Commissioner of Income Tax vs T. Stanes and Co. Ltd.

Ramaswami, J.—The assessee in this case is a public limited company and it has several activities. Originally, the business was carried on in

partnership and then it was converted into a public limited company. Somewhere in the year 1939 a decision was taken to convert this company

into a private company. At this stage two agreements of the same date dated March 14, 1939, came into existence. These two agreements

evidence the following facts : One F. J, Stanes, who was the then managing director of the company and was about to retire from his office of

managing director and his wife, Margaret W. Stanes, were joint holders of 1,679 ordinary shares of the face value of Rs. 100 each in the

assessee-company. They were desirous of disposing of their shares. The company was anxious to avoid the increase of membership which might

be resulted if the Stanes were to sell their shares without any restriction. The company was desirous of also prohibiting F. J. Stanes, the managing

director, from engaging himself directly or indirectly after his retirement in any trade or business similar or competing with that carried on by the

company. The company, therefore, entered into an agreement with the said Stanes with reference to the disposal of these 1,679 shares. As a

machinery for carrying into effect these agreements, the company constituted a fund called the Stanes and Company Staff Pension Fund

(hereinafter called ""the fund""). Under one of the agreements the company agreed to pay from 1st April, 1939, into this fund for the benefit of F. J.

Stanes a sum of Rs. 1,000 per month free of Indian tax as extra remuneration so long as the said F. J. Stanes shall remain a director of the

company and after his retirement as pension during his lifetime and after his death to his wife till her lifetime. The amount of Rs. 1,000 is subject to

reduction as and when the shares are transferred to the transferees approved by the company and such reduction is to be at the rate of Rs. 7 per

month for each share so transferred and shall cease altogether when the last is transferred. It was further provided that if at the end of any financial

year of the company the dividend declared on the 1,679 shares or on such lesser number of shares as at any time remain untransferred shall not

amount to the aggregate sum of Rs. 12,000 in the year or lesser sum as may be ascertained with reference to the shares transferred as stated

above, the deficiency will have to be made good by the company as extra remuneration to F. J. Stanes so long as he continued as director and

thereafter as pension for his life and the life of his wife. If, however, the dividend so declared exceeds Rs. 12,000 or lesser sum as is referred to

above, such excess shall be paid to the trustees of the fund upon the trusts therein declared.

Under the other agreement, the Stanes had agreed to transfer the shares to Eric Henry Stanes and Charles Eric Wootton, who are two other

directors of the company. This deed further provided for the purchase of the shares by these two directors or their successors in office as directors

of the company at the face value and in a phased programme. If within five years the transferees have not acquired one quarter of the said shares

or within ten years have not acquired one-half of the shares or within fifteen years three-quarters of the said shares, after notice the transferor shall

be entitled to treat the agreement as coming to an end. With the constitution of the fund, rules were also framed with the said Eric Henry Stanes

and Charles Eric Wootton as trustees. Rules 5, 6, 7 and 8 of these Rules which are relevant for our purpose read as follows :

The fund has been constituted in the first place to provide machinery for carrying into effect an agreement dated the fourteenth March, 1939,

made between the company of the one part and Frederic James Stanes and Margaret Winifred Stanes (therein and hereinafter called the

''grantees'') of the other part under which the company has contracted to provide payments to the grantees at a rate of Rs. 1,000 per month or

such lesser sum as therein provided by way of extra remuneration or pension if the dividends of the 1,679 ordinary shares of the grantees in the

company shall not be sufficient for that purpose in return for the grantees agreeing that any excess dividends above the rate of Rs. 1,000 per month

or lesser rate as therein provided should be paid into a pension fund constituted by the company and in the second place to provide pensions for all

other employees and ex-employees of the company and their dependants.

The fund shall also be entitled to receive any payments made to it from time to time by the company or any other person or persons and to

utilise the same or the interest or dividends on the fund''s investments to provide pensions for ex-employees of the company and their dependants.

Except for the payments to the grantees the discretion of the trustees as to the persons entitled to benefit from the fund and the amounts to be

paid out of the fund shall be final.

The trustees shall invest any moneys received by them as aforesaid in any investment for the time being authorised by law for the investment of

trust funds, but nothing in these rules shall prohibit the trustees from purchasing shares in the company out of moneys received by them being

moneys other than the excess dividends on the said 1,679 shares of the grantees referred to in rule 5 or from accepting gifts of such shares and

retaining them in their existing form.

As far as the office of trustees is concerned, it shall be ipso facto vacated upon a trustee ceasing to be a director of a company and the power of

appointing new trustees shall be vested in Messrs. T. Stanes & Co. Ltd. The trustees for the time being were also empowered to alter or vary any

of the rules of the fund subject to the condition that such alteration or amendment shall not affect the rights of the Stanes. In 1949, Rule 8 was

amended by lifting the prohibition of investing the monies received by the trustees other than the excess dividends on the said 1,679 shares and

specifically authorising the trustees to invest the dividends by purchasing all shares in the company or shares or debentures in any other company

under the management of the company. These rules were further modified in 1953 and the modified rules came into force on 1st April, 1953. The

relevant Rules 3, 4, 5, 8, 9, 10, 11 and 12 which are in addition to the existing rules read as follows :

The pension hereby provided to the ''grantees'' for their lives or for the life of either of them shall be the amount of the dividend on 540 ordinary

shares held by the fund in the company subject to a maximum of 10% dividend in any one year, such sum to be paid in 12 equal monthly

instalments from the date of receipt of such dividend by the fund.

The fund shall furthermore pay a sum of Rs. 100 per month each for life to Miss. Lily Stanes and Miss Eva Stanes (daughters of Sir Robert

Stanes, deceased).

The fund shall be vested in trustees and the first trustee of the fund shall be Eric Henry Stanes and Charles Eric Wootton.....

The accounts of the fund shall be maintained by Messrs. T. Stanes & Co. Ltd., and all dividends, interest payments and cash balance shall,

pending investment in accordance with Clause 10, be paid to the credit of the fund with the company or with the company''s bankers.

The income of the fund arising from dividends and interest shall, after payment of expenses incurred by the trustees and after payment of the

pension specified in Rules 3 and 4 above, be paid to the company and the whole or part of such sum may be utilised by the company for the

payment of pension.

The trustees shall invest any moneys received by them for credit of the fund, and not required for the payment of pensions or gratuities, in any

investment authorised by law for the investment of trust funds, but nothing in these rules shall prohibit the trustees from purchasing shares in the

company, and shares or debentures in any of the companies under the management of Messrs. T. Stanes & Co. Ltd., out of moneys received by

them or from accepting gifts, or allotments by bonus issue or otherwise of such shares and retaining them in their existing form, and the trustees may

from time to time sell, realise or vary such investments.

No pension shall be allotted to any employees, ex-employee or his dependants except on a recommendation from the directors of the

company.

The fund is a non-contributory fund, and all moneys and investments of the fund having been contributed to the fund by the company, no

employee or ex-employee or pensioner shall have any claim or right of property in the fund or any voice in its management, unless qualified as a

trustee, and no pension is assignable.

So far as the recommendation of the directors for pension as provided under Rule 11 is concerned, the board of directors passed a resolution on

the 30th September, 1953, setting out the qualifications necessary for an employee for allotment of pension and the criteria to be followed in

respect of the same.

The staff pension fund had its own accounts. For the assessment year 1959-60 in addition to Rs. 12,000 paid to the Stanes, the fund received

an income of Rs. 18,431. A sum of Rs. 13,789 was paid as pension to the employees during the year from this amount. In the accounts of the

assessee this item appeared as follows :

Staff Pension Fund :

Rs.

Income during the year 18,431

Less : Payment during the year 13,789

4,642

The sum of Rs. 4,642 was transferred to the pension and gratuity fund and shown in the balance-sheet. For the assessment year 1960-61 a sum of

Rs. 16,587 was paid as pension and the excess of Rs. 1,844 was transferred to the pension and gratuity reserve. For the assessment year 1961-

62 which covered a period of 18 months ending with March 31, 1961, the amount paid as pension to the employees was Rs. 31,454 and this was

in excess of the receipt by the trustees of the staff fund by Rs. 1,004, the receipt of the income by the trustees being Rs. 30,450. The company has

charged this Rs. 1,004 to the profit and loss account. Similarly, for the years 1962-63, 1963-64 and 1964-65 the payment of pension was Rs,

14,622, Rs. 12,907 and Rs. 15,570 which were in excess over the receipt by Rs. 5,070, Rs. 2,352 and Rs. 6,760, respectively, and these

amounts were charged to the profit and loss account. The company claimed in respect of the assessment years 1959-60 to 1964-65 deductions

u/s 10(2Xxv) of the Indian Income Tax Act, 1922 (hereinafter called ""the Act""), and the corresponding Section 37 of the Income Tax Act, 1961,

the sums of Rs. 13,789, Rs. 16,587, Rs. 31,454, Rs. 14,622, Rs. 12,907 and Rs. 15,570 in the respective assessment years as pension paid as

wholly and exclusively spent for the purpose of the business. The Income Tax Officer pointed out that the income credited to the staff pension fund

had already been subject to tax when it first arose in the hands of the trustees of the fund and that it did not form part of the income of the

assessee. The pension payments were made specifically out of these amounts accruing to the pension fund and in accordance with the agreement

entered into by the trustees of the fund. The liability for paying pension to the employee was that of the fund and the payments had not been

charged to the profit and loss account as an expenditure. The assessee had also adjusted these payments in the books of account against the

income of the fund. On these grounds the Income Tax Officer disallowed the claim. On appeal by the assessee the Appellate Assistant

Commissioner was of the view that whether there was any income from the fund or not the company will have to make the payments by way of

pension to its employees in discharge of their contractual liability and the mere fact that the assessee had adjusted this payment in their books

towards another income which they get from another fund, styled as the Stanes Company Ltd. Staff Pension Fund, does not change the nature of

the payment. He, therefore, held that it is a deductible expenditure u/s 10(2)(xv) of the Act.

Revenue preferred an appeal to the Tribunal, The Tribunal held that the claim of the assessee arose out of the actual payment made to the

employees and the ex-employees and by long usage and implementation this had become an obligation on the part of the assessee to grant pension

to the employees and ex-employees. What the company received was only a contribution from the fund after payment to the two specified

beneficiaries and Income Tax and other outgoings. The assessee might have utilised these amounts for the payment of pension but the primary

obligation was on the company to pay the pension and the fund had no legal obligation to pay pension to the other employees and the other

employees had no right to demand pension from the funds. In this view, the Tribunal confirmed the order of the Appellate Assistant Commissioner,

At the instance of the revenue the following question has been referred:

Whether, on the facts and in the circumstances of the case, the assessee would be entitled to claim as deductions the sums of Rs. 13,789, Rs.

16,587, Rs. 31,454, Rs. 14,622, Rs. 12,907 and Rs. 15,570, respectively, for the assessment years 1959-60 to 1964-65, or any part thereof u/s

10(2)(xv) or under the corresponding provisions of Section 37 of the Income Tax Act, 1961 ?

On behalf of the revenue it was contended that the trust, namely, the Stanes and Company Ltd. Staff Pension Fund was created and had its own

sources of income as a separate entity. But so far as the amount paid as pension is concerned, it is really an expenditure of the trust fund and spent

as per the rules of the fund and it is not correct to say that the legal obligation to pay the pension was on the assessee and the amount was paid by

the assessee. Though the amount might have been in fact paid by the assessee-company that was because the accounts of the fund was maintained

by the company and the trustees were the directors of the company but the payment made was in pursuance of the rules of the trust and the

agreement and not de hors the same. The amount was also paid out of the income of the fund. On the other hand, the learned counsel for the

assessee contended that the obligation to pay pension to its employees was on the company; the fund was not obliged to pay pension and the

company cannot also direct its employees to go to the fund for payment of the pension. The pension paid was an expenditure of the company and

if the company received any money from the fund towards payment of that expenditure it is in the nature of reimbursement of the whole or part of

such expenditure. The payment of pension though voluntary in the sense that the company was not obliged to pay under any agreement or pension

claim or any pro* vision of law, it is still a payment made out of business and commercial expediency and as such it is an allowable deduction. The

fact that the payment is mixed up in the accounts with that of the fund of the staff pension fund does not affect or alter the situation. It is essentially

an expenditure of the company and as such the deductions were rightly allowed..

The fund was constituted, as seen from the original rules framed, for the purpose of (1) giving effect to the agreement dated March 14, 1939,

made between the Company and the Stanes; and (2) to provide pension for all the employees and ex-employees of the company and their

dependants. Clause 6 of the original rules provide that the fund shall be entitled to receive any payments made to it from time to time by the

company or any other person or persons and after meeting the expenses and pension to the Stanes the balance could be utilised for providing

pension for the employees and their descendants. As seen from this clause, the payment of pension was to be by the fund itself though to the extent

of the money available for distribution. While re-drafting the rules in 1952 the procedure for payment of pension was modified. Rule 9 required the

fund to make over to the company the excess of income after meeting their expenses and the pension payable to the Stanes and their daughters

and further provided that the whole or part of such money may be utilised by the company for the payment of pension. On the basis of this Rule it

was contended by the learned counsel for the assessee that the company is the final beneficiary under the rules, that the liability to pay pension was

that of the company, that the company is permitted to use the income of the fund made over to them for payment and that merely because they

paid the money from and out of the sum received by them as beneficiary under the rules will not in any way alter the situation. We are unable to

agree with this contention of the learned counsel. It would be seen from the other provisions in the rules of the fund that the accounts of the fund

shall be maintained by the company and all dividends; interest, payments and cash balance shall, pending investment of the same in other securities,

be paid to the credit of the fund with the company or with the company''s bankers. The trustees are entitled to invest on securities only such portion

of the money which are not required for payment of pension to the Stanes and to the employees of the company. The pension to the Stanes and

the expenses of the trust, would have to be met by the fund direct from and out of the amount standing to the credit of the fund with the company.

So far as the balance of the amount which is available for payment of pension to the employees are concerned, Rule 11 states that no pension shall

be allowed to any employee or ex-employee or his dependants except on the recommendation of the directors of the company. This rule implies

that the authority competent to allot pension the trustees. Of course, the trustees could allot only on the recommendation of the directors of the

company, but that is not to say that the allotment itself was by the directors of the company. In this connection we have to note the position as

obtained in the original rules which came into force on April 1, 1939. Rule 7 stated that except for the payment to the Stanes, the discretion of the

trustees on the persons entitled to the benefit of the fund and the amount paid out shall be final. This rule had been modified to the effect that the

fund will have to make allotment on the recommendation from the directors of the company. We are of the view that the rules contemplated the

payment of pension by the fund and neither the discretion vested in the matter of allotment nor the requirement of a recommendation from the

directors of a company in any way change the position that it is a payment of pension by the fund and out of its own resources. But the obligation

of the fund to pay the money was only to the extent of the money available after meeting its own expenses and payment of pension to the Stanes.

We are, therefore, of the view that the amount paid as pension to the employees and their dependants is properly an expenditure of the fund and

not that of the company. That is how the company has treated the same in their accounts. As we have already noted, for the assessment years

1959-60 and 1960-61, the receipt of the income by the fund was in excess of the payment of pension and the excess amount was transferred to

the pension and gratuity reserve. The pension in these years was thus paid specifically from out of the sum received from the fund and in

accordance with the rules and the payment was not de hors the rules and out of the funds of the company which the company could be said to

have recouped from the income of the fund. Neither the income of the fund formed part of the income of the assessee nor its expenditure a part of

the expenditure of the company. But, as we have already stated, the obligation of the fund was only to the extent of the money available for

payment. Any amount paid by the company over and above the amount received by it for such payment could not be said to be a payment made

on behalf of the fund. It is seen from the statement of facts, for the assessment year 1961-62, the company had paid a sum of Rs. 1,004 as pension

over and above the sum of Rs. 30,450 received from the fund. This Rs. 1,004 has been charged to the profit and loss account of the company.

Similarly, for the assessment years 1962-63, 1963-64 and 1964-65 such excess payment which was Charged to the profit and loss account

amounted to Rs. 5,070, Rs. 2,352 and Rs. 6,716, respectively. The question for consideration is whether the company is entitled to a deduction of

this excess payments u/s 10(2)(xv) of the Act or the corresponding Section 37 of the new Act.

These amounts were paid as pension. It is also seen from the statement of facts that the company had been paying pension for quite some time.

The company had also framed rules relating to the principles to be allowed for allotment of pension. One of the rules provides that 30 years of

continuous service and/or attaining the age of 60 years after not less than 25 years of service will normally be the basis for consideration for

allotment of pension. Another rule states that special consideration may be given in the case of incapacity for further work due to illness or

accident, or to dependants of deceased long service employees, i.e., a widow or minor children. It further states that the general basis on which

retirement pension will be payable is 1/100th part of every year of service of the average monthly substantive salary during the last five years''

service, and such pension may be allotted as a net monthly sum, or as a pension plus variable dearness allowance. Of course, these rules were

ostensibly framed for the purpose of recommending to the fund for allotment of pension. But we are pointing out these rules only to show that even

these excess payments paid by way of pension were with reference to the rules framed generally and applicable to all employees in general and the

payment was not with reference to any particular individual or for any particular reason and it was generally motivated by business considerations

and Warranted by commercial expediency. While such is the case it cannot be denied that the payment was out of the business or commercial

expediency and that it was wholly and exclusively spent for the purpose of the business. In this connection we have also to keep in mind that in

order to make the company eligible for deduction of the amount paid by way of pension there need not be any particular, scheme for payment of

such pension governing the relationship of the employer and employee. In this connection we may also usefully quote a passage from the judgment

of this court in Indian Overseas Bank Ltd. v. Commissioner of Income Tax, [1967] 63 ITR 733, 737 which reads as follows :

It is true that the assessee had no general scheme for payment of pension to its employees. But that is not conclusive of the question. Though there

may be no pension scheme, still in exceptional cases, we do not see why a business concern may not enter into a contract of service providing for

pension and properly claim deduction of pension paid. The principal question to be kept in view is whether the expenditure claimed is laid out for

the purpose of the business, whether it is a legitimate business expenditure and whether it is in the interest of the business. The directorate of the

business itself is the best judged that matter, for it is for them to consider the business expediency and whether a particular expenditure should be

incurred for the purposes of the business.

The learned counsel for the revenue relied on the oft-quoted passage in Atherton v. British Insulated and Helsby Cables Ltd., [1925] 10 TC 155

in support of his argument that even this excess amount paid by the company as pension and which was charged to the profit and loss account is

not an allowable deduction u/s 10(2)(xv) of the old Act. The passage relied on is as follows:

... in determining whether a particular item may or not be deducted from profits, it is necessary first to enquire whether the deduction is expressly

prohibited by the Act, and then, if it is not so prohibited, to consider whether it is of such a nature that it is proper to be charged against incomings

in a computation of the balance of profits and gains for the year.

Again,

... a sum of money expended, not of necessity and with a view to a direct and immediate benefit to the trade, but voluntarily and on the grounds of

commercial expediency, and in order indirectly to facilitate the carrying on of the business, may yet be expended wholly and exclusively for the

purposes of the trade.....

We are of the view that the facts stated above fully satisfy the test laid down in this case. We, accordingly, hold that, (1) in respect of the

assessment years 1959-60 and 1960-61 the sum of Rs. 13,789 and Rs. 16,587 are not allowable deductions u/s 10(2)(xv) of the Act; and (2)

except to the extent of Rs. 1,004, Rs. 5,070, Rs. 2,352 and Rs. 6,716 referable to the excess of amounts paid over and above the income of the

fund and which was charged to the profit and loss account in the assessment years 1961-62, 1962-63, 1963-64 and 1964-65, respectively, the

balance of the amount in these assessment years are not allowable deductions. We answer the reference accordingly. As the revenue has

succeeded in substance, it will be entitled to its costs. Counsel fee Rs 250.