K.R. Kothandaraman vs Commissioner of Income Tax, Madras

Veeraswami, J.

(1) The assessee is the Managing Director of a Public Limited Company called ""Transformer and Switchgear Ltd."". He was the promoter of the

Company and would appear to have established contacts with experts in a German Concern in the particular type of business. The Company was

incorporated on November 28, 1956, Article 106 of the memorandum and Articles of Association provided for the appointment of the assessee

as the Managing Director of the Company for a period of five years subject to the control and supervision of the Board of Directors and upon the

terms, provisions and conditions as to remuneration and management as specified in the agreement to be executed between them. Pursuant to this

Article they did enter into an agreement on May 22, 1957. The preamble referred to the services of the assessee in promoting the Company and

his experience in the line of the business and by Clause (1) he was appointed as the Managing Director of the Company for a period of five years

from the date of its incorporation. Clauses (2) and (4) and Clause (9) defined his powers and duties as a Managing Director which were to be

exercised by him subject to the supervision direction and control of the Board of Directors and also subject to the provision of the Memorandum

and Articles of Association. In consideration thereof and subject to the relative provisions in the Companies Act, 1956, and of the services to be

performed by the Managing Director, Clause (5) provided that ""the company shall pay to the Managing Director in respect of each year of account

of the Company........ a monthly remuneration of Rs. 1250 plus commission at the rate of five percent on the net profits made by the Company"".

The commission was to be come due and be paid to him yearly and he would be entitled to draw the same immediately after the annual accounts

of the Company of each year were made up by him and profits certified by the Auditors of the Company and the accounts were laid before the

Company in General Meeting. But this is subject to the provision that the Managing Director would be entitled to draw the minimum remuneration

in monthly installments not exceeding Rs. 1250 per month. The assessee included the receipt to monthly remuneration in his Income Tax returns for

the assessment years prior to the assessment year 1960-61 under the head of salary and he had been assessed accordingly. The accounting year

for the Company is the calendar year for the assessee, the financial year. For the accounting year ended December 31, 1959 the Company

credited to the assessee a remuneration of Rs. 1250/- every month. But on December 31, 1959 the Company, however, debited the assessee with

a sum of Rs. 15,000 which represented the salary for the whole year. This was said to be pursuant to a resolution of the Board of Directors dated

May 9, 1960 which was:

In view of the company not making any profit the company decides to stop payment of remuneration of Rs. 15,000 per annum to the Managing

Director Mr. K.R. Kothandaraman for the year 1959"".

The assessee in respect of the assessment year 1960-61 claimed that he was not entitled to remuneration for the whole year of 1959 by virtue of

the resolution and that the credit entries made month after month did not entitle him or remuneration in the circumstances. This contention was

rejected and the sum of Rs. 11,250 credited to the assessee''s account for nine months from April to December 1959 was brought to tax. The

assessee succeeded in his appeal in relation to this amount, the Appellate Assistant Commissioner being of the view that by reason of the

Company''s resolution the assessee was compelled not to demand the amount of remuneration and that such compulsion was the result of business

expediency. He was also of the view that there was no surrender of the remuneration because he was not entitled to any remuneration at all for the

year ending December 31,1959. But the Tribunal on appeal by the Revenue reversed that decision. The Tribunal held that having regard to the

relationship of the assessee with the Company under the agreement, he must be regarded as a salaried employee and, the remuneration credited to

him for the nine months was salary chargeable to tax u/s 7 of the Income Tax Act, 1922. It further held that as the resolution of the Company was

passed long after the accounting year of the assessee it could not in any event, abrogate the right of the assessee under the agreement and literally

read the resolution had only the effect of stopping the payment of remuneration. At the instance of the assessee, the reference has been made to us,

u/s 66(1) of the Act, of the following question:

Whether on the facts and in the circumstances of the case the sum of Rs. 11,250 is assessable u/s 7 of the Income Tax Act?"".

Having regard to the frame of the question we are not called upon to answer whether the remuneration for the nine months would fall within section

The question is confined to whether the sum us assessable u/s 7. Two aspects of this question have been presented to us on behalf of the

assessee. (1) Whether the sum represents salary and (2) if it is salary whether there was real income accrued to the assessee in that sum. On the

first aspect the submission for the assessee is that the relationship of the assessee with the company is such that he could hardly be treated as an

employee. Under the terms of the agreement, he is invested with powers in the exercise of which he virtually carries on the business of the

Company. The indicia according to the argument which determine the relationship between a master and servant are lacking. It is recognised by

learned Counsel for the assessee himself that the solution to this question lies in the terms of the agreement.

We have already referred to Article 106 of the Memorandum an Articles of Association which itself made the appointment of the assessee as the

Managing Director but left the terms of the appointment to be regulated by an agreement. The agreement no doubt invested the assessee with

extensive powers of management covering the entire conduct and exigencies of the business. But provision was specifically made that he was to

exercise his functions subject to the superintendence, direction and control of the Board of Directors and subject also to the provisions of the

Memorandum and Articles of Association. It is true as was held in Lakshminarayan Ram Gopal and Son Ltd. Vs. The Government of Hyderabad,

: that a master is one who not only directs what and when thing is to be done but how it should be done. That is a principle often applied in

distinguishing between an employee ore a servant and an independent contractor particularly in the field of Industrial law. But we are not certain

that his test is necessarily the only test in deciding whether the relationship of master and servant exists for, one has to take note of various changing

factors in human and industrial relationships which regulate and change or alter the concept of the relationship of master and servant. Take for

instance a driver of a private motor car. He is undoubtedly a servant of the employer tells the driver how to drive the motor car. It is even

conceivable that the employer may not know driving himself or even less about the mechanism of a motor car. In such a case however one knows

it as an obvious fact that the driver is a servant and is recognised as such by reference to other factors. But even applying the test of

Lakshminarayan Ram Gopal and Son Ltd. Vs. The Government of Hyderabad, ; we are satisfied that the terms of the agreement and the functions.

But even applying to the assessee and the reservation to the Board of Directors of the right of superintendence, direction and control show that the

relationship between the Company and the assessee is that of an employer and an employee. The Indian Companies Act, 1956 under the

provisions of which the Company here was incorporated defines the terms ''director'' ''manager'' ''managing agent'' and managing director''.

Notwithstanding the nomenclature, it appears that, with reference to the terms of the agreement and the functions the assessee is called upon to

exercise there under he is virtually a manager but under the definition of a ''manager'' he has the management of the whole or substantially the whole

of the affairs of the company. It may be seen that the term ''manager'' as defined in the Companies Act, 1956 includes also a director or any other

person occupying the position of a manager by whatever name called and whether under a contract of service or not. In this case the agreement in

our view cannot be construed as anything other than a contract be construed as anything other than a contract of service. It may be that a director

of a company only be reason of that capacity will not be a servant of the company: COMMISSIONER OF Income Tax, BOMBAY CITY Vs.

LADY NAVAJBAI R. J. TATA., But there is nothing to prevent him from being a servant of the company too under a special contract of service

which he may enter into the with the company.

(2) Our attention is however invited by learned counsel for the assessee to Inderchand Inderchand Hari Ram Vs. Commissioner of Income Tax

and C.P. and Berar, , and Commissioner of Income Tax, Madras Vs. K.R.M.T.T. Thiagaraja Chetty and Co., : which, as we think are of no

assistance to him They are both cases of managing agency and relate to commission payable to it. In the first of these cases, the managing agency

was a firm. Under the Memorandum and Articles of Association of the company of which it was the managing agent it was entitled to a monthly

allowance and a certain commission on sales of the company''s products and on its profits. The firm contended that the income received as the

managing agent of the company and as its sole selling agent should be assessed under S. 7 of the Indian Income Tax Act but the Revenue would

not admit it and charged the income under S. 10. The Allahabad High Court on a reference upheld the view of the Revenue and pointed out that

the question in which capacity the sole agent was working would depend upon the facts of each case Commissioner of Income Tax, Madras Vs.

K.R.M.T.T. Thiagaraja Chetty and Co., was also a firm being the managing agent of a limited company and under the managing agency agreement

it was entitled to a certain monthly remuneration, a commission of 10 percent., on the net profits of the company and a small percentage on sales

and purchases. During the year of assessment in that case, the assessee became entitled to a large amount by way a commission. By a resolution

the Board of Directors decided to keep the entire commission is suspense without payment. This sum was debited as a revenue expenditure of the

company and was allowed as deduction in computing the profits of the company. The question was whether the managing agent was liable to pay

tax on the commission amount. According to the Revenue since the assessee followed the mercantile method of accounting the income having

accrued it became assessable whether it was received or not. The Appellate Tribunal took a contrary view. But the High Court was of the view

that there was no material for the Tribunal''s finding that the assessee was being assessed on cash basis in previous years. The decision of the High

Court was confirmed by the Supreme court. It was suggested in the course of the arguments before the Supreme Court that the managing agency

was not a business. But the Supreme Court considered that this question was immaterial for the purpose of Income Tax because of S. 13 and so

refrained from deciding the point. Even so it pointed out in passing, that the point was directly decided in Inderchand Hari Ram Vs. Commissioner

of Income Tax and C.P. and Berar, ; to which we have made reference. It may be seen therefore that Commissioner of Income Tax, Madras Vs.

K.R.M.T.T. Thiagaraja Chetty and Co., did not decide the question and does not help in deciding the question we are called upon to answer.

(3) It may be that the concept of a servant may in a sense involve an element of agency but on the account, servant is not to be regarded as an

agent; and an agent is never a servant. We have already held that having regard to the terms of the agreement and the functions which the assessee

exercised with reference to them, he should be regarded as a manager. In any case, at best he may be treated as a Managing Director under a

contract of service. Though a director simplicities is not a servant of a company, when a managing directors enters into an agreement of service,

there is no reason why he should not be held to hold two capacities, one of them as an employee of the company. In Commissioner of Income

Tax, Madras Vs. B. Nagi Reddy, ; this court was of the view that the remuneration received by managing director was salary. The question there

was whether the remuneration received by the managing director of a concern carrying on a business was income from salary assessable under S.

10 or income from salary assessable under S. 7 or income from other sources assessable under S. 12. This court stated that the answer depended

on the nature of the activities and functions performed by the managing director. The agreement between the assessee and the company which was

engaged in the productions of films provided that the assessee was appointed as managing director for ten years and was entitled to a monthly

remuneration of Rs. 500. Subsequently a resolution was passed by the company in which the assessee became entitled to 121/2 per cent of the net

profits of the company in addition to the monthly remuneration. Following Lakshminarayan Ram Gopal and Son Ltd. Vs. The Government of

Hyderabad, ; this court, as we said expressed the view that the remuneration was not income assessable under S. 10. This court observed that it

was the nature and scope of the activity and not the extent of the operations which was relevant in determining the question and added at p. 191:

The remuneration of an agent is only the quid pro quo of the services rendered and however much an agent may represent a business he cannot

be said to be carrying on a business"".

We are respectful agreement with these observations. In this case it was the Company that was carrying on the business and the assessee was

employed by the company in managing its affairs including the carrying on of its business. We are of opinion therefore that the monthly

remuneration credited to the assessee for the nine months is question represented his salary. We are not concerned in this reference with the nature

of accrual to or receipt of the commission by the assessee and the capacity he held in relation to it. Though we do not exclude the possibility of a

combination of a servant and an agent in one and the same person, this question too we do not decide as it in unnecessary.

(4) That takes us to the second aspect of the question. The argument for the assessee is that if S. 7 applies no salary accrued is assessee during the

relevant period. It is stated that in view of the resolution of the Board of Directors, he became disentitled to payment of the salary and so the

assessee had no vested right in the credit entries and that unless he had such rights the mere book entries cannot be taken to be an accrual of salary

to the assessee. We are afraid that the argument proceeds on a wrong conception of the effect of the entries in the books of the company and of

the resolution of the Board of Directors. As we said under the agreement dated May 22, 1957 the company shall pay to him a monthly

remuneration of Rs. 1250 and he will be entitled to draw that remuneration every month. These are the words used in the agreement.

........the company shall pay to the Managing Director....... in monthly installments not exceeding Rs. 1250 per month"".

This is not subject to any exception and the agreement does not provide for the Board of Directors, by a resolution, to stop or deny payment of

this remuneration. It is no doubt true as held in Commissioner of Income Tax, Kerala and Coimbatore Vs. L.W. Russel, ; the word ""allowed"" in

section 7 of the Indian Income Tax Act, 1922 presupposes a vested right. But the agreement certainly conferred on the assessee a right at the end

of the month to payment of the monthly salary. In fact, the folio relating to the assessee in the books of the company shows that practically at the

end of every month a sum of Rs. 1250 was credited to his account. The entry on December 31,1959 is: ""To M.D. Remuneration Amount

transferred... Rs. 15,000"". That would not suggest that the assessee had no vested right but the credit in his favour was transferred and not

withdrawn which the company could not as far as we can see, do under the terms of the agreement. It is contended perhaps rightly that the book

entries are not necessarily conclusive and it cannot invariably be said that the income results from such entries of credit. But is the present context

we have no doubt that the entries in the folio page relating to the assessee in the books of the company did result in accrual of salary from month to

month for the period in question. Commissioner of Income Tax, Bombay City I Vs. Shoorji Vallabhdas and Co., ; is relied on by the assessee in

support of a contention that it was open to the company to withdraw the salary by a resolution passed subsequent to the assessment year. We do

not think that the authority supports him, for, there the withdrawal was by a subsequent agreement between the assessee and the Company and the

agreement was during the assessment year itself. It is then contended that on the principle to doctrine of the ""real income"" laid down in H.M.

Kashiparekh and Co. Ltd. Vs. Commissioner of Income Tax, Bombay North, Kutch and Saurashtra, Baroda, : it must be held that in point of fact

there was no real accrual of salary during the period in question, to the assessee. In that case, the assessee adopted the mercantile system of

accounting. The assessee was the managing agent of the paper mill company and under the terms of the managing agency agreement, the assessee

was under a duty to forgo one-third of his commission where the profits of the company were not sufficient to pay a dividend of six per cent. For

the accounting year ended March 31,1950 the assessee earned a certain commission but as result of the resolutions passed by the company, the

assessee gave up a considerable part of the commission in December 1950. The Tribunal held that what was forgone exceeded the proportionate

profit provided for in the agreement; nevertheless it also found that the excess given up was for reasons of commercial expediency. The Bombay

High Court held.

It was the real income of the assessee company for the accounting year that was liable to tax and that the real income could not be arrived at

without taking into account the amount foregone by the assessee. In ascertaining the real income the fact that the assessee followed the mercantile

system of accounting did not have any bearing. The accrual of the commission, that making of the accounts the legal obligation to give up part of

the commission and the foregoing of the commission at the time of the making of the accounts were not disjointed facts: there was a dovetailing

about them which could not be ignored. The real income of the assessee was Rs. 27,644 and the amount of Rs. 97,000 foregone by the assessee

could not be included in the real income of the assesee for the accounting year

It was further observed that the principle of real income was not be so subordinated as to amount virtually to a negation of it when a surrender or

concession or rebate in respect of managing agency commission was made, agreed to or given on grounds of commercial expediency simply

because it took place some time after the close of an accounting year. Relying on this decision learned counsel for the assessee argues that although

the resolution of the Board of Directors was passed subsequent to the assessment year, it was passed subsequent to the assessment year, it was

passed on the ground of commercial expediency and on the same ground the assessee was justified in foregoing the salary for a period of nine

months. On that basis it is said that there was really no accrual of salary to the assessee for the period. We are unable to accept this contention.

The Bombay High Court in that case was concerned with what was admittedly a business income. That was a case of assessment u/s 10.

Naturally, therefore the question of business expediency in relation to a loss or expenditure for the purpose of the business expediency in relation to

a loss or expenditure for the purpose of the business would be germane. We are unable to extend the doctrine of ''real income'' in he context of

commercial expediency to receipt or accrual of salary which is liable to tax u/s 7. On this view it is necessary for us to deal with the other question

whether each accounting or assessment year being an independent unit, withdrawal of income by a resolution subsequent to the assessment year

would have any effect on the computation of income in such assessment year. The point here is whether where the salary had accrued to the

assessee but the Board of Directors by a resolution made subsequent to the assessment year purported to stop payment of it can be said that, in

the circumstances, there was no accrual of the salary to the assessee. In the first place the resolution, worded as it is, does not purport to withdraw

the salary already accrued to the assessee. All that it stated was: ""the company decides to stop payment of remuneration of Rs.15,000....... to the

Managing Director..... for the year 1959"". It only means withholding of payment of remuneration and not denial or withdrawal of the remuneration

for the period. Even assuming that the resolution can be read as a withdrawal of the remuneration, even so we are of opinion that if would only

amount to a kind of disposal by the assessee if he agreed to accept the resolution. On more or less similar circumstances, this court took that view

in Kothari Mehta and Co. (PTE.) Ltd. Vs. Commissioner of Income Tax, Madras, There the managing agency commission under the terms of the

agreement should be paid every year out of the profits of that year. There was also a provision that the commission should become payable to the

managing agents on the company''s auditors certifying the company''s annual balance sheet. The audited accounts of the company for each year

contained a statement to the effect that the managing agents had waived the commission due to them on the profits. The accounts bore dates which

were subsequent to the assessment years. The question arose whether is the managing agency commission had accrued to the assessee

immediately upon the close of its accounting year, the waiver long subsequent to the close of the accounting year, was anything more than a

disposal of the income which had accrued to it and whether it would justify the claim that there was no accrual at all till the date of the waiver was

made. The question was answered against the assessee. The learned Judges there observed at page 757:

As we have pointed out, there is no evidence of any agreement of any description which operated to alter the rate of commission or give up the

commission due to the assesee. No such agreement or transaction which could be regarded as an agreement was entered into during the

accounting year. If after the accrual of the income, according to the terms of the managing agency agreement, the managing agents purported to

give up any part of that income that cannot be regarded as affecting the terms of the agreement whereunder such income had accrued to it. It

follows that the view taken by the department and the Tribunal that the income had accrued to the assessee in the instant case and that the waiver

operated only as a disposal of that income is correct"". That precisely is the position in this case too. As we have already mentioned the agreement

while providing for accrual of the salary or remuneration to the assessee every month provided nowhere for waiver of any part or whole of such

remuneration; nor did the agreement reserve power for the Board of Directors to decide that the assessee should forego any part of his

remuneration which had accrued to him. If the resolution, therefore, in this case is to be read as having the effect of denying the salary during the

period of nine months to the assessee or if it is to be taken that the assessee had waived the accrued remuneration such denial, withdrawal or

waiver occurred subsequent to the assessment year, and it would, therefore, be totally ineffective on the computation of the income for the

assessment year which would be liable to tax u/s 7. The entries made in the folio page relating to the assessee in the books of the company having

particular regard to the terms of the agreement, would appear to be irrevocable entries and it would not be open to the Board of Directors to

cancel those entries in their effect by the resolution. On this view also, the remuneration for the period of nine months can be rightly brought to tax.

(5) The question referred to us in answered against the assessee with costs. Counsel''s fees Rs. 250/-