COMMISSIONER OF INCOME TAX vs NATIONAL PHARMACEUTICALS and MEDICAL SERVICES (P) LTD.

V. V. KAMAT, J. :

The following question is brought by the Revenue for answer :

"Whether, on the facts and in the circumstances of the case and also on an interpretation of s. 40(c) of the IT Act, the Tribunal is right in interfering with the disallowance of the commission paid in excess of the limit laid down in the statute ?"

The factual matrix will encircle the controversy and reduce consideration of irrelevant aspects.

The assessment year is 1976-77 ending on 31st March, 1976. In fact the assessment was completed on 20th Oct., 1976. The ITO finding in consequence of information that chargeable income had escaped assessment, proceedings were initiated under s. 147(b) of the IT Act. Notice was served under s. 148 of the Act on the assessee. On 4th Sept., 1980 the assessee furnished return of income in response to the notice. The assessee is M/s National Pharmaceuticals and Medical Services (P) Ltd.

As seen from the order passed in pursuance thereof on 30th March, 1981 that the commission at the rate of 9% with regard to the amount of Rs. 21,71,963 was paid to one Shri P. G. Oommen as a selling agent. Shri P. G. Oommen was found as the son of Shri P. G. George who had substantial interest in the assessee-company. Therefore, the ITO resorted to the provisions of s. 40(c) of the Act, because in the case of a company any expenditure which results directly or indirectly in the provision of any remuneration or benefit or amenity to a director or to a person who has a substantial interest in the company or to a relative of the director or of such person and in case the amount is in excess of Rs. 72,000, the excess upon the said limit is to be disallowed under the said statutory provision. Rs. 1,08,598 was found to be given by way of commission to this Shri P. G. Oommen and therefore the ITO disallowed excess of Rs. 72,000 following the statutory provisions of s. 40(c) of the IT Act, 1961.

In the process of reasoning the ITO found that the audit party had given factual information that the commission paid to a person who is related to a person having substantial interest in the company and such commission had exceeded Rs. 72,000, attracting the above statutory provision. Accordingly by the order, the amount of commission found in excess of Rs. 72,000, namely Rs. 36,598 came to be disallowed by the ITO.

The assessee appealed before the CIT(A), Ernakulam. The appeal is decided by the order dt. 12th Aug., 1982. The first appellate authority considered the submissions along with reliance, firstly on the decision of the Punjab and Haryana High Court in Commissioner of Income Tax Vs. Avon Cycles (P.) Ltd., and also the decision of the Karnataka High Court in T.T. Pvt. Ltd. Vs. Income Tax Officer, Company Circle-III, Bangalore, . The first appellate authority allowed the appeal holding that no information could be said to have come to the possession of the ITO after the completion of the original assessment and the information was apparently available at the time when the original assessment was made. The first appellate authority, therefore, concluded that the decision is taken by the officer with the knowledge of the facts of the case and, therefore, the reopening of the assessment is not warranted in law. This was the only aspect considered by the appellate authority in allowing the appeal. The Department brought the matter to the Tribunal, Cochin Bench, and the assessee placed his objections before the Tribunal.

The Tribunal found that the assessee had not placed any material before the Tribunal to show that at the time of passing of the original assessment order the relationship of Shri P. G. Oommen with the shareholders of the company was disclosed in any manner. The Tribunal also held that the balance sheet and the profit and loss account would not have disclosed the relationship. The Tribunal also found that in the statement of details of sundry expenses furnished by the assessee the relationship was not disclosed. The reasoning proceeded to record a conclusion that the ITO at the time of passing the original assessment order was not aware of the relationship earlier. With this reasoning the Tribunal accepted the reopening of the assessment.

In fact it is the second contention that was taken up for consideration by the Tribunal that has direct connection with the question which we are called upon to answer.

It was argued before the Tribunal that s. 40(c) was not attracted to payment of commission to a sole selling agent. In regard to this submission reliance was placed on the decision of the Karnataka High Court (supra) as well as on the decision of the Punjab and Haryana High Court (supra). Following the earlier decision of the Karnataka High Court the Tribunal has observed in this connection that it is held therein that where a company pays compensation to a firm as its sole selling agent and the partners of the firm are directors of the company and their relatives, there is no nexus between the services rendered by the partners of the firm and the payment of commission by the company to the firm, and, therefore, the compensation paid to the firm in lieu of services rendered by the firm in its business activity cannot be said to be payment of reward, pay, wages or salary and that such payments will not be hit by s. 40(c).

It was urged before the Tribunal for the purpose of distinguishing the decision cited that the selling agents were firms and in the factual matrix to be taken into consideration the sole selling agent is an individual. The Tribunal found that there is no material and it was not the case of the Department that the said sole selling agent had no organisation or establishment of his own in functioning as a sole selling agent.

It was also submitted before the Tribunal on behalf of the Department, placing reliance on the decision of the Supreme Court in Gestetner Duplicators Pvt. Ltd. Vs. Commissioner of Income Tax, West Bengal, that the said decision has not been considered in the decision of the Karnataka and Punjab & Haryana High Courts cited in support, thereof. The Tribunal considered the matter before the Supreme Court in Duplicators case and has observed that it related to the expression salary defined in s. 2(h) of Part A of IV Schedule to the IT Act, 1961. It is observed that the decision related to the case of employees being entitled to salary and also commission and the dispute was whether the employer-assessees contributions relating to the commission portion was allowable as a deduction. The Tribunal concluded the discussion by stating that the issue arising in the present case did not come up before the Supreme Court and, therefore, has not been considered.

In the process of reasoning in answer to the submission of the Department the Tribunal observed that it is not the case of the Department that Shri P. G. Oommen was an employee of the assessee-company. The Tribunal has stated this on the basis of a query from the letter dt. 21st April, 1980 addressed by it to the ITO, to find out as to whether there was any kind of employee-employer relationship on the basis of the material on record. The Tribunal came to the conclusion that the issue is covered by the two High Court decisions referred to above. In conclusion the Tribunal upheld the order of the first appellate authority for different reasons as enumerated hereinbefore.

We have reproduced the question referred hereinabove and we have to answer as to whether provisions of s. 40(c) of the IT Act, 1961 squarely applies to the situation available with reference to the factual matrix enumerated hereinbefore.

Firstly the learned senior standing counsel for taxes took us through the statutory provisions of s. 40 relating to situations showing amounts which are not deductible by reason thereof. The said statutory provision deals with four situations and are classified by cls. (a) to (d). Needless to state that s. 40(c) is one of the said four provisions and it relates to the case of any company and specifically to any expenditure or allowance in regard to which the normal deduction is sought. Statutory key words would show that such item should directly or indirectly result with regard to any remuneration or benefit or amenity, to a director or to a person who has substantial interest in the company or to a relative of the director or of such person, with an addition that such expenditure or allowance would not be deductible if the situation gets satisfied with regard to the requirements and even in a case whether such expenditure or allowance is either wholly or partly shown to have been used or received for his own purpose or benefit.

After specifying that the requirements are available for application certain further requirements are also available in the provision.

The ITO has to be of the opinion that such expenditure or allowance is excessive or unreasonable having regard to the legitimate business needs of the company and the benefits derived by or accruing to it therefrom.

Yet, after this formation of opinion the concerned ITO has been given a statutory limit in respect of aggregate of such expenditure or allowance in respect of any one person by enacting that in no case such expenditure or allowance shall exceed Rs. 72,000. These are statutory provisions that are really necessary in the aid of consideration of answer to the question referred to us.

Learned senior standing counsel for taxes submitted that on the factual matrix as is presented before us and the order that has been passed by the authorities below, the application of the provisions of s. 40(c) of the IT Act, 1961 would be beyond question. Learned counsel submitted that what is firstly required is to know the person on whose account deduction is claimed by the assessee-company. Learned counsel submitted with the help of the statutory provision that if the person is himself the director of company then the provisions would be directly applicable. Learned counsel submitted that if such a person who is one who has substantial interest in the company even then the provisions would be applicable with regard to the expenditure or allowance received by him from the company. Learned counsel additionally submits that there is yet a third category of a person being the relative either of the director or of such person and if the said person is a relative he would also be governed by the said statutory provision alone and no other provisions of the Act in regard to the question as to whether the amount paid by the company and received by such person is sought to be the subject-matter of a claim for deduction. Learned senior counsel submitted that the ITO has done no other thing than application of the said provision with regard to the claim for deduction which was not within the knowledge when the original assessment was completed.

At the other end learned counsel for the assessee strenuously drawing much from the decision from the Karnataka and Punjab & Haryana High Courts took us to the provisions of s. 40(a) of the IT Act to contend that the situation would be governed by the said statutory provision [s. 40(a) of the Act]. In the process learned counsel also took us through the recent decision of the Supreme Court in Commissioner of Income Tax, Bombay, etc. Vs. M/s. Mafatlal Gangabhai and Co. (P) Ltd., .

Bare reading of the provisions of s. 40A would arrest our attention to the proviso thereto. [proviso to s. 40A(2)(a)]. It would be apt to quote the said proviso ad verbatim and it is as follows :

"Provided that the provisions of this sub-section shall not apply in the case of an assessee being a company in respect of any expenditure to which sub-cl. (i) of cl. (c) of s. 40 applies."

It would at once be clear that when the assessee is a company and the question is of expenditure to which sub-cl. (i) of cl. (c) of s. 40 applies, the situation would not be governed for application of s. 40A of the Act.

Apart from the above statutory provision the learned senior standing counsel for taxes brought to our notice two decisions of the Supreme Court : Commissioner of Income Tax, Bombay Vs. M/s. Indian Engineering and Commercial Corporation Pvt. Ltd., and Bharat Beedi Works (Pvt.) Ltd. and another etc. Vs. Commissioner of Income Tax, . On the basis of the two decisions of the Supreme Court learned counsel contended that when the question is answered by the apex Court the decisions of the High Court would pale into insignificance by virtue of Art. 141 of the Constitution of India. We have carefully gone through both the decisions and in our judgment reading the two decisions the question is answered in a crystal clear manner.

The Indian Engineering case (supra) was taken up before the Supreme Court on questions relating to the remuneration paid by the assessee-company to its directors, forming part and parcel of the salary allowed to them. In other words the amount stated to have been paid by the company to the directors and sought to be deductible related to salary and the amounts of commission in proportion in regard thereto. It is observed that the commission was paid to the said directors on the sales effected by the assessee-company at a prescribed percentage. The Supreme Court has posed the question as to whether the commission on sales falls within the four corners of s. 40(a)(v) or s. 40A(5) of the Act. It is needless to state as regards the statutory provision as was applicable for the concerned assessment years in question before the Supreme Court (1971-72 and 1972-73), the Supreme Court has considered the provisions in regard to directors and who were employees and with regard to the amounts paid to them by way of commission having relationship of percentage to the salary of the directors concerned. In the process of analysis, we find from reading of the judgment that the payment was in cash and was paid as such to the concerned directors. In paragraph appearing at page 728 it is specifically observed that the provision in cl. (c) of s. 40 applies to directors amongst others. It is specified thereafter that s. 40(c) is applicable only to companies whereas s. 40A(5) is applicable to the employees whether of companies or others. It is further clarified that in the case of directors who are employees, both the provisions will be attracted - the higher of the two ceilings has to be applied. Therefore apart from the statutory provision in the nature of the proviso reproduced hereinbefore, the decision under consideration at present declares the law that it would be s. 40(c) of the Act that would cover the situation of directors and the provisions of s. 40A(5) would cover the situation of employees whether of companies or others and whether such employees may be directors, leading to a situation in regard to them that both the provisions would be attracted.

Supreme Court in the Bharat Beedi Works case (supra) has in fact considered the object behind the said statutory provisions and it was to discourage and disallow payment of high salaries and remunerations which go ill with the norms of an egalitarian society. It has also observed that the said provision is not confined to the directors and it took in relatives of directors, persons having substantial interest in the company and their relatives and in regard thereto the ITO is vested with the power to determine whether such expenditure or allowances was excessive or unreasonable having regard to the legitimate business needs of the company and the benefit derived by or accruing to it therefrom. It is also observed that a wide net is cast by reason of the two statutory provisions with the sole purpose of ensuring that excessive and unreasonable payments are not made to the persons in control of the affairs of the assessee in the name of paying for the goods, services and facilities rendered, supplied or extended to them, as the case may be.

In our judgment, in view of the above position, it is not necessary to run after other questions considered in the two decisions. It is also not necessary, in view of the declaration of law as specified hereinabove and also the plain statutory provision in the nature of the proviso to consider other aspects dealt with by the two decisions of the Supreme Court. Needless to state in the context that the decision in Mafatlal Gangabhai & Co.s case (supra) placed before us by the learned counsel for the assessee dealing with the question relating to cash payments by the company to its employees would also be unnecessary for consideration in the context of the above discussion. The decision related to the nature of payment and the payment was a cash payment. In fact the decision also rules that the language employed is not capable of taking within its ambit cash payments made to the employees by the assessee. The decision would have to be appreciated on the basis of factual peculiarities in regard thereto. The question before us is whether the situation would be governed by the provisions of s. 40(c) of the Act and the answer to it is crystal clear both from statutory positions and the two decisions of the Supreme Court referred to above. It also needs to be mentioned that the decision of the Tribunal is a situation of finality as far as the assessee is concerned.

For the above reasons the question is answered in the negative - in favour of the Revenue and against the assessee.