SANKAR PRASAD MITRA, J. - (1.) : This is a reference under s. 66(1) of the Indian IT Act, 1922. The applicant is a registered firm manufacturing plastic goods. There were two partners of the firm in the relevant accounting year, namely, the year ending December 31, 1952, corresponding to the asst. yr. 1953-54. The two partners were Sagarmal Bengani and Hanumanmal Bengani, each having eight annas share in the firm. In the manufacturing account, the applicant showed a loss of Rs. 1,08,075 as against a gross profit of 64 per cent shown in the preceding accounting year. The ITO found that the assessee had purchased 71,488 lbs. of styron out of which 3,280 lbs. were purchased from I. C. I. at Rs. 2-11-0 per lb., and the remaining 68,208 lbs. were shown as having been purchased from M/s Hindusthan Plastic Co. at a cost of Rs. 3,07,653, which worked out to Rs. 4-7-9 per lb. The ITO also found that the Hindusthan Plastic Co.'s constitution was the same as that of the assessee- firm, that is to say, that Sagarmal Bengani and Hanumanmal Bengani were also partners of the Hindusthan Plastic Co. Originally, the styron in question was imported by the Hindusthan Plastic Co. through an overdraft account with the Hongkong and Shanghai Banking Corporation Ltd. in 1951. The Hindusthan Plastic Co. paid to the bank a sum of Rs. 1,52,231-13-0 an a further sum of Rs. 1,54,704 was due by the Hindusthan Plastic Co. to the bank. The applicant took over the stock of styron and paid to the bank the amount due to it by the Hindusthan Plastic Co. plus the buying charges, godown rent, etc. The applicant also paid to the Hindusthan Plastic Co. the sum of Rs. 1,52,232, being the amount paid by the Hindusthan Plastic Co. to the bank. The applicant showed that it had incurred expenditure to the extent of Rs. 3,07,653 for the purchase of 68,208 lbs. of styron in the manner aforesaid. The ITO found that the purchase price had thus been inflated by Rs. 1,18,000, and he resorted to the proviso to s. 13 and estimated the sales at Rs. 3,00,000, with a gross profit of Rs. 54,000.
(2.) THE AAC, in his order made on the 24th March, 1957, observes, inter alia, as follows : "From a perusual of the assessment order it appears that the appellant purchased goods from I. C. I. at Rs. 2-11-0 per lb. in the months of January and February, 1952. As against these it showed to have purchased 68,208 lbs. of the same type of raw materials from M/s Hindusthan Plastic Co. at Rs. 4-7-9 per lb. Hindusthan Plastic Co. is comprised of the same partners as that of the appellant and there was no justification for paying such high price to this concern. It is submitted that, as the business of Hindusthan Plastic Co. was being closed, the goods from this concern were purchased at the price which the latter paid for them. It is therefore obvious that the appellate paid a higher price for consideration other than that of business. THE inflations of the purchase have been established." The Tribunal, by its order made on the 4th September, 1959, states as follows : "The appellant purchased goods from I. C. I. at Rs. 2-11-0 per lb. When the market rate was Rs. 2- 11-0 per lb., the appellant purchased from M/s Hindusthan Plastic Co. a large quantity of goods, i.e., 68,208 lbs. at Rs. 4-7-9 per lb. The constitution of the appellant-firm and of M/s Hindusthan Plastic Co. was the same. It is, therefore, evident that the appellant paid a higher price to M/s Hindusthan Plastic Co. for extra- commercial reasons. The purchase price was thus inflated and, consequently, profits were rightly estimated under proviso to s. 13 of the IT Act." On these facts, the question of law framed for our consideration by the Tribunal is as follows: "Whether, on the facts and in the circumstances of the case, the Tribunal was justified in holding that the applicant had paid a higher price for 68,208 lbs. of styron for extra-commercial reasons ?"
(3.) MR. D. Pal, for the applicant, has strongly urged that if, in reality, payment has been made by the appellant and that payment is not questioned by the tax authorities, it is not open to the authorities to substitute their own standard of reasonable expenditure for that of the assessee. I do not think there can be any dispute as to this proposition, so long as the transaction is a genuine or a straightforward one, or is neither colourable nor illusory nor fraudulent (vide Craddock vs. Zevo Finance Co Ltd. (1946) 27 Tax Cases 267 (HL)). In Newtone Studios Ltd. vs. CIT (1955) 28 ITR 378 (Mad) the assessee was a private limited company owning a studio, and engaged in the production of motion pictures. There were six shareholders, one of whom was the managing director, two were technician directors, and one a technician. The "honorarium" of these four persons was fixed in 1938 at Rs. 250 each, and a commission at a certain percentage on the net profits. From time to time the "honorarium" was increased, but the commission remained the same. In 1944 and 1945 the salary paid to these four persons amounted to Rs. 18,000 a year. For 1946 the salary increased to Rs. 59,100 by a resolution of the 30th March, 1946. The IT authorities, in view of the increase of profits, allowed only Rs. 36,000 out of this sum of Rs. 59,100 as business expenditure. On a reference to the High Court, it was held that it was not open to the IT authorities to adopt a subjective standard of reasonableness of the amounts paid, and, on the facts and circumstances of the case, the whole expenditure of Rs. 59,100 incurred by the assessee for payment of remuneration to the managing director and the other technician directors should have been allowed under s. 10(2) (xv) of the IT Act. In order that an expenditure may be incurred wholly and exclusively for the purpose of earning the profits, it is not necessary to show that it was incurred "of necessity". It is sufficient if it was incurred voluntarily and on the ground of commercial expediency and indirectly to facilitate the carrying on of the business; and on applying the test of commercial expediency to determine whether the expenditure was wholly and exclusively laid out for the purpose of the business, the reasonableness of the expenditure should be considered from the point of view of the business men and not from the point of view of outsiders including the ITO. At p. 385, Rajagopalan J. observes as follows : "Under our taxing system, it is for the assessee to conduct his business, and in his wisdom or otherwise to fix the remuneration to his staff. The IT Act does not clothe the taxing authority with any power or jurisdiction to determine the reasonableness of the amount so fixed and paid by the assessee. The only test for the deductibility of such remuneration is whether the expenditure has been incurred solely and exclusively for the purpose of the business. If the reality of the payment is challenged or is in dispute, different considerations arise : so also in cases where the tax authorities are able to point to some consideration other than the purpose of the business as accounting for any portion of the payment made. In such cases, of course, such portion of the amount claimed, which is either not held to have been paid or is held to have been paid for reasons other than business expediency, could and should be disallowed; but the reason for disallowance is because either the portion disallowed is not paid, or because the expenditure is not solely and exclusively for the business, and not on the ground that in the opinion of the ITO or other taxing authority the remuneration is 'unreasonably' high--either because the employee does not, in the authority's opinion, deserve so much, or because the assessee could have secured other employees on more favourable terms." ;