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Commissioner of Income-Tax Versus Panipat Woollen And General Mills Co. Limited

1976 (1) TMI 1 - SUPREME Court

Whether the payment of profit to the agent is a business expenditure - agreements amount to a joint venture to divide the profit after they were ascertained and the payments made by the assessee were not deductible under s. 10(2)(xv) - C.A. 622 OF 1971 - Dated:- 21-1-1976 - Judge(s) : R. S. SARKARIA. and S. MURTAZA FAZAL ALI. JUDGMENT The judgment of the court was delivered by FAZAL ALI J.-These are appeals by the revenue by special leave against the order of the High Court of Punjab & Harya .....

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spinning of yarn from imported wool tops was started some time in the year 1952. Weaving operations were, however, carried on in both these departments. One of the departments was known as M/s. Panipat Woollen Mills, Kharar, while the other one was known as M/s. Navin Woollen Mills. It is said that the assessee-company was running at a constant loss as a result of which, in 1952, the assessee-company decided to instal a plant for manufacture of worsted yarn from imported wool tops by raising a .....

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ts were to finance the assessee-company to the extent of ₹ 2,50,000 and the assessee-company agreed to pay 6% interest on the advances to be made by the agents and further agreed to pay 2% commission on the net proceeds of sales of goods in India. Before expiry of this agreement, another agreement was entered into by the assessee-company with the agents on October 20, 1955, under which the agents were to get 6% interest on all the advances made by them, 1 1/4% commission on net sales and 5 .....

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ment years 1956-57 ending on March 31, 1956, and 1957-58 ending on March 31 1957. The assessee-company accordingly in its return for the year 1956-57 claimed the amount of ₹ 37,157 and ₹ 73,787 for the assessment year 1957-58 as a deduction under the provisions of section 10(2)(xv) of the Indian Income-tax Act, 1922. The case of the assessee was that the two amounts mentioned above being in the nature of commission paid to the selling agents would be deemed expenses incurred by the c .....

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peal to the Appellate Assistant Commissioner who accepted the plea of the assessee-company and held that the payment was a permissible deduction as it was incurred for the purpose of the assessee's trade in order to facilitate the business of the assessee. The revenue then went up in appeal before the Tribunal which after considering the facts and the law on the subject upheld the contention of the revenue and held that the sums in question were not legal deductions as contemplated under sec .....

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" 1. Whether, on the facts and in the circumstances of the case, the Tribunal rightly held that the sums of ₹ 37,157 and ₹ 73,787 were chargeable to tax in the hands of the assessee-company in the assessment years 1956-57 and 1957-58, respectively ? 2. Whether, on the facts and in the circumstances of the case, the Tribunal rightly disallowed the assessee-company's claim for deduction of the payment of ₹ 37,157, and ₹ 73,787, under section 10(1) and section 10(2) .....

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cted, the appellant filed a petition for special leave. The special leave having been granted, the appeal is now before us. The High Court in reversing the order of the Tribunal mainly relied on what it described the surrounding circumstances under which the alleged payments were made to the selling agents by the, assessee-company as spelt out from the agreement entered into by the assessee-company with the selling agents. The main point which was argued before the Tribunal as also before the Hi .....

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e Tribunal held that the agreement amounted to a joint venture resulting in division of net profits and, therefore, the amount paid to the agents could not be claimed by the assessee-company as a deduction under section 10(2)(xv) of the Act, as it was not incurred for the purpose of the business or for earning profits. The High Court held that the mere fact that the agents agreed to share the profits and the losses would not take the case of the assessee beyond the ambit of section 10(2)(xv) of .....

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ompany. In support of the appeal Mr. Ahuja, the learned standing counsel for the revenue, submitted the following two points before us : (1) In the first place it was submitted that there being an express provision in the agreement dated October 20, 1955, by which the agents agreed to share losses which was a provision peculiar to the present transaction and was not at all covered by any authority cited before the Tribunal or the High Court, that itself was proof positive of the fact that the tr .....

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bsolutely correct and the facts of the present case are clearly covered by the decision of this court in Dharamvir Dhir v. Commissioner of Income-tax . A number of other cases have also been cited at the Bar and we shall refer to the same after marshalling the facts found in the present case. Before coming to the facts it may be necessary to mention that there can be no dispute with respect to the two important propositions : (1) That in order to fall within section 10(2)(xv) of the Act the dedu .....

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esent case. on the basis of which the questions of law referred to the High Court and answered in favour of the assessee-company arise. To begin with, it is conceded by the learned standing counsel for the revenue that the assessee-company was running at a loss as a result of which it had to raise a loan of several lakhs of rupees from the Industrial Finance Corporation. It was perhaps for this reason that the assessee-company entered into an agreement with the new selling agents, M S. Saligram .....

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st agreement is concerned the terms thereof do not make out a case of joint venture but appear to be in consonance with the agreement being one of an agency simpliciter. It is the second agreement that in our opinion appears to change the entire complexion of the case. This agreement is set out at page 17 of the paper book and consists of ten main clauses. The agreement, was to enure for a period of two years to commence from January 1, 1956, or the date on which manufacturing actually starts un .....

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nt of the agents. In other words, if the agents withheld their consent, they could veto the programme of manufacture. Such a limitation placed on the power of the assessee-company does not appear to us to be in consonance with a pure and simple contract of agency. Clause 6 which deals with financial arrangements may be extracted thus : " (i) The agents shall invest full amount for the working of the worsted plant to the full possible capacity beginning from the purchase of tops to the compl .....

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r goods in transit or in godowns, the same will be debited to the account of the worsted plant. (ix) The accounts of the worsted plant will be maintained separately in an office situated near the worsted plant and the agents will have free access to the account books. " Sub-clause (i) clearly contemplates that the agents would have to make full and complete investment for the working of the worsted plant to the fullest possible capacity including wages, power, stores, repairs and maintenanc .....

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that the damage to the tops or goods in transit would have to be debited to the account of the worsted plant and such accounts would have to be maintained separately. The obvious object is that the agents would be in a position to ascertain the net profits and control the working of the worsted plant. Clause 7 is the most important clause of this agreement, which, in our opinion, clearly shows that the agreement in essence and in purport is a sort of a partnership or a joint venture rather than .....

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g expenses, interest, insurance, depreciation and selling commission, etc. For allowing annual depreciation in the value of the machinery and buildings and interest on the value of machinery and buildings and commencing from the date on which manufacturing actually starts under this agreement, a lump sum of ₹ 50,000 has been agreed to be deducted for determining the net profits or loss position. In case of net loss, if any, there will be a deduction of 50% (fifty per cent.) of such loss fr .....

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ring costs, interest, insurance, etc. The conduct of the agents in sharing half of the net profits does not appear to us to be consistent with the payments made to the agents for services rendered. It is difficult to lay down any rule of universal application as to what percentage of profit would be consistent with the payment in lieu of services but taking the totality of the provisions of the agreement it seems to us that the percentage of profits and the manner in which it is to be determined .....

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25,000 for six months as provided in sub-clause (i) above, will be paid to the company every half year within ten days. The profits and loss account of the worsted plant will be made every six months within ten days and the adjustments will be made accordingly by actual payments, as the case may be, within ten days. " The above sub-clause clearly provides for a separate commission account to be maintained by the agents and the commission to be paid every six months. Consequently, the agent .....

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also pertinent in order to determine whether the transaction amounted to a joint venture in the garb of a contract of agency. It is well settled that the court in order to construe an agreement has to look to the substance or the essence of it rather than to its form. A party cannot escape the consequences of law merely by describing an agreement in a particular form though in essence and in substance it may be a different transaction. In these circumstances, therefore, if we construe the agreem .....

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es. In this connection, Greene M. R. observed as follows : " It is not cash that passes in exchange for these profits, it is services : and the badge of such a contract is remuneration for services, and therefore the first thing that this remuneration would certainly not be is a share of profits purchased by the employee... I can conceive of a case where a person contributes to some sort of a joint adventure services, while others contributes perhaps capital, land, plant, and goods arrangin .....

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regard to the terms and conditions of the agreement detailed and analysed above, there can be no doubt that the agents by contributing to the investments and by sharing the profits as also the losses have actually contributed to a joint venture and ultimate division of the profits with the principals and the agreement must be construed as an agreement for division of the profits in specified proportions as mentioned therein. It is true that in the aforesaid case on the facts found the court hel .....

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dated October 20, 1955. The High Court, however, appears to have relied upon the decision in Dharamvir Dhir's case. The facts of that case appear to be clearly distinguishable from those of the present case. What had happened in Dharamvir Dhiry's case was that the assessee was an employee of the firm earning a particular salary. The employee entered into a coal raising contract with a coal company and as he did not have the necessary funds he persuaded a public charitable trust to advan .....

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was undoubtedly permissible. The trust was also to get 11/16ths of the profits of the business. It was, however, not agreed between the parties that the profits would be ascertained after deducting the net expenses as mentioned in the agreement before us. It is true that the contract was to be carried on in accordance with the policy settled between the assessee and the trust but that did not give any veto power to the trust to torpedo the contract. In the instant case the agreement clearly pro .....

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s case. Finally, not only there was no provision in Dharamvir Dhir's case, under which the trust was to share the losses but there was an express provision to the contrary, namely, that the trust was not liable for any loss. Thus, the mere payment of interest at the rate of 6 per cent. on the loan advanced to the assessee and a percentage in the profits of the business would be quite consistent with a remuneration in lieu of services lent and would certainly amount to an expenditure incurred .....

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st the contract if he had failed to enter into the agreement, i.e., the agreement to pay the amounts in dispute. Therefore, in a commercial sense, the payments were an expenditure wholly and exclusively laid out for the purpose of the business. " It may be mentioned that this court had considered the decision in British Sugar Manufacturers Ltd.'s case and had approved of the same. Great stress was laid by counsel for the assessee-company on the fact that this court could not go behind t .....

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ial expediency cannot be reduced in the shape of a ritualistic formula, nor can it be put in a water-tight compartment so as to be confined in a strait jacket. The test merely means that the court will place itself in the position of a businessman and find out whether the expenses incurred could be said to have been laid out for the purpose of the business or the transaction was merely a subterfuge for the purpose of sharing or dividing the profits ascertained in a particular manner. It seems to .....

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or increase the commercial activity they may amount to an expenditure which is incurred for the purpose of the business. Reliance was also placed by counsel for the assessee-company on the decision in J. K. Woollen Manufacturers v. Commissioner of Income-tax where this court observed as follows : " The question as to whether an amount claimed as expenditure was laid out or expended wholly or exclusively for the purpose of business, profession or vocation as required under section 10(2)(xv) .....

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penditure has to be adjudged from the point of view of the businessman and not of the income-tax department. It is, of course, open to the Appellate Tribunal to come to a conclusion either that the alleged payment is not real or that it is not incurred by the assessee in the character of trader or it is not laid out wholly and exclusively for the purpose of the business of the assessee and to disallow it. But it is not the function of the Tribunal to determine the remuneration which in their vie .....

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Commissioner of Income-tax v. Travancore Sugars and Chemicals Ltd., this court added a word of caution that the test of commercial expediency should not be applied in a mechanical manner and observed as follows : " In considering the nature of the expenditure incurred in the discharge of an obligation under a contract or a statute or a decree or some similar binding covenant, one must avoid being caught in the maze of judicial decisions rendered on different facts and which always present .....

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hereafter to apply the principle embalmed in the decisions of those facts. Judicial statements on the facts of a particular case can never assist courts in the construction of an agreement or a statute which was not considered in those judgments or to ascertain what the intention of the legislature was. What we must look at is the contract or the statute or the decree, in relation to its terms, the obligation imposed and the purpose for which the transaction was entered into. " The learned .....

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and we find ourselves in complete agreement with the view taken by the Tribunal. The High Court on the other hand relied upon what it called the surrounding circumstances that the assessee-company was a losing concern from its inception and had to get rid of the previous selling agents, M/s. Murlidhar Chiranjilal, because they caused considerable embarrassment to the assessee-company. While the standing counsel for the revenue has admitted that the company was running at some loss there was no .....

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no other connection with the assessee-company except that of the business connection. The High Court further found that the promoter of the assessee-company, Mr. Desh Bandhu Gupta, had a stature which enabled him to borrow loans from the banks on personal security and as he died in an air crash the credit of the company went down and it was not able to raise money from the banks. There is absolutely no warrant for these facts referred to by the High Court which are neither mentioned in the agree .....

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acts found. Neither the High Court nor this court has jurisdiction to go behind or to question the statement of facts made by the Tribunal. The statement of case is binding on the parties and they are not entitled to go behind the facts of the Tribunal in the statement. When the question referred to the High Court speaks of 'on the facts and circumstances of the case', it means on the facts and circumstances found by the Tribunal and not on the facts and circumstances as may be found by .....

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ld only amount to apportionment or distribution of the profits after they have been earned. It cannot, therefore, be said that the amount set apart for the purpose of distribution amongst the consumers is not chargeable to tax on the ground that it represents over-charge. " This case, however, was decided on its own facts and has no application to the facts in the instant case. Reliance was also placed by counsel for the assessee-company on a Division Bench decision of the Patna High Court .....

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ed merely because the assessing authority thinks that the assessee could have managed by paying a lesser amount as a prudent businessman. The test of prudence by substituting its own view in place of the businessman's had not been approved by the Supreme Court in the decisions referred to above. " Here also the observations were confined only to the question that the test of prudence was to be determined from the point of view of the businessman. Jamshedpur Motor Accessories Stores' .....

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in the assessee-company and got interest on the loans apart from the commission they also shared profit to the extent of 50% as also loss to that extent and had complete controlling power in the manufacturing programme or the sale of the products and yet the transaction would be one of agency simpliciter and not a joint venture. On the facts found by the Tribunal and those mentioned in the statement of the case as discussed above leads to the inescapable conclusion that the present contract of .....

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dicherry Railway Co. Ltd. v. Commissioner of Income-tax, Lord Macmillan pointed out that a payment out of profits and conditional on profits being earned cannot be legitimately described as a payment made to earn profits. It assumes that profits have first come into existence. But profits on their coming into existence attract tax at that point and the revenue is not concerned with the subsequent application of the profits. In this connection the Privy Council observed as follows : " It is .....

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rofits on their coming into existence attract tax at that point and the revenue is not concerned with the subsequent application of the profits .................. but the principle laid down by Lord Chancellor Halsbury in Gresham Life Assurance Society v. Styles is of general application unaffected by the specialities of the English tax system : ' ......... But when once an individual or a company has in that proper sense ascertained what are the profits of his business or his trade, the des .....

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