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Income‑tax Reference No. 23 of 1961, decided on 4th Septem ber 1962.
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-----‑Salaries of officers ‑In crease‑Whether should be reflected in profits‑No increase of salary of staff generally‑Relationship to director‑Effect‑Indian Income‑tax Act, 1922, S. 10 (2) (xv).
The assessee was a private company which carried on the managing agency of nine companies belonging to the Walchand Group. Sometime before Seth Walchand Hirachand, who was himself a director of the assessee‑company, ceased to do any work in the company, the assessee employed three executive officers who were related to one of its directors. During the previous years relevant to the assessment years 1953‑54 and 1954‑55, the assessee‑company successively increased the remunera tion of the directors and the salary of its executive officers. The assessee explained that one of the managed companies had undertaken a special contract for the construction of one of the biggest dams in India and the assessee's activities had been considerably enlarged and the work of the directors had been considerably increased. Further the profits of the managed companies had considerably improved and the commission earned by the assessee‑company had also increased. The Income‑tax Officer disallowed the increase in the directors' remuneration as well as the executive officers' salaries on the grounds that the rise granted was not reflected by the profits of the company and that in the case of the executive officers there was no general rise in the salaries of the other members of the staff. The Appellate Tribunal allowed in full the increase in remuneration of the directors and allowed only a part of the increase in the salaries of the executive officers and disallowed the rest of the increase on the grounds that they were relation of a director and that their salaries were doubled in a period of two years. On a reference :
Held, on the facts, that there was no material on record for the disallowance of a part of the increase in the salaries of executive officers. The two circumstances mentioned by the Appellate Tribunal, namely, that the officers were relations of a director and that their salaries were doubled by the rise in two years and the further circumstance mentioned by the Income‑tax Officer that the rise granted was not reflected in the profits of the assessee‑company, could not by themselves without anything more serve as proper or adequate material leading to the conclu sion that the expenditure was for a consideration other than for purposes of the business.
Newtone Studios Ltd. v. Commissioner of Income‑tax (1955) 28 I T R 378 and Veeriah Reddiar v. Commissioner of Income‑tax (1960) 38 I T R 152 fol.
Merely because the assessee asserts that he has agreed to pay his employees a certain amount and is therefore paying the same to them the Income‑tax officer or the Appellate Tribunal is not bound to accept it as an explanation properly falling within section 10 (2) (xv) of the Indian Income‑tax Act, 1922. The Income‑tax Officer or the Tribunal will be entitled on proper and adequate material to disallow what the assessee wants to claim as deduction by way of salaries. But if the Income‑tax Officer or the Tribunal wants to do that, there must be material before them from 'which they can arrive at this conclusion that the increase in the salaries is for consideration other than for the purposes of the business and therefore not allowable under section 10 (2) (xv).
In compliance with the requisition of the High Court of Judicature at Bombay under section 66 (2) of the Income‑tax Act in the matter of Messrs Walchand & Co. (Private) Ltd. v. Commis sioner of Income‑tax, Bombay City, Bombay I. T. A. No. 23 of 1958 we hereby draw up a statement of the case and refer it to the High Court of Judicature at Bombay.
2. The Tribunal has been called upon to refer the following question of law :
"Whether on the facts and in the circumstances of the case the Tribunal acted without evidence in disallowing Rs. 30,000 (Rupees thirty thousand) "
3. The assessee is a company registered under the Companies Act. The assessment years are 1953‑54 and 1954‑55.
4. The assessee carries on the business as managing agents of the following public limited companies
(1) Walchandnagar Industries Ltd.
(2) Ravalgon Sugar & Farms Ltd.
(3) Indian Hume Pipe Co. Ltd.
(4) Cooper Engineering Co. Ltd.
(5) Acme Mfg. Co. Ltd.
(6) Premier Construction Co. Ltd.
(7) The Building Construction Co. Ltd.
(8) All India Construction Co. Ltd.
(9) Hindustan Construction Co. Ltd.
5. Till 31st January 1949, Seth Walchand Hirachand was one of the directors of the assessee and he used to help the assessee in discharge of its function as managing agents of the various companies. During the period when Seth Walchand Hirachand acted as a director of the assessee, the other three directors who also helped Shri Walchand Hirachand were his three brothers, to each of whom the assessee paid a remuneration of Rs. 2,500 per month. Just before Seth Walchand Hirachand ceased to do any business in the assessee company, the assessee bad to employ as its officers, the following three persons :
(i) Shri Govindji Rawji,
(ii) Bahubali G. Doshi,
(iii) Bharat Gulabchand.
6. During the relevant accounting periods the assessee by its various resolutions increased the remuneration of its directors and officers as follows :
Directors Rs. 1,000 each per month Total Rs. 36,000
2 Officers Rs. 500 each per month Total Rs. 21,000
1 Officer Rs. 750 per month ‑‑‑ _____________
Rs. 57,000
Directors Rs. 500 each per month Total Rs. 18,000
3 Officers Rs. 250 each per month Total Rs. 9,000
_____________
Rs. 27,000
During the relevant accounting years the assessee claimed the amounts paid as remuneration to its directors and salaries paid to its officers.
7. In the course of assessment proceedings for the assess ment years 1953‑54 and 1954‑55 the Income‑tax Officer called upon the assessee to satisfy him as to why the increase made in the remuneration of directors and officers should be allowed as a deduction in the computation of the total income of the assessee. In reply thereto the assessee offered explanation relying on the letter dated 21st January 1953, addressed by its solicitors during the proceedings of the assessment year 1952‑53 giving the reason that the said increase in the remune ration should be regarded as solely and exclusively incurred for the purposes of the business of the assessee and claimed that accordingly the same should be allowed as a deduction. Hereto annexed and marked Annexure "A" is a copy of the said letter. The Income‑tax Officer, however, did not accept the explanation offered by the assessee and disallowed the sum of Rs. 84,000 being the amount of increase in the remuneration of its directors and officers. Hereto annexed and collectively marked Annexure "B" are the copies of the orders of assessment.
8. Being aggrieved by the said orders the assessee preferred appeals first to the Appellate Assistant Commissioner and then to the Tribunal. Before the Tribunal, the assessee contended that :
(a) it was for the assessee alone to decide whether a particular person should be employed and at what remuneration and that it was not open to the income‑tax authorities to decide whether a person should be employed by an assessee and if so on what remuneration. The assessee relied upon the judgment of the Madras High Court in the matter of Newtone Studios Ltd. v. Commissioner of Income‑tax (1955) 28 I T R 378
(b) in any event in view of the evidence already on record the increase in the remuneration made by the assessee be regarded as solely and exclusively incurred for the purposes of the business.
The assessee accordingly submitted that the entire increase should be allowed as a deduction in the computation of the assessee's total income.
9. The Tribunal by its order dated 25th July 1957, copy whereof is enclosed herewith and marked Annexure "C" held that the remuneration paid by the assessee to the directors should be allowed as deduction. However, in respect of the increase made in the remuneration of its officers, the Tribunal held that the same should be allowed only at Rs. 250 per month.
10. 'As directed by their Lordships we refer the question set out in paragraph 2 hereinabove.
N. A. Palkhivala with. S. P. Mehta, Y. P. Trivedi, U. T. Shah and S. J. Mehta for the Assessee.
G. N. Joshi with R. J. Joshi for the Commissioner.
‑The question raised on this reference relates to the disallowance of certain sums from the salaries paid by the assessee to its three executive officers during the assessment years 1953‑54 and 1954‑55. The assessee is a private limited company carrying on the work of managing agents of nine companies belonging to the Walchand Group. The directors of the assessee‑company are also from the Walchand Group and till 31st January 1949, Seth Walchand Hirachind was himself one of the directors of the assessee -company. Some time before Seth Walchand ceased to do any work in the assessee‑company, the assessee employed three executive officers on its staff. Out of these three executive officers, one was the cousin and the other two were sons of one of the directors of the assessee‑company. These three officers before their appointment in the assessee‑company had been sent for training to the several managed companies as appren tices. During the previous year relevant to the assessment year 1953‑54, the assessee‑company passed resolutions increasing tee remuneration of the directors and also the salaries of the three executive officers with effect from 1st April 1952. In the next year also, i.e., in the assessment year 1954‑55, the company passed similar resolutions increasing the remunera tion of the directors and also the salaries of the three officers still further. In the course of the assessment proceedings for the assessment years 1953‑54, and 1954‑55 the Income‑tax Officer called upon the assessee to satisfy him as to why the increase made in the remuneration of the directors and officers should be allowed as a deduction in the computation of the total income of the assessee. The assessee in reply thereto offered an explanation which was contained in the letter dated 21st January 1953, addressed by its solicitors to the Income‑tax Officer, during the proceedings for the assessment year 1952‑53. The explanation was not accepted by the Income‑tax officer and he disallowed the entire sum by which remuneration of the directors and the salaries of the three executive officers was increased during the assessment years 1953‑54 and 1954‑55. The assessee went in appeals to the Appellate Assistant Commissioner and, those appeals having been dismissed, took further appeals to the Tribunal. The Tribunal took the view that so far as the increase in the remuneration of the directors was concerned, the whole of it could be allowed as a deduction under section 10 (2) (xv), but so far as the increase in the salaries of the three executive officers was concerned, the increase could be only allowed to the extent of Rs. 3,000 per year and not in respect of the remaining amount. The Tribunal accordingly allowed the assessee's appeals in, part. The assessee applied under section 66 (i) for reference to this Court, but that application was rejected by the Tribunal. It‑then made an application to this Court under section 66 (2) and, on that application, this Court directed the Tribunal to draw up a statement of the case, referring the following question to this Court, viz. :
"Whether on the facts and in the circumstances of the case the Tribunal acted without evidence in disallowing Rs. 30,000 (Rupees thirty thousand) "
The figure of Rs. 30,000 stated in the question may not be correct. It is however meant to represent the aggregate amount of the disallowed part of the salary of the three executive officers during the assessment years 1953‑54 and 1954‑55. The Tribunal took the view that although it was not for the Income‑tax Officer to run the assessee's business and fix the salaries of every member of the staff, he was still entitled to consider whether the rise in the salaries of the employees was a rise justified by valid reasons, and it did not amount to giving them a gift in the garb of a salary, especially when the employees to whom the rise was given were relations of the directors of the company. According to the Tribunal, the rise amounting to doubling the salaries of these executive officers within a period of two years was an unreasonable rise and the whole of it would not be allowable as a deduction under section 10 (2) (xv). It accordingly allowed only Rs. 3,000 per annum as a permissible deduction.
Mr. Palkhivala, learned counsel appearing for the assessee, has contended that there was no material before the income‑tax authorities or the Tribunal for disallowing any part of the increase in the salaries of these three executive officers. It was for the assessee‑company to decide what it should pay to its employees. It had accordingly on a proper appreciation of the services which were being rendered by these three executive officers decided to increase their salaries during the relevant assessment years. The bona fides of the payments made to these officers or the fact that actual payments were made to them is not in dispute. According to Mr. Palkhivala, it was for the employer as to what he should properly pay to the employees. He urges that unless there is material in the case from which it could be gathered that the increase in the salary is for considerations other than for the purposes of business, the income‑tax authorities would not be justified in disallowing the payments. The circumstance that the officers are related to the directors of the assessee‑company is by itself not sufficient to show that the increase in their salaries is for considerations other than for the purposes of business. The circumstance that during the years during which increase in salary has been granted to the officers there has not been an adequate rise in the net profits of the business is not relevant in considering whether the said expenditure is incurred for the purposes of the business or not. Mr. Palkhivala has further pointed out that the rise in the remuneration of the directors has been allowed by the Tribunal to the full extent. That rise was considered as justifiable in view of the increase in the activities of the assessee by reason of the prosperity and rise of the business of the managed companies. If the work of the assessee‑company has increased and has become more strenuous by reason of the prosperity of the managed comp anies, it would be reasonable and natural to infer that not only the strain on the directors would increase so as to justify a rise in their remuneration, but so also the work of the three remuneration, but so also the work of the three executive officers. There was, therefore, no reason why when the increase in the remuneration of the directors has been allowed by the Tribunal, the increase in the salaries of the executive officers should have been disallowed.
Mr. Joshi, learned counsel for the revenue, has, on the other hand, argued that the burden is always on the assessee to satisfy the income‑tax authorities that the expenses claimed by it as deductible under section 10 (2) (xv) satisfied the requirements which would render them permissible as deductions under the said provision. In other words, it is not enough for the assessee to show that it has incurred expenditure, but it has further to show to the satisfaction of the income‑tax authorities that it is such as is laid out or expended wholly or exclusively for the purposes of the assessee's business. Accordingly to Mr. Joshi, that burden has not been discharged by the assessee at all. It was called upon by the Income‑tax Officer to satisfy him that the increase in the salaries fell properly within section 10 (2) (xv). The assessee was content to give the explanation that it was entirely for the assessee to determine what should be the proper remuneration paid to the employees, as the assessee was the best Judge of the qualifications and activities of the employees. This, says Mr. Joshi, is not sufficient at all to discharge the burden which ‑lay on the assessee. In the absence of a proper explanation given by the assessee coupled with the further fact which was decided on the record, namely, that the officers were relations of the directors taken along with the circumstances that there was no evidence showing that not only the salaries of the three officers but the salaries of all the members of the staff were also increased, or that there was any demand on the part of these employees for a rise, or that their work had increased particularly during the assessment years, the Income‑tax Officer and the Tribunal were justified in disallowing the rise in the salaries given to the officers. In our opinion, if the Income -tax Officer or the Tribunal, having properly applied their minds to the facts and circumstances of the case, and after having properly appreciated what they had to find upon; had come to a finding that, on the facts and circumstances of the case and on the material on record, the rise in the salaries granted to the three executive officers by the assessee‑company for the relevant assessment years was for considerations other than for the purposes of business, it would not have been possible for us either to find fault with that conclusion or to interfere with it, since it would have been a finding of fact arrived at on the material before the authorities. However, there is no such finding recorded either by the Income- tax Officer or by the Tribunal in the present case. In the assessment order of the Income‑tax Officer, he has stated that the increase in the salaries of the officers, had been considered by him as inadmissible under section 10 (2) (xv) during the last year, on arguments which he had fully set out in that order. In addition to the said arguments referred to by him, he has stated a further argument, namely, that in the assessment year 1953‑54 the business profits of the assessee have been less than in the previous year by an amount of Rs. 2 lakhs and the rise in the salary is not, therefore, reflected in the increase in the profits of the company. Mr. Joshi has invited our attention to the assessment order for the previous year, to which the Income‑tax Officer has referred in his order for the assessment year 1953‑54. That order mostly deals with the arguments of the Income‑tax Officer for disallowing the rise in the remuneration of the directors. The only circumstance which we find as special to the case of the executive officers is that there is nothing to show that any extra bonus payment was made to the other members of the staff of the managed companies during the assessment year which may indicate some justification for increase in the salaries of the officers. An inference has been drawn from this circumstance by the Income‑tax Officer that the prosperity of the assessee‑company appears to have benefited only the directors and the three executive officers. It seems to us that the circumstance that the salaries on the other members of the staff were also not simultaneously increased is not a circumstance which could be pressed into service for showing that the rise in the salaries of the executive officers is unreasonable or unjustified. It appears from the statement of the case as also from the reasons which are contained in the solicitors' letter to the Income‑tax Officer, dated the 21st January 1953, that the assessee -company has a small staff and only these three executive officers. There is nothing to show that there were anymore executive officers whose salaries have not been increased and only the three executive officers have been selected for giving them a substantial rise in their salary. The circumstance, therefore, that there has not been an all round rise in the salary of every member of the staff or a payment of bonus to the entire staff is, in our opinion, not a relevant circumstance. The other circumstance relied on by the Income‑tax Officer, that the profits of the assessee‑company have not further increased in the assessment years to justify the rise in the salary of the executive officers, is again an irrelevant circumstance, as pointed out by the Kerala High Court in S. Veeriah Reddiar v. Commissioner of Income‑tax ((1960) 38 I T R 152). We find from the letter of the assessee's solicitors dated 21st January 1953, that the managed companies were all prospering and their work was increasing every year. One of the managed companies, namely, Hindustan Construction Company, had undertaken the contract of Vaitarna Dam, which involved a special type of work and was considered to be the biggest dam in India, and the activities of the assessee‑company, therefore, had been considerably enlarged and the work of the directors and the strain on them had also considerably increased. It was pointed out in the said letter that the profits of the several managed companies had considerably improved and the commission earned by the assessee‑company had also increased in consequence. The explanation contained in this letter was found by the Tribunal as sufficient to discharge the burden which lay on the assessee to establish that the amounts claimed by it as deductions properly fell within section 10 (2) (xv) so far as the rise in the directors' remuneration was concerned. We do not see why the same explanation could not be regarded as sufficient to discharge the burden so far as the rise in the salaries of the officers is concerned. It is true that, in this explanation, no details have been given showing in what way and in what manner the work of the executive officers had increased so as to justify the increase in their salaries. But when the assessee‑company has only three executive officers and the work of the assessee‑company has considerably expanded as a result of the prosperity and increase in the business of the nine managed companies, it would not require a further and particular mention that the work of the executive officers has also further increased. Mr. Joshi says that, even if it is assumed that the work of the executive officers might have increased to some extent, such assumption would not suffice to hold that the work had increased to such an extent as to justify the whole amount of rise in their salaries. The Tribunal has made an allowance for this increase in the work of the executive officers by permitting them an increase to the extent of Rs. 3,000 per annum. We do not, however, find that the Tribunal has allowed the rise to the extent of Rs. 3,000 on the basis that it would be a proper and adequate rise for the increase in the work of the officers. No reasons whatever have been given by the Tribunal why it is allowing only Rs. 3,000 and disallowing the rest. We cannot, therefore, agree with Mr. Joshi that the Tribunal in disallowing a part of the rise in the salaries of the officers has done so on the basis of some material on the record of the case. We agree with Mr. Joshi that simply because the assessee says that it has agreed to pay its employees a certain amount and is therefore paying the same to him the Income‑tax officer or the Tribunal is not bound to accept it as an explanation properly coming within section 10 (2) (xv). We agree with him that the Income‑tax Officer or the Tribunal will be entitled on proper and adequate material to disallow what the assessee wants to claim as a deduction by way of salaries. But if the Income‑tax Officer or the Tribunal wants to do that, there must be material before them from which they could arrive at this conclusion that the increase in the salaries is for consideration other than for the purposes of business and therefore not allowable under section 10 (2) (xv). The two circumstances, which are disclosed in the short order of the Tribunal, namely, that the officers are relations of a director and their salaries by the rise given to them are doubled in a period of two years and the further circumstance pointed out by the Income‑tax Officer that the rise granted in the assessment year 1953‑54 is not reflected in the profits of the company cannot by themselves without anything, more suffice to serve as proper or adequate material leading to the conclusion that the expenditure is for consideration other than for purposes of business : see Newtone Studios Ltd. v. Commissioner of Income‑tax ((1955) 28 I T R 378) and S. Veeriah Reddiar v. Commissioner of Income- tax.
In the view that we are taking, our answer to the question is that the Tribunal has acted without evidence in disallowing a part of the increase in the remuneration allowed to the three executive officers during the assessment years 1953‑54 and 1954‑55. The assessee will get its costs from the Commis sioner.
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