Income-tax---

----Business expenditure---General principles---Remuneration to employees-- Company taking over business of firm---Amount paid by company as work incentive in the very first year of business---Finding that no such payments ever made by firm and that payment in question had not been made on grounds of commercial expediency---Amount paid as work incentive was not deductible---Indian Income Tax Act, 1961, S.37.

The general principle underlying section 37(1) of the Income Tax Act, 1961, is that anexpenditure which is found to have been wholly and exclusively made or laid out by a businessman for purposes of his business is to be allowed. The businessman is the best judge to determine the business expediency and therefore, when he claims to have incurred a certain expenditure for business expediency his version should ordinarily be accepted. This principle, however, does not debar the assessing authorities from enquiring and investigating as to whether such expenditure was actually incurred by the businessman and if incurred whether the same was incurred wholly and exclusively for business considerations. The doctrine that the businessman is the best judge of business expediency does not affect the right of the assessing authorities to know whether-the-expenditure was incurred for business purposes and not for other extraneous considerations. It is open to the Appellate Tribunal to come to a conclusion either that the payment was not real or that it was not incurred by the assessee in the character of a trader or it was not laid out wholly and exclusively for the purpose of the business of the assessee and to disallow it.

The assessee-company took over the business of a firm as a going concern with effect from May 17, 1974. The first accounting year of the assessee-company ended on June 30, 1974. During the accounting year, the assessee-company had made payments of Rs.54,000 as work incentive to its employees. The Income-tax Officer held that the amount was not deductible. The Tribunal examined the payments made to the persons in detail and held that the payments to the employees were not made for any business consideration and were ex gratia payments and such payments had rightly been disallowed by the Income-tax Officer. On a reference:

Held, that the Tribunal had recorded a clear finding that the payments on account of work incentive were not made out of any business expediency and the expenditure incurred was not laid out wholly and exclusively for the purpose of the business of the assessee. In view of the fact that this was the first year of the assessee-company and there was no scheme for making such payments and no such payments had ever been made by the predecessor firm to any of the employees in the past, the conclusion was justified. The Tribunal was justified in holding that the sum of Rs.54,000 paid to the staff was not on account of work incentive and disallowing the said amount.

Gordon Woodroffe Leather Manufacturing Co. v. CIT (1962) 44 ITR 551 (SC) rel.

CIT v. Walchand & Co. (P.) Ltd. (1967) 65 ITR 381 (SC); J.K. Woollen Manufacturers v. CIT (1969) 72 ITR 612 (SC) and Swadeshi Cotton Mills Co. Ltd. v. CIT (No. 1) (1967) 63 ITR 57 (SC) applied.

S.M. Mehta, Senior Advocate and Ms. Sonal Mehta for the Assessee.

K. S. Gupta on behalf of G. S. Bapna for the Commissioner.

JUDGMENT

M.A.A. KHAN, J.---As directed by this Court under section 256(2) of the Income Tax Act, 1961 (for short "the Act"), the Income-tax Appellate Tribunal, Jaipur Bench, Jaipur (for short "the Tribunal"), has referred the following question to this Court for its opinion:

"Whether, in the facts and circumstances of the case the Tribunal was justified in holding that the sum of Rs.54,000 paid to the staff was not on account of work incentive and was further justified in disallowing the said amount as having not been expended wholly and exclusively for the purpose of business of the company?"

The relevant facts, giving rise to the abovementioned question, are these

The assessee-company was incorporated on April 17, 1971. It took over the business of the firm, Asiatics, Jaipur, as a going concern with effect from May 17, 1974. The said firm had been deriving income mainly from assembling, manufacturing and selling diesel generating sets.

The first accounting year of the assessee-company ended on June 30, 1974. Its managing director, Shri Manak Raj Jain, filed the return of income on June 28, 1975, showing a total income at Rs.3,60,040. On scrutiny of the accounts, the Income-tax Officer noted that during the relevant period, the assessee-company had made payments of Rs.54,000 as work incentive to its following employees:

The Income-tax Officer required the assessee-company to inform him whether there was any scheme in the assessee-company for payment of work incentive to its employees and similar payments had ever been made by its predecessor-firm to the aforesaid persons or whether the payments in question were ex gratia. He further required the assessee-company to prove that the payments in question had been made wholly and exclusively to promote its business interests. The assessee-company informed the Income tax Officer that the payments on account of work incentive were made to the employees as per decision of the board of directors and that similar work incentive was given to the employees in the subsequent year. In substance, the assessee-company explained that the payments in question were made by it to its employees out of business expediency and wholly and exclusively for business purposes.

The Income-tax Officer did not accept the contention of the assessee-company and pointed out that the employees to whom the incentives were given were already in the employment of the assessee's predecessor firm. He further pointed out that the sales of Asiatics Jaipur amounted to about-Rs.1.80 crores in the preceding year but no payment as work incentive was ever made by the said firm to any of its employees in any year. He further pointed out that the work incentive was not given to all the employees of the company and also that no evidence was brought on record to show that the increase in sales in the year under consideration or in the following year was entirely due to the efforts made by the aforementioned employees. In this respect, the Income-tax Officer pointed out that the assessee had made payments of Rs.54,000 to various parties during the year and such parties had helped it in obtaining orders for its products from various parties. The increase in sales in the next year was partly due to increase in the prices of raw material. The Income-tax Officer took note of the fact that in addition to the salaries paid to its aforementioned employees, the assessee-company had also paid substantial amount towards dearness allowance, bonus and provided free accommodation to them. After having thus considered the question of allow ability of the work incentives paid to the aforementioned persons by the assessee on the ground of business expediency, the Income-tax Officer concluded that the payments made were ex gratia for non-business considerations. He accordingly disallowed the expenditure of Rs.54,000.

In appeal, the learned Appellate Assistant Commissioner of Income tax examined the issue in sufficient detail and held that the disallowance of Rs.54,000 made by the Income-tax Officer was not justified as the expenditure had been wholly and exclusively incurred for business purposes. He accordingly deleted the addition of Rs.54,000 as had been made by the Income-tax Officer.

In second appeal, the Tribunal examined the payments made to the aforementioned persons in sufficient detail and held that the payments to the employees were not made for any business consideration and were ex gratia payments and such payments had rightly been disallowed by the Income-tax Officer. The order so passed by the Tribunal has given rise to the question set out above.

It was urged by Shri S.M. Mehta, learned senior counsel for the assessee-company, that the justification and reasonableness of the expenditure, as wholly and exclusively laid out for the purpose of the business, has to be judged from the point of view of the businessman and not of the Revenue. Learned counsel submitted that in the instant case since the payments made by the assessee-company to its aforementioned employees were never doubted by the Income-tax Officer, it was not for the Revenue to have disallowed the same on the ground that the expenditure was not incurred or laid out wholly and exclusively for the purposes of the assessee's business. In support of such contention, Mr. Mehta relied upon the decisions of the Supreme Court in the cases of Gordon Woodroff Leather Manufacturing Co. v. CIT (1962) 44 ITR 551, CIT v. Walchand & Co. (P.) Ltd. (1967) 65 ITR 381 and J.K. Woollen Manufacturers v. CIT (1969) 72 ITR 612.

The learned Departmental Representative, on the other hand, vehemently urged that findings recorded by the Tribunal were essentially findings of fact and such findings do not give rise to any question of law. He, therefore, proposed that we should deline to answer the question referred to us.

The learned Departmental Representative may be correct in his contention that the question whether a particular expenditure was or was not wholly and exclusively laid out for business purpose is to be answered on appreciation of relevant facts. Such a question may be considered in two parts. In the first part it is to be considered whether a particular expenditure has at all been incurred or laid out. The answer to such question may be given on appreciation of the relevant facts. In the second part of the question it has to be considered whether the expenditure was incurred wholly and exclusively for business purposes. This part of the question is again to be answered on the basis of appreciation of the relevant facts and material on record. But it was after considering the question referred from that angle that this Court had required the Tribunal to state the case to it raising and referring the question, as set out above, to it for its opinion. In view of the order of the Court passed under section 256(2) of the Act the Revenue cannot now be permitted to contend that the referred question being a question of fact should not be answered by us. We accordingly overrule the objection of the learned Departmental Representative.

Now, in so far as the contention of Mr. Mehta is concerned, we are clearly of the opinion that on the facts of the case, as stated to us by the Tribunal, the question referred is required to be answered in the affirmative, i.e., for the Revenue and against the assessee.

The general principle underlying section 37(1) of the Act is that an expenditure which is found to have been wholly and exclusively made or laid out by a businessman for purposes of his business is to be allowed. There can hardly be any dispute to the proposition that the businessman is the best judge to determine the business expediency and, therefore, when he claims to have incurred a certain expenditure for business expediency his version should ordinarily be accepted. This principle, however, does not debar the assessing authorities to enquire and investigate as to whether such expenditure was actually incurred by the businessman and if incurred whether the same was incurred wholly and exclusively for business consideration. The doctrine that the businessman is the best judge of business expediency does not affect the right, any duty, of the assessing authorities to know whether it was incurred for business purposes and not for other extraneous considerations.

In the case of Gordon Woodroffe Leather Manufacturing Co. (1962) 44 ITR 551 (SC), the person to whom a gratuity of Rs.40,000 was paid by the assessee-company in appreciation of his long and valuable services to the company had been an employee of the managing agent of the assessee from 1922 to 1935 and was an employee of the assessee from 1935 and also its director from 1940. The company had no scheme for payment of gratuity nor had it paid such gratuities in practice. There was also nothing to show that the employee had accepted a low salary in expectation of a gratuity on retirement or that the gratuity was paid for the purpose of facilitating the carrying on of the business of the company or as a matter of commercial expediency. The Supreme Court held that the amount of gratuity paid by the assessee was not, under the circumstances, an expenditure laid out or expended for the purposes of the assessee's business and was not deductible in computing the profits and gains of the company. The apex Court further observed that the tests to apply in a case like this are whether the payment was made as a matter of practice, which affects the quantum of salary or there was an expectation by the employees of getting a gratuity or the money was paid on the ground of commercial expediency and in order indirectly to facilitate the carrying on of the business. The test laid down by the apex Court was not found applicable to the case before their Lordships and, therefore, the gratuity payment was not held deductible in computing the profits and gains of the company. This case goes a long way to support our views in the present case.

In the case of CIT v. Walchand & Co. (P.) Ltd. (1967) 65 ITR 381 (SC), the assessee was a private limited company carrying on the business of acting as managing agent for nine public limited companies. The business of the assessee-company was being managed by three directors and each director was being paid a remuneration of Rs.2,500 per month. The assessee had employed three executive officers to administer its affairs. By resolution dated July 9, 1952, the remuneration of each of the directors of the assessee was increased with retrospective effect from April 1, 1952, by Rs.1,000 per month and of two out of the three officers by Rs.500 per month each and of the remaining officer by Rs.750 per month. In the year 1953, the remuneration of each of the directors was increased by Rs.500 per month and each of the officers by Rs.250 per month. In the assessment proceedings for the assessment years 1953-54 and 1954-55, the Income-tax Officer disallowed the increase in the remuneration of the directors and officers of the assessee on the ground that the expenditure was not laid out wholly and necessarily for the purposes of the business of the assessee-company. In appeal, the Appellate Assistant Commissioner confirmed the order of the Income-tax Officer. In second appeal, the Income-tax Appellate Tribunal modified the order of the assessment by observing, that "it was not for the Income-tax Officer to run the assessee's business and to fix the salary of every member of the staff". That, however, does not mean that it is open to the assessee to allow unreasonable rise in the salary without a valid reason. The Tribunal directed that salary at the rate of Rs.4,000 per month in each case be allowed as revenue deduction. On a reference, the Bombay High Court held that the Tribunal acted without evidence in partially disallowing the increase in the remuneration of the three executive officers. The view, of the Bombay High Court was upheld by the Supreme Court. The apex Court held that in applying the test of commercial expediency for determining whether an expenditure was wholly and exclusively laid out for the purpose of a business, the reasonableness of the expenditure has to be judged from the point of view of the businessman and not of the Revenue. Their Lordships further observed that (at page 385) "an employer in fixing the remuneration of his employees is entitled to consider the extent of his business, the nature of the duties to be performed, and the special aptitude of the employee, future prospects of extension of the business and a host of other related circumstances". Their Lordships further held that it is erroneous to think that increased remuneration can only be justified if there is a corresponding increase in the profits of the employer.

In the case of J.K. Woollen Manufacturers (1969) 72 ITR 612 (SC), the same principle was reaffirmed. In that case the assessee was a firm carrying on the business of manufacture and sale of blankets and other woollen cloth and had appointed Shri J.P. Vanish as its general manager at a salary of Rs.1,000 per month and commission of twelve and a half per cent on the net profits along with certain other benefits. In case the profit exceeded rupees one lakh the commission was payable at 25 per cent. Shri Vaish earned no commission in the first year as the assessee firm suffered a loss. In the next year, Shri Vaish earned a commission of Rs.4,063. In the year relevant to the assessment year 1948-49, Shri Vaish was paid a commission of Rs.75,465 (at 25 per cent. of the profits). After the death of Shri Vaish, the firm was converted into a company and the post of general manager abolished and a director, with a total remuneration of Rs.24,000 per annum to manage the affairs of the company, was appointed. The Income-tax Officer allowed only a sum of Rs.5,000 as reasonable commission and disallowed the balance of Rs.70,465. The Appellate Assistant Commissioner held that commission at twelve and a half per cent. was reasonable and increased the allowance to Rs.37,733. The Appellate Tribunal disallowed Rs.37,733 out of the commission of Rs.75,465 on the ground that the commission paid to Shri Vaish in excess of Rs.24,000 was not really paid wholly for the purposes of carrying on the business. On a reference, the High Court answered the question against the assessee. It was on such facts that the Supreme Court, reaffirming the principles laid down in Swadeshi Cotton Mills Co. Ltd. v. CIT (No. 1) (1967) 63 ITR 57 (SC) and CIT v. Walchand & Co. (Pvt.) Ltd. (1967) 65 ITR 381 (SC) held that in applying the test of commercial expediency for determining whether an expenditure was wholly and exclusively laid out for the purpose of the business, the reasonableness of the expenditure has to be judged from the point of view of the businessman and not of the Income-tax Department. Their Lordships further held that "it is, of course, open to the Appellate Tribunal to come to the conclusion either that the alleged payment is not real or that it is not incurred by the assessee in the character of a trader or it is not laid out wholly and exclusively for the purposes of the business of the assessee and to disallow it".

It may be noted that though in the three cases mentioned above the facts were quite distinguishable from those obtaining in the present case, yet the principle laid down by the apex Court was that it is open to the Appellate Tribunal to come to a conclusion either that the allowed payment is not real or that it is not incurred by the assessee in the character of a trader or it is not laid out wholly and exclusively for the purpose of the business of the assessee and to disallow it. In the case before us the Tribunal has recorded a clear finding that the payments on account of work incentive were not made out of any business expediency and the expenditure incurred was not laid out wholly and exclusively for the purpose of the business of the assessee. We find that the Tribunal has discussed the cases of each and every concerned employee in sufficient detail and it is after taking into account all the relevant facts that the Tribunal has recorded its finding on the so-called business expediency of the assessee-company. In view of the fact that this was the first year of the assessee-company and there was no scheme for making such payments and no such payments had ever been made by the predecessor-firm to any of the employees in the past, the Tribunal could have come to the conclusion, which was arrived at by it. The findings recorded by the Tribunal cannot, thus, be claimed as based on no material. On the facts of the case we hold that the Tribunal was justified in holding that the sum of Rs.54,000 paid to the staff was not on account of work incentive and accordingly the Tribunal was further justified in disallowing the said amount as having not been expended wholly or exclusively for the purpose of business of the assessee-company.

To sum up, we answer the question referred to us in the affirmative, i.e., for the Revenue and against the assessee. Let the record of the Tribunal, if requisitioned, be returned along with our opinion for further action according to law.

V.K.SINGHAL, J.---I agree with the order proposed by my learned brother but would like to add a few lines to that:

The Tribunal found that the assessee has not brought on record the price of the raw material and sale price during the accounting period relevant to the assessment year under appeal as compared to the immediately preceding year to establish that there was an increase in sale on account of efforts of these employees. The details of the order in respect of old parties and new parties were also not submitted. No evidence was brought on record to show that the increase in sale was entirely due to special effort by those employees. Besides this, payment of Rs.54,000 was made to other parties for obtaining the orders. The work incentive paid to the employee was found disproportionate to the monthly salary and not commensurate with the pay and benefits salary allowed. The increased incentive had not been paid to other employees. Thus, the totality of the circumstances, were taken into consideration and it was found that no nexus has been established between the expenditure incurred and the business of the assessee. The burden to prove that the expenditure incurred or laid out was exclusively for the purpose of business of the assessee, was on the assessee and it was found by the Tribunal that no evidence has been produced that by any extra efforts of these employees the sales have been increased or the amount expended was in any way related wholly and exclusively for the business of the assessee. Simply because certain amount had factually been expended, it cannot be allowed as deduction unless it is established -that it, was wholly and exclusively for business or had intimate connection, thereto or-was incurred for carrying on such business.

M.B.A./1628/FCOrder accordingly.