TMI Blog1971 (6) TMI 7X X X X Extracts X X X X X X X X Extracts X X X X ..... fied in the facts of the instant case, the payment to the Rani of a larger sum in the matter of distribution of the total amount by agreement between the parties cannot be considered to be unjustified, particularly as such payment results in smooth working of the company on the basis of the articles. - - - - - Dated:- 22-6-1971 - Judge(s) : SANKAR PRASAD MITRA., A. N. SEN. JUDGMENT A. N. SEN J.- This reference under section 66(1) of the Indian Income-tax Act, 1922, raises the question of applicability of the provisions of section 10(4A) of the said Act to the remuneration paid to the directors of Edward Keventer Pvt. Ltd. which happens to be the assessee in the instant case. The assessee is a private limited company of which at the material times there were only 5 members, all of whom, except Sri K. A. Dikshit, were also directors of the company. They are: (1) Rani Jagadamba Kumari Devi who holds 65% of the total shares. (2) Sri A. C. Roy Chowdhury who holds 10.5% of the total shares. (3) Sri J. C. Chowdhury who holds 10.5% of the total shares. (4) Sri S. Das Gupta who holds 10.5% of the total shares. (5) Sri K. A. Dikshit who holds 3.5% of the total shares. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y from time to time revoke, withdraw, alter or vary all or any of such powers." Article 120. "If any director being willing shall be called upon to perform extra service or to make any special exertion in going or residing away from Calcutta for any of the purposes of the company or in giving special attendance to the business of the company as a member of the committee of directors, the company may remunerate the director so doing either by a fixed sum or by a percentage of profits or otherwise as may be determined by the directors, and such remuneration may be either in addition to or in substitution for his or her share in the remuneration above provided for the directors. On the basis of the articles, the directors have been receiving their shares of the remuneration. The said aricles 109, 110 and 111 along with various other articles of the company came to be amended later on. The amended articles, however, were not in force during the relevant years. The assessment years in question are 1956-57 to 1959-60, the relevant previous years being the financial years which ended on 31st March, 1956, 31st March, 1957, 31st March, 1958, and 31st March, 1959, respectively. Dur ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as being allowed and during the relevant years the Income-tax Officer applying the provisions of section 10(4A) which had come into existence, disallowed the sums earlier mentioned. The material portion of section, 10(4A) reads: "Nothing in sub-section (2) shall, in the computation of the profits and gains of a company, be deemed to authorise the making of-- (a) any allowance in respect of any expenditure which results directly or indirectly in the provision of any remuneration or benefit or amenity to a director or a person who has a substantial interest in the company within the meaning of sub-clause (iii) of clause (6C) of section 2, or....... if in the opinion of the Income-tax Officer any such allowance is excessive or unreasonable having regard to the legitimate business needs of the company and the benefit derived by or accruing to it therefrom." Before the Income-tax Officer it was contended on behalf of the assessee that considering the gross profit and the net profit accruing during the 4 years in question, the payment of remuneration and commission to the board of directors was reasonable. It was also submitted that such payments were covered by article 110 of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... supervision for which the service of one of the directors was sufficient. The assessee preferred further appeals to the Appellate Tribunal. The Tribunal allowed the appeals preferred by the assessee. According to the Tribunal, the only factors relevant for the purpose of judging whether the remuneration was excessive or unreasonable by which the provisions of section 10(4A) could be applied, were--(i) the legitimate business needs of the company, and (ii) the benefit derived by the company by making such expenditure and these two factors had to be viewed with the eye of the businessman himself. The Tribunal held that the entire approach of the department to the case for justifying the applicability of the provisions of section 10(4A) was wrong. The department had not viewed the legitimacy or reasonableness of the assessee's claim from the point of view of the businessman and the factors taken into consideration by the income-tax authorities did not substantiate a case for disallowing any portion of the remuneration by application of section 10(4A) of the Act. The Tribunal had accordingly deleted the addition on account of disallowance out of directors' remuneration and allowed the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pany, about 33% of the gross profits and about 50% of the net profits. The learned counsel has submitted that the Income-tax Officer after having considered all the relevant materials has rightly applied the provisions of section 10(4A) in disallowing the bulk of remuneration paid. Mr. Pal has also drawn our attention to the order of the Appellate Assistant Commissioner who confirmed the orders of the Income-tax Officer and he has pointed out that the Appellate Assistant Commissioner has also exhaustively discussed the matter. Mr. Pal complains that the Tribunal has not discussed any of these findings of the taxing authorities and has proceeded on an erroneous approach to the question. Mr. Pal has referred to the following decisions: Natesan and Co. Private Ltd. v. Commissioner of Income-tax, Nund and Samonta Company Private Ltd. v. Commissioner of Income-tax, Nund and Samont Compaany (P.) Ltd. v. Commissioner of Income-tax, Commissioner of Income-tax v. Raman and Raman Ltd., Commissioner of Income-tax v. Motor and Generals Sales (P.) Ltd., Mercantile Express Co. Private Ltd. v. Commissioner of Income-tax and Newtone Studios Ltd. v. Commissioner of Income-tax. Mr. A. K. Sen, lear ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... es which constitute the agreement between the members including the directors and also between the members and the company; and the smooth working of the company on the basis of the articles is an essential business need of the company. Mr. Sen points out that the provision in the articles relating to the remuneration of the director has been in existence long before section 10(4A) came to be introduced in the statute and he comments that it can never be said that this article was introduced as a device to escape the provision of section 10(4A). Mr. Sen has submitted that taking into consideration the nature of business, the volume of work done and the profits earned, the total amount spent on the directors' remuneration in the years in question can never be said to be excessive or unreasonable. Mr. Sen has drawn our attention to the fact that the company has two producing centres at Fattabad and Ghoom and other branches which are distributing centres and the turnover ran into several lakhs. Mr. Sen has pointed out that for a company of this type the head office expense, apart from what is paid to the directors, does not exceed Rs. 500 per month. Mr. Sen argues that this fact alone ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he item of expenditure comes within the purview of section 10(4A) and the Income-tax Officer is not to allow the entire amount so spent, if the provisions of section 10(4A) are attracted and the sum spent comes within the mischief of the said provisions. The Income tax Officer must, however, consider the entire position dispassionately and objectively and from the view-point of a prudent businessman. The Income-tax Officer must appreciate that section 10(4A) is not to be applied capriciously as a matter of routine and he must realise that the said section is to be applied judiciously and can only be applied, if the necesssary conditions of the said section are satisfied. The opinion of the Income-tax Officer as to the reasonableness or otherwise of the amount spent must not be arbitrary and is nof to be the subjective and prejudiced opinion of an officer interested in collecting more revenue. The opinion as to reasonableness or otherwise of the amount spent must be formed, having regard to the legitimate business needs of the company and the benefit derived by the company or accruing to the company from the said sum expended. The said section 10(4A) itself, while conferring the nec ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tesan and Co. Private Ltd. v. Commissioner of Income-tax, while dealing with section 10(4A), observed at pages 391-392: "This provision was inserted by the Finance Act of 1956. The object of the legislature was to prevent avoidance of tax by companies allowing remuneration or other benefits to directors or persons substantially interested in the company extravagantly without a due sense of commercial propriety or without balancing it with the adequacy of the benefit obtained by their services. Prior to 1956, before the amendment, an assessee-company could claim deduction of allowance to directors under section 10(2)(xv). But the department was forbidden to sit in the armchair of the management of the company and decide what would be the proper remuneration. (See Newtone Studios Ltd. v. Commissioner of Income-tax, and N. M. Rayaloo Iyer and Sons v. Commissioner of Income-tax ). The company was, therefore, free to be lavish in the matter of payment of such remuneration, though the department was always inclined to frown upon even a little liberality. Now the question is what is the scope of section 10(4A). The Income-tax Officer is not authorised or empowered to grant any allowance ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... The case was clearly covered by the terms of section 10(4A), and the Income-tax Officer had jurisdiction to consider whether the allowance was excessive or unreasonable having regard to the legitimate business needs of the company and the benefit derived by or accruing to it therefrom." Whether in any particular case the Income-tax Officer has properly exercised his jurisdiction and power under section 10(4A) or not, must necessarily depend on the facts of each particular case. The principles which should, however, govern the exercise of the power and jurisdiction by the Income-tax Officer have already been noted. Whether the Income-tax Officer has properly and correctly applied the principles underlying the said section 10(4A) or not will have to tested in the light of the facts of every particular case. The other cases which were cited from the Bar are not of any material assistance in the facts of the present case. In the facts of the present case, we are of opinion that the Income-tax Officer did not properly exercise his jurisdiction and power under section 10(4A) and the Income-tax Officer did not apply the correct principles in forming his opinion as to the reasonablene ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ervices to the company. The fact that some of the directors also happen to be directors of some other companies does not establish that the directors are not discharging their duties properly or are not rendering sufficient services to the company. The amounts paid to the directors, other than the Rani inclusive of remuneration and commission, appear to vary between Rs. 750 and Rs. 850 per month for each of them. These amounts paid to these individual directors, excepting the Rani, cannot be considered to be excessive or unreasonable by any standard. So far as the Rani is concerned she happens to be the chairman of the board of directors. It may be true that she does not participate in the day to day administration of the business of the company in the way the other directors do. It is, however, clear that she bears the largest amount of responsibility in the matter of taking all important decisions relating to the affairs of the company, its administration and business. It appears that any and every matter of importance is referred to the Rani and her advice and decision in all such matters are of vital consequence in guiding the affairs of the company and its smooth and effic ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hich enable the company to earn the profits. Taking into consideration the legitimate business needs of the company and the benefit derived by the company the amounts paid to the Rani cannot, in our opinion, be considered to be excessive or unreasonable. There is another aspect which, in our opinion, justifies the payments made to the Rani in the facts of the instant case. We have earlier observed that the total sum paid to the directors on account of remuneration and commission, including the payments made to the Rani, is justified and is not excessive or unreasonable. The amount of remuneration of directors and the manner of distribution thereof are both provided in the articles of association of the company. Payment of remuneration by virtue of any provision contained in the articles does not undoubtedly oust the jurisdiction of the Income-tax Officer under section 10(4A) and, by itself, in the absence of other relevant materials, may not sufficiently justify an amount paid. In view, however, of the fact that the total amount paid to the directors on account of remuneration and commission in the instant case is not unreasonable or excessive and is justified, the manner of dist ..... X X X X Extracts X X X X X X X X Extracts X X X X
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