TMI Blog1967 (6) TMI 16X X X X Extracts X X X X X X X X Extracts X X X X ..... rtant and in order to arrive at a proper determination of the question, it is necessary to state them in some detail. The reference arises out of two separate assessments made on the assessee for the assessment year 1962-63. The relevant account year of the first assessee, namely, Kasturbhai Lalbbai, is Samvat year 2016, commencing from 1st November, 1959, and ending on 20th October, 1960 and that of the second assessee, namely, Gautam Sarabhai, is the financial year 1960-61. The assessees are two prominent industrialists of Ahmedabad and both of them were during the relevant period of account, directors of the Ahmedabad Electricity Co. Ltd., a public limited company carrying on business of generating and distributing electrical energy in Ahmedabad. Killick Industries Limited was the managing agent of the company at the relevant time. In or about the begining of 1960, differences arose between the assessees on the one hand and the managing agent and the other directors of the managed company on the other, as a result of alleged mismanagement of the managed company on the part of the managing agent and the majority directors. The genesis of the starting point of the differences wa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the purpose of the reference to refer to these changes in detail, but it will be sufficient if we set out two of these changes. One Clark, who was the chairman of the managed company, was removed from the chairmanship in March, 1960, and about that time the technical adviser and two other competent officers of the managing agent with long records of faithful service were deprived of responsible work. On 24th March, 1960, a meeting of the board of directors of the managed company was held and at this meeting A. N. Haksar read out a letter from the managing agent stating that Clark had been replaced as ex-officio chairman by A. N. Haksar under the articles of association of the managed company. The other items on the agenda included the appointment of new directors and the reappointment of Killick Industries Limited as managing agent, but since the first assessee had gone abroad and was not present, the second assessee requested A. N. Haksar and the other directors not to take a decision in regard to these matters during the absence of the first assessee. No decision was accordingly taken in regard to these matters at this meeting of the board of directors, but within a few days ther ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y, 1960, pointing out these facts to the shareholders. Three paragraphs of this circular have been relied upon by the Tribunal and they run as follows : " We, the undersigned directors of your company regret that differences have arisen between the directors and also between some directors and Killick idustries Limited, the managing agents of the company, on matters of vital importance to the satisfactory conduct; as it is, we consider it our duty to place the following facts and views before the shareholders believing it to be in the discharge of our responsibility to the shareholders. The safeguarding of the interest of the shareholders is our principal obligation as members of the board. What happens within Killick Industries Limited would be of no concern to us if they were not the managing agents of this company and their ability to discharge their duties as managing agents in the day to day conduct of our business remained unaffected ..... we are convinced that the managing agents, so constituted, are not in a position to discharge their duties satisfactorily in the best interests of this company. We have no substantial interest in either the Ahmedabad Electricity Compa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... , 1960, and 5th September, 1960, and collecting proxies from the shareholders, the assessees jointly spent an aggregate sum of Rs. 33,299 and each of the assessees claimed 1/2 of this amount as a deduction in his assessment for the assessment year 1961-62. The claim for deduction was founded both under section 12(2) and section 10(2)(xv). The Income-tax Officer disallowed the claim and on appeal the view taken by the Income-tax Officer was confirmed by the Appellate Assistant Commissioner. Each of the two assessees thereupon preferred an appeal to the Tribunal and the two appeals were heard together by the Tribunal. The Tribunal rejected the claim of the assessee in so far as it was based on section 10(2)(xv) but upheld the claim based on section 12(2) and allowed the expenditure as a permissible deduction under section 12(2). This view taken by the Tribunal is challenged by the Commissioner in the present reference. The first question that arises for consideration is whether the claim for deduction made by the assessee is sustainable under section 12(2). The answer to the question depends not so much on the construction as on the application of section 12(2). The construction of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... td. v. Commissioner of Income-tax . Bose J., delivering the judgment of the Supreme Court in this case, stated the propositions relevant to the determination of this question in the following terms : " (a) though the question must be decided on the facts of each case, the final conclusion is one of law: Indian Radio and Cable Communication Ltd. v. Commissioner of Income-tax anf Tata Hydro-electyric Agencies Ltd. v. Commissioner of Income-tax; (b) it is not necessary to show that the expenditure was a profitable one or that in fact any profit was earned : Moore v. Stewarts and Lloyds and Usher's case; (c) it is enough to show that the money was expended ' not of necessity and with a view to a direct and immediate benefit to the trade, but voluntarily and on the ground of commercial expediency, and in order indirectly to facilitate the carrying on of the business' : British Insulated and Helsby Cables Ltd. v. Atherton; (d) beyond that no bard and fast rule can be laid down to explain what is meant by the word ' solely '. " The second proposition shows that the expenditure need not be a profitable or fruitful one ; it is not necessary to show that in fact it produced any i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ce to the terms of section 12(2), it does seem to support the argument urged on behalf of the assessees. But we do not think this argument is correct. What section 12(2) says in so many terms is that the expenditure must be incurred for the purpose of earning the income and, therefore, there must be some connection or nexus between the expenditure incurred and the income earned. The connection may not be direct : even an indirect connection would be sufficient. But the expenditure in order to be admissible under section 12(2) must be incurred directly or indirectly to facilitate the earning of the income, for then only we can say that the expenditure is incurred for the purpose of earning the income. It must be remembered that the third proposition quoted by the Supreme Court was taken from the decision in British Insulated and Helsby Cables Ltd., v. Atherton, and that was a case relating to income from business and that is why the words used were " in order indirectly to facilitate the carrying on of the business". But when the Supreme Court applied that proposition in the construction of section 12(2), it must be read in the context of that section and so it is clear that the wor ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... isk of being turned out of the board of directors, notwithstanding their position in industry and the expenditure was, therefore, incurred for protecting their directorships. On these contentions it was urged on behalf of the assessees that the expenditure was incurred solely for the purpose of making or earning the income by way of directors' fees and was therefore allowable under section 12(2). After setting out these contentions in paragraph 8, the Tribunal proceeded to give its conclusion in paragraph 9 as under : " We are inclined in this case to accept the contentions for the assessees. There is prima facie evidence of mismanagement and of acts prejudicial to the interests of the Ahmedabad company. We are satisfied about the good faith of the assesses in this case. It is impossible to take the view that if a director does not like the conditions in which he is called upon to work, he can resign, and that he cannot undertake any expenditure which will secure more satisfactory conditions of work. It is difficult to say, for purposes of section 12(2), that a person has ' earned ' his income, if he does nothing but attend meetings of the board. One cannot take a negative view ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... at his election as a member of the Local Board of the Reserve Bank of India was invalid was held to be an allowable deduction under section 12(2). But there being no finding of the Tribunal that the directorships of the assessees were in jeopardy, this decision cannot avail the assessees. The only question which, therefore, falls for consideration is whether, on the finding of the Tribunal that the expenditure was incurred by the assessees, not for the purpose of gaining any personal end or gratification of the ego but for the purpose of bringing the mismanagement of the compnay to the notice of the shareholders with a view to bringing such mismanagement to an end, it can be said that the expenditure was incurred solely for the purpose of making or earning the income within the meaning of section 12(2). Now, the income which was sought to be assessed was income by way of fees as directors of the managed company and, therefore, applying the test above formulated, the question which we must ask ourselves is whether the expenditure was incurred of necessity or voluntarily on the ground of commercial expediency in order directy or indirectly to facilitate the earning of the directors ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e himself from such action by voting against it and in a given case he would also be justified in approaching the shareholders, but there is no duty on him to take action with a view to preventing general mismanagement of the company. Considerable reliance was placed on the decision in Joint Stock Discount Company v. Brown but if this decision is carefully scrutinized, it does not go as far as the assessees would have it. In order to understand the true import of this decision, it is necessary to notice the facts on which the decision was given. One Brown was a director of a joint stock company and at a meeting of the board of directors of the company held on 19th June, 1865, at which Brown was present, it was resolved that an application should be made for 10,000 shares in a new company called Barnad's Banking Company Limited. The minutes of this resolution were confirmed at another meeting of the board of directors and at this subsequent meeting also, Brown was present. Brown, thereafter went out of London and during his absence the first cheque in part payment of pound 30,000, being the purchase price of 3,000 shares was drawn and paid by the company. Upon his return on 7th July ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... anagement of the company and he is not in a position to put an end to it by persuading his " brother directors ", he is bound to send a general circular to the shareholders to tell them what the directors are doing and in the last resort he may even approach the court for the purpose of putting an end to the mismanagement. Now, it must be remembered that these observations were made in the context of a specific transaction which was being entered into by the directors and which was ultra vires the company, and which was initially approved by Brown by voting in favour of it. Though Brown originally voted in favour of the transaction, yet, when it dawned upon him that the transaction was ultra vires the company and the moneys of the company were being wrongly misappropriated, he did nothing except addressing a letter of protest to the directors. The learned Vice-Chancellor held in these circumstances that mere protest did not disprove acquiescence on his part. It was his duty as a director, knowing what was going on, not to have remained " quiescent, or acquiescent ", but should have sent a general circular to every one of the shareholders to tell them what the directors were doing ; ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ited was substantially higher than the price at which similar machinery was available from another equally reputable company. Thereafter Clark was replaced as chairman of the managed company by A.N. Haksar and the technical adviser and two other competent Officers of Killick Industries Limited with long records of faithful service were deprived of responsible work. Meetings of the board of directors dated 31st March, 1960, and 4th April, 1960, were convened by A. N. Haksar at extremely short notice taking advantage of the absence of the assessee and at these meetings new directors were appointed, the new managing agency agreement with Killick Industries Limited was approved and Nixon Forrest and Company Limited were appointed agents of the managed company in U. K. This last decision was taken despite an earlier decision of the board of directors not to take any action until after obtaining a report on the advisability of appointing an agent in U. K. and information regarding the constitution of Nixon Forrest and Company Limited and the interest in that company of persons who were concerned with Killick Industries Limited or the managed company. Moreover, according to the informatio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ng the principles of commercial expediency to the farthest extent, the action of organising the voting strength of the shareholders by collecting proxies for the purpose of setting right the mismanagement of the company cannot be regarded as a function legitimately appertaining to the officer of a director. A director may certainly, as a prudent commercial man, bring mismanagement to the notice of the shareholders so that the shareholders can take appropriate action for the purpose of bringing it to an end, but no considerations of commercial expediency can justify him in his capacity as a director and here we are concerned only with his capacity as a director to channelize and organize the voting strength of the shareholders by collecting proxies for the purpose of putting an end to mismanagement. It is undoubtedly difficult to draw a line between cases where certain action taken by a director may be justified on the ground of commercial expediency and cases where it may not be, but it is not necessary for us to draw the line, for we have no doubt that, wherever the line may be drawn, the action of the assessees in collecting proxies from the shareholders must fall on the wrong si ..... X X X X Extracts X X X X X X X X Extracts X X X X
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