B.P.SARAF,J. - (1.) BY this reference made at the instance of the assessee, the Tribunal has referred the following three questions of law for opinion under S. 256(1) of the IT Act, 1961 : ''1. Whether, on the facts and in the circumstances of the case, the Tribunal erred in holding that the disallowance of a sum of Rs. 1,83,842 out of the amount of commission an sales paid to International Paper Co., which was a sole proprietary concern of Shri T.S.N. Swamy, had been rightly made under S. 40(c) of the IT Act ? 2. Whether, in any event, the Tribunal erred in holding that it was the entire expenditure of Rs. 1,83,842 which was disallowable under S. 40(c) without taking into account the expenditure incurred by the selling agent in discharging his obligations ? 3. Whether, on the facts and in the circumstances of the case, the Tribunal ought to have held that the provisions of S. 40(c) could apply only where, in the first instance, some part of the expenditure was found to be excessive and not otherwise ?"
(2.) THE assessee is a private limited company engaged in the business of dealing in paper and allied products. It has only two shareholders, namely, Shri T.S.N. Swamy and his wife Mrs. S. Swamy both of whom were the directors in the relevant previous year ended on 31st March, 1975 corresponding to the asst. year 1975 76. M/s International Paper Co., which was a sole proprietary concern of late T.S.N. Swamy, was acting as a selling agent of the assessee company. For the relevant previous year ending 31st March, 1975, commission was payable to M/s International Paper Co. for the period from 1st April, 1974 to 30th June, 1974 as per the terms of an agreement dt. 18th May, 1973 and according to the amended agreement w.e.f. 1st July, 1974. According to cl. 5 of the agreement dt. 18th May, 1973, International Paper Co. was entitled on all sales effected by it on resale basis to customers to a discount of 5% and where the orders were being handled by the assessee directly, as in the case of Government orders, to a commission of 2 1/2%. There was also a provision to grant additional bonus upto a maximum of 2 1/2% subject to working results. According to the amended agreement, as approved in the meeting of the board of directors held on 16th Oct., 1974, w.e.f. 1st April, 1974 the dealers discount was revised from 5% to 7 1/2% and the commission on the direct orders handled by the assessee was revised from 2 1/2% to 5%. Some other amendments were also made, which are not material for the present purpose. The appointment of M/s International Paper Co. as the sole selling agents on identical terms for the subsequent year as per the agreement dt. 25th June, 1975 which was on identical terms was also approved by the Government of India by their letters dt. 17th June, 1976 and 29th Nov., 1976. During the relevant previous year, the assessee company paid Shri T.S.N. Swamy, its Managing Director, for his services a salary of Rs. 37,200 and commission of Rs. 22,800. It also made commission payments to the sole selling agents, M/s International Paper Co., of which Shri T.S.N. Swamy was the sole proprietor, amounting to Rs. 1,95,842 as under : The assessee claimed deduction for the above amount as business expenditure. The ITO, however, holding that the payment at the above amount by way of commission to the sole selling agent M/s International Paper Co., which was the proprietary concern of Shri T.S.N. Swamy, amounted to payment of further remuneration to the managing director, applied the provisions of S. 40(c) of the Act and restricted the allowance of total payments to Swamy including the commission paid to his sole proprietary concern as sole selling agency commission to Rs. 72,000 and disallowed the balance of Rs. 1,83,842 in computing the total income of the assessee company for the asst. yr. Commission on sales Rs. 1,63,422 Commission on processing charges Rs. 32,420 Rs. 1,95,842 1975 76.
(3.) THE above action of the ITO was affirmed, on an appeal, by the AAC and also the Tribunal. The Tribunal rejected the assessee's contention that the remuneration contemplated under S. 40(c) was confined to payment for services rendered by a director managing the affairs of the company. It was further held by the Tribunal that the mere fact that the managing director acted as the selling agent by using a trade or business name does not, in law, create a legal entity or an independent person diversed from the individual managing director and, hence, while considering the payment of selling agency commission, therefore, it was not possible to regard M/s International Paper Co., which was a sole proprietary concern of the managing director, as a person different from the managing director himself. If further held that what is contemplated by S. 40(c) is not the remuneration or benefit or amenity to a director or any person mentioned therein but the expenditure which would bring about such remuneration, benefit or amenity to the director, etc. The Tribunal rejected the contention of the assessee that S. 40(c) only contemplated such expenditure which resulted into remuneration to a director or a managing director in his capacity as a director or managing director. Hence this reference at the instance of the assessee.;