Case Law Companies Act Commissioner of Income Tax Kerala Vs Alagappa Textile Cochin Ltd

Case Law Companies Act

Commissioner of Income Tax Kerala Vs

Alagappa Textile Cochin Ltd

 

DATE OF JUDGMENT  19/09/1979

 

BENCH: TULZAPURKAR, V.D.

BENCH: TULZAPURKAR, V.D. PATHAK, R.S.

 

CITATION: 1980 AIR  235

1980 SCR  (1) 723 1980 SCC  (1) 214

ACT: Business Expenditure-Section  10(2)(xv) of       the Income- Tax Act, 1922-Whether the remuneration towards the ‘Manager’ Kamala Mills  Ltd. is  falling within the meaning of Section 384 read  with s.  2(24) of  the Companies  Act allowable as “business  expenditure”-Construction   of   the   terms   of Agreement-Whether the  managing  company  falls  within  the meaning of Section 2(24) of the Companies Act, 1956.

 

HEADNOTE: Respondent, assessee  (M/s. Alagappa  Textiles (Cochin) Limited company  was carrying on business of manufacture and sale of  yarn. It  entered into  an Agreement dated November 10, 1955  with Kamala  Mills Ltd.,  Coimbatore for financing and managing  the assessee  Mills at  Alagappa Nagar  for  a period of  five years.  Clause 8  of the  Agreement provided that Kamala  Mills Ltd.  shall be  paid  for  the  services, rendered by  it by  way of  purchases, sales  and management remuneration at  the rate  of 1% on all purchases made by it for the assessee Mills and at half a percent on all sales of yarn, yarn  waste and cotton waste and other products of the Mill. Clause 13 of the agreement was to the effect that “the company (assessee)  either represented by its managing Agent or  Board   of  Directors  shall  not  exercise  the  powers delegated to  the Managers  (Kamala  Mills  Ltd.  under  the foregoing clauses,  except by way of general supervision and advice nor  interfere with discretion of the managers in the exercise of  their functions  and powers  vested in  them by virtue of  this Agreement.”  Clause 14,  provided  that  the Managers (Kamala  Mills Ltd.)  powers were  limited  in  the manner aforesaid  and shall  not be  deemed to be manager in charge of  the whole  affairs  of  the  company  within  the meaning of  section 2(9)  of the companies Act, 1913.

Clause 16 provided  that the  agreement shall  be in  force  for  a period of  five years  commencing from  the date thereof and that “this  Agreement for management being an Agency coupled with interest”  could be  revoked before  the expiry  of the said period  of five  years by  12 months’ notice in writing being given  by one  party to the other, but if the assessee were to revoke it the assessee shall be liable to compensate Kamala  Mills   for  the   loss  of  remuneration  for,  the unexpired period  of the  Agreement at  the average  rate at which  Kamala   Mills  Ltd.  had  been  earning  by  way  of remuneration under  the Agreement  fill  the  date  of  such notice of termination Pursuant to the aforesaid terms, Kamala Mills Ltd. drew remuneration to  the tune of Rs. 1,03,547/- and Rs. 18,249/- respectively  for   the  calendar   years  1957   and   1958 corresponding to  the assessment  years 1958-59 and 1959-60. The amounts  were assessed  to tax  in the  hands of  Kamala Mills  Ltd.   Respondent,

Assessee   in   its   assessment proceedings  for  the  said  two  assessment  years  claimed deduction in  respect of  the said  two Amounts  as business expenditure under  section 10(2)(xv)  of the Income-tax Act. The claim  was disallowed  by the  Income Tax officer on the ground that  under section  384 of  the companies  Act. 1956 which had  come into force on April 2, 1956 the continuation of a 724 body corporate  as manager  was prohibited  for  the  period beyond six  months from  the coming  into force  of the Act, that the  remuneration paid  to Kamala Mills Ltd. subsequent to October 1, 1956 was illegal being in violation of s. 381. The Appellate  Assistant Commissioner  rejected  the  Appeal mainly on  the ground  that the  assessee by its own conduct had disputed its liability to pay any remuneration to Kamala Mills Ltd.  as after  October 1,  1956 and in that behalf he relied on  an admitted  fact that  the assessee  had filed a suit against Kamala Mills to recover such remuneration which had been  paid to  it in contravention of section 384 of the Companies Act  on the  basis  that  since  the  payment  was illegal  Kamala   Mills  was   holding   such   amounts   of remuneration in  trust for  and on  behalf of  the assessee. Respondent carried  the matter  in further  appeals  to  the Tribunal, but  the Tribunal confirmed the view of the taxing authorities. On  a reference,  the High  Court answered  the question in  the negative  in favour  of  the  assessee  and against the  Revenue. The  High Court held that Kamala Mills could not  be said  to be

“subject to  the superintendence, control and  directions of  the Board  of Directors”  of the respondent and therefore was not a “manager” of the assessee within the meaning of section 2(14) of the Companies Act, so as to attract the illegality under section 384 ibid. and (b) that in  view of  the provisions  of section  41(1)  of  the Income-tax Act,  the  pendency  of  an  appeal  against  the Judgment the  suit for  recovery could not be a valid ground for disallowing  the deduction  permissible under  ) section 10(2)(xv) of the Income-tax Act. Dismissing the  appeal by Revenue by special leave, the Court ^ HELD: 1.  Section 384  of the  Companies Act,  1956  in express terms  prohibits, after the commencement of the Act, the appointment  of  a  firm  or  a  body  corporate  or  an association of  persons as  manager as also the continuation of such  employment after  expiry of  six months  from  such commencement.    To     attract    the     prohibition    or disqualification, under this section, a firm, body corporate or association  must be  a “manager”  within the  meaning of section 2(24), that is to say, it should be in management of the whole  or substantially  the whole  of the  affairs of a company and  should be  under superintendence,  control  and direction of the Board of Directors of the company [730 C-D, E-F] 2. Section       2(24) of  the Companies  Act requires three conditions to  be satisfied:  (a) the  Manager  must  be  an individual, which  means that a firm or body corporate or an association is  excluded and  cannot be  a Manager  (a  fact which is expressly made clear in section 384). (b) he should have the  management of the whole or substantially the whole affairs of  the company  and

 

(c) he should be subject to the superintendence, control  and directions  of  the  Board  of Directors in  the matter  of managing  the  affairs  of  the company. Subject  to the  changes made in the aspect covered by (a)  and (b),  in both  the definitions [s. .2(9) of 1913 Act and s. 2(24) of the 1956 Act], the aspect that a Manager has to  work or  exercise his  powers under  the control and directions  of   the  Board   of  Directors  is  common  and essential. In  fact, it  is this  aspect which distinguishes ‘Manager’  from   “Managing  Agent”.  A  comparison  of  the definition of “Manager” as given in s; 2(24) of the 1956 Act with that  of “Managing  Agent” in  s. 2(25)  makes it clear that though  there is an overlapping of the functions of the Manager as  well as  the Managing  Agent of  the company the essential distinction is that whereas the 725 Manager has  to be  subject to  the superintendence, control and direction  of the Board of Directors, the managing Agent is not so subject. [729 G-H, 730 A-C] 3. On  a perusal  of  the  clauses  and  in  particular clauses 8, 13, 11 and 16 of the Agreement dated November 10, 1955 in the instant case, two or three things stand out very clearly. It  is true  that at  the commencement  of the deed Kamala Mills  Ltd. has been described and referred to as the “Managers” of the asses see throughout the document but mere label or  nomenclature given to a party in the document will not be decisive. It is also true that the several powers and functions were entrusted to Kamala Mills Ltd. under clause 1 of the Agreement to enable it “to manage or run the Mill” of the assessee.  But simply  because powers and functions were given to  Kamala Mills Ltd. for the purpose of “managing and running the Mills” of the assessee, it could not follow that Kamala Mills  Ltd. was in truth and substance a ‘manager’ of the assessee within the meaning of s. 2(24) of the 1956 Act. For this  purpose the  Agreement will  have to  be read as a whole and  the Court  w ill have to decide what was the true intention of  the parties  in entering  into such Agreement.

[733 E-G] 4. The  dominant object  with which  the Agreement was entered into was that Kamala Mills Ltd. should really act is a financier  so-that the  assessee Mill  could run and since heavy finances  were to  be procured  by Kamala  Mills  Ltd. large powers and functions connected with the working of the mill were  entrusted to  it. This  aspect become  abundantly clear from  cl. 16  of the  Agreement  wherein  the  parties expressly provided that this Agreement for management was by way of  and amounted  to an  Agency coupled with interest so far as  Kamala Mills  Ltd.  was  concerned  and,  therefore, revocation of the Agreement before the expiry of five years’ period was  made dependent upon 12 months’ notice in writing being given  by one  party to  the other and further if such revocation was  done by  the assessee  suitable compensation was made  payable to  Kamala  Mills  Ltd.  In  other  words, managerial functions were incidental and had to be entrusted to Kamala  Mills because  of the financier’s role undertaken by it.  The large  powers and  functions entrusted to Kamala Mills Ltd.  under the  several sub-clauses  of cl.  1 of the Agreement do  show  that  management  of  substantially  the whole, if  not the  whole, of  the affairs  of the  assessee company had been made over to Kamala Mills Ltd. [734 B-E] 5. Clause 13 of  the Agreement which is very eloquent.

provided that  so  far  as  the  powers  conferred  and  the functions entrusted to Kamala Mills Ltd. were concerned, the Board of  directors shall  not exercise  or perform the same except by  way of  general supervision and advice and it was further made  clear that  the Board  of Directors  shall not interfere with  the discretion  of Kamala  Mills Ltd  in the exercise of  their functions  and powers  vested  in  it  by virtue  of  the  Agreement.  In  other  words,  the  general supervision or  advice of the Board of directors was of such character that  the Board had no way whatsoever nor could it interfere with  the discretion  of Kamala  Mills Ltd. in the matter of  the exercise  of the  powers and the discharge of the functions  entrusted to  Kamala  Mills  Ltd.  under  the Agreement. It  is thus clear that the dominant object of the Agreement  was   that  Kamala   Mills  Ltd.  should  act  as financiers of  the assessee  Mill and  in the  matter of the exercise of its powers and discharge of its functions Kamala Mills Ltd. was never “subject to the superintendence control or direction” of the Board of 726 directors of  the  assessee.  This  is  the  position  which clearly emerges  on true construction of the Agreement. [734 F-H, 735A] 6. Therefore,  Kamala Mills  Ltd.       was  not  acting  or working as  the “Manager” of the assessee within the meaning of s.  2(24) of  the Companies  Act, 1956  and as  such  the illegality of  section 384  of the Act was not attracted. In this view  of the  matter,  the  remuneration  paid  by  the assessee to  Kamala Mills  Ltd. for  the two  calendar years 1957 &  1958 relevant  to the  assessment years  1958-59 and 1959-60 could  not be  regarded as  being in violation of s. 384 of  the companies  Act, 1956 and as such the expenditure incurred  by  way  of  paying  such  remuneration  would  be deductible as “Business Expenditure” under section 10(2)(xv) of the Income-tax Act, 1922. [735A-D]

JUDGMENT: CIVIL APPELLATE  JURISDICTION: Civil Appeals Nos. 2001- 2002 of 1978. Appeals by  Special Leave  from the  Judgment and order dated 14-12-1971  of the  Kerala High  Court in  Income  Tax Reference No 19 of 1969. V. S. Desai, S. P. Nayar and Miss A. Subhashini for the Appellant S. T.  Desai, N.  Sudhakaran and  P. K.  Pillai for the Respondent. The Judgment of the Court was delivered by TULZAPURKAR, J.  These appeals by special leave raise a common  question  whether  on  proper  construction  of  the Agreement dated  November 10,  1955,  entered  into  by  the assessee  with   Kamala  Mills  Ltd.,  the  latter  was  the “manager” of  the assessee within the meaning of s. 384 read with s.  2(24) of the Companies Act, 1956 and if so, whether the remuneration  paid by  the assessee to the latter in the two calendar  years 1957 and 1958 relevant to the assessment years 195859  and 1959-60  cannot  be  allowed  as  business expenditure under  s. 10(2)  (xv) of  the Indian  Income-Tax Act, 1922? The facts giving rise  to the  question may briefly be stated as  follows:

The  assessee  (M/s  Alagappa  Textiles (Cochin) Ltd.)  is a  public  limited  company  carrying  on business of  manufacture  and  sale  of  yarn  and  has  its registered office  at Alagappa  Nagar in  Kerala  State.  It entered into  an Agreement  dated  November  10,  1955  with Kamala Mills  Ltd. Coimbatore for financing and managing the assessee mills at Alagappa Nagar for a period of five years. Clause 8  of the  Agreement provided  that Kamala Mills Ltd. shall be  paid, for  the services  rendered by  it by way of purchases, sales and management, remuneration at the rate of 1% on all purchases made by it for the assessee mills and at half a  per cent on all sales of yarn, yarn waste and cotton waste and  other products  of  the  mill.  Pursuant  to  the aforesaid term  Kamala Mills  Ltd. drew  remuneration to the tune of Rs. 1,03,547/- and Rs. 18,294/- respectively for the calendar years 1957 and 1958 727 corresponding to  the assessment  years 1958-59 and 1959-60. These amounts  were assessed  to tax  in the hands of Kamala Mills Ltd.  The assessee  in its  assessment proceedings for the said  two assessment  years claimed deduction in respect of the  said two  amounts as  business expenditure  under s. 10(2) (xv)  of the Act. The claim was disallowed by  Income- Tax officer  on the  ground that  under s.  384 of  the  new Companies Act,  1956, which  had come into force on April 1. 1956, the  continuation of  a body  corporate as manager was prohibited for  the period beyond six months from the coming into force  of the  Act, that  remuneration paid  to  Kamala Mills Ltd.  subsequent to October 1, 1956, was illegal being in violation of s. 384 and, therefore, the deduction claimed in respect  of such  payment for the calendar years 1957 and 1958 could  not be  allowed. In the appeals preferred by the assessee against  the decision of the Income Tax officer, it was contended  that though  the payment of remuneration to a body corporate  as Manager after October 1, 1956 was illegal under s.  384,

the  payments were  for services rendered and were fully  justified by  commercial expediency  and as such the same  should be  allowed under s. 10(2) (xv) of the Act. It was also urged that even if the expenses incurred were in violation of  the statute  such expenses  should be  allowed since in computing the profits even of illegal business only the net  profit was  taxed after  allowing all the expenses. The Appellate  Assistant Commissioner  was not  impressed by these arguments;  but he  disallowed the deduction mainly on the ground that the assessee by its own conduct had disputed its liability  to pay  any remuneration to Kamala Mills Ltd. after October  1, 1956  and in  that behalf  he relied on an admitted fact  that the  assessee had  filed a  suit against Kamala Mills  Ltd. to  recover such  remuneration which  had been paid to it in contravention of s. 384 on the basis that since the  payment was illegal Kamala Mills Ltd. was holding such amounts  of remuneration  in trust for and on behalf of the assessee and in such a situation the deduction could not be allowed.  The assessee  carried  the  matter  in  further appeals to the Tribunal, but the Tribunal confirmed the view of the taxing authorities that under s. 384 of the Companies Act, 1956  it  was  not  legal  for  the  assessee  to  have permitted Kamala  Mills Ltd.  to continue  to  work  as  its Manager after  October 1,  1956  and  that  the  payment  of remuneration after  the said  date was illegal and could not be considered as valid expenditure for the purpose of Income Tax Act. fn this behalf the Tribunal relied on two decisions in C.I.T.  v. Haji  Aziz and  Abdul  Sakoor  Bros.  and  Raj Woollen Industries  v. C.I.T.  An argument was raised before the Tribunal that Kamala 728 Mills Ltd.  was not  only a manager but also a financier and that the  remuneration should be treated as having been paid to the  financier While observing that it was a new case put forward  by   the  assessee,

The  Tribunal  negatived  the contention holding,  on construction  of the Agreement, that it was  by virtue  of its  position as  Manager that  Kamala Mills Ltd.  was allowed to carry on the financial affairs of the assessee  and the  remuneration was  payable  to  it  as Manager and  in no  other capacity.  The Tribunal  also held that the  claim for  deduction was  in respect of a disputed liability inasmuch  as the  assessee had  not merely filed a suit to  recover the amount but had in the meantime obtained a decree  against Kamala  Mills Ltd.,  and,  therefore,  the amounts  could   not  be  lawfully  claimed  as  permissible deduction. At the  instance of the assessee the following question was referred to the High Court for its opinion: “Whether on  the facts and in the circumstances of the  case,        the  Tribunal  was  justified  in  law  in disallowing the  claim of the assessee for deduction of Rs. 1,03,547/-  and Rs. 18,294/- from the income of the assessment years   1958-59  and   1959-60  as  not  an admissible business expenditure under sec. 10(2)(xv) of the Indian Income Tax Act, 1922 -” The High  Court answered  the question  in the  negative  in favour of  the assessee and against the Department. The High Court, on  construction of  the Agreement dated November 10, 1955, took the view that since in the matter of the exercise of its  powers and the discharge of its functions thereunder Kamala Mills  Ltd. could  not be  said to be “subject to the superintendence  control  and  direction  of  the  Board  of Directors” of  the assessee,  Kamala Mills  Ltd. was  not  a “manager” of  the assessee within the definition given in s. 2(24) of  the  Companies  Act,  1956,  and,  therefore,  the illegality under  s. 384  was not  attracted and as such the remuneration paid  by the  assessee to Kamala Mills Ltd. for services rendered  during the  calender years  1957 and 1958 was allowable  as a business expenditure under s. 10(2) (xv) of the  Act.

As regards the decree that had been obtained by the assessee  against  Kamala  Mills  Ltd.  the  High  Court observed that  the appeal filed by Kamala Mills Ltd. against the said  decree was  still pending in the High Court and if ultimately the  appeal was  dismissed and  the amounts  were recovered back from Kamala Mills Ltd., the assessee could be taxed on  those amounts  under s. 41(1) of the 1961 Act, but that could  not  be  a  valid  ground  for  disallowing  the deduction  claimed   by  the   assessee.  The   Revenue  has challenged in  these appeals the view of the High Court that Kamala Mills Ltd. was not the Manager of the 729 assessee within  the meaning of s. 384 read with s. 2(24) of the Companies  Act, 1956  and  the  further  view  that  the remuneration paid  to Kamala  Mills Ltd. during the calendar years 1957  and 1958  was deductible as business expenditure under s. 10(2) (xv) of the Act. Before we       consider the  principal question relating to the proper  construction of the Agreement dated November 10, 1957, it  will be  desirable to note the relevant provisions of the  Indian Companies Act, 1913 as also the new Companies Act, 1956,  which have  a bearing  on the question at issue. Since the Agreement between the assessee on the one hand and the Kamala  Mills Ltd.  On the  other was  entered into at a time when  the Indian  Companies Act,  1913 was  in force it will be proper first to refer to the definition of ‘Manager’ given in s. 2(9) of the said Act. Section 2(9) ran thus: “2(9) “manager” means a person who, subject to the control  and   direction  of   the       directors  has  the management of  the whole  affairs of  a  company,  and includes a  director or  any other person occupying the position of  a manager  by       whatever  name  called  and whether under a contract of service or not. It will  be clear that to satisfy the aforesaid definition a person, which  could include  a firm,  body corporate  or an association of  persons, apart  from being  in management of the whole  affairs of.  a company  had to be “subject to the control and direction of the directors”. This definition has undergone a  substantial change  under  the  Companies  Act, 1956.

Under  this  Act  s.  2(24)  defines  the  expression “manager” thus. 2(24) “manager  means an individual (not being the managing agent)  who, subject  to the  superintendence, control and  direction of       the Board  of directors, has the management  of       the  whole,  or  substantially  the whole, of       the affairs  of a  company, and  includes  a director or  any other person occupying the position of a manager, by whatever name called, and whether under a contract of service or not.” In this  definition three  conditions  are  required  to  be satisfied: (a)  the manager  must be  an  individual,  which means that  a firm  or a body corporate or an association is excluded and  cannot be a manager (a fact which is expressly made clear  in s. 384), (b) he should have the management of the whole  or substantially the whole affairs of the company and (c) he should be subject to the superintendence, control and directions  of the  Board of  Directors in the matter of managing the  affairs of the company. Subject to the changes made in the aspects 730 covered by  (a) and  (b), in both the definitions the aspect that a  manager has to work or exercise his powers under the control and  directions of  the Board of Directors is common and essential. In fact it is this aspect which distinguishes ‘Manager’  from  ‘Managing  Agent’.  If  the  definition  of ‘Manager’ as  given in  s. 2(24)  is compared  with that  of ‘Managing Agent’  as given  in s. 2(25) it will appear clear that though  there is an overlapping of the functions of the manager as  well as  the managing  agent of  the company the essential distinction  seems to  be that whereas the manager has  to  be  subject  to  the  suprintendence,  control  and direction of  the Board  of directors  the managing agent is not so subject. Section 384 of the Companies Act, 1956 in express terms prohibits,  after   the  commencement   of  the   Act,   the appointment of  a firm or a body corporate or an association of persons  as a  manager as  also the  continuation of such employment  after   expiry   of   six   months   from   such commencement.

It runs thus: “384. No  company shall, after the commencement of this Act, appoint or employ, or after the expiry of six months from  such commencement continue the appointment or       employment   of,  any   firm,  body   corporate  or association as its manager. The aforesaid provision positively disqualifies a firm, body  corporate  or  association  from  being  appointed  as manager of  a company or from continuing the employment of a firm, body  corporate or  association as  manager after  the expiry of  six months  from the  commencement  of  the  Act. Obviously, to  attract the  prohibition or  disqualification contained in  s. 384,  a firm, body corporate or association must be  a “manager” within the meaning of s. 2(24), that is to  say,  it  should  be  in  management  of  the  whole  or substantially the  whole of  the affairs  of a  company, and should be  under superintendence,  control and  direction of the Board  of directors of the company. It was not seriously disputed that  under the  terms and  conditions contained in the Agreement  dated November  10, 1955,  Kamala Mills  Ltd. could be said to be in management of substantially the whole of the  affairs of  the assessee  mills but  the question is whether it  was working  under the  superintendence, control and direction  of the  Board of directors of the assessee so as to be its ‘Manager’ within s.

2(24) of the Act? Turning now  to the  Agreement in question it  may  be stated that  at the  commencement of  the deed  the  parties thereto have  been described in a particular manner, namely, the assessee has been described 731 and referred to as the “Company” while Kamala Mills Ltd. has been described  and referred to as the “Managers” throughout the document. Then follow two recitals which make very clear the object  or purpose  with which the Agreement was entered into; according  to these  recitals  the  assessee  was  not having sufficient  finance  to  carry  on  its  business  of manufacture and  sale of  yarn and  the Board  of  directors thought it  proper of find out a financier who was agreeable to help  the assessee monetarily and take active interest in its business  and that  since Kamala  Mills Ltd.  agreed  to assist the  assessee with  sufficient finance  and to manage the assessee’s  mill on  certain terms  and conditions which the Board  of Directors  had  approved,  the  Agreement  was executed between  the parties.  Then  follow  the  operative parts of  the deed  setting out  the terms and conditions on which Kamala Mills Ltd. agreed to provide sufficient finance as also  to manage  the business  of the  assessee. Clause 1 enlisted in  sub-clauses (b) to (m) the powers and functions which were  to be  exercised and  performed by  Kamala Mills Ltd. during the period of five years for which the Agreement was to  operate; such  powers were  conferred and  functions entrusted for the purpose of “managing and running the mill” of the  assessee; inter  alia, Kamala Mills Ltd. was to make purchases of  all cotton,  staple fibre  or  any  other  raw material for  the manufacture  of the yarn and to enter into contracts in  that behalf at such rates and prices as it may deem  fair  and  proper  and  make  payments  for  all  such purchases and  incur all expenses incidental thereto; it was also to  make purchases  of all  stores and spares and other materials necessary  for the  manufacture of yarn;

it was to appoint all  staff, technical  or non-technical  and workers skilled  and  unskilled  as  also  clerks  and  other  staff necessary for  the working  of the  mill and fix their terms and remuneration  and could  discharge or  dismiss  or  take disciplinary action  against them;  it had  to sell and make contracts for sale for immediate or future delivery of yarn, yarn waste or cotton waste or any other material or products of the  mill at  such rates  or prices and on such terms and conditions as  it may  think fit;  it could decide, lay down and change from time to time the programme of manufacture of yarn and  other products  of the  mill and to insure against fire and  other risks  all cotton, yarn, material, stock-in- trade and incur and pay all premia necessary in that behalf; it could  pledge, secure  and  hypothecate  all  stocks  and stores and  stock-in-trade with  such bank  or  banks  where arrangements for overdrafts shall have been completed by the Board of  Directors; and it could claim, demand, realise and sue for all goods, materials and amounts due to the assessee in the exercise and carrying out of any or all of the powers conferred under  sub-cls.  (a)  to  (k).  Clause  2  of  the Agreement stipulated that Kamala Mills Ltd. shall 732 provide  funds   or  arrange   for  finance   necessary  for exercising the  powers of  purchase of  cotton,  stores  and other  materials   and  for   payment  of  wages,  salaries, commissions and  allowances and  for  meeting  all  expenses incidental to  manufacture and  sale of  yam and  other pro- ducts of the mill. Under clause 3 the assessee was to open a separate Current  Account and  an overdraft  Account  for  a limit not  exceeding Rs.  30,00,000/- with  such bankers  as Kamala Mills  may require  with power  to  Kamala  Mills  to operate on  the said  accounts exclusively  by itself and in the name  of the  assessee and  it  was  to  have  power  to receive, endorse,  sign, transfer  and negotiate  all bills,

cheques, drafts etc. that may be received in the name of the assessee in  the course of the management of the mill and it was specifically  agreed that  no one  except  Kamala  Mills shall have  power to  operate on the said accounts. Clause 4 entitled Kamala  Mills Ltd.  to charge the assessee interest at the  rate of 7.5% per annum with half-yearly rests on all advances made  by it and funds provided for the purposes set out in clause 2. Clause 5 gave Kamala Mills Ltd. a first and prior charge on all the stocks and stores and stock-in-trade for all the moneys and amounts that may be advanced by it to the assessee  except to the extent of any charge or security of such  stocks and  stores and  stock-in-trade that  may be created in favour of the banks for the overdraft account and such charge in favour of Kamala Mills was to be a possessory charge. Clause  8 quantified  the  remuneration  payable  to Kamala Mills Ltd. for services rendered by way of purchases, sales, and  the management of the mill at the rate of 1 % on all purchases  made by  it for the assessee mill and at 0.5% on all  sales of  products effected for and on behalf of the assessee. Clause  10 required  Kamala Mills Ltd. to maintain proper accounts  in respect  of  all  purchases,  sales  and expenses, commissions  and remunerations  due to it etc. and submit to  the  assessee  monthly  statements  of  accounts.

Clause 11  put the outer limit of Rs. 15,00,000/- at any one point of time on the advances and financial assistance to be given by  Kamala Mills  Ltd. to  the  assessee  and  it  was provided that  if and  when sums  over and  above  the  said limits become  necessary to  be advanced, Kamala Mills would be entitled to appropriate and take for itself as owner such quantity of  yarn as  may be  in stock  as in value would be equivalent, at  cost or market value whichever was lower, to the sum that it may be obliged to advance over and above Rs. 15,00,000/-. Clause  13 of  the Agreement  is very important having a crucial bearing on the question at issue and may be set out verbatim. It ran thus: “13. The  Company (assessee) either represented by its Managing  Agent or  Board of  Directors  shall  not exercise the  powers delegated  to the Managers (Kamala Mills Ltd.) 733 under the       foregoing clauses,  except by way of general supervision  and advice,  nor   interfere  with   the discretion of  the Managers  in the  exercise of  their functions and  powers vested  in them by virtue of this Agreement.

” Under cl.  14 it  was provided  that the  Managers’  (Kamala Mills Ltd.)  powers were limited in the manner aforesaid and they were  not and  shall not  be deemed  to be  managers in charge of  the whole  affairs  of  the  company  within  the meaning  of   s.  2(9)   of  the  Indian  Companies  Act,  a significant provision  showing the  intention of the parties that Kamala Mills Ltd. was not to be regarded as a ‘Manager’ under  the   Indian  Companies   Act,  1913.  Clause  16  is significant and  it provided that the Agreement shall be, in force for  a period  of five  years commencing from the date thereof and  that “this  Agreement for  management being  an Agency coupled  with interest”,  it could  be revoked before the expiry  of the  said period  of five  years by 12 months notice in  writing being given by one party to the other but if the  assessee were  to revoke  it the  assessee shall  be liable  to   compensate  Kamala   Mills  for   the  loss  of remuneration for  the unexpired  period of  the Agreement at the average rate at which Kamala Mills Ltd. had been earning by way  of remuneration under the Agreement till the date of such notice  of termination.

A modification  by introducing one additional  term. in  the Agreement was made on November 21, 1955  but the  additional term  is not  material for our purposes. On a  perusal of the aforesaid clauses of the Agreement in question  two or  three things stand out very clearly. It is true  that at  the commencement  of the deed Kamala Mills Ltd. has been described and referred to as the “Managers” of the assessee  throughout the  document  but  mere  label  or nomenclature given  to a  party in  the document will not be decisive. It  is also  true that  the.  several  powers  and functions were entrusted to Kamala Mills Ltd. under cl. 1 of the Agreement  to enable  it “to  manage or run the mill” of the assessee.  But simply  because powers and functions were given to  Kamala Mills Ltd. for the purpose of “managing and running the mills” of the assessee, it would not follow that Kamala Mills  Ltd. was in truth and substance a ‘manager’ of the assessee within the meaning of s. 2(24) of the 1956 Act. For this  purpose the  Agreement will  have to  be read as a whole and  the Court  will have to decide that was the true, intention of  the parties  in entering  into such agreement. The two  recitals clearly indicate the object with which and the purpose  for which  the Agreement  was entered  into. It does  appear   that  the   assessee   was   in   financially straightened circumstances  and on  that account was utterly unable to  carry on  its business of manufacture and sale of yarn and, therefore, 734 the board  of directors  were in  search of  a financier who would make  available the necessary finances for the running of the  mill as also to take active interest in the business of the assessee and when Kamala Mills Ltd. agreed “to assist the company  (assessee) with  sufficient finance  and manage the mill

” belonging to the assessee on terms and conditions that were  approved  b-y  the  Board  of  Directors  of  the assessee that  the Agreement  was entered  into between  the parties; in  other words,  it is  clear  that  the  dominant object with  which the  Agreement was  entered into was that Kamala Mills Ltd. should really act as financier so that the assessee mill  could run and since heavy finances were to be procured by  Kamala Mills  Ltd. large  powers and  functions connected with the working of the mill were entrusted to it. This aspect  becomes abundantly  clear from  cl. 16  of  the Agreement wherein  the parties  expressly provided that this Agreement for  management was  by way  of and amounted to an Agency coupled with interest so far as Kamala Mills Ltd. was concerned and, therefore, revocation of the Agreement before the expiry of the five years’ period was made dependent upon 12 months’ notice in writing being given by one party to the other and  further  if  such  revocation  was  done  by  the assessee suitable  compensation was  made payable  to Kamala Mills  Ltd.   In  other  words,  managerial  functions  were incidental and  had to  be entrusted to Kamala Mills because of the  financier’s role  undertaken by it. The large powers and functions  entrusted to  Kamala  Mills  Ltd.  under  the several sub-clauses  of cl.  1 of the Agreement do show that management of  substantially the whole, if not the whole, of the affairs  of the  assessee company  had been made over to Kamala Mills  Ltd.

But  the crucial question is whether such management was  to be  done by  Kamala Mills Ltd. under “the superintendence, control  and  direction  of  the  Board  of Directors” of  the assessee and in that behalf cl. 13 of the Agreement which  we have  quoted above  is very eloquent. In terms it  provided that  so far  as the powers conferred and the  functions   entrusted  to   Kamala  Mills   Ltd.,  were concerned, the  Board of  Directors shall  not  exercise  or perform the  same except  by way  of general supervision and advice and  it was  further made  clear that  the  Board  of Directors shall  not interfere with the discretion of Kamala Mills Ltd.  in the  exercise of  their functions  and powers vested in it by virtue of the Agreement. In other words, the general supervision  or advice of the Board of Directors was of such  character that the Board had not say whatsoever nor could it  interfere with the discretion of Kamala Mills Ltd. in the  matter  of  the  exercise  of  the  powers  and  the discharge of  the functions  entrusted to  Kamala Mills Ltd. under the  Agreement.

It  is  thus  clear  to  us  that  the dominant object  of the Agreement was that Kamala Mills Ltd. should act as financiers of the assessee mill and in the 735 matter of  the exercise  of its  powers and discharge of its functions Kamala  Mills  Ltd.  was  never  “subject  to  the superintendence, control  or  direction”  of  the  Board  of directors of  the assessee. If this position clearly emerges on true construction of the Agreement in question then it is obvious that  Kamala Mills  was not acting or working as the “Manager” of  the assesses within the meaning of s. 2(24) of the Companies Act, 1956 and as such the illegality of s. 384 of that  Act was  not attracted. In this view of the matter, the remuneration  paid by the assessee to Kamala Mills Ltd.. for the  two calendar  years 1957  and 1958  relevant to the assessment years 1958-59 and  1959-60 could not be regarded as being  in violation  of s. 384 of the Companies Act, 1956 and as  such the  expenditure incurred by way of paying such remuneration would  be deductible as business  expenditure under s. 10 (2) (xv) of the Income Tax Act. 1922. In view of our aforesaid conclusion the aspects whether the  assessee had  disputed  its  liability  to  pay  such remuneration to Kamala Mills Ltd. Or had filed a suit at the instance of  the Company  Law Board to recover it back from Kamala Mills  Ltd. Or  had obtained  a decree in that behalf against Kamala  Mills Ltd.  become irrelevant. However, we would like to place  on record  the fact  that  the  decree obtained by the assessees against Kamala Mills Ltd. has been reversed or  set aside  in appeal by the Kerala High Court-a fact which  was brought  to our  notice by  the Advocate-on- Record for the assessee communicated to him by his client in a letter  dated 22nd  August, 1979.  However, even  7 if  in further appeal  the trial  court’s decree  were restored and the assessee  were to  recover  back  the  remuneration  the assessee can  be taxed  on the two amounts under s. 41(1) of the 1961 Act. In our  view, therefore,  the High Court was  right in answering the  question in favour of the assessee. The appeals are, therefore, dismissed with costs. V.D.K.

Appeals dismissed. 736

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