Sabyasachi Mukharji, J. - (1.) This is a reference under Section 256(1) of the Income-tax Act, 1961. This reference relates to the assessment years 1962-63 and 1963-64, the relevant previous years for which were calendar years 1961 and 1962, respectively. It appears that there was a company known as Indian Galvanizing Co (1926) Ltd., which has been referred to briefly by the Tribunal as I.G., and we shall follow the same pattern. It was a subsidiary of Balmer Lawrie & Co. Ltd., which has been referred to shortly as B.L, B.L. held 1,95,722 out of 3,69,459 ordinary shares of I.G. and was carrying on business in the manufacture of steel containers and drums in the factories at Bombay and at Calcutta. B.L. were its managing agents appointed as such under an agreement dated 8th December, 1926. This agreement of managing agency expired on the 14th January, 1957, but by an agreement dated the 11th March, 1957, I.G. reappointed B.L. as managing agents for a period of 10 years as and from 15th January, 1957. In the year 1958, the remuneration that was paid by I.G. to B.L, for acting as managing agent was Rs. 40,000 and the directors' remuneration was Rs. 8,000. In the calendar year 1959, I.G.'s profits were Rs. 90,167. The remuneration that was paid to B.L. amounted to the same figure of Rs. 40,000, while the directors' remuneration came to Rs. 8,600. It has to be mentioned that the sum actually paid to B.L. in these years was the minimum remuneration as per Clause 5 of the said managing agency agreement. Some time in 1958, the management of I.G. appears to have decided to start three new concerns, i.e., the assessee-company took over the factory of I.G. at Bombay, a company called Industrial Containers Ltd. to take over its Calcutta factory and a third company known as Hopes Metal Windows (India) Ltd- to start a new business in metal windows. In pursuance of the aforesaid desire the assessee-company was incorporated in Calcutta on the 16th June, 1958, with a share capital of Rs. 14,00,070 comprised of 1,40,007 shares of Rs. 10 each. A company known as Industrial Containers was also formed. The assessee-company in pursuance of the scheme took over with effect from 1st January, 1959, the factory of I G. at Bombay in consideration of which the assessee was allotted 1,40,000 ordinary shares of I.G. and thus became a subsidiary of I.G. and hence of B.L. The Industrial Containers took over the Calcutta organisation of I.G. and allotted 31,000 out of 31,014 shares to I.G. in consideration thereof. The business of metal windows, however, did not materialise. On the 30th December, 1960. I.G. went into voluntary liquidation. In 1961, out of its assets some of the shares held by it in the assessee-company and in the Industrial Containers were distributed to B.L. 76,942 shares of the assessee-company came into the hands of B.L. and the assessee directly became a subsidiary of B.L. It may incidentally be mentioned that in the relevant years with which we are concerned, the assessee had not actually become the subsidiary of B.L. but for all practical purposes that does not make any material difference in this case. As a result of winding up, B.L. ceased to be the managing agents of I.G. The assessee-company commenced business on the 1st January, 1959. For the two years the assessee-company had no secretaries or managing agents though it was claimed on behalf of the assessee that B.L. was looking after its affairs as the assessee was one of its subsidiaries. On the 29th December, 1960, the board of directors of the assessee-company passed a resolution approving the execution of the agreement appointing B.L. as secretaries of the company for a period of five years from 1st January, 1961. It would be necessary to refer to some of the relevant provisions of the said agreement : " 2. It is hereby expressly declared that notwithstanding anything contained in this agreement the secretaries shall not at any time during the currency of this agreement whether subject to the superintendence, control and direction of the board of directors of the company or otherwise have or be entitled to the management of the whole or substantially the whole of the affairs of the company. 3. The secretaries shall be responsible for the keeping and custody of the books and papers of the company and shall duly make, keep, file or cause to be made, kept and filed all such registered returns, statements and accounts as under the provisions of the Companies Act, 1956, or any statutory modification thereof for the time being in force are required to be made, kept and filed by the company or its officers and the secretaries shall perform all such duties for the company as are ordinarily performed by secretaries. 4. The secretaries may subject to the provisions of Clause 2 hereof in addition to their duties as secretaries of the company perform any other duties and work for the company as the board of directors of the company may determine. 5. The secretaries shall have power to perform all the duties which may be performed by a secretary under the Companies Act, 1956, or subject to the provisions of Clause 2(m) hereof in the performance of their duties under this agreement. 6. The secretaries shall be entitled to receive from the company by way of remuneration for its services as secretaries the sum of, or in respect of any period of less than one calendar month, calculated at the rate of rupees ten thousand per calendar month, such sum being payable in arrear on the last day of each calendar month. 7. The remuneration payable under Clause 6 hereof shall not be regarded as in any manner or to any extent intended to reimburse the secretaries in respect of any expenses incurred or to be incurred by the secretaries on behalf of the company and the secretaries, in addition to receiving such remuneration, shall be entitled to be reimbursed by the company in respect of any expenses incurred by the secretaries on behalf of the company and sanctioned by the board of directors of the company. "
(2.) It appears that under Clause 6 of the said agreement B.L. became entitled to remuneration of Rs. 10,000 per month and under Clause 7 of the reimbursement of the expenses incurred by them on behalf of the assessee. In accordance with the agreement the assessee paid Rs. 1,20,000 each in the calendar years 1961 and 1962, and these items were included as part of debit of Rs. 3,68,946 and Rs. 4,76,025 shown in the assessee's balance-sheet for the two years against the head " Miscellaneous expenses ". In addition to the above remuneration the assessee paid to B.L. sums of Rs. 41,319 and Rs. 38,991, respectively, for the aforesaid two previous years by way of reimbursement of expenses in respect of various services rendered by them to the asses see-company.
(3.) The Income-tax Officer in making the assessment for the relevant assessment years 1962-63 and 1963-64 was of the opinion that the entire remuneration paid to B.L. should be disallowed in view of the provisions of Section 37 as well as Section 40(c)(i) of the Income-tax Act, 1961. He held, inter alia : (i) B.L, rendered various managerial services to the assessee-company and other concerns for which it charged fees. The assessee had paid Rs. 41,319 and Rs. 38,991 to B.L. by way of such fees ; (ii) The assessee did not, despite several opportunities given, show any satisfactory evidence of the necessity for the appointment of B.L. as secretaries when there was no such necessity in the earlier years and when it was otherwise being remunerated for services rendered by it ; (iii) B.L. had not rendered any additional service than in the earlier year and had no responsibility in the management. It was being appointed as secretaries and remunerated only because it held the majority of the shares in the assessee-company.;