PATEL J R AND SONS PRIVATE LIMITED Vs. COMMISSIONER OF INCOME TAX

JUDGEMENT

(1.) THIS is a reference under s. 66(1) of the Indian IT Act, 1922. The assessee in this case is J. R. Patel and Sons (P) Ltd. the assessment year being 1957-58, the accounting year being the calendar year 1956. The assessee company was acting as the managing agent of the Mahendra Mills Ltd. w.e.f. 20th Aug., 1945, the period of managing agency being twenty years. Under the terms of the agreement the assessee company was entitled to an office allowance of Rs. 1,000 per month and to a commission calculated at the rate of ten per cent. on the annual net profits of the managed company. A. J. Patel was the managing director of the assessee company. He was also a director of the managed company. He was employed by the managed company to render technical service to the managed company and the managed company used to pay to him a sum of Rs. 2,500 per month. He was also acting as the selling agent of the managed company and the managed company was paying to him a commission at the rate of two and half per cent. on the sale price of healds and reeds. The assessee company was paying to him a sum of Rs. 12,000 per annum as and by way of remuneration for attending to the affairs of the assessee company as its managing director. On 1st April, 1956, the Companies Act, 1956, came into force. The Mahendra Mills Ltd. is a public limited company. Under the provisions of s. 198 of the Companies Act, 1956, it was provided that save as otherwise expressly provided by the Act in the case of a public company, the total remuneration payable by the company to its directors, its managing agent or secretaries and treasurers, if any, shall not exceed eleven per cent. of the net profits of that company computed as therein provided, the percentage being exclusive of any fees payable to directors for meetings of the board attended by them. sec. 354 of the Act provided that the managing agent shall not be paid any office allowance but he may be reimbursed in respect of any expenses incurred by him on behalf of the company and sanctioned by the board or by the company in general meeting. Sec. 356 of the Act provided that no managing agent and no associate of a managing agent shall receive any commission or other remuneration from the company, in respect of sales of goods produced by the managed company, if the sales were made from the premises at which they were produced or from the head office of the managing agent or from any place in India. The expression "associate of a managing agent" has been defined in s. 2(3) (c). Sec. 2(3) (c) lays down that where the managing agent is a body corporate, the expression would, inter alia, include a director of such body corporate, and where the managing agent is a private company, it would also include any member of the private company. Shri Patel was an associate of the assessee company which was the managing agent of the managed company. In view of the provisions of s. 356, Patel could not receive any commission or other remuneration from the managed company in respect of the sales of healds and reeds produced by the managed company. Sec. 361 of the Companies Act, 1956, provided that all the contracts in force at the commencement of the Act, to which a company or the managing agent or an associate of the managing agent of a company was a party, would in so far as the contracts relate to any of the matters referred to in ss. 356 to 360, be deemed to terminate on the first day of March, 1958, unless they terminated on an earlier date.

(2.) ON 13th June, 1956, Patel addressed a letter to the directors of the assessee company drawing the attention of the directors that from 1st April, 1956, the office allowance that was being paid to the assessee company by the managed company, namely, Rs. 12,000 per year, had ceased to become payable by the managed company to the assessee company. He stated in that letter that he was receiving from the managed company remuneration as technical adviser at the rate of Rs. 2,500 per month and an annual bonus of Rs. 3,000. He stated that in view of s. 198 of the Companies Act, 1956, it appeared that the managed company could not make that payment because it would cause the total remuneration permitted by that section to exceed eleven per cent. of their net profits. He further stated that he was working as a selling agent of the managed company for the sale of healds and reeds on remuneration of two and a half per cent. on the sale price and that s. 356 of the Companies Act had prohibited the appointment of an associate as a selling agent and that he had, therefore, ceased to work as a selling agent from 1st April, 1956. He stated that it was not necessary in order that he may devote his attention to the work which he used to do as technical adviser and also devote his attention to the sale of healds and reeds that he should be remunerated for that work by the assessee company as it was in the interest of the assessee company itself that the same attention was continued to be paid to the sales of healds and reeds as also to the technical side of the working of the mills and that he should be sufficiently remunerated for looking after the management of the mill company on behalf of the assessee company. He suggested that the assessee company should remunerate him out of its earnings, that his remuneration as technical adviser was Rs. 33,000 per annum and that the commission as selling agent which he earned in 1955 at the rate of two and a half per cent. amounted to Rs. 20,628-11-0 and that Rs. 12,000 was received as office allowance and that he in one capacity or the other received in all a sum of Rs. 65,628-11-0. He further stated that as the members of the board had desired that he should continue to assist the managed company in the same manner as he used to do before as that was in the large interests of the assessee company itself and that they had agreed to remunerate him so that he should be placed in the same position as he had been occupying before, he requested the board to convene an extraordinary general meeting for voting remuneration to him.

(3.) THE assessee company contended that the sum of Rs. 44,367 paid by it to Patel was an expenditure laid out or expended wholly and exclusively for the purpose of the business of the assessee company. THE ITO by his order dt. 30th Jan., 1958, allowed out of this sum of Rs. 44,367 only a sum of Rs. 12,000 at the rate of Rs. 1,000 per mensem, being the amount which was being allowed to be deducted in previous years on account of payment made to Patel in the previous years. He disallowed the balance of Rs. 32,367. In the course of his decision he observed as follows :