Decided on March 27,1965



- (1.)THIS statement of case has been submitted by the Income-tax Appellate Tribunal, Bombay Bench, professedly under section 66(2) of the Income-tax Act on July 15, 1960, at the instance of the assessee. The questions formulated by the Tribunal are these: "1. Was there any material for the finding - (a) that the managing agents had rendered no service to the assessee company; (b) that Lala Ram Ratan Gupta and Lala Ram Prasad Gupta were acting qua their position as directors and not as partners of the managing company; (c) that a device was adopted to provide funds in the hands of parties at the expense of the company for the purpose of settling their individual accounts and that the payment of the amount in question was made only as a part of this device; (d) that the disputes between the partners of the managing agency firm could not, in any way, have affected the carrying on of the normal business of the company; and (e) that the company gained nothing by terminating the managing agency agreement. Whether the whole or any apart of the sum of Rs. 18,90,000 was paid by the company to the managing agents having promoted the company? What was the true nature of the payment of the sum of Rs. 18,90,000 by the company to the managing agents on a correct interpretation of the managing agency agreement? Whether the sum of Rs. 18,90,000 together with the sum of Rs. 13,300 paid as expenses of litigation or any part thereof was an expenditure incurred wholly and exclusively by the company for purposes of its business and as such it was an allowable deduction?"
(2.)THE statement arises out of an order passed by the Tribunal on April 25, 1951, holding that the sum of Rs. 19,03,300 paid by the assessee company to the partners of the partnership, Beharilal Kailashpat, which was its managing agents, was not a revenue or business expenditure within the meaning of section 10(2)(xv) of the Income-tax Act,i.e., an expenditure "not being in the nature of capital expenditure..... laid out or expanded wholly and exclusively for the purpose of such business."
The facts, as gathered from the statement of the case and its annexures, are as follows: The assessee-company was incorporated in 1934 as a private limited company to carry on various business and for other purposes and its 3,000 ordinary shares of Rs. 500 each were held equally by members of two families, (1) the family of Sir Padampat Singhania, and (2) the family of Lala Ram Ratan Gupta. About the same time the firm Beharilal Kailashpat was brought into existence; its partners were eight, four being members of the Singhania family and the other four being members of the Gupta family and the total of the shares held by each family was 8 annas. The memorandum of association of the company, clause 6, provided that M/s. Beharilal Kailashpat were appointed as the secretaries, treasurers and agents of the company upon the remuneration and the terms, with the powers, and for the consideration, set forth in the draft agreement annexed to the memorandum. The articles of association provided that there must be between 3 and 7 directors, including ex-officio directors, that two members named from time to time by M/s. Beharilal Kailashpat must be the ex-officio directors, that the business of the company (except as was by the articles expressly provided to be carried on by the agents) must be managed with the assistance of the agents by the directors and that such of the powers as were entrusted to the agents from time to time must be exercised by them: vide articles 103, 104 and 121. Article 142 dealt with the management of the business affairs of the company will be in the agents of the company and that the agents must be entrusted with, and exercise and perform, the powers and duties of building, erecting and maintaining warehouse, factories, etc., buying machinery and machinery stores, buying and selling cotton, waste, and spinning and weaving the same, selling the yarn and cloth so manufactured, buying and selling raw cotton, wool, etc., for dyeing, spinning, cleaning, weaving and manufacturing the same and selling the same in Kanpur, shipping or consigning for sale to any place goods manufactured by the company, borrowing money, entering into negotiations and contracts, executing and signing agreements, contracts, etc., commencing, instituting, prosecuting and defending actions and suits and generally doing all such other acts and things as are necessarily incidental or conductive to the attainment of all or any of the objects of the company. By article 143 the members for the time being of the firm of Beharilal Kailashpat were appointed agents of the company upon the terms, for the remuneration, and with the powers mentioned in the draft agreement attached as a schedule and it was expressly provided and declared that "in consideration of the services rendered by them in promoting this company, the appointment of the said firm of Beharilal Kailashpat to the office of the agents of the company shall not be liable to be, at any time hereafter, revoked or cancelled on any ground or for any reasons whatever, save and except their being found guilty of fraud in the management and discharge of their duties as such agents of the company". On May 2, 1935, the managing agency agreement was executed by the company and the firm, M/s. Beharilal Kailashpat, as provided in the memorandum and the articles of association of the company. The relevant terms of the agreement are as follows: "The firm will perform the office of the agents of the company faithfully and to the best of its ability. In consideration of this promise and in further consideration of the firm having promoted the company, the company hereby promise and agree with the firm and its members for the time being: (a) That the firm shall be the agents of the company for a period of ninety-nine years and thereafter until they shall resign or until they are thereafter removed from their office. (b) The firm shall receive from the company commission at certain rates on sale of various products. (c) The company shall defray the expenses of maintaining a suitable office of the firm as agents. (d) In case the company sells its mills, machinery and business the sale will be subject to the rights and claims of the firm as provided by the agreement and the memorandum and the articles of association.

The firm shall keep books of account for the use of the company, shall have the superintendence of all the hands engaged in the company's mills, shall approaches all cotton, wool, machinery and stores required for the use of the company's mills and sell the same, shall sell at the market rate all loose or baled yarn and cloth produced or manufactured in the mills and shall exercise all the powers given to the agents by the articles of association. So long as the firm is not dissolved it shall be free to change its constitution, name or style from time to time, without thereby in any way affecting their appointment as agents of the company. It would be lawful for the firm, or subject to the partnership contract, for any member of the firm, to assign the whole or any portion of the earnings of the firm or the partner without affecting its appointment as agents of the company, for any member of the firm, to assign the whole or any portion of his interest or to withdraw from the firm altogether, without thereby in any way affecting the appointment of the firm as agents, and for the firm to assign its office as agents and all the rights and obligation as agents and in the event of assignments the assignee will be deemed to have been appointed as agents of the company with like powers, authorities, remuneration and emoluments and subject to like terms and conditions."

(3.)THE partners of the firm, Beharilal Kailashpat, were changed from time to time and in 1943 they were, (1) Lady Ansuiya Devi (wife of Sri Padampat Singhania), (2) Shrimati Pushpavati Devi (wife of Sri Lakshmipat Singhania), (3) Vijaipat and Ajaikumar (minor sons of Shri Kailashpat Singhania), (4) Srimati Ram Devi (wife of Sri Beharilal Gupta), (5) Lala Ram Ratan Gupta, (6) Lala Ram Prasad Gupta and (7) Shrimati Keshobai (wife of Lala Ramgopal Gupta). THE Singhanias held 8 annas share and the Guptas held the remaining 8 annas. In 1943 disputes arose between the members of the two families in respect of the business carried on under the names of the company and the firm and under other names and they were referred to the arbitration of Sri Kanhaya Singh. By his award dated January 18, 1944, he declared as follows: THE company should go exclusively to the members of the Gupta family and the members of the Singhania family should part with all their rights and interests in it. Accordingly, the members of the Singhania family should transfer their shares to Lala Ram Ratan Gupta or his nominees at a certain price. On payment of the said price they will cease to be share-holders of the company and three of them who were directors shall resign and cease to be directors. As a necessary corollary the partners of the firm, Behari Lal Kailashpat, who belonged to the Singhania family should cease to be the partners and are to be deemed to have retired and withdrawn and the remaining partners, namely, Shrimati Ram Devi, Lala Ram Ratan Gupta, Lala Ram Prasad and Shrimati Keshobai will be entitled to continue the said managing agency business, if they so like, in their own partnership or in partnership with others, but they must exclude the name "Kailashpat" from the name of their firm. THE members of the Singhania family will not be entitled to carry on any business in the name of Behari Lal Kailashpat."
On January 25, 1944, members of the Gupta family paid to the share-holders of the Singhania family of the company the price of the shares held by them. Thereafter, the company consisted entirely of members of the Gupta family and the Singhania family ceased to have any interest in it. under the award itself with effect from January 25, 1944, the rate of payment of the price of the shares to the shareholders of the Singhania family, the members of the Singhania family ceased to be partners of the firm exclusively of members of the Gupta family though with a liability to change in the name by deletion of the word "Kailashpat". On January 27, 1944, the firm decided to change the name of Beharilal Ramcharan and drew up a fresh partnership deed and informed the company of the change in its name and its constitution. The company on March 31, 1944, approved of the change in the name and constitution of the firm. On May 25, 1944, the old Singhania partners of the firm wrote to the directors of the company protesting against the recognition of the firm, Beharilal Ramcharan, as its managing agents in the place of Beharilal Kailashpat and contended that the recognition did not bind them or the firm, Beharilal Kailashpat. The directors sent a copy of the letter to Beharilal Ramcharan for its comments and sent an inter in reply to the Singhanias that thy had ceased to have any interest in the firm, Beharilal Kailashpat, and that the remaining partners had changed its name to Beharilal Ramcharan. Beharilal Ramcharan on June 26, 1944, informed the directors of the company that the award of Sri Kanhaya Singh was binding upon the Singhanias, who were parties to it, and that they were not justified in protesting against Beharilal Ramcharan being recognized as the company's managing agents. The directors sent a copy of this reply to the Singhanias in continuation of this interim reply. On July 18, 1944, the Singhanias, as representing Beharilal Kailashpat, wrote to the directors of the company contending that the award was not final and binding and they had filed an objection against it as also against the very reference to the arbitration, that if it still recognized Beharilal Ramcharan as its managing against it would do so at its own risk and would continue to be responsible to Beharilal Kailashpat and its partners for all loss that may accrued to it or them and that Beharilal Ramcharan could not be treated as a continuation of Beharilal Kailashpat because no original partner of Beharilal Kailashpat was a partner of Beharilal Ramcharan. When the partnership, Beharilal Kailashpat, was formed in 1935, none of Ram Ratan Gupta, Ram Prasad, Ram Devi and Keshobai was its partner but that was immaterial. Partners of Beharilal Kailashpat kept on changing and the members Gupta family who are partners in 1935 ceased to be partners and in 1943 the partners representing the Gupta family were Lala Ram Ratan Lal, Ram Prasad, Srimati Ram Devi and Srimati Keshobai and under the award they were entitled to continue the partnership under a changed name. The directors sent a copy of this second letter of the Singhanias to Beharilal Ramcharan on July 27, 1944, and stated that as the validity of the award was vehemently contested in a court of law it would not be safe for the company to recognize anybody other than Beharilal Kailashpat as its managing agents. In reply Beharilal Ramcharan wrote to the directors contending that the award so long as it was not set aside bound all and that the objection that none of the original partners of Beharilal Kailashpat was a partner of Beharilal Ramcharan was without any substance because Lala Ram Ratan Gupta was an original partner. On September 20, 1944, the directors of the company wrote to, (1) Beharilal Ramcharan, and(2) the Singhania partners of Beharilal Kailashpat that the company had decided not to recognize anybody other than Beharilal Kailashpat as its managing agents, that it could not safely continue to interest its management and affairs in the hands of Beharilal Kailashpat and that consequently it had decided to terminate the managing agency agreement with effect from September 30, 1944. The Singhanias replied on September 25, 1944, that the termination of the agreement was mala fide, unjustifiable and wrongful because for 99 years Beharilal Kailashpat could not be removed from the office of managing agents and called upon the directors to revise the decision and restore Beharilal Kailashpat to the managing agency or pay it adequate damages and compensation for the wrongful termination of the agreement. The reply from Beharilal Ramcharan came later on October 5, 1944; it also attacked the termination of the managing agency agreement and removal of the managing agents from office as unjustifiable, improper and wrongful and called upon the directors either to restore it to the office of managing agents or pay Rs. 40,00,000 as compensation for the wrongful termination. On September, 30, 1944, the directors informed the Singhanias that they could not review their decision and that their claim for compensation was misconceived and the agreement had to be terminated on account of quarrels and conflicts among the partners. The Singhanias as partners of Beharilal Kailashpat and that the company was liable to pay Rs. 30,00,000 as compensation to the Singhanias for the wrongful termination of the agreement and removal of Beharilal Kailashpat from the office of managing agents. On October 9, 1944, the company informed (1) the Singhanias, and(2) Beharilal Ramcharan, refuting their claims to compensation and suggesting reference of the dispute to the arbitration of any of the five named persons including Sri K. M. Munshi. The Singhanias and the partners of Beharilal Ramcharan, jointly entered into an agreement on October 19, 1944, referring to the arbitration of Sri K. M. Munshi the dispute whether the termination of the agreement and the removal from the office of Beharilal Kailashpat or its alleged successor, Beharilal Ramcharan, was wrongful and, if it was wrongful, to what compensation, if any, were the ex-managing agents entitled.


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