G. K. MITTER, J. - The question referred to this court under section 66(1) of the Income-tax Act are as follows :
'(1) Whether, on the facts and in the circumstances of the case, the payment of Rs. 2,53,166, to Messrs. Air Transport Ltd., the managing agents, was an expenditure laid out or expended wholly and exclusively for the purpose of the assessees business within the meaning of section 10(2) (xv) of the Indian Income-tax Ac ?
(2) Whether, on the facts and in the circumstances of the case, the payment of Rs. 50,000 to Shri K. K. Roy, the managing director, was an expenditure laid out wholly and exclusively for the purpose of the assessees business within the meaning of section 10(2) (xv) of the Indian Income-tax Ac ?'
The facts are as follows : The assessee is company incorporated in the year 1945, having for its object, inter alia :
(1) To establish, maintain and work lines of aerial conveyances, aeroplanes, seaplanes, flyingboats, helicopters, gliders, etc., and to provide air transportation between two or more places in India and between other places in and outside India to be selected from time to time by the company.
It entered into an agreement with Messrs. Air Transport Limited in January, 1949, whereby the latter became the managing agent of the assessee for a period of 20 years at a remuneration of Rs. 3,000 per month as allowances and a commission of 10% of the net annual profits of the assessee as defined by section 87C of the Indian Companies Act. The company also had several directors, one of whom was K. K. Roy, the managing director. Towards the close of the year 1952 and early in 1953, it became apparent that the Government of India would nationalise airways services all over India and that private undertakings like that of the assessee would have little or no business left to them. There was a meeting of the board of directors of the assessee on January 30, 1953, wherein it was recorded that 'the directors felt convinced that in the immediate future the undertaking of the company would be taken over by the Government more or less on the lines outlines by the managing director.' It should be noted that the managing director had made a report to the board in this connection giving them the result of the discussion he had with the authorities of the Government of India, 'with regard to the acquisition of the company by the Government in the process of nationalisation of the Air Transport Industry.' The minutes of the said board meeting further recorded that 'it was also felt by the directors that in the event of the Government implementing their scheme of nationalisation, the directors should remain prepared for all consequences which would follow affecting not merely the shareholders of the company but also the managing agents, the managing director, the personnel and other operational agencies.
The directors were advised that the managing agents under their agreement with the company were entitled to compensation in the event of premature termination by the company of their managing agency agreement. The managing agents are naturally anxious to be compensated in the manner provided in their agency agreement in the event of the company being taken over by the Government.' Among the resolutions passed by the directors were the following :
'(a) Resolved that in view of the uncertainties created by the impending scheme of nationalisation the subsisting managing agency agreement be terminated as from the 1st March, 1953.
(b) Resolved further that such compensation as may be determined by the companys auditors in terms of the subsisting managing agency agreement be paid to the managing agents.
(c) Resolved further that the approval of the shareholders for such termination and consequent payment of compensation to them as provided in the managing agency agreement be obtained at an early date.'
There were two further resolutions regarding the managing director.
'(a) Resolved that Mr. K. K. Roy, managing director of the company, be given a lump sum of Rs. 50,000 on the Government taking over this company, it being understood that Mr. Roy shall not be liable for income-tax on such payment and, even if he is made liable, the company shall compensate to the extent of the tax so payable.
(b) Resolved further that this proposal of payment to Mr. K. K. Roy be also placed before the shareholders for confirmation at an early date.'
In pursuance of the above an extraordinary general meeting of the company was called on February 28, 1953, wherein the following resolutions were passed :
'Resolved that the action of the board of directors in terminating the appointment of Messrs. Air Transport Ltd., managing agents of the company, as such managing agents as from 1st March, 1953, in view of the impending nationalisation of the company and in sanctioning the payment of compensation for premature termination of their agency as may be determined by the companys auditors under the managing agency agreement be approved and confirmed. The meeting placed on record that the amount of compensation payable to the managing agents as determined by the companys auditors under the managing agency agreement (Ref. Auditors letter dated 27th February, 1953), which was read out before the meeting is Rs. 2,53,166-4-0. Resolved that the recommendation of the board of directors that a payment of Rs. 50,000 free of income-tax as a lump sum payment be made to Mr. K. K. Roy, the managing director of the company, in view of the impending termination of his association with the company due to nationalisation of the company as aforesaid, such payment being made only in the event of such nationalisation taking effect, be approved.'
In terms of the said resolution a sum of Rs. 2,53,166-4-0 was paid to the managing agents and a sum of Rs. 50,000 was paid to the managing director. The question before us is whether these two payments are deductible under section 10(2) (xv) of the Act for computation of the profits of the company. This will depend on whether the expenses were incurred wholly and exclusively 'for the purpose of the company.' The revenue authorities have throughout held that the payments are not deductible.
Before us it was argued that the revenue authorities failed to assess the position correctly. It is admitted that on August 1, 1953, the undertaking of the company including all its assets and its aircrafts were taken over by the Indian Airlines Corporation. The Appellate Assistant Commissioner in his order recorded that, thereafter, for a period of more than one and a half years the company did not transact any business at all and that the auditors report on the accounts for the year ending 31st December, 1953, stated 'as from 1st August, 1953, the undertaking of the company was taken over by the Indian Airlines Corporation under the Air Corporation Act, 1952.' The Appellate Assistant Commissioner further recorded that 'the printed balance-sheet as on 31st December, 1953, shows that the entire fixed assets valued at Rs. 17,03,472 were taken over by the Indian Airlines Corporation.' He also recorded that in their report for the year 1953 the directors had stated that 'though the operation of all scheduled services has been reserved for the Air Corporation, the Government have allowed the non-scheduled operators to carry on with their business. The company has secured a permit to operate air services on non-schedule basis. An arrangement has also been made with the Government to operate an air service to Andaman Islands for a period of three years. The company has recently purchased a Dakota Aircraft from the Indian Airlines Corporation. The prospects of non-scheduled and chartered operation in the domestic and international field are considered reasonably good.' According to the Appellate Assistant Commissioner this report was given on 20th June, 1955, and it was only in that year that the assessee commenced air transport business on non-schedule basis. The printed accounts for the calendar year 1954 shows that no business at all had been transacted in that year.
The contentions urged before the Appellate Assistant Commissioner were repeated before the Tribunal and in particular that only the air transport business in respect of the scheduled lines had been taken over by the Government and that other activities of the assessee such as the operation of air freight transport between Calcutta and Assam had not been taken over and such business was continued by the assessee in subsequent years. The Tribunal however found from the evidence on record and especially the auditors report for the year ending 31st March, 1953, that the entire undertaking of the company including all its fixed assets had been taken over by the Government as and from 1st August, 1953. The Tribunal agreed with the finding of the Appellate Assistant Commissioner that there was no air transport business left with the assessee after 1st August, 1953, until some time in 1955. The Tribunal found that so far as the managing director was concerned there was no agreement for payment of any compensation on termination of his services and payment to him was purely voluntary.
According to the Tribunal 'on the nationalisation of the airlines, the assessee-company had transferred its business, though perhaps under a compulsion, to the Indian Airlines Corporation. There was, therefore, no obligation on the part of the assessee-company to pay any compensation whatsoever to the managing agents. This compensation is also,............ ex gratia payment not necessitated by the needs of the business. It is therefore clear that the expenditure was incurred not for terminating a disadvantageous relationship in order to avoid future losses, but was a payment made voluntarily on the nationalisation of the business carried on by the assessee. The company did not get rid of them for reasons of trade.'
Our attention was drawn to an enclosure to the application before the Income-tax Tribunal by the assessee under section 66(1) of the Act and to certain statements of fact contained in an enclosure to the said application and printed at pages 41 to 60 of the paper-book. In particular reference was made to page 43 containing a statement of the assessee that 'in the early part of the year 1954, it became apparent that the company matter, it acquired office accommodation on April 27, 1954. On July 5, 1954, the Indian Airlines Corporation offered to the assessee-company to sell one Dakota. Thereupon, on August 18, 1954, the company applied for a permit for non-scheduled operations and on September 24, 1954, the Director General of Civil Aviation issued the necessary permit. The purchase of the Dakota was effected some time in 1955. In the meanwhile, in anticipation of the reopening of the non-scheduled operation, by a resolution dated July 5, 1954, the directors appointed Shri K. K. Roy as director-in-charge and the agreement made previously with Messrs. G. Basu was terminated except that they were to continue to handle the compensation matters.'
Relying mainly on the above statements it was argued on behalf of the assessee that it had at no time ceased to carry on business. According to counsel all that had happened was that in August, 1953, its existing operations had been stopped by the statutory vesting of all its assets and undertaking in the Indian Airlines Corporation. This did not prevent the assessee from acquiring other aircraft and operating on non-scheduled routes. The assessee was not without income as it received sums by way of transfer fees and interest on bonds representing compensation had from Government. As a matter of fact the assessee had taken on rent another office and appointed clerks and other personnel for managing its business. Counsel cited the case of Commissioner of Inland Revenue v. Dale Steamship Co. Ltd. in support of his proposition that it was possible for the assessee to carry on business even though all its aircrafts and operations on scheduled routes were taken over by the Government. The facts in that case were as follows : At the outbreak of the First World War the assessee owned and traded with five ships. Of these, one was detained by the enemy, one was sold and the remaining three were sunk during the War. The proceeds of sale and the insurance moneys received were all placed on deposit or invested in easily realisable investments in order to facilitate the resumption of trading or winding up. There it was held on the authority of the case of Commissioner of Inland Revenue v. South Behar Railway Co. Ltd. that the company was carrying on a trade or business, and that it was liable to assessment to corporation profits tax. No judgment was delivered.
The South Behar Railway Company Limiteds case went to the House of Lords. The principal object for which this company was formed was to enter into a contract with the Secretary of State for India in Council relating to the construction of a railway in India to be called 'the South Behar Railway' and to carry the same into effect. By the agreement the company was to supply to the Secretary of State for India the funds and materials required for the construction of the railway; the Secretary of State was to provide free of costs to the company the land required for the railway, and was to allow the company to have possession of such lands during the continuance of the contract; the construction of the railway was to be undertaken by the Secretary of State through such agency as he should appoint; the Secretary of State was, as from the opening of the railway and until the determination of the contract, to work and maintain the railway and keep it supplied with rolling stock, plant and machinery; the Secretary of State was to retain 45 per cent. of the gross earnings of the railway, the balance being the net earnings of the company. The South Behar Railway was duly constructed and opened for traffic. Before the determination of the first agreement of 1895 between the company and the Secretary of State a further agreement was entered into between the parties on December 11, 1906. By this the Secretary of State was to be entitled as from January 1, 1906, to hold and deal with the railway for his own benefit without any interference by the company. The Secretary of State was to pay to the company in London the yearly sum of pounds 30,000. Since the date of the last mentioned agreement the company had no office in India but had an office in England and received the annuity of pounds 30,000 and, after paying the interest on the companys debentures, held general meetings and declared dividends in the ordinary way. In these circumstances, it was held by the House of Lords that, although the company carried on no trade or manufacture and its principal and only function at the relevant time was to receive and distribute the fruits of its undertaking, the same was a part and a material part of the purpose for which it had come into existence. According to Viscount Cave L. C. : 'It object was, not to construct or work a railway, but to provide funds for that purpose and, as a reward for so doing, to receive a yearly sum for a period and afterwards a lump sum by way of return of capital... The company can no longer be called upon to fulfill its first purposes, viz., to make advances for the construction of the line, because all the necessary funds have been already advanced; but it is still fulfilling its second purpose, which was to receive an income for its shareholders while the line was running and to distribute it among them, and if and when the principal agreement comes to an end, it will have the further function of recovering and dividing the capital to be repaid. I think, therefore, that the company still carries on a business or similar undertaking within the meaning of section 52 of the Finance Act, 1920. The case is not unlike Commissioners of Inland Revenue v. Korean Syndicate, with the decision in which case I agree.'
Strong exception was taken to the reliance on the enclosures to the application contained in pages 41-60 of the paper-book. It was argued on behalf of the revenue that these statements were not to be found in the statement of the case by the Tribunal. In my opinion, the objection of the revenue is well-founded but quite apart therefrom the South Behar Railway Companys case or Dale Steamship Company Limiteds case is of no assistance to the assessee. In both these cases it was found that, although the railway was not operated on by the assessee or the steamships were lost, the objects of the assessee permitted the holding of investment and distribution of dividends thereon which both the companies were doing. But the facts here as placed before the revenue authorities and as they were in the year 1953, when the resolution was passed, were entirely different. The directors and the shareholders of the company thought that the company was virtually coming to an end and its corporate life would terminate very soon. It was in view of that they terminated the services of the managing agents and paid a handsome honorarium to the managing director. It does not appear that after the passing of the resolution the company or its directors had any thought of being able to carry on business any further as all its assets and undertaking including the aircrafts were going to be taken over by the Indian Airlines Corporation. It was in 1954, long after the close of the accounting year, that the directors or the company thought of other avenues of business. The case is not like those reported in 12 Tax Cases. The business of the company as foreshadowed by its objects clause to be found at page 41 of the enclosure could not be carried on unless it secured airplanes, seaplanes, etc., and all those it had were lost in August, 1953 - an event the directors and the shareholders of the company knew long before as something certain.
The further argument on behalf of the assessee that the payment to the managing agent was made with a view to curtail the running expenses of the company in anticipation and, as such, a deductible expenditure is of no merit. To be within section 10(2) (xv), the expenditure must be incurred wholly and exclusively for the purpose of its business. The expression 'for the purpose of its business' is no doubt one of wide import. But it can only mean something which will further the cause of the business-something which will aid in the carrying on of the business or prolong effectively the life of the company. If the business itself was going to come to as end as contemplated by the directors and the shareholders, it is difficult to see how any expenditure incurred can fall under section 10(2) (xv) unless made with an idea of saving it from extinction. In circumstances like these, any payment made with an idea of prolonging the life of the company would be deductible but not those given to servants under a contract of service or by way of recognition for services rendered in the past. There is no evidence that the payment to the managing agent was with a view to avoid litigation and when it was known that the business of the company had at best only a few months to go during which the managing agent would probably receive not more than Rs. 20,000 to Rs. 30,000, it can hardly be said that a lump sum payment of Rs. 2,50,000 to it was incurred for the furtherance of the business or the objects of the company.
The question before us is what was in the mind of the directors and the shareholders at the time the termination of the contract was agreed upon. It is clear from the resolutions that the thought that dominated their minds at the time of such termination was that there would be nothing for the managing agents to do. The case of Liquidators, Begg Dunlop & Co. Ltd. v. Commissioner of Income-tax hardly helps the assessee. There it was said that the test for finding out whether the payment was business expenditure admissible under section 10(2) (xv) was to examine whether the expense was such as commercial men would be justified in incurring for their business without taking any extraneous matters into consideration and that there must be no element of ex gratia payment in it. It is impossible to hold that the payment to the managing agent was dictated by any idea of furthering the business of the company. Neither the directors nor the shareholders were prompted by any consideration of furthering the interest of the company in sanctioning the payment. All that they were thinking of was the fact of the managing agent about to lose a good job for no fault of its own.
The case of the managing director is worse. The sole motive behind the payment to him could only be one of giving a gratuity for services rendered in the past. There is no evidence that the company was in the habit of giving gratuities to its servants on superannuation or for other cause. The managing director did not even have a contract of service for a particular period. It was not a case where an employee had an expectation of reasonable gratuity. The test laid down by the Supreme Court in Gordon Woodroffe Leather Manufacturing Co. v. Commissioner of Income-tax at page 555 would preclude an expenditure like this being considered as a deductible item under section 10(2) (xv).
The answer to both the questions in this case must be in the negative and against the assessee who will pay the costs of this reference.
S. A. MASUD J. - I agree.
Questions answered in the negative.