SANKAR PRASAD MITRA J. - This is a reference under section 66(1) of the Indian Income-tax Act, 1922. The applicant is a registered firm manufacturing plastic goods. There were two partners of the firm in the relevant accounting year, namely, the year ending December 31, 1952, corresponding to the assessment year 1953-54. The two partners were Sagarmal Bengani and Hanumanmal Bengani, each having eight annas share in the firm. In the manufacturing account, the applicant showed a loss of Rs. 1,08,075 as against a gross profit of 64 % shown in the preceding accounting year. The Income-tax Officer found that the assessee had purchased 71,488 lbs. of styron out of which 3,280 lbs. were purchased from I. C. I. at Rs. 2-11-0 per lb., and the remaining 68,208 lbs. were shown as having been purchased from Messrs. Hindusthan Plastic Co. at a cost of Rs. 3,07,653, which worked out to Rs. 4-7-9 per lb. The Income-tax Officer also found that the Hindusthan Plastic Co.s constitution was the same as that of the assessee-firm, that is to say, that Sagarmal Bengani and Hanumanmal Bengani were also partners of the Hindusthan Plastic Co. Originally, the styron in question was imported by the Hindusthan Plastic Co. through an overdraft account with the Hongkong and Shanghai Banking Corporation Ltd. in 1951. The Hindusthan Plastic Co. paid to the bank a sum of Rs. 1,52,231-13-0 an a further sum of Rs. 1,54,704 was due by the Hindusthan Plastic Co. to the bank. The applicant took over the stock of styron and paid to the bank the amount due to it by the Hindusthan Plastic Co. plus the buying charges, godown rent, etc. The applicant also paid to the Hindusthan Plastic Co. the sum of Rs. 1,52,232, being the amount paid by the Hindusthan Plastic Co. to the bank. The applicant showed that it had incurred expenditure to the extent of Rs. 3,07,653 for the purchase of 68,208 lbs. of styron in the manner aforesaid. The Income-tax Officer found that the purchase price had thus been inflated by Rs. 1,18,000, and he resorted to the proviso to section 13 and estimated the sales at Rs. 3,00,000, with a gross profit of Rs. 54,000.
The Appellate Assistant Commissioner, in his order made on the 24th March, 1957, observes, inter alia, as follows :
'From a perusual of the assessment order it appears that the appellant purchased goods from I. C. I. at Rs. 2-11-0 per lb. in the months of January and February, 1952. As against these it showed to have purchased 68,208 lbs. of the same type of raw materials from Messrs. Hindusthan Plastic Co. at Rs. 4-7-9 per lb. Hindusthan Plastic Co. is comprised of the same partners as that of the appellant and there was no justification for paying such high price to this concern. It is submitted that, as the business of Hindusthan Plastic Co. was being closed, the goods from this concern were purchased at the price which the latter paid for them. It is therefore obvious that the appellate paid a higher price for consideration other than that of business. The inflations of the purchase have been established.'
The Appellate Tribunal, by its order made on the 4th September, 1959, states as follows :
'The appellant purchased goods from I. C. I. at Rs. 2-11-0 per lb. When the market rate was Rs. 2-11-0 per lb., the appellant purchased from Messrs. Hindusthan Plastic Co. a large quantity of goods, i.e., 68,208 lbs. at Rs. 4-7-9 per lb. The constitution of the appellant-firm and of Messrs. Hindusthan Plastic Co. was the same. It is, therefore, evident that the appellant paid a higher price to Messrs. Hindusthan Plastic Co. for extra-commercial reasons. The purchase price was thus inflated and, consequently, profits were rightly estimated under proviso to section 13 of the Income-tax Act.'
On these facts, the question of law framed for our consideration by the Appellate Tribunal is as follows :
'Whether, on the facts and in the circumstances of the case, the Tribunal was justified in holding that the applicant had paid a higher price for 68,208 lbs. of styron for extra-commercial reasons ?'
Mr. D. Pal, for the applicant, has strongly urged that if, in reality, payment has been made by the appellant and that payment is not questioned by the tax authorities, it is not open to the authorities to substitute their own standard of reasonable expenditure for that of the assessee. I do not think there can be any dispute as to this proposition, so long as the transaction is a genuine or a straightforward one, or is neither colourable nor illusory nor fraudulent (vide Craddock v. Zevo Finance Co Ltd.).
In Newtone Studios Ltd. v. Commissioner of Income-tax the assessee was a private limited company owning a studio, and engaged in the production of motion pictures. There were six shareholders, one of whom was the managing director, two were technician directors, and one a technician. The 'honorarium' of these four persons was fixed in 1938 at Rs. 250 each, and a commission at a certain percentage on the net profits. From time to time the 'honorarium' was increased, but the commission remained the same. In 1944 and 1945 the salary paid to these four persons amounted to Rs. 18,000 a year. For 1946 the salary increased to Rs. 59,100 by a resolution of the 30th March, 1946. The income-tax authorities, in view of the increase of profits, allowed only Rs. 36,000 out of this sum of Rs. 59,100 as business expenditure. On a reference to the High Court, it was held that it was not open to the income-tax authorities to adopt a subjective standard of reasonableness of the amounts paid, and, on the facts and circumstances of the case, the whole expenditure of Rs. 59,100 incurred by the assessee for payment of remuneration to the managing director and the other technician directors should have been allowed under section 10(2) (xv) of the Income-tax Act. In order that an expenditure may be incurred wholly and exclusively for the purpose of earning the profits, it is not necessary to show that it was incurred 'of necessity'. It is sufficient if it was incurred voluntarily and on the ground of commercial expediency and indirectly to facilitate the carrying on of the business; and on applying the test of commercial expediency to determine whether the expenditure was wholly and exclusively laid out for the purpose of business, the reasonableness of the expenditure should be considered from the point of view of the business men and not from the point of view of outsiders including the Income-tax Officer. At page 385, Rajagopalan J. observes as follows :
'Under 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 authority with any power or jurisdiction to determine the reasonableness of the amount so fixed and paid by the assessee. The only test for the deductibility of such remuneration is whether the expenditure has been incurred solely and exclusively for the purpose of the business. If the reality of the payment is challenged or is in dispute, different considerations arise : so also in cases where the tax authorities are able to point to some consideration other than the purpose 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 business expediency, could and should be disallowed; but the reason for 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 authority the remuneration is unreasonably high - either because the employee does not, in the authoritys opinion, deserve so much, or because the assessee could have secured other employees on more favourable terms.'
It should however be observed that this decision of the Madras High Court was given before the introduction of section 10(4A) of the Income-tax Act by section 7 of the Finance Act of 1956.
There are two judgments of the Supreme Court which may be usefully referred to in this connection. In Commissioner of Income-tax v. Chandulal Keshavlal & Co. the assessee, a firm, was the managing agent of a company. In accordance with the managing agency agreement, the commission for the accounting year 1950 was a sum of Rs. 3,09,114, but at the oral request of the board of directors of the managed company, the assessee agreed to accept a sum of Rs. 1,00,000 only as the commission. The Appellate Tribunal found (i) that the financial position of the managed company was rather unsatisfactory, (ii) that the assessee had been remitting a part or whole of its commission in the past whenever the profits of the managed company were unsatisfactory, (iii) that the waiver was neither a bounty nor mala fide, and (iv) that the business of the assessee was so linked up with the managed company that if the latter was put on a sounder position, the assessee would get a larger commission in the future; and held that a part of the commission remitted by the assessee was given up for reasons of commercial expediency and was business expenditure allowable under section 10(2) (xv) of the Income-tax Act. The Supreme Court held (a) that, in cases such as these, in order to justify deduction, the sum must be given up for reasons of commercial expediency; it might not be voluntary, but so long as it was incurred for the assessees benefit, the deduction was allowable; (b) that the Appellate Tribunal had found that the amount was expended for reasons of commercial expediency and was not given as a bounty but to strengthen the managed company so that if the financial position of the managed company became strong the assessee would benefit thereby. The Appellate Tribunal, according to the Supreme Court, rightly came to the conclusion that it was deductible expense under section 10(2) (xv). It is a question of fact in each case whether the amount claimed as a deductible allowance under section 10(2) (xv) of the Income-tax Act was laid out wholly and exclusively for the purpose of such business and if the fact-finding tribunal comes to the conclusion on evidence which would justify that conclusion, it being for them to find the evidence and to give a finding, then it will become an admissible deduction. The decision of such questions is for the Income-tax Appellate Tribunal and the decision must be sustained if there is evidence upon which the Tribunal could have arrived at such a conclusion. If the expense is incurred for fostering the business of another only or was made by way of distribution of profits or wholly gratuitous or for some improper or oblique purpose outside the course of business, then the expense is not deductible. In deciding whether a payment of money is a deductible expenditure, one has to take into consideration questions of commercial expediency and the principles of ordinary commercial trading. If the payment or expenditure is incurred for the purpose of the trade of the assessee, it does not matter that the payment may enure to the benefit of a third party. Another test is whether the transaction is properly entered into as a part of the assessees legitimate commercial undertaking in order to facilitate the carrying on of its business; and it is immaterial that the third party also benefits thereby. But in every case it is a question of fact whether the expenditure was incurred wholly and exclusively for the purpose of the trade or business of the assessee.
The other Supreme Court decision I had in mind was the one in Commissioner of Income-tax v. Royal Culcutta Turf Club. In this case the Royal Calcutta Turf Club was an association of persons whose business it was to hold race meetings on a commercial basis. The turf club itself did not own any horse or employ jockeys. As it was of opinion that there was a risk of jockeys becoming unavailable and that such unavailability would seriously affect its business, the turf club established in 1948 a school for the training of Indian boys as jockeys. During the year ending March 31, 1949, the turf club spent a sum of Rs. 62,818 on the running of the school and claimed that amount as a deduction under section 10(2) (xv) of the Income-tax Act. It was held, (i) that, though the question whether the item of expenditure was wholly and exclusively laid out for the purpose of the assessees business must be decided on the facts of each case, the final conclusion was one of law; (ii) that the amount spent by the turf club was not in the nature of a capital expenditure because no asset of an enduring nature was created thereby; (iii) that as the amount was spent for the preservation of its business, it was laid out wholly and exclusively for the purposes of the business of the turf club and was an allowable deduction under section 10(2) (xv) of the Income-tax Act.
The position, therefore, is that it is not open to the income-tax authorities to substitute their own standard of reasonableness of expenditure for that of the assessee. But this proposition is subject to various limitations. Where, for instance, it appears, on the facts of a particular case, that (a) the transaction is not a genuine or a straightforward one or is either colourable or illusory or fraudulent, (b) there were considerations other than the purpose of the business, (c) on grounds of commercial expediency the expenditure was not justified, or (d) the expenditure was incurred for fostering the business of another only or was made by way of distribution of profits or was wholly gratuitous of for some improper or oblique purpose outside the course of the business, the tax authorities are entitled to disallow the deduction claimed. They have also the same power when the reality of the payment is questioned or challenged or is in dispute.
Applying the principles aforesaid to the facts in the instant case, it seems to me that the Appellate Tribunal was right in coming to the conclusion that the applicant paid a higher price to Messrs. Hindusthan Plastic Co. for extra-commercial reasons. It, for instance, the applicant had produced evidence to show that, at the relevant point of time styron was not available in the market at less than Rs. 4-7-9 per lb., different considerations might have arisen. But the applicants only contention before the Appellate Assistant Commissioner was that as the business of Hindusthan Plastic Co. was being closed, the goods of that concern were purchased at the price which they paid for them. On the facts available to us, it appears that the burden or liability of the Hindusthan Plastic Co. was taken over by the assessee; the partners of the assessee were also the partners of the Hindusthan Plastic Company; and the transaction resulted in deflation of the profits of the assessee.
The Supreme Court has said that the decision of the Appellate Tribunal must be sustained if it is found that on the evidence the Tribunal arrived at the correct conclusion. In the present case also, on the evidence adduced before the tax authorities, their conclusion appears to me to be justifiable.
In the result the answer to the question raised must be in the affirmative. The applicant shall pay to the respondent the costs of this reference; certified for counsel.
SEN J. - I agree.
Question answered in the affirmative.