Hyderabad Deccan Cigarette Factory vs Commr. of Income Tax

Jaganmohan Reddy, J.—We had directed the Income Tax Tribunal at Bombay by our order of 8-8-1952 to state a case upon two questions, viz.,

Whether the Tribunal was right in law in disallowing the sum of Rs. 1,25,482/- paid to the Manager for the year 1357F. as an expenditure not laid out or expended wholly or exclusively for the purpose of the Assessee''s business?

Whether the Tribunal is correct in law in arbitrarily fixing the amount of Rs. 36,000/- as emoluments including the salary of the General Manager and further holding that any payment beyond Rs. 36,000/-was not a business expenditure?

The Income Tax Tribunal has in compliance with the aforesaid order stated a case from which it appears that the Hyderabad Deccan Cigarette Factory belonging to the late Abdul Sattar was being run since 1343F., by his two heirs, namely by his widow Salim Khatoon and his daughter Abida Khatoon, with the assistance of Gulam Hyder Khan, the father and grandfather of the widow and daughter respectively. During the life time of Abdul Sattar, the manager of the company was paid Rs. 1,000/- per month, but on his death Gulam Hyder Khan who was appointed as a manager was being paid a salary of Rs. 500/- per month which was raised to Rs. 1000/- per month a few years later. In the year of assessment, 1357F., the Assessee returned an income of Rs. 5,19,558- in respect of the factory, but the Income Tax Officer computed the amount at Rs. 6,49,148/-. The Appellate Officer, however, reduced the factory income by Rs. 33,928/-which was maintained by the Tribunal in appeal. In assessing this amount the salary of Rs. 1,000/ per month paid to Gulam Hyder Khan was allowed as an expense, but the Assessee claimed over and above this amount a deduction of Rs. 1,25,482/- as four annas share in the net profits of the factory business which was said to be payable to Gulam Hyder Khan by and under an agreement dated 28th Bahman, 1357F., entered into between the Assessee and the said Gulam Hyder Khan. It is with respect to this amount that the Assessee has come up before us on an application under Sub-section (2) of Section 82 of the Hyderabad Income Tax Act, on the Tribunal refusing to state a case on an application under Sub-section (1) of Section 82.

The appellate tribunal in stating a case has annexed a copy of the service agreement referred to above, the preamble of which runs as follows:

a. Whereas Gulam Hyder Khan has been working since 21st Amardad, 1343 Fasli as the General Manager and Mukhtar-e-am of the business run in the name of the Hyderabad Deccan Cigarette Factory owned by the parties of the First Part;

b. Whereas due to the industry and efficient management of the said Gulam Hyder Khan the employers have been making good profits since 1343 Fasli;

c. Whereas the said Gulam Hyder Khan has been asking from a very long time to give him a share in the profits of the said factory as the entire profits earned by the Factory are due to the Employee''s skilful and efficient management;

d. And whereas the employers are Purdah Nishin ladies and. it is not possible for them to actively engage themselves in the daily routine and management of the business;

The operative portion of the agreement is in these terms:

The said Gulam Hyder Khan shall receive a monthly remuneration of Rs. 1,000/- and a share of four annas in the net profit of the business, after charging all business expenditure including the monthly remuneration paid to the said employee, and also alter charging any donations and charities whatever is given with full consent and approval of both the Employers and the Employee".

The Income Tax Officer in the course of his order observed:

One of the considerations for increasing the emolument is stated to be the old age of the employee and the service rendered by him so far. This is indeed not a sound reason for increasing the emoluments in excess of the monthly remuneration of Rs. 1000/- to the tune of Rs. 1,25,482/- in the accounting year. The said employee is no other than the father of Salim Khatoon, one of the said partners of the firm and has been looking after the business for the last 12 years. I do not think that any consideration should be given to the employee in the accounting year for his past services, and this agreement in my opinion, is not so much to the services he rendered to the factory as to the relationship with the alleged partners.

The Deputy Commissioner While maintaining the view point of the Income Tax Officer, further observed that the recipient did not know English. Dealing with the contention that the Manager supervised the work of the business and also purchased tobacco from Guntur and other places, the Deputy Commissioner expressed the view that the progress of the factory was due to the skill of the workmen and the work of the machines and it cannot be said that the profits of over three lakhs were earned through the personal exertions of the recipient. Having regard to the qualifications and the actual work done by Gulam Hyder Khan the salary of Rs. 1,000/- paid to him was quite normal. The Tribunal, however, considered that on the face of the service agreement a share of four annas in the rupee of the net profits was out of all proportion to the work done by Gulam Hyder Khan and that it was not impressed by the argument that an agreement for a higher remuneration was not entered into earlier by reason of the minority of Abida Khatoon. It further held that there is no evidence that Gulam Hyder Khan threatened to leave the ladies or that he could have got elsewhere the terms as alleged to have been granted under the service agreement or that a manager of the concern of the size of the Cigarette Factory got such higher lucrative terms from any other firm. Having regard to the remuneration paid to the Assistant Manager in 1357 F., i.e., Rs. 750/- per month and Rs. 25,000/- as flavouring charges, the Tribunal allowed in all Rs. 36,000/- as a reasonable remuneration to the Manager who was the Chief Executive of the Factory,as an expenditure laid out or expended wholly and exclusively for the purpose of the Assessee''s business.

The deduction claimed by the. Assessee is u/s 12 (2) (xv) of the Hyderabad E. P. T. Act (Section 10 (2) (xv) of the Indian Income Tax Act) which is as follows:

Any expenditure (not being in the nature of a capital expenditure or personal expense of the Assessee) laid out or expended wholly and exclusively for the purposes of such business, profession or vocation.

It has been observed by the Supreme Court in the case of -- Commissioner of Income Tax, West Bengal Vs. Calcutta Agency Ltd., that where the Assessee claims an exemption of amount, on the ground of its being an expenditure falling u/s 10 (2) (xv), the burden of proving the necessary facts in that connection is on the Assessee. It is hot necessary for the Income Tax Tribunal to challenge the validity or otherwise of the agreement or consider the question whether the amount was actually paid or not. If without challenging either the validity of the agreement or the factum of payment, the Income Tax Tribunal considered the amount paid as not being reasonable or wholly or exclusively expended for the purposes of the business, it can disallow the whole or so much of such expenditure as in its opinion is in excess of the amount reasonably necessary for the purposes of the business. In � Jethabhai Hiraji and Co. Vs. Commissioner of Income Tax, Chagla C.J. dealing with the arguments of Sir Jamshedji Kanga, (which are the same as those addressed before us by Mr. Sitharamiah, Advocate for the Assessee) that it is for the employer to determine what remuneration he should pay for the services rendered to him by an employee and that the Income Tax Officer could never be in a position to judge as to how and in what manner the employer should remunerate his employees, observed following the principles laid down by the Privy Council in � Aspro Ltd. v. Commissioner of Taxes 1936 4 ITR 264 (C) as follows:

Section 10 (2) (xv) of the Indian Income Tax Act, 1922, requires that whatever amount he pays to his employee must be paid wholly and exclusively for the purposes of his business, and it is for the Income Tax Officer to decide whether any remuneration paid by the employer to his employee was wholly and exclusively expended for the purpose of his business. It is erroneous to contend that as soon as an Assessee has established these two facts, namely, the existence of an agreement between an employer and an employee and the fact of actual payment, no discretion is left to the Income Tax Officer except to hold that the payment was made wholly and exclusively for the purposes of the business. Although the payment might have been made and although there might be an agreement in existence, it would be open to the Income Tax Officer to take into consideration various factors which would go to show whether the amount was paid as required by the section.

In that case the Assessee employed two persons to attend to his branch of business on salaries of Rs. 125/- and 111/-. Later he agreed to pay to each of these employees a commission of 20 per cent on the net profits of the branch in addition to their respective salaries and pursuant to this agreement each employee was paid Rs. 6,000/-. The Income Tax Officer considered this claim and allowed only a sum of Rs. 1,000/- and the balance of Rs. 11,000/- was disallowed by him. The Tribunal came to the conclusion that the sum of Rs. 11,000/- was rightly disallowed by the Income Tax Officer as according to the Income Tax Officer the amount was not wholly and exclusively expended for the purposes of. the Assessee''s business. In coming to this conclusion the Tribunal considered all the evidence and all the factors placed before it.

Mr. Sitharamiah contends that in that case an opportunity was given to the employees to file affidavits in order to satisfy that these two employees performed extra work in order to merit so large a sum of as Rs. 6,000/- each, but in this case no such opportunity has been given. This contention in our view, has no force as the burden of establishing facts necessary for the Income Tax authorities in coming to the conclusion that the amount claimed was wholly and exclusively expended for the purposes of the business, is upon the Assessee and it was for the Assessee to have established these facts to the satisfaction of the Income Tax authorities, Now what are the facts and circumstances that the Assessee sets forth in this case? A reference to the preamble of the agreement set out above would show that the following considerations were taken into account for paying the remuneration claimed as deduction: (a) that Shri Gulam Hyder Khan was working since Amerdad 1343 F., as the General Manager and Mukhtar-e-am of the business and that due to his industry and efficient management the employers have been making good profits since that date; (b) that the entire profits earned by the factory are due to the skill and efficient management of Gulam Hyder Khan; (c) that the employers are Purdah Nishin ladies and it is not possible for them to actively engage themselves in the daily routine and management of the business; and (d) that the age of the employee, the services rendered by him so far & the necessity of his continuing as an employee in future. The aforesaid considerations set out in the preamble for paying the amount have been held to be insufficient to allow the deduction, in view of the absence of proof that the factory could not be run at all without the services of the employee. The Tribunal came to the conclusion that the remuneration sought to be deducted was for past services and that at any rate it was not shown that the business could not be run without the services of Shri Gulam Hyder Khan, nor has it been shown that he would get the same or similar remuneration elsewhere. It was not alleged that the employee had any particular technical skill by reason of which his employment at high remuneration was necessary for the conduct of the business. The contention that the entire earnings of the factory were due to the skilful and efficient management of the employee was also quite properly negatived on the ground that it was the skill of the workmen and the machines which contributed to the earning of the profits and that it cannot be said that the services of the Manager are alone responsible for the earning of profits of the company. Further the obligations of the employee under the service agreement are very unreal, namely, that he shall diligently and honestly devote his full time to the business of the employers, that he shall not act in any manner prejudicial to the interest of the employers and shall not sell or dispose of or deal otherwise with the property and assets belonging to the company nor assign, transfer or deal otherwise with his interest in the factory under any circumstances whatsoever. These obligations appear to us to be either to pertain ordinarily to the duties of an employee or are not consistent with the status of an employee. It is somewhat strange to suggest that an employee should not sell, dispose of or deal otherwise with the properties or assets belonging to the factory which he as an employee cannot do. In our view the Income Tax Tribunal was entitled to the view that the remuneration was not reasonable having regard to the nature of the business and that at any rate it was out of all proportion to the services which the employee was capable of rendering. This finding is a question of fact and in our view the Income Tax Tribunal had sufficient basis for coming to the conclusion which they did.

There is no substance in the argument of the learned Advocate for the Assessee that there was no basis for fixing Rs. 36,000/-. It was, in our view, open to the Income Tax authorities to have rejected the entire claim on the ground that the Assessee has not shown to their satisfaction that the amount paid was neces- sary for the purposes of the business but the Tribunal having regard to the highest salary paid to an executive officer in the Government fixed the remuneration at Rs. 3,000/- per month and allowed Rs. 36,000/-. In this view of the matter our answer to the questions 1 and 2 of the reference is in the affirmative. The Assessee Will pay the costs of this reference.