Case: Commissioner of Income Tax Punjab, Haryana, J and K, H.P. and Union Territory Ofcha Vs. Panipat Woollen and General Mills Company Limited Chandigarh

M/s. Panipat Woollen & General M ills Co. Ltd.-hereafter referred to as the assessee Company had two Departments- (1) for spinning of yarn from raw and waste wool and (2) for spinning of yarn from imported wool tops. The second Department which carried on the operations of spinning of yarn from imported wool tops was started some time in the year 1952. Weaving operations were, how ever carried on in both these Departments. One of the Departments was known as M/s. PaniPat Woollen Mills, Kharar while the other one was known as M/s. Navin Woollen Mills. It is said that the assessee Company was running at a constant loss as a result of which in 1952 the assessee Company decided to instal a plant for manufacture of worsted yarn from imported wool tops by raising a loan of Rs. 7 lakhs from the Industrial Finance Corporation. The plant went into production in September 1952. The assessee Company appointed M/s. Murlidhar Chiranjilal as the sole selling agents for the worsted yarn on payment of 2% commission. Subsequently on December 15, 1953 the assessee Company entered into an agreement with Mis Saligram Premnath under which the latter were appointed as the sole selling agents on certain specified conditions, the important of which being that the agents were to finance the assessee Company to the extent of Rs. 2, 50, 000/- and the assessee Company agreed to pay 6% interest on the advances to be made by the agents and further agreed to pay 2% commission on the net proceeds of sales of goods in India. Before expiry of this agreement, another agreement was entered into by the assessee Company with the agents on October 20, 1955 under which the agents were to get 6% interest on all the advances made by them, 1% commission on net sales and 50% commission on net sales of the worsted plant.  What is more was that the agents agreed to a deduction of 50% of the loss incurred by the assessee Company from their remuneration. There were a number of other conditions with which we shall deal later. The selling agents M/s. Saligram Premnath advanced a sum of Rs. 6, 26, 847/- and Rs. 8, 71, 873/- and received Rs. 37, 157/- and Rs. 73, 787/- as 50% commission on the net profits of the worsted plant in the co urse of two years, namely, assessment years 195-57 ending on March 31, 1956 and 1957-58 ending on March, 31, 1957. The assessee Company accordingly in its return for the year 1956-57 claimed the amount of Rs. 37, 157/- and Rs. 73, 787/- for the a ssessment year 1957-58 as a deduction under the provisions of s. 10(2) (xv) of the Income-tax Act, 1922. The case of the assessee was that the two amounts mentioned above being in the nature of commission paid to the selling agents woul d be deemed expenses incurred by the Company in order to earn profits and would, therefore, fall within the ambit of s. 10(2) (xv) of the Income-tax Act, 1922-hereafter referred to as the Act. The Income-tax officer, however, disallowed th e deduction and held that the deduction claimed was actually a division of profits after the profits had come into existence and had been ascertained, and therefore could not he claimed as a valid deduction under the provisions of the Act.The assessee Company went up in appeal to the Appellate Assistant Commissioner who accepted the plea of the assessee Company and held that the payment was a permissible deduction as it was incurred for the purpose of the assessees trade in order to facilitate the business of the assessee. The Revenue then went up in appeal before the Tribunal which after considering the facts and the law on the subject upheld the contention of the Revenue and held that the sums in question were not legal deductions as contemplated under s. 10(2)(xv) of the Act but amounted to application of profits after they were earned. The Tribunal further held that the agreement dated October 20, 1955 amounted to a joint venture for the distribution of profit, between the assessee Company and the selling agents after the profits were ascertained. The assessee Company then approached the Tribunal for making a reference to the High Court and the Tribunal accordingly referred the following two questions to the High Court for itsWhether on the facts and in the circumstances of the case, the Tribunal rightly held that the sums of Rs. 37, 157/- and Rs. 73, 787/- were chargeable to tax in the hands of the assessee Company in the assessment years 1956-57 and 1957-58 respectively?2. Whether on the facts and in the circumstances of the case, the Tribunal rightly disallowed the assessee Company`s claim for deduction of the payment of Rs. 37, 157/ and Rs. 73, 787/-, under sec. 10(l) and Sec. 10(2)(xv) of the Income-tax Act, 1922, in the assessment years 1956 57 and 1957-58High Court by its judgment dated January 20, 1 970, answered both the questions in favour of the assessee Company and held that the payments in question amounted to a legitimate deduction under i. 10(2)(xv) of the Act, and the Tribunal was wrong in disallowing the same. Thereafter the appellant moved the High Court for grant of leave to appeal to the Supreme Court which having been rejected the appellant filed a petition for special leave. The special leave having been granted, the appeal is now before us.The High Court in reversing the order of the Tribunal mainly relied on what it described as the surrounding circumstances under which the alleged payments were made to the selling agents by the assessee Company as spelt out from the agreement entered into by the a ssessee Company with the selling agents. The main point which was argued before the Tribunal as also before the High Court was that the cumulative effect of the interpretation of the various clauses of the agreement dated October 20, 1955 unmistakably revealed that in the garb of an agency the parties entered into a joint venture for distributing the net profits, after being ascertained between themselves and that is why there was an express provision in the agreement by which the agents agreed to share the losses to the extent of 50% which were to be deducted from the remuneration payable to the agents. The Tribunal held that the agreement amounted to a joint venture resulting in division of net profits and therefore t he amount paid to the agents could not be claimed by the assessee Company as a deduction under s. 10(2)(xv) of the Act, as it was not incurred for the purpose of the business or for earning profits. The High Court held that the mere fact that the agents agreed to share the profits and the losses would not take the case of the assessee beyond the ambit of s. 10(2)(xv) of the Act in order to show that the payments made to the agents were not expenses incurred for the purpose of the business. The High Court laid special emphasis on the fact that the Revenue could not examine the question of the commercial expediency of the businessman to incur expenses or earn profits in a particular manner. The High Court accordingly found that the agreement per se was a contract of agency and not a joint venture and accordingly the High Court accepted the plea of the assessee Company.

Court's reasoning:
Analysing the terms of this sub-clause it would appear that the agents have been able to secure most liberal and profitable terms. To begin with they were to get a commission at the rate of one and a quarter per cent on the net proceeds of sales of all goods There can be no objection to this. Secondly, the agents will get 50% commission on the net profits of the worsted plant. The net profits would have to be ascertained after deducing all the manufacturing costs, interest, insurance etc. The conduct of the agents in sharing half of the net profits does not appear to us to be consistent with the payments made to the agents for services rendered. It is difficult to lay down any rule of universal application as to what percentage of profit would be consistent with the payment in lieu of services but taking the totality of the provisions of the agreement it seems to us that the percentage of profits and the manner in which it is to be determined is more consistent with the position of a partner than that of an Agent. Finally the provision for sharing the loss incurred by the Company and for a lump sum deduction of Rs. 50, 000/- is totally inconsistent with a contract of agencyabove sub-clause clearly provides for a separate commission ac count to be maintained by the agents and the commission to be paid every six months. Consequently the agents agreed to pay a sum of Rs. 25, 000/- for six months every half year within ten days. We might further mention here that the provision in the agreement regarding s haring of the loss is absolutely peculiar to this particular agreement and there is not a single authority, which has, in spite of such a provision, held that the transaction does not amount to a joint venture or a division of profits. The provision regarding the consent of the agents to the sales and the programme of manufacture is also pertinent in order to determine whether the transaction amountted to a joint venture in the garb of a contract of agency. It is well settled that the Court in order to construe an agreement has to look to the substance or the essence of it rather than to its form. A party cannot escape the consequences of law merely by describing an agreement in a particular form though in essence and in substance IT H may be a different transaction. In these circumstances, therefore, if we construe the agreement as a sort of a joint venture or a transaction like a partnership which has been given the form and appearance of a contract of agency , the law must have itsso w hatever be the commercial considerations, it is difficult to hold that the commercial expediency dictated the assessee Company to allow itself to be completely overshadowed by its selling agents so as to pay them not only for the services rendered but also allow them to share profits, control the manufacture of the goods and the programme thereof and also to share the losses. The test of commercial expediency cannot be reduced in the shape of a ritualistic formula, nor can it be put in a water-tight compartment so as to be confined in a strait jacket. The test merely means that the Court will place itself in the position of a businessman and find out whether the expenses incurred could be said to have been laid out for the purpose of the business or the transaction was merely a subterfuge for the  purpose of sharing or dividing the profits ascertained in a particular manner. It seems to us that in ultimate analysis the matter would . depend on the intention of the parties as spelt out from the terms of - the agreement or the surrounding circumstances, the nature or character of the trade or venture, the purpose for which the expenses are incurred and the object which is sought to be achieved for incurring those expenses. If the expenses incurred amount to a profit of an enduring nature they may be treated as capital expenditure, whereas if the expenses merely serve to promote or increase the commercial activity they may amount to an expenditure which is incurred for the purpose of thelearned counsel for the assessee Company relied on the aforesaid case because the question whether the transaction amounted to a joint venture appears to have been raised but it appears that this point had been given up when the case was sent on remand and was therefore not decided. In these circumstances, the decision in the aforesaid case does not appear to be of any assistance to the assesseeother decisions were cited at the Bar but they have no bearing on the issue and it is not necessary for us to refer to them. What is, therefore, important to us is that no decision has been cited before us which takes the view that even though under the contract of agency the selling agents who agreed to make substantial investments in the assessee Company and got interest on the loans apart from the commission they also shared profit to the extent of 50% as also loss to that extent and had complete controlling power in t he manufacturing programme or the sale of the products and yet the transaction would be one of agency simpliciter and not a joint Venture. On the facts found by the Tribunal and those mentioned in the statement of the case as discussed above leads to the inescapable conclusion that the present contract of agency really amounts to a transaction by which substantial investments had been made by the selling agents with a. view to control the manufacturing programme and the a gents had also agreed to share the profits and losses equally. This is, therefore, nothing, but a joint venture to divide the profits after the same are ascertained and cannot in any sense be deemed to be expenses incurred by the assessee Company for t he purpose of its business or for that matter for earningin short by controlling the manufacturing programme, sharing to the extent of 50% in the net profits ascertained in the manner stipulated in the agreement and above all for sharing 50% of the losses which are to be deducted from the commission of the agents the agents become completely equated with the proprietors of the firm itself and therefore the contract of agency is really a sort of a partner ship and has been given the cloak and colour of an agency to conceal the real intent and purpose the commercial venture.In view of the decisions referred to above and the peculiar facts of the present case we are satisfied that the view taken by the Tribunal that the payments in question were not legally deductible under s. 10(2)(xv) of the Act was correct. The view taken by the High Court that the amounts in question were deductible under s. 10(2) (xv) appears to be legally erroneous cannot be upheld.