B.S. Dhillon, J. - (1.) THIS judgment will dispose of Income-tax References Nos. 110 of 1977 and 56 of 1979. Since the facts on the basis of which the questions of law arise in both these references are common, the same are being disposed of by a common judgment.
(2.) THE facts as given in I.T. Ref. No. 110 of 1977, which pertains to the assessment year 1972-73, may be stated. THE assessee is a private limited company and carries on the business of manufacture and sale of cycles. THE previous year for the assessment year 1972-73 ended on 31st March, 1972. By an agreement dated 1st April, 1960, the assessee had appointed M/s. Hans Raj Pahwa and Brothers, Ludhiana, as its sole distributors for the sale of all its products for a period of five years from 1st April, 1960, to 31st March, 1965, and the commission was fixed at 4% on all the sales made by the company direct or through the efforts of the sole distributors. THE firm of M/s. Hans Raj Pahwa and Brothers was constituted by a partnership deed dated 26th March, 1960, comprising the following partners, who agreed to share the profits and losses of the firm in equal proportion : (1) Shri Hans Raj representing his HUF. (2) Shri Jagat Singh representing his HUF. (3) Shri Sohan Lal representing his HUF. By a deed of partnership dated 15th February, 1963, Shri Harmohinder Singh, son of Shri Jagat Singh, was taken as a fourth partner and whereas the aforesaid three partners' share in profits and losses was fixed at 20% each, Shri Harmohinder Singh's share was fixed at 16%. By another agreement dated 30th March, 1965, the assessee again appointed M/s. Hans Raj Pahwa and Brothers, Ludhiana, as its sole selling agent for a further period of five years from 1st April, 1965, to 31st March, 1970. The rate of commission was reduced to 3% on all sales made to parties in India by the company direct or through the efforts of the sole selling agents. By a deed of partnership dated 1st April, 1969, there was a change in the constitution of M/s. Hans Raj Pahwa and Brothers, inasmuch as two more persons, namely, Inderjit Singh, son of Shri Hans Raj Pahwa, and Swaranjit Singh, son of Shri Jagat Singh Pahwa, were taken as partners. The shares in the profits and losses of the firm were fixed as under : (1) Shri Hans Raj Pahwa 18%. (2) Shri Jagat Singh Pahwa 15%. (3) Shri Sohan Lal Pahwa 25%. (4) Shri Harmohinder Singh Pahwa 12%. (5) Shri Inderjit Singh Pahwa 18%. (6) Shri Swaranjit Singh Pahwa 12%. The assessee-company again appointed M/s. Hans Raj Pahwa and Brothers as its sole selling agents for a further period of five years from 1st April, 1970, to 31st March, 1975. The sole selling agents were entitled to commission at 3% on all sales made to parties in India by the assessee direct, or through the efforts of the sole selling agents. By a deed of partnership dated 1st April, 1971, there was a change in the profit-sharing ratio of the six partners of M/s. Hans Raj Pahwa and Brothers and the share in profits and losses of the firm of each partner was fixed at l/6th. Consequent upon the aforesaid agreements the assessee-company paid commission to M/s. Hans Raj Pahwa and Brothers in different years. The figures of sales and commission, etc., during the period of ten years, from the assessment year 1963-64 to 1972-73, are as under : The aforesaid commission paid to M/s. Hans Raj Pahwa and Brothers as sole selling agents was allowed in all the assessment years including the assessment year 1972-73 for which the assessment was framed on 26th February, 1973.
(3.) BELOW the assessment order for the year under consideration, the ITO wrote the following note which was also communicated to the assessee along with the copy of the aforesaid assessment order : " Applicability of section 40A(4)(ii) read with the proviso was studied. This section is applicable only where payment exceeding Rs. 72,000 are made to directors or to their relatives who is an employee or a former employee. In this case commission has been paid to M/s. Hans Raj Pahwa and Brothers in which the directors are also partners. However, none of the directors was mere employee during the accounting year relevant to the assessment year 1972-73. This position also appears to be correct in view of the comments made at page 16 of the explanatory note of the relevant Finance Act, 1971. " After the assessment, the ITO wrote a letter dated 29th March, 1973, that in view of the amended Section 40(c) of the Income-tax Act, 1961 (hereinafter called " the Act "). with effect from 1st April, 1972, each of the six partners of M/s. Hans Raj Pahwa and Brothers was not entitled to a remuneration of more than Rs, 72,000 because Sarvshri Hans Raj, Jagat Singh and Sohan Lal were directors of the assessee-company and Sarvshri Harmohmder Singh, Inderjit Singh and Swaranjit Singh were relatives of the directors within the meaning of Section 2(41) of the Act. He, therefore, proposed to reopen the assessment and issued a notice under Section 148 of the Act and called for the assessee's objection for disallowing the following amounts : No written reply seems to have been furnished by the assessee. The assessee seems to have orally explained its position and the ITO was apparently satisfied that the amended provisions of Section 40(c) of the Act were not applicable because it is admitted that no notice came to be issued under Section 148. ;