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Eastern Scales (P.) Ltd. Vs. Commissioner of Income-tax - Court Judgment

LegalCrystal Citation
SubjectDirect Taxation
CourtKolkata High Court
Decided On
Case NumberIncome-tax Reference No. 221 of 1974
Judge
Reported in[1979]117ITR477(Cal)
ActsIncome Tax Act, 1961 - Sections 30, 37, 39 and 40
AppellantEastern Scales (P.) Ltd.
RespondentCommissioner of Income-tax
Appellant AdvocateK.K. Roy and ;R.N. Dutta, Advs.
Respondent AdvocateS. Sen and ;Ajit Sen Gupta, Advs.
Excerpt:
- .....to the assessment years 1967-68, 1968-69 and 1969-70. in the three aforesaid assessment years, the assessee-company claimed that there had been an increase in the salary of sri j. h. somerville, managing director, from rs. 3,000 per month to rs. 4,500 per month with effect from 1st september, 1966, and even after retirement with effect from 1st may, 1968, he continued to draw the same amount as pension. similarly, in the case of the other director, viz., j. d. somerville, the assessee-company claimed that his salary was increased from rs. 2,250 per month to rs. 3,530 per month with effect from 1st september, 1966, and he had continued to draw the same salary on being appointed as the managing director on the retirement of his father, sri j. h. somerville, with effect from 1st may, 1968......
Judgment:

Sabyasachi Mukharji, J.

1. The assessee is a private limited company. This reference relates to the assessment years 1967-68, 1968-69 and 1969-70. In the three aforesaid assessment years, the assessee-company claimed that there had been an increase in the salary of Sri J. H. Somerville, managing director, from Rs. 3,000 per month to Rs. 4,500 per month with effect from 1st September, 1966, and even after retirement with effect from 1st May, 1968, he continued to draw the same amount as pension. Similarly, in the case of the other director, viz., J. D. Somerville, the assessee-company claimed that his salary was increased from Rs. 2,250 per month to Rs. 3,530 per month with effect from 1st September, 1966, and he had continued to draw the same salary on being appointed as the managing director on the retirement of his father, Sri J. H. Somerville, with effect from 1st May, 1968. It may also be noted here that Sri J. H. Somerville held most of the shares of the assessee-company and was the managing director of the company till his retirement on 30th April, 1968. On 1st May, 1968, Sri J. D. Somerville, who was his son and director of the company till 30th April, 1968, became the managing director with, effect from 1st May, 1968. It was further claimed that for the assessment years 1967-68 and 1968-69, Sri J. H. Somerville, the then managing director, was paid a bonus of Rs. 9,000 in cash for two years. Similarly, in the case of the other director, Sri J, D. Somerville, it was claimed by the assessee-company that he was paid a bonus of Rs. 4,560 for the assessment year 1967-68 and also Rs. 6,300 for each of the two assessment years 1968-69 and 1969-70. The ITO considered all the facts and circumstances of the case and held that there was no justification for any increase in the remuneration of the then managing director, Sri J. H. Somerville, or the other director, Sri J. D. Somerville. He also held that on the retirement of Sri J. H. Somerville, there was no justification whatsoever on his being paid the same amount as pension which he was drawing as salary prior to retirement. He further held that there was no justification for payment of bonus to these persons. It may be appropriate in this connection to set out the relevant portion of the order for the assessment year 1967-68. The reasons and grounds of the order in the other two assessment years were identical. In the said assessment order, the ITO observed, inter alia, as follows:

Rs.(3)Rs. 10,500 on account of increment given to the managing director, I do not see any justification whenthe income of the company has gone down and no additional work has been entrusted by the company. Financial position of the assessee alsois no better than before. The otheremployees of the company have not received any similar gains in theiremoluments

10,500(4)Rs. 8,950 on account of increment to Mr. J. D. Somerville, director, for the samereasons as given above

8,950(5)Rs. 10,113 out of salary of Sri J. D. Somerville including perquisites 1/4th disallowed following the decision of the Tribunal in the earlier years

10,113(6)Rs. 69,074 on account of depreciation considered separately

69,074(7)Rs. 13,500 on account of bonus paid to the directors for the same reasons13,500

The result was that in the assessment year, the salary allowed to Sri J. H. Somerville was only Rs. 3,000 per month till his retirement, that is, up to 30th April, 1968, and thereafter the pension was allowed only at Rs. 1,000. Similarly, in the case of the other director, Sri J. D. Somerville, the salary was allowed to him at Rs. 2,250 till the time he remained only as director, that is, up to 30th April, 1968, and thereafter with effect from 1st May, 1968, he was allowed the salary at Rs. 3,000 as managing director. The rest of the salary paid to these persons and claimed as deduction was disallowed by the ITO.

2. Against the orders of the ITO, appeals were filed before the AAC. The AAC held on consideration of the facts and circumstances of the case that an increment of Rs. 500 per month to Sri J. H. Somerville would be reasonable with effect from 1st September, 1968, and reasonable pension on his retirement with effect from 1st May, 1966, in his case would be Rs. 1,750. Similarly, in the case of the other director, Sri J. D. Somerville, he held that he should be allowed an increment of Rs. 200 per month with effect from 1st September, 1966, and on his appointment as managing director he should be given a salary of Rs. 3,000 per month. The disallowance of excess over these amounts which were claimed as deduction was confirmed by the AAC. He also confirmed the disallowance of bonus claimed to have been paid by the assessee-company to these persons.

3. There were further appeals to the Tribunal. The Tribunal came to the conclusion that provisions of Section 40(c) of the I.T. Act, 1961, were applicable. The Tribunal took into consideration all the facts and circumstances of the case in order to hold, looking at the legitimate business needs of the company and the benefit derived by it that the salary and bonus paid to these directors as worked out by the AAC was reasonable and the excess was rightly disallowed under the provisions of Section 40(c) of the I.T. Act,-1961. The Tribunal also upheld the disallowance of bonus paid to these persons under the provisions of Section 40(c) of the I.T. Act, 1961.

4. On an application made, the Tribunal has referred, under Section 256(1) of the I.T. Act, 1961, the following question to this court:

'Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was correct in holding that the disallowance out of payments made to Sri J. H. Somerville and Sri J. D. Somerville could be sustained under Section 40(c) of the Income-tax Act, 1961 ?'

5. Under Section 29 of the I.T. Act, 1961, profits and gains of business have to be computed in accordance with the provisions contained in Section 30 to Section 43A of the I.T. Act, 1961. Section 37 of the I.T. Act, 1961, which is similar to Section 10(2)(xv) of the Indian I.T. Act, 1922, deals with deduction of expenditure laid out wholly and exclusively for the purpose of business or profession excluding capital expenditure. But, even in respect of those expenditure which are permissible under Section 37 of the I.T. Act, 1961, under Section 40 the amounts mentioned in the said section should not be deducted in computing the income from profits and gains of business or profession. Section 40(c) of the I.T. Act, 1961, provides as follows :

'40. (c) In the case of any company-

(i) any expenditure which results directly or indirectly in the provision of any remuneration or benefit or amenity to a director or to a person who has a substantial interest in the company or to a relative of the director or of such person, as the case may be,

(ii) any expenditure or allowance in respect of any assets of the company used by any person referred to in Sub-clause (i) either wholly or partly for his own purposes or benefit,

if in the opinion of the Income-tax Officer any such expenditure or allowance as is mentioned in Sub-clauses (i) and (ii) is excessive or unreasonable having regard to the legitimate business needs of the company and the benefit derived by or accruing to it therefrom, so, however, that the deduction in respect of the aggregate of such expenditure and allowance in respect of any one person referred to in Sub-clause (i) shall, in no case, exceed-

(A) where such expenditure or allowance relates to a period exceeding eleven months comprised in the previous year, the amount of seventy-two thousand rupees;

(B) where such expenditure or allowance relates to a period not exceeding eleven months comprised in the previous year, an amount calculated at the rate of six thousand rupees for each month or part thereof comprised in that period :

Provided that in a case where such person is also an employee of the company for any period comprised in the previous year, expenditure of the nature referred to in Clauses (i), (ii), (iii) and (iv) of the second proviso to Clause (a) of Sub-section (5) of Section 40A shall not be taken into account for the purposes of Sub-clause (A) or Sub-clause (B), as the case may be.

Explanation.--The provisions of this clause shall apply notwithstanding that any amount not to be allowed under this clause is included in the total income of any person referred to in Sub-clause (i).'

6. On behalf of the assessee, it was urged that Section 40(c); in the facts and circumstances of the case, would have no application. It was submitted that in case of payment of salary or other amounts in the shape of bonus or pension, this would not be an expenditure which resulted directly or indirectly in any remuneration or benefit or amenity to the director. When the sub-section speaks of resulting 'in any remuneration' the expenditure must be such other than the remuneration. The expenditure in the shape of remuneration or benefit or amenity, according to counsel for the assessee, could not be termed as something which resulted in the remuneration or' benefit or amenity to a director. It was submitted that on a proper construction of the section, the disallowance that was spoken of in the subsection was not in respect of salary or bonus or pension but of other benefit or amenity by way of perquisite which might increase the remuneration or benefit or amenity of a director or other person contemplated by Clause (c) of Section 40. Reference in this connection was made to the principles of construction in Maxwell on the Interpretation of Statutes, 12th edn., at page 289, which states as follows :

'Noscitur a sociis.

Where two or more words which are susceptible of analogus meaning are coupled together, noscuntur a sociis. They are understood to be used in their cognate sense. They take, as it were, their colour from each other, the meaning of the more general being restricted to a sense analogous to that of the less general (one application of this general principle is the ejus-dem generis rule.....)'

7. Reliance was also placed on the case of IRC v. Frere [1965] AC 402. At page 426 of the report, Viscount Radcliffe observed as follows:

'The context of the words in Rule XVII appears to me to indicate exactly the same meaning. The first heading covers income upon which the claimant is directly assessable. The second heading relates to income to which he is taxable by deduction and retention on the part of the payer, in other words the kinds of payment which the Act treats as being the taxable income of payee, not payer. These payments are described in the words 'Rents, interests, annuities or other annual payments'. The word 'interests' is not qualified by any adjective, but I think it inescapable that one must read it here, either because of its collocation with other annual payments' or for common sense, as meaning annual interest only, because it is only for that kind of interest that the Act has allowed deduction and retention of tax by the payer. Then there comes the third heading, described as 'Declaration of the amount of interest, annuities, or other annual payments, to be made out of the property or profits assessed on the claimant.....' The collocation of interest with annuities and other annualpayments is the same as in the preceding heading, and as a straightforward question of construction alone I think that any reader would naturally suppose that the word 'interest' was being used in the same sense in each ofthe two successive headings, and would never guess that in the second one it was being used with a different meaning from that which he had attributed to it in the first. In my opinion, there is no change in the meaning that is intended.'

8. An identical contention was raised before this court in the case of the present assessee in Income-tax References Nos. 271 & 272 of 1968 (Eastern Scales P. Ltd. v. CIT (since reported infra in : [1979]117ITR488(Cal) ). In that case while dealing with this contention, I had observed that it was not necessary to rest our decision on this contention in the view we had taken on the other contentions urged in that matter. It was, however, observed that the points raised on behalf of the assessee were substantial. In the instant reference before us, counsel for the assessee has again urged for acceptance of this contention. On a closer examination of this argument, it appears to us that the same cannot be accepted. The sub-section speaks of disallowance of the expenditure. The expenditure would be incurred by the company. The company's expenditure would result in the benefit either in the shape of remuneration or benefit or amenity. Therefore, where the remuneration of a director is increased or other benefit or amenity is given to a director of the company, the expenditure incurred by the company would cause that result. The expression 'results' is not an expression of art. It is an ordinary expression which would mean anything which arises as a consequence or has effect thereof (see in this connection Shorter Oxford Dictionary, 3rd edn., Vol. 2, page 1792). In legal terminology, the most familiar context in which one comes across with this expression is the expression of ' resulting trust'. Anything which is occasioned as a result of or as a consequence of something else can be said to be the result thereof. The expenditure incurred by the company from that point of view results in the provision of remuneration or benefit or amenity to the director. The passage from Maxwell on the Interpretation of Statutes referred to hereinbefore does not, in our opinion, deal with the specific problem with which we are confronted nor do the observations of Viscount Rad-cliffe militate against this view. After all, an expression in a particular statute has to be construed in the context and in the situation in which the expression is used. We have to bear in mind that this expression in Clause (c) of Section 40 deals with matters spoken of in Sections 30 to 39 of the I.T. Act, 1961, and-this section is primarily a section dealing with the deductibility of amounts in computing the chargeable profits of a company. Therefore, it must be construed, in the light of expenditure incurred by the company, that the nature of the expenditure must be such as those which are permissible under Section 37 of the Act. We may here incidentally mention that the Supreme Court in the case of Nund & Samont Co. P. Lid. v. CIT : [1970]78ITR268(SC) , a decision with which we shall deal with in detail later, upheld the disallowance of similar expenditure under Section 10(4A) of the Indian I.T. Act, 1922, which is in identical terms. The first contention, therefore, urged on behalf of the assessee cannot be accepted.

9. It was then contended that, in any event, the revenue authorities, in the instant case, had not applied the correct test under Section 40(c) of the Act in disallowing the amounts, as they have done. It was submitted that neither the fact that the income of the company had gone down nor that no additional work had been entrusted by the company to the directors concerned nor that the financial position of the company was no better than before, were relevant factors in considering the applicability of Section 40(c) of the Act of 1961. It was, therefore, urged that the revenue authorities had proceeded on erroneous basis. It was further submitted that so far as item No. (5), viz., Rs. 10,113, out of the salary of Sri J. D. Somerville including perquisites was concerned, this should have, in any event, been allowed because the disallowance, by the Tribunal in the earlier years had not been sustained by the High Court subsequently. This question will now have to be viewed in the light of the decision of the Supreme Court, as mentioned hereinbefore, in the case of Nund & Samont Co. P. Ltd. v. CIT : [1970]78ITR268(SC) . There, the Supreme Court was dealing with Section 10(4A) of the Indian I.T. Act, 1922, which was in identical terms with the present Section 40(c) of the Income-tax Act, 1961. The Supreme Court observed that in any enquiry under Section 10(4A) of the Indian I.T. Act, 1922, into excessive-ness or unreasonableness of an allowance resulting in the provision of any remuneration or benefit or amenity to a director or a person who had a substantial interest in the assessee-company, it was for the taxpayer to establish by evidence that a particular allowance was justifiable. If the taxpayer did dot produce any evidence in support of the claim for allowance, the ITO was not bound independently to collect evidence and decide that the allowance claimed was excessive or unreasonable having regard to the legitimate business needs of the assessee-company before the power under Section 10(4A) of the Indian I.T. Act, 1922, could be exercised. In the case before the Supreme Court, the assessee-company had provided towards remuneration for its managing director and deputy managing director certain amounts in accordance with the articles of association. In the absence of evidence in support of the claim for deduction of remuneration so provided, the ITO allowed the remuneration at an average of the amounts allowed during the last three years and disallowed the balance under Section 10(4A) of the Indian I.T. Act, 1922. The Tribunal confirmed the order of the ITO even though it was not proved that the payment of the remuneration was influenced by extra-commercial consideration. It was held by the Supreme Court that in the absence of evidence relating to the duties of the managing director and the deputy managing director, theservices rendered by them, the manner in which the profits of the assessee were enhanced by reason of their special aptitude or qualifications, the legitimate business needs of the assessee-company and the benefit derived by the assessee in consequence of the services rendered by them, the finding recorded by the ITO and confirmed by the Tribunal had to be accepted. If this is the principle, then in this case, it appears that the claim for increased remuneration was not supported by any evidence of the legitimate business needs of the company or of any tangible benefit to the company. On the other hand, the ITO had observed in his order that the income of the company had gone down and there was no evidence of any additional work being performed by the concerned directors. The financial position of the assessee-company did not also indicate any better position. It is also apparent that the other employees of the company had not received any similar increment in their emoluments. Bonus, it has to be borne in mind, is generally paid to workers or employees as inducement and encouragement for better work. In the instant case, bonus was being paid to two directors, one of whom was the managing director and the other a director and, between these two, they controlled practically the entirety of the shareholdings of the concerned company. It has also to be borne in mind that there was no evidence of payment of any bonus in any earlier year or to other employees of the company. There was no tangible evidence also of any difference in the quality of work done as a result of the payment of bonus. Similarly, in the case of pension to the managing director it has to be borne in mind that there was no scheme of pension in this company as a result of which this payment was made. This pension was not paid as a matter of a scheme which would attract better people to the company, nor was this pension announced to the directors concerned at the beginning of their careers with the company so as to be an inducement to make them work better. In this background and in the absence of any further evidence if the Tribunal has considered all the evidence adduced by the assessee, and in the instant case there is no grievance that any further evidence adduced by the assessee had been neglected or not considered by the revenue authorities, then it cannot be said that there has been misapplication of the provisions of Clause (c) of Section 40 of the Act.

10. Counsel for the assessee drew our attention to the observations of the Division Bench of this court in the case of CIT v. Edward Keventer (P.) Ltd. : [1972]86ITR370(Cal) . It appears, however, that the attention of the Division Bench of this court was not drawn to the decision of the Supreme Court in the case of Nund & Samont Co. P. Ltd. v. CIT : [1970]78ITR268(SC) , though the judgment of the Supreme Court was delivered on the 6th May, 1970. When the matter was heard by the Division Bench of this court, perhaps the judgment of the Supreme Court was not reported. TheDivision Bench, however, had occasion to consider the decision of the Patna High Court in the case of Nund & Samont Co. P. Ltd. v. CIT : [1966]62ITR538(Patna) , which was affirmed by the Supreme Court in the aforesaid decision. Counsel for the assessee drew our attention to the observations of this court at page 381 of : [1972]86ITR370(Cal) , where the Division Bench observed that it was necessary for the ITO to apply correctly, judiciously and in a dispassionate manner the two tests laid down by the requirements of the section, being Section 10(4A) of the Indian I.T. Act, 1922. The Division Bench further reiterated that the two tests were the legitimate business needs of the company and, secondly, the benefit derived by or accruing to the company. Whether in a particular case, however, such tests have been correctly applied or not and whether in a particular case the legitimate business needs of the company or the benefit derived by the company had been correctly appreciated or not would depend upon the facts and circumstances of each case. Reliance was also placed on behalf of the revenue on the decision of the Madras High Court in the case of Sri Krishna Tiles and Potteries (Madras) Pvt. Ltd. v. CIT : [1973]90ITR439(Mad) , where the assessee-company had claimed deduction of the bonus paid to its two managing directors apart from their salaries and commissions. The ITO disallowed the claim on the ground that payment of bonus was necessary in the case of employees as an incentive and that there was no need for payment of bonus to the managing directors, who held sizable number of shares in the company and who had also been given a commission on the net profits. This disallowance was upheld by the AAC and the Tribunal. This disallowance was ultimately sustained by the Division Bench of the Madras High Court. In the case of CIT v. India Radiators Ltd. : [1976]105ITR680(Mad) , the Madras High Court had to consider whether bonus formed part of the salary and it was held that it had formed part of the salary in terms of Section 40(c)(iii) as it stood as at the relevant time. Our attention was also drawn to, the decision of the Gauhati High Court in the case of CIT v. India Carbon (P,) Ltd. , but in view of the facts and circumstances of that case, which were different from the case before us, it is not necessary to discuss the said decision in any detail.

11. For the principles mentioned before, we have, therefore, to uphold the order of the Tribunal. So far as the arguments with regard to item No. 5 in the order of the ITO for the assessment year 1967-68 and similar orders in the subsequent two assessment years are concerned, it appears that the ITO has proceeded on the basis that one-fourth was disallowed by the Tribunal in the earlier years. Now, in the earlier years, one-fourth had been disallowed on the ground that the same were capital expenditure being expenditure incurred for expansion of the existing business. But, in this case, all the increments had been considered by the Tribunal in the light of the evidence adduced by the two yardsticks of the section, namely, the legitimate business needs of the company and, secondly, the benefit accruing to the company and by these two tests these disallowances were found to be justified by the Tribunal. If that is the position, then, in our opinion, the Tribunal was right in the conclusion to which it had come.

12. In the premises, the question referred to this court is answered in the affirmative and in favour of the revenue. Each party will pay and bear its own costs.

Sudhindra Mohan Guha , J.

13. I agree.


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