Case: The Commissioner Of Excessprofits Tax, Madras Vs. N. M. Rayaloo Iyer &amp; Sons

2. M/s. N. M. Rayaloo Iyer and Sons- hereinafter referred to as the assessees - are a firm carrying on business principally in dyes and chemicals. They are the chief representatives in "South India" of the products of the Imperial Chemical Industries Company (India) Ltd. - hereinafter referred to as the "I. C. I.". The business in dyes and chemicals was in the years material to these appeals, conducted in the name and style of "Colours Trading Company", with its Head Office at Madura and in thirteen branch offices in different towns in "South India". The business was carried on originally in partnership by three brothers, N. M. R. Venkatakrishna Iyer, N. M. R. Subbaraman and N. M. R. Krishnamurti. On April 13, 1946, N. M. R. Subbaraman retired from the firm and the share of N. M. R. Venkatakrishna Iyer was taken over by a private limited company N. M. R. Venkatakrishna Iyer and Sons Ltd., but the business was, notwithstanding the changes in the personnel, continued in the original name and style. One N. M. r. Mahadevan (son of N. M. R. Venkatakrishna Iyer) - hereinafter referred to as Mahadevan - was employed by the assessees as the General Manager of the Colours Trading Co. By letter dated April 17. 1940, the assessees wrote to Mahadevan agreeing to pay him remuneration at the rate of Rs. 1,800/- per annum and 5% of the net profits of the concern (Colours Trading Company) calculated by deducting from the gross profits of the business, salaries, wages and other outgoings but without making any deduction for capital. By letter dated March 30, 1943, the salary of Mahadevan was fixed at Rs. 3,000/- per annum and the commission was enhanced to 12 1/2% of the net profits of the Colours Trading Company. The branch offices were managed by local managers and assistant managers who were paid in addition to monthly salary, annual and special bonus and dearness allowance. The assessees received from the I. C. I. commission at rates varying between 7 1/2% and 12% on different products sold to them. With effect from April 1, 1944, the I. C. I. allowed a special emergency commission of 5% on all dyes and dye-stuffs sold to the assessees. This special emergency commission was increased to 15% on all sales on or after March 1, 1945, but was subsequently reduced to 10% on sales on and after September 1, 1946.3. These appeals relate to the liability of the assessees to Excess Profits Tax for the chargeable accounting periods ending April 13, 1943, April 12, 1944, April 12, 1945, and March 31, 1946 and for Business Profits Tax for the chargeable accounting periods ending April 12, 1946, March 31, 1947, April 13, 1947, March 31, 1948, and April 12, 1948.4. The assessees claimed that they had paid to their employees in the years of account 1942-43 to 1947-48 under agreements executed from time to time a share in the special emergency commission received from the I. C. I. in addition to monthly salary, dearness allowance and general and special bonus. The I. C. I. in allowing the emergency commission by its letter dated January 24, 1944, recommended that 1% out of the 5% commission allowed may be "passed on" by the assessees to their "sub-distributors". The assessees claimed that pursuant to this recommendation, they paid to their employees commission at rates varying between 1 1/2% to 4%, and when the emergency commission was increased to 15% and the I. C. I. by letter dated February 23, 1945, recommended that 6% out of this commission may be passed on to the sub-distributors, the assessees claimed to have distributed commission at rates varying from 2% to 7 1/2 % and in some cases at a rate as high as 12%. Under the service agreements, commission was payable to the employees only if the turnover in dyes exceeded Rs. 1,00,000/- net in any year, but to employees in several branches the assessees claimed to have paid commission at generous rates even when the turnover fell far short of that amount. In the year account ending April 12, 1945, there was a revision of the scales of salaries of the employees, and the assessees commenced giving to their employees dearness allowance and special bonus which in the aggregate exceeded 50% of the basic annual salary and also annual bonus equal to the annual salary. The result of this revision of emoluments was that each employee received an amount equal to at least 2 1/2 times his enhanced basis salary. In addition to this remuneration, the assessees claimed that they had paid a share in the commission which in some cases exceeded 12 times the basis salary.5. In computing the total income of the assessees for the years 1943-44 and 1944-45 for purposes of income tax, the Income Tax Officer disallowed the payment of 12 1/2% of the net profits of the Colours Trading Co. to Mahadevan and in computing the income for the assessment years 1945-46, 1946-47,1947-48 and 1948-49 the Income Tax Officer disallowed the commission paid to the Branch Managers and other employees. In appeal the Appellate Assistant Commissioner set aside the order which disallowed the amount of commission paid to Mahadevan and following the order of the Income Tax Appellate Tribunal in certain Excess Profits Tax Appeals, allowed 5% of the net profits without deduction of Excess Profits Tax or Business Profits Tax, or 12 1/2% after deduction of Excess Profits Tax or Business Profits Tax whichever was higher. That order was confirmed in appeal by the Income Tax Appellate Tribunal. The Tribunal also confirmed the order disallowing the emergency commission paid to the branch managers and other employees, and in the computation of taxable income for purposes of Income Tax, Excess Profits Tax and Business Profits Tax, added back all those payments. At the instance of the assessees, the Tribunal referred two sets of questions to the High Court under S. 66 (1) of the Income Tax Act read with S. 21 of the Excess Profits Tax Act.6. Questions 1 to 3 in Referred Case No. 44 of 1953 wereWhether in allowing a deduction under S. 10 (2) (xv) of the Income Tax Act, the Income Tax Officer is precluded from going into the question whether the amount was paid wholly and exclusively for the purpose of the assessees business?(2) Whether there was any material before the Tribunal to hold that the commission payment to N. M. R. Mhahadevan at 12 1/2% before deduction of Excess Profits Tax or Business Profits Tax was not wholly and exclusively laid out for the purpose of the assessees business?(3) Whether the commission payment to the branch managers, assistant managers and other employees is expenditure laid out wholly and exclusively for the purpose of theQuestions referred in Referred Case No. 53 of 1952 were:(1) Whether the Appellate Tribunal erred in law in holding that in accordance with the terms of letters dated 17th April, 1940, and 30th March, 1943, and the conduct of the parties the Excess Profits Tax payable by the assessee should be deducted from the profits before the commission of 12 1/2% payable to M. N. R. Mahadevan in calculated?(2) Whether there is any material on evidence sufficient in law for the Appellate Tribunal to hold that the commission of 12 1/2% on profits paid to Mahadevan was unreasonable within the meaning of R. 12 of Sch. 1 of the Excess Profits Tax Act?(3) Whether on the facts and circumstances of the case the disallowance by the Excess Profits Tax authorities of the commission paid to branch managers is justified under R. 12 of Sch. 1 of the Excess Profits Tax Act?8. The material provisions relating to allowances under the Excess Profits Tax Act and the Business Profits Tax Act (which Act superseded the Excess Profits Tax Act as from 30th March, 1946) were on the questions arising in this case substantially the same and hereafter reference to the Excess Profits Tax Act will in respect of the period after 30th March, 1946, be deemed to be a reference to the Business Profits Tax Act.

Reasoning:
9. In the opinion of the High Court, in computing the taxable income, the deductions claimed by the assessees fell to be considered not under s. 10(2)(xv) of Income-tax Act but properly under S. 10(2)(x) of the Income-tax Act, the latter being a specific provision in the Act relating to deduction of commission or bonus paid to an employee. The High Court observed that in assessing liability to Excess Profits Tax the bonus or commission paid to the employees of the tax payer may be permitted as a deduction in the light of S. 10(2)(x) of the Income-tax Act and R. 12 of Sch. 1 to the Excess Profits Tax Act. The case of Mahadevan, according to the High Court, did not present much difficulty, the only question which fell to be determined in his case being whether in allowing deduction of commission at the rate of 12 1/2% on the net profits, the Excess Profits Tax paid by the assessees was to be taken intoHigh Court after considering the supplementary statement observed that the assessees had undoubtedly distributed substantial sums out of the emergency commission to its managers and assistant mangers in the branches at rates well above the minima recommended by the I. C. I., but the distribution was at rates within the percentages allowed by the I. C. I., as additional commission and the balance retained by the appellants out of the emergency commission was also substantial. In the view of the High Court, the Tribunal had to consider three factors, (1) the reasonableness of the commission in the light of the conditions laid down in S. 10(2)(x), (2) the reasonableness of the percentages above the minima suggested by the I. C. I., and (3) the need for maintaining the reputation of the I. C.I., and the distributor in conditions that prevailed during that period when "black-marketing was rampant", but observed the High Court "the Tribunal had made no real attempt to analyse the evidence before it to justify its conclusion that only the minima recommended by the I. C. I., and nothing in excess satisfied the test of reasonableness under R. 12, Sch. 1, of the Excess Profit Tax Act." They then observed that, whether the test of reasonableness is that prescribed by S. 10(2)(x) of the Income-tax Act or whether reasonableness has to be judged in the light of commercial expediency under R. 12, Sch. 1, of the Excess Profits Tax Act, the expenditure was to be judged from the point of view of a businessman and not by the application of any subjective standard of a taxing officer and that on an analysis of the materials furnished, they were unable to see anything per se unreasonable in the amounts of commission actually paid by the assessees to the branch managers and assistant managers in thethe view of the High Court in determining the "net profits" under the agreement "in accordance with the principles of commercial accountancy and the principles laid down under the Excess Profits Tax Act" the Excess Profits Tax which is a tax on profits could not be deducted. In our judgment the question is one of the true interpretation of the agreement. Mahadevan was under the agreement to receive 12 1/2% commission on the net profits of the colours Trading Co. calculated by deducting from the gross profits of the business the salaries, wages and other outgoings. The expression "outgoings" is not restricted to business or commercial outgoings. The agreement specifically disentitles the employers to make deductions of capital expenditure but there is no indication that the outgoings are to be business outgoings only. There is nothing in the agreement or in the context justifying the view that in the expression outgoings is not included the Excess Profits Tax paid by the assessees.In the case in hand, the Excess Profits Tax Officer held, (a) that the employees of the assessees were being amply remunerated for services rendered by adequate salary, generous dearness allowance and annual bonus equal to the basis salary, (b) that the emolument of the employees had been increased year after year and there was no material to show that the employees had made a persistent demand for increased emoluments, (c) that the commission was credited to the employees account at the end of the year and was carried forward but no payments were made to them, (d) that the agreements which had been produced by the assessees were fabricated with a view to reduce tax liability, and (e) that the expenditure claimed was not proved to have been laid out wholly and exclusively for the purpose of the business. Taking into account these circumstances, the E. P. T. Officer held that the remuneration paid to the employees was adequate and any additional commission paid was in excess of what was reasonable and necessary. The only criticism urged by counsel for the assessees against the grounds given is that the E. P.T. Officer observed that while the net profit according to the Profit and Loss Account of the firm was Rs. 20,487/- leaving a share of Rs. 6,800/- only to each of the partners, some of the managers got more than this amount. It appears that the E. P. T. Officer committed an error in so observing. The profits of the Colours Trading Co. as disclosed by the order of assessment for the year 1945-46 were Rs.99,435/- and not Rs. 20,487/-; but that error did not affect the ultimate conclusion recorded by the E. P. T. Officer. According to the books of account of the assesses for the year 1943-44 of the business in dyes, the profits were Rs. 99,435/- and they claimed to have distributed a commission of Rs. 1,00,715/- to their employees out of the emergency commission, which was prima facie wholly disproportionate to the amount received by them.There was thus ample evidence in support of the conclusion of the E. P. T. Officer which was confirmed by the Tribunal.As we have already observed, it is the province of the E. P. T. Officer and the Tribunal to assess the permissible deductions in the context of reasonableness and necessity having regard to the requirements of the business and interference with the conclusion is permissible if the view of the Taxing Authorities is vitiated by an error of law or is not based on any materials, or the conclusion is such that no man instructed in law could have arrived at. It is true that in considering whether the deduction claimed by the assessees for payments made as bonus or commission paid to an employee is to be allowed, the taxing officer must have regard to the provisions of S. 10 (2)(x) of the Income Tax Act and cl. (12)of Sch. 1 of the Excess Profits Tax Act; and in assessing the reasonableness, consideration of commercial expediency must undoubtedly be taken into account. But commercial expediency must be viewed in the light of the requirements of the business and the actual services rendered by the persons concerned. Any abstract consideration of commercial expediency is out of place.In our view, the High Court was not justified in seeking to reappreciate the evidence on which the conclusion of the E. P. T. Officer which was confirmed by the Tribunal was based. Their jurisdiction being advisory, the High Court had to answer the questions submitted for opinion on the facts found; if the High Court held the view that the taxing authorities had misdirected themselves in law or had made a wrong inference in law or had failed to apply the correct tests or had misconceived the evidence, it was open to them to invite the attention of Taxing Authorities to the error committed by them; but the High Court could not set aside the decision of the taxing Authorities on a reapplication of the evidence. We may also point out that even if the High Court concluded that the total disallowance of the deduction claimed was not justified, the High Court could not substitute its own view as to what was reasonable and necessary. The High Court had, if it disagreed with the taxing authorities, still to answer the questions submitted and leave to the consideration of the E. P. T. Officer what in the circumstances was reasonable and necessary.In our view the answer to the question whether the disallowance by the E. P. T. authorities of the commission paid to branch managers was justified under R. 12, Sch. 1, of the Excess Profits Tax Act should have been answered in the affirmative. On the view taken by us. Appeal No. 494/1958 will be allowed, but there will be no order as to costs.