Case: The Commissioner Of Income-Tax, Delhi Vs. The Delhi Flour Mills Co., Ltd., Delhi

1. By an agreement made in 1936, the assessee company appointed a firm as its managing agents. The agreement provided that the managing agents would be remunerated in the mannerconsideration for acting as Managing Agents the Company should pay to the firm remuneration at Rs. 750 p.m. or such principal sum as may from time to time be deemed reasonable by the Directors and in addition a commission equal to 10 per cent of the annual net profits. Such net profits will be arrived at after allowing the working expenses, interest on loans and due depreciation, but without setting aside anything to reserves or other special funds.The question has arisen in the course of the assessment of excess profits tax payable by the assessee. The Excess Profits Tax Officer held that the commission has to be ascertained on the profits remaining after deduction of excess profits tax. This view was upheld by the Appellate Assistant Commissioner on an appeal being taken to him by the assessee. On a further appeal by the assessee to the Appellate Tribunal it was held that the commission has to be ascertained on the profits without any deduction of the tax. The revenue authorities then applied for and obtained an order from the Tribunal referring the following question for decision by the Highon a true construction of the Managing Agency Agreement between the assessee Company and its Managing Agents entered into in 1936, the relevant clause of which is quoted above, the Excess Profits Tax payable should be deducted from the profits of the Company for the purpose of arriving at the annual net profits of which a percentage should be paid to the Managing Agents as theirHigh Court answered the question in the negative. The present appeal is by the revenue authorities against the judgment of the High Court.

Reasoning: The agreement is that "the net profits will be arrived at after allowing the working expenses, interest on loans and due depreciation but without setting aside anything to reserves or special funds." We can leave out the things expressly made not deductible for as to these no question arises, the question being whether something more, namely, excess profits tax, can be deducted. Working expenses, interest on loans and due depreciation have however been expressly made deductible in ascertaining the net profits. If these are all the deductions that can be made, excess profits tax cannot be deducted for it does not come under any one of them. But it seems to us that the agreement was not intended to lay down all the deductions that can be made. It is not in dispute that expenses like overhead expenses, litigation expenses and similar other expenses properly incurred for carrying on the business can be deducted in arriving at the net profits. These would not be included within "working expenses" for that expression is usually understood as referring to expenses debitable to the trading account as having been incurred directly in making the income shown there. If this were not the sense in which the expression "working expenses" was used and it was meant to cover all revenue expenses incurred, then there would have been no need to mention, interest on loans and depreciation, separately for these latter would have been included as revenue expenses in the expression "working expenses". We are therefore inclined to think that there are other items besides those expressly mentioned, which have to be deducted before the net profits can be arrivedother words, they are the divisible profits of the company, divisible that is to say, between the master and the servant. In order that the divisible profits can be ascertained, excess profits tax has of course to be deducted. As to that there does not seem to be any doubt, for, that part of the profits which is taken away by the State as excess profits tax, is not available either to the master or the servant and cannot therefore be divided betweenwe do not refer to these judgments as supporting anything that we say but because the High Court unwittingly fell into the error of thinking that the Walchand and Co. Ltd. case (AIR 1944 Bom 5  ) came before the James Finlay and Co. Ltd. case (47 Bom LR 774) and that in the later case Beaumont C. J. had doubted the correctness of what he had said in the former. These observations are wholly wrong because, the James Finlay and Co. Ltd. case (47 Bom LR 774) was decided long before the Walchand and Co. Ltd.. case (AIR 1944 Bom 5  ) had been decided. Neither do we find that there is any conflict between the two cases. In the Walchand and Co. Ltd. case (AIR 1944 Bom 5  ), Beaumont C. J. gave reasons for making a distinction betweenand excess profits tax and thought that the distinction between them made in the English cases to which we have referred, was not of substance. We do not think it necessary to say anything as to whether Beaumont C. J. was right in this view.Now it seems to us that there is nothing in the Ashton Gas Co. case, 1906 AC 10   which prevents us from holding that in ascertaining the net profits for the purpose of the agreement that is before us, excess profits tax has to be excluded. That was not a case of profit sharing. It was not concentred with deciding what sums are deductible in arriving at the divisible profits in a profit sharing agreement. That is what we have to decide. Therefore we think that the Ashton Gas Co. case, 1906 AC 10   does not assist in answering the question that has arisen in this case.e should also refer to an argument advanced by the assesses which was founded on S.of the Indian Companies Act, 1913, introduced by an amendment made in 1936, which provides that the remuneration of the managing agents of a company shall be a fixed percentage of its net annual profits, and that in calculating the net profits no deduction in respect of any tax or duty on income is to be made.It is said that the statute incorporates the universal commercial practice and therefore in construing the present agreement excess profits tax cannot beare not aware whether the section incorporates any practice but we think that this contention is entirely unfounded for the section was applied only to a managing agency agreement made after the amending Act came into force, while the agreement in the present case was made before that date.19. Lastly, we have to point out that nothing turns on the fact that at the date the agreement under consideration was made, Excess Profits Tax Act had not come on the statute book nor perhaps been thought of, and therefore could not have been in the contemplation of the parties. If the net profits are the divisible profits, everything necessary to be excluded to arrive at the divisible profits has to be deducted whether it was in the contemplation of the parties or not.It is easy to imagine instances. Suppose after the agreement the Government imposed a licence fee on the payment of which alone the business could have been carried on and that licence fee was not in the contemplation of the parties when the agreement had been made. None the less it has clearly to be deducted in finding out the divisible profits. In the result we would answer the question framed in the affirmative.