The Judgment of the Court was delivered by

Bimal Chandra Basak, J.:— The question of law arising in this reference under s. 256(1) of the I.T Act, 1961 (hereinafter referred to as “the Act”), is as follows:

“Whether, on the facts and in the circumstances of the case, the Tribunal was correct in holding that the managing director's remuneration allowable for the assessment year 1970–71 was only Rs. 1,200 per month?”

2. The facts of this case as admitted and not disputed are as follows:

For the assessment year 1970–71, the assessee-company claimed the managing director's remuneration at the rate of Rs. 2,000 per month, apart from provident fund contribution and commission on sales. The ITO by his order of assessment dated 26th March, 1973, allowed the provident fund contribution and commission on sales. He, however, restricted the allowable salary to Rs. 1,000 per month and gave a deduction of Rs. 12,000 as against Rs. 24,000 as claimed by the assessee. In doing so he relied on the order of the AAC in respect of the assessment year 1969–70. The balance of Rs. 12,000 was disallowed “as being excessive and not dictated by the business needs of the company”.

3. Being aggrieved by the same the assessee preferred an appeal. The AAC by his order dated 20th November, 1972, has merely stated that the matter has been decided by the Tribunal and following the order of the Tribunal the ITO was directed to allow the salary at Rs. 1,200 per month and provident fund equal to one month's salary, i.e, Rs. 1,200 (relief Rs. 2,600). This decision of the Tribunal was in respect of the earlier year. The assessee preferred an appeal before the Tribunal. Nobody appeared on behalf of the assessee at the time of the hearing of the appeal. The Tribunal passed the following order:

“The AAC has merely directed this issue in accordance with the Tribunal's order and directed the allowance of the salary at Rs. 1,200 per month and contribution of one month's salary to the provident fund, i.e, equal to Rs. 1,200. The departmental representative relied on the findings of the AAC and we see no reason to take a view different from the AAC on the facts of the case. The addition made on this point is sustained. Against the same this reference has been made.”

4. Mr. Sanjoy Bhattacharyya, the learned counsel appearing on behalf of the assessee, has submitted that the Tribunal has proceeded wrongly in this matter. He has further submitted that the scope and power of the ITO in this context was considered by a Division Bench of this court in the case of Cit, West Bengal v. Edward Keventer (P) Ltd. , [1972] 86 ITR 370 (Cal). He has submitted that this decision has examined the scope of the power and the duties of the ITO in respect of disallowing a claim for deduction. He has submitted that in the facts of this case the ITO has not properly exercised his jurisdiction and power. The ITO has merely relied on the AAC's order for the earlier year. Though the ITO has stated “in this order keeping in mind the trading results of the year”, it is not known what is meant by that because it appears from the order itself that the sales have been increased by Rs. 12,000 over the last year. He has submitted that each year's assessment is separate from the other and that an order in respect of the earlier year may be relevant, but the ITO cannot and should not automatically follow the order made in respect of the earlier year. He should apply his mind independently in respect of every year. He is not to act arbitrarily. He is to act objectively which he has failed to do in the present case.

5. Mr. Naha, learned counsel appearing on behalf of the revenue, has made the following submission:

Regarding the decision in Edward Keventer's case, [1972] 86 ITR 370 (Cal), he has made it clear that the position in law has been now well settled by the said decision. However, he submits that in the present case if these principles are applied we must hold that the ITO and the Tribunal have acted correctly. He has submitted that in respect of the earlier assessment year a particular deduction was allowed. The ITO acted properly in following the same in respect of the assessment year in question because there was not much difference in that year. If the position remained practically the same, in that event the ITO was justified in holding that the remuneration paid extra to that of the earlier year was unreasonable or excessive. There was practically no difference in respect of the year under assessment because the extra sales of Rs. 12,000 in the year under reference makes no practical difference at all. He has further submitted that it has been held by the Supreme Court in the case of Nund & Samont Co. (P.) Ltd. v. CIT, [1970] 78 ITR 268, that in respect of an enquiry under s. 10(4A) of the Indian I.T Act, 1922, into the excessiveness or unreasonableness of an allowance resulting in the provision of any remuneration or benefit or amenity to a director or a person who has a substantial interest in the assessee-company, it is for the taxpayer to establish by evidence that the particular allowance is justifiable. If the taxpayer does not produce any evidence in respect of the claim for allowance, the ITO is not bound independently to collect evidence and decide that the allowance claimed is excessive or unreasonable having regard to the legitimate business needs of the assessee-company before the power under s. 10(4A) may be exercised. Mr. Naha has submitted that in this particular case the assessee did not produce any material, on the other hand, it did not appear at all before the Tribunal. In that view of the matter, the ITO and the Tribunal acted properly and within the scope of their duties and jurisdiction.

6. The scope and effect of the power of an ITO in disallowing a claim in such a case on the ground of its being excessive or unreasonable is now well settled by a decision of this court in the case of Cit, West Bengal v. Edward Keventer (P) Ltd. , [1972] 86 ITR 370 (Cal). In that case Mr. Justice A.N Sen, delivering the judgment of the Division Bench, held as follows (pp. 380, 381):

“Section 10(4A) casts a duty and confers the power on the ITO not to allow any deduction in respect of any remuneration or benefit or amenity to any director or any person who has a substantial interest in the company, as contemplated in the said section, if the ITO is of the opinion that any such allowance is excessive or unreasonable, having regard to the legitimate business needs of the company and the benefit derived by or accruing to it therefrom. It is to be noted, as the section itself expressly mentions, that this power can be exercised by the ITO, in the matter of computation of the profits and gains of the company, notwithstanding the provisions contained in s. 10(2), which must necessarily include s. 10(2)(xv). This section contains a substantive provision and is not merely clarificatory in nature. This section clearly contemplates that even if the requirements of s. 10(2) including the necessary requirements u/s. 10(2)(xv) are satisfied, the ITO is enjoined not to make any allowance in respect of any expenditure which may come within the mischief of s. 10(4A). In other words, even if the qualitative characteristics of s. 10(2)(xv) justify any item of expenditure as wholly and exclusively laid out for the business of the company, the Income-tax Officer is enjoined and empowered to consider the reasonableness or otherwise of the quantum or the amount expended on the item, if the item of expenditure comes within the purview of s. 10(4A) and the ITO is not to allow the entire amount so spent, if the provisions of s. 10(4A) are attracted and the sum spent comes within the mischief of the said provisions. The ITO must, however, consider the entire position dispassionately and objectively and from the view-point of a prudent businessman. The ITO must appreciate that s. 10(4A) is not to be applied capriciously as a matter of routine and he must realise that the said section is to be applied judiciously and can only be applied, if the necessary conditions of the said section are satisfied. The opinion of the ITO as to the reasonableness or otherwise of the amount spent must not be arbitrary and is not to be the subjective and prejudiced opinion of an officer interested in collecting more revenue. The opinion as to the reasonableness or otherwise of the amount spent must be formed, having regard to the legitimate business needs of the company and the benefit derived by the company or accruing to the company from the said sum expended. The said s. 10(4A) itself, while conferring the necessary powers on the ITO, places two limitations in the matter of exercise of the power, and the said sections enjoin the ITO to take into consideration in exercising the power: (1) the legitimate business needs of the company, and (2) the benefit derived by or accruing to the company in forming any opinion as to the reasonableness or otherwise of the amount spent. The legitimate business needs of the company must be judged from the view-point of the company itself and must be viewed from the point of view of a prudent businessman. It is not for the ITO to dictate what the business needs of the company should be and he is only to judge the legitimacy of the business needs of the company from the point of view of a prudent businessman. The benefit derived or accruing to the company must also be considered from the angle of a prudent businessman. The term ‘benefit’ to a company in relation to its business, it must be remembered, has a very wide connotation and may not necessarily be capable of being accurately measured in terms of pound, shillings and pence in all cases. Both these aspects have to be considered judiciously and dispassionately without any bias of any kind from the viewpoint of a reasonable and honest person in business.”

7. We may point out that this decision has been affirmed in appeal by the Supreme Court which is reported as Cit, West Bengal v. Edward Keventer (P) Ltd. , [1978] 115 ITR 149 wherein their Lordships of the Supreme Court have expressed their approval of the reasonings of the judgment of the Calcutta High Court.

8. Applying this principle to the facts of the case we must come to the conclusion that the ITO did not perform his duties as he was bound to do. In our opinion, he has not considered the entire position dispassionately and objectively and from the view-point of a prudent businessman. He has acted in a routine manner and not judiciously. He has acted in an arbitrary fashion. He has merely and automatically followed the decision of the AAC in respect of the previous assessment year. Each assessment year is to be treated separately. There is no waiver or estoppel or res judicata in respect of the same. A claim for deduction is to be disallowed wholly or partially on the grounds that it is unreasonable or excessive. The ITO has to apply his mind properly. It is not open to him to follow an earlier order in respect of an earlier assessment year automatically and without the application of an independent mind. The earlier order might have some bearing or relevance but that does not conclude the matter. Merely because of a decision in respect of the earlier year, the ITO should not automatically follow the same. We are unable to accept the contention of Mr. Naha that there was no change from the earlier year. The ITO in his order himself noted that there has been a change by way of increase in sales. Moreover, whether there is any practical change in the year or not, as sought to be argued on behalf of the Revenue now, was not considered in that aspect either by the ITO or the AAC or the Tribunal. It appears to us that the authorities concerned have acted automatically and have followed the order of the earlier year without applying their mind objectively or judiciously as they are bound to do under the Act.

9. Nund & Samont's case, [1970] 78 ITR 268 (SC) is of no relevance to Mr. Naha. The facts are different. It is not a question of burden of proof but it is the question of the duty of the ITO. In that view of the matter, we accept the contention of Mr. Bhattacharyya. We answer the question in the negative and in favour of the assessee. In our opinion, on the facts and in the circumstances of the case, the Tribunal was not correct in holding that the managing director's remuneration allowable for the assessment year 1970–71 was only Rs. 1,200 per month. There will be no order as to costs.

Dipak Kumar Sen, J.:— I agree.