BHAGWATI,J. - (1.) THE principal question which arises for determination in this reference is whether a certain expenditure incurred by the assessees can be said to be expenditure incurred solely for the purpose of making or earning fees as directors so as to be a permissible deduction within S. 12(2) of the IT Act, 1922. Lord MacMillan pointed out in Tata Hydro Electric Agencies Ltd vs. CIT (1937) 5 ITR 202 (PC) : ". . . the decided cases show how difficult it is to discriminate between expenditure which is and expenditure which is not, incurred solely for the purpose of earning profits or gains."
(2.) AND this reference is no exception. The facts giving rise to the reference are a little important and in order to arrive at a proper determination of the question, it is necessary to state them in some detail. The reference arises out of two separate assessments made on the assessee for the asst. yr. 1962 63. The relevant account year of the first assessee, namely, Kasturbhai Lalbhai, is Samvat year 2016, commencing from 1st November, 1959, and ending on 20th October, 1960, and that of the second assessee, namely, Gautam Sarabhai, is the financial year 1960 61. The assessees are two prominent industrialists of Ahmedabad and both of them were, during the relevant period of account, directors of the Ahmedabad Electricity Co. Ltd., a public limited company carrying on business of generating and distributing electrical energy in Ahmedabad. Killick Industries Limited was the managing agent of the company at the relevant time. In or about the begining of 1960, differences arose between the assessees on the one hand and the managing agent and the other directors of the managed company on the other, as a result of alleged mismanagement of the managed company on the part of the managing agent and the majority directors. The genesis of the starting point of the differences was a certain order for machinery placed by the managing agent on behalf of the managed company with an English concern called International Combution Limited. The technical adviser of the central administration Department of the managing agent found that the price for which this order was placed with International Combustion Limited was substantially higher than the price at which similar machinery was available from another equally reputable company, namely, Babcock and Wilcox Limited and he reported this fact to the directors of the managed company. As the matter was of sufficient gravity to justify an investigation, the directors asked M/s Merz and MacLellan, a leading firm of consulting engineers in England, to make a report in the matter and the report was submitted by M/s Merz and MacLellan on 15th July, 1958. The report said that the price for which the order was placed with International Combustion Limited was higher than the price quoted by Babcock and Wilcox Limited by ï¿ 1/2 1,23,420, that is, approximately Rs. 16,51,360. Fortunately, however, the managed company was saved this excess amount as the import licence for the order placed with International Combustion Limited was not received and the order was, therefore, cancelled and a fresh order placed with Babcock and Wilcox Limited at the proper price. All this was evidently the result of the disclosure made by the technical adviser. An attempt was, therefore, made by E. D. Sheppard and K. G. Milne, chairman, and managing director respectively of the managing agent, supported by A. N. Haksar, a director to victimise the technical adviser and they urged that disciplinary action should be taken against him on the ground of insubordination and he should be dismissed from service. This proposal was opposed by Sir Chunilal V. Mehte, Sir Purshottamdas Thakurdas and Shri Jaisinh Vithaldas who were three of the then directors of the managing agent and due to their opposition the proposal could not be carried through. But soon thereaftre, these three directors resigned, Sir Chunilal V. Mehta in July, 1959, and Sir Purshottamdas Thakurdas and Shri Jaisinh Vithaldas in September, 1959. Various other changes were also brought about in the management and staff of the managing agent which, in the opinion of the assessees, were detrimental to the interests of the managed company. It is not necessary for the purpose of the reference to refer to these changes in detail, but it will be sufficient if we set out two of these changes. One Clark, who was the chairman of the managed company, was removed from the chairmanship in March, 1960, and about that time the technical adviser and two other competent officers of the managing agent with long records of faithful service were deprived of responsible work. On 24th March, 1960, a meeting of the board of directors of the managed company was held and at this meeting A. N. Haksar read out a letter from the managing agent standing that Clark had been replaced as ex officio chairman by A. N. Haksar under the articles of association of the managed company. The other items on the agenda included the appointment of new directors and the reappointment of Killick Industries Limited as managing agent, but since the first assessee had gone abroad and was not present, the second assessee requested A. N. Haksar and the other directors not to take a decision in regard to these matters during the absence of the first assessee. No decision was accordingly taken in regard to these matters at this meeting of the board of directors, but within a few days thereafter, though the first assessee was still abroad and the second assessee was not in a position to attend, two meetings of the board of directors, one on 30th March, 1960, and the other on 4th April, 1960, were called by A. N. Haksar at very short notice and at these meetings important decisions were taken regarding the appointment of new directors, reappointment of Killick Industries Limited as managing agent, and appointment of Nixon Forest and Company Limited as agent of the managed company in U. K. Earlier, a decision had already been taken by the board of directors to obtain a report on the advantages of the appointment of an agent in U. K. as also information about the constitution of Nixon Forest and Company Limited and the interest in that company of the persons previously connected with Killick Industries Limited and the managed company ; but despite this decision, without waiting for such report or information, Nixon Forest and Company Limited was appointed agents of the managed company in U. K. The next meeting of the board of directors was held on 28th April, 1960, and at that meeting the assessees recorded their protest against the holding of the meetings dated 30th March, 1960, and 4th April, 1960, at such short notice as also against the appointment of A. N. Haksar as chairman of the managed company in place of Clark, the appointment of new directors without the consent and approval of all the directors and the appointment of Nixon Forest and Company Limited as agent of the managed company in U. K. This protest made by the assessees was, however, not recorded in the minutes of the meeting held on 28th April, 1960, and the assessees, therefore, drew the attention of the chairman to this omission in the minutes at the next meeting of the board of directors held on 26th May, 1960, and moved a resolution disapproving the conduct of the managing agent and in particular of the chairman, A. N. Haksar, in regard to the proper maintenance of the minutes of the board meeting held on 28th April, 1960. This resolution was, however, ruled out of order by A. N. Haksar and the protest of the assessees remained unrecorded. The assessees were outnumbered on the board of directors and in these circumstances they felt that it was their duty as directors to bring these facts to the notice of the shareholders and they, accordingly, issued a circular dated 11th July, 1960, pointing out these facts to the shareholders. Three paragraphs of this circular have been relied upon by the Tribunal and they run as follows : "We, the undersigned directors of your company regret that differences have arisen between the directors and also between some directors and Killick Industries Limited, the managing agents of the company, on matters of vital importance to the satisfactory conduct ; as it is, we consider it our duty to place the following facts and views before the shareholders believing it to be in the discharge of our responsibility to the shareholders. The safeguarding of the interest of the shareholders is our principal obligation as members of the board. What happens within Killick Industries Limited would be of no concern to us if they were not the managing agents of this company and their ability to discharge their duties as managing agents in the day to day conduct of our business remained unaffected . . . . . we are convinced that the managing agents, so constituted, are not in a position to discharge their duties satisfactorily in the best interests of this company. We have no substantial interest in either the Ahmedabad Electricity Company Ltd. or the managing agency company (our shareholding including that of our families, is about 1,158 and 83 shares in the Ahmedabad Electricity Co. Ltd., and nil and 386 shares respectively in Killick Industries Ltd.) and we are not interested in acquiring the managing agency of the Ahmedabad Electricity Co. Ltd. or seeking a position of profit. We have been elected directors of the company and we feel unable to assume the responsibility we owe to the shareholders as long as Mr. Haksar continues as chairman of the company and without the board of directors being properly reconstituted, since we are outnumbered in the present board. The only course open to us, therefore, is to place the matter before the shareholders."
(3.) IT appears that thereafter a circular dated 12th August, 1960, was issued by A. H. Haksar in reply to the circular dated 11th July, 1960, and certain statements were made in that circular which according to the assessees did not represent the correct facts. The assessees, therefore, issued another circular dated 5th September, 1960, pointing out the incorrect statements made in the circular of A. N. Haksar. In the meantime, it appears a notice requisitioning a general meeting of the shareholders of the managed company was filed and resolutions were proposed to be moved for removal of newly appointed directors, appointment of other directors in their place and cancellation of the agreement appointing Nixon Forest and Company Limited as agents of the managed company in U. K. The assessees thereupon started collecting proxies and collected proxies from about 3,25,000 shareholders. Before, however, the general meeting of the share holders was held, the disputes in regard to the management of the managed company were settled as a result of the intervention of Shri Morarji Desai and the resolutions sought to be moved at the general meeting were withdrawn. The general meeting was thereafter held on 29th November, 1960, and at this meeting the board of directors of the managed company was reconstituted as suggested by the assessees. The first assessee had already attained the age of 65 years on 19th December, 1959, but he was again elected as director after complying with the provisions of S. 281 of the Companies Act, 1956, and on 26th April, 1961, he was elected Chairman of the board of directors. Now, in issuing the circulars dated 11th July, 1960, and 5th September, 1960, and collecting proxies from the shareholders, the assessees jointly spent an aggregate sum of Rs. 33,299 and each of the assessees claimed 1/2 of this amount as a deduction in his assessment for the asst. year 1961 2. The claim for deduction was founded both under S. 12(2) and S. 10(2)(xv). The ITO disallowed the claim and on appeal the view taken by the ITO was confirmed by the AAC. Each of the two assessee thereupon preferred an appeal to the Tribunal and the two appeals were heard together by the Tribunal. The Tribunal rejected the claim of the assessee in so far as it was based on S. 10(2)(xv) but upheld the claim based on S. 12(2) and allowed the expenditure as a permissible deduction under S. 12(2). This view taken by the Tribunal is challenged by the CIT in the present reference.;