MASUD, J. - (1.) THIS reference under s. 66(1) of the IT Act, 1922, arises under the following circumstances : The assessee is a Private Ltd. Co. incorporated in India and is a 100per cent subsidiary of Imperial Chemical Industries Ltd., London, which holds the entire share capital of the assessee. The assessment years are 1949-50, 1950-51, 1951-52 and 1952-53 and the corresponding accounting years ended on 30th September, 1948, 1949, 1950 and 1951 respectively. The assessee, among other things, acts as selling agents for a large variety of goods. Another complete subsidiary of Imperial Chemical Industries Ltd., London, aforesaid is the Imperial Chemical Industries (Exports) Ltd., Glasgow, which is hereinafter described as "I. C. I. (Exports) Ltd." THIS last company had four agents in India, (1) M/s Gillanders Arbuthnot and Co., Calcutta, (2) Best and Co. Ltd., Madras, (3) Anglo-Thai Co. Ltd., Bombay, and (4) Shaw Wallace and Co. for their Products. As a result of confabulations in 1974, which e.w.f. April 1, 1948, these selling agencies were terminated and the assessee was appointed as sole agent in their places. The I. C. I. (Exports) Ltd. agreed to pay compensation to the ex-selling agents at the rate of 2/5ths, 2/5ths and 1 and 2/5ths of the normal rate of commission payable by the principals for the three years from April 1, 1948. In pursuance of this arrangement the compensation was paid to the ex-selling agents through the assessee's accounts. The method by which the compensation payable to the former agents was shown as paid in the books of accounts of the assessee is as follows :
(2.) THE total compensation payable to the ex-selling agents was spread over three years and assuming the turnover was constant over the said three years, the commission payable to the assessee would be 4/15ths of the commission at the normal rates. Under the aforesaid arrangement the ex- agents were entitled to get 2/5ths of the normal rate of commission in the first years, 2/5ths in the second year and 7/5ths in the third year which would amount to payment of 11/5ths of the normal commission in three years. Accordingly, the ex-agents were shown to have been paid (II/5/3) = 11/15ths of the normal rate of commission every year. Further, in the company's profit and loss account each year as evidence the assessee's books of accounts, the latter in the first stance credited the full commission account and debited I. C. I. (Exports) Ltd. with the amount equivalent to commission at the normal rates on sales effected during the year. THE proportion that would be payable as compensation, namely, 11/15th, was then transferred each year from the commission account to a special reserve account so that the funds retained might be accumulated and paid to the former agents from time to time. In the assessments for the asst. yrs. 1949-50, 1950-51, 1951-52 and 1952-53 the assessee showed a certain amount of commission as having been earned on the selling agency for I. C. I. (Exports) Ltd. with footnotes added that the amounts were arrived at after deduction of the compensation paid to the outgoing agents. THE ITO held that the payments of 11/15ths of the normal rate of commission payable to the former agents amounting to Rs. 2,03,503, Rs. 5,41,526, Rs. 5,29,284 and Rs. 4,00,052 for the asst. yrs. 1949-50 to 1952-53, respectively, were not admissible deductions against the assessee's profits and accordingly disallowed the amounts. He, therefore, held that the assessee was entitled to the full normal commission and that the aforesaid payment to the ex-selling agents were to be viewed as appropriation of profits. THE assessee appealed to the AAC and the Tribunal, but the said appeals were dismissed. On these facts the following question of law has been referred to this Court : "Whether the inclusion by the ITO of Rs. 2,03,503, Rs. 5,41,526, Rs. 5,29,284 and Rs. 4,00,052 in the assessment for the years 1949-50, 1950-51, 1951-52 and 1952-53 for the relevant accounting years ending the 30th September, 1948, 1949, 1950, and 1951, respectively, in the computation of the total income of the assessee in justified and correct ?" Mr. Meyer, learned counsel for the assessee, has submitted that according to the terms of the agreement between the assessee and the I. C. I. (Exports) Ltd., the commission receivable by the assessee-company was to be the difference between the commission calculated at the usual rates and the commission payable to the outgoing agents, or, in other words, the income or actual profit or gain of the assessee is only the differential sum and not the entire amount of commission calculated at the usual rates. He has, therefore, stated that the said sums of Rs. 2,03,503, Rs. 5,41,526, Rs. 5,29,284 and Rs. 4,00,052 paid to the ex-agents as compensation cannot be included in the computation of the total income of the assessee. Secondly, Mr. Meyer has urged that, in any event, having regard to the agreement between the assessee and I. C. I. (Exports) Ltd., the amount payable as compensation to the ex-agents has been diverted from the assessee's income by an overriding title, i.e., the agreement between the assessee and the I. C. I. (Exports) Ltd. to the effect that the amount equivalent to normal rates of compensation would not be receivable by the assessee. Alternatively, Mr. Meyer has argued that the amount paid as compensation to the ex-agents by the assessee in terms of the arrangement between the assessee and I. C. I. (Exports) Ltd. is an expenditure admissible as a deduction under s. 10(2)(xv) of the IT Act, 1922. Mr. Balai Pal, learned counsel for the CIT, has with great force asked us to confirm the order of the Tribunal on the following grounds : (a) The payment of compensation to the ex-agents was entirely the liability of the I. C. I. (Exports) Ltd. and the assessee has no legal obligation to pay proportionate amount of compensation in the four assessment years. (b) The payment of compensation by the assessee-company was made entirely for the purpose of business of the foreign principal, namely, I. C. I. (Exports) Ltd., and, accordingly, the expenditure on the part of the assessee have nothing to do with the assessee's business. (c) The assessee-company was only chosen as the agent of its foreign principal for the purpose of the said payments to the ex-agents. These payments were, therefore, not made by the assessee in the character of a trader but in the character of an agent of its principal. Further, such a payment, if it was to be deductible either under s. 10(1) or under s. 10(2)(xv) must spring directly from the carrying out of the assessee's own business or must be incidental to such carrying out. In the present case, even on the terms as they emerged from the arrangement on record and on the basis of the book entries, the full normal commission was earned by the assessee as from the annual sales. The payment of the compensation to the ex-agents had no direct relation to the carrying on of the selling agency business of the assessee nor was even incidental to the said carrying on. The payment was thus an appropriation or application of income already earned by the assessee. The deductions which the assessee had claimed were not permissible in law, inasmush as the payments of compensation to the former agents were not only capital expenditure, but also expenditure not incurred for the assessee's business. (d) Lastly, no deduction for payments of the said compensation was permissible under s. 10(2)(xv) inasmuch as the sums paid by the assessee to the ex-agents were paid for acquisition of a capital assets.
(3.) BEFORE we consider the taxability of the sums of money paid by the assessee as compensation to the ex-agents, it is necessary to consider the circumstances under which such payments were made. The first document which is material for the purpose is the letter dated 11th March, 1947, from Imperial Chemical Industries (Exports) Ltd., Glasgow, to Gillanders Arbuthnot and Co., annexure "F" to the statement of case, which indicates the terms and conditions of the transfer under which the assessee become the sole agent of I. C. I. (Exports) Ltd. in place of the former agents. The terms as proposed in the said letter may be stated as follows : "1. For the first three post-transfer years we shall pay you 2/5ths of the commission accruing on annual sales in the territory of your agency taken over by Imperial Chemical Industries (India) Ltd., such commission to be computed at the commission rates formally paid to you. 2. In the third post-transfer year we shall pay you, in addition a sum equivalent to the full commission on sales for that year effected by Imperial Chemical Industries (India) Ltd. In your territory calculated at the same rates. 3. Payment will be made you after the end of each year as soon as the amount due is ascertained." The second important document is an affidavit of Mr. W. A. Bell, a director of I. C. I. (India) Private Ltd., being annexure "A" to the statement of case, sworn on 30th September, 1957, the material portions of which may be stated as below : "........................ (2) Imperial Chemical Industries (Exports) Ltd., Nobel branch, Glasgow, the principals, had notified to the outgoing agents in March, 1974, that their agencies would be terminated as from the 1st April, 1948, and intimation of the same was also given to I. C. I. (India). ......................... (4) Mr. John Weston Donaldson was then the director-in-charge of the Nobel Branch of Imperial Chemical Industries (Exports) Ltd. and it was agreed between us that from April, 1951, onwards the commission that would be payable to I. C. I. (India) would be the same as was being allowed to the outgoing agents on the various items of explosives and accessories. For the interval, however, between 1st April, 1948, and 1st April, 1951, during which years the outgoing agents had to be paid their compensation as agreed upon I. C. I. (India's) commission would on an overall basis be the difference between the normal rates of commission which would be allowed after 1st April, 1951, and the sums of compensation payable to the outgoing agents during the three years. (5) During the talks Mr. Donaldson desired that I. C. I. (India) should out of the sale proceeds accruing to I. C. I. (Exports) Ltd. during the three years 1948-49, 1949-50 and 1950-51 pay to the outgoing agents for and on behalf of the I. C. I. (Exports) the sums which the I. C. I. (Exports) had agreed to pay to the outgoing agents. "In pursuance of the aforesaid arrangement I directed payment of same to the outgoing agents for the years 1948-49, 1949-50 and 1950-51 calculated in terms of the agreement between I. C. I. (Exports) Ltd. and the former. As in the final years I. C. I. (India) Ltd. were to pay a sum greater than the commission, I directed the creation of a new account headed 'Explosives, Ex-agents' Compensation Reserve A/c' so as to provide for an accumulation of funds during the first two years wherewith to pay the increased compensation during the third years." ;