Companies Act Case Law M/S Amalgamation Pvt Ltd Vs Commissioner Of Income Tax Madras

PETITIONER:
M/S AMALGAMATION PVT. LTD.

Vs.

RESPONDENT:
COMMISSIONER OF INCOME TAX,MADRAS

DATE OF JUDGMENT: 25/04/1997

BENCH:
S.C. AGRAWAL, K.S. PARIPOORNAN

 
ACT:

 

HEADNOTE:

 

JUDGMENT:
W I TH
CIVIL APPEALS NOS. 7-11 OF 1980
JU D G ME N T
S.C. AGRAWAL, J. :-
These appeals, by certificate of fitness granted by the
Madras High Court under Section 66(A)(2) of the Income Tax
Act, 1922(hereinafter referredto as ‘the 1922 Act’) and
Section261 of the Income Tax Act, 1961(hereinafter referred
to as’the 1961 Act’) read with Article133 of the
Constitution of India,are directed against the Judgment of
the Said High Court dated March 1, 1976 in Tax CasesNos.
160 of1969 and 239 of1971 (References Nos. 52 of 1969 and
1 of T.C. No. 160 of 1969
“(1) Whether, on the facts and in
the circumstancesof the case, the
Tribunal was rightin upholding the
basis of valuation adopted by the
Income-taxofficer for the shares
inMessrs. Sri Rama Vilas Service
(Private) Ltd. as on January 1,
1954?
(2) Whether, on the facts and in
the circumstancesof the case, the
Tribunal was right in holding that
the proviso to section 12B(2) has
noapplication in regard to the
sale of shares to M/s Simpson &
Company Ltd ?”
T.C.No. 239 of 1971
“(1) Whether, on the facts and in
the circumstances of the case, the
Tribunal was right in holding that
the proviso to section 12B(2) has
noapplication in regard to the
sale various sharesby the
assessee-company to M/s Simpson &
General Finance Co. (Private) Ltd.
and that the assessee wasentitled
toa capital loss of Rs. 9,47,541/-
inthe assessment year 1958-59?
(2) Whether, on the fact and in
the circumstancesof the case, the
Tribunal was right in law in
holding that the second proviso to
section 12B(2) had no application
and that the full value of the
consideration accounted for by the
assessee should not be altered ?”
These questions arise in the following facts and
circumstances.
M/s Amalgamation Private Limited (hereinafter referred
to as ‘the assessee-Company’ )is a company incorporated on
December 22,1938 as a private limited Company. The assessee-
companyheld shares in several companies, such as simpson
and Company Ltd., Addison & Company Pvt. Ltd.,George Oakes
(Private) Ltd., Addison Paints & Chemicals private Ltd.,
India pistons Private ltd., etc. Out of the issued capital
of Rs. 7,50,000shares of Rs. 10 in Simpson andCompanyLtd.
the assessee-company held, atthe material time, 7,06,933
ordinary shares. Simpson and Company Ltd, hada subsidiary
by name simpson and General Finance Company (private)Ltd,
Carrying on the business offinancing by way ofhire
purchase transactions to outsiders and by wayof loans and
advance to the companies of this group. As onJuly 1,1956
a sum of Rs. 1,85,16,000/- was due to Simpson and General
Financecompany (Private) Ltd. from the assessee-company.
Under Section 295 of the Companies Act,1956 which cameinto
force on April1, 1956 no company could, without obtaining
the previous approval of the CentralGovernment inthat
behalf , directly or indirectly, make any loan to a company,
which is its holding company . In sub-section (3) of Section
295 itis provided that where any loan madeby a lending
companyand outstandingat the commencement of the companies
ace, 1956, could not have been made withoutthe previous
approval of the Central Government If that section hadthen
been in force,then the lending company had to, within six
months from thecommencement ofthe Actor suchfurthertime
not exceedingsix months asthe Central Government might
grant for thatpurpose, either obtain the approval of the
Central Government to the transaction orenforce the
repayment ofthe Loan made. The liability of Rs.
1,85,16,000/- to Simpson and General Finance company
(Private ) Ltd. by theassessee-company was affected by the
aforesaid provision and, therefore, itbecame necessary for
the asessee-company to liquidate this liability. Simpson and
GeneralFinance Company (Private) Ltd. owed a sum of Rs.
1,05,21,750/- to Simpson and Companyltd. The assessee-
companyapproached theGovernment of India for necessary
approval to put through certain transactions sale of shares
held by it tosimpsonand General Finance Company(Private)
Ltd. in liquidation of the liability. Simpson and General
FinanceCompany(Private) Ltd.,in its turn, would discharge
its liability to Simpson and CompanyLtd. by selling its
holdings to simpson and General Finance Company (Private)
Ltd. The assessee-company as well assimpsonand General
FinanceCompany (private) Ltd. proposed to sell the shares
at certain specified price per share and soughtthe approval
of theCentralGovernment for such sale .The Central
Government, inapproving the sale, fixed its own prices and
stated that the said fixationwas without prejudice to any
valuation ofsharesfor purposesof capital gains.
Thereafter the shares held by theassessee-company in
variouscompanies in respect of which approval hadbeen
grantedby theCentral Government were transferred by the
assessee-company to Simpson and General Finance Company
(Private ) Ltd. with effect from June13,1957at the price
fixed by the Company Law Administration andSimpson and
GeneralFinance company (Private) Ltd.sold part thereof to
Simpsonand Company Ltd. The Transaction between Simpson and
GeneralFinance Company (Private) Ltd. andSimpson and
CompanyLtd. was also at the same prices.
Insubmitting itsincome tax return for the assessment
year 1958-59, the relevantprevious yearendingJune
30,1957, the assessee-company claimed a capital loss of Rs.
4,37,703/- in respect of theabove the transaction. In
arriving at this lossthe assessee-company opted for the
substitution of the Market Value as on June1, 1954 in
respectof shares in (1) S.R.V.S (Private) ltd., (2) Addison
& Company Ltd., (3) George Oakes (private Ltd., and (4)
India Pistons (Private) Ltd. As regards the rest of the
shares,the assessee-company adopted the cost prices. The
Income Tax Officer, while making the assessment, proceeded
on thebasis that the pricestructure approved by the
department of Company Law Administration for the transfer of
the aforesaid shares was pure and simple on an add hoc basis
and meant to serve the limited purpose of approval to be
given under section 372 of theCompanies Act, 1956 andthat
the price at whichthe sales took place couldnot,
therefore, be taken to represent thefair market value of
the Shares. Hetook the break- up value as on January 1,
1954 for the purpose of computation of capital gains and
revisedthe sale pricesand arrived at Rs. 6,95,082/- as the
net capital gains. Even according to his computation there
were certain capital determined by him. In the case of
S.R.V.S. (Private) Ltd. the Income Tax Officer took the
break-up valueas on January 1,1954 at Rs. 36,35,350/- and
their sale value at Rs.21,88,395/- resulting in the capital
loss ofRs. 14,46,955/-.
The assessee-company appealed against the assessment of
the capital gains to the Appellate Assistant Commissioner.
While the saidappealwas pending, the Commissioner, of
Income Tax proceeded Under Section 33B of the 1922 Act as he
was of the viewthat the order of the Income Tax officer was
erroneous and prejudicial to the interest of revenue in so
far ashe had wrongly allowed the capital lossamounting to
Rs. 14,46,955/- on the sale of thesharesin S.R.V.S.
(Private) Ltd.After considering the submission of the
assessee-company, the Commissioner held that the
appreciation in value of the shares of Simpson and Company
Ltd. held by S.R.V.S.(Private) Ltd.should not havebeen
taken into account and if the value of the shares held by
S.R.V.S.(Private) ltd.in Simpson & Company Ltd. , as on
January1,1954had been Rs. 24,38,578/- S.R.V.S. (Private)
Ltd. would not have parted withthese shares atcost onJuly
31,1955. The commissioner revised thecapital loss of Rs.
14,46,955/- allowed by the Income Tax Officer and considered
that there wascapital gain liable for assessment of Rs.
3,91,579/-. This figure was directed to be substituted and
the assessment of capital gainswas revised accordingly.
The assessee-company appealed against the said order of
he Commissioner to the Tribunal contending that thesale
value fixed bythe Company law Administration represented
the correct value of the shares and the transactionswere
withoutany motive toavoid capital gain and they hadbeen
necessitated by the various provisionsof the Companies Act
which prohibited inter-companyloans and that the method
adoptedby theIncomeTax officer, viz., the secondary
valuation, wasproper.The said appeal was allowed by the
Tribunal and the order of the Commissioner of Income Tax was
set aside and the method adopted by the Income Tax Officer
of Secondary Valuationwas held to be proper, The Appellant
Assistant Commissionertook upthe appeals of the assessee-
companyfor this and other years subsequent tothe order of
the Tribunal and following the Tribunal’s order he worked
out the Capital loss in respect of the othershares under
consideration and in effect accepted the assessee-company’s
claim of capital loss of Rs. 4,37,703/-. The said order led
to appeals both by the assessee-company and the Revenue to
the Tribunal.The assessee-company’s appeal related to
computation of the capital loss of Rs. 4,37,703/- as
emerging from the order of theAppellate Assistant
Commissioner instead of Rs. 4,90,244/- whichwould be the
correctfigure. The Revenue contested the acceptance of the
Claim of the assessee-company with reference to the capital
loss of Rs. 4,37,703/-as shown in thereturns.
Onthe first occasion when the matter come before the
Tribunal; it remanded the case to the Appellate Assistant
Commissioner and called for aspecific finding whether the
sales under consideration were effected with the object of
avoidance of tax or reductionof liability totax andalso
Wanted the full value of considerationto be worked out, in
case the first proviso to section 12B(2) of the1922 Act was
held to be applicable.The Appellate AssistantCommissioner
observed that there wasample evidence to show that thesale
of shares was aforced one and that theassessee-company had
no option but to comply withthe statutory provisions and
that the evidence produced clearly established the assessee-
company’s contention that the sale wasnot motivated by any
desire to avoid capital gainsand that the Revenue had not
proved by any conclusive evidence that the motive underlying
the transaction was the avoidance or reduction of the
liability to capital gains tax.He worked out the figures in
accordance with the rules framed under the wealth Tax Act
and found that thepricesfixed by theCompany Law
Administration were notvery much different from the figures
worked out byhim. After receivingthe report of the
Appellate Assistant Commissioner, theTribunal considered
the matter again and held that the proviso to Section 12B of
the 1922 Act could not be invoked in the instant case as
there was no evidenceto support theview that the sales
were effected with a view to avoid the provisions of Section
12B. The Tribunal accepted the contention of the assessee-
companyand held thatthe Revenue was not justified in
computing the capital gains anddisturbing the figures fixed
by theGovernment of India. The two questions referred in
T.C. No. 160 of 1969 arise outof proceedings under Section
33B of the 1922Act, while questions Nos. land 2 referred in
T.C. No. 239 of 1971 arise outof the order ofthe Tribunal
in theappeal againstthe order of the Appellate Assistant
Commissioner inrespectof the assessment year 1958-59.
Since thesecond question in T.C. No. 160 of 1969 and
questions Nos.1 and 2 in T.C. No. 239 of 1971 raisedmore
or less the same issue, they were taken up together by the
High Court. After referring to the provisions of Sections
12b (2) and more particularly the first proviso to thesaid
sub-section, the High Court has observed that the first
requisite for the applicationof the said proviso, namely,
that the person to whom the sale is made should be a person
with whom the assesseeis directly or indirectly connected,
was satisfied in the present case because the sale of shares
to a subsidiaryof a subsidiaryis one to a person withwhom
the assessee-company isdirectly or indirectly or indirectly
connected. As regards the second requirement ofthe proviso,
as to whether the sale was effected with the object of
avoidance or reductionof theliability of the assessee-
companyunder that Section, the High Court has pointed out
that the object with which the transaction was put through
was the avoidance or reduction of the liability to capita
gains. According to theHigh Court, such a finding of taking
the result as if it was the object would not satisfy the
requirement ofthe first proviso to Section 12B(20 of the
1922 Act. The High Court was of the view thatthe tribunal
had rightly called fora finding on this pointspecifically
from the appellate Assistant Commissioner. After referring
to the finding recorded by theAppellate Assistant
Commissioner, which was accepted by the Tribunal, that the
Object of the transaction wasnot toavoid or reducesuch
liability to capital gains tax, that the saleswas a forced
case since theassessee-company had no optionand that the
prices had beenfixed by the company law Administration, the
High Court held that the first proviso to Section 12B(2)
cannot be attracted tothe present case. The High Court did
not accept thecontention urged on behalf of the Revenue
that the sale price had beenfixed by thecompany law
Administration on ad hoc basisand, inthis context, it has
observed that the letter dated May 18of 1957(Annexure G.
VII. At the remand report of theAppellate Assistant
Commissioner) clearly shows that the company Law
Administration worked out the figures in consultation.with
the Central Board of Revenue and whenthe assessee-company
sold the shares at those prices, itcould not be validly
contended thatthe assessee-company transferred the shares
at certain prices withthe object of avoidanceor reduction
of liability to capital gains. On that view the High Court
answered the second question in T.C. No.160 of1969 and the
second question in T.C.No. 239 of 1971 in the affirmative
and against theRevenue.
Asregards the first question inT.C. No. 160 of1969
which raises the question of valuation, the High Courtfelt
that onthe view it hadtaken as regards the second question
it would not survive for considerationbecausethe question
of valuation would be materialonly ifthe proviso applied.
The High Courthas, however, considered the said question
and hasindicated the answer tothat question also. TheHigh
Court has expressed the view that this is a case of
substantial holding andthat there is textual backing to the
method adoptedby theIncomeTax officer and that the
Commissioner had foundfault with it without any valid
reason. The High Court, therefore,answered the first
question in T.C. No. 160 of 1969 inaffirmative and in
favour of the assessee-company.
Asregards the first question in T.C. No.239 of 1971,
the High Courtfelt that it did not require any independent
treatment in view of the answer given with regard to second
question in T.C. No. 160 of 1969 which would answerthat
question also. Therefore, that questionalso was answered in
the affirmativeand in favour of the assessee-company.
Wehave heard Shri K.N. Shukla,the learned senior
counselappearing for the Revenue in support of the appeals
in respect of the answers given by the High Court to these
questions,. Having considered the submissions of the learned
counsel, we are of the view that the High Court to these
questions, Having considered the submissions of the learned
counsel, we are of theview that the High Court has rightly
construed the provisions contained in the proviso to section
12B(2) of the 1922 Actand, inview ofthe finding recorded
by theAppellate Assistant Commissioner , which finding was
accepted by theTribunal, that the object of the transaction
was not to avoid or reduce the liability to capital gains,
the said proviso was not attracted. In our opinion, thesaid
findingof theHigh Court does not suffer from any legal
infirmity and there is no ground tointerfere with the
judgment of theHigh Court on this aspect of the case .
Wemay now take up the appealsof the Revenue in
respectof questions Nos. 4, 5 and 6 in T.C. No. 239 of
1971.
The said questions were as
follows:-
“(4) Whether, on the facts and in
the circumstancesof the case, the
Appellate Tribunalwas right in law
inholding that the loss sustained
by the assessee on account of
standing guarantee to sembiam Saw
Mills (Private) Std. (in voluntary
liquidation) should be allowed in
1962-63 assessment after taking
into account the amountsreceived
from theliquidators during the
years 1959-60 to 1962-63 ?
(5) Whether, on the facts and in
the circumstances of the case , the
Tribunal was right in law in
deleting the receiptsof Rs.
1,41,000/-, Rs.2,29,627/-, Rs.
1,10,500/-and Rs.4,381/-from the
liquidators of Sembiam Saw Mills
(Private) Ltd. (in voluntary
liquidation), from the assessments
for 1959-60, 1960-61,1961-62 and
1962-63 respectively?
(6) Whether, on the facts and in
the circumstancesof the case, the
Appellate Tribunalwas right in law
inholding that an amount of Rs.
4,23,256/- representing the real
loss sustained bythe assessee on
account of standing guarantee of
Sembiam Saw Mills (Private) Ltd.
(in voluntary liquidation) should
beallowed in the assessment year
1962-63?”
There was a company by name Sembiam Saw Mills (Private)
Ltd. (for short’SSM’),which was originally a subsidiary of
Addison& company (Private) Ltd. On and from February 1,
1954, the assessee-company purchased all the shares of SSM
from M/s Addison & company (Private)Ltd, and SSMthus
became the direct subsidiary of the assessee-company. SSM
had borrowed monies from the National Bank of India Ltd, and
the assessee-company had guaranteed theloan tosaid company
by thesaid Bank. SSMwent into liquidationsome time in
1995. For the purpose of overdraft facilities SSM executed a
promissory note in favour of the assessee-company which was
endorsed by the assessee-company to the Bankalong with a
separate guarantee letter in favour of the Bank. When SSM
went into liquidation,the assessee-company, as guarantor,
was required to clearthose overdrafts in accordancewith
the terms of the guarantee. After adjusting the amount
recovered from the liquidators,the sumdue to the assessee-
companyfrom the liquidated company on account of thesaid
overdraft was Rs. 9,08,764/-.The assessee-company claimed
this amount asa losswhich arose in the Course of and
incidental to its business inthe assessment for the 1958-
59. There werereceipts by the assessee-company in the
course of the liquidation of SSM in the later years, The
total amount received came toRs. 4,58,508,28 spreadover
the relevant accountingyears for the assessment years 1959-
60 to 1962-63.The assessee-company relied on the clause in
the memorandumof associationauthorising it to be the
guarantor for the loans and contended that thetransactions
in question sprang out of normal business transactions and
hence the losswas an allowable deduction in the assessment
for 1958-59. The Income Tax Officer held that the loss in
question did not arise during the course of or incidental to
the business of the assessee-company and in his view it was
at best a capital loss which did not come within the scope
of Section 12Bof the1922 Act. In making the assessments
for the years 1959-60to 1962-63 theIncomeTax officer
treatedthe receipts from theliquidator as income as a
protective measure. In appeal theAppellate Assistant
Commissioner did not accept the claim of the assessee-
companyfor allowance of the loss in1958-59as he was of
the view that it was not a loss which arose during the
course of or was incidental to its business. But the appeals
for the years 1959-60to 1962-63 wereallowedin so far as
they related to thequestion of the receipts in the
respective years from the liquidator. As the guaranteeloss
had not beenallowed as adeduction in 1958-59, the
Appellate Assistant Commissioner heldthat the subsequent
recoveries could not be included in the total income in the
later years. The assessee-company as well asthe Revenue
Preferred appeals against thesaid order of the Appellate
Assistant Commissionerbefore the Tribunal. The Tribunal
held that the assessee-company had guaranteed the loan in
the course of carrying on its own business and that theloss
was clearly admissible as a deduction. But since the
assessee-company had received the lastof the paymentsfrom
the liquidator in the previous year relevant to the
assessment year 1962-63 it washeld that the balance of Rs.
4,23,256/- remaining unrecoverable represented thereal
business loss allowable for the assessment year 1962-63. At
the instance of the Revenuethe Tribunal referred the
aforementioned questions Nos. 4,5 and6 for the opinion of
the High Court.
The High Court, while dealing with said questions, has
observed that the real pointin issue waswhether the
guarantee that was executed in favour of the Bank in respect
of theloan toSSM, the subsidiary of the assessee-company,
was done in the course of itsown business. The High Court
has referred to its earlier judgmentin Amalgamations P.
Ltd. V. Commissioner of Income Tax, (1969)73 ITR380,
whereinthe nature ofthe business ofthe assessee-company
has been considered andit has been held that the provisions
of Section 23Aof the1922 Act were applicable to the
assessee-company since the assessee-company’s business
includes furnishing guarantee to debts borrowed by
subsidiary companies. The HighCourt has held that thesaid
findinggiven in thatcase is clearly applicable to the
questions under consideration before it and that the
assessee-company had incurred the loss in carrying on its
own business which includes furnishing guarantees to debts
borrowed by its subsidiary companies. According to theHigh
Court, the loss was allowable as a deduction in the year in
which it came to be ascertained and inthe instant case the
High Court held that the assessee-company couldhave
ascertained whether there wasloss in the transaction of
guarantee only at the stage of final payment by the
liquidators which was received in the relevant previousyear
for the assessment year 1962-63 and that theTribunal was
right in allowing it in that year, TheHigh Court,
therefore, answered questionsNos. 4, 5 and 6 in the
affirmative andagainstthe Revenue.
After hearing Shri Shukla on theappealsfiled by the
Revenuein respect of these questions, we are unable tohold
that the judgment of the High Court in respect of these
questions suffers fromany legal infirmity. We, therefore,
affirm the answer given by theHigh Court to questionsNos.
4,5 and 6 referred to it . In the circumstances, it must be
held that Civil Appeals Nos. 139-142of 1980filed by the
Revenueare liable to be dismissed.
Wewould now come to Civil Appeals Nos.7-11 of1980
filed by the assessee-company in relation to questionNo.3
in T.C.No. 239of 1971, which was as under :-
“(3) Whether, on the facts and in
the circumstancesof the case, the
Appellate Tribunalwas right in law
inholding that the sums of Rs.
437,066/-, Rs. 90,896/-, Rs.
1,08,978/-, Rs. 1,18,102and Rs.
1,11,740/- are admissible as a
deduction in the assessments of the
assessee for the assessment years
1958-59 to1962-63respectively ?”
The assessee-company was a bulk shareholder in several
companies and in therelevant yearthere were sixteen
companies. The assessee-companywas rendering certain common
services to its subsidiaries by having (1) a finance
committee: (2)a liaison office in Delhi; (3) an export
promotion department; and (4) an internal audit department.
The expenditure on account of maintenance of liaison office
in Delhi andthe departments of export promotion and
internal auditwas borne by the assessee-company and was
recovered fromthe subsidiaries. The finance committee was
workingin an advisory capacity to the various subsidiary
companies to help them to carry on their businessmore
efficiently. All purchase requisitions for the purchase of
capitalequipment beyond Rs. 500/- of each purchase and Rs.
2,500/-with referenceto purchase of raw materialswere
submitted to the finance committee for their approval. The
purposeof such control was tojudiciously usethe funds of
the company tothe best advantage of each company. Various
data were gathered before such sanction wasaccorded or
refused, Technical matters orother matters of management
were also referred tothe members of the finance committee
who were experienced intheir respective fields. The finance
committee went through the financial position ofeach
companydaily.The directors of the assessee-companywere
also Directors/managers in thesubsidiary companies. As per
the service agreements between them and the concerned
subsidiary company they were entitled to payment of
remuneration and also acertainpercentage of the profits as
commission. Similar service agreements had been entered by
other directorsof the subsidiary companies whowere not the
directors of the assessee-company. In view of the provisions
of Section 198of the Companies Act, 1956, fixing a ceiling
on theoverallmanagerial remuneration at 11% of the net
profits of the company, itwas not possible for the
subsidiary companies to pay the contracted remuneration to
the persons concerned. On April 4,1959 the Board of
Directors ofthe assessee-company passed a resolution
wherebyit wasresolved that the remuneration payable to
nine directorsof the subsidiary companies would be paid to
them in full in accordance with the terms ofthe contract
respectively entered into by them and the amount in excess
of themaximumamountpermissible under the CompaniesAct,
1956 would be met by the assessee-company. Out of thesenine
directors three were directors of theassessee-company and
out of these three directors two were members of the finance
committee, Noneof the other six directors of the subsidiary
companies was a member ofthe finance committee. In
accordance with the said resolution the assessee-company
paid diverse amounts to thesaid directors. The total
amountsso paid to the several persons for the different
years are mentioned in question No.3.The assessee-company
claimedthe said amounts as deductionunder Section 10 (2)
(XV) of the 1922 Act for theassessment years 1958-59 to
1961-62and under Section 37of the 1961 Act for the
assessment year 1962-63. Before the Income Tax Officer it
was not disputed thatthese paymentswere in respect of
services rendered by respective persons tothe various
subsidiary companies of whichthey were directors/managers
and that no part of the payment could be related to any
servicedirectly rendered by them to the assessee-company.
It wassubmitted thatthough the services were rendered by
them to other companies, theyshouldbe deemed tohave
rendered the service to the assessee-company in view of the
nexus between the holding company and its subsidiaries, The
Income Tax officer did not accept this submission andheld
that the excess remuneration over and above what was
admissible under Section 198 ofthe Companies Act, which was
not borne by the respective companiescould not be allowed
as deduction under Section 10(2)(XV) of the1922 Act and
Section37 ofthe 1961 Actas expenditure wholly and
exclusively incurred for the purpose of the business of the
assessee-company. It was alsostressed that the resolution
of the Board ofDirectors of the assessee-company was passed
on April 4, 1959, after the previous years relevant to the
assessment years 1958-59 and 1959-60, On appeal the
Appellate Assistant Commissioner tookthe same view, The
matterwas remanded by theTribunal to the Appellate
Assistant Commissionerfor consideration and submission of
report on the points mentioned in theorder of remand. The
Appellate Assistant Commissioner after taking further
evidence submitted his report wherein he reportedthat
deduction may be allowed in respect of remuneration paid to
personswho were directors of the assessee-company andwere
membersof thefinance committee, butsuch deduction could
not beallowedin respect of remuneration paid by the
assessee-company in respect of the persons who wereonly
directors and employees of the subsidiariesbut neither
directors of the assessee-company nor members of the finance
Committee. TheTribunal was ofthe view that looking to the
nature of the business of the assessee-company of holding
shares of a number ofsubsidiary companies and that it was
lookingafter the interest and welfare of those companies
with aview toearn dividends,the whole of the expenditure
referable to the remunerationpaid bythe assessee-company
was admissible as a deduction.
Rejecting the contention urged on behalf of the Revenue
that the assessee-company wasnot carrying onany business
becausemerelyholdingof investmentswould not constitute
business, the High Court has held that in view of Section
23A ofthe 1922 Act holding of investments, in appropriate
cases, would equally be a business as dealing in them and
what is required is that there must be a real substantial
and systematicor organised course of activity or conduct
with the set purpose ofearningprofit which isthe test for
a business. The High Court has observed that the assessee-
companyis nota mereinvestor in a single company but has
investments in sixteen companies and had taken active
Interest in thebusiness of these companies as is clearfrom
the services that hadbeen rendered in the shape of export
promotion, liaison office at Delhi and internalaudit and it
also rendered consultation inrespectof finance by its
directors meeting every day with reference to the needs and
requirements ofeach company and that it is nota case where
the assessee-company contenteditself with merely making an
investment and looking for the dividend, The High Courthas,
therefore, held that there was a business activity in the
matter of holding of investments. While dealing with the
question whether the expenditure that has beenincurred was
wholly and exclusivelylaid out for the purpose of the
assessee-company’s business, the HighCourt has negatived
the contentionthat the said question is purely factual
becausein order to be deductible the expendituremust
satisfytwo tests: (1) the expenditure must be uncurred by
the assessee in his capacity as a trader; and(ii) itmust
be incidental to the carryingon of his business. TheHigh
Court was of the view that there must be a nexus between the
expenditure andthe business ofthe assessee. Applying these
tests the HighCourt has held that the purpose of the
paymentin thepresent case was only to take out the
subsidiary from an inconvenient situation in which it found
itself as a result of statutory change restricting the
remuneration payableto itas director and that the
expenditure had not been incurred wholly and exclusively
for thebusiness of theassessee-company and itcould not be
allowedas deduction. The alternativeclaim put forward on
behalfof the assessee-company that at any rate the
expenditure incurred bythe assessee-company inremunerating
its own directors whowere also members forthe finance
committee should be allowed as deduction as there is a nexus
betweenthe expenditure and the business of the assessee-
companyin rendering servicesto its subsidiaries, was not
accepted by the High Court for the reason that the
resolution passed by the assessee-company doesnot saythat
the expenditurewas incurred for the purpose ofremunerating
its own directors is so far asthey rendered services to it
as members of the finance committee. The High Court has
observed that the resolution treated the directors, whether
they be the members of the finance committee or notas a
class and with reference to allof themthe assessee-company
incurred the expenditure onlybecausethey could not be
remunerated tothat extent bythe subsidiary companies and
the fact that they weremembersof the finance committee had
not been takeninto account intaking over theremuneration
payableto them, Question No. 3 was, therefore, answered in
the negative and against the assessee-company.
The amounts paid by the assessee-company to the
directors of its subsidiary companies can be admissibleas a
deduction under Section 10(2)(XV)of the 1922 Act
exclusively for the purposes of the business” of the
assessee-company, Thisexpression was also used in the
IncomeTax Act, 1918 in U.K. In Atherton V. British
Insulated and Helsby Cables Limited, (1925) 10 TC 155(HL),
Viscount Cave, L.C., has thus explained thesaid
expression:-
“..a sum of moneyexpended, not of
necessity and with a view to a
direct andimmediate benefit to the
trade, but voluntarily and on the
grounds of commercial expediency,
and in order indirectly to
facilitatethe carrying on of the
business,may yet beexpended
wholly and exclusivelyfor the
purposes of the trade.”
[p.191]
These observations have been referred to with approval
by thisCourt while construing Section 10(2)(XV) of the1922
Act. [See : Eastern Investments Ltd.V. Commissioner of
Income Tax, V. Chandulal Keshavlal & Co., (1960) 38 ITR601]
InTravancore Titanium Products Ltd. V. Commissioner of
Income Tax, Kerala, (966) 60 ITR 227, thisCourt while
construing theexpression ” for the purpose ofbusiness” in
Section10(2) (XV) of the 1922 Act, hassaid :-
“The expenditure must be incidental
to the business and must be
necessitated or justified by
commercialexpediency. Itmust be
directly and intimately connected
with the businessand belaid out
bythe taxpayer inhis character as
atrader. To be a permissible
deduction,there must bea direct
and intimate connection between the
expenditure and the business i.e.
between the expenditureand the
characterof the assessee as a
trader, and not asowner of assets,
even if they are assets of the
business.”
InThe Indian Aluminium Co. Ltd. V. Commissioner of
Income Tax, (1972) 84ITR 735, decided by aConstitution
Bench of this Court, the aforementioned testlaid down in
Travancore Titanium Products ltd. V. Commissioner of Income
Tax, Kerala (supra), was qualified in these terms :-
“In our view, the test adopted by
this Court in TravancoreTitanium
case that to be a permissible
deduction,there must bea direct
and intimate connection between the
expenditure and the business; i.e.,
between the expenditureand the
characterof the assessee as a
trader, and not asowner of assets,
even if they are assets of the
business’ needs to be qualified by
startingthat if the expenditure
islaid out by the assessee as
owner-cum-trader, and the
expenditure is really incidental to
the carrying on ofhis business, it
must be treated to have been laid
out by him as a trader and as
incidentalto hes business.”
[p.747]
The High Court, in our opinion, has rightly proceeded
on the basis that theremust bea nexusbetween expenditure
and business ofthe assessee.
Shri T. A. Ramachandran,the learned senior counsel
appearing for the assessee-company, has submitted that the
said test is satisfied in the present case since the purpose
of thepaymentof remuneration to the directors of the
subsidiary companies was to enable these companies toearn
higher profitswhich would bepassedon to the assessee-
companyas and by way of dividends. The learned counsel has
placed strong relianceon the decisionof Bombay High Court
in J. R. Patel and Sons (P) Ltd. V. Commissioner of Income
Tax, Gujarat, 69 ITR 782, and has urged that the High Court
has committed an error in distinguishing these cases on
ground that they related to managingagentswhereas the
present caserelates to holding company and its
subsidiaries, Shri Ramachandran hascontended that the
principle laid down in thesaid decisions is equally
applicable to acase ofholdingcompany.
Weare unable toacceptthis contention. TheHigh
Court, in our opinion, has rightly pointedout that the
business of the assessee-company is the holding of
investments any expenditure had been incurred that could
have been allowed as deduction. The expenditure incurred in
paymentof managerial remuneration tothe directors of the
subsidiary companies cannot be said to be expenditure
incurred in carrying onthe business ofthe assessee-company
of holding itsinvestments. The assessee-company couldhold
its investments and earn its dividends the entire profits
earned on account of their managerialremuneration paid by
the assessee-company and the assessee-company wasonly
entitled to dividend from the subsidiary company as andwhen
declared, it cannot be said that there was a direct and
immediate connection between the expenditure incurred and
the business of the assessee-company. The decisions inTata
Sons Ltd. V. Commissioner of Income Tax, BombayCity (supra)
and J.R. Pateland Sons (P) Ltd. V. Commissioner of Income
Tax, Gujarat (supra) ar not applicablein the facts ofthis
case.
InTata sons Ltd. V. Commissioner of Income Tax, Bombay
City (supra) the assessee was the managing agent of another
companyand under the managingagency agreement the asessee
was tobe paid a commission at a certain ratewhich was to
be computed upon the net profits of the managed company.
During the relevant years the assessee paid voluntarily
certainsums as half share of the bonus which the managed
company paid to some of its officers and it claimed
deduction of the said amounts underSection10(2)(XV) of
the 1922 Act. The Bombay High Court upheld theclaim of the
assessee for such a deductionon theview that from the
point of view of commercial principles what theassessee had
done was something which had as its object increasing the
profitsof themanaged company and thereby increasing its
own shares oncommission and, therefore, the deduction
claimedby theassessee was wholly and exclusively for the
purposes of its business and was anallowable deduction
under section 10(2)(XV) of the1922 Act. Whiledealingwith
the contentionurged on behalf of the Revenue that the
paymenthad been madenot to the employees ofthe assessee
but tothe employees of a managed company -a different
entity altogether – theHigh Court has observed:-
“Here again if it can be shown that
there wasa veryimportant nexus
between the assessee company and
the managedcompany which
necessitated the assessee company
making thepaymentto the employees
ofthe managed company, taken again
it would be possiblefor the
assessee company to satisfy us that
the expenditure was one which fell
within the ambit of Section
10(2)(XV). Nowit cannot be
seriously disputed that the bonus
was paid by the managed company to
their employees in order to
increase the efficiency of the
order to increase the efficiency of
the working of the company. An
increased efficiency of that
company would incidentally result
inhigherand better profits, and
the assessee company would be as
much interested in the working of
the managed company being more
efficient as themanaged company
itself. Whatever tended toincrease
the profits of the managed company
would also tend to increase the
income and profits of theassessee
company, Therefore, it cannot be
suggested that theassessee company
had an indirect or ulterior motive
inmakingthis payment. The only
motive by which itwas actuated was
a purely commercial and pecuniary
one and that wasto see that more
profits were madeby the managed
company so that its own commission
should thereby be increased.”
[p.468]
Inthat case there was a direct nexusbetween the
increased profits of the managed company and the managerial
commission payable to the assessee since the managing agency
commission was a prescribed percentage of the net profits
of themanagedcompany. As indicated earlier,there was no
such nexus between the increased profit of the subsidiary
companyand theprofit earned by the assessee-company by way
of dividend onthe shares held by it in the subsidiary
company.
InJ.R. Patel and Sons (P) Ltd,V. Commissioner of
Income Tax, Gujarat (supra) the assessee wasthe managing
agent and its managing directorwas also the director of the
managed company. Prior tocominginto force of the
Companies Act, 1956 on April 1,1956, he was getting monthly
salary from the assessee and in addition hewas getting
monthlyremuneration as technical adviser of the managed
companyas well as commissionat a prescribed rate on the
sale price of healds and reedsmanufactured and sold by the
managedcompany. Afterthe passing of the CompaniesAct,
1956, the remunerationthat could bereceived by him was
reducedand hecould not also be paid the commission. The
assessee, therefore, increased the emoluments. Thesaid
excess paymentmade by the assessee was disallowed and the
expenditure incurred was restricted to the amount that was
being paid prior to coming intoforce of the companiesAct,
1956. The Gujarat High Court held that the assessee had
paid extra payment toits managing director so that the
affairsof themanaged company couldbe properly looked
after and thatas a result ofthe remuneration the profits
of themanagedcompany and the shareof the commission of
the assessee increasedand, therefore, the excess amount
paid by the assessee to its managing directingwas expended
wholly and exclusivelyfor the purpose of itsbusiness and
was anallowable deduction under Section 10(2)(XV) of the
1922 Act, Reliance was placedon the decisionin TataSons
Ltd. (supra). This wasalso a case where the profits of the
assessee in the form of managing agency commissionwere
directly linked to the profitof the managed company which
is not the position in the present case.
The alternative claim by the assessee-company for
deduction in respect of the expenditure incurred by the
assessee-company in respect of amount paidto its own
directors who were alsothe members of the finance committee
has been rightly rejected by the HighCourt in view of the
resolution passed by the assessee-companywherein the
directors, whether they be the members ofthe finance
committee or not, have been treated as a class andwith
reference to all of them the assessee-companyincurred the
expenditure only because theycould not be remunerated to
that extent by the subsidiary companies. The fact thatthey
were directorsof theassessee-company and members of the
financecommittee was not taken into account in takingover
the remuneration payable to them. In the circumstances,
Civil Appeals Nos. 7-11 of 1980 filed by the assessee-
companyare also liableto be dismissed.
Inthe result, Civil Appeals Nos. 139-142 of 1980 filed
by theRevenueand Civil Appeals Nos. 7-11 of 1980 filed by
the assessee-company are dismissed. No order asto costs.

 

 

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