K.K Desai, J.:— In this reference under section 66(2) of the Indian Income-tax Act, 1922, three questions of law raised at the instance of Sassoon J. David & Co. Private Ltd. (hereinafter referred to as “the assessee company”) relating to the rejection of the claim for deduction of the expenditure of the aggregate sum of Rs. 1,64,899 under section 10(2)(xv) for the assessment year 1957-58 arise for consideration.
2. The facts which require to be noticed are as follows:
The assessee-company carried on business for a very large number of years prior to December 2, 1955. The management of the business of the assessee-company was on that date carried on with the assistance of a managing director, Mr. R. Mathalone, a manager, one A.E Joseph and 22 other employees in the office establishment of the company roughly consisting of 2 officers, 6 clerks, 9 peons, 2 drivers and one watchman. Though the fact is not on the record, we are informed by Mr. Palkhivala for the assessee-company that there were 11 other employees of the company who were not on the office establishment and worked by attending on the properties being the estate of the company.
3. It appears that the issued capital of the company consisted of 1,000 ordinary shares and all the issued shares were held directly or through nominees only by three persons, viz., Sir Percival David, Lady David, and V.P David. It further appears that a proforma balance-sheet as on December 31, 1955, prepared by A.F Ferguson & Co., the auditors of the company, was furnished to Tata Sons Ltd. in connection with the negotiations that took place for sale of the whole of the holding of the issued capital (1,000 ordinary shares of the company) and the transfer of management of the assessee-company to Tata Sons Ltd. By a directors' resolution dated December 2, 1955, it was decided to terminate the employment of all the 22 employees in the office establishment and to recommend for payment to them of certain amounts by way of retrenchment compensation. In that connection, it was decided to convene an extraordinary general meeting of the company on January 17, 1956. That meeting was convened but was adjourned to January 25, 1956, and the company in general meeting by extraordinary resolution dated January 25, 1956, decided to terminate the services of the 22 employees of the company in the office establishment as of and from March 31, 1956, and in that connection decided that certain amounts be, paid as retrenchment compensation. The company also decided to terminate the services of the manager A.E Joseph also as of and from March 31, 1956, and to pay to him by way of compensation an annuity of Rs. 16,885 for a period of five years. It was also decided to commute pensions which were already being paid to six of the retired employees and/or widows of such employees and to pay to them in the aggregate by commutation of pension of Rs. 21,200. The aggregate amount resolved to be payable to the 22 employees as retrenchment compensation came to Rs. 1,04,626.
4. Mr. Mathalone was working as a managing director and under the contract appointing him his services as such director were liable to be terminated by six months' notice in writing on either side. His appoint ment as managing director was decided to be terminated by directors' resolution dated March 29, 1956, as of and from March 31, 1956. The directors decided that the termination should be without any notice of six months and in that connection resolved to pay to him Rs. 16,188 as com pensation in lieu of six months' notice. This amount was his salary for the six months' notice period.
5. In pursuance of the above resolution and termination of services, in the assessment year 1957-58, expenditure was incurred by payments of the aggregate sum of Rs. 1,64,899. The details of that expenditure are as follows:
Rs. 73,599 to 13 employees.
Rs. 37,037 to 9 employees who were re-employed as from April 1, 1956.
6. Further additional sum of Rs. 3,800 to 13 employees and Rs. 2,200 to the 9 employees who continued in employment.
Rs. 21,200 for payment towards the pensions liability.
Rs. 16,885 being the first year's annuity compensation paid to the manager, A.E Joseph.
Rs. 16,188 paid as compensation in lieu of six months' notice to R. Mathalone.
7. One more fact which requires to be noticed is that by an agreement in writing dated March 23, 1956, Sir Percival David and the other two holders of the total share capital of the company agreed to sell and Tata Sons Ltd. agreed to purchase from these sellers the total share capital for the price of rupees 155 lakhs. Needless to state that the agreement for sale was made for completely vesting the management and the whole of the company in the purchasers. Under clause 2 of the agreement, reference was made to the proforma balance-sheet prepared as ofj December 31, 1955. Under clause 3, reference was made to the fact of tjhe company having decided to grant gratuities and compensation amounting to Rs. 2,32,500 by the above referred resolutions. This sum includes the amount, payable to R. Mathalone. In this clause it was specified that the purchasers would deduct from the purchase price this sum of Rs. 2,32,500. Under clauses 4 and 5, it was provided that the purchasers would acquire the company on the footing of the obligations and liabilities disclosed in the proforma balance-sheet as at the end of December 31, 1955. Clause 6 ran as follows:
“The sellers shall arrange to terminate the services of all employees (other than the managing director) with effect from the 31st March, 1956, and also arrange that all directors (including the managing director) resign their office by the 1st March, 1956, to the end and intent that the purchasers and/or their nominees shall be entitled to appoint or elect all members of the staff and directors (including existing directors and members of the staff) of the company as they shall think fit effective from 31st March, 1956, and 1st March, 1956, respectively.”
8. Under clause 7, the sale was to be completed as of March 1, 1956.
9. By the assessment order dated January 31, 1958, the Income-tax Officer held against the company that the services of the employees and the manager and managing director were terminated, because the purchasers of the shares made that a condition. His finding was that the expense was not incurred for any business expediency. His further finding was that there was no expectancy or custom of paying gratuity in the company. In this connection, he referred to the fact that many of the employees had been in service for more than 40 years. In connection with the contention of the company that the termination of employment had resulted in considerable economy because aged staff was reduced, he held that nine of the old employees were reinstated and the termination of employment was part of the transaction of sale of shares and passing over of the control of the company to the purchaser.
10. Towards denying the finding of the Income-tax Officer regarding the fact that there was no expectancy or custom of payment of gratuity in the company, by letter dated July 1, 1959, the company through its secretary wrote to the Appellate Assistant Commissioner, to state:
“In connection with the compensation paid in the past, viz., in 1946, 1951 and 1952, we have been able to trace in two cases that it was paid on the basis of one month's salary for each year of service.”
11. In the last part of the letter, particulars of the gratuities paid to the employees or their widows between 1946 and 1955 were furnished.
12. These particulars run as follows:
“Year Name of payee Amount Rs. 1946 Mr. Aonram Hayeem 1,400 1951 Mainibai B. Kenny, widow of late Mr. Kenny 2,500 „ Mr. B.N Desai 2,000 „ Poova Augura (Hamal) 1,000 „ Rama Goorava (Hamal) 850 „ Mrs. Marker, widow of late Mr. S.J Marker 1,200 „ Malukhan S. Pathan 800 8,350 1952 Gurruddin Gajadhar 850”
13. In this letter the comparative statements of salaries disbursed in the years 1955 to 1958 were also given, possibly, towards proving that by termination of employment of the managing director, the manager and 13 of the employees, expenses had become reduced and economy was effected. These particulars run as follows:
1955 1956 1957 1958 Rs. Rs. Rs. Rs. Salaries and Bonus as per P & L Account 1,28,443 71,511 58,848 54,960 Less: Bonus 14,246 4,243 4,724 Salaries (yearly) 1,14,197 67,268 54,124 54,960 Salaries (monthly) 9,516 5,606 4,510 4,580
14. The Appellate Assistant Commissioner by his order dated July 18, 1959, observed that from the information furnished to him it appeared that establishment expenses were substantially reduced. I He, however, held that the termination of services and the payment of compensation were not done wholly with a view to the business requirements of the company and were “bound up with the changing of hands of the shares of the company. The decision to pay compensation cannot in the circumstances be said to have been taken solely with a view to the business requirement of the company though incidentally the company might have benefited by it…….” These findings were confirmed by the Appellate Tribunal by its order dated October 11, 1960. The Tribunal emphasized that it was unable to see any commercial purpose in the transaction of sale of shares and that the payment of compensation had been made purely as a result of the bargains between the incoming and outgoing shareholders. The Tribunal accepted the fact that the expenses had been considerably reduced, but held that the payments had been made as a result of the bargain between the sellers and purchasers of the shares and was not in connection with the business of the company. As regards the compensation paid to the managing director, the Tribunal held that the agreement with the managing director was net on record and that it was not in a position to find any separate and individual motive in the termination of the employ ment of the managing director.
15. For these reasons, the claim for deduction of the above sum of Rs. 1,64,899 has been completely rejected. Mr. Palkhivala for the assessee-company has first contended that the expenditure and disbursement of the whole of the above sum of Rs. 1,64,899 was incurred for commercial considerations' and expediency. The purpose of termination of the employment of the managing director, the manager and the 22 employees was to effect economy and to reduce revenue expenditure. In that connection, he emphasised that there was a finding by the lower authorities in favour of the assessee-company that in fact considerable economy was effected and expenses by way of salary were considerably reduced. Towards the fact that the staff was excessive and retrenchment was necessary, he relied upon the fact that no new staff was engaged and only 9 of the old employees of the office establishment were re-employed. His second contention was that the compensation decided to be paid was in pursuance of the practice for payment of gratuity to retiring employees which was in existence. His submission was that by the letter dated July 1, 1959, addressed to the Appellate Assistant Commissioner, all the relevants facts had been furnished by the company. Thereafter, it had not been decided against the company that such a practice of payment of gratuity to retiring employees did not exist. He accordingly submitted that a finding should be made in favour of the assessee-company that it was entitled to deduction in respect of the whole of the above amount of Rs. 1,64,899 as expenditure wholly and exclusively incurred for the purposes of the business of the company. In that connection, his emphatic submission was that the fact that an agreement for sale of the shareholding was made and that it provided for termination of employment of all the employees of the company was irrelevant. The agreement might be a cause and motive for termination of service, but the purpose of the payment and disbursements of the whole of the above amount was towards discharging a liability to pay gratuity in accordance with the prevalent practice of the company and compensation for termination of service of the managing director. The purpose of the payments being to discharge this liability, the existence of and/or intervention of the agreement for sale and the provisions therein in connection with termination of service must be held to be mere motive but can never be held to be the purpose of the payment. In that connection, relying upon the observations of this court in the case of Ormerods (India) Private Ltd. v. Commissioner of Income-tax [1959] 36 I.T.R 329, 335 Bom.. followed in the case of Kevalchand Nemchand Mehta v. Commissioner of Income-tax [1968] 67 I.T.R 504 Bom.., he submitted that clear and specific distinction must be always maintained between motive for doing a thing and the purpose for which it was done. In the first of the above cases expenditure was incurred for purchases of certain shares and deduction was claimed in respect of the price paid as revenue expenditure. Since the shares were purchased in order to oblige two of the directors, the tax authorities had rejected the claim for deduction. A Division Bench of this court set aside the findings of the tax authorities and the Appellate Tribunal and observed that the motive for the purchase of shares was to oblige the two of the directors, but the expense for the purchase was for the purpose of earning dividend and interest on the shares and to acquire the assets by way of shares. The motive and the purpose must be distinguished. It was, therefore, held that the assessee in that case was entitled to have the deduction of this expense as revenue expenditure.
16. In the case of Kevalchand Nemchand Mehta v. Commissioner of Income-tax the assessee had made certain gifts and in that connection borrowed certain amounts and was paying interest. Deduction of interest was disallowed by the Appellate Tribunal, but the court affirmed the observations of the Division Bench in the case of Ormerods (India) Private Ltd. v. Commissioner of Income-tax and once again held that motive must be distinguished from the purpose of the expenditure and allowed the claim for deduction of interest from revenue expenditure.
17. Towards developing these submissions, Mr. Palkhivala submitted that the provisions in clause 6 of the agreement relating to termination of service should be read in the context of the facts, viz., that the purchasers having examined the affairs of the company had decided to effect economy in the administration of the company. The purchasers for the benefit of the commerce of the company had decided to retain in the employment of the company such members of the staff as it thought fit. He stated that the scheme in the agreement for sale which provided that the whole of the expense of compensation should be borne by the shareholders-sellers was irrelevant in this connection and should not make any difference to the contention that the termination of service was for effecting economy and for retrenching surplus staff. When his attention was drawn that 9 of the employees were by the new management retained in employment, he submitted that since under the prevalent practice at the end of the termination of their service they would have in any event received amounts of gratuity, the expenses of gratuity incurred by paying to them diverse amounts at earlier dates should not make any difference to his contention that the payment to these 9 employees of compensation was towards discharging commercial liability of the company.
18. In connection with the sum of Rs. 16,188 paid to Mr. Mathalone, the managing director, in lieu of 6 months' notice period, hiss contention was that, as stated on behalf of the assessee-company in its letter dated July 1, 1959, appointment of Mr. Mathalone as managing director was liable to be terminated by both sides by 6 months' notice in writing. Every time the company desired to terminate his service, the company would be liable to give 6 months' notice and thereupon to pay salary for that period of 6 months. The liability to retain him as managing director could, therefore, in law be terminated and ended immediately by paying to him 6 months' salary in lieu of notice for that period. The fact that his services are not needed by the company was a matter to be decided by the company. The payment of Rs. 16,188 must be held to be wholly and exclusively incurred for the purposes of the business of the company. That must be so, because the payment is in accordance with the term of employment which provided for 6 months' notice for termination of the employment.
19. In connection with the sum of Rs. 21,200 being liability to make payments of monthly pension amounts, he submitted that the liability continued in existence and was a legal liability. The liability had been accepted by the company for a number of years. Such a liability could be ended by commutation, that being a method to completely discharge a liability for all times to come. The expenses for discharge of the liability to pay pensions would always be disbursements for business purposes and wholly and exclusively for that purpose.
20. In support of his arguments, Mr. Palkhivala relied upon the case of Commissioners of Inland Revenue v. Patrick Thomson Ltd., where three subsidiary companies which were all controlled by the Scottish Drapery Corporation were separate assessees. One of the subsidiaries was Patrick Thomson Ltd. Fraser Ltd. purchased the shareholding of Scottish Drapery Ltd. and thus completely controlled the assessee, Patrick Thomson Ltd. A little prior to the purchase made by Fraser Ltd., under an agreement dated August 18, 1952, a managing director was appointed for the management of the affairs of Patrick Thomson Ltd. Fraser Ltd. arranged to terminate the employment as managing director and under an agreement dated December 2, 1952, in connection with the termination of his employment, agreed to pay £3,000. In connection with the question whether the disbursement of £3,000 should be allowed as deduction in calculation of the income taxable, at page 158, it was observed that “the test is not who benefited, but for what purpose the expenditure was incurred”. In connection with the disbursements made for payments to the employees and the manager and the managing director, Mr. Palkhivala submitted that for finding out whether the disbursements were incurred for business purposes, we must not give any importance to the fact of the above agreement for sale.
21. Mr. Joshi for the respondent in reply referred to the provisions in section 10(2)(xv) and submitted that to be entitled to deduction, the assessee-company was bound to prove that each and all items of disbursements aggregating to the above sum of Rs. 1,64,899 were laid out or expended wholly and exclusively for the purpose of the business of the assessee-company. He contended that every item of disbursement was made in this case for the purpose of fulfilment of and carrying out the provisions in the agreement for sale dated March 23, 1956. Termination of service of the employees and the managing director was necessitated for carrying out the obligation undertaken by the sellers in the above agreement for sale. His submission was that having regard to the above fact, expenditure for payment of retrenchment compensation was incurred not for any part of the business of the assessee-company and in any event such expenditure was not wholly and/or exclusively made in connection with the business of the assessee-company. His further contention was that as has been held in the case of Gordon Woodroffe Leather Mfg. Co. v. Commissioner of Income-tax, and in appeal from the decision of the Madras High Court in that case by the Supreme Court, the question in this reference should be decided on the footing that expenditure laid out for payment of gratuity or retrenchment compensation is not in all cases wholly or exclusively for the purposes of business. When such expenses are incurred voluntarily and not with reference to an existing undertaking to pay gratuity and/or compensation for retrenchment, it must be held to be gratuitous payment and/or bounty and, therefore, not with reference to the purpose of business of the assessee concerned. His submission was that in this case the assessee-company has failed to prove that a practice of payment of gratuity to all its retired employees was prevalent in the company's administration. The facts relied upon by the assessee-company, on the contrary, went to prove that in some exceptional cases the company decided to make payments of the above kind without existence of any legal obligation to do so. His further argument was that in the contentions made by Mr. Palkhivala facts not found and inference not warranted by the facts found were assumed to exist. The submission was that there was no evidence and/or finding for the assumption made by Mr. Palkhivala (i) that the staff in the office establishment was surplus and necessary to be retrenched and (ii) that the termination of service was done by way of retrenchment. In that connection, he submitted that though the wage bill of the company had become reduced, that however did not mean that whilst the directors and the company decided to terminate the services they were deciding that there was surplus staff liable to be retrenched or that the number of employees was unnecessary for the office work and/or the business of the company. He submitted that what was of importance was that the action of termination and the decision to pay retrenchment compensation was a direct result of the agreement for sale. In that connection, he repeatedly requested us to look at the provisions in clauses 3 and 6 of the agreement for sale. He emphasised that the contention that the compensation was gratuity was, prima facie, defeated by the fact that the termination of service had not been effected by reason of the employees reaching any superannuation age. No thought was applied to the fact that these employees had reached superannuation age and should be retired. In his submission, this contention was applicable in all respects to the amounts paid to the manager, A.E Joseph, and Mr. Mathalone, the managing director, as also the amount paid by way of commutation of the pension liability to certain retired employees and/or their widows. In connection with his submissions, he relied upon the case of James Snook & Co. Ltd. v. Blasdale (H.M Inspector of Taxes) where, in connection with disbursements made (in pursuance of an agreement for sale of share-holding) for termination of office of the directors who had ceased to be directors, at page 250, the argument was: “the shareholders could not validly authorise the paying away of the company's money in mere implementation of their private bargain”, it was, inter alia, observed:
“But, it is essential in such cases that the company should prove to the Commissioners' satisfaction that it considered the question of payment wholly untrammelled by the terms of the bargain its shareholders had struck with those who were to buy their shares and came to a decision to pay solely in the interests of its trade.”
22. This decision of Donovan J., in the first court, was confirmed by the appeal court. It would be out of place to include in this judgment all the relevant observations made by the appeal court.
23. Now, in connection with these rival contentions, it is useful to reproduce the relevant parts of section 10.
“10. (1)………
(2) Such profits or gains shall be computed after making the following allowances, namely:— …
(xv) any expenditure……. laid out or expended wholly and exclusively for the purpose of such business,….”
24. Having regard to the above provision, in claiming the deduction in respect of the disbursement of the above sum of Rs. 1,64,899, the assessee-company undertook the burden of proving that the expenditure of the above sum was laid out wholly and exclusively for the business of the assessee-company. In that connection, the most relevant fact on which reliance could be placed and has been placed is that in the administration of the company a practice of paying gratuity to retiring employees was prevalent. Now, in connection with the question whether the payments made towards remuneration were of the nature of gratuity, the decision in the case of Gordon Woodroffe Leather Mfg. Co. v. Commissioner of Income-tax is useful. The claim for deduction in that case was in connection with a sum of Rs. 40,000 paid as gratuity to an employee of the managing agent of the assessee-company. The person had been an employee of the assessee from 1935, and its director from 1940. The gratuity was resolved to be paid by the assessee-company in appreciation of his long and valuable services to the company. Upon investigation, it was ascertained that the company had no scheme for the payment of gratuities nor did it pay such gratuities in practice. It was observed that there was nothing to show that the employee had accepted a low salary in expectation of gratuity receivable on retirement or that gratuity was paid for the purpose of facilitating the carrying on of the business of the company or, as a matter of commercial expediency. Having regard to these facts, the Supreme Court observed that the payment was made in recognition of long and faithful service. The payment had not affected in past the quantum of salary that was being received by the employee. In arriving at the test which should apply to cases where claims were made for deductions in respect of payments of the nature of gratuity, the Supreme Court referred to the cases of J.P Hancock v. General Revisionary and Investment Co. Ltd. and J.W Smith v. Incorporated Council of Law Reporting for England and Wales, and observed that in the first case a lump sum had been paid for the purchase for the benefit of a former actuary of the assessee-company of an annuity equal in amount to the pension which the company had resolved to pay him. That amount was held to be an expense admissible by way of deduction, because in that case “it was the practice of the assessee-company to grant pensions to its servants after a considerable period of service and this practice was known to the employees and affected the rate of salary paid by the company in that the employees were willing to serve the company at lower rates than they otherwise would have by reason of the expectation of the pension at the end of their service”. It was observed that in the second case “there was a practice of granting gratuities and that was the ground for holding the amount to be a proper deduction”. The Supreme Court then stated:
“In our opinion the proper test to apply in this case is, was the payment made as a matter of practice which affected the quantum of salary or was there an expectation by the employee of getting a gratuity or was the sum of money expended on the ground of commercial expediency and in order indirectly to facilitate the carrying on of the business.”
25. Having regard to the test applicable in connection with the contentions made by Mr. Palkhivala, what required to be investigated is whether the payments in question were made as a matter of practice which had affected the quantum of salary or whether there was an expectation by the employees (whose employment was terminated) of getting a gratuity or, in the alternative, the above sums were expended on the ground of commercial expediency and in order indirectly to facilitate the carrying on of the business.
26. The attempt of Mr. Palkhivala was to prove that sufficient evidence had been led on behalf of the assessee-company and was on record towards proving the facts relevant to the matters of test mentioned above. But in this case Mr. Palkhivala has in his arguments specifically admitted that there was no legally enforceable liability against the assessee-company for payment of gratuity to any of its employees. The only evidence on which reliance has been placed in this connection is to be found in the following contents of the letter dated July 1, 1959, addressed on behalf of the assessee-company by its secretary to the Appellate Assistant Commissioner:
“In connection with the compensation paid in the past, viz., in 1946, 1951 and 1952, we have been able to trace in two cases that it was paid on the basis of one month's basic salary for each year of service.” Whilst reciting facts, we have already quoted the particulars submitted at the end of this letter in respect of payments made between 1946 and 1952 to 8 employees as gratuity. It is not clear from the above contents of the letter dated July 1, 1959, as to whether only 8 employees of the company had retired between 1946 and 1956 being the relevant assessment year. The basis for ascertaining the amount paid as gratuity is also not clear. The only thing clear is that gratuity was paid to 8 retired employees. In respect of two of them only it was fixed on the basis of one month's basic salary for each year of service. That these 8 retired employees had expected payment of gratuity and had for that reason continued in employment at reduced remuneration of salary is also not clear. The list of the 22 employees whose services were terminated as from March 31, 1956, appears in the resolution of the extraordinary general meeting dated January 25, 1956. Except about 5 of these employees, the rest of them were in service for long periods varying between 54 to 13 years. Having regard to the fact that the particulars furnished go to show payment of gratuity for the first time in 1946, we find it difficult to imagine that the employees who had been in service for a considerable number of years had joined service at a reduced amount of salary in the expectation that they were bound to get amounts of gratuity at the date of retirement. On the contrary, it would not be difficult to hold that those of the employees who joined service before 1946, i.e (had been in service for more than 10 years before the relevant assessment year 1956) joined service at normal ordinary salaries which they were able to earn without any expectation that on retirement they would be paid a gratuity. In the resolutions the payments to be made are described as “retrenchment compensation” and not gratuity. The amounts mentioned have been arrived at to the extent of Rs. 1,04,626 by multiplying basic monthly salary with the years of service. To the amounts ascertained in the above manner, without mentioning any reasons, 20 per cent. further amount is added and the aggregate as arrived at above is fixed as retrenchment compensation. In connection with 14 of those 22 employees, an additional amount of Rs. 6,000 is also resolved to be paid as additional retrenchment compensation. It first requires to be noticed that the amounts resolved to be paid are described as retrenchment compensation. Apparently, this is the result of the fact that the company was aware that in its administration there was no prevalent scheme for payment of gratuity. The company was aware that it was not possible to claim for payment of gratuity. The contents of the above resolutions and the manner in which the retrenchment compensation was fixed show that a practice of paying gratuity was not prevalent in the assessee-company. That between 1946 and 1956, 8 of the retired employees received some amounts by way of gratuity on no fixed basis does not go to prove the case made out by Mr. Palkhivala. In our view, it has not been established that in the administration of the assessee-company a practice of payment of gratuity was prevalent. It has accordingly not been established that any of the 22 retired employees or manager, A.E Joseph accepted reduced salary in the expectation that at the date of their retirement the company would pay to them gratuity in accordance with prevalent practice or at all. The first two tests mentioned in the judgment of the Supreme Court are thus not satisfied.
27. The further question having regard to the tests mentioned by the Supreme Court is whether the above sum of Rs. 1,54,899 was money expended on the ground of commercial expediency and in order indirectly to facilitate the carrying on of the business. Now, in this connection, it requires to be recorded that strong reliance has been placed by Mr. Joshi on the concession made by Mr. Palkhivala that motive [for these expenses was the agreement for sale of the shareholding and transfer of the management of the company by the original holders of shares to Tata Sons Ltd. That this agreement provided in its clause 6 for termination of services of all employees is not in dispute. It is not in dispute that in fact, as shown by the particulars in the last part of the letter dated July 1, 1959, to the Appellate Assistant Commissioner, the yearly wage bill of the company for salaries was reduced from Rs. 1,14,197 in 1955 to Rs. 67,268 in 1956 and thereafter in 1957 and 1958 respectively to Rs. 54,124 and Rs. 54, 960. It is also not in dispute that though services of 22 employees of the office establishment were terminated, 9 of the employees were re-employed immediately as from April 1, 1956. It has been rightly submitted by Mr. Joshi that the termination of employment of all the employees was such that on April 1, 1956, the office establishment would not have functioned at all. It is also not disputed that under the scheme of the agreement for sale the price of rupees 155 lakhs was net price and the new shareholders were not to bear the liability of the amounts of retrenchment compensation resolved to be paid by the company to the 22 employees as well as to the manager and the managing director. Mr. Palkhivala insists that the fact that the wage bill was reduced goes to show that the termination of the employment had been made for commercial considerations and expediency. Now, in this connection, Mr. Joshi is right that facts have not been proved to show that whilst the resolutions for termination of service and payment of compensation were made by the board of directors in the first instance and by the extraordinary general meeting of the company thereafter, any question of there being surplus staff was considered. It is quite clear that the resolutions do not discuss and/or mention that the staff was surplus or that the work was so less that the staff was required to be retrenched. It is also clear on a reading of the agreement for sale that the purchasers, Tata Sons Ltd., had by the provisions in clause 6 of the agreement for sale and other similar clauses provided for the carrying on of the business of the company from April 1, 1956, by the employees of its own choice in the office establishment and in accordance with such policies of administration as they thought fit. Though the fact that wage bill became reduced is true, it has not been proved to our satisfaction that retrenchment compensation was decided for the reason that the company ascertained that the staff was surplus and was liable to be retrenched. If the company had applied its mind to such facts, apparently, services of all employees of the office establishment would not have been terminated. Nine or more or less number of employees would have been fixed as necessary for the further carrying on of the business of the company. Notices of termination would have been served on the employees as were, having regard to the quantum of the work, ascertained to be surplus. It is quite clear that the amounts resolved to be paid to the 22 employees and the manager, A.E Joseph, were in respect of retrenchment of their services without considering any factors like their having arrived at a retirement date and being for that reason entitled to payment of gratuity. Consideration of reduction of the wage bill was foreign to the decisions made by the company to terminate the services of these employees and to pay them retrenchment compensation. It requires to be emphasised at this stage that the amounts fixed were in the view of the company itself retrenchment compensation to be paid on the footing that for all purposes and for all times to come all these employees were not required for the business of the company. Mr. Joshi is, therefore, right that the second assumption in the arguments advanced by Mr. Palkhivala, viz., that the retrenchment was effected to reduce staff and to effect economy is not justified on the evidence that is on record.
28. Mr. Palkhivala, however, argues that what we have emphasised above is the aspect of motive and the purpose of payment was to remunerate the employees and accordingly to discharge business liability. It is quite true that as has been held in the cases of Ormerods (India) Private Ltd. v. Commissioner of Income-tax and Kevalchand Nemchand Mehta v. Commissioner of Income-tax, referred to above, the motive for which a transaction may be made by an assessee is not relevant in connection with the claims for deduction to be allowed under clause (xv) of sub-section (2) of section 10. The purpose of the expenditure must always be, therefore, borne in mind in deciding the question of deduction claimed. The question is, “what was the purpose in terminating the services of 9 employees who admittedly were re-employed from April 1, 1956”. If they were not re-employed, the company's wage bill would have been possibly nil. But this situation as regards the number of employees necessary for the further carrying on of the business of the assessee-company was never considered when the matter of payment of retrenchment compensation was decided by the company. The purpose of the payment, so far as can be ascertained from the contents of resolutions of the board of directors and the company when read with the relevant contents of the agreement for sale, was carrying out of the obligations arising under the agreement for sale. Though there was neither legal nor commercial liability against the company to make any payment whatsoever as gratuity, diverse amounts were fixed to be paid to the 22 employees and the manager, A.E Joseph. It is not possible to fix as to how many months' notice was necessary to be given to these employees and manager for termination of their services. Apparently, the services could be terminated by due notices. It is difficult to hold that employees whose services could be terminated by due notices of particular periods were entitled to payment of retrenchment compensation. In those circumstances, it is difficult to accept the submissions made by Mr. Palkhivala and hold that the disbursements and/or the expenditure of the diverse amounts of the retrenchment compensation paid to these employees was made for commercial expediency and/or commercial considerations and/or for the benefit of the business of the company. That in fact the expenses became reduced is insufficient to make a finding that amounts of retrenchment compensation were paid for commercial considerations and expediency.
29. Mr. Palkhivala is right in his submission that the sum of Rs. 21,200 which was commutation of liability for payment of pension is an amount disbursed towards the company's already existing liability. It is not possible to accept Mr. Joshi's contention that this disbursement was not made towards discharge of the already existing liability.
30. Similarly, Mr. Palkhivala is right that, since the appointment of Mr. Mathalone, managing director, was under the contract with him liable to be terminated by 6 months' notice, the sum of Rs. 16,188 paid to him in lieu of 6 months' notice must be held to be paid towards discharge of the already existing liability. This liability is the result of provision in the contract of appointment of R. Mathalone as managing director. If he had continued to work as managing director, the very same amount would have been expended towards his salary. It is impossible to hold that this amount which is expended towards discharge of a legal liability is not made wholly and exclusively for the purpose of business of the company. In the result, except as regards the above two items of Rs. 21,200 and Rs. 16,188, we confirm the finding made by the Appellate Tribunal that the rest of the disbursements have not been made wholly or exclusively for the purposes of business of the company. These are, in any event, not disbursements for which any deduction can be allowed under section 10 of the Act.
31. Our answers to the question accordingly are:
Question No. 1 in the negative but only in respect of the amount aggregating to Rs. 1,27,511 (excluding the two items of Rs. 21,200 and Rs. 16,188). Question No. 2 in the affirmative but only in respect of the amount aggregating to Rs. 1,27,511 (excluding the two items of Rs. 21,200 and Rs. 16,188). Question No. 3 in the affirmative.
32. The fair order for costs under the circumstances discussed above is that each party will bear and pay its own costs.
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