COMMISSIONER OF INCOME-TAX VS NATIONAL PHARMACEUTICALS AND MEDICAL SERVICES (P.) LTD.
1999 P T D 2065
[226 I T R 518]
[Kerala High Court (India)]
Before V. V. Kamat and P.A. Mohammed, JJ
COMMISSIONER OF INCOME-TAX
Versus
NATIONAL PHARMACEUTICALS AND MEDICAL SERVICES (P.) LTD.
Income-tax Reference No.27 of 1987, decided on 11/06/1996.
Income-tax---
----Business expenditure---Company---Disallowance of expenditure-- Commission paid to selling agent---Finding that selling agent was related to a person having substantial interest in company---Section 40(c) was applicable---Commission paid in excess of statutory limit was not deductible---Indian Income Tax Act, 1961, S.40(c).
Section 40(c) of the Income Tax Act, 1961, relates to the case of any company and specifically to any expenditure or allowance in regard to which the normal deduction is sought. The statutory key words would show that such items should directly or indirectly result in a remuneration, benefit or amenity to a director or to a person who has substantial interest in the company or to a relative of the director or of such person, with an addition that such expenditure or allowance would not be deductible even where such expenditure or allowance is either wholly or partly shown to have been used or received for his own purpose or benefit. The Income-tax Officer has to be of the opinion that such expenditure or allowance is excessive or unreasonable having regard to the legitimate business needs of the company and the benefits derived by or accruing to it therefrom. Yet, after this formation of opinion the concerned Income-tax Officer has been given a statutory limit in respect of aggregate of such expenditure or allowance in respect of any one person by enacting that in no case such expenditure or allowance shall exceed Rs.72,000.
The assessee-company paid commission at the rate of nine per cent which amounted to Rs.1,08,598 to O as a selling agent. It was found that O was the son of G, who had substantial interest in the assessee-company. Therefore, the Income-tax Officer resorted to the provisions of section 40(c) of the Act. The Income-tax Officer disallowed the amount in excess of Rs.72,000. The Tribunal deleted the disallowance. On a reference:
Held, that section 40(c) applied and the amount paid as commission in excess of Rs.72,000 was not deductible.
Bharat Beedi Works P. Ltd. v. CIT (1993) 201 ITR 1063 (SC) and CIT v. Indian Engineering and Commercial Corporation P. Ltd. (1993) 201 ITR 723 (SC) rel.
CIT v. Avon Cycles (P.) Ltd. (1980) 126 ITR 448 (P & H); CIT v. Mafatlal Gangabhai & Co. (P.) Ltd. (1996) 219 ITR 644 (SC); Gestetner Duplicators P. Ltd. v. CIT (1979) 117 ITR 1 (SC); Prakash Beedies P. Ltd. v. CIT (1993) 201 ITR 1063 (SC) and T.T. Pvt. Ltd. v. ITO (1980) 121 ITR 551 (Kar.) ref.
P.K.R. Menon for the Commissioner.
C. Kochunni Nair, M.A. Firoz and Dale P. Kurien for the Assessee.
JUDGMENT
V.V. KAMAT, J.---The following question is brought by the Revenue for answer:
"Whether, on the facts and in the circumstances of the case, and also on an interpretation of section 40(c) of the Income-tax Act, the Tribunal is right in interfering with the disallowance of the commission paid in excess of the limit laid down in the statute?"
The factual matrix will encircle the controversy and reduce the consideration of irrelevant aspects.
The assessment year is 1976-77 ending on March 31, 1976. In fact, the assessment was completed on October 20, 1976. The Income-tax Officer, finding in consequence of information that chargeable income had escaped assessment, initiated proceedings under section 147(b) of the Income-tax Act. A notice was served under section 148 of the Act on the Assessee. On September 4, 1980, the Assessee furnished a return of income in response to the notice. The assessee is National Pharmaceuticals and Medical Services (P.) Ltd.
As seen from the order passed in pursuance thereof on March 30, 1981, commission at the rate of 9 per cent. with regard to the amount of Rs.21,71,963 was paid to one Shri P.G. Oommen as a selling agent. Shri P.G. Oommen was found to be the son of Shri. P.G. George who had a substantial interest in the assessee-company. Therefore, the Income-tax Officer resorted to the provisions of section 40(c) of the Act, because in the case of a company and expenditure which results directly or indirectly in the provision of any remuneration or benefit or amenity to a director or to a person who has a substantial interest in the company or to a relative of the director or of such person and in case the amount is in excess of Rs.72,000 the excess over the said limit is to be disallowed under the said statutory provision. Rs.1,08,598 was found to be given by way of commission to this Shri P.G. Oommen. and, therefore, the Income-tax Officer disallowed the excess over Rs.72,000, following the statutory provisions of section 40(c) of the Income Tax Act, 1961.
In the process of reasoning the Income-tax Officer found that the audit party had given factual information that the commission was paid to a person who is related to a person having substantial interest in the company and such commission had exceeded Rs.72,000, attracting the above statutory provision. Accordingly by the order, the amount of commission found in excess of Rs.72,000 namely, Rs.36,598, came to be disallowed by the Income-tax Officer.
The assessee appealed before the Commissioner of Income-tax (Appeals), Ernakulam. The appeal is decided by the order, dated August 12, 1982. The first appellate authority considered the submissions alongwith reliance, firstly on the decision of the Punjab and Haryana High Courts in CIT v. Avon Cycles (P.) Ltd. (1980) 126 ITR 448, and also the decision of the Karnataka High Court in T.T. Pvt. Ltd. v. ITO (1980) 121 ITR 551. The first appellate authority allowed the appeal holding that no information could be said to have come to the possession of the Income-tax Officer after the completion of the original assessment and the information was apparently available at the time when the original assessment was made. The first appellate authority therefore, concluded that the decision is taken by the officer with the knowledge of the facts of the case and, therefore, the reopening of the assessment is not warranted in law. This was the only aspect considered by the appellate authority in allowing the appeal. The Department brought the matter to the Income-tax Appellate Tribunal. Cochin Bench, and the assessee-placed his objections before the Tribunal.
The Tribunal found that the assessee had not placed any material before the Tribunal to show that at the time of the passing of the original assessment order the relationship of Shri P.G. Oommen with the shareholders of the company as disclosed in any manner. The Tribunal also held that the balance-sheet and the profit and loss account would not have disclosed the relationship. The Tribunal also found that in the statement of details of sundry expenses furnished by the assessee the relationship was not disclosed. The reasoning proceeded to record a conclusion that the Income tax Officer, at the time of passing the original assessment order, was not aware of the relationship earlier. With this reasoning, the Tribunal accepted the reopening of the assessment.
In fact it is the second contention that was taken up for consideration by the Tribunal that has direct connection with the question which we are called upon to answer.
It was argued before the Tribunal that section 40(c) was not attracted to payment of commission to a sole selling agent. In regard to this submission reliance was placed on the decision of the Karnataka High Court in T.T. Pvt. Ltd. v. ITO (1980) 121 ITR 551, as well as on the decision of the Punjab and Haryana High Courts in CIT v. Avon Cycles (P.) Ltd. (1980) 126 ITR 448. Following the earlier decision of the Karnataka High Court, the Tribunal has observed in this connection that it is held therein that where a company pays commission to a firm as its sole selling agent and the partners of the firm are directors of the company and their relatives, there is no nexus between the services rendered by the partners of the firm and the payment of commission by the company to the firm, and, therefore, the commission paid to the firm in lieu of services rendered by the firm in its business activity cannot be said to be payment of reward, pay: wages or salary and that such payments will not be hit by section 40(c).
It was urged before the Tribunal for the purpose of distinguishing the decision cited that the selling agents were firms and in the factual matrix to be taken into consideration the sole selling agent is an individual. The Tribunal found that there is no material and it was not the case of the Department that the said sole selling agent had no organisation or establishment of his own in functioning as a sole selling agent
It was also submitted before the Tribunal on behalf of the Department, placing reliance on the decision of the Supreme Court in Gestetner Duplicators P. Ltd. v. CIT (1979) 117 ITR 1. that the said decision has not been considered in the decision of the Karnataka and Punjab and Haryana High Courts cited in support thereof. The Tribunal considered the matter before the Supreme Court in Gestetner Duplicators' case (1979) 117 ITR 1, and has observed that it related to the expression "salary" as defined in Rule 2(h) of Part A of Schedule IV to the Income Tax Act, 1961. It is observed that the decision related to the case of employees being entitled to salary and also commission and the dispute was whether the employer-assessee's contributions relating to the commission portion was allowable as a deduction. The Tribunal concluded the discussion by stating that the issue arising in the present case did not come up before the Supreme Court and, therefore, has not been considered.
In the process of reasoning in 'answer to the submission of the Department, the Tribunal observed that it is not the case of the Department that Shri P,G. Oommen was an employee of the assessee-company. The Tribunal has stated this on the basis of a query from the letter, dated April 21, 1980, addressed by it to the Income-tax Officer, to find out as to whether there was any kind of employee-employer relationship on the basis of the material on record. The Tribunal came to the conclusion that the issue is covered by the two High Courts decisions referred to above. In conclusion, the Tribunal upheld the order of the first appellate authority for different reasons as enumerated hereinbefore.
We have reproduced the question referred hereinabove. We have to answer as to whether the provisions of section 40(c) of the Income Tax Act, 1961, squarely applies to the situation available with reference to the factual matrix enumerated hereinbefore.
Firstly, learned senior standing counsel for taxes took us through the statutory provisions of section 40 relating to situations showing amounts which are not deductible by reason thereof. The said statutory provision deals with four situations and are classified by clauses (a) to (d). Needless to state that section 40(cl is one of the said four provisions and it relates to the case of any company and specifically to any expenditure or allowance in regard to which the normal deduction is sought. The statutory key words would show that such items should directly or indirectly result with regard to any remuneration or benefit or amenity, to a director or to a person who has a substantial interest in the company or to a relative of the director of such person, with an addition that such expenditure or allowance would not be deductible if the situation gets satisfied with regard to the requirements and even in a case whether such expenditure or allowance is either wholly or partly shown to have been used or received for his own purpose of benefit.
After specifying that the requirements are available for application, certain further requirements are also available in the provision.
The Income-tax Officer has to be of the opinion that such expenditure or allowance is excessive or unreasonable having regard to the legitimate business needs of the company and the benefits derived by or accruing to it therefrom.
Yet, after this formation of opinion the concerned Income-tax Officer has been given a statutory limit in respect of the aggregate of such expenditure or allowance in respect of any one person by enacting that in no case expenditure or allowance shall exceed Rs.72,000. These are statutory provisions that are really necessary in the aid of consideration of answer to the question referred to us.
Learned senior standing counsel for taxes submitted that on the factual matrix as is presented before us and the order that has been passed by the authorities below, the application of the provisions of section 40(c) of the Income Tax Act, 1961, would be beyond question. Learned counsel submitted that what is firstly required is to know the person on whose account deduction is claimed by the assessee-company. Learned counsel submitted with the help of the statutory provision that if the person is himself the director of a company then the provisions would be directly applicable. Learned counsel submitted that if such a person who is one who has substantial interest in the company even then the provisions would be applicable with regard to the expenditure or allowance received by him from the company. Learned counsel additionally submits that there is yet a third category of a person being the relative either of the director or of such person and if the said person is a relative he would also be governed by the said statutory provision alone and no other provisions of the Act in regard to the question as to whether the amount paid by the company and received by such person is sought to be the subject-matter of a claim for deduction. Learned senior counsel submitted that the Income-tax Officer has done no other thing than application of the said provision with regard to the claim for deduction which was not within the knowledge when the original assessment was completed.
At the other end, learned counsel for the assessee strenuously drawing much from the decision from the Karnataka and Punjab and Haryana High Courts took us through the provisions of section 40-A of the Income tax Act to contend that the situations would be governed by the said statutory provisions (section 40-A of the Act). In the process, learned counsel also took us through the recent decision of the Supreme Court in CIT v. Mafatlal Gangabhai and Co. (P.) Ltd. (1996) 219 ITR 644.
A bare reading of the provisions of section 40-A would arrest our attention to the proviso thereto (proviso to section 40-A(2)(a)). It would be apt to quote the said proviso ad verbatim and it is as follows:
"Provided that the provisions of this subsection shall not apply in the case of an assessee being a company in respect of any expenditure to which sub-clause (i) of clause (c) of section 40 applies. "
It would at once be clear that when the assessee is a company and the question is of expenditure to which sub-clause (i) of clause (c) of section 40 applies, the situation would not be governed for application of section 40-A of the Act.
Apart from the above statutory provision learned senior standing counsel for taxes brought to our notice two decisions of the Supreme Court in CIT v. Indian Engineering and Commercial Corporation P. Ltd. (1993) 201 ITR 723 and Bharat Beedi Works P. Ltd. v. CIT and Prakash Beedies P. Ltd. v. CIT (1993) 201 ITR 1063. On the basis of the two decisions of the Supreme Court, learned counsel contended that when the question is answered by the Apex Court the decisions of the High Court would pale into insignificance by virtue of Article 141 of the Constitution of India. We have carefully gone through both the decisions and in our judgment, reading the two decisions the question is answered in a crystal clear manner.
Indian Engineering's case (1993) 201 ITR 723 (SC), was taken up before the Supreme Court on questions relating to the remuneration paid by the assessee-company to its directors, forming part and parcel of the salary allowed to them. In other words, the amount stated to have been paid by the company to the directors and sought to be deductible related to salary and the amounts of commission in proportion in regard thereto. It is observed that the commission was paid to the said directors on the sales effected by the assessee-company at a prescribed percentage. The Supreme Court has posed the question as to whether the commission on sales falls within the four corners of section 40(a)(v) or section 40-A(5) of the Act. It is needless to state, as regards the statutory provision as was applicable for the concerned assessment years in question before the Supreme Court (1971-72 and 1972-73). The Supreme Court has considered the provisions in regard to directors who were employees and with regard to the amounts paid to them by way of commission having relationship of percentage to the salary of the directors concerned. In the process of analysis, we find from a reading of the judgment that the payment was in cash and was paid as such to the concerned directors. In the paragraph appearing at page 728 it is specifically observed that the provision in clause (c) of section 40 applies to directors amongst others. It is specified thereafter, that section 40(c) is applicable only to companies whereas section 40-A(5) is applicable to the employees whether of companies or others. It is further clarified that in the case of directors who are employees, both the provisions will be attracted--the higher of the two ceilings has to be applied. Therefore, apart from the statutory provision in the nature of the proviso reproduced hereinbefore, the decision under consideration at present declares the law that it would be section 40(c) of the Act that would cover the situation of directors and the provisions of section 40-A(5) would cover the situation of employees whether of companies or others and whether such employees may be directors, leading to a situation in, regard to them that both the provisions would be attracted.
The Supreme Court in the Bharat Beedi Works' case (1993) 201 ITR 1063, has in fact considered the object behind the said statutory provisions and it was to discourage and disallow payment of high salaries and remuneration which go ill with the norms of an egalitarian society. It has also observed that the said provision is not confined to the directors and it took in relatives of directors, persons having substantial interest in the company and their relatives and in regard thereto the Income-tax Officer is vested with the power to determine whether such expenditure or allowance was excessive or unreasonable having regard to the legitimate business needs of the company and the benefit derived by or accruing to it therefrom. It is also observed that a wide net is cast by reason of the two statutory provisions with the sole purpose of ensuring that excessive and unreasonable payments are not made to the persons in control of the affairs of the assessee in the name of paying for the goods, services and facilities rendered, supplied or extended to them, as the case may be.
In our judgment, in view of the above position, it is not necessary to' run after other questions considered in the two decisions. It is also not necessary, in view of the declaration of law as specified hereinabove and also the plain statutory provision in the nature of the proviso to consider other aspects dealt with by the two decisions of the Supreme Court. Needless to state in the context that the decision in Mafatlal Gangabhai and Co.'s case (1996) 219 ITR 644 (SC), placed before us by learned counsel for the assessee dealing with the question relating to cash payments by the company to its employees would also be unnecessary for consideration in the context of the above discussion. The decision related to the nature of payment and the payment was a cash payment. In fact, the decision also rules that the language employed is not capable of taking within its ambit cash payments made to the employees by the assessee. The decision would have to be appreciated on the basis of factual peculiarities in regard thereto. The question before us is whether the situation would be governed by the provisions of section 40(c) of the Act and the answer to it is crystal '.clear both from the statutory provisions and the two decisions of the Supreme Court referred to above. It also needs to be mentioned that the decision of the Tribunal is a situation of finality as far as the assessee is concerned.
For the above,reasons the question is answered in the negative, in favour of the Revenue and against the assessee.
A copy of this judgment under the seal this Court and the signature of the registrar shall be sent to the Income-tax Appellate Tribunal, Cochin Bench, for passing consequential orders.
M.B.A./1951/FCReference answered.