In the other two suits in which the applicant company was not a party decrees were passed for Rs. 1,15,735/12/5 and for rupees 21,593/8/3.
7. An agreement was entered into between the applicant company and the Basanti Cotton Mills Ltd. Inasmuch as good deal of argument has been advanced on the language of this agreement, the same is set out below :
'Memorandum of Agreement made between the Calcutta Agency Limited of the one part and Basanti Cotton Mills Limited of the other part Whereas the Nath Bank Limited demanded from the Mills the payment of the sum of Rs. 1,80,000 and interest thereon And Whereas the said Mills repudiated their liability in respect thereof as it appeared from the books of the said Mills that the said mills did not have the use of the said sum of Rs. 1,80,000 or any part thereof And Whereas the said Nath Bank Limited thereupon instituted four suits in High Court being suit Nos. 1683, 1720, 1735 and 1757 of 1939 for the said aggregate sum of Rs. 1,80,000 and the interest thereon And Whereas the said Mills have been advised to settle the said suits amicably And Whereas the Calcutta Agency Limited by its Directors S.N. Mitter or S.C. Mitter, having been and being still the Managing Agents of the said Mills have undertaken to reimburse the said Mills in respect of the decrees to be made in the said four suits in the manner hereinafter appearing NOW THESE PRESENTS WITNESS AND IT IS HEREBY AGREED AND DECLARED.
(i) That out of the commission of 3% payable by the said mills to the said Agency under Regulation 131 of the Articles of Association of the Company, the Company shall have a paramount lien on and deduct and set off a moiety thereof against any payment which the Slid Mills may make in respect of the said decrees or any of them and/or costs of the said suits.
(ii) The said moiety shall be one half of the commission so payable less such sum as the Directors of the Mills may from time to time allow to be deducted.'
8. By virtue of this agreement, the applicant company was in effect given Rs. 22,500 less than what was due to it by way of its remuneration.
9. Before the Income-tax Officer it was urged on behalf of the applicant company that the sum of Rs. 22,500 should not be taxed in its hands as it was diverted by virtue of the above agreement and was paid to the Nath Bank by the Basanti Cotton Mills Ltd. and this sum therefore, did not reach the applicant as remuneration. Both the Income-tax Officer and the Appellate Assistant Commissioner repelled this contention of the applicant.
10. Before the Tribunal Mr. Mitra, learned counsel on behalf of the applicant company, contended that the remuneration received by the applicant was in the nature of salary or commission within Section 7, Income-tax Act. In this Court, Mr. Mitra put forward the same contention and relied on the first proviso to Section 7. Section 7 states that tax shall be payable by an assessee under the head 'salaries' in respect of any salary or wages, any annuity, pension or gratuity, and any fees, commissions, perquisites or profits in lieu of, or in addition to, any salary or wages, which are due to him from an employer. The first proviso to Section 7 runs as follows:
'Provided that the tax shall not be payable in respect of any sum which the assessee by the conditions of his employment is required to spend out of his remuneration wholly, necessarily and exclusively in the performance of his duties.'
11. Mr. Mitra urges that payment out of the commission of the sum aforesaid was made by the applicant company 'wholly, necessarily and exclusively' in the performance of its duties. Mr. Mitra's argument was that unless the company agreed to pay the amount aforesaid, its managing agency would have been terminated by the Mills and therefore such payment came within the said proviso to Section 7.
12. The Tribunal held that the proviso to Section 7 was not intended to cover payment of this nature. It is difficult to bring this payment within the first proviso to Section 7. The expenditure must be made wholly, necessarily and exclusively in the performance of its duties. In my opinion, the payment made by the Managing Agents under the aforesaid agreement is not a deduction permissible under the said proviso to Section 7. That proviso was introduced to cover cases where a gross sum is fixed as salary or commission, which includes a necessary outlay on the part of the assessee in the carrying out of his duties. The deduction under that proviso can be made when the assessee is required by the terms of his employment to spend the amount in question and such expenditure must be incurred not only exclusively but necessarily for the performance of its duties. If there is no stipulation in the contract of service or employment to spend a particular amount, then the deduction is not permissible under the first proviso to Section 7. For example, when an engineer is appointed to supervise certain works outside the city and is required to maintain a motor car fox the purpose of inspecting the work site in the course of his duties, then the proviso would be attracted, as the expenditure would be then incurred necessarily and wholly in the performance of his duties.
13. The next argument put forward by Mr. Mitra was that the expenditure came within Section 10 (2) (xv), Income-tax Act. Section 10 deals with the tax payable by an assessee in respect of profits and gains of business, profession or vocation. Clause (2) specifies permissible allowances or deductions. Sub-clause (xv) mentions :
'Any expenditure (out being in the nature of capital expenditure or personal expenses of the assessee) laid out or expended wholly and exclusively for the purpose of such business, profession or vocation.'
14. Mr. Mitra's argument is that if the applicant company had not agreed to pay the amount mentioned in the aforesaid agreement, then the Basanti Cotton Mills Ltd. would have sued the company for the realisation of the amount due on the Hundies and it seems that there would have no defence to the action. This would have subjected the applicant company to the danger of public exposure and in order to save itself from the scandal and in order to maintain the Managing Agency the applicant company agreed to deduct certain amounts from the Managing Agency commission and, therefore, such expenditure came within Section 10 (2) (xv) of the Act.
15. Reference has been made to the case of Mitchell v. B. W. Noble Ltd., (1927) 1 K.B. 719 : (96 L. J. K. B. 484). A company, which carried on an insurance business wanted in the interest of its business to get rid of one of its directors. The company entered into an agreement with him under which in consideration of a payment to him by the company of 19,200, the director undertook to retire from the company, to sell and transfer the 300 1 shares held by him in the company to the remaining directors at par, and to abandon all claims that he might have against the company, or its directors. The other directors were parties to this agreement. 19,200 was payable in five annual instalments. The company paid the first instalment of 5200 and sought to deduct it for income tax purposes from the profits in the year of payment as being money wholly and exclusively laid out for the purposes of the business. The commissioners allowed the claim, Rowlatt J., held that inasmuch as the directors were satisfied that in order to save the company from scandal it was necessary to get rid of the director and to pay him the sum in question, that sum must be regarded as money 'wholly and exclusively laid out and expended for the purposes of the trade' of the company within the meaning of Rule 3 of the Rules applicable to cases I and II of Schedule. D.
16. The Court of appeal affirmed Rowlatt J., and held that the payment was not made to secure an actual asset so as effectually to increase the capital of the company, but was made in order to enable the directors to carry on the business of the company as they had done in the past, unfettered by the presence of the retiring director which might have had a bad effect on the credit of the company and, therefore, it must be treated as an income and not as a capital expenditure, and was deductible as such for income-tax purpose's.
17. Rowlatt J., held that the payment made to the director to get rid of him was a business expense and that it was not a capital expense. The learned Judge observed :
'But is it a capital expense on any ground As Lord Cave points out in British Insulated and Helsby Cables Ltd. v Athorton, 1926 A. C. 205: (95 L.J. K.B. 336), it is a capital expense if you buy an asset or purchase an enduring advantage. This was not that case or anything like it.'
18. Dr. S.K. Gupta strongly urged that the payment which was made in this case was really not a business expense but it was a capital expense and, therefore, not deductible. He drew our attention to the judgment of Viscount Cave L. C. in British Insulated and 'Helsby Cables Ltd. v. Athorton, 1926 A.C. 205: (95 L.J.K.B. 336). In that case, the House of Lords held that a lump sum set aside out of profits for contribution to a pension fund was in the nature of capital expenditure and was, therefore, not an admissible deduction. In his speech Viscount Cave L. C. said:
'But when an expenditure is made, not only once and for all, but with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade, I think that there is very good reason (in the absence of special circumstances leading to an opposite conclusion) for treating such an expenditure as properly attributable not to revenue but to capital.'
19. Mr. Gupta argued that this payment in satisfaction of the decree was made with a view to bring into existence an advantage for the enduring benefit of the trade of the applicant company and thus it came within the dictum of Viscount Cave.
20. It is to be observed, however, that the Lord Chancellor in Atherton's case, (1926 A. C. 205 : 95 L. J. K. B. 336), further pointed out that
'a sum of money expended not of necessity and with a view to a direct and immediate benefit to the trade but voluntarily and on grounds of commercial expediency, and in order indirectly to facilitate the carrying on of the business, may yet be expended wholly and exclusively for the purposes of the trade.'
21. Atherton's case: (1926 A. C. 205 : 95 L. J. K. B. 336) was discussed at some length before the Court of appeal in Mitchell case: (1907-1 K. B. 719 : 96 L. J. K. B. 484). Lord Hanworth M. E. held that when payment is made in the course of business, with reference to a particular difficulty and is made not in order to secure an actual asset to the company, but to enable the company to continue to carry on, as it had done in the past, the same type and quality of business, it is not a capital expenditure. Sargant L.J. took the same view and pointed out that the payment was being made to the director in order to get rid of him and to preserve the status and dividend earning power of the company and that was within the ordinary purposes of the trade, profession or vocation of the company. The learned Lord Justice observed :
'It is quite impossible to put against the capital account of the company, as I conceive it a payment of this nature. It seems to me that the payment, though large and though exceptional, was not of such nature; it certainly was not capital withdrawn from the company, or any sum employed or intended to be employed as capital in the business. It was a payment which as a matter of fact was made out of the profits of the company, apparently, as to the 5200, in the year in which it was paid, and, as to the future payments, they will have to be made out of the profits of the year in which those payments will have to be made. To my mind, it is essentially different from those various payments in the cages which have been referred to which were of the nature of adding to or improving the equipment; or otherwise made for the permanent benefit of the company.'
Lawrence L. J. was of the same view and said:
'I agree that the sum in question was wholly and exclusively expended by the company for the purpose of its business, in the sense that the sole object with which the company made the payment was to enable the company to continue to carry on and earn profits in its business.'
22. The ratio decidendi of Mitchell's case, (1927-1 K. B. 719 : (96 L. J. K. B. 484) is this. If an expenditure is made not to secure an actual asset but to remove a difficulty in carrying on the business and if it is made to continue the business on the same lines as before, then the expenditure is from revenue and not from capital. Mitchell's case, (1927-1 K. B. 719 : 96 L. J. K. B. 484) was followed in Anglo Persian Oil Co., Ltd. v. Dale, 1932-1 K. B. 124 : (100 L. J. K. B. 504). In Dale's case, (1932-1 K. B. 124: 100 L. J. K. B. 504), a payment was made to determine an onerous agency agreement and it was held to be a revenue payment and was deductible by the company in ascertaining its net profits. The observation of the Lord Chancellor in Atherton's case, (1926 A. C. 205 : 95 L. J. K. B. 336) was explained by the Court of Appeal. It was pointed out that the payment in question in Dale's case, (1932-1 K. B. 124 : 100 L. J. K. B. 504) did not bring any assets into existence and it could not properly be said to have brought into existence an advantage for the enduring benefit of the company's trade within the meaning of that expression as used by Viscount Cave.
23. Mr. Mitra cited the case of Bijoysing Dhudhuria v. Commissioner of Income tax . In that case by a decree a maintenance allowance in favour of a step-mother was made a charge upon the ancestral estate of a Raja. It was held that the decree diverted a portion of his income from the assessee and had directed it to his stepmother. To that extent what he received for her was not his income. The Privy Council observed:
'It is not a case of the application by the appellant of part of his income in a particular way; it is rather the allocation of a sum out of his revenue before it becomes income in his hands.'
Really in charging the income of an individual the Income-tax Act intends to charge what reaches the individual as income. It was pointed out by Dr. Gupta that in Jagadish Chandra v. Dhanpati Singh : 13ITR64(Patna) , a Division Bench of Patna High Court has held that where a testator has bequeathed his properties to another creating a charge for an annuity for maintenance the principle laid down in Dhudhuria's case will apply and the annuity will not become income of the legatee, but where the legatee himself creates a charge for a debt payable to him that principle will not apply. In Dhudhuria's case , however, the decree had been passed by consent of parties and there was no testamentary disposition by the Raja's father creating any charge.
24. Dr. Gupta drew our attention to Commissioner of Income-tax v. Manager, Katras Encumbered Estate, 13 Pat. 197 : (A. I. R. (21) 1934 Pat. 116 S.B.). In that case the proprietor of a coal mine owed monies to a company. To secure the repayment of the monies, due the proprietor mortgaged the mine to the company. He also executed a lease of the mine to the same company at a royalty. It was provided that a minimum sum of Rs. 8,000 a year was to be paid to the proprietor himself and the balance of royalty was to be applied by the mortgagee to the liquidation of the debt under the mortgage. It was held that the whole of the royalty was to be considered the income of the assessee and was assessable to income tax. Courtney Terrell C. J. distinguished the Dhudhuria case and pointed out that the position was entirely different when out of the profits or income a portion was to be paid to liquidate a debt.
25. The learned Judges in the Katras case, (13 Pat. 197 : A. I. R. (21) 1994 Pat. 116 S.B.), however, had not to deal with facts which are present in this case. The assessee in that case was being taxed as an individual and there was no question of taxing any business and there was consequently no question of any allowance or deduction in respect of payment being made in order to enable a business to continue its same course as before.
26. Of all the cases cited Mitchell's case, (1927-1 K. B. 719: 96 L. J. K. B. 484) most closely resembles the present case. The real question is what was the object of the agreement which provided for payment by the Mills to the Nath Bank. In Mitchell's case, (1927-1 K. B. 719 : 90 L. J. K. B. 484), the payment was made to a Director whose presence was detrimental to the company's business and the money was paid in order to avoid the publicity of an action for wrongful dismissal and it was held to be a proper deduction in arriving at the profits. In this case it is clear that the agreement was entered into with a view to avoid the publicity of an action against the managing agent and consequent exposure and scandal and in order to maintain the managing agency so that the company could carry on its business as before. The payment in question did not bring in any new assets into existence nor in my opinion can it properly be said that it brought into existence an advantage for the enduring benefit of the company's trade. The appellate tribunal observed that the decree was evidently passed against the appellant company for certain misfeasance committed by its directors and the appellant company agreed to pay it off from its remuneration. The method of book-keeping is, however, not conclusive. The object of the agreement was to enable the company to remove a difficulty in carrying on the business of the company and to earn profits in its business. Therefore, this case is covered by the judgment of the Court of Appeal in Mitchell's case, (1927-1 K. B. 719 : 96 L. J. K. B. 484) and the payment should be treated as expenditure from revenue and not from capital and is a proper deduction in the computation of profits or gains.
27. The payment here cannot be attributed to capital inasmuch as it was not made with a view to bringing a tangible asset or advantage into existence. It is also to be noted that in order to make it a capital payment the asset or advantage is to be for the 'enduring' benefit of the trade. As Rowlatt J. said by ''enduring' is meant 'enduring the way that fixed capital endures.' Romer L. J. approved of this view in Dale's case, (1932-1 K. B. 124 :100 L. J. k. B. 504). Therefore, the payment or expenditure in question was made or incurred in the conduct of the business of the company and it is not a capital expense.
28. I answer the question framed in the statement of case in the negative and I hold that in the facts of this case the sum of Rs. 22,500 is not taxable in the hands of the applicant company. The applicant is entitled to the costs. of the reference certified for two counsel.