Commissioner of Income Tax vs Sudarsan Chits (India) Ltd.

K.A. Nayar, J.—The question arising for consideration in this case is whether the payment made by the assessee-company to its holding company under an agreement for the use of services of the managing director and four officers of the holding company is an allowable deduction.

The matter arises out of the Income Tax assessment for the assessment year 1975-76, for which the previous year ended on April 30, 1974. The assessee-company paid Rs. 2,50,000 to its holding company, namely, Sudarsan Trading Company Limited. This amount is an annual payment liable to be paid by the subsidiary company under an agreement, dated May 1, 1973, for the use of services of the managing director and four officers of the holding company for the business of the assessee-company. The agreement provided that 75 per cent. of the salary payable by the holding company to the five persons named therein or Rs. 2,50,000, whichever is less, is payable to the holding company for their services being made available by the holding company to the assessee. There was also a provision for taking over the chit business of the assessee-company from the holding company. As the profits of the assessee-company were only Rs. 1,55,101, the Income Tax Officer held that the payment of the salary routed through the holding company was unreasonable. He sustained the deduction of the claim for salary only to the extent of Rs. 42,000. In so doing, he applied Section 40(c) of the Income Tax Act to the payment. On appeal, the Commissioner of Income Tax (Appeals) held that the payment was a contractual one pursuant to an agreement. The agreement has not been shown to be colourable and it was not otherwise suspected. In view of the scale and extent of chit business, the bulk of the time spent by the management on the assessee''s business and also in view of the fact that the payment has been made to another company, he held that Section 40(c) of the Act is not attracted. He held that the assessee was entitled to claim deduction of the entire amount,

The Revenue filed an appeal ; but the Appellate Tribunal agreed with the finding of the Commissioner of Income Tax (Appeals). It is thereafter, at the instance of the Commissioner of Income Tax, Cochin, as directed by this court, that the following question was referred to this court :

"Whether, on the facts and in the circumstances of the case and on an interpretation of Section 40(c) read with sections 2(31) and 2(32) of the Income Tax Act, the Tribunal is right in holding that the provisions of Section 40(c) are not attracted ?"

We heard counsel.

Section 40 of the Income Tax Act introduced a non-obstante clause and it says that notwithstanding anything to the contrary in sections 30 - 39, the amount mentioned in Section 40(c) of the Act shall not be deducted in computing the income chargeable under the head "Profits and gains of business or profession". The clause empowers the Income Tax Officer to disallow the whole or any part of any expenditure incurred by a company which results directly or indirectly in the provision of any remuneration or benefit or amenity to a director or a person who has a substantial interest in the company as mentioned in Section 2(32) or a relative as defined in Section 2(41) of a director or of such person if, in the opinion of the Income Tax Officer, any such expenditure is excessive or unreasonable having regard to the legitimate business needs of the company and the benefit derived by or accruing to it therefrom. (See Mund and Samont Co. (P) Ltd. Vs. Commissioner of Income Tax , Bihar, Orissa and Patna, , DR. SARMUKH SINGH and CO. (PRIVATE) LTD. Vs. COMMISSIONER OF Income Tax, SIMLA., ; Harbour Engineering Private Ltd. Vs. Commissioner of Income Tax, Madras, and Sri Krishna Tiles and Potteries (Madras) Private Ltd. Vs. Commissioner of Income Tax, .

The contention of the Revenue is that the payment made by the assessee-company to the holding company is hit by the provisions of Section 40(c) of the Act. In order to apply that clause, the payment must be made (a) by way of pemuneration to a director, or (b) to a person having substantial interest in the company, or (c) to a relative of a director, or (d) to a relative of a person having substantial interest in the company. The argument is that even though the amount is not directly paid to a director, its ultimate destination or a portion of it will be a director of the holding company and, therefore, there is an indirect payment to a director. Alternatively, it was contended that the payment is made to the parent company and the parent company is a person having substantial interest in the assessee-company. It is further contended that the payment can also be considered as made to a relative of a person having substantial interest in the company. For this, the Revenue relied on the meaning of relative as "having or standing in a relation to something else".

We are not inclined to accept these contentions made on behalf of the Revenue, The payment in question was made on contractual basis and it was incurred on account of business expediency. The arrangement was made bona fide and in the interest of the business. The contractual payment has not been shown as colourable or otherwise suspect. That is the finding of the Commissioner of Income Tax (Appeals) as well as of the Tribunal. The appellate authorities also found that the apportionment is justified with reference to the gross turnover. There was nothing to suspect in the payment which was a contractual one made to another company. The Tribunal clearly found that the agreement arrived at by the parties is genuine and bona fide and it was not the case of the Revenue that the said agreement was bogus or sham. The assessee-company has an independent and legal personality distinct from its members. The corporate veil can be lifted in exceptional circumstances as indicated in Life Insurance Corporation of India Vs. Escorts Ltd. and Others, . In The Commissioner of Income Tax, Madras Vs. Sri Meenakshi Mills Ltd., Ors., , the corporate veil was lifted and evasion of Income Tax prevented by paying regard to the economic realities behind the legal facade. No such exceptional circumstances are found in this case. Hence, we are of the opinion that Section 40(c) is not attracted on the facts of this case. The amount also has been considered as reasonable. In the circumstances of the case, we hold that Section 40(c) read with sections 2(31) and 2(32) of the Act is not attracted.

We, therefore, answer the question referred to us in the affirmative, that is, in favour of the assessee and against the Revenue.

A copy of the judgment under the seal of the High Court and the signature of the Registrar shall be forwarded to the Income Tax Appellate Tribunal, Cochin Bench.