Commissioner of Income Tax vs Patiala Flour Mills Co. P. Ltd.

Gokal Chand Mital, J.—At the instance of the Revenue, the Income Tax Appellate Tribunal, Chandigarh, has referred "the following questions for our opinion:

"1. Whether, on the facts and in the circumstances of the case, the Income Tax Appellate Tribunal was right in law in holding that the assessee''s claim for deduction of litigation expenses amounting to Rs. 32,385, Rs. 82,274 and Rs. 2,833 for the assessment years 1977-78, 1978-79 and 1979-80 were allowable u/s 37 or 57 of the Income Tax Act, 1961 ?

Whether, 6n the facts and in the circumstances of the case, the Income Tax Appellate Tribunal was right in law in holding that the commission paid to the managing director for the assessment years 1978-79 and 1979-80 was not covered by Section 40(c) of the Income Tax Act, 1961 ?

Whether, on the facts and in the circumstances of the case, the Income Tax Appellate Tribunal was right in law in confirming the order of the Commissioner of Income Tax (Appeals) relating to the assessment years-1978-79 and 1979-80 holding that interest of Rs. 2,12,158 is not hit by the mischief of Section 40A(8) of the Income Tax Act, 1961 ?"

Question No. 3 related to the assessment years 1978-79 and 1979-80 but in the question printed in the paper book, 1979-80 was omitted. Counsel for the parties agree that question No. 3 related to both the assessment years and, therefore, we have incorporated the correction in the question. A reading of para 2 of the statement of the case confirms that question No. 1 relates to three assessment years, whereas the other two questions, namely, Nos. 2 and 3, relate to two years only.

The assessee is Patiala Flour Mills Co. Pvt. Ltd., and its business has been of milling of wheat into wheat products and the sale thereof, to operate cold storage plant and to invest its funds in shares of various companies.

In 1966, the assessee promoted a company called "Modi Pon Ltd.", with a share capital of Rs. 2 crores. The U.P. State Industrial Corporation Ltd. (hereinafter called "the Corporation") undertook to underwrite 20% of the shares of Modi Pon worth Rs. 40 lakhs.

The assessee persuaded the Corporation to underwrite a share capital of Rs. 58.80 lakhs instead of a share capital of Rs. 40 lakhs and entered into an agreement in this behalf. The Corporation did not return the shares worth Rs. 18.80 lakhs, the additional shares to which the Corporation had also undertaken to underwrite and to get them back the assessee-company was engaged in litigation and during the accounting years relevant to the assessment years 1977-78 to 1979-80, it incurred litigation expenses and claimed the amounts as revenue expenditure u/s 37 or 57 of the Income Tax Act, 1961 (hereinafter called "the Act"). On these facts, we have to answer question No. 1 and we proceed to do so.

As per the agreement, the Corporation had agreed to return the additional shares of Rs. 18.80 lakhs and undertook to underwrite them but later on backed out of it. The litigation expenses incurred by the assessee in doing so clearly fell within the ambit of Section 37 or Section 57 of the Act The litigation expenses cannot be added to the value of the shares ; rather the expenses were incurred in the assessee''s effort to protect the shares worth Rs. 18.80 lakhs. On behalf of the Revenue, reliance was sought to be placed on Rajasthan Construction Co. (P.) Ltd. Vs. Commissioner of Income Tax, , for not allowing the litigation expenses. The facts of that case are distinguishable. In that case, the assessee had entered into an agreement to purchase certain land and when the transferor backed out, a suit for specific performance was filed. The Bombay High Court held that the litigation expenses had not been incurred to protect any asset. Here, the litigation was started to protect the shares worth Rs. 18.80 lakhs. Moreover, we have held in Income Tax Reference No. 135 of 1979 ( Hindustan Milkfood Manufacturers Ltd. Vs. Commissioner of Income Tax, ), decided on March 7, 1989, on the basis of India Cements Ltd. Vs. Commissioner of Income Tax, Madras, , a Supreme Court decision, that the expenses like stamp duty, lawyers'' fee, etc., would be revenue expenditure. Accordingly, we hold that the Tribunal was right in allowing deduction of the litigation expenses u/s 37 or 57 of the Act and answer the question in favour of the asses-see, in the affirmative.

For the decision of question No. 2, the following facts deserve to be kept in view. During the accounting period relevant to the assessment years 1978-79 and 1979-80, the assessee paid Rs. 2,000 per month as salary and gave commission at the rate of 4% on the net profits to Seth Harmukh Rai Modi, who was the managing director of the assessee-company. The salary and commission were sought to be deducted in the assessment proceedings for the two years. The Income Tax Officer came to the conclusion that payment of bonus, commission, honorarium or any share in the profits of the assessee-company to the managing director constituted remuneration and was covered by Section 40(c) of the Act and the whole of it could not be allowed under that provision read with Section 40A(5) of the Act if it exceeded Rs. 72,000. However, when the matter came before the Tribunal, it took a contrary view and granted relief to the assessee.

Question No. 2 deserves to be decided in favour of the Revenue in view of the decision of this court in Commissioner of Income Tax Vs. Patiala Flour Mills Co. (P.) Ltd., , in the case of the same assessee for the assessment, years 1972-73 to 1974-75, wherein also the point arose as to whether the commission paid to the managing director is remuneration or not. It was concluded that in view of Section 40A(5), deduction of Rs. 72,000 per annum was permissible. Moreover, a reading of Section 40A(5), as it stood" at the relevant time, also shows that deduction in regard to salary and commission paid to the managing director or director could not exceed Rs. 72,000 per annum. Accordingly, in view of the aforesaid provision and the decided case inter panes, it is held that the Tribunal was not right in allowing the deduction beyond Rs. 72,000 per annum.

On behalf of the assessee, reliance was placed on Commissioner of Income Tax Vs. Avon Cycles (P.) Ltd., for allowing the entire commission and salary and not limiting it to Rs. 72,000 per annum. The reported decision is distinguishable as payment of commission was not made to the director but to a partnership concern, which was the sole selling agent of the assessee in which one of the directors of the assessee-company was a partner. It was held that the partnership was an independent legal entity and its dealing with the assessee-company did not amount to dealing by a director with its company.

In the question referred, Section 40(c) of the Act has been mentioned. In view of the decisions in Travancore Rayons Ltd. Vs. Commissioner of Income Tax, and Travancore Rayons Ltd. v. CIT [1988] 172 ITR 350, we are of the opinion that Section 40(c) alone is not applicable. Rather, Section 40A(5) read with Section 40(c) would be applicable and payment made to the managing director beyond Rs. 72,000 per annum, whether as salary or commission, is not a permissible deduction and the question is answered in favour of the Revenue, in the negative.

For answering question No. 3, the following facts need consideration. Seth Chiranji Lal Multanimal Rai Bahadur were the buying agents of the goods manufactured by the assessee for Patiala. The Company Law Board approved the buying agency agreement u/s 314 of the Companies Act, up to January 31, 1976. Beyond January 31, 1976, extension of commission agency was not granted and that is why the assessee did not pay any commission to the sole buying agents after January 31, 1976. This is an admitted fact noticed by the Tribunal in its order printed at page 100 of the paper book.

When the agreement regarding the buying agency was entered into, the buying agent deposited the amount with the assessee by way of security or advance. The deposited amount was not refunded to the buying agents on or after January 31, 1976, and the amount remained with the assessee and on that amount the assessee kept on paving interest. The amount of interest paid to the buying agents was claimed as deduction u/s 40A(8), Explanation (b)(vii). The Income Tax Officer took the view that since the buying agency came to an end on January 31, 1976, the deposited amount of the buying agency thereafter could not be considered as a deposit by the buying agents and Explanation (b)(vii) to Section 40A(8) was not attracted and under Sub-section (8) of Section 40A, 15 per cent. out of the interest paid on the deposited amount could not be allowed as a deduction. However, this view did not find favour with the Tribunal and the Tribunal allowed the deduction of the entire interest.

The argument raised on behalf of the assessee was that the deposit was made by the buying agency and even if the buying agency could not be considered legal after January 31, 1976, the nature of the deposit would continue to be the same, that is, from the buying agency. In highlighting the argument, it was urged that the nature of the deposit has to be seen at the time of the deposit and would not vary unless there was a contract to the contrary and, in this case, according to learned counsel, there was no contract to the contrary although the buying agency was not being considered legal after January 31, 1976, as the Company Law Board did not grant extension or approval beyond that date. We are not impressed with the argument. It is true that when the deposit was made, the depositor was the buying agent and tilt the buying agency continued by virtue of Clause (b)(vii) of the Explanation to Section 40A(8), such a deposit would not be a "deposit" within the meaning of Sub-section (8) of Section 40A and the cut of 15 per cent., in the interest paid, could not be made. The moment the buying agency came to an end, whether by contract or by operation of law, the nature of the deposit would not be that of a deposit from a buying agent but would partake of the nature of any other deposit. Conversely, suppose when a person makes a deposit, he is not the buying agent of the assessee, but later on becomes the buying agent and the deposit is adjusted towards the security or advance from the buying agent. From the date of the creation of the buying agency, the interest payable on such deposit would not be sub jected to the cut of 15 per cent., but the moment the buying agency would come to an end, the provisions of Section 40A(8) of the Act would again be applied and. the cut. would be imposablc. In this view of the matter, we are of the opinion that the Tribunal was in error in confirming the order of the Commissioner of income tax" (Appeals) in holding that the interest paid to the ex-buying agency on the deposit made by it is not hit by the mischief of Section 40A(8) of the Act. Therefore, we are clearly of the view that Section 40A(8) of the Ad. is applicable and since interest on the deposit was paid at a time when there was no legal buying agency in operation, the assessee could not, claim the benefit of Explanation (b)(vii) appended to the afore said sub-section. Accordingly, the third question is answered in favour of the Revenue, in the negative.

In view of the divided success, the parties are left to bear their-own costs.