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Commissioner of Income-tax, Versus Alagappa Textiles (Cochin) Ltd.

1979 (9) TMI 133 - SUPREME COURT OF INDIA

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 section 384 read with section 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 1958-59 and 1959-60 cannot be allowed as business expenditure under section 10(2)(xv) of the Indian .....

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tained by the assessee 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 if in further appeal the trial court's decree was restored and the assessee were to recover back the remuneration, the assessee can be taxed on the two amounts under section 41(1) of the 1961 Act. - 2001 AND 2002 OF 19 .....

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) 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 1958-59 and 1959-60 cannot be allowed as business expenditure under section 10(2)(xv) of the Indian I.T. 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 .....

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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 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 .....

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med 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 ITO, it was contended that though the payment of remuneration to a body corporate as manager after October 1, 1956, was illegal under section 384, the payments were for services rendered and were fully justified by commercial expediency and as such the same should be allowed under section 10(2)(xv) of the Act, It was also urged that even i .....

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essee had filed a suit against Kamala Mills Ltd. to recover back such remuneration which had been paid to it in contravention of section 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 sectio .....

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gument was raised before the Tribunal that Kamala 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 payab .....

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he 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 section 10(2)(xv) of the Indian Income-tax Act, 1922 ? The High Court answered the question in the negative, in favour of assessee and against the department. The High Court, on construction of the agreement dated November 10, 1955, took the v .....

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ls Ltd. for services rendered during the calendar years 1957 and 1958, was allowable as a business expenditure under section 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 thos .....

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under section 10(2)(xv) of the Act. Before we consider the principal question relating to the proper construction of the agreement dated November 10, 1955, 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 .....

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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, section 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 t .....

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) he should have the management of the whole, or substantially the whole, of the 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 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 .....

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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, a .....

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ection 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, 1979, 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 work .....

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ecitals 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 to 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 .....

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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 a .....

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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 .....

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for meeting all expenses incidental to manufacture and sale of yarn and other products 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., .....

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res 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 Karnala 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 .....

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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 owners 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 s .....

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ited 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 section 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 tha .....

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f 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 par .....

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6 Act, For this purpose the agreement will have to be read as a whole and the court will have to decide what 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 straitened circumstances and on that account was utterly unable to carry on its business of manufacture and sale of yarn and, therefore, the board of dire .....

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t object with which the agreement was entered into was that Kamala Mills Ltd. should really act as 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 becomes abundantly clear from Clause 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 int .....

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and functions entrusted to Kamala Mills Ltd. under the several sub-clauses of Clause 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 Clause 13 of the agreement which we have quoted .....

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n or advice of the board of directors was of such character that the board had no 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 matter of the exercise of its powers and discharge of its f .....

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