Cossul and Co. (P.) Ltd. Vs. Commissioner of Income-tax - Court Judgment

M.C. Agarwal, J.

1. The Income-tax Appellate Tribunal, Allahabad, has under Section 256(1) of the Income-tax Act, 1961, referred the following question stated to be of law and to arise out of the Tribunal's order dated October 31, 1980, passed in ITA Nos. 942 and 943 (All) of 1977-78 for the assessment years 1972-73 and 1973-74 for the opinion of this court :

'Whether, on the facts and in the circumstances of the case and on a correct interpretation of the word 'lawfully' appearing in Section 70 of the Indian Contract Act, the Appellate Tribunal was justified in holding that the appointment of the sole selling agent, Tools Implements and Machinery Distributors, was in contravention of Sections 294 and 314 of the Companies Act, 1956, and, therefore, the sole selling agency commission paid by the assessee-company was not an admissible deduction in working out the business income ?'

2. We have heard Sri Bharat Ji Agarwal, learned counsel for the assessee, at whose instance this reference has been made and Sri Prakash Krishna, learned standing counsel for the Commissioner-respondent.

3. The facts of the case are that the assessee, Cossul and Company (P.) Ltd. is a private limited company and the matter in issue relates to the assessment years 1972-73 and 1973-74. By an agreement dated October 24, 1963, the assessee-company appointed a partnership firm, Tools Implements and Machinery Distributors, as its sole selling agent with effect from October 1, 1963. The following persons were partners in the said firm :

'(1) Smt. Pushpa Khanna, W/o. Shri Nand Lal Khanna, the chairman, 60%man, referred to above.(2) Shri Gokulchand Khann, S/o. Shri Kishan Narain Khanna 7%(3) Shri Ram Kishore Mehra S/o. Shri Kanwar Kishore Mehra 7-1/2%(4) Shri Mahendra Kapoor, S/o. Shri V.C. Kapoor, one of the 25%'directions of the company

4. Out of the aforesaid persons, Smt. Pushpa Khanna was the wife of Shri Nand Lal Khanna who was the chairman of the board of directors of the assessee-company and Shri Mahendra Kapoor was the son of Shri V. C. Kapoor, a director of the said company. The company paid commission to the said partnership firm purportedly for services rendered as a selling agent. The Assessing Officer disallowed the payment on the ground that the relatives of the directors being partners in the said firm the appointment of the firm as a sole selling agent was in violation of Sections 294 and 314 of the Companies Act, and, therefore, the appointment was invalid. The Assessing Officer also held that the agreement was a fictitious transaction merely to evade tax. The assessee appealed to the Appellate Assistant Commissioner without success. Second Appeals Nos. 942 and 943/(All) of 1977-78 preferred by the assessee before the Tribunal were also unsuccessful. The Tribunal was of the view that the following three points were relevant for deciding the issue relating to the admissibility of the expenditure :

'(1) Whether the sole selling agency agreement dated October 24, 1963, was in operation in the eye of law during the accounting periods under consideration ?

(2) If so, whether it was a sham device or a genuine agreement which was acted upon and

(3) If the latter, what was its scope ?'

5. After a very detailed discussion it held that the appointment of the firm as sole selling agent was in violation of the provisions of the Companies Act and, therefore, the payment of commission to the firm was not allowable as expenditure. Regarding points Nos. 2 and 3 formulated by the Tribunal it observed that in view of answer to question No. 1 it was not necessary to answer questions Nos. 2 and 3, nevertheless as the same had been argued before it at length, it went on to decide the same. It held that the payment made in respect of sales out of the territory of India was not covered by the agreement and, therefore, such commission was not allowable as expenditure. As regards question No. 2, although the Tribunal had stated that the same was argued before it and it would record its finding thereon, the Tribunal's order shows that it failed to record any finding on question No. 2.

6. The relevant portion of Section 294 is as under :

'294. Appointment of sole selling agents to require approval of company in general meeting.--(1) No company shall, after the commencement of the Companies (Amendment) Act, 1960, appoint a sole selling agent for any area for a term exceeding five years at a time :

Provided that nothing in this sub-section shall be deemed to prohibit the re appointment, or the extension of the term of office, of any sole selling agent by further periods not exceeding five years on each occasion. (2) After the commencement of the Companies (Amendment) Act, 1960, the board of directors of a company shall not appoint a sole selling agent for any area except subject to the condition that the appointment shall cease to be valid if it is not approved by the company in the first general meeting held after the date on which the appointment is made.

(2A) If the company in general meeting as aforesaid disapproves the appointment, it shall cease to be valid with effect from the date of that general meeting.'

7. Section 294A provides that a company shall not pay or be liable to pay to its sole selling agent any compensation for the loss of his office in the following cases :

'(a) Where the appointment of the sole selling agent ceases to be valid by virtue of Sub-section (2A) of Section 294.'

8. Section 314 then provides that except with the consent of the company accorded by a special resolution, no director of a company shall hold any office or place of profit, and no partner, 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 such sum as may be prescribed. It provides 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. Sub-section (3) of Section 314 defines 'of profit' as under :

'(3) Any office or place shall be deemed to be an office or place of profit under the company within the meaning of this section,

(a) in case the office or place is held by a director, if the director holding it obtains from the company anything by way of remuneration over and above the remuneration to which he is entitled as such director, whether as salary, fees, commission, perquisites, the right to occupy free of rent any premises as a place of residence, or otherwise ;

(b) in case the office or place is held by an individual other than a director or by any firm, private company or other body corporate, if the individual, firm, private company or body corporate holding it obtains from the company anything by way of remuneration whether as salary, fees, commission, perquisite, the right to occupy free of rent any premises as a place of residence, or otherwise.'

9. Ordinary and special resolutions are provided for in Section 189 of the Companies Act, which stands as under :

'189. Ordinary and special resolutions--(1) A resolution shall be an ordinary resolution when at a general meeting of which the notice required under this Act has been duly given, the votes cast (whether on a show of hands, or on a poll, as the case may be), in favour of the resolution (including the casting vote, if any, of the chairman) by members who, being entitled so to do, vote in person, or where proxies are allowed, by proxy, exceed the votes, if any, cast against the resolution by members so entitled and voting.

(2) A resolution shall be a special resolution when-

(a) the intention to propose the resolution as a special resolution has been duly specified in the notice calling the general meeting or other intimation given to the members of the resolution ;

(b) the notice required under this Act has been duly given of the general meeting ; and

(c) the votes cast in favour of the resolution (whether on a show of hands, or on a poll, as the case may be) by members who, being entitled so to do, vote in person, or where proxies are allowed, by proxy, are not less than three times the number of the votes, if any, cast against the resolution by members so entitled and voting.'

10. In the present reference we are concerned with the assessment years 1972-73 and 1973-74 for which the relevant accounting periods were the years ending June 30, 1971, and June 30, 1972. The validity of the contract entered into between the assessee-company and the aforesaid sole selling agent has, therefore, to be seen only for the period referred to above. The Tribunal has found that the initial appointment was authorised by a special resolution adopted in the general meeting of the company held on October 14, 1963, a copy of the said resolution is at page 97 of the paper book and it was in pursuance of this resolution that an agreement was executed between the company and the said sole selling agent on October 24, 1963. The initial appointment was thus a valid appointment for a period of three years ending on September 30, 1966. On August 28, 1966, the directors passed a resolution renewing the aforesaid appointment for another period of five years and authorising the chairman to revise the rate of commission from time to time. On May 11, 1972, the company passed a special resolution in its general meeting as under :

'Resolved unanimously that the reappointment of Tools Implements and Machinery Distributors as the sole selling agent by the board of directors with effect from October, 1971, and earlier to the same, on the terms and conditions as specified in the agreement and resolution of the directors is hereby approved and the action of the directors for the said re-appointment is hereby ratified and the remuneration paid or payable to them for the services rendered in this connection from 1966 onwards is hereby approved.'

11. The Tribunal has held that the initial appointment came to an end on September 30, 1966, and thereafter no appointment was made in accordance with the provisions of the aforesaid sections. In other words, according to the Tribunal, no special resolution having been adopted by the company in its general meeting held after the coming to an end of the earlier appointment, the appointments made by the directors of the company were invalid. The Tribunal placed reliance, inter alia, on Shalagram Jhajharia v. National Co. Ltd. : 69CWN369 in which it was held that where the appointment of the sole selling agent was not placed at all at the first general meeting after the appointment, or if the appointment for some reason was not considered though placed at the first general meeting, and was thus not approved at such meeting, the appointment would be invalid from its very inception. It was also held that the provisions of Section 294 were mandatory and had to be strictly complied with. In Arantee . : AIR1967Bom440 , also the Bombay High Court held that the object of Section 294 is to place restrictions or curbs on the powers of the board of directors and the condition prescribed under Sub-section (2) is a condition precedent which attaches to the very act of making of a contract of appointment of sole selling agent and the appointment made without such a condition would be void ab initio and it is only a valid appointment made by the board of directors after complying with the conditions mentioned in Sub-section (2) that has to be put before the general meeting of the company for its approval. Admittedly, there was no special resolution of the company till May 11, 1972, and the procedure prescribed in Section 294 had not been adopted by the board of directors and, therefore, the continuation of the said firm as sole selling agent was invalid.

12. On behalf of the assessee reliance is placed on Parmeshwari Prasad Gupta v. Union of India : [1974]1SCR304 , in which the services of an employee were terminated in pursuance of a resolution of the board of directors in a meeting that was invalid. Subsequently, however, the termination was ratified in a valid meeting and the Supreme Court held that the ratification related back to the date of the chairman's order terminating the services. This judgment thus pertains to a different set of facts. The law specifically required the appointment of a sole selling agent in the manner prescribed under Section 294 which procedure was not at all followed in this case and, therefore, the ratification by the company in its general meeting held on May 11, 1972, could not cure the defect as the agreement, if any, had become invalid because of its non-approval in the first general meeting of the company after the appointment. We, therefore uphold the Tribunal's finding that the appointment of the sole selling agent, i.e., Tools Implements and Machinery Distributors, was in contravention of Sections 294 and 314 of the Companies Act, and was, therefore, invalid.

13. The question, however, remains whether even though the agreement is invalid the remuneration paid to the agents could be allowed as an expenditure in computing the total income of the assessee.

14. Section 37 of the Income-tax Act, 1961, provides that any expenditure laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head 'Profits and gains of business Or profession'. Therefore, if an expenditure is laid out wholly or exclusively for the purpose of the business the same can be allowed as an expenditure and it has been held that unless the payment is in the nature of a penalty for infraction of law the expenditure incurred can be allowed as a deduction even though there may not be any legal obligation for payment. In CIT v. Ramakrishna Mills (Coimbatore) Ltd. : [1974]93ITR49(Mad) some payments were made to a partner of a managing agency firm in his capacity as manager in violation of the provisions of Section 348 of the Companies Act. The Madras High Court held that even though the payment infringed Section 348 of the Companies Act, still the same was allowable as an expenditure. It was observed as under (page 58) :

'Even assuming that the said payment infringed Section 348 of the Companies Act, still the company is entitled, in our view, to the deduction under Section 10(2)(xv). As pointed out by the Tribunal, in considering the allowability of an expenditure under Section 10(2)(xv) one cannot travel outside the provisions of the Income-tax Act and deny the benefit of deduction under that section on the ground that the payment is unauthorised or has been prohibited by some other statute. As already stated, Section 348 does not impose an absolute prohibition and if there is an excess payment it could be authorised under Section 352. Therefore, the only thing that can be said against the company is that they did not get the required permission from the Central Government as per Section 352 for paying the remuneration in excess of the limit prescribed in Section 348. We are not inclined to hold that any payment in excess of the limit prescribed in Section 348 is illegal so as to have it excluded from Section 10(2)(xv) and that Section 10(2)(xv) only contemplates expenditure which is not prohibited by any statute.'

15. This judgment was followed in CIT v. Sree Rajendra Mills Ltd. : [1974]93ITR122(Mad) , in which the payment was made to the managing agents in contravention of the provisions of Section 360 of the Companies Act and the same was held to be an allowable expenditure. This view has been reiterated by the Madras High Court in Nilgiri Finance and Hire Purchase Pvt Ltd. v. CIT : [1995]213ITR384(Mad) , in which remuneration was paid to its directors in violation of the provisions of the Companies Act.

16. In Central Distillery and Chemical Works Ltd. v. CIT : [1955]27ITR100(All) , the assessee-company appointed a firm of partners as its managing agents. Under the Defence of India Rules the Government issued a notification appointing a Controller to control and supervise the working of the company but the notification neither terminated the managing agency agreement nor did it expressly provide that the managing agents would not be entitled to the remuneration. In the assessment year 1945-46, the shareholders passed a resolution sanctioning payment of remuneration to the managing agents as per the managing agency agreement. The Controller, however, did not sanction the payment but the assessee paid the amount later to the managing agents. The question was whether the asses-see could claim under Section 10(2)(xv) of the Indian Income-tax Act, 1922, the deduction of the remuneration paid to the managing agents as being expenditure laid out or expended wholly and exclusively for the purpose of the business. This court held that the mere fact that the Controller did not give the sanction for the payment will not take the payment outside the Section 10(2)(xv).

17. In Shahzada Nand and Sons v. CIT : [1977]108ITR358(SC) , a firm had paid some commission on sales ex gratia, i.e., without any contract or agreement on the subject but in consideration of the services rendered by them in pushing up the sales of the assessee. The Assessing Officer had disallowed the commission and the matter ultimately reached the Supreme Court which held that the existence of a contract was not necessary for allowing the expenditure. The Supreme Court observed that even where there is no contract an employer may pay commission to an employee if he thinks that it would be in the interest of business to do so. Reliance is also placed on behalf of the assessee in State of West Bengal v. B.K. Mondal and Sons : AIR1962SC779 . In that case the respondent had laid a claim against the State of West Bengal claiming a sum of Rs. 19,325 for works done by it and the Supreme Court held that although the contract may not be valid as it was not executed in the manner prescribed by Section 175(3) of the Government of India Act, such a claim can be supported under Section 70 of the Contract Act which reads as under (page 786) :

'Where a person lawfully does anything for another person, or delivers anything to him, not intending to do so gratuitously, and such other person enjoys the benefit thereof, the latter is bound to make compensation to the former in respect of, or to restore, the thing so done or delivered.' The Supreme Court considered the scope of the word 'lawfully' and observed as under (page 788) :

'It is of course true that between the person claiming compensation and the person against whom it is claimed some lawful relationship must subsist, for that is the implication of the use of the word 'lawfully' in Section 70 ; but the said lawful relationship arises not because the party claiming compensation has done something for the party against whom the compensation is claimed but because what has been done by the former has been accepted and enjoyed by the latter. It is only when the latter accepts and enjoys what is done by the former that a lawful relationship arises between the two and it is the existence of the said lawful relationship which gives rise to the claim for compensation. This aspect of the matter has not been properly brought into the picture when Straight J., laid down the test on which Mr. Sen's argument is based. If the said test is literally applied then it is open to the comment that if one person is entitled by reason of the relationship as therein contemplated to receive compensation from the other Section 70 would be hardly necessary. Therefore, in our opinion, all that the word 'lawfully' in the context indicates is that after something is delivered or something is done by one person for another and that thing is accepted and enjoyed by the latter, a lawful relationship is born between the two which under the provisions of Section 70 gives rise to a claim for compensation.

There is no doubt that the thing delivered or done must not be delivered or done fraudulently or dishonestly nor must it be delivered or done gratuitously. Section 70 is not intended to entertain claims for compensation made by persons who officiously interfere with the affairs of another or who impose on others services not desired by them. Section 70 deals with cases where a person does a thing for another not intending to act gratuitously and the other enjoys it. It is thus clear that when a thing is delivered or done'by one person it must be open to the other person to reject it. Therefore, the acceptance and enjoyment of the thing delivered or done which is the basis for the claim for compensation under Section 70 must be voluntary. It would thus be noticed that this requirement affords sufficient and effective safeguard against spurious claims based on unauthorised acts. If the act done by the respondent was unauthorised and spurious the appellant could have easily refused to accept the said act and then the respondent would not have been able to make a claim for compensation. It is unnecessary to repeat that in cases falling under Section 70 there is no scope for claims for specific performance or for damages for breach of contract. In the very nature of things claims for compensation are based on the footing that there has been no contract and that the conduct of the parties in relation to what is delivered or done creates a relationship resembling that arising out of contract.'

18. Learned counsel for the assessee contended that the said sole selling agent had rendered services to the assessee and it was not acting gratuitously and, therefore, if the assessee had not paid amounts it could have realised the same through a court of law taking recourse to Section 70. The selling agents might not have been able to enforce their claim because of the provisions of Section 294A(1)(a) and Section 314(2B) of the Companies Act. Section 294A prohibits a company from paying compensation to a sole selling agent where the appointment of the sole selling agent ceases to be valid by virtue of Sub-section (2A) of Section 294 and Section 314(2B) provides that the relative, etc., shall be liable to refund to the company any remuneration received from the company. The provisions of the Companies Act, however, show that they are not prohibitive and are only regulatory. In other words these provisions merely require a special procedure for the appointment of the sole selling agent and the holding of office of profit by the relatives of the directors or the directors themselves, so that the interests of the shareholders are not jeopardised. In the present case, the company only omitted to follow the procedure in the subsequent appointment, although the same was duly followed in the initial appointment made in the year 1965. Therefore, in case the sole selling agent had rendered services to the assessee and the payment of compensation was reasonable, the expenditure or a reasonable portion thereof could have been allowed as a deduction as expenditure laid out wholly and exclusively for the purpose of the business.

19. In view of the above discussions, we answer the said question as under:

1. The Tribunal was right in holding that the appointment of the sole selling agent Tools Implements and Machinery Distributors, was in contravention of Sections 294 and 314 of the Companies Act.

2. The Tribunal was not right in holding that the commission paid by the assessee-company was not an admissible deduction in working out the business income without recording any finding on the question whether the appointment of the said sole selling agent was a sham device or a genuine agreement and whether and to what extent, if any, the commission paid was reasonable and commensurate with the services rendered.

20. An authenticated copy of this judgment be transmitted to the Appellate Tribunal in accordance with law for further action.