M.K Srinivasa Iyengar, J.:— The Income-tax Appellate Tribunal, Bangalore Bench, has referred the following question of law for the opinion of this court:

“Whether, on the facts and in the circumstances of the case, the Tribunal was right in disallowing Rs. 12,000 out of the remuneration of Rs. 72,000 paid to the managing director of the assessee-company?”

2. The matter relates to the assessment of M/s. International Instruments (P.) Ltd., Bangalore, for the assessment year 1972-73. N. Krishnan was the managing director of the company. The articles of association provided that he shall be the managing director of the company for a period of 10 years from the time of incorporation of the company and thereafter for such period or periods as the directors may from time to time determine. This was provided under art. 35 of the articles of association. Article 37 provided that the remuneration of the managing director shall be fixed by the board of directors from time to time.

3. It transpires that an agreement had been entered into in regard to the remuneration on December 9, 1960, and the period of the agreement expired on August 18, 1968. The board of directors passed a resolution on. August 12, 1968, appointing N. Krishnan as the managing director of the company for a period of five years from August 19, 1968, and, thereafter, an agreement was entered into setting out the terms and conditions of his appointment for the period commencing from August 19, 1968, to August 18, 1973. The board of directors again passed another resolution on February 13, 1971, revising the terms of the remuneration to be effective from January 1, 1971, and an agreement was entered into detailing the terms agreed upon which would be effective till August 18, 1973. He was to be paid a monthly remuneration of Rs. 6,000 plus certain perquisites, viz. (1) actual medical benefits at the expense of the company including hospitalisation for Mr. N. Krishnan and his family; (2) personal accident policy covering Mr. N. Krishnan for a sum of Rs. 2 lakhs, and (3) gratuity benefit as applicable to the executives of the company from time to time.

4. During the year ending December 31, 1971, the relevant assessment year being 1972-73, the company paid Sri N. Krishnan Rs. 72,000 by way of remuneration and certain other perquisites, viz., Rs. 501 as personal accident premium and Rs. 614 as medical allowance. The ITO being of the opinion that s. 40A(5)(a) of the I.T Act, 1961 (hereinafter referred to as “the Act”), applied to the facts of the case, disallowed a sum of Rs. 12,000 from out of the remuneration of Rs. 72,000 paid to Sri N. Krishnan. There were also certain other disallowances which are not relevant for the purposes of this case.

5. The assessee preferred an appeal to the AAC contending, inter alia, that the disallowance of Rs. 12,000 was untenable in the light of the first proviso to s. 40A(5)(a). The AAC accepted that contention and set aside the disallowance. However, the department preferred an appeal before the Tribunal and the Tribunal came to the conclusion that the AAC was in error and restored the disallowance made by the ITO. At the instance of the assessee, this reference has been made.

6. The relevant provisions of ss. 40(c) and 40A(5)(a) of the Act are as follows:

“40. Amounts not deductible.— Notwithstanding anything to the contrary in sections 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:

(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,

(ii) any expenditure or allowance in respect of any assets of the company used by any person referred to in sub-clause (i) either wholly or partly for his own purposes or benefit,

if in the opinion of the Income-tax Officer any such expenditure or allowance as is mentioned in sub-clauses (i) and (ii) is excessive or unreasonable having regard to the legitimate business needs of the company and the benefit derived by or accruing to it therefrom, so, however, that the deduction in respect of the aggregate of such expenditure and allowance in respect of any one person referred to in sub-clause (i) shall, in no case, exceed—

(A) where such expenditure or allowance relates to a period exceeding eleven months comprised in the previous year, the amount of seventytwo thousand rupees;

(B) where such expenditure or allowance relates to a period not exceeding eleven months comprised in the previous ‘year, an amount calculated at the rate of six thousand rupees for each month or part thereof comprised in that period:

Provided that in a case where such person is also an employee of the company for any period comprised in the previous year, expenditure of the nature referred to in clauses (i), (ii), (iii) and (iv) of the second proviso to clause (a) of sub-section (5) of section 40A shall not be taken into account for the purposes of sub-clause (A) or sub-clause (B), as the case may be.

Explanation.— The provisions of this clause shall apply notwithstanding that any amount not to be allowed under this clause is included in the total income of any person referred to in sub-clause (i);

“40A. Expenses or payments not deductible in certain circumstances.— (1) The provisions of this section shall have effect notwithstanding anything to the contrary contained in any other provision of this Act relating to the computation of income under the head ‘Profits and gains of business or profession’….

(5)(a) Where the assessee—

(i) incurs any expenditure which results directly or indirectly in the payment of any salary to an employee or a former employee, or

(ii) incurs any expenditure which results directly or indirectly in the provision of any perquisite (whether convertible into money or not) to an employee or incurs directly or indirectly any expenditure or is entitled to any allowance in respect of any assets of the assessee used by an employee either wholly or partly for his own purposes or benefit,

then, subject to the, provisions of clause (b), so much of such expenditure or allowance as is in excess of the limit specified in respect thereof in clause (c) shall not be allowed as a deduction:

Provided that where the assessee is a company, so much of the aggregate of—

(a) the expenditure and allowance referred to in sub-clauses (i) and (ii) of this clause; and

(b) the expenditure and allowance referred to in sub-clauses (i) and (ii) of clause (c) of section 40,

in respect of an employee or a former employee, being a director or a person who has a substantial interest in the company or a relative of the director or of such person, as is in excess of the sum of seventy-two thousand rupees, shall in no case be allowed as a deduction.”.

7. The view of the Tribunal is summed up in para. 14 of its order which reads as follows:

“From a reading of the proviso to section 40A(5) it appears that before the proviso is made applicable, it is not enough that a company is the assessee. Another ingredient must also be satisfied, i.e, there must have been a disallowance or allowance under Section 40(c). The proviso deals with the aggregation of the disallowance under two different sections and it will not come into play unless there is a case for aggregation. It would-be, therefore, possible to say that the proviso would be applicable only to the case of an employee who, for part of the year, was a director or a person, having substantial interest in the company and for another part of the year was an employee. Only then both the sections would be considered and there would be an aggregation of the allowances or disallowances. We, therefore, come to the conclusion that the proviso will not apply to a case, where the person concerned is throughout the year an employee or throughout the year a director. The proviso will not be applicable in the assessee-company's case since the managing director has been an employee throughout the year and he had not received any remuneration other than what has been allowed to him as salary. Section 40(c) has not at all been involved to disallow or allow any payments made. Since the proviso is not applicable, the independent ceilings fixed for salary and perquisites operate and the salary allowable will be only Rs. 60,000. The Income-tax Officer would be justified in disallowing the excess over this figure.”

8. The contention on behalf of the assessee was that only the provisions of s. 40(c) were applicable and not the provisions of s. 40A(5)(a) of the Act on the ground that Mr. N. Krishnan, managing director of the company, cannot be considered as an employee of the company. Alternatively, it was maintained that even under the provisions of s. 40A(5)(a) of the Act, by virtue of the first proviso thereto, the disallowance of Rs. 12,000 was untenable and only any amount in excess of Rs. 72,000 could be disallowed. The Tribunal was of the view that s. 40(c) was not attracted and on the view it took of the effect of the provisions of s. 40A(5)(a), it held that the disallowance was correct.

9. In our opinion, the view taken by the. Tribunal is unsupportable having regard to the effect of s. 40A(5)(a) read with the proviso. The view of the Tribunal that there must have been a disallowance under s. 40(c) on the ground that the employee was, for part of the year, a director and for another part of the year only an employee and the proviso could be applied only when the provisions of both ss. 40(c) and 40A(5)(a) were to be considered, is not warranted by the provisions. First proviso to s. 40A(5)(a) refers to expenditure incurred in respect of an employee or a former employee, being a director or a person who has a substantial interest in the company or a relative of the director or of such person. It does not, - like proviso to s. 40(c), speak of the period for which he was a director. Hence, it applies to an employee being a director during the whole year.

10. The question whether the managing director is an employee is a debatable one and would have to he determined having regard to the provisions in the articles of association and any other contract entered into between the company and him. It is, however, unnecessary in the instant case to decide the question whether the Tribunal was right in holding that Mr. N. Krishnan was an employee, of the eompany as the said question has not been specifically referred for the opinion of this court. We proceed on the assumption that he was an employee and also a director of the company. That he was a director is clear from the articles of association which has been marked as annex. “B”. Whether having regard to the provisions therein and the terms of the agreement, annex. “A”, his position vis-a-vis was only that of a managing director and not an employee is left open. It is, however, significant to note that the question referred speaks of the managing director of the assessee-company and his remuneration and not an employee or salary as such. As stated earlier we proceed on the basis that he was an employee and a director as has been held by the Tribunal. Even so, the first proviso to s. 40A(5)(a) is clear. The relevant provision, though in the form of a proviso, is a special provision where the assessee is a company and where, inter alia, the person concerned is an employee being a director of the company. What-is provided is regarding the aggregate expenditure or allowance referred to in sub-cls. (i) and (ii) of s. 40A(5)(a) and the expenditure and allowance referred to in sub-cls. (i) and (ii) of s. 40(c) incurred in respect of an employee being a director, and that the excess over Rs. 72,000 cannot be allowed as a deduction. Therefore, the maximum amount that could have been allowed as a deduction is Rs. 72,000 and there could not be a deduction out of that amount. Accordingly, disallowance made in a sum of Rs. 12,000 was unwarranted. Therefore, the question is answered in the negative: that the Tribunal was not right in disallowing Rs. 12,000 out of the remuneration of Rs. 72,000 paid to the managing director of the assessee-company.