TMI Blog1970 (2) TMI 50X X X X Extracts X X X X X X X X Extracts X X X X ..... , 9 peons, 2 drivers and one watchman. Though the fact is not on the record, we are informed by Mr. Palkhivala for the assessee-company that there were 11 other employees of the company who were not on the office establishment and worked by attending on the properties being the estate of the company. It appears that the issued capital of the company consisted of 1,000 ordinary shares and all the issued shares were held directly or through nominees only by three persons, viz., Sir Percival David, Lady David, and V. P. David. It further appears that a proforma balance-sheet as on December 31, 1955, prepared by A. F. Ferguson Co., the auditors of the company, was furnished to Tata Sons Ltd. in connection with the negotiations that took place for sale of the whole of the holding of the issued capital (1,000 ordinary shares of the company) and the transfer of management of the assessee-company to Tata Sons Ltd. By a directors' resolution dated December 2, 1955, it was decided to terminate' the employment of all the 22 employees in the office establishment and to recommend or payment to them of certain amounts by way of retrenchment compensation. In that connection, it was decided to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... total share capital of the company agreed to sell and Tata Sons Ltd. agreed to purchase from these sellers the total share capital for the price of rupees 155 lakhs. Needless to state that the agreement for sale was made for completely vesting the management and the whole of the company in the purchasers. Under clause 2 of the agreement, reference was made to the proforma balance-sheet prepared as of December 31, 1955. Under clause 3, reference was made to the fact of the company having decided to grant gratuities and compensation amounting to Rs. 2,32,500 by the above referred resolutions. This sum includes the amount payable to R. Mathalone. In this clause it was specified that the purchasers would deduct from the purchase price this sum of Rs. 2,32,500. Under clauses 4 and 5, it was provided that the purchasers would acquire the company on the footing of the obligations and liabilities disclosed in the proforma balance-sheet as at the end of December 31, 1955. Clause 6 ran as follows : " The sellers shall arrange to terminate the services of all employees (other than the managing director) with effect from the 31st March, 1956, and also arrange that all directors (including th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ursed in the years 1955 to 1958 were also given, possibly, towards proving that by termination of employment of the managing director, the manager and of the employees, expenses had become reduced and economy was effected. These particulars run as follows : 1955 1956 1957 1958 Rs. Rs. Rs. Rs. Salaries and Bonus as per P L Account 1,28,443 71,511 58,848 54,960 Less: Bonus 14,246 4,243 4,724 -------------- -------------- -------------- -------------- Salaries (yearly) 1,14,197 67,268 54,124 54,960 Salaries (monthly) 9,516 5,606 4,510 4,580 The Appellate Assistant Commissioner by his order dated July 18, 1959, observed that from the information furnished to him it appeared that establishment expenses were substantially reduced. He, however, held that the termination of services and the payment of compensation were not done wholly with a view to the business requirements of the company and were "bound up with the changing of hands of the shares of the company. The decision to pay compensation cannot in the circumstances be said to have been taken solely with a view to the business requirement of the company though incidentally the company might have benefited b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ct of the whole of the above amount of Rs. 1,64,899 as expenditure wholly and exclusively incurred for the purposes of the business of the Company. In that connection, his emphatic submission was that the fact that an agreement for sale of the shareholding was made and that it provided for termination of employment of all the employees of the company was irrelevant. The agreement might be a cause and motive for termination of service, but the purpose of the payment and disbursements of the whole of the above amount was towards discharging a liability to pay gratuity in accordance with the prevalent practice of the company and compensation for termination of service of the managing director. The purpose of the payments being to discharge this liability, the existence of and/or intervention of the agreement for sale and the provisions therein in connection with termination of service must be held to be mere motive but can never be held to be the purpose of the payment. In that connection, relying upon the observations of this court in the case of Ormerods (India) Private Ltd. v. Commissioner of Income-tax followed in the case of Kevalchand Nemchand Mehta v. Commissioner of Income-tax ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... were by the new management retained in employment, he submitted that since under the prevalent practice at the end of the termination of their service they would have in any event received amounts of gratuity, the expenses of gratuity incurred by paying to them diverse amounts at earlier dates should not make any difference to his contention that the payment to these 9 employees of compensation was towards discharging commercial liability of the company. In connection with the sum of Rs. 16,188 paid to Mr. Mathalone, the managing director, in lieu of 6 months' notice period, his contention was that, as stated on behalf of the assessee-company in its letter dated July 1, 1959, appointment of Mr. Mathalone as managing director was liable to be terminated by both sides by 6 months' notice in writing. Every time the company desired to terminate his service, the company would be liable to give 6 months' notice and thereupon to pay salary for that period of 6 months. The liability to retain him as managing director could, therefore, in law be terminated and ended immediately by paying to him 6 months' salary in lieu of notice for that period. The fact that his services are not needed ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y was bound to prove that each and all items of disbursements aggregating to the above sum of Rs. 1,64,899 were laid out or expended wholly and exclusively for the purpose of the business of the assessee-company. He contended that every item of disbursement was made in this case for the purpose of fulfilment of and carrying out the provisions in the agreement for sale dated March 23, 1956. Termination of service of the employees and the managing director was necessitated for carrying out the obligation undertaken by the sellers in the above agreement for sale. His submission was that having regard to the above fact, expenditure for payment of retrenchment compensation was incurred not for any part of the business of the assessee-company and in any event such expenditure was not wholly and/or exclusively made in connection with the business of the assessee-company. His further contention was that as has been held in the case of Gordon Woodroffe Leather Mfg. Co. v. Commissioner o Income-tax, and in appeal from the decision of the Madras High Court in that case by the Supreme Court, the question in this reference should be decided on the footing that expenditure laid out for payment o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the amount paid by way of commutation of the pension liability to certain retired employees and/or their widows. In connection with his submissions, he relied upon the case of James Snook Co. Ltd. v. Blasdale (H. M. Inspector of Taxes) where, in connection with disbursements made (in pursuance of an agreement for sale of share-holding) for termination of office of the directors who had ceased to be directors, at page 250, the argument was "the shareholders could not validly authorise the paying away of the company's money in mere implementation of their private bargain", it was, inter alia, observed : " But, it is essential in such cases that the company should prove to the Commissioners' satisfaction that it considered the question of payment wholly untrammelled by the terms of the bargain its shareholders had struck with those who were to buy their shares and came to a decision to pay solely in the interests of its trade." This decision of Donovan J., in the first court, was confirmed by the appeal court. It would be out of place to include in this judgment all the relevant observations made by the appeal court. Now, in connection with these rival contentions, it is usef ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... first case a lump sum had been paid for the purchase for the benefit of a former actuary of the assessee-company of an annuity equal in amount to the pension which the company had resolved to pay him. That amount was held to be an expense admissible by way of deduction,because in that case "it was the practice of the assessee-company to grant pensions to its servants after a considerable period of service and this practice was known to the employees and affected the rate of salary paid by the company in that the employees were willing to serve the company at lower rates than they otherwise would have by reason of the expectation of the pension at the end of their service". It was observed that in the second case "there was a practice of granting gratuities and that was the ground for holding the amount to be a proper deduction ". The Supreme Court then stated : " In our opinion the proper test to apply in this case is, was the payment made as a matter of practice which affected the quantum of salary or was there an expectation by the employee of getting a gratuity or was the sum of money expended on the ground of commercial expediency and in order indirectly to facilitate the ca ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... loyees, the rest of them were in service for long periods varying between 54 to 13 years. Having regard to the fact that the particulars furnished go to show payment of gratuity for the first time in 1946, we find it difficult to imagine that the employees who had been in service for a considerable number of years had joined service at a reduced amount of salary in the expectation that they were bound to get amounts of gratuity at the date of retirement. On the, contrary, it would not be difficult to hold that those of the employees who joined service before 1946, i.e. (had been in service for more than 10 years before the relevant assessment year 1956) joined service at normal ordinary salaries which they were able to earn without any expectation that on retirement they would be paid a gratuity. In the resolutions the payments to be made are described as "retrenchment compensation" and not gratuity. The amounts mentioned have been arrived at to the extent of Rs. 1,04,626 by multiplying basic monthly salary with the years of service. To the amounts ascertained in the above manner, without mentioning any reasons, 20 per cent. further amount is added and the aggregate as arrived at a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d Rs. 54, 960. It is also not in dispute that though services of 22 employees of the office establishment were terminated, 9 of the employees were re-employed immediately as from April 1, 1956. It has been rightly submitted by Mr. Joshi that the termination of employment of all the employees was such that on April 1, 1956, the office establishment would not have functioned at all. It is also not disputed that under the scheme of the agreement for sale the price of rupees 155 lakhs was net price and the new shareholders were not to bear the liability of the amounts of retrenchment compensation resolved to be paid by the company to the 22 employees as well as to the manager and the managing director. Mr. Palkhivala insists that the fact that the wage bill was reduced goes to show that the termination of the employment had been made for commercial considerations and expediency. Now, in this connection, Mr. Joshi is right that facts have not been proved to show that whilst the resolutions for termination of service and payment of compensation were made by the board of directors in the first instance and by the extraordinary general meeting of the company thereafter, any question of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the employees and accordingly to discharge business liability. It is quite true that as has been held in the cases of Ormerods (India) Private Ltd. v. Commissioner of Income-tax and Kevalchand Nemchand Mehta v. Commissioner of Income-tax, referred to above, the motive for which a transaction may be made by an assessee is not relevant in connection with the claims for deduction to be allowed under clause (xv) of sub-section (2) of section 10. The purpose of the expenditure must always be, therefore, borne in mind in deciding the question of deduction claimed. The question is, "what was the purpose in terminating the services of 9 employees who admittedly were re-employed from April 1, 1956". If they were not re-employed, the company's wage bill would have been possibly nil. But this situation as regards the number of employees necessary for the further carrying on of the business of the assessee-company was never considered when the matter of payment of retrenchment compensation was decided by the company. The purpose of the payment, so far as can be ascertained from the contents of resolutions of the board of directors and the company when read with the relevant contents of the ag ..... 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