COMMISSIONER OF INCOME TAX vs INDIA CEMENTS LTD.

R. Jayasimha Babu, J. :

The substantive question requiring our answer is, as to whether the infraction by the assessee- company of the provisions of s. 349 of the

Companies Act, in not deducting the interest on the borrowings while computing the net profits, a percentage of which was paid to the managing

agents as remuneration, was required to be ignored, and the amount of remuneration paid by the assessee allowed in full as an item of expenditure

under s. 37 of the Income Tax Act, even after the amount of interest admittedly paid by the assessee- company, and which had been ignored while

calculating the net profit for determining the remuneration of the managing agent, had been claimed as a deduction and allowed as such in the

assessment of the company''s income in these assessment years. The assessment years are 1967-68, 1968-69, 1969-70, 1970-71 and 1971-72.

With regard to assessment year 1967-68, the tenability of the reopening of the assessment under s. 154 of the Income Tax Act is an additional

question, which also requires our answer.

The facts are not in dispute. The assessee is a public limited company, which, during the relevant assessment years, was managed by a managing

agent. Remuneration payable to the managing agent was a percentage of the net profits of the company, such net profits being computed in

accordance with the provisions of the Companies Act. The manner of computing the net profits is laid down in s. 349 of the Companies Act.

Interest on debentures issued by the company, interest on mortgages executed by the company and on loans and advances secured by a charge on

its fixed or floating assets, interest on unsecured loans and advances are required to be deducted under sub-cls. (f), (g) and (h) of s. 349(4) of the

Companies Act, while determining the net profits of the company. The remuneration payable to the managing agent is subject to a ceiling of 10 per

cent of the net profits of the company for that financial year, as provided by s. 348 of the Companies Act. That section provides that the company

shall not pay to its managing agent, in respect of any financial year beginning at or after the commencement of this Act, by way of remuneration,

whether in respect of his services as managing agent, or in any other capacity, any sum in excess of 10 per cent of the net profits of the company

for that financial year. The language of s. 348 of the Act is emphatic. It provides that the company ''Shall not pay"" the amount in excess of that

specified in the section. The percentage referred to in s. 348 of the Act is a percentage of the net profits, which is required to be calculated in

accordance with s. 349 of the Act.

In all these assessment years, it is admitted that the company had paid interest on its borrowings, and the entire amount of interest so paid had

been claimed as a deduction in the Income Tax assessment for the relevant years and such claim had also been allowed. It is also not in dispute

that in all these years, while calculating the remuneration payable to the managing agent, the interest paid on borrowings for acquisition of

machinery had not been deducted while calculating the net profits, and as a consequence, the amount paid to the managing agent as remuneration

was much in excess of what would have been payable had the net profits been calculated strictly in the manner provided in s. 349 of the Act. The

assessing officer had disallowed that excess amount, while the Tribunal has held that such excess is also to be allowed as a deduction ignoring the

infraction of provisions of the Companies Act, solely on the ground that the payment had been made, and that the books of accounts disclosed

such payments having been made to the managing agent.

In reaching the conclusion that it did, the Tribunal relied upon the decision of this Court in the case of Commissioner of Income Tax, Madras Vs.

Ramkrishnan Mills (Coimbatore) Ltd., and in the case of Commissioner of Income Tax Vs. Sree Rajendra Mills Ltd., . The Court, in these

decisions, observed that payment made in violation of s. 348 of the Act would not amount to the payments becoming illegal. The Court dissented

from the decision of the Bombay High Court speaking through Chagla C.J., in the case of Ramabe, A. Thanawala Vs. Jyoti Limited, holding that

payment made to a partner in a managing agency for services rendered to the company is not affected by s. 348 of the Companies Act.

Counsel for the assessee placed strong reliance of those judgments of this Court to sustain the order of the Tribunal.

The aforementioned decisions can no longer be regarded as good law, in the light of the decision of the Supreme Court in the case of Maddi

Venkataraman and Co. (P) Ltd. Vs. Commissioner of Income Tax, . We may notice here that decision of the apex Court was rendered in an

appeal from the decision of the Andhra Pradesh High Court in the case of Commissioner of Income Tax, Andhra Pradesh Vs. Maddi

Venkataratnam and Co. (P.) Ltd., . Jeevan Reddy, J. (as he then was) speaking for the Bench of the Andhra Pradesh High Court referred to the

decision of this Court in the case of Ramakrishna Mills (supra), and expressly dissented from the view taken in the decision of this Court viz., that

in considering the allowability of the expenditure, 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.

The apex Court in the case of Maddi Venkataraman (supra) found that the assessee therein had indulged in transactions in violation of the

provisions of the Foreign Exchange (Regulation) Act, and that the assessee''s case that had it not violated the Act, it would have incurred a loss

could not constitute a justification for contravention of the law. The Court observed that the assessee was expected to carry on the business in

accordance with law, and that the expenditure incurred for evading the provisions of the Act and also the penalty levied for such evasion could not

be allowable as a deduction. The Court further held:

Moreover, it would be against public policy to allow the benefit of deduction under one statute, of any expenditure incurred in violation of the

provisions of another statute or any penalty imposed under another statute. If the deductions claimed by the assessee were allowed, the penal

provisions of the Foreign Exchange (Regulation) Act would become meaningless. It has also to be borne in mind that evasion of law cannot be a

trade pursuit. The expenditure in this case could not be allowed as wholly exclusively laid out for the purpose of the assessee''s business.

The assessee is expected to carry on its trade or business in accordance with law, and not in violation of law. In making the assessment under

the Income Tax Act, the authorities under the Act are not required to close their eyes to the infraction of other applicable laws by the assessee, and

render such other laws and the penal provisions therein meaningless by allowing a trader or an owner of a business to reap the benefit of the

violation of the law. The Income Tax Act does not require the authorities under that enactment to ignore the provisions of the other statutes, and

the blatant violation thereof by the assessee who come forward with claims for deductions despite the patent violation of the other applicable laws

with regard to the claim so made. The computation of the profits and gains of business or profession is not required to be made on the basis that

the business can be carried on only by ignoring, or by violating the provisions of other applicable statutes and any and every outgoing allowed as a

deduction even when such outgoing was in whole or in part, a result of the violation of other applicable laws. The ascertainment of commercial

profits permissible in certain contexts also does not require that the infraction of the law is to be wholly ignored and the profit as determined by the

assessee in its balance sheet or P&L a/c adopted without further question as the proper basis on which the Income Tax assessment should be

made. As observed by the apex Court, it would be ""against the public policy"" to allow the benefit of deduction under one statute or the benefit of

deduction of expenditure incurred in violation of the provisions of another suit.

Learned counsel for the assessee contended that the payments having been made though admittedly in excess of what is properly payable under

s. 348 of the Companies Act, and though admittedly in violation of s. 349 of the Act, the assessee- company has suffered an outgoing and,

therefore, it is an item of expenditure from the point of view of the assessee and is required to be allowed under s. 37 of the Act. It was further

submitted that the expenditure so incurred and the payments so made was bona fide. It was also submitted that violation of s. 348 of the

Companies Act, and payments made in excess thereof cannot be characterised as unauthorised or prohibited.

None of the submissions so made for the assessee can be accepted. The mere fact that payment has been made by itself does not constitute a

justification for allowing that payment as an item of deduction under s. 37 of the Act. The fact that payment has been reflected in the books of

accounts does not also lead to the conclusion that such payment has been made bona fide. It cannot be held that payments made in violation of the

express injunction contained in s. 348 of the Act is a payment which is not prohibited or which is not unauthorised. Sec. 348 of the Companies Act

injuncts companies from making payments to the managing agent by way of remuneration amounts in excess of that specified in that section, and

for the purpose of making the calculations relevant to that section, s. 349 of the Act must necessarily be complied with. No other mode of

ascertaining the net profits is permissible. If, as contended by the assessee, the assessee had in its books of accounts capitalised the interest which

had been claimed, and allowed as a revenue expenditure, that fact even if true, does not by itself entitle the assessee to adopt a mode of calculation

different from the one provided in s. 349 of the Act for determining the net profits.

The remuneration properly payable to the managing agent in accordance with the provisions of the Companies Act is the amount which can

properly be claimed as deduction by the assessee under s. 37 of the Act, where the infraction is patent, and the extent paid in excess is also

ascertainable, it is the duty of the assessing officer to disallow the excess, and that having been done by the assessing officer, the Tribunal was

clearly in error in rejecting the appeal of the assessing officer, that appeal having been filed against the order of the Commissioner (Appeals) who

had held in favour of the assessee.

The fact that businesses often violate the law, and also with equal frequency offer practical necessity as a justification for such infraction does

not entitle them to claim the expenditure incurred, or the payments made while violating the applicable laws as expenditure which should be

allowed for the purposes of computation of their income under s. 37 of the Act. The Income Tax Act does not stand in isolation. It is an

enactment, which is to be enforced along with, and in the context of other laws which are currently in force, and an approach which seeks to

isolate Income Tax Act, and all actions taken thereunder in disregard of the surrounding environment of other current legislation is not an approach

which is required to be made under any of the provisions of the Income Tax Act.

The Tribunal, therefore, was clearly in error in holding that the assessee is entitled to deduction of the entire amount paid as remuneration to the

managing agent. To the extent the remuneration so paid was in excess of what was permissible under s. 348 r/w s. 349 of the Companies Act.

Such excess amount having been paid in contravention of provisions of s. 348 of the Act, the Income Tax Officer was fully justified in disallowing

such excess payment.

So far as the assessment year 1967-68 is concerned, the assessing officer had initially allowed the entire amount claimed as remuneration paid

to the managing agent. Without any new facts having been brought to his notice, he merely, by a change of his own opinion, initiated proceedings

under s. 154 of the Act, and held that part of the amount paid as remuneration was in excess. At the time the order on the proceedings initiated

under s. 154 of the Act was made, the decision of this Court in the case of Ramakrishna Mfrs (supra) was available. In the state of the law as it

then prevailed it could not be said that there was a mistake apparent on the face of the record, which could be set right by resorting to proceedings

for rectification. The Tribunal, therefore, was right in holding that the rectification proceedings were not warranted in setting aside the same.

For all the assessment years excepting 1967-68, we hold that the assessee was not entitled to the deduction of the entire amount paid by it as

remuneration to the managing agent, and that the amount so paid which are in excess of the amounts as computed under s. 348 r/w s. 349 of the

Companies Act are required to be disallowed, and that the disallowance of such excess by the assessing officer was proper and correct.

Our answer to the first three questions, which read as under..

Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the managing agent''s remuneration should be

allowed as per the profits arrived at by the assessee in the books before deduction of interest capitalised which, however, was allowed as a

deduction in computing the assessee''s income?

Whether, the Tribunal''s view that there can be two different methods for arriving at the profits for Income Tax purposes and for allowances of

managing agent''s remuneration is sustainable in law especially when the interest capitalised was clearly a revenue expenditure deductible?

Whether, on the facts and in the circumstances of the case, and having regard to the provisions of s. 349(4) of the Companies Act, 1956, the

Tribunal''s view that the computation of profits for determining the managing agent''s remuneration is in accordance with the Companies Act, 1956,

is sustainable in law especially when the interest on loans and advances was not deducted in terms of s. 349(4) of the Companies Act while

computing such profit?

are, therefore, in favour of the Revenue and against the assessee. Our answer to the fourth question,

Whether, on the facts and in the circumstances of the case, the Income Tax Officer was not justified in invoking the provisions of s. 154 of the

Income Tax Act, 1961, for withdrawing the excess managing agent''s remuneration allowed by the assessee for the assessment year 1967-68?

is in favour of the assessee, and against the Revenue. The Revenue shall be entitled to costs in the sum of Rs. 1,000.

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