Madhya Pradesh H.C : Whether, on the facts and in the circumstances of the case, the Tribunal was right in disallowing the items of Rs. 4,800, Rs. 12,785 and Rs. 1,500 as expenditure within cl. (xv) of s. 10(2) of the Indian IT Act, 1922 ?

Counsel Appeared

Y. S. Dharmadhikari, for the Assessee : B. K. Rawat, for the Revenue

G. P. SINGH, C.J.:

This is a reference made by the Tribunal in compliance with the order of this Court dated 19th July, 1978, passed in Misc. Civil Case No. 38 of 1973, on an application made by the assessee under s. 66(2) of the Indian IT Act, 1922. The question of law referred is as follows :

“Whether, on the facts and in the circumstances of the case, the Tribunal was right in disallowing the items of Rs. 4,800, Rs. 12,785 and Rs. 1,500 as expenditure within cl. (xv) of s. 10(2) of the Indian IT Act, 1922 ?”

2. The assessee is a private limited company. The assessee-company functions as managing agents of two other companies, namely, M/s Straw Products Ltd. and M/s M. P. Industries Ltd. The managing agency agreements were part of the record of the assessment case and are referred to in the order passed by the Tribunal. These agreements, however, by oversight, were not annexed to the statement of the case. With the consent of parties, copies of these agreements were produced in this Court and were admitted as forming part of the statement of the case. Under cl. 3 of both these agreements, the remuneration payable to the assessee- company for acting as managing agents is a commission at a certain percentage of the net profits of the managed companies. In the agreement with M/s M.P. Industries Ltd., the commission is payable at 10per cent of the net profits whereas in the agreement with M/s Straw Products Ltd., the commission is payable at 10per cent on the first 10 lakhs. The rate of commission decreases on higher slabs of profits and is only 4per cent on profits over one crore of rupees. The relevant assessment year is 1961-62, for which the account year was from 1st October, 1959, to 30th September, 1960. The question before us is whether the Tribunal was right in disallowing the following items of expenditure under s. 10(2)(xv) of the Act: (i). 4,800 paid to Shri R. K. Gupta, director of M/s M.P. Industries Ltd., as entertainment allowance. (ii) Rs. 12,785 paid as brokerage on sale of shares of M/s Straw Products Ltd. (iii) Rs. 1,500 paid as travelling allowance to Shri R. K. Gupta.

The principles bearing on the question as to what expenditure can be allowed under s. 10(2)(xv) have been laid down in a number of cases. These principles are that in deciding whether a payment of money or incurring of expenditure is for the purposes of the business and an allowable expenditure, the test applied is of commercial expediency and principles of ordinary commercial trading. If the payment or expenditure is incurred to facilitate the carrying on of the business of the assessee and is supported by commercial expediency, it does not matter that the payment is voluntary or not necessary or that it also enures to the benefit of a third party. In other words, if the object is business promotion, the expenditure would still be wholly and exclusively for the purposes of the assessee’s business even though some other object necessarily results, being inherent in the nature and quality of the expenditure [See Sassoon J. David & Co. P. Ltd. vs. CIT (1979) 10 CTR (SC) 1383 (1979) 118 ITR 261 (SC), Addl. CIT vs. Kuber Singh Bhagwandas (1979) 9 CTR (MP) 94 : (1979) 118 ITR 379 (MP) (FB) and other cases referred to in Kuber Singh’s case].

The item of expenditure of Rs. 4,800 has been disallowed on two grounds first that it was not incurred during the relevant account year and, secondly, that it bears no connection with the assessee’s business. The amount of Rs. 4,800 was paid to Shri R. K. Gupta, director of M/s M.P. Industries Ltd., as entertainment allowance on 17th March, 1960. The board of directors of the assessee certified this payment in their meeting held on 15th November, 1960. The ratification by the board of directors was no doubt after the close of the account year but the expenditure had already been incurred on 17th March, 1960. As the expenditure was incurred within the account year, it cannot be excluded from reckoning simply on the ground that the resolution of the board of directors was passed after the close of the account year. The Tribunal’s finding must, however, be upheld on the second ground. After the assessee-company became the managing agents of M/s M.P. Industries Ltd., the work of promotion of sales was undertaken by the assessee. Shri Gupta, who was the director of the managed company, did the work of promotion of sales of the managed company’s products before the assessee became managing agents and in that context received entertainment allowance. Shri Gupta ceased to have any claim to this allowance after the work of promotion of sales of the products of the managed company was taken over by the assessee as managing agents. The Tribunal has found that there is no evidence that during the relevant account year, Shri Gupta participated in the promotion of sales of the products of the managed company. On this finding the expenditure of Rs. 4,800 cannot be said to bear any nexus with the business of the assessee-company. The position would have been different had Shri Gupta also promoted the sales of the products of the managed company during the relevant account year. In that case, it could not be said that entertainment expenses which the assessee-company was bound to incur was partly incurred by Shri Gupta and, therefore, there was good reason to reimburse him for that expenditure. But as the finding is that Shri Gupta did not do any work of promotion of sales of the products of the managed company, the expenditure cannot be said to bear any connection with the assessee’s business. The Tribunal, in our opinion, was right in disallowing this expenditure.

The second and third items of expenditure of Rs. 12,785 and Rs. 1,500 are connected with M/s Straw Products Ltd. This managed company decided to raise fresh capital to set up a paper-mill in Orissa. The scheme of floating the fresh issue of share for the purpose of raising fresh capital was put into operation by the assessee as managing agents. The assessee paid a sum of Rs. 12,785 as brokerage on sales of new shares. The amount of Rs. 1,500 was paid to Shri Gupta for his travelling expenses for the work of J.K. Paper Mills which is a concern of M/s Straw Products Ltd. Shri Gupta was asked to go to Delhi and Bombay in connection with the opening of guarantee and letter of credit for the purchase of machinery from a West German concern. The Tribunal held that both these expenditures were in the nature of capital expenditure of the managed company and the assessee was not entitled to have them allowed as business expenditure under s. 10(2)(xv). This reasoning of the Tribunal cannot be accepted. It may be that these expenditure, if incurred by the managed company, would have been in the nature of capital expenditure but from the point of view of the assessee-company they were only in the nature of revenue expenditure as by these expenses the assessee did not acquire any capital asset or any benefit of endurable nature. The only question is whether these expenditures could be supported on the ground of business expediency or, in other words, whether there was a reasonable nexus of these expenditures with the business of the assessee. We have already stated that the assessee’s remuneration was in the shape of commission payable at a certain percentage of the profits of the managed company. If the managed company earned more profits, that benefited the assessee, as, that increased the remuneration or commission payable to it. Therefore, an expenditure incurred by the assessee which had the effect of promoting the business of the managed company and to enable it to earn more profit could also be an expenditure for the purposes of the business of the assessee with a view to enable it to earn more commission. The increase in profits of the managed company by the expenditures in question would have directly benefited the assessee-company in its business of managing agents by enabling it to earn more commission. This factor establishes the element of commercial expediency or a reasonable nexus between the expenditure and the business of the assessee-company. The expenditures would, therefore, be covered by s. 10(2)(xv) even though the assessee was not bound to incur them. There are a number of cases in support of this line of reasoning which we shall hereinafter refer.

In Tata Sons Ltd. vs. CIT (1950) 18 ITR 460 (Bom), the assessee-company, the managing agents for another company, received commission at a certain rate on the net profits of the managed company. During the relevant account year, the assessee paid voluntarily a certain sum as its share of the bonus which the managed company paid to some of its officers. It was held that looking from the point of view of commercial principles what the assessee had done was something which had as its object increasing the profits of the managed company and thereby increasing its own share of the commission and, therefore, the expenditure was allowable under s. 10(2)(xv). In the Supreme Court case of CIT vs. Chandulal Keshavlal & Co. (1960) 38 ITR 601 (SC), the assessee-firm, which was the managing agent of a company, waived a part of its share of commission having regard to unsatisfactory financial position of the managed company. It was held by the Supreme Court that the business of the assessee was so linked up with the managed company that if the latter was put on a sounder position the assessee would get a larger commission in future and so the part of the commission remitted by the assessee was given up for reasons of commercial expediency and was business expenditure allowable under s. 10(2)(xv). On the same principles, it has been held by the Calcutta and Gujarat High Courts in CIT vs. J. K. Industries P. Ltd. (1969) 71 ITR 594 (Cal) and Karamchand Premchand Pvt. Ltd. vs. CIT (1982) 137 ITR 209 (Guj), that payment by the managing agency company of expenses incurred by a director of the managed company on foreign tours to explore the possibilities of expansion of business was an allowable expenditure under s. 10(2)(xv). It was observed in these cases that though by reason of the expenses incurred by the managing agents certain assets of enduring benefit might have accrued to the managed company, yet, as the managing agents incurred these expenses with the object of creating possibilities for enlargement of their income, the expenses were business expenditure and had to be allowed. In CIT vs. Tata Sons Pvt. Ltd. (1978) 111 ITR 290 (Bom), the managing agents contributed a sum of Rs. 1,00,000 to the managed company for construction of a canteen for its workers. It was held that the expenditure did not bring into existence any enduring asset in favour of the assessee- company and was made for earning more commission and was an admissible deduction under s. 10(2)(xv). On the same lines is the decision of the Madras High Court in CIT vs. Seshasayee Bros. P. Ltd. (1981) 20 CTR (Mad) 299 : (1981) 127 ITR 218 (MP). In this case, the assessee, which was a managing agency company, incurred expenses for investigating several projects and, wherever feasible, promoted new industrial undertakings for the managed company. It was held that the expenses incurred by the assessee were in the course of its business as promoters and managing agents with a view to augmenting its income and, therefore, allowable as revenue expenditure. All these cases support our conclusion that the two items of expenditure of Rs. 12,785 and Rs. 1,500 should have been allowed by the Tribunal as business expenditure under s. 10(2)(xv).

The learned standing counsel for the Department relied upon the decision of the Calcutta High: Court in Indian Press Exchange Ltd. vs. CIT (1982) 30 CTR 114 (1982) 138 ITR 594 (Call). This case is clearly distinguishable. The payment of commission in this case was made to persons who did not render any service to the assessee- company and it was made simply on the ground that they were sons of an influential executive of various concerns with which the assessee had business dealings. The decision has no application to the facts of the case before us. The learned standing counsel also submitted that the question whether a particular item of expenditure is business expenditure is a question of fact and the Tribunal’s finding on such a question should not be disturbed. The Tribunal in the instant case did not take into account that the assessee was to be paid as remuneration a commission at a certain percentage of the profits of the managed company and, therefore, if a particular expenditure increased the profits of the managed company that also benefited the assessee-company. Further, the Tribunal misdirected itself in holding that expenses which were in the nature of capital expenditure if incurred by the managed company would also be of the same nature if incurred by the managing agents and, therefore, could not be allowed as business expenditure. As the Tribunal omitted to consider an important circumstance and misdirected itself in law, the finding reached by it cannot be said to be a pure finding of fact binding on us.

For the reasons given above, we answer the question as follows : “The Tribunal was right in disallowing the item of Rs 4,800 but was not right in disallowing the items of Rs. 12,785 and Rs. 1,500 as expenditure under cl. (xv) of s. 10(2) of the IT Act, 1922.”

9. There will be no order as to the costs of this reference.

[Citation : 142 ITR 126]