Commissioner of Income Tax vs Sarabhai Sons Ltd.

Mankad, J.—The Tribunal, Ahmedabad Bench ''A'' has, at the instance of the Commissioner, referred to us for our opinion following three questions, u/s 256(1) of the income tax Act, 1961 (''the Act''):

Whether, on the facts and in the circumstances of the case, the Tribunal, was right in holding that when a private limited company was managed the liability to pay remuneration to director or directors had accrued in law?

Whether, the Tribunal was justified in directing that the assessee was entitled to deduction in respect of remuneration payable to director or directors and directing the income tax Officer to quantify the allowable amount?

Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that the assessee was entitled to relief u/s 84 at 6 per cent of the capital employed Rs. 5,51,365 though the Systronix division worked only for nine months in the accounting year?

The assessee is a private limited company and the assessment year involved in this reference is assessment year 1967-68, the year of account being financial year 1966-67 ending at 31-3-1967. It would be convenient to first deal with Question Nos. 1 and 2, which arise out of the assessee-company''s claim for deduction in respect of the remuneration paid to Mr. Gautam Sarabhai, Chairman of the board of directors of the assessee-company. The facts insofar as they are relevant to the first two questions may be briefly stated as under:

Late Dr. Vikram Sarabhai, who was the Chairman of the board of directors of the assessee-company resigned as Chairman with effect from 30-6-1966. Dr. Vikram Sarabhai was not paid any remuneration for the services which he rendered to the assessee-company. He was paid entertainment allowance of Rs. 400 per month. After his resignation, he was not paid even this entertainment allowance. Mr. Gautam Sarabhai was appointed as Chairman of the board of directors in place of Dr. Vikram Sarabhai and at the request of the board of directors, he looked after the management of the assessee-company from 1-4-1966 to 31-3-1967. No remuneration was fixed for the services which Mr. Gautam Sarabhai was to render to the assessee-company. It, however, appears that provision of Rs. 14,750 was made in the profit and loss account for the year in question for remuneration to directors, subject to the approval of the annual general meeting of the assessee-company. Narration in the voucher which was prepared in respect of this provision was to the effect that Rs. 14,750 were debited as remuneration to directors'' account. However, no remuneration was in fact determined till the annual general meeting of the assessee-company, which was held on 29-9-1967. By a notice dated 25-12-1967, an extraordinary general meeting of the shareholders of the assessee-company was called on 22-1-1968 and at this meeting, the shareholders passed resolution fixing Mr. Gautam Sarabhai''s remuneration at Rs. 1,35,000 and bonus at 20 per cent thereof together with benefits of contributory provident fund and gratuity for the period from 1-4-1966 to 31-3-1967, which, as stated above is the previous year relevant to the assessment year 1967-68. Remuneration, bonus, etc., which became payable to Mr. Gautam Sarabhai for the year 1966-67 under the said resolution were as follows :

Rs.

Remuneration

1,35,000

Bonus at 20 per cent

27,000

Company''s contribution to the provident fund

13,500

1,75,500

In the accounts for the financial year 1967-68, corresponding to the assessment year 1968-69, having regard to the provision of Rs. 14,750 already made in the financial year 1966-67, an amount of Rs. 1,60,750 was deducted from the profits. In the course of the assessment proceedings for the assessment year under reference, that is, the assessment year 1967-68, the assessee-company claimed deduction of Rs. 1,75,000 being the remuneration paid to Mr. Gautam Sarabhai. It may be mentioned here that this claim for deduction was made by the assessee-company by filing a revised return of income and that the assessee-company had not claimed deduction even of Rs. 14,750, the provision made for remuneration to be paid to the directors as stated above.

The ITO while framing assessment for the assessment year 1967-68, disallowed the assessee-company''s claim for deduction of Rs. 1,75,000. In his view, deduction of Rs. 14,750, the provision made as aforesaid, also could not be allowed as there was no resolution sanctioning the payment of such remuneration during the relevant year of account. So far as the balance of remuneration of Rs. 1,75,000 was concerned, the ITO took the view that the claim for deduction of expenditure is allowable only when it is actually taken into account books and since the above expenditure of Rs. 1,60,750 was considered for deduction in the accounts for the assessment year 1968-69, no question of admissibility of the expenditure as deduction arises in the assessment year under reference, that is, the assessment year 1967-68. In the result, the ITO disallowed the above claim for deduction made by the assessee-company.

The AAC, before whom the assessee-company carried the matter in appeal, having agreed with the view taken by the ITO, the assessee-company preferred further appeal to the Tribunal. The Tribunal took the view to the effect that since Mr. Gautam Sarabhai had rendered his services in the management of the affairs of the assessee-company, liability to pay remuneration for such services, accrued during the year of account relevant to the assessment year under reference. According to the Tribunal, the mere fact that, liability was quantified after the close of the accounting year would not be adequate reason to disallow the assessee-company''s claim for deduction of the expenditure incurred by it in paying remuneration to Mr. Gautam Sarabhai. However, since the ITO had not examined the assessee-company''s claim in the light of the provisions of section 40(c) of the Act, the Tribunal remanded the question of admissibility of the above deduction for fresh examination to the ITO in the light of the provisions of section 40(c). It is in the background of the above facts that first two questions are referred to us for our opinion.

What is strenuously argued on behalf of the revenue is that the assessee-company had failed to establish that the liability to pay remuneration to Mr. Gautam Sarabhai had accrued in the relevant year of account and, therefore, its claim for deduction of remuneration deserves to be rejected. It was urged that it was for the assessee-company to bring all relevant facts on record in support if its claim and unless such facts are brought on record, it would not be possible to come to any de finite conclusion whether or not the liability to pay remuneration to Mr. Gautam Sarabhai had in fact accrued in the year of account. In this connection, our attention was drawn to section 314 of the Companies Act, 1956, and it was urged that a director of a company cannot hold any office or place of profit, unless the procedure as laid down in section 314 of the Companies Act was followed. The contention of the revenue was that Mr. Gautam Sarabhai must be deemed to have held office or place of profit within the meaning of subsection (3) of section 314 of the said Act. He could not have held office or place of profit unless a special resolution sanctioning remuneration to Mr. Gautam Sarabhai was passed at the general meeting of the company held for the first time after the holding of such office or place of profit. The facts on record show that no resolution sanctioning the remuneration to Mr. Gautam Sarabhai was passed at the annual general meeting held on 29-9-1967, which it may be assumed for the sake of argument, was the first general meeting of the company after Mr. Gautam Sarabhai held the office or place of profit. Consequently, Mr. Gautam Sarabhai should be deemed to have vacated his office under sub-section (2) of section 314 and the remuneration, even if paid to him, was liable to be refunded. It was, therefore, urged that no liability to pay remuneration to Mr. Gautam Sarabhai had accrued at all. But even apart from that, it was urged, no remuneration had become payable to Mr. Gautam Sarabhai till resolution was passed at the extraordinary general meeting of the assessee-company held on 22-1-1968. It was this resolution, which created the liability of the company and the right in favour of Mr. Gautam Sarabhai to claim remuneration. Therefore, the liability to pay remuneration, even if it arose, arose for the first time on 22-1-1968, which fell outside the relevant year of account. In other words, according to the revenue, even if any liability to pay remuneration accrued, it accrued in the subsequent assessment year, that is, the assessment year 1968-69.

It was never the case of the revenue before the lower authorities that the assessee-company was not entitled to claim deduction of remuneration paid to Mr. Gautam Sarabhai because it had contravened or not followed or not complied with the provisions of section 314 of the Companies Act. The only ground on which the assessee-company''s claim was rejected was that since the resolution sanctioning remuneration was passed in the subsequent year, the liability to pay remuneration could not be said to have arisen in the year of account relevant to the assessment year under reference. According to the revenue, the liability to pay remuneration was not known when the accounts of the company were closed for the said year. Ordinarily, we would not have permitted the revenue to raise the contention for the first time that there was non-compliance with the provisions of section 314 of the Companies Act and, therefore, the liability to pay remuneration to Mr. Gautam Sarabhai had not accrued; but even if we were to permit the revenue to raise this contention, having regard to the facts on record, we do not find any merit in this contention. Section 314(1) of the Companies Act on which the revenue relies reads as under:

(1) Except with the consent of the company accorded by a special resolution,-

(a) no director of a company shall hold any office or place of profit, and

(b) no partners or relative of such director, no firm in which such director, or a relative of such director, is a partner, no private company of which such director is a director or member, and no director or manager of such a private company, shall hold any office or place of profit carrying a total monthly remuneration of five hundred rupees or more,

except that of managing director or manager, banker or trustee for the holders of debentures of the company-

(i) under the company; or

(ii) under any subsidiary of the company, unless the remuneration received from such subsidiary in respect of such office or place of profit is paid over to the company or its holding company:

Provided that it shall be sufficient if the special resolution according the consent of the company is passed at the general meeting of the company held for the first time after the holding of such office or place of profit:

Provided further that where a relative of a director of a firm in which such relative is a partner, is appointed to an office or place of profit under the company or a subsidiary thereof without the knowledge of the director, the consent of the company may be obtained either in the general meeting aforesaid or within three months from the date of the appointment, whichever is later.

Explanation : For the purpose of this subsection, a special resolution according consent shall be necessary for every appointment in the first instance to an office or place of profit and to every subsequent appointment to such office or place of profit on a higher remuneration not covered by the special resolution, except where an appointment on a time scale has already been approved by the special resolution.

On a plain reading of sub-section (1) of section 314, it would appear that consent of the company accorded by a special resolution would not be necessary in the case of managing director or manager, banker or trustee for the holders of debentures of the company. It was, however, urged on behalf of the revenue that clause (b) of sub-section (1) ends with the words "paid over to the company or its holding company". In other words, according to the revenue, following portion of sub-section (1) after clause (a) and before the first provision is part of clause (b) of sub-section (1):

except that of managing director or manager, banker or trustee for the holders of debentures of the company-

(i) under the company; or

(ii) under any subsidiary of the company, unless the remuneration received from such subsidiary in respect of such office or place of profit is paid over to the company or its holding company;

The argument of the revenue was that it is only in case of managing director or manager, banker or trustees for the holders of debentures of the company, covered by clause (b) that consent of the company by a special resolution is not necessary. However, the case of the assessee-company falls under clause (a) and, therefore, such consent was necessary. The location of the above quoted words and the way in which sub-section (1) has been worded, does not support the revenue''s contention. Clause (b) of sub-section (1) of section 314, in our opinion, ends with the words ''a total monthly remuneration of Rs. 500 or more'' and the portion referred to above governs both clauses (a) and (b). We have examined the history of enactment of the above provision. In the Indian Companies Act, 1913, the corresponding provision was contained in section 86E. There also, an exception was carved out in the case of managing director or manager or a legal or technical adviser or a banker, etc. In other words, in case of office or place of profit held by the managing director, etc., the consent of the company accorded by a special resolution was not required. Section 314 was on the same lines as section 86E of the Indian Companies Act, 1913 when the 1956 Act was enacted (sic).

Section 314 was amended in 1960 and two categories were specified in clauses (a) and (b) of sub-section (1) of section 314. However, the exception which was applicable before 1956 was kept untouched. The subsequent amendment also did not make any material change insofar as the exception is concerned, in the sense that it continued to govern both clauses (a) and (b) though some of the offices which were earlier included are now excluded from the exception. There is no commentary on the company law, which supports the view canvassed on behalf of the revenue. On the contrary, the commentaries on section 314 by the different authors indicate that the exception applies to both the categories specified in clauses (a) and (b) of sub-section (1) of section 314. We do not consider it necessary to reproduce what is observed by different authors on the above subject in their commentaries on the company law. Clarification made in the book entitled ''Clarifications and Circulars on the Company Law'' published by the Ministry of Law, Justice and Company Affairs, Department of Company Affairs, Government of India, also support the view which we are inclined to take. In Chapter XXIII of the said book at page 205, while answering a query on section 314, it is stated "if a director of a company functions as manager and secretary and drews remuneration therefor, then he in fact, is a managing director, and holds office of profit in the capacity of a Secretary".

Section 314 does not apply if the director holds office as a managing director, and sections 198 to 260and 309, etc., will be attracted. It is clear from the language of section 314 that the exception governs both clauses (a) and (b) of section 314(1). In other words, a managing director or manager, banker or trustees for the holders of debentures of the company do not hold office or place of profit for which consent of the company by a special resolution is necessary. In the instant case, we find that Mr. Gautum Sarabhai was a managing director of the assessee-company. Section 2 (26) of the Companies Act, which defines ''managing director'' reads as under:

(26) ''managing director'' means a director, who by virtue of an agreement with the company or of a resolution passed by the company in general meeting or by its Board of directors or, by virtue of its memorandum or articles of association, is entrusted with substantial powers of management which would not otherwise be exercisable by him, and includes a director occupying the position of a managing director, by whatever name called:

The special resolution passed by the extraordinary general meeting of the assessee-company held on 22-1-1968, reads as under:

Resolved that the remuneration of Mr. Gautam Sarabhai, the Chairman of the board of directors, who has at the request of the board, devoted during the year from 1st April, 1966 to 31st March, 1967 his time and attention to the services of the company in the management of its business be and is hereby fixed at Rs. 1,35,000 in addition to the sitting fees paid to him for attending the board meetings of the company.

Further resolved that in addition to the fixed remuneration, Mr. Gautam Sarabhai be paid bonus at 20 per cent of the fixed remuneration for the period from 1st April, 1966 to 31st March, 1967 and be given other benefits with effect from 1st April, 1966 as under:

(a) participation in the provident fund rules of the company to be approved by the board of directors;

(b) participation in the company''s annuity- cum -gratuity scheme according to the Rules of the company to be approved by the board of director.

This resolution clearly shows that Mr. Gautam Sarabhai who was appointed as Chairman of the board of directors was entrusted with the management of the assessee-company''s business. In other words, Mr. Gautam Sarabhai rendered his services to the assessee-company in managing its business. This is, in our opinion, is sufficient to establish that Mr. Gautam Sarabhai was the managing director of the assessee-company. That being the position, the assessee-company was not required to follow the procedure laid down u/s 314 of the Companies Act as urged on behalf of the revenue. In other words, Mr. Gautam Sarabhai did not hold the office or place of profit for which consent of the assessee-company by a special resolution as laid down in section 314 was necessary. There is, therefore, no contravention of the provisions of section 314 as urged on behalf of the revenue.

It is not in dispute that Mr. Gautam Sarabhai did render services to the assessee-company from 1-4-1966 to 31-3-1967 in managing its business and affairs. In other words, Mr. Gautam Sarabhai rendered his services to the assessee-company in the year of account, relevant to the assessment year 1967-68. Mr. Gautam Sarabhai had not agreed to render his services gratuitously or in other words without any remuneration. The assessee-company was, therefore, liable to pay remuneration to Mr. Gautam Sarabhai. The liability of the assessee-company to pay remuneration arose no sooner the services were rendered by Mr. Gautam Sarabhai to it. Such remuneration did not depend upon passing of the resolution by the assessee-company. Irrespective of the resolution passed by the assessee-company, Mr. Gautam Sarabhai could have sued the assessee-company for remuneration. By resolution dated 22-1-1968, what the assessee-company did was to quantify its liability to pay remuneration to Mr. Guatam Sarabhai. In other words, the liability which had already arisen was quantified by the resolution of 22-1-1968. We, therefore, do not agree with the submission of the revenue that the liability to pay remuneration was created for the first time when the above resolution was passed. The liability to pay remuneration was known to the assessee-company as it had taken the advantage of the services rendered by Mr. Gautam Sarabhai. As already pointed out above, what was done by resolution dated 22-1-1968 was to quantify the liability. Under the circumstances, in our opinion, the Tribunal was justified in allowing deduction of remuneration paid to Mr. Gautam Sarabhai, the liability for payment of which has accrued during the year of account relevant to the assessment year 1967-68. Since the ITO had not examined the assessee-company''s claim with reference to the provisions of section 40(c), the Tribunal was right in remanding the matter to the ITO for examining it in the light of the provisions of section 40(c). In the view which we are taking, we answer first two questions referred to us in the affirmative and against the revenue.

This brings us to the third question relating to the assessee''s claim for relief u/s 84 of the Act. The assessee-company started a new industrial undertaking, named, ''Syntronix'' in the year of account relevant to the assessment year 1967-68. The assessee-company claimed that it had employed a capital of Rs. 5,51,365 in this new industrial undertaking and, therefore, it was entitled to a rebate of Rs. 33,081, which is equivalent to 6 per cent per annum on the capital employed as provided in section 84 of the Act. It was not in dispute that the new industrial undertaking had worked only for a period of nine months from July to March in the relevant year of account. The ITO was of the view that since the new industrial undertaking had worked only for nine months, the assessee-company was entitled to only proportionate rebate or relief at the rate of 6 per cent per annum on the capital employed u/s 84. The ITO accepted the working of the capital employed at Rs. 5,51,365 during the year by the assessee-company. However, since the industrial undertaking had worked only for nine months during the year, the ITO allowed rebate only to the extent of Rs. 24,811 as against the claim of Rs. 33,081 made by the assessee-company. In the appeal preferred by the assessee-company, the AAC accepted the plea of the assessee-company and granted it relief as claimed by it. Feeling aggrieved by the order passed by the AAC, the revenue went in appeal before the Tribunal. The Tribunal, however, following its earlier decision, confirmed the view taken by the AAC. The revenue has challenged the view taken by the Tribunal and at its instance Question No. 3 set out above has been referred to us for our opinion.

For the purpose of resolving the controversy raised before us, it is necessary to read only sub-section (1) of section 84. It may be mentioned here that section 84 under which the assessee-company claimed relief is no longer on the statute book as it stands deleted. Subsection (1) of section 84 as it then stood read as under :

Income of newly established industrial undertakings or hotels. -(1) Save as otherwise hereinafter provided, income tax shall not be payable by an assessee on so much of the profits and gains derived from any industrial undertaking or business of a hotel or from any ship, to which this section applies, as does not exceed six per cent per annum on the capital employed in such undertaking or business or ship, computed in the prescribed manner.

Rule 19 of the income tax Rules, 1962 provides for mode of computation of capital employed. It is not disputed that the assessee-company has computed the capital employed in its new industrial undertaking as prescribed by rule 19. In other words, it is not in dispute that the assessee-company is entitled to rebate or relief on the basis that capital of Rs. 5,51,365 was employed in the new industrial undertaking. According to the assessee-company, it is entitled to rebate to the extent of 6 per cent of the capital employed. On the other hand it is contended on behalf of the revenue that the assessee-company is entitled to the relief at the rate of 6 per cent per annum on the capital employed and, therefore, if the new industrial undertaking in which the assessee-company has employed capital, has worked only for a part of the year, it is entitled to only proportionate relief at the rate of 6 per cent per annum. It was contended on behalf of the revenue that the words ''per annum'' used by the Legislature are not meaningless, and if these words are given their plain meaning, the assessee-company would be entitled to only proportionate relief at the rate of 6 per cent per annum for the period during which the new undertaking has worked during the year. We find considerable force in the arguments advanced on behalf of the revenue. Profits and gains of new industrial undertaking, ships and hotels which fulfill the conditions prescribed by section 84 are entitled to relief from income tax to the extent of ''6 per cent per annum'' on the capital employed. The section was obviously intended to encourage setting up of new industrial enterprises and, therefore, undoubtedly it must be construed liberally from a common sense point of view. The interpretation canvassed on behalf of the revenue turns on the meaning to be assigned to the words ''per annum''. Are these words meaningless or in other words surplusage? Presumption is always against superfluity in a statute. An act should be construed as to avoid redundancy or surplusage and as far as possible full meaning must be given to every word of a statute. Prima facie, unless we hold the words ''per annum'' to be surplusage, we cannot accept the view which is canvassed on behalf of the assessee. However, the question is no longer res integra as we find that section 84(1) has been construed by the Madras and Madhya Pradesh High Courts. In Commissioner of Income Tax, Tamil Nadu-I Vs. Simpson and Company, , the Madras High Court was called upon to construe the words ''6 per cent per annum'' used in section 84. A Division Bench of the Madras High Court observed that as a matter of practice of the administration of the above provision, 6 per cent per annum has all along been applied on the computation of the capital as made under rule 19. Section 84 had its predecessor in section 15C of the Indian income tax Act, 1922 introduced in the year 1949. Section 15C contained more or less identical words. The rule framed earlier u/s 15C was almost on the same lines as the present rule 19. After referring to this old practice of administration of the above provision, the Division Bench stated principles on which fiscal statute had to be construed and then proceeded to construe words ''6 per cent per annum'' used in section 84. The Division Bench observed that the above expression was not surplusage. According to it, the words ''per annum'' appear to have been added only to ensure that the assessee would get, for each of the five years during which the relief u/s 84 is available, the relief at 6 per cent on the capital employed. The words ''per annum'', the Division Bench went on to say, cannot be understood as contrasted with any broken period. It further observed that the proportion contended for had already been worked out in taking the assets proportionate to the period of user. It was, therefore, not necessary to carry the same idea even in working out the 6 per cent. In the result, the Division Bench rejected the revenue''s plea that relief u/s 84 was to be allowed only proportionately in cases where new industrial undertaking had not worked for the whole year. Without entering into detailed discussion, we may state that as at present advised, with respect, we are not inclined to agree with the view of the Madras High Court that the words ''per annum'' appear to have been added only to ensure that the assessee would get relief for each of the five years during which the relief u/s 84 is available. Years or period for which relief is available is prescribed by sub-section (7) of section 84. Whatever relief which is available under sub-section (1) is available for the assessment years as prescribed by sub-section (7). Under the circumstances, it would appear, it was not necessary to use the words ''per annum'' only to ensure that the assessee gets relief for each of the said years. As already observed above, prima facie, it would appear that the words ''per annum'' clearly indicate that relief was to be given to the assessee at the rate of 6 per cent per annum and, therefore, if a new industrial undertaking in respect of which relief is claimed had not worked for whole year, the assessee would be entitled to only proportionate relief at the rate of 6 per cent per annum.

In Commissioner of Income Tax Vs. Sanghi Beverages (Pvt.) Ltd., , an identical question had come up for consideration before the Madhya Pradesh High Court with reference to the provisions of section 80J. The Division Bench of the Madhya Pradesh High Court held that even if a new undertaking has functioned in only a part of the accounting year, deduction has to be allowed to the full extent and percentage cannot be reduced in proportion to the part of the year during which the undertaking was in productive operation. The reason which weighed with the Division Bench of the Madhya Pradesh High Court was that section 80J nowhere further provides for "reduction of the amount of deduction on time basis with reference to the working of the industrial undertaking". It may be mentioned here that relevant provision of section 80J was similar to the provision of section 84. We are told that the Bombay High Court has taken the same view which is taken by the Madras High Court while rejecting applications made on behalf of the revenue u/s 256(2). It appears that the Tribunal allowed full relief at 6 per cent of the capital employed as claimed by the assessee and refused to make reference to the Bombay High Court u/s 256(1). Thereupon, the revenue approached the Bombay High Court u/s 256(2) to direct the Tribunal to refer the question for opinion to the Bombay High Court. The Bombay High Court, however, rejected the revenue''s application. We are told that all such applications made by the revenue have so far been rejected by the Bombay High Court. It was, therefore, urged that the Bombay High Court has also taken the same view which the Madras High Court has taken in the case of Simpson & Co. (supra). As indicated by the Madras High Court in its decision adverted to above, there is a long standing practice under which the assessees have been given relief to the extent of 6 per cent of the capital employed and not proportionate relief to the extent of 6 per cent per annum in case where new industrial undertaking has worked only for a part of the year, as contended on behalf of the revenue. Further, the two High Courts have taken the view which favours the assessee. Under the circumstances, as observed by Chagla, CJ. in Maneklal Chunilal and Sons Ltd. Vs. Commissioner of Income Tax (Central), Bombay, in conformity with the uniform policy which has been laid down in income tax matters, whatever our view may be, we must accept the view taken by the another High Court on the interpretation of the section of a statute which is an all-India statute. Similar view has expressed by the Bombay High Court in Ramanlal Amarnath (Agency) Ltd. (In Voluntary Liquidation) Vs. Commissioner of Income Tax, Bombay City I, , while following a decision of this Court in Baroda Traders Ltd. Vs. Commissioner of Income Tax, Gujarat, . Even though, we may be persuaded to take a different view, we are not inclined to do so in view of the settled practice referred to in the decision of the Madras High Court and the decision of Bombay High Court and the Madhya Pradesh High Court adverted to above. Therefore, respectfully following the decisions of the Madras High Court and the Madhya Pradesh High Court, we must answer the third question referred to us also in the affirmative and against the revenue. Reference answered accordingly with no order as to costs.