Andhra Pradesh H.C : Whether, on the facts and in the circumstances of the case, the Tribunal is justified in holding that for purposes of computing disallowance under s. 40(c) of the IT Act 1961, commission paid to the managing director cannot be taken into account?

High Court Of Andhra Pradesh

CIT vs. Coromandal Fertilizers

Sections 35D, 37(1), 40(c), Rule 6D
S.V. Maruthi & T. Ranga Rao, JJ.
Case Referred No. 51 of 1990
21st October, 1998

Counsel Appeared

S.R. Ashok, for the Applicant : K.K. Viswanatham, for the Respondent

JUDGMENT

S.V. mARUTHI, J.

The following questions are referred by the Tribunal for the opinion of this Court :

“1. Whether, on the facts and in the circumstances of the case, the Tribunal is justified in holding that for purposes of computing disallowance under s. 40(c) of the IT Act 1961, commission paid to the managing director cannot be taken into account?

Whether, on the facts and in the circumstances of the case, the Tribunal is justified in holding that allowance of expenditure has to be limited under r. 6D of the IT Rules, 1962 with reference to the whole of the previous year and not by splitting up each trip of an employee?

Whether, on the facts and in the circumstances of the case, the Tribunal is justified in holding that the amount of Rs. 2,29,306 spent by the assessee towards fees to Tata Sons Ltd. constitutes business expenditure deductible from its business income?

Whether, on the facts and in the circumstances of the case, the Tribunal is justified in holding that the amounts of Rs. 13,241 and Rs. 7,860 spent by the assessee towards reimbursement of expenses incurred by Apex Geological Services (P) Ltd. and Holtec Engineers (P) Ltd. constitute business expenditure deductible from its business income?”

2. The first question relates to payment of Rs. 45,000 as remuneration to the managing director. The CIT excluded the amount for the purpose of s. 40(c) of the IT Act, 1961 (for short ‘the Act’). The Tribunal agreed with the view of the CIT following their view for the earlier assessment year. The learned counsel appearing for the Revenue contended that the issue is now covered by a judgment of this Court in CIT vs. Bakelite Hylam Ltd. (1995) 127 CTR (AP) 46 : (1996) 217 ITR 469 (AP) : TC S16.1744 wherein it was held that the commission paid to the managing director of the company would constitute remuneration for the purpose of computing disallowance under s. 40 (c) of the Act. While the learned counsel for the assessee contended that the said judgment is not correctly decided as the Supreme Court in CIT vs. Indian Engg. & Commercial Corpn. (P) Ltd. (1993) 112 CTR (SC) 56 : (1993) 201 ITR 723 (SC) : TC 18R.587, held that commission on sales paid to the managing director of the company is not covered by s. 40(a)(v) and 40A(5) of the Act; that the said judgment of the Supreme Court was not brought to the notice of the learned Judges; and that it is per incuriam. The learned counsel for the assessee also submitted relying on CIT vs. Colgate Palmolive (India) (P) Ltd. (1994) 118 CTR (Bom) 212 : (1994) 210 ITR 770 (Bom) : TC 16R.1464 that the Bombay High Court was of the view that the payment covered by s. 40(c) applies to periodic payments and, therefore, the commission paid to the director is not to be taken into account for the purpose of disallowance under s. 40(c).

3. Sec. 40(c) at the relevant time reads as follows : “Amounts not deductible.—Notwithstanding anything to the contrary in ss. 30 to 39, the following amounts shall not be deducted in computing the income chargeable under the head ‘Profits and gains of business or profession’,— (a) and (b)…… (c) in the case of any company— (i) 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, as the case may be;”

4. The main argument of the learned counsel for the assessee is that Rs. 45,000 was paid as percentage on net profit under s. 309(5) of the Companies Act, 1956. It is true that in Bakelite Hylam Ltd.’s case (supra) this Court held that any commission paid to the managing director of the company amounts to remuneration within the meaning of s. 40(c) of the Act. However, there is no reference to the nature of commission paid in the said judgment. Relying on the definition of ‘remuneration’ in Law Lexicon and the judgment of the Supreme Court in CIT vs. Calcutta Stock Exchange Association Ltd. (1959) 36 ITR 222 (Cal) : TC 13R.1271 and the dictionary meaning, the learned Judges held that the commission paid shall not be taken into account under s. 40(c) of the Act. However, it is pointed out that s. 40(c) does not use the expression ‘commission’, while under s. 40(b), in the case of any firm, any payment of interest, salary, bonus, commission or remuneration made by the firm to any partner of the firm is to be excluded while computing the amounts deductible. In other words, s. 40(b) expressly uses the word ‘commission’, while under s. 40(c) expression ‘commission’ is not used, but only the expressions ‘remuneration or benefit or amenity’ are used.

5. From the above, it follows that the legislature intended to use the expression ‘commission’ and ‘remuneration’ with different meanings and in different contexts. In other words, the expression ‘remuneration’ cannot be interpreted as including ‘commission’. If the intention of the legislature was to include ‘commission’ paid in the expression ‘remuneration’, it would not have used both the words ‘commission’ and ‘remuneration’ under s. 40(c) and omitted the word ‘commission’ under s. 40(c) of the Act. The very fact that the legislature has not used the word ‘commission’ under s. 40 (c) of the Act indicates that the commission does not mean remuneration. Further, as pointed out in the earlier paragraph, the nature of commission paid in Bakelite Hylam Ltd.’s case (supra) to the director is not explicit from the facts of the case, whereas in the present case, a percentage of net profit was paid. Therefore, the judgment of this Court in Bakelite Hylam Ltd.’s case (supra) is not applicable to the facts of the present case.

6. As regards the judgment of the Supreme Court in Indian Engg. & Commercial Corpn. (P) Ltd. case (supra), it is a case where they were considering commission on sales paid to the director in addition to the salary, whether it is ‘salary’ and ‘perquisite’ to an employee within the meaning of s. 40(a)(v). In that context, the learned Judges have held that the payment of commission on sales directly to the employee concerned did not fit into ss. 40(a)(v) and 40A(5) of the Act. The judgment is distinguishable on facts as the question here is not whether ‘commission’ paid is a ‘perquisite’ or a ‘salary’. Similarly, the judgment of the Bombay High Court in Colgate Palmolive (India) (P) Ltd.’s case (supra) was considering a case of payment of gratuity to the chairman-cum-director. In that context, the learned Judges have held that s. 40(c) or s. 40A(5) of the Act has no application. In other words, gratuity is not a periodic payment and, therefore, s. 40(c) is not applicable to periodic payments. Further, there is no reasoning given by the learned Judges.

As pointed out in the earlier paragraph, since the expression ‘commission’ has not been used under s. 40(c), any commission paid as a percentage on the profits to the director is neither ‘remuneration’ nor ‘benefit’ or ‘amenity’ within the meaning of s. 40(c) of the Act. In other words, the said amount is not liable to be included. We, therefore, answer the 1st question in the affirmative, in favour of the assessee and against the Revenue.

As regards the 2nd question, the question is now covered by a judgment of this Court in CIT vs. Coramandel Fertilisers Ltd. (1996) 135 CTR (AP) 354 : (1996) 220 ITR 298 (AP) : TC S17.1921, where in it was held that the unit of expenditure for the purposes of r. 6D of the IT Rules, 1962 is the trip and not the individual employee, and therefore, the expenditure incurred by the assessee would have to be taken into consideration with reference to each trip of the individual employee. We, therefore, answer the 2nd question in the affirmative, in favour of the assessee and against the Revenue.

As regards the 3rd and 4th questions, the facts in brief are as follows : During the current year 1979, the assessee paid Rs. 2,29,306 to Tata Sons Ltd. (Tata Economic Consultancy Services, Bombay) towards fee and reimbursement of incidental expenditure incurred for undertaking certain techno-economic feasibility studies to identify projects that may be taken up by the assessee advantageously. These feasibility studies related to the possibility of establishing a large-scale cement plant and rayon grade pulp unit. The ITO disallowed this on the ground that the expenditure related to the starting new lines of business which are not covered by the existing memorandum of association and those expenses would come up for consideration as pre-commencement expenses after the units come into existence. The assessee contended that the identification of new projects which may be taken up with advantage does not amount to initiation of a new business but, on the other hand, it forms part of the development activity of the assessee’s existing business. It was further contended by the assessee that mere conducting of studies for finding out the possibility of taking new lines of business activity would not per se mean that new business had been brought into existence and, therefore, the expenses are revenue in nature as they were incurred wholly and exclusively for the purpose of business and in the normal course of running the business. The CIT(A) held that the said expenditure is revenue. On appeal, the Tribunal agreed with the CIT. Hence, at the instance of the Revenue, the 3rd question set out above is referred for the opinion of this Court. Similarly, the assessee incurred an expenditure of Rs. 13,241 towards reimbursement of air fares and other expenses of Apex Geological Services (P) Ltd. in connection with the preliminary study undertaken regarding the availability of limestone deposits in Kallamalla Taluq of Andhra Pradesh. It has also incurred an expenditure of Rs. 7,860 by way of reinbursement of the expenditure incurred by Holtec Engineers (P) Ltd. in connection with the preliminary study regarding the availability of limestone deposits in Cuddapah and Kurnool districts of Andhra Pradesh. The ITO disallowed both these amounts on the ground that the relevant expenditure is related to new lines of business which are not covered by the existing memorandum of association of the assessee and such expenses would be considered as pre-commencement expenses if at all the new business starts. On appeal, the CIT(A) held that the expenditure incurred is in the nature of Revenue which was confirmed by the Tribunal. Hence, at the instance of the Revenue, the 4th question set out in the earlier paragraph is referred for the opinion of this Court.

The argument of the learned counsel for the Revenue is that in view of the judgment of the Supreme Court in Empire Jute Co. Ltd. vs. CIT (1980) 17 CTR (SC) 113 : (1980) 124 ITR 1 (SC) : TC 16R.953 and the judgment of the Gujarat High Court in Saurashtra Cement & Chemical Industries Ltd. vs. CIT (1992) 103 CTR (Guj) 283 : (1992) 196 ITR 237 (Guj) : TC 16R.1326, the expenditure incurred by the assessee is capital and not Revenue.

The learned counsel for the assessee contended that the feasibility report has not resulted in acquiring a new asset and, therefore, a capital asset as such has not been acquired. In other words, the expenditure incurred did not result in acquiring an asset of enduring nature. In the judgment of the Saurashtra Cement & Chemical Industries Ltd.’s case (supra), the assessee has already taken a decision to establish a soda ash plant and for that purpose it obtained a techno-economic feasibility report from Industrial Consulting Bureau (P) Ltd. on payment of a fee of Rs. 15,000, whereas in the present case, the object of obtaining feasibility report is for utilising the surplus funds. The company wanted to ascertain how best it can utilise the surplus funds for the purpose of expanding its business. Therefore, it is contended that since the object of the expenditure is for utilisation of the surplus funds it is a revenue expenditure and it is of an antinatal nature. Further, the expenditure incurred is exclusively for carrying on its business, viz., for the purpose of proper utilisation of the surplus funds. The counsel for the Revenue strongly relied on the following observation of the Supreme Court in Empire Jute Co. Ltd.’s case (supra) : “(ii) There may be cases where expenditure, even if incurred for obtaining an advantage of enduring benefit, may, nonetheless, be on Revenue account and the test of enduring benefit may break down. It is not every advantage of enduring nature acquired by an assessee that brings the case within the principle laid down in this test. What is material to consider is the nature of the advantage in a commercial sense and it is only where the advantage is in the capital field that the expenditure would be disallowable on an application of this test. If the advantage consists merely in facilitating the assessee’s trading operations or enabling the management and conduct of the assessee’s business to be carried on more efficiently or more profitably while leaving the fixed capital untouched, the expenditure would be on revenue account, even though the advantage may endure for an indefinite future. The test of enduring benefit is, therefore, not a certain or conclusive test and it cannot be applied blindly and mechanically without regard to the particular facts and circumstances of a given case. (iii) What is an outgoing of capital and what is an outgoing on account of revenue depends on what the expenditure is calculated to effect from a practical and business point of view rather than upon the juristic classification of the legal rights, if any, secured, employed or exhausted in the process. The question must be viewed in the larger context of business necessity or expediency.” and contended that the expenditure incurred is capital and not revenue while the counsel appearing for the assessee relying on the same observations contended that the expenditure incurred is revenue and not capital.

13. It is true, according to the observations of the Supreme Court in Empire Jute Co. Ltd.’s case (supra) if the expenditure incurred is for obtaining an advantage of enduring benefit, it is a capital expenditure. However, if the advantage consists merely in facilitating the assessee’s trading operations or enabling the management and conduct of the assessee’s business to be carried on more efficiently or more profitably, the expenditure is revenue. Admittedly, on the facts of the present case, the feasibility report submitted by Tata Consultancy Services has not resulted in establishing a new unit. Further, the object of the expenditure is to utilise the surplus funds more efficiently and more profitably while leaving the fixed capital untouched. The study taken up by the assessee is for utilisation of surplus funds alone. Therefore, as long as it has not resulted in setting up of a new unit and as long as the object of the assessee is to utilise the surplus funds profitably and efficiently, it cannot be said that the expenditure incurred is on capital account.

14. The judgment in Saurashtra Cement & Chemical Industries Ltd.’s case (supra), as pointed out by the learned counsel for the assessee, is a case where a decision was already taken by the assessee to set up a new soda ash plant whereas in the instant case, no decision has yet been taken. It is only at a stage of studying the feasibility for exploring the area for investing the surplus funds. It has not resulted in a benefit of enduring nature. Further, as pointed out in the earlier paragraph, the object of the expenditure is how to make the best use of the surplus funds. Therefore, we are of the view that the expenditure incurred by the assessee is on account of revenue and not of capital. In this context, the following observation of the Supreme Court in Alembic Chemical Works Co. Ltd. vs. CIT (1989) 77 CTR (SC) 1 : (1989) 177 ITR 377 (SC) : TC 16R.1277 is relevant : “There is also no single definitive criterion which, by itself, is determinative as to whether a particular outlay is capital or revenue. The

‘once for all’ payment test is also inconclusive. What is relevant is the purpose of the outlay and its intended object and effect, considered in a commonsense way having regard to the business realities. In a given case, the test of ‘enduring benefit’ might break down. . . . . . .”

15. The next question is if the expenditure incurred by the assessee is revenue, whether it is incurred wholly and exclusively for the purpose of business?

16. As pointed out in the earlier paragraphs, the object of the expenditure incurred by the assessee is profitable and effective utilisation of the surplus funds of the existing business and to explore the revenue for investment of such funds. In other words, the assessee has utilised its surplus funds for the purpose of putting it to an effective and profitable use. Therefore, it is wholly connected with its existing business and it is wholly and exclusively incurred for the purpose of carrying on its existing business. There is a nexus between the expenditure incurred and the business it is carrying on. In this context, we may refer to the observations of the Calcutta High Court in Kesoram Industries & Cotton Mills Ltd. vs. CIT (1992) 196 ITR 845 (Cal) : TC 17R.489, wherein it was held that :”(viii) that the assessee was a manufacturer of cement. In addition to its factory in Andhra Pradesh, it proposed to start another factory in Rajasthan. Miscellaneous and legal charges were incurred for the proposed factory. It pertained to exploring the feasibility of expanding or extending the assessee’s existing business. It was in connection with the carrying on the assessee’s business. The miscellaneous expenses and law charges were deductible as revenue expenditure.”

It follows from the above that the expenditure incurred by the assessee has nexus with the business which it is carrying on, viz., utilisation of its surplus funds profitably and effectively. Therefore, the expenditure incurred is wholly and exclusively for the purpose of carrying on its business and, hence, is an allowable expenditure under s. 37 of the Act.

The learned counsel for the Revenue contended relying on s. 35D of the Act that if the assessee incurs any expenditure in connection with preparation of feasibility report or preparation of a policy report before the commencement of the business, he is entitled to have a deduction and, therefore, he cannot claim deduction under s. 37 of the Act. While the learned counsel for the assessee contended that s. 35D applies to a case of commencement of business expenditure incurred in connection with preparation of feasibility report or preparation of policy report before the commencement of business is an allowable expenditure under s. 35D of the Act. In this case, it cannot be said that the expenditure is incurred before the commencement of the business as that stage has not yet arrived as no decision is taken for setting up of a new business. Sec. 35D of the Act reads as follows : “Amortisation of certain preliminary expenses.—(1) Where an assessee, being an Indian company or a person (other than a company) who is resident in India, incurs, after the 31st day of March, 1970, any expenditure specified in sub-s. (2),— (i) before the commencement of his business, or (ii)xxxxxxx the assessee shall, in accordance with and subject to the provisions of this section, be allowed a deduction of an amount equal to one- tenth of such expenditure for each of the ten successive previous years beginning with the previous year in which the business commences or, as the case may be, the previous year in which the extension of the industrial undertaking is completed or the new industrial unit commences production or operation. (2) The expenditure referred to in sub-s. (1) shall be expenditure specified in any one or more of the following clauses, namely :

(a) expenditure in connection with— (i) preparation of feasibility report; (ii) preparation of project report;”

A reading of s. 35D makes it clear that the expenditure in connection with the preparation of feasibility report should be incurred before the commencement of the business. In other words, a decision should be taken proposing to set up a specific or definite business. If an expenditure incurred is in connection with such decision, then s. 35D of the Act applies, otherwise not. On the facts of this case, no decision has yet been taken to set up a new business. On the other hand, the intention of the assessee is to utilise the surplus funds profitably and effectively.

In the light of the above, we answer the question in the affirmative and against the Revenue. The reference is answered accordingly.

After pronouncing the judgment today, the learned counsel for the Revenue pointed out that the second question referred was answered in favour of the assessee and against the Revenue and in the affirmative, instead of answering it against the assessee and in favour of the Revenue and in the negative, as while answering the question, the judgment in Coramandel Fertilisers Ltd.’s case (supra) was followed. After going through the judgment, we found that by mistake it is typed that : “We, therefore, answer the 2nd question in the affirmative, in favour of the assessee and against the Revenue.” Since it is mistake, we correct the same and hold that : “We, therefore, answer the 2nd question in the negative, in favour of the Revenue and against the assessee.”

[Citation : 247 ITR 417]

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