COMMISSIONER OF INCOME TAX Vs. SATHE D R
LAWS(BOM)-1962-7-18
HIGH COURT OF BOMBAY
Decided on July 05,1962

COMMISSIONER OF INCOME TAX Appellant
VERSUS
D.R.SATHE Respondents

JUDGEMENT

V.S.DESAI, J. - (1.)THE question referred to us on this reference under s. 66(1) of the Indian IT Act at the instance of the CIT is as follows :
"Whether, on the facts and circumstances of the case, the amount of Rs. 23,732 in the case of Shri D. R. Sathe and the amount of Rs. 22,832 in the case of Shri. N. R. Sathe was exempt from tax in their hands in view of the Notification No. 878-F dt. 21st April, 1922, as amended by Notification No. 8 dt. 21th March,1928, issued by the Central Government under s. 60 of the Indian IT Act ?"

(2.)THE question arises out of the assessment of the assessees for the asst. yr. 1947-48. THE two assessees, viz., D. R. Sathe and N. R. Sathe, who are brothers, were employed by their third brother, G. R. Sathe, in his biscuit and chocolate factory, which was run under the name and style of "Sathe Biscuit and Chocolate Works". D. R. Sathe was a mechanical engineer and N.R. Sathe was a chemist and both of them were looking after the manufacturing side of the biscuit factory. In the asst. yr. 1947-48 the regular salary of D. R. Sathe was Rs. 5,700 for the year and that of N. R. Sathe was Rs. 4,980. During that year, however, a further sum of Rs. 34,382 was paid to each of them as additional remuneration by way of share of profits calculate at four annas share of the profits under an agreement entered into by them with the employer. In the assessment of the employer, G. R. Sathe, for the asst. yr. 1947-48, the entire amounts which were paid to D. R. Sathe and N.R. Sathe by way of remuneration inclusive of the payment of Rs. 34,382 to each of them by way of share of profits were claimed by G. R. Sathe as a deduction under s. 10(2)(xv) of the IT Act. THE ITO took the view that the entire amount so claimed as paid to the two employees by way of remunera- tion could not be allowed as the increased salary granted was quite abnormal and out of all proportion to the services rendered by them. According to him only Rs. 9,000 could be allowed as an expense of salary in respect of each of them. Allowing, therefore, a sum of Rs. 18,000 for the salary of the two brothers, he disallowed the rest of the amount claimed as deduction under s. 10(2)(xv). In the appeal against this order of assessment by the ITO, the AAC allowed salary to each of the two brothers at the rate of Rs. 1,000 per month. He, therefore, allowed a further deduction of Rs. 6,000 and disallowed the rest. In the second appeal to the Tribunal, salary to each of the two brothers was allowed at Rs. 1,500 per month and the rest was disallowed. THE Tribunal observed that they considered the balance of the payment made to the brothers as expenditure incurred not wholly and exclusively for the purpose of the assessee's business.
In the returns, which the assessees, D. R. Sathe and N. R. Sathe, submitted to the IT authorities, each of them included the amount of Rs. 34,382 under the head "salary" in addition to the regular salary received by them. Thus, in the return of D. R. Sathe under the head "salary and remuneration" the amounts shown were Rs. 7,350 and Rs. 34,382 and in the return of N. R. Sathe the amounts shown under the said head were Rs. 6,450 and Rs. 34,382. Both of them contended before the ITO that out of the said amounts only Rs. 18,000 could be brought to tax and the excess over the said sum was exempt under the Finance Department Notification No. 878- F dt. 21st April, 1922, as amended by the Notification No. 8 of 24th March, 1928. The claim of the assessees was not accepted by the ITO. They, accordingly, appealed to the AAC. The AAC in that appeal held that inasmuch as in the assessment of G. R. Sathe, who was the employer of the assessees, it was held that the amounts paid by him to the assessees as remuneration in excess of Rs. 1,500 per month did not constitute expenditure incurred wholly and exclusively for the purpose of the business and were disallowed, it would follow from the Tribunal's decision in the said case that the said amounts had been paid out of the profits of the business and, consequently, the assessees would be entitled to exemption under the notification relied on by them in respect of the said amounts. He, therefore, allowed the appeals filed by the assessees and directed the ITO to modify the assessment in accordance with his decision. Against the said appellate orders, the Department went in appeal to the Tribunal. The Tribunal agreed with the view taken by the AAC and dismissed the appeals. Thereafter, at the instance of the department, it drew up a statement of the case and referred the question of law which arose out of its order, which we have already stated.

The notification under which the exemption was claimed by the assessees so far as it is material stands as follows :

"The following classes of income shall be exempt from the tax payable under the said Act, but shall be taken into account in determining the total income of an assessee for the purposes of the said Act : (1) Sums received by an assessee on account of salary, bonus, commission or other remuneration for services rendered or in lieu of interest on money advanced, to a person for the purposes of his business, where such sums have been paid out of, or determined with reference to, the profits of such business, and by reason of such mode of payment or determination, have not been allowed as a deduction but have been included in the profits of the business on which income- tax has been assessed and charged under the head `business'."

(3.)AS observed by their Lordships of the Supreme Court in CIT vs. M. K. Kirtikar (1959) 36 ITR 360 (SC) in order to claim exemption under the notification, the three cumulative conditions specified in the said notification had to be fulfilled and the said three conditions were :
(i) that the sum had been paid out of or determined with reference to the profits of the business ; (ii) that by reason of such mode of payment or determination of the said sum, the same must not have been allowed as a deduction, but must have been included in the profits of the business; and (iii) that on the sum so disallowed in the computation of the profits of the business, income-tax must have been assessed and charged under the head "business".

Now, in the present case, there is no doubt whatever that the first and third of these three conditions have been satisfied. The payment of Rs. 34,382, which was made by the employer to each of the assessees in the assessment year was on the basis of four annas share of the profits. It was clearly, therefore, determined with reference to the profits and also paid out of profits. There is also no dispute that the payment made by G. R. Sathe to each of his brothers for salary and remuneration in excess of Rs. 1,500 per month, which was disallowed, had been assessed and charged under the head "business" in the assessment of the employee. The only dispute is whether the second condition has or has not been fulfilled in the present case. That condition, as we have stated, is that by reason of the mode of payment or determination of the sum with reference to the profits of the business, it must not have been allowed as a deduction but must have been included in the profits of the business.



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