Judgment:
Per Shri P. J. Goradia, Accountant Member - These appeals are directed against the common order passed by the Commissioner (Appeals). The common grounds taken are as follows : (i) disallowing Rs. 22,326 being the amount of commission paid to Anand Dyes Corpn., Bombay under section 40A of the Income-tax Act, 1961 (the Act); (ii) disallowing out of car expenses Rs. 5,000 on the ground of personal use by the directors; (iv) disallowing an amount of Rs. 45,000 being amount of bank guarantee commission paid to the directors; (v) disallowing an amount of Rs. 1,000 spent towards public welfare scheme; (vii) disallowing an amount of Rs. 18,000 towards depreciation for the second and third shifts; (viii) disallowing Rs. 34,360 being incentive bonus paid to the workers and staff; (ix) disallowing an amount of Rs. 17,458 being the amount of commission paid to Anand Dyes Corpn. on the ground that the liability is of past year; (x) disallowing an amount of Rs. 4,400 being bonus payment to an employee Mr. Bhurabhai Desai.
2. The assessee is a private limited company engaged in the business of manufacturing dyes. It has only three shareholders, who themselves are directors of the company. The company is in business for past more than 10 years.
2.1 In respect of the first ground regarding disallowance of selling commission paid to Anand Dyes Corpn, the ITO observed as follows in paragraph 4 of his order : "In the profit and loss account an amount of Rs. 1,26,107 is debited as commission to sole selling agents. This includes an amount of Rs. 17,45458 pertaining to the earlier year. The break up of this amount shows an amount of Rs. 66,862 paid to Anand Dyes Corpn., Bombay, a partnership firm in which the director Smt. S. D. Oza has 50 per cent share and the partners may be relatives. Last year, invoking the provisions of section 40A, I held that there is no special reason for giving commission at 10 per cent to this partnership firm when the commission paid to others vary between 2.5 per cent to 5 per cent and, accordingly, I had considered 5 per cent reasonable in the case of this firm and disallowed the excess over 5 per cent. Before last year this firm was being paid commission at 5 per cent. For this year besides the point of commission paid in excess of 5 per cent, there is another point regarding the commission of Rs. 17,458 claimed as deduction in this year not relating to the liability of the earlier year. I called for the assessees explanation as to why this amount being the liability of the past year should not be disallowed. In response thereto the assessee submitted that it had received the approval of the Company Law Board only in the relevant accounting year for the payment to the said partnership firm as sole selling agent a commission at the rate of 10 per cent. This contention of the assessee cannot be accepted as the liability for the commission did not pertain to the relevant accounting year. Secondly, in the last year also the company had paid the commission of 10 per cent to this very firm and claimed it as deduction. Thirdly, it has been clarified in the letter of approval by the Company Law Board that the approval does not constitute an approval for the purpose of any other law. In these circumstances, since this amount being liability of past year is disallowable on this scope itself, I do not apply the criterion of unreasonableness under section 40A. This amount of Rs. 17,458, therefor, is disallowed.
4(b). Now, there are other items on which the commission to the said firm is paid at 10 per cent whereas to other selling agents, it is paid at 2 per cent to 5 per cent. It is obviously because this partnership firm viz. Anand Dyes Corpn., Bombay is a partnership firm in which the directors are substantially interested. In accordance with the provisions of section 40A, the expenditure which is excessive or unreasonable having regard to the fair market value of the service for which the payment is made or the legitimate needs of business, then, so much of the expenditure as is so considered to be excessive or unreasonable, shall not be allowed as a deduction. The section applies to the payments made to a firm or partner or a member who has substantial interest in the business of the assessee. If the assessee had paid same rate of the commission to other selling agents also, the question of disallowance in the case of the said partnership firm would not arise. But it is a case where others are paid a lesser rate of commission whereas this firm is paid at much higher rate, and therefore, the question of reasonableness arises. In the circumstances, the excess over 5 per cent is disallowed and the disallowance is worked out as under : 2.2 On appeal, the order passed by the ITO was confirmed on the basis as under : (i) the matter was required to be considered in view of huge amounts paid to the directors by way of remuneration, bank guarantee commission, sole selling agency commission, etc. (ii) the ITO had not been provided with the materials in order to consider that the payment of the commission was justified for the services rendered by the sole selling agents. (iii) The decision of the Tribunal for the assessment year 1979-80 could be different if facts regarding huge amounts paid to the directors, etc. and the amount required to be considered as reasonable or excessive on the basis of necessary details, etc., were brought on record.
2.3. The learned counsel appearing on behalf of the assessee submitted that the ground should be treated as covered by the Tribunals order in assessees own case for the assessment year 1979-80 in IT appeal Nos.
1418 and 1467 (Ahd.) of 1983, dated 22-9-1985 from which highlighting certain aspects it was submitted that commission was paid to the sole selling agents as per the permission obtained from the Company Law Board, under section 294AA of the Companies Act, 1956 and this was the tenth year when the commission was paid to the sole selling agents.
again, it was not correct to say that in past no commission at the rate of 10 per cent was paid, but in fact it was so paid and for this necessary mention in the order of the Tribunal for the assessment year 1979-80 was brought to our notice. Commenting on the findings given by the Commissioner (Appeals) in paragraph 3 of his order, it was submitted that non-furnishing of the details in respect of the terms of the contract, copy of the agreement, etc., were not asked for specifically by the ITO, at least he, the counsel, could not locate such request. Again. it could not be so because this was not the first year of the payment of the commission. On the aspect of overall picture taken by the Commissioner (Appeals), it was complained that remuneration was paid for working on behalf of the company, bank guarantee commission was paid for specific services and sole selling agency commission was paid for altogether different types of services and, therefore, there was no substance in the picture taken by the Commissioner (Appeals). Besides significance attached to the perquisites obtained by the directors, it was stated that it was as per the law and the revenue authorities should not have grievance on the same because perquisites are taxed in the hands of the directors.
Again, regarding omission according to the Commissioner (Appeals) in respect of certain facts regarding huge amounts paid to the directors, etc., not having been brought to the notice of the Honble Members of the Tribunal while deciding the appeal for the assessment year 1979-80, it was submitted that such observation was baseless because neither any miscellaneous application was preferred by the revenue not any reference was made and in fact all the situations and circumstances were considered by the Tribunal. On the aspect regarding the disallowance of liability for an amount of Rs. 17,458 pertaining to earlier year as alleged and stated in ground No. 9 for the assessment 1980-81, it was submitted that the same is covered by the decision of the Supreme Court in Nonsuch Tea Estate Ltd. v. CIT [1975] 98 ITR 189.
2.4. The learned departmental representative on the other hand strongly supported the order passed by the (Appeals) and submitted that no investigation was done since the assessment year 1971-72 and only this year some investigation was made by the ITO and stressed the fact that the company was owned by only three shareholders who themselves were the directors of the company. The approval by the Company Law Board regarding payment of the sole selling agents commission did not mean that it was required to be followed by the income-tax authorities because Company Law Board was concerned with public interest while income-tax authorities were concerned with allowability of expenditure incurred for the purpose of business, whether excessive or unreasonable. Besides, whole of 10 per cent rate was not disallowed, but only the excess over 5 per cent was considered for the purposes of disallowance in the absence of proper material for supporting the excess payment. Again amount pertaining to earlier year also was properly disallowed as the case was of renewal of permission.
2.5. In our opinion, there is no reason to take a view different from the one we have taken for this very assessee in the assessment 1979-80.
Probably the income-tax authorities are not fully conversant with the history behind insertion of section 294AA which was introduced by the Companies (Amendment) Act, 1974. Clause 24 of the Notes on clauses stated as under : "It has been noticed that sole selling agents are appointed in respect of goods, the demand for which by the consumers is substantially in excess of the production or supply of such goods. It is felt that in such cases, the goods will have an easy market and the services of sole selling agents may not be necessary to create a market for the same.
This avoidable expenditure would result in unnecessary erosion of funds which could be usefully utilised for the business of the company. Hence to avoid diversion of funds it is considered necessary to provide that the Central Government may, be notification, specify commodities in which sole selling agents shall not be appointed. In order to avoid diversion of funds it is also considered necessary to provide that no individual, firm or body corporate who or which has a substantial interest in a company shall be appointed as a sole selling agent of that company unless such appointment has been previously approved by the Central Government. Further to provide a check on the appointment of sole selling agents and thus prevent unnecessary expenditure it is proposed that such appointment in companies with paid-up capital of rupees fifty lakhs and above would require the approval of shareholders by special resolution and also of the Central Government. These provisions will apply also to sole buying or for personal gain their power in relation to the purchase of raw materials and other goods." The powers and functions of the Central Government under this section have been delegated to the Company Law Board by GSR 343(E), dated 24-6-1975. The Central Government has also made rules called the Company (Appointment of Sole Selling Agents) rules, 1975 as published in the Gazette of India, dated 1-3-1975, when the package of emergency measures were taken. Form of application for approval of the Central Government to the appointment of sole selling agents by a company prescribes plenty of information including factual data called for from the applicant. In brief the following information is required to be supplied.
(i) Management structure including particulars of other directors. (ii) Products manufactured together with details of production in past years. (iii) The nature of organisation and structure and size of the organisation of the sole selling agents to be utilised for conducting sales of the company. (iv) Experience of sole selling agents, reasons for their appointment, terms of remuneration and the proposed agreement or arrangement indicating which of the services are rendered by the sole selling agents such as securing orders, providing warehousing facilities and despatches, etc. engaging any sales promotion, after sale service, where selling agents employed exclusive staff for marketing of companys products, etc. (v) Details regarding commission earned in past and break-up of expenditure incurred by selling agents on salaries, travelling, rent minute details required to be given in respect of direct sales and otherwise, interest of the sole selling agents in shares of the company, associate concerns of the directors and their projected target of the sales, reduction in the amount of commission if other agents are paid by way of commission, names of auditors, etc. (vii) Item 32 prescribes mention whether any portion of the sole selling agency commission has been disallowed by the Income-tax Department.
3. From the above, it would be clear that the income-tax authorities can independently consider the allowability or otherwise as per section 37/40A of the Act. But then the Company Law Board takes into consideration not only the public interest, but also business need in respect of payment of commission to sole selling agents and also services rendered by them and then approves the rates of commission.
Therefore, proceedings on the basis that there is no material or the remuneration paid is execessive is erroneous. mention regarding amount disallowed in income-tax assessments would be to ensure co-ordination and also to invoke further enquiry before the appointment and terms to be approved from time to time. A decision taken by the body like Company Law Board cannot be rejected in absence of sufficiency of material and finding regarding inadequate services so as to disprove the date submitted to the Company Law Board. The ITO has not enquired into the date furnished to the Company Law Board and made out a case that in fact no services were rendered to justify increased remuneration. The revenue authorities have not even enquired with their counterpart in sister-Ministry what were the criteria for approving increased rates as alleged. Decisions taken by inter-Ministry-departments are required to be extended due weightage.
Suffice to say that the authorities below have not know the provisions of section 294AA and Rules framed framed thereunder. The learned counsel for the company was correct in stating that it is not only in this year that commission has been paid at the rate of 10 per cent, but there is a mention on this factual aspect even in the order of the Tribunal for earlier year. We, therefore, do not see any reason to retain any part of the disallowance made and, therefore, delete the same in both the years.
4. In respect of amount of Rs. 17,458 pertaining to earlier year disallowed in the assessment year 1980-81, the reliance placed by the learned counsel on decision in the case of Nonsuch Tea Estate Ltd. (supra) is correct and therefore, the same cannot be disallowed.
5. Coming to the next ground regarding disallowance of bank guarantee commission, the same was disallowed by the ITO on the basis that the assessee was requested to furnish the details of the assets of the directors, who had given guarantee to the bank in other to procure the loan for the business of the assessee-company.
5.2 The Commissioner (Appeals) confirmed the order on the basis as follows : (i) It is not clear that the directors have given the guarantee for to the bank and to what extent the banks depended upon such guarantee.
(ii) The assessee-company had sufficient raw materials as well as furnished goods. (iii) There was no necessity for the directors to give extra personal guarantee to the bank. (iv) The company was silent and rather reluctant to furnish details in respect of the considerations which made the directors to give additional guarantee. (v) Considering the total amounts paid to the directors including remuneration etc. the payments were superfluous.
5.3 The learned counsel for the assessee submitted that since Assessment years 1971-72, the guarantee commission was paid and in the printed balance-sheet no figure appeared in the column for the previous year because of the change in the accounting year. It was not for the assessee to prove to what extent the banks depended upon the directors guarantee. It is common knowledge that in respect of private limited companies, banks do insist for personal guarantees of the directors and whether there was need or not cannot be the matter for judgment by the revenue authorities. Regarding the sufficiency of the assets of the company, and details of assets required so as to judge the worth of the director, it was submitted that the Commissioner (Appeals) could not sit in the chair of sanctioning authority to grudge because the payments are made for services and with prior sanctions as per the law.
The payments are made not only on account of necessity or business expendiency but as per the past practice and the same is allowed from year to year.
5.4. The learned department representative supporting the order of the Commissioner (Appeals) stated that totality of the remuneration and payments made to the the directors were required to be considered.
5.5. In our opinion, there is no justification to disallow the amounts.
From the paper book, we find that the assessee has been paying guarantee commission to the directors right from Samvat year 2026, i.e., the assessment year 1971-72. It is an admitted position that every year the expenditure is allowed and rightly so on the basis of risk undertaken by the directors. We do not see any reason to sustain the addition and, therefore, the same is deleted.
6. Coming to the disallowance of bonus payment to directors the same is covered by the decision of the Tribunal for the assessment year 1979-80 and, therefore, respectfully following the same, we delete the addition made.
7.1. Coming to the disallowance in respect of contribution for drainage, paragraph 8 of the order passed by the Commissioner (Appeals) states as under : "The next objection is with regard to the disallowance made by the Income-tax Officer of Rs. 6,000 being the welfare expenditure during the assessment year 1981-82 and such disallowance of Rs. 10,000 made during the assessment year 1980-81. The Income-tax Officer has held that the amount spent is not for the purpose of the business.
Therefore, this expenditure have been made to the Junagarh Vikas Council for the drainage of the dirty water. This amount was paid to the said concern for the purpose of the removal of the dirty water and to repair the drainage system. Thus, it is urged that the amount has been spent towards working of the factory. There, the same is allowable. On perusal of the facts of the case, it may be seen that the District Collector called a meeting of various persons and urged to make a voluntary contribution to drain-out the dirty water in the city.
The payment made cannot be treated as an expenditure for the purpose of the business as to qualify for the deduction under section 37 of the Act. There is no nexus between the expenditure and carrying on the business of the assessee-company. The expenditure incurred cannot be considered as incidental to the business. The expenditure, therefore, has been rightly disallowed by the Income-tax Officer. In any case the contribution made by the assessee towards the drainage system has to be considered as a capital expenditure because the appellant is getting the entire benefit for the drainage system." 7.2. The learned counsel for the assessee submitted that considering the nature of the business of the assessee proper discharge of the effluents is an obligation and for this purpose letter addressed the District Collector was brought to our notice to prove that there was nexus with the business of the assessee. The necessary resolution passed in the presence of the District Collector was also brought to our notice. Reliance was placed CIT v. Navsari Cotton & Silk Mills Ltd. [1982] 135 ITR 546 (Guj). The expenditure could never be a capital expenditure because no asset was acquired by the assessee.
7.3 The learned departmental representative submitted that there was neither legal obligation nor any necessity because no letter was issued to the assessee either by municipality or by concerned authority under any statute. Meeting called by the District Collector was only voluntary and the payment was also voluntary. In any case, enduring benefit was received by the assessee and, therefore, it was a capital expenditure.
8.1. We do not see any reason to retain the allowance of the expenditure incurred by the assessee. Considering the nature of the business need of controlling the environment and pollution steps taken by various concerned authorities like the Pollution Control Board, trade associations, etc. we do not see any reason to consider the same as not for the purpose of business. Against, it is not necessary that for every allowance there must be a demand by the statutory board.
Again, there is no question of holding expenditure as capital because the asset, if any, does not belong to the assessee. The decision of the Supreme Court in the case of Empire Jute Co. Ltd. v. CIT [1980] 124 ITR 1 would support the case of the assessee. Again, it is seen from the orders of the authorities below that in spite of holding the same as capital expenditure, no depreciation is allowed by them as this would prove the case of the assessee that the claim was not required to be considered from the point of view of capital expenditure as the asset did not belong to the assessee-company.
8.2. Coming to the disallowance in respect of car expenses, following the decision of the Tribunal for the assessment year 1979-80, we hold that the same is required to be deleted and, hence, no disallowance is made.
9. Coming to the claim, in respect of miscellaneous expenses, it was submitted by the learned counsel for the assessee that he had instructions not to press the disallowance of Rs. 12,155 for the assessment year 1981-82. However, for the assessment year 1980-81, it was submitted that the same was in connection with building of a statue in the memory of one of the directors of the company and he was the founder director. The statute was put up in the factory premises and not at the residence of the directors. The statue was erected out of business expediency, as was the desire of management and the staff.
10. The learned departmental representative supported the order passed by the Commissioner (Appeals).
11. Here also, in our opinion, there is no reason to reject the claim of the assessee. The expenditure is in the factory premises of the assessee-company and the same is in memory of the companys founder. The same is allowable under section 37 of the Act. Such expenditure is in consonance with status and image of the company apart from boosting the morale of management. Disallowance for the assessment year 1980-81 is deleted and for the assessment year 1981-82 is confirmed.
12. Coming to the claim in respect of depreciation for extra shift allowance, it was submitted by the learned counsel that the same was allowed in past as also in future years because the process in the manufacturing of the goods employed by the assessee was continuous process and the factory was running all throughout. Because of some arithmetical mistake by office of the chartered accountant, there was some discrepancy in claim for extra shift allowance and, therefore, ITO disallowed the same. The Commissioner (Appeals) confirmed the same on the basis of absence of further details. If it was required the same be sent back to the ITO for the purpose of verification and satisfaction and necessary direction regarding claim of the assessee, be given.
13. The learned departmental representative supported the order passed by the Commissioner (Appeals).
14. In our opinion, there is no need to send the matter back to the ITO. Considering the nature of business in which the assessee-company is engaged and on going through the audited accounts placed before us and considering the statement made at the bar, we accept the claim of the assessee in respect of depreciation for extra shifts allowance and direct the ITO to allow the same after verifying the arithmetical accuracy.
14.1. (a) Coming to the objection with regard to incentive bonus to the workers, the relevant paragraph of the order passed by the Commissioner is reproduced below : "The assessee has claimed incentive bonus of Rs. 34,360. The Income-tax Officer has given the findings that as per the provisions of the Bonus Act, these bonus payments are excess and not allowance as per the provisions of the Bonus act. Therefore, the Income-tax Officer has disallowed the same in accordance with the provisions of section 36(1) (ii). The learned counsel has stated that the new scheme was drawn during the year under consideration in order to increase the production and hence the agreement was made with the employees members, resolution was passed that certain amount of incentive bonus would be given to the workers if the production reaches after certain level and hence it is stated that the Income-tax Officer should have considered these facts because of the persons to whom the incentive bonus have been paid and there is an evidence to show that this agreement has been made in order to increase the production." 15. The learned counsel for the assessee relied upon the decisions in the case of Mumbai Kamgar Sabha v. Abdulbhai Faizullabhai AIR 1976 SC 1455. Hukumchand Jute Mills Ltd. v. Second Industrial Tribunal [1980] 4 Taxman 43 (SC) and Baidyanath Ayurveda Bhavan Mazdoor Union v.Management of Shri Baidyanath Ayurveda Bhavan (P.) Ltd. [1984] 17 Taxman 19 (SC).
16. The learned departmental representative supporting the order of the Commissioner (Appeals) stated that section 36 of the Act applied to the productivity based profits and, therefore, ceiling prescribed was mandatory.
17. In our opinion there is no reason to disallow the payment made on the basis of productivity. The resolution passed by the directors on 15-6-1978 clearly brings out terms regarding incentive bonus payable to the employees of the company and the resolution has the binding force.
It is pertinent to note that resolution was passed before the beginning of the accounting year and there is also proof regarding increased production. Such disallowance can only be looked upon as derogatory to the spirit of the Payment of Bonus Act, 1965 because in fact, it is the philosophy of the Government to encourage productivity based distribution of profits since it will have similarity with reward on the basis of workers participation in the business of the company.
Section 31A of the Payment of Bonus Act specifically makes mention in this regard. Again, not extending the due recognition to the resolution passed by the board of private limited company goes contrary to the provisions of the Companies Act in respect of the maintenance of secretarial records like minute book where the resolution passed by the directors at the meeting are required to be entered and signed at next meeting required to be held periodically as per the Companies Act.
Payment not made in the subsequent year on the basis of productivity cannot be fatal to the claim because if in earlier year because of the huge profits management decides to remunerate the workers on the basis of workers participation, such system having not been followed in the future year, cannot be consideration for disallowance. It is an admitted fact that payments to the workers are genuine and enjoyed by the workers themselves. Whether there is need for such payment, for the purpose of allowance under section 37, cannot be a matter of decision by revenue authorities because it is the exclusive sphere of the businessmen to consider the propriety of an expenditure and even if the expenditure is unnecessary or incurred because of the wrong decision by the businessman as long as the expenditure is wholly and exclusively for the purpose of business, the same cannot fall for disallowance. We, therefore, delete the disallowance made in the assessment year 1980-81.
18. coming to the disallowance of Rs. 4,400 in respect of bonus paid to one of the employees Shri Desai, it is submitted by the learned counsel that the same falls outside the Payment of Bonus Act similar to the payment made to the directors. On the basis of our order for the assessment year 1979-80 and the reasons for allowing the bonus paid to the directors in that year, as also in this year, we uphold the claim of the assessee and delete the addition sustained.
19. To the extent as above, the order of the Commissioner (Appeals) is modified and the ITO is directed to pass the appropriate orders in accordance with law.
20. In the result, the appeal for the assessment year 1980-81 is allowed in full and that for assessment year 1981-82 is allowed in part.