1. This Reference comes to us on a supplementary case stated by the Income-tax Appellate Tribunal in pursuance of an order made by us on 11-5-1953.
2. The assessee is a Hindu undivided family of the name of Kalu Babu Lalchand of which the. Karta is one Mr. B. K. Rohatgi. It appears that in the year 1930 Mr. Rohatgi became interested in a concern called the India Electric Works and promoted the formation of a company for taking it over. The actual incorporation of the company took place on 19-12-1930. Article 132 of the Articles of Association provided that the first Managing Director would be Mr. B. K. Rohatgi or 'his assigns or successors in business whether under his name or any other style or firm' and that he would continue to be Managing Director until he resigned or was found guilty of any act of fraud or dishonesty or was removed in the manner provided in the Article next following. The next Article laid down the procedure which would have to be followed if the company desired to remove Mr. Rohatgi from his position of Managing Director at any time. Article 138 next provided that the company would forthwith enter into an agreement with Mr. Rohatgi in terms of a draft which had already been approved on behalf of the company and that the validity of that agreement would not be liable to be impeached on the ground that Mr. Rohatgi stood in a fiduciary relation to the company or on any other ground. The Article proceeded to provide that every person who might at any time become a member of the company would be deemed to approve of and confirm the said agreement.
3. Although Article 138 stated that an agreement had already been drafted and the terms had been approved by the company, it would appear that it was not till 31-1-1934, that an agreement was actually entered into between the company and Mr. Rohatgi. The recitals in the prefatory part of that agreement as to how the draft had come into existence and when its terms had been formally approved do not correspond with what is stated in Article 138 of the Articles of Association, but it is not disputed that it is under the agreement, executed on 31-1-1934, that Mr. Rohatgi was occupying the position of a Managing Director at the relevant time. The agreement recited that inasmuch as Mr. Rohatgi had been one of the promoters of the company and had taken over the business of the India Electric Works as such promoter and had carried on the business since then for the benefit of the company, it was being agreed that he would be the Managing Director upon the terms and conditions and with the powers and authorities set out in the body of the agreement. Those terms and conditions and powers and authorities were practically the same as set out in Article 136 of the Articles of Association. Mr. Rohatgi's remuneration under the agreement is an annual sum of Rs. 6000/- payable in equal monthly instalments or a commission of 15 per cent. on the net profits of the company, whichever might be larger.
4. It would appear that ever since Mr. Rohatgi commenced earning the Managing Director's remuneration from the India Electric Works Limited, the family had been showing the amount as its own income in its income-tax assessments and the remuneration had been taxed in its hands. It was in the course of the assessment for the assessment year 1943-44 that the assessee family for the first time put forward the contention that the remuneration earned by Kohatgi during the relevant accounting year was his personal income and was not liable to be included in the assessable income of the family. That contention was rejected by the Income-tax Officer as well as by the Appellate Assistant Commissioner. The Appellate Tribunal, however, chose a middle course. The amount in question was Rs. 61,282/-. The Tribunal held that it was really a composite sum of two kinds of remuneration, one remuneration for the services rendered by the asses-see family in the flotation and financing of the India Electric Works Limited and the other remuneration for the personal services of Mr. Rohatgi. Proceeding on that basis, the Tribunal held that the personal services of Mr. Rohatgi could be properly valued at Rs. 2,500/- a month and that to that extent the remuneration earned by him might be treated as a part of his personal income. The personal income thus accounted for Rs. 30,000/-. The Tribunal held that the balance of Rs. 31,282/- should be assessed in the hands of the family as the remuneration earned by the family on account of the benefits conferred by it on the company.
5. The reason on which the Tribunal proceeded was that it had nowhere been stated that when Mr. Rohatgi had promoted the incorporation of the company, he had done so in his individual capacity and that it had also not been proved that he had attained bis position of Managing Director without the aid of the family funds. The controlling shares in the new company were owned by the family of which Mr. Rohatgi was the Karta, and that circumstance, the Tribunal thought, justified the conclusion that the attainment by Mr. Rohatgi of his position as Managing Director was a product of family assets. The Tribunal also referred to the fact that in the past the family had offered Mr. Rohatgi's remuneration for assessment as a part of its own income.
6. The assessee was dissatisfied with the Tribunal's decision and asked for a Reference to this Court. The Tribunal made a Reference and the questions referred are as follows :
'(1) Whether on the facts and in the circumstances of this case, the Income-tax Appellate Tribunal was justified in apportioning the sum of Rs. 61,282/- into two parts assessing one in the hands oF the Assessee Hindu Undivided Family and the other in the hands of Mr. B. K. Rohatgi.'
'(2) If the answer to the above question be in the negative, whether the assessment of the said sum of Rs. 61,282/- should be on Mr. Rohatgi personally or on the assessee Hindu Undivided Family.'
7. When the Reference came up before us for hearing, we felt that the Statement of the case was inadequate and it would not be possible to answer the questions unless certain further facts were clearly stated. We accordingly directed the Tribunal to submit a further Statement of Case and to include therein answers to the following questions :
''(a) With whose funds were the shares, on the strength of which Mr Rohatgi has been and is the Managing Director, purchased and to whom do they really belong?
(b) Who has been in enjoyment of the dividend paid on those shares?
(c) In what capacity was Mr. Rohatgi originally appointed to and was holding, at the relevant time, the office of the Managing Director' of the India . Electric Works Ltd., namely whether in his personal and individual capacity or otherwise?
(d) Besides the qualifying shares, are there any further shares of the Company standing in the name of Mr. Rohatgi and if there are such shares, with whose funds were such shares acquired and to whom do they really belong?'
8. A further Statement of Case has since been received. The Tribunal have now stated that out of the total of 900 shares of Rs. 500/- each, which is the share capital of the company, 326 shares stood in the name of Mr. Rohatgi and 356 shares stood in the name of his brother, another member of the assessee family during the accounting year. Another ten shares stood in the name of one Lakshminarayan Rohatgi, who was said to be an employee of the family. All the shares standing in the names of Mr. B. K. Rohatgi and Mr. R. K. Rohatgi were acquired with funds belonging to the assessee family and they belonged to the family. The family has also been in enjoyment of the dividends paid on those shares. The ten qualifying shares on the strength of which Mr. B. K. Rohatgi is a director of the company are included in the 326 shares which he holds on behalf of the family.
9. The Tribunal have not given any direct answer to question (c) formulated by us. Instead, they have said that the answer is a matter of inference from the facts stated by them, but their own conclusion was that Mr. B. K. Rohatgi had been originally appointed to and was, at the relevant time, holding the office of the Managing Director of the India Electric Works Limited in his capacity as a member and Karta of the assessee family.
10. The principal question to be answered in this Reference is the second one. As to the first, the assessee naturally submitted that the Tribunal had been wholly unjustified in making an artificial division of the income on an imaginary basis of their own. On behalf of the Commissioner of Income-tax also, no attempt was made to support the Tribunal in their choice of the middle path. Mr. Meyer, who appeared for the Commissioner, submitted that the income was either the income of the family or the personal income of Mr. Rohatgi and that there could be no justification for ascribing a portion of it to the remuneration of Mr. Rohatgi as an officer of the company and ascribing the other portion to a return made by the company to the family for benefits received.
11. In our opinion, the parties were right in their disapproval of the manner in which the Tribunal had distributed the income between two categories invented by themselves. The basis on which they bad done so has been explained a little more fully in their second Statement of Case. The basis on which the Tribunal proceeded', observe the Tribunal,
'is that the office of the Managing Director of the Company, in so far as it could be regarded as a source of business income, belonged to the asses-see family and that as between the other members of the family and Mr. B. K. Rohatgi, the profits of the business, subject to the allocation made on the basis of what might have been payable to a stranger if one had been employed to perform the same duties, belonged to the family.'
12. I confess that what the Tribunal mean by this observation is somewhat mystifying to me. The basis of their decision as indicated, though not very clearly, in the Original Statement of the case was at least intelligible. The basis which they now claim appears to be that the whole income was a business income of the family and that a portion of it was payable to Mr. Rohatgi as his remuneration for attending to the business on the family's behalf and that, therefore, it was something in the nature of expenditure laid out by the family for the purpose of earning the income. That portion, which was paid to Mr. Rohatgi, went out of the business income derived by the family from the company as expenditure incurred and it became in the hands of Mr. Rohatgi his personal income, because it was remuneration earned by him, not from the company but from the family. I can only say that artificial as the original basis was the new basis appears to be utterly unreal. In my view, once it was found, as the Tribunal did find, that Mr. Rohatgi rendered personal service to the company and was entitled to remuneration therefor which would be his personal income, there was no basis at all upon which it could be held that the whole of the remuneration was, nevertheless, not his personal income and that a portion was paid to him as the representative of the family or through him to the family as a kind of return for financial and other advantages received. Whatever the true nature of the remuneration may be, whether it be Mr. Rohatgi's personal income or it be the income of the family, it must be held that the allocation made by the Tribunal between the family and Mr. Rohatgi was entirely unwarranted.
13. The real question, as I have said, is the second one which asks directly whether it was Mr. Rohatgi who was liable to be assessed in his personal capacity on the amount of the remuneration or whether the liability to assessment was of the family.
14. Mr. Gupta, who appeared on behalf of the assessee, advanced an argument which he had advanced before us on other occasions. He contended that the principles on which the earnings of a member of a Hindu undivided family might be treated in Hindu Law as the family's income were altogether irrelevant to the application of taxing statutes. The Income-tax Act, Mr. Gupta contended, caught income at the stage at which it accrued or arose or was received and it had its own standards as to what receipts were taxable as income and as to the categories under which they would fall. The remuneration of a Managing Director, Mr. Gupta contended, was the fruit of the personal agreement which he had with the company and it came to him and was paid to him as his salary. Whether it then found its way into the family coffers, either by way of a gift from the recipient or whether it could be treated as the family's income for purposes of partition of the joint family assets, was in no way relevant to the question as to whether the amount was taxable in the hands of the person who received it as a salary or in the hands of the joint family to which he belonged. There could be no question, Mr. Gupta contended, that the company paid the amount to Mr. Rohatgi as his salary or remuneration and he received it as such. The tax would, therefore, attach to the receipt at that point and it could be fastened on the amount only in the hands of Mr. Rohatgi when it became, due to him or when he received it.
15. The decisions under the Income-tax Act have not been in accordance with the extreme view contended for by Mr. Gupta, Cases in which questions of the present character have arisen have been mostly cases of partnerships. We ourselves have held in more than one case that although a Hindu undivided family cannot enter into a contract of partnership as an immediate contracting party, it can do so through the agency of the Karta and when the Karta of an undivided family has entered into a partnership in that capacity and the assets thrown into the partnership stock have come from the family, the profits earned by the Karta may properly be regard-ed as the family's profits. A variety of supporting circumstances are however required before it can be held that a Karta of a Hindu undivided family, who is a partner in a partnership, is not there in his personal or individual capacity but is representing the family of which he is the Karta. One of the circumstances for which the court always looks is whether the status of a partner had been acquired by the expenditure of family funds or, as I put it in another case, whether it can properly be said that the family had invested certain funds in the concern and along with the funds had invested its Karta, whose earnings from the partnership would therefore be the return due to the family on its investment. Whether the expenditure of family funds means mere use of such funds or whether it means such use as causes, depletion or destruction of the funds, is a matter of some difficulty. But cases under the Income-tax Act appear to have proceeded on the basis that mere use will be sufficient or, to use the language of Lord Sumner, in the case of --'Gokal Chand v. Hukam Chand' 48 Ind App 162: AIR 1921 PC 35 (A), it will be sufficient if the profits were earned :
'by labouring on the patrimony or, by laying out the family funds and reaping the fruits of the outlay.' I must hasten, however, to add that Lord Sumner was not using those words to describe a case where the profits would be the property of the family, but he was describing amounts which would be exceptions. The decisions on the Income-tax Act, however, as I have already said, do not seem to have observed the distinction between mere use of their family funds and use to their detriment.
16. I have referred, to the above consideration, because it was contended in this case that if the majority of the shares were held by the family and even if Mr. Rohatgi had become Managing Director, because his family held those shares, yet by the in-vestment of the funds of the family in the purchase of the shares, no detriment to them had been caused. The shares were earning dividends and no one disputed that those dividends were the property of the family. The real question was whether the earnings made by Mr. Rohalgi out of his position as Managing Director and as consideration for the services rendered by him in that capacity could be said to be the income of the family for taxing purposes, merely because his position as Managing Director might be the indirect result of the large investment made by his family in the shares of the company,
17. In my view, cases of Managing Directors stand on a different footing from those of partnerships. Reference was made to the case of -- 'Haridas Purshottam In re', : 15ITR124(Bom) , a case of partnership, the case of --'Kaniram Hazarimull v. Commr. of Income-tax, West Bengal : 27ITR294(Cal) , also a case of partnership decided by ourselves; the case of --'M. N. Murugappa Chetty and Sons v. Commr. of Income-tax, Madras', : 21ITR319(Mad) , a case of Managing Agents; the case of -- 'Commr. of Income-tax, Bombay v. L. Armstrong Smith : 14ITR606(Bom) , a case of a Managing Director; and lastly, the case of -- 'Commr. of Income-tax, Madras v. S. N. N. Sankaralinga Iyer', : 18ITR194(Mad) , also a case of Managing Director. ' In my view, only the two last cases are relevant. I do not consider it necessary on the facts of this case to examine, once again, the extreme contention of Mr. Gupta. Even proceeding on the principles which have been applied to partnerships I find it difficult to hold on the facts of this case, that there was evidence before the Tribunal on which they could properly hold that the remuneration earned by Mr. Rohatgi was earned by him as the Karta of the family over which he presided and that such remuneration was not his but the family's income. The only facts found are that the family holds a controlling block of shares and that even the qualifying shares on the strength of which Mr. Rohatgi is the Managing. Director of the company, really belong to the family. I leave aside the fact that, in the past the family had offered Mr. Rohatgi's remuneration for assessment as it's own income, because if the receipt be in its nature incapable of being the income of the family, its treatment as such in other years cannot alter, or be evidence of, its true character. The facts on the other side are that Mr. Rohatgi holds his position as Managing Director under an agreement which is in effect, a contract of service. The history of the position he holds is set out in the introductory paragraph of the agreement where it is stated that he was chosen as the first Managing Director and made practically irremovable in consideration of the fact that he had been one of the persons who had promoted the company and that he had carried on the business of the concern, both before the company had been incorporated and thereafter, till the date of the agreement. It is not stated that Mr. Rohatgi had promoted the company as the Karta of the undivided family and it may well have been that his efforts in that behalf were purely personal, although he might have received the wherewithal from the family over which he presided. The fact that he was assisted by family funds does not, to my mind, itself establish that his employment as Managing Director was due to the fact that he was the Karta of the family or that the remuneration paid to him was paid, because the family had practically financed the formation of the company. If the agreement or the Memorandum of the Articles of Association of the company had stated that inasmuch as the family had rendered conspicuous service towards the formation of the company, its Karta for the time being would always be the Managing Director, there might be some justification for saying that the remuneration paid to the Managing director was not really paid as salary for services rendered but was paid as instalments of the price for the financial assistance received from the family. Cases are not infrequent where a family furnishes some funds in a direct or indirect manner in order that a member of the family may acquire a position out of which he will be able to earn an income. If, for example, it be required that the holder of a particular post shall have to make a cash deposit of a fairly substantial sum of money and if a family supplies the necessary funds in order that one of its members may qualify for the post, it can hardly be said that the income earned by such member from the post, if he actually gets it, will be the income of the family, because he acquired it by expenditure of the family funds. To my mind, the consideration which distinguishes the present case and would distinguish all cases of the remuneration of a Managing Director is that, prima facie at least, such remuneration is paid for services rendered under a contract of service and unless it be shown that the remuneration would be paid, whether the Director rendered any services or not, simply for the reason that he came from a family which had benefited the concern, it cannot be rightly held that the remuneration would be the family's income. Where the remuneration of a Managing Director is earned under a contract of service and the service is practically a permanent one, it appears to me to be extremely difficult to hold that such remuneration is the income of the family of which the Managing Director is, in his private life, the Karta. To take the facts of the present case, even if all but the 10 qualifying shares owned by the family were to be sold away, Mr. B. K. Rohatgi would not, under the terms of his contract, lose his position as Managing Director. Among the contingencies stated in the agreement and in the Articles of Association in which Mr. Rohatgi's Managing Directorship may come to an end, is not to be found the contingency of the family ceasing to hold the shares held by it for the time being or a substantial number of shares. It is true that even the 10 qualifying shares are owned by the family, but those shares by themselves would not enable the family to exercise any influence over the affairs of the company, if the rest were sold away. If, under the terms of the contract Mr. Rohatgi's position as Managing Director would remain unaffected even upon the transfer of the majority of the shares held by his family to third parties, it would seem to be clear that his post of Managing Director is not really dependent on family assets or the investment made by the family in the shares of the company. The primary circumstance, as I have already said, is that a Managing Director is under a contract of service with the company and he earns his remuneration as the price of the labour which he expends in the prosecution of the duties of the office held by him, I am unable to hold that there were any facts in the present case from which it could be concluded that Mr. Rohatgi's-remuneration as a Managing Director was the income-of his family for taxing purposes and that it could be assessed in the family's hands. Even the Tribunal found that Mr. Rohatgi did render personal service to the company which had to be paid for in money and that he earned such remuneration by personal labour, although, according to the Tribunal, the whole of the remuneration could not be attributed to the service rendered by him. A Managing Director's income can be held to be the income of the family over which he presides only by introducing several assumptions at variance with accepted notions of law. I do not desire to hold for the purposes of the present case that in no circumstances can such remuneration be held to be the family's income and I can well imagine a case, like the illustration I gave a few moments ago, where a company undertakes for all time to appoint as its Managing Director the Karta, for the time being, of a family which had rendered it financial assistance, irrespective of any service rendered by him and in fact, assigning no duties to him. If there be ever a case of such an ornamental or titular Managing Director appointed for no other reason than that he is a Karta of the family which supplied the major portion of the company's share capital, it may have to be considered whether the remuneration paid is not in truth and law the income of the family. But, in ordinary cases, it is impossible to conceive a family being appointed Managing Director through its Karta, because the amount in question being remuneration paid to and earned by the Managing Director as such, it could be remuneration earned by the family only if the family could function as the Managing Director which appears to me to be an impossible notion, except, however, in cases where, as an illustration I gave, no services are called for. In my opinion, the correct view to be taken in such cases was taken in the case of : 18ITR194(Mad) and I would refer, in particular, to the judgment of Viswanatha Sastri J. :
18. For the reasons given above, it appears to me that there were no materials in this case on which the Tribunal could properly hold that any part of the remuneration paid to Mr. Rohatgi as Managing Director was the income of the assessee family for taxing purposes. The Tribunal, it would be remembered, did not hold the whole of the remuneration to be the family's income but only a part. In my view, there are no facts in the present case, from which it could be held that the amount in question was assessable in the hands of the assessee family as a part of its income.
19. The answer to the questions referred must, therefore, be:
Question (1): 'No.'
Question (2): 'On Mr. Rohatgi personally.'
The assessee will have the costs of this Reference.
20. I agree.