1. This reference under Section 66(2) of the Income-tax Act 1922 relates to the assessment year 1954-55, the corresponding previous year of which ended on the 30th June 1953. The facts are briefly stated as follows:
2. The assessee was a Private Limited Co. prior to October 1949 when it was converted into a public Limited Co. The private company had been incorporated on 6th November 1942 with a fully paid share capital of Rs. 10 lacs divided into 10,000 shares of Rs. 100/- each and the shares were held by Shri Dayaram Poddar and the members of his family and, in particular, Shri Dayaram Poddar and his two sons, who were also the Directors of the private company, held 6365 shares, i.e., more than 63 per cent of the total share holding. Remuneration of the Directors was provided for in the Art. 16 of the Articles of Association of the Private Company at the rate of Rs. 16/- at every meeting in addition to travelling allowance etc. as might be decided upon. The conversion of the private company into a public company was effected by the share-holders of the former company at an extraordinary general meeting by means of a resolution. The capital structure of the company was not changed but the relevant article for the remuneration of the Managing Director was modified in the following manner:
'The remuneration of the Managing Director shall be as follows:
(a) An office allowance of Rs. 500/- per mensem payable monthly;
(b) A commission of the net annual profits of the company at the rate of 10 per cent. The net profit will be calculated in accordance with the provisions of Section 87(3) of the Indian Companies Act.'
3. In the relevant previous year a sum of Rs. 6,000/- was paid to Shri Dayaram Poddar, the Managing Director as his office allowance besides a sum of Rs. 4,078/- as commission. The Income-tax Officer allowed only Rs. 200/-as office allowance per month and disallowed the balance of Rs. 300/- per month as well as the entire amount of commission as expenditure not incurred for the purpose of the business. The assessee's appeal was dismissed by the Appellate Assistant Commissioner. Thereafter, in second appeal, the Tribunal confirmed the order of the Income-tax Officer as to the Managing Director's remuneration of Rs. 200/- per month but it held that a commission of 5 per cent of the net profits should also be allowed as the remuneration and accordingly allowed the appeal in part. On the above facts the following question of law has been referred to us;
'Whether the Tribunal was justified in refusing to allow deduction in respect of the remuneration of the Managing Director at Rs. 500/- per month plus commission of 10 per cent on net profits as provided in the company's articles on the ground that the fixing such remuneration was not for the business purpose but for some extra commercial reasons and, therefore, the amount was not wholly and solely laid out for the business.'
4. Dr. D. Pal, learned Advocate for the assessee has submitted before us that the Tribunal's order should be set aside inasmuch a the Tribunal has no jurisdiction to reduce the rate of commission fixed by the company. He has not contended the extreme proposition, namely, that the adequacy and reasonableness of the Managing Director's remuneration can only be decided by the company itself and that the Income-tax Officer cannot decide what would be the fair remuneration. He has submitted that the Tribunal in its order has only laid emphasis to one fact that at the time of conversion of the private company into a public company the Share-holders taking advantage of their majority incorporated an Article entitling the Managing Director to receive the remuneration, and on that basis alone has come to the conclusion that the remuneration is not quite for the purpose of business and for some extra commercial reasons and therefore the amount paid to the Managing Director was not wholly and solely laid out for business. According to him the adequacy or reasonableness of a Managing Director's remuneration cannot be determined by a subjective or arbitrary standard. There has been no finding by the Tribunal that the Managing Director did not render actual services to the company nor, he added, the Tribunal has found that the payment to the Managing Director was collusive or mala fide. He has particularly stressed the fact that inasmuch as the Tribunal has not dealt with or determined the correctness or validity of the findings of fact set out in assessment order of the Income-tax Officer, the department cannot rely upon those findings before us for substantiating the order of the Tribunal to the effect that the Managing Director's remuneration as provided in the Articles was for extra commercial reasons and not wholly and solely laid out for the business.
5. In our opinion, Dr. Pal's contention cannot be accepted in the facts of the instant case. The Managing Director's remuneration has been claimed by the assessee as a deductible allowance under Section 10(2)(xv) which reads us follows:
(2) such profits or gains shall be computed after making the following allowances, namely:
(xv) Any expenditure (not being an allowance in the nature described in any of the Clauses (i) to (xiv) inclusive and not 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'.
It is now a settled Jaw that though the question whether an item of expenditure is wholly or exclusively laid out for the purpose of the assessee's business must be decided on the facts of each case, the final conclusion is one of law; Vide Commr. of Income-tax v. Royal Calcutta Turf Club : 41ITR414(SC) ; Eastern Investments Ltd. v. Commr. of Income-tax : 20ITR1(SC) . The conclusion arrived at by the Tribunal should therefore follow from the evidence on record. We agree with Dr. Pal that in arriving al such conclusion the Tribunal should not he guided by a subjective test. The adequacy and the reasonableness of a Director's remuneration should be based on some objective facts. By the subjective test if he means that the Tribunal cannot make a decision arbitrarily or on an individual fiat, we see no reason to differ with him. But if he contends that the Revenue or the Tribunal cannot interfere with the company's decision to increase the Director's remuneration in any case we cannot agree. The company may increase the Director's remuneration without cogent reasons, but the Income-tax Authorities are not bound to accept the increase. Similarly the Revenue Authorities cannot question the quantum of the remuneration or honorarium of the Managing Director in cases where there are some materials on the basis of which the increase can be justified. A mere ipse dixit on the part of the share-holders of a company or by the Tax authorities will not do. There must be some objective facts or positive grounds on the basis of which a legitimate case for increased remuneration should be made. Once there are some materials to show that there are positive facts which may justify the increase of remuneration or salary, the Revenue cannot challenge the reasonableness of the amount on the ground that the remuneration is extremely disproportionate. This view is supported by the observation of Lawrence J. in Copeman v. Williams Flood and Sons Ltd., (1941) 24 Tax Cas 53 where at p, 26 he stated:--
'It does not follow that because the sums of money were paid to the Directors as remuneration that they were necessarily wholly and exclusively laid out for the purposes of trade.'
6. This case was followed in L. G. Berry Investment Ltd. v. Attwool, (1964) 2 All ER 126 where Ploughman J. at p. 129 has observed:
'1. am only concerned with the question of law, namely, is the whole of the Director's remuneration which has admittedly been properly voted and paid in accordance with the Articles of Association of the tax-payer company necessarily expenses of management? That it is in law capable of being expenses of management there can be no doubt; but I agree with the special commissioners that whether in any particular case the whole of the Director's remuneration is expenses of management is a question of fact. Suppose that in this case the net surplus had been not pound 1,800 but pound 18,000 or pound 1,80,000 and suppose that that increase has been due merely to the fact that the same investments had been of larger amount and that no more work in managing the tax-payer company had then voted the Director's pound 18,000 or pound 1,80,000 as remuneration, could it then be said that the expenses of the management of the business of the company must necessarily increase ten-fold or a hundred fold: T think no.'
7. Dr. Pal has referred us to Walchand and Co. (Private) Ltd. v. Commr. of Income-tax, Bombay City : 48ITR638(Bom) ; Raman and Raman Ltd. v. Commr. of Income-tax, Madras : 46ITR400(Mad) but we need not discuss those oases because in both the cases there are positive finding of facts on the basis of which the increase of remuneration has been legitimately made. Both the learned Advocates for the assessee and the department have relied on the Newton Studios Ltd. v. Commr. of Income-tax, Madras : 28ITR378(Mad) where a Division Bench of the Madras High Court has discussed the applicability of Section 10(2)(xv) to the case of Directors remuneration. The facts of the case may be stated as follows:
8. The assessee was a Private Limited Co. owning a studio and engaged in the production of motion pictures. There were six shareholders, namely (1) Mr. R. M. Ramanathan Chettiar (2) Mr. Jittan Banerjee (3) Mr. D.K. Tehrani (4) Mr. F. Nagoor (5) Mr. Veerappa Chettiar and (6) Mr. Natarajan Chettiar. The first four persons rendered services to the company as Managing Director, Chief Cameraman, Chief Sound Engineer and Art Director respectively and the first three were also Directors of the company. The remuneration of these four persons was fixed in 1938 at an honorarium of about Rs. 250/- each and a commission at a certain percentage of the net profits. From time to time the honorarium was increased after being duly sanctioned by resolutions of the company, but no alteration was made in respect of the commission fixed. In 1944 and 1945 the honorarium paid to these four persons amounted to Rs. 18,000/- a year. For 1946 the remuneration was increased to Rs. 59,100/-. In view of the increase in the profits the Income-tax authorities allowed Rs. 36,000/- out of the sum of Rs. 59,100/- as business expenditure and refused to allow the balance of Rs. 23,100/-. The High Court on a reference, holding that the said sum of Rs. 23,100 should be allowed as deduction under Section 10(2)(xv) has stated at p. 385 (of ITR): (at p. 647 of AIR):
'Tender 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 does not clothe the taxing authorities with any power or jurisdiction to determine the reasonableness of the amount so fixed 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 business. If the reality of the payment is challenged or is in dispute different considerations arise: So also in cases where the taxing authorities are able to point some consideration other than the purposes 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 the business expediency, could and should be disallowed; but the reasons 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 authorities the remuneration is 'unreasonably' high either because the employee does not in the opinion of the authorities, deserve so much, or because the assessee could have secured other employees on some favourable terms.
9. We respectfully agree with the principles enunciated but, in our opinion, the facts of that case are distinguishable from those in the instant case. In that case there were objective facts on the basis of which the Tribunal should have come to the conclusion that the increased honorarium of the Directors was an expenditure solely and exclusively for the business. The four persons whose remunerations were increased were technical hands and the net profits of the company had increased from Rs. 41,541/-in 1945 to Rs. 1,05,871/- in the accounting year. There was also a finding that these persons have turned out substantial work in the, year of accounting. But in the instant case, apart from the fact that the private company was converted into a public company, there is no material to show whether such conversion was made for expansion of business, increase, of volume of business, higher profit, development or for any other business purposes. At the time of the conversion the Articles were changed, for payment of increased remuneration to the Managing Directors, but no fact was there to support the payment on grounds of commercial expediency. On the contrary the Income-tax Officer in his order of assessment had come to the following finding of facts:
'The company has practically no business activity but gets only interest on moneys lent out on interest and dividends on shares held. As per assessee's own version no business deal in shares has ever been entered into. Under these circumstances, it is difficult to realise in what direction the Managing Director put forth any exertion to deserve such payment. In the past a sum of Rs. 1,200/- only has been claimed as Director's allowance. There has been no increase in the activities. Practically the same shares and the same loan continued and the yield is without any exertion from any quarter.'
10. Dr. Pal, on behalf of the assessee, has contended that as these facts do not find place in the order of the Tribunal, we should not look into them. It is true that the Tribunal has not discussed those findings in details in the orders, but in paragraph 4 it is stated:
'We have considered the circumstances. We have already found that the element of extra commercial consideration is present in this case and merely because the articles contained a particular rate of remuneration we do not think that it should be held that the amount was laid out solely for the purpose of business.'
In our opinion, by the word 'circumstances' the Tribunal was referring to the facts found by the Income-tax Officer and the Appellate Assistant Commissioner. Substantial portions of these findings are not only set out in the agreed statement of case, but also the orders of the Income-tax Officer and the Appellate Assistant Commissioner are annexures to the statement of case. In any event, those findings of fact were not set aside or modified by the Tribunal.
11. For the reasons stated above, the answer to the question is in the affirmative and against the assessee who will pay the costs of the reference to the Respondent.
12. I agree.