Case: Lakshmiratan Cotton Mills Company Limited Vs. Commissioner of Income Tax, Uttar Pradesh

2. The facts which give rise to the reference require to be stated in some detail. The Company was incorporated in 1934. The shares of the Company were held in equal moities by members of two families, who way for the sake of convenience be referred to as Singhanias" and "Guptas". Under a deed dated August 3, 1934, Singhanias and Guptas formed a partnership to carry on, in the name of Beharilal Kailashpat, several businesses including the business of Secretaries, Treasurers and Agents of the Company. By agreement dated May 2, 1935, the Company appointed Beharilal Kailashpat as its managing agents. The firm then consisted of eight partnersfour belonging to the family of Singhanias and the other four belonging to the family of Guptas. Under the Articles of Association of the Company two ex officio directors were to be nominated by Beharilal Kailashpat Clause 2 of the managing agency agreement read asconsideration of the agreement hereinbefore contained on the part of the firm and in further consideration of the firm having promoted "the Company", the Company hereby promise and agree with the Firm and its Members for the time being:(a) That the Firm shall be the Agents of the Company for a period ofyears and thereafter until they shall resign or until they are thereafter removed from their office as Agents of the Company by a majority ofof the shareholders of the Company.(b) The Firm shall receive from the Company a commission at the rate of two per cent on the sale price of all the cotton, yarn and cotton cloth manufactured and sold by the Company and a commission of one per cent on the sale proceeds of all materials, yarns and fabrics manufactured from wool, jute, silk and other fabrics, and sold by the Company, and a commission of ten per cent on the gross profits after deducting all expenses but before deducting Depreciation, made by the Company from its ginning or pressing operations independently of the usual adat commission, exchange and interest payable to their branch firms or agents and adatias appointed by them outside Cawnpore for purchasing or selling any goods or commodities for or on account of the Company.(c) The Company shall defray the expenses of maintaining a suitable office and such staff as the Firm may deem proper to transact the business of the Firm as Agents of the Company.(d) In case the Company shall sell their Mill premises and machinery and the business thereof, the same shall be sold subject to the rights and claims of the Firm of the Agents of the Company as provided by this Agreement and the Memorandum and Articles of Association of theclause 3 of the agreement it was provided that in the event of the Company being wound up the managing agents Beharilal Kailashpat shall be entitled to receive compensation for loss of appointment as agents a sum equal to the amount earned by the firm during five years preceding the winding up of the Company. Beharilal Kailashpat were under clauses 3 (f) and (g) to purchase all cotton, wool, machinery and stores that may from time to time be required for the use of the Company Mills and to sell the same and also to sell all loose or baled yarn, and cloth produced or manufactured at the Companys Mills. By clause (h) the managing agents were to exercise all the powers given to them by the Articles of Association of the Company. It was also provided that if the firm be not dissolved it shall be lawful for the firm to change its constitution, name or style from time to time without thereby in any way affecting their appointment as agents of the Company.3. From time to time the constitution of Beharilal Kailashpat was changedsome members ceased to be partners and new members entered the firm without affecting the equal representation of Singhanias and Guptas. On February 15, 1943, a fresh deed of partnership of Beharilal Kailashpat was executed under which the four representatives of Singhanias were(1) Smt. Ansuiya Devi; (2) Smt. Pushpavati Devi; (3) Vijaipat (minor) and (4) Ajaipat (minor) Nos. (3) and (4) being minor sons of Lala Kailashpat Singhania: the representatives of Guptas were(1) Smt. Ramdevi; (2) Smt. Keshobai; (3) Lala Ram Rattan Gupta and (4) Lala Ram Prasad Gupta; Each of the family collectively held an eight annas share. Under the terms of this partnership deed it was agreed that Lala Ram Rattan Gupta a partner of the firm will be entitled to carry on business on behalf of the firm.4. Disputes arose in 1943 between Singhanias and Guptas in regard to the management of the various businesses in which they were interested. These disputes were referred for adjudication to Thakur Kanhaiya Singh who made and published his award on January 18 1944. Under the award the arbitrator allotted certain business exclusively to Singhanias and the rest to Guptas. In regard to the managing agency of the Company, the award directed that the Singhania group do withdraw from the Company, and the shares held by them be given to the Gupta group "at the rate of Rs. 2000/per share": that Padampat and his two brothers do resign from the Board of Directors, that the Singhanias group be deemed to have retired from the partnership of the managing agency as from 25th January, 1944 and that Lala Ram Rattan Gupta along with his members of the group be entitled to continue the said managing agency business: that the name of Kailashpat be removed from the firms name of Beharilal Kailashpat; that the profit and loss account of Beharilal Kailashpat be made upto January 18, 1944, and that the amount due to either of the groups ascertained after providing for excess profits tax andliabilities be paid. Pursuant to the award the shares held by the Singhanias were taken over by the Guptas, and the name of the managing agency firm was changed to Beharilal Ramcharan. On March 31, 1944, the shareholders of the Company approved of the changes in the constitution of the managing agency firm.5. Apparently Singhanias were not satisfied with the award made by Thakur Kanhaiya Singh and they commenced and action (Suit No. 31of 1944) in the Civil Court at Kanpur, and claimed relief in respect of the termination of their interest in Beharilal Kailashpat, and in respect of certain other matters. There was correspondence between Singhanias and Guptas which it is unnecessary at this stage to refer. On September 19, 1944, at a meeting of the shareholders of the Company the firm of Beharilal Ramcharan which was brought into existence under a deed of partnership dated January 27, 1944, were appointed managing agents of the company. The Singhanias insisted that they remained interested in the managing agency and the Guptas asserted that under the award of Thakur Kanhaiya Singh the Singhania group had ceased to have interest in the managing agency and on retirement of the members of the Singhanias, the name of Beharilal Kailashpat was changed to Beharilal Ramcharan. The shareholders of the Company at their meeting held on September 19, 1944, also passed a resolution that the managing agents be dismissed from the office and the managing agency agreement be terminated with effect from September 30,1944.6. Thereafter the members representing the Singhanias claimed compensation from the Company for wrongful termination of the managing agency. The Guptas also made a claim for compensation and threatened to bring an action against the Company. By agreement dated October 19, 1944, the disputes between the Company and Beharilal Kailashpat were referred to the arbitration of Mr. K. M. Munshi with authority to decide two. (1) whether the termination of the managing agency and removal from the office of the managing agents of the firm of Beharilal Kailashpat and/or its alleged successor Beharilal Ramcharan was wrongful or not; and (2) if it was wrongful, to what compensation, if any, are theagents entitled? Before Mr. Munshi entered upon the reference, the award made by Thakur Kanhaiya Singh was modified by a supplementary award made by Thakur Kanhaiya Singh with the consent of the parties. Under the award so modified, it was providedthe claim of the retiring partners for a share in the goodwill of the said firm and in the value of the said Managing Agency the said L.R. C.M. Co. Ltd. having terminated the said Managing Agency Agreement and the Managing Agents having claimed compensation for the said termination which they allege was wrongful and the dispute arising out of such claim having been referred to arbitration, it is agreed and awarded that any sum awarded as compensation in the said arbitration shall be paid to and retained by the continuing partners and that irrespective of the result of the said award and in any event they, i.e., the continuing partners shall pay to the retiring partners a sum of Rs. eight lacs as representing their share in the compensation for the premature and wrongful termination of the Managing Agency Agreement with the said firm. The above payments shall be in full satisfaction and discharge of all claims and demands whatsoever of the retiring partners on and to the assets, goodwill and contracts of the said firm including the Managing Agency Agreement with the L. R. C. M. Co. Ltd., and also in full satisfaction and discharge of the claim made by them against the Laskhmiratan Cotton Mills Co. Ltd. or compensation for the termination of the said Managingthis modified award a consent decree was obtained in suit No. 31of 1944 filed by Singhanias.7. Thereafter Mr. Munshi made an award on March 25, 1945,That the termination of the managing agency of M/s. Beharilal Kailashpat and their removal from the office of Managing Agents of the said company i.e. Laxmiratan Cotton Mills Co. Ltd. was wrongful.(2) That the said Laxmiratan Cotton Mills Co. Ltd. are liable to pay to the firm of M/s. Beharilal Kailashpat a sum of Rs. 18,90,000/only as and by way of compensation for such wrongful dismissal.(3) That the said Laxmiratan Cotton Mills Co. Ltd. to pay to party of the third part, that is to say, L. Ramratan Gupta and Lala Ramprasad Gupta sons of Lala Beharilal and Smt. Keshobai, wife of Lala Ramgopal the said sum of Rs. 18,90,000/. only, with interest thereon at the rate of 3 per cent per annum from the date hereof.(4) That the said company do pay the said parties of the 2nd part and of the 3rd part their respective costs of the reference and the arbitration proceedings (which included fees of Rs. 10,000/to Mr. K. M.was thereafter made by the Company in pursuance of this award of Rs.18,90,000/to Beharilal Kailashpat and Rs. 13,300/were disbursed as expenses of arbitration.8. TheOfficer rejected the claim of the Company to treat as a permissible allowance under Section 10 (2) (xv) of theAct, 1922, the amount of Rs.He held that the expenditure incurred was not connected with the business of the Company and in any event it was capital expenditure. In appeal the Appellate Assistant Commissioner held that the payment was made "for some improper purpose * * * not connected with the business". In further appeal before the Tribunal, counsel for the Company urged two arguments in support of the claim forthat the main object in terminating the managing agency was to save the Company from loss which the Company would have suffered on account of the disputes between the two groups of partners of the managing agency firm; and(2) that the Company was by the payment absolved from liability to the remuneration of the managing agents for the year of account and for future years also. The Tribunal held that before the termination of the managing agency agreement the affairs of the Company were administered by Lala Ram Rattan Gupta and Lala Ram Prasad Gupta, that even after the termination of the managing agency Lala Ram Rattan Gupta and Lala Ram Prasad Gupta continued to administer he affairs of the Company, and that on the materials on record it was not proved that the managing agents were performing any service to the Company. The Tribunal therefore held that the payment of the managing agency commission to the managing agents was not expenditure wholly and exclusively incurred for the purpose of the Companys business. The Tribunal also observed that the disputes between the two groups could in no way harm or cause hinderance to the "normal day to day working" of the Company.Referring to the second plea the Tribunal observed that consideration for the appointment of the managing agents were(1) promotion of the Company; (2) rendering service to the Company; anything paid for promoting the Company was not admissible as a revenue deduction, and by making a consolidated payment to pay off such a liability the Company did not reduce the future revenue liability of the Company.10. The Tribunal in summarising the findingsdisputes (between Singhanias and Guptas) were taken to the Court and (were) also referred to arbitration. After the first arbitration datedthe Singhania group was not satisfied. Ultimately some sort of a settlement was arrived at through an arbitrator whose supplementary award forms the basis of the consent decree of the Court. Under this award each party had to pay the other large sums. Therefore, a device was adopted to prove funds in the hands of the parties at the expense of the company for the purpose of settling their individual accounts. In preparing the scheme the authors had made an effort to reduce the tax liability of the company by claiming the amount as a revenueTribunal also observed that the firm styled Beharilal Ramcharan was brought into existence in place of Beharilal Kailashpat, but it rendered no services as managing agents. The Tribunal accordingly rejected the claim of the Company for treating the compensation paid to the managing agents an the legal expenses in relation thereto as a permissible deduction in the computation of its total income.11. The Company submitted an application under Section 66 (1) of theAct, 1922, for submitting a statement of case and prayed that seven questions set out in the application be referred to the High Court. The Tribunal rejected the application holding that no question of law arose out of the order of the Tribunal, and that the questions sought to be raised by the company "were pure questions of fact", The Company then moved an application in the High Court of Allahabad requesting that the Tribunal be directed to state a case in respect of twoWhether in the circumstances of the case the expenditure made by the assessee company for "the purpose of getting rid of the Managing Agents was not the expenditure admissible under Section 10 (2) (xv) of theAct?(2) Whether there was any or sufficient evidence to justify the Tribunal to hold that no services whatever were rendered by Managing Agents to the assessee Company under the Managing Agency Agreement and that therefore nothing was payable to the Managing Agents in respect of suchHigh Court directed the Tribunal to state a case on questions of law arising out of its order. Pursuant to this order, the Tribunal on December 29, 1954, submitted the followingthere was material on which the Tribunal could have come to the conclusion that Rs. 19,03,300/were not spent by the assessee company wholly and exclusively for the purpose of itsCompany wad apparently dissatisfied with the question referred by the Tribunal and filed a petition in the High Court praying that certain questions set out in the application be decided along with the question already referred and theAppellate Tribunal be directed to amend the statement of case and to refer the additional questions also to the High Court for decision. The High Court in purported exercise of the power under Section 66 (4) of the IndianAct, called upon the Tribunal to submit another statement of case on the followingWas there any material for thethat the managing agents had rendered no service to the assessee company;(b) that Lala Ram Ratan Gupta and Lala Ram Prasad Gupta were acting qua their position as Directors and not as partners of the managing company;(c) that a device was adopted to provide funds in the hands of parties at the expense of the company for the purpose of settling their individual accounts and that the payment of the amount in question was made only as a part of this device;(d) that the disputes between the partners of the managing agency firm could not, in any way, have affected the carrying on of the normal business of the company; and(e) that the company gained nothing by terminating the managing agency agreement?2. Whether the whole or any part of the sum of Rs. 18,90,000/was paid by the company to the managing agents having promoted the company?3. What was the true nature of the payment of the sum of Rs. 18,90,000/by the company to the managing agents on a correct interpretation of the managing agency agreement?4. Whether the sum of Rs. 18,90,000/together with the sum of Rs. 13,300/paid as expenses of litigation or any part thereof was an expenditure incurred wholly and exclusively by the company for purposes of its business and as such it was an allowableTribunal complied with the order and submitted another statement of the case setting out in detail the materials on which the various findings which were sought to be incorporated in the questions were founded.12. At the hearing of the reference the High Court was of the view that the Court had no jurisdiction under Section 66 (4) of theAct to direct the Tribunal to submit second statement of case and the questions in addition to the one submitted before the Tribunal "could not legally have come before the High Court," since the earlier statement of the case was not quashed, nor was it returned to the Tribunal: and the Court in calling upon the Tribunal to submit another statement of case did not act in conformity with the provisions of(4) of Section 66 of theAct. In the view of the High Court a comparison of the question originally framed with the questions referred with the second statement of case by the Tribunal showed that the second set of questions were not parts of, or included in, the former question but were substantially different; some of the questions in the view of the High Court were pure questions of fact, some of them were overlapping, and the questions were different from the two questions mentioned in the application under Section 66 (2), and that on the application submitted by the Company, even if it be treated as an application or calling for a statement of case under Section 66 (2) the only question that the Court could call upon the Tribunal to refer was question No. 1 (a) submitted with the second statement of case. The High Court then observed that they were under a duty to refuse to answer questions which did not arise out of the order passed by the Tribunal or were not included in the application under Section 66 (1) and (2). But out of deference to the order previously passed, the Court proceeded to consider and set out reasons in support of the answers to the questions referred if those questions were required to be answered. The High Court said that on the question there was evidence that no change had taken place for carrying on the companys business after the termination of the agreement. Questions 1 (b), 1 (c), 1 (e) and (2) and (3), the High Court observed, were not incorporated in the applications under Sections 66 (1) and (2) an Question 1 (d) was not mentioned in the application under Section 66 (2), and those questions did not arise out of the order of the Tribunal. Further, the High Court observed. Questions 1(b), 1(c), 1(d) 1(e) and (2) could not be answered in favour of the assessee, and Question (3) was irrelevant and need not be considered. In the view of the High Court Question (4) consisted of two limbs: whether the payment of Rs. 18,90,000/was made for the purpose of the companys business, and whether the payment for that purpose amounted to revenue expenditure. The first, in the view of the High Court, was a question of fact and the second though a mixed question of law and fact did not arise for determination unless the first limb was answered in favour of the Company, and that in any event if the question were to be reduced to the form whether there was any material for the finding that the payment was not an expenditure incurred wholly and exclusively the purpose of the companys business, the answer must be against the Company.13. After a detailed consideration the High Court held that the expenditure in question was not made wholly and exclusively for the purpose of the companys business, and was by way of distribution of profits, and being wholly gratuitous or for some improper or oblique purpose outside the course of business management" it. could not be treated as a permissible deduction. Against the order recorded by the High Court, this appeal has been preferred with special leave.

Reasoning: 16. It is also well settled that in an application under Section 66 (2) of theAct the High Court cannot order that a case be stated on questions which were not included in the application submitted under Section 66High Court was, therefore, incompetent to call upon the Tribunal to submit a statement of case on questions of fact or questions which were not incorporated in the application under Section 66 (1).17. The Company in its application under Section 66 (2) requested that a statement of case be called for in respect of only two questions. Thereafter the Company applied to the High Court for an order that other questions which were neither incorporated in the application under Section 66 (2) nor in the application under Section 66 (2) be submitted to the High Court.The High Court had no power, in our judgment, to grant that application. The power under Section 66 (4) may be exercised to call for a supplementary statement only when the Court is satisfied that the statements in a case referred underion (2) of Section 66 are not sufficient to enable it to determine the question raised by that statement. It does not confer a power to raise any additional questions or to call for a statement of case on questions not referred by thepower under Section 66 (4) may be exercised when the High Court is not satisfied that the statements in a case referred are sufficient to determine the question referred thereby, it cannot be exercised for calling for another statement on questions not referred by the Tribunal.The procedure followed by the High Court in calling for, in exercise of the power under Section 66 (4), an additional statement of the case on questions which were not incorporated in the applications under Section 66 (1) and (2) was, in our judgment, irregular.19.Correctness of an order of High Court calling for a statement of case may be challenged at the hearing of the reference and the Court may decline to answer the question referred pursuant to the direction of the High Court, if it did not arise out of the order of the Tribunal, or is a question of fact or is academic or could not have been raised because it was not incorporated in the application under Section 66 (1) :Commissioner ofv. Smt. Anusuya Devi, 68 ITR 750   = (AIR 1968 SC 779  ). Counsel for the Company has, therefore rightly confined himself to the question which was originally submitted by the Tribunal by order dated December 29, 1954, and has raised his argument on that question only.We are unable to hold that the finding that no services were rendered by the managing agents was based on "surmises and conjectures", or that it was based on no evidence.The burden of proving that services were rendered by the managing agents for earning the remuneration lay upon the Company, and if no reliable evidence was forthcoming the Tribunal was competent to reach the conclusion it did.25. The recitals in the agency agreement which authorised the managing agents to do certain acts could not be a substitute for evidence that those acts were done by the managing agents. Counsel for the Company made no effort to enlighten the Tribunal on how the business of the Company would have suffered by the quarrels between Guptas and Singhanias. Even prior to the termination of the contract of the managing agents of the Company the Singhanias had no effective voice in the management of the firm. No representative of the Singhanias was on the Board of Directors prior to the termination of the contract. If in that state of evidence the Tribunal concluded that quarrels between the Guptas and Singhanias could in no way harm or put hindrance in the normal day to day working of the Company, the finding could not be again said to be based on surmises andis difficult to understand that because of the disputes between the two sets of partners of the managing agency firm, a Civil Court could have appointed a receiver to manage the affairs of the Company: a receiver may have been appointed of the remuneration payable by the Company but not of the management. It is not suggested that the affairs of the Company were mismanaged. The management of the Company was conducted after September 30, 1944, in the same manner and by the same directors as it was originally conducted. A futile threat could not reasonably be taken into consideration, and was not apparently taken into account, for determining the managing agency agreement. This plea was apparently not even suggested before the Tribunal. "27. The burden of proving that the expenditure was incurred wholly and exclusively for the purpose of the business lay upon the Company and no evidence was led and not even an attempt was made to explain how the affairs of the Company would have been prejudiced by the disputes pending between the Singhanias and Guptas.28. The remuneration payable under the managing agency agreement was for a) the services rendered by the managing agents in the promotion of the Company; and (2) for rendering services to the Company.Expenditure incurred for remunerating the persons who had promoted the Company was not in law, a revenue expenditure admissible under Section 10 (2) (xv) of theAct and if no services were rendered by the managing agents, the remuneration must be regarded as exclusively payable for the services rendered by the managing agents in the promotion of the Company. The expenditure could not in the circumstances be said to be made wholly and exclusively in the interest of the business of the Company.29. The Tribunal has stated in paragraph 30 of its order that under the award of Thakur Kanhaiya Singh each party had to pay the other large sums, and a device was adopted to provide funds in the hands of the parties at the expense of the Company for settling their individual accounts; and that "in preparing the scheme the authors had made an effort to reduce the tax liability of the Company by claiming the amount as a revenue deduction." The Tribunal appears to have reached this conclusion from the terms of the award of Thakur Kanhaiya Singh, the settlement between Singhanias and Guptas of the civil suit by consent decree dated January 11, 1945, by a supplementary award which provided for distribution of compensation which it was expected "would be receivable" for determination of the managing agency, and the ultimate award of Mr. K. M. Munshi which contained a mere bald decision and no reasons in support thereof. Whether this part of the judgment of the Tribunal is correct need not detain us in this case. If the amount paid was not expenditure incurred wholly and exclusively for the purpose of the business, it is unnecessary to consider whether a "device" was adopted to provide funds in the hands of the parties at the expense of the Company for the purpose of settling their individual accounts or for some other reason. The question raised by the Tribunal for the decision of the High Court, it may be recalled, was whether there was any material on which the conclusion of the Tribunal could be justified, and in our judgment there was ample material on which the conclusion could be founded. The answer recorded by the High Court was, on the question referred by the Tribunal by their statement dated December 29, 1954, in our judgment right. The High Court was also right in declining to record formal answer on the other questions.30. No separate argument was advanced in regard to the amount of Rs.13,300/which was incurred for the costs of the arbitrator and for the arbitration proceedings. No argument was also apparently raised before the High Court supporting the claim for that amount as a permissible allowance even if the claim for Rs. 18,90,000/