G.K.MITTER, J. - (1.) THE main question in this reference under s. 66(1) of the Indian IT Act is whether a sum of money paid to a manager and director of a company in terms of a resolution of the board of directors to dispense with his service was an expenditure admissible as an allowance under s. 10(2)(xv) of the Indian IT Act. THE other question of a similar nature relates to certain payments made by way of commission to four managers of the company. According to the terms of their engagement, commission was payable on the result of the year of account for which it was due but as they appear to have left the service of the company before the completion of the year, the payments were made on the basis of the figures of the previous year which exceeded the figures for the year in question by about Rs. 22,199.
(2.) THE facts are as follows : THE assessees are the liquidators of Begg Dunlop and Co. Ltd., which went into liquidation on 30th March, 1948. THE assessment year is 1948-49 and the financial year is that ending on 30th March, 1948. THEre was a material change in the composition of the shareholders of the company in the month of July, 1947. According to the statement of case the new shareholders influenced the management of the company in various ways and were of the view that a thorough reshuffling in the management was necessary. Ultimately, they decided to have the company wound up. Before they took such decision the directors of the company passed a resolution by virtue of which Mr. Mackay, the manager, who was also a director, was asked to retire from the service of the company and was given a sum of Rs. 2,80,000. THE text of the resolution of the board of directors passed on 20th Sept., 1947, is as follows : "THE chairman reported that owing to the recent changes in the holding of the controlling interest in the company and the changes and economies that were being effected in the running of the company by the new shareholders there was no longer any suitable employment for Mr. H. G. G. Mackay as a manager of the company and it was with great regret that the board had decided to dispense with Mr. Mackay's service as a manager of the company w.e.f. the 30th Sept., 1947. It was resolved that in view of the fact that Mr. Mackay would in normal circumstances have continued as a manager of the company for a further seven years and the premature termination of his service by the company, he should be given the sum of Rs. 2,80,000 as compensation for such premature termination of his service." It should be noted that there was no subsisting agreement between the company and Mr. Mackay regarding the tenure of his service. It is recorded that Mr. Mackay had been in service for a pretty long period and had worked up to the position of manager by his efficiency. According to the assessees Mr. Mackay would have retired in about seven years from 1947 and he could therefore expect to be in service for that period. As such the directors felt dispensing with his service by premature termination had to be compensated and the payment of Rs. 2,80.000 was occasioned by commercial expediency and admissible as an expense under s. 10(2)(XV). The assessee further paid a sum of Rs. 49,295 to the managers of the company by way of commission. The entire commission was determined with reference to the profits for the year ending on 30th March, 1947, and not on the profits for the year ending on 30th March, 1948, relevant for the assessment year in consideration. The auditors of the company had made a note that this was an exceptional procedure and there was no authority for the company to make such payment. The commission due on the profits made up to 30th March, 1948, was Rs. 27,096. The ITO allowed this amount as a deductible expense and added back a sum of Rs. 22,199 as not allowable. In their comment on the audit the auditors observed, "we understand that this procedure was adopted in order to expedite settlement of accounts with managers but we have seen no authority for this method of payment." With regard to the payment to Mr. Mackay the Tribunal observed in its order that the employee was not under an agreement to serve for a particular period and the company was under no legal liability to pay any compensation to him for terminating his service. The Tribunal also noted that just a few months after the termination of his service the company itself went into liquidation and if the dismissal had taken place at the same time as the liquidation no question of compensation could have arisen and the payment would have been taken to be an ex gratia one. According to the Tribunal, "merely because the termination was a few months earlier, we cannot say that the ultimate intention of the assessee company was to liquidate the company's affairs and this treatment with Mr. Mackay was only a process undertaken by the company before the shareholders resolved to wind up. Even apart from the fact that the services were not dispensed with immediately at the time of liquidation, the reasons given are economically conducting the affairs of the company...... In any case, to our mind, the payment was not a compensation for premature termination but merely an ex gratia payment for services rendered by him in the past. As such the payment was not an expenditure admissible under s. 10(2)(XV)." It appears that in deciding the case before it the Tribunal did not at first adjudicate upon the ground whether the amount of Rs. 22,199 paid in excess to the managers was liable to be disallowed against the computation of profits. The Tribunal accepted the contention of the Revenue and rectified its order under s. 35 of the IT Act by adding a paragraph to the above order. By this further order the Tribunal notes that according to the auditors of the company this extra payment to the managers was without any authority and in disregard to the procedure followed in previous years. The Tribunal added that as the assessee was maintaining the system of mercantile accounting it could find no reason to interfere with the order of the AAC.
(3.) THE questions framed for determination by this Court are as follows : "(1) Whether, on the facts and in the circumstances of the case, the sum of Rs. 2,80,000 paid by the assessee company to the director and manager was an expenditure admissible as an allowance under s. 10(2)(XV) of the Indian IT Act ? (2) Whether, on the facts and in the circumstances of the case, the entire amount of Rs. 49,295-9- 6 paid to the managers was an expense admissible under s. 10(2)(xv) of the Indian IT Act ?" To come within s. 10(2)(XV) the expenditure must not be an allowance of the nature described in cls. (i) to (xiv) inclusive; it must not also be in the nature of capital expenditure or personal expense of the assessee but must be laid out or expended wholly and exclusively for the purpose of its business. THE test, therefore, is whether the payment can be related wholly and solely to business expediency. It must be such as commercial men would be justified in spending for their business without taking any extraneous matters into consideration. Thus, for instance, there must not be an element of an ex gratia payment or gratuity. This does not mean that commercial men are supposed to be deprived of all human considerations but for IT purposes the payment must be measured in terms of commercial efficacy. Thus if an employee is asked to quit his employment all of a sudden because there is no work for him or because the condition of the business in such that economies must be effected by retrenchment it would hardly be right to throw him out of employment without any compensation. If he had been working under a definite service agreement regard must be had to that including the surrounding circumstances and the financial circumstances of the assessee to give him reasonable compensation. Even if an employee is not working under an agreement for a definite period he ought not to be asked to go without any compensation whatsoever. Even such a person may be paid some compensation which will not be the same as in the case of one who had been working under a service agreement for a definite period. Ordinarily, if the master has fixed the compensation bona fide and reasonably no exception ought to be taken thereto. But it would be for the assessee to place all the available material before the IT authorities to satisfy them that fixation of compensation was reasonable and bona fide. If the service of an employee is being terminated to effect economy material must be disclosed to show how economy was being effected. It is not enough to say that an employee was being paid a not inconsiderable sum of money as compensation without informing the IT authorities as to the emoluments which he was getting at the time of the termination of his service. In this case all that we know is that Mr. Mackay would in the normal course of things have been superannuated after seven years from September, 1947. No material has been disclosed to show what was his yearly remuneration. If, for instance, his yearly remuneration was in the neighbourhood of rupees five lakhs, the payment of Rs. 2,80,000--roughly remuneration for six months--would be quite reasonable but if his yearly remuneration came to no more than Rs. 40,000 or Rs. 50,000 then the payment of Rs. 2,80,000 to him would mean paying him for the entire period he would have been in the service of the company and in the result this would mean paying him for the said period without taking any service from him. When all the circumstances are disclosed it may be that a particular board of directors might have decided to pay Mr. Mackay Rs. 2,00,000 while another set of directors might have fixed Rs. 3,00,000 as the proper amount of compensation but in that case no exception can be taken if the amount actually fixed is Rs. 2,80,000, but if no circumstances are disclosed then it is impossible for the Revenue authorities to test the correctness of the ground given, namely, effecting economy in the running of the company. I do not think much importance can be attached to the fact that within six months after the board of directors had passed their resolution relating to Mr. Mackay, the shareholders decided to put the company into liquidation. It would have been otherwise if the board had decided to make this payment with the knowledge that the shareholders were thinking of putting an end to the venture but there is no such suggestion in this case. I now proceed to examine the authorities which cited at the Bar on the first question. Some of these are judgments of the English Court of Appeal or the House of Lords while the others are Indian. In this connection it is necessary to remember that by clauses I and II, rule I of Schedule D to the English IT Act no sum was to be deducted "for any disbursements or expenses whatever, not being money wholly and exclusively laid out or expended for the purposes of such trade, manufacture, adventure or concern." Under s. 10(2)(xv) of the Indian Act on the other hand only such expenditure is allowable which is not covered by cls. (i) to (xiv) of s. 10(2) of the Act and is not in the nature of capital expenditure or personal expense of the assessee but is laid out or expended wholly and exclusively for the purpose of such business, profession or vocation. The earliest English authority referred to is the case of British Insulated and Helsby Cables Ltd. vs. Atherton (1926) AC 205, where three of the law Lords were of opinion that the payment concerned was in the nature of capital expenditure while two others held a contrary view. It is not necessary to examine the facts of that case but Viscount Cave L.C., after scrutiny of several older decisions, observed "that a sum of money expended, not of necessity and with a view to a direct and immediate benefit to the trade, but voluntarily and on the grounds of commercial expediency, and in order indirectly to facilitate the carrying on of the business, may yet be expended wholly and exclusively for the purposes of the trade." His Lordship also said "but when an expenditure is made, not only once and for all, but with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade, I think that there is very good reason (in the absence of special circumstances leading to an opposite conclusion) for treating such an expenditure as properly attributable not to revenue but to capital". These dicta were referred to by Mr. Mitra, counsel for the assessee, as having been followed in a large number of English cases. In Anglo- Persian Oil Co. Ltd. vs. Dale (1932) 1 KB 124 16 Tax Cas 253, the decision mentioned above was extensively referred to. In this case the assessee were a company incorporated with the object of raising, refining, selling and otherwise dealing with crude oil and its products in Persia and elsewhere. By an agreement of the year 1914 the assessee appointed Strick, Scott and Company Ltd., as their agents, to manage their business in Persia and the East and to carry out the sale of petroleum and other products on certain terms as to remuneration including commission on the sales. The agreement was to be in force for ten years in the first instance renewable for a further period on terms to be arranged either by agreement or by arbitration. The assessee found that the remuneration payable under the agreement was more onerous than anticipated and started negotiations with the agents for terminating the agreement.;