TMI Blog1980 (12) TMI 30X X X X Extracts X X X X X X X X Extracts X X X X ..... sseecompany had two managing directors, namely, Sri K. Narayanaswamy and Sri S.. Srinivasan. Each of these managing directors have received remuneration from the company in excess of Rs. 60,000 in both the aforementioned years. In the return filed by the assessee-company for 1972-73, the assessee claimed that the remuneration paid to the two managing directors amounting to Rs. 72,000 each was fully allowable. The ITO allowed the said deduction in full. The Commissioner took up the matter in suo motu revision and held that the deduction allowed by the ITO in excess of Rs. 60,000, which is the ceiling limit specified under s. 40A(5) of the Act, could not be sustained in law. Accordingly, the Commissioner directed the ITO to modify the assessment by withdrawing the excess deduction. In passing the said order the Commissioner had taken the view that there was an employer-employee relationship between the company and, the managing directors and, hence, the provisions of s. 40A(5) were attracted. The assessee carried the matter in second appeal before the Tribunal by filing ITA No. 232/76-77. For the assessment year 1973-74, the ITO had initially allowed in full the deduction claimed ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... if the directors resolve to increase the number of the managing directors the vacancy shall be filled by the board of directors and the managing director so appointed shall hold the office for such period as the board of directors may fix. Clause (h) enjoins that if the managing director ceases to hold office as director he shall ipso facto and immediately cease to be a managing director. Clause (i) deals with the subject of remuneration of the managing directors and it is in the following terms: " Subject to the provisions of the Act and subject to such sanction of the Central Government as may be required for the purpose, the managing directors shall receive such remuneration (whether by way of salary, commission or participating in profits or partly in one way and partly in another) as the company in general meeting may from time to time determine. " Clause (j) of art. 65 provides, inter alia, that if two or more managing directors are appointed then they shall be entitled to exercise all the powers conferred on the managing director or managing directors by the articles of association or by law either jointly or severally unless otherwise directed by the board of directors ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he ceiling limit specified in cl. (c). The question to be considered is whether the two managing directors of the assessee-company were employees of the company during the relevant accounting period so as to attract the applicability of cls. (a) and (c) of sub-s. (5) of s. 40A. For ascertaining whether a person is a servant or an agent of another a rough and ready test is whether under the terms and conditions governing their mutual relationship a supervisory control is exercised by the latter in respect of the work entrusted to the former. A servant acts under the direct control and supervision of his master. An agent, on the other hand, in the exercise of his work, is not subject to the direct control or supervision of the principal, though he is bound to exercise his authority in accordance with all lawful orders and instructions which may be given to him from time to time by his principal. But, as pointed out by the Supreme Court in Ram Prashad v. CIT [1972] 86 ITR 122, this test is not universal in its application. In determining whether a relationship of employer and employee exists, due regard must also be had to the nature of the particular business, the terms of the enga ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 4, Laxminarayan Ram Gopal and Son Ltd. v. Government of Hyderabad [1954] 25 ITR 449, Qamar Shaffi Tyabji v. CEPT [1960] 39 ITR 611 and Piyare Lal Adishwar Lal v. CIT [1960] 40 ITR 17, the legal position was summed up by the learned judge thus (p. 130): " A detailed consideration of all the cases cited and the passages from text books referred to before us do not assist us in coming to the conclusion that the test for determining whether the person employed by a company is a servant or agent is solely dependent on the extent of supervision and control exercised on him. The real question in this case is one of construction of the articles of association and the relevant agreement which was entered into between the company and the assessee. If the company is itself carrying on the business and the assessee is employed to manage its affairs in terms of its articles and the agreement, he could be dismissed or his employment can be terminated by the company if his work is not satisfactory, it could hardly be said that he is not a servant of the company." On an examination of the articles of association of the company concerned in that case and the terms and conditions contained in th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n terms of the articles of association by the board of directors and the company in its, general meeting. As a managing director he functions also as a member of the board of directors whose collective decisions he has to carry out in terms of the articles of association and he can do nothing which he is not permitted to do. Under section 17(2) of the Indian Companies Act, 1913, regulation No. 71 of Table A, which enjoins that the business of the company shall be managed by the directors is deemed to be contained in the articles of association of the company in identical terms or to the same effect. Since the board of directors are to manage the business of the company they have every right to control and supervise the assessee's work whenever they deem it necessary. Every power which is given to the managing director, therefore, emanates from the articles of association which prescribes the limits of the exercise of that power. The powers of the assessee have to be exercised within the terms and limitations prescribed thereunder and subject to the control and supervision of the directors which, in our view, is indicative of his being employed as a servant of the company." In the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the managing directors emanates from the articles of association which prescribe the limits of the exercise of that power. The aforesaid provisions contained in the articles of association make it clear that the management of the company is vested in the board of directors, the managing director or managing directors appointed by the board is/are to hold office for such period as the board of directors may fix, that a managing director may be removed from the directorship by the company by an extraordinary resolution whereupon he has to automatically cease to be managing director and that in the discharge of their duties and functions the managing directors are subject to the supervision, control and directions of the board of directors who shall have power to impose restrictions and conditions subject to which alone the management of the affairs of the company is to be carried on by the managing directors. There is also the further provision that the managing directors shall receive such remuneration (whether by way of salary, commission or participating in profit or partly in one way and partly in another) as the company in general meeting may from time to time determine. In ou ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... interest of the company. The further reasons stated by the Tribunal, namely, that the managing directors are not members of the provident fund and that they are not entitled to any bonus, leave privileges or even to a minimum remuneration are, in our opinion, totally irrelevant for determining the nature of the relationship that exists between the company and managing directors. In Gestetner Duplicators P. Ltd. v. CIT [1979] 117 ITR 1, the Supreme Court has held that where, under the terms of the contract of employment, remuneration or recompense for the services rendered by an employee is determined at a fixed percentage of the turnover achieved by him, then such remuneration or recompense will partake of the character of salary, the percentage basis being the measure of the salary. The same is the legal position when, under the terms of the contract of employment, the employee is to receive remuneration at a fixed percentage of the net profits of the company. In the light of the foregoing discussion, we hold that the two managing directors were employees of the company and hence the company is entitled to claim a deduction in respect of the remuneration paid to them only subje ..... X X X X Extracts X X X X X X X X Extracts X X X X
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